Related link: http://www.oreillynet.com/pub/wlg/8788
Part 1 of this series is here, Part 3 is here.
In Part 1 we looked at the revenues and costs of a moderately successful indie album release, and saw how hard it is for a record company to make money selling CDs. The promise of digital downloading is that it offers dramatically more efficient distribution. But a look at a comparison scenario using iTunes shows that the label may end up worse off.
In our first scenario, the label lost $11,600 (before overhead) on sales of 30,000 CDs, based on a low end mainstream marketing budget. For an indie, 30,000 units sold is an achievement. But it would still need to sell a few more thousand to break even, and wouldn't earn serious money unless it had a hit (especially since more marketing will be required to drive more sales). Alternative indies make do with lower marketing budgets, and try to compensate with heavy touring and other tactics.
Now we'll run a comparable project through iTunes. My numbers here are based in part on an article at musicbizacademy.com by entertainment lawyer Diana LaPolt:
iTunes Scenario: Label's Gross Revenues Per Album1
| Wholesale Price2 | 6.44 |
| Recording | (0.33) |
| Mechanical royalties | (1.02) |
| Artist royalties3 | (1.00) |
| Producer royalties3 | (0.25) |
| Postage | (0.00) |
| Distribution Fee | (0.00) |
| Positioning Fee | (0.00) |
| Manufacturing | (0.00) |
| Returns postage | (0.00) |
| Refurbishing | (0.00) |
| GROSS REVENUES | $3.83 |
Wow, looking good so far! The label makes $3.83 per album as opposed to $2.95, even with a wholesale price of $6.44 instead of $9.50. It looks like we're seeing the magic of zeroing out all the manufacturing, shipping and handling associated with physical product (and last I heard, Apple doesn't charge for favorable positioning).
Now let's factor in the marketing expenses (radio promotion, publicity, advertising, etc) and estimate the take from sales of 30,000 albums--with, of course, no returns:
iTunes: Label's Net Revenues, 30,000 Albums Sold
| Sales revenue | 114,805.00 |
| Promotion, etc | (100,000.00) |
| NET | $14,805.00 |
A profit! $14,805 to put towards rent and salaries.
Except... There's a new factor with downloading: Digital delivery unbundles the album format, allowing the purchaser to buy only the songs he or she wants. How often do people buy an entire album on iTunes? I don't know, but on average they buy some fraction of total number of the songs.
Let's see what happens if our 12-song album sells an average of six songs to each customer, which actually seems optimistic to me, at 64 cents wholesale (based on iTunes' 99 cent/song retail price):
iTunes: Label's Net Revenues, Avg. Customer Buys 6 Songs1
| Sales revenue | 72,943.00 |
| Promotion, etc | (100,000.00) |
| NET | ($27,057.00) |
Oh oh.
This is why record companies want you to buy albums. From the consumer's point of view, it stinks to buy a whole album if you only end up liking a few songs. But from the label's point of view, selling singles is a lousy business.
And of course it gets worse if people buy fewer songs from the album. At an average of three songs per album, the label loses $72,022. At one song, they lose $87,843.
Again, they will make a profit on a hit, but labels have similar up-front investments for dogs and for hits. The rule of thumb in the traditional record industry is that you're doing well if one out of ten of your artists sells enough to pay for the other nine who lose you money. You can see why artists' royalty rates work out to be roughly 10 cents on the dollar--the other 90 cents is paying for the other nine albums.
From the artist's point of view: Your advance is recouped at the royalty rate. So if your record earns $1,000, your debt to the label goes down by only $100. It's kind of an owing-your-soul-to-the-company-store thing. Producer Steve Albini runs those numbers in "The Problem With Music" at negativland.com. See also Moses Avalon's Confessions Of A Record Producer.
1. After a challenge from teejay (see below) I've corrected some of these figures.
2. A typical album retails for $9.90 on iTunes, a single is 99 cents, and Apple takes 35%.
3. Artist and producer royalties are based on 130% of the wholesale price. As in the CD scenario, I'm assuming a 12% royalty for the artist and 3% for the producer.
Next time: According to the Long Tail hypothesis, good filters are critical to making downloading work as a business. We'll look at the value those filters will have to add.
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Product vs. service
Thanks for the interesting points. I sure hope these sorts of things lead to new business models, and although I'm not clear yet on how they'll work, I don't believe they can't work. If the past is a guide something probably will work sooner or later - the demand for music is not likely to go away, and musicians will probably have to be paid, or at least some of them, anyway.
Regarding the impact of digitization on production, one concern I have currently is that while the good news for artists is that it makes it easier and cheaper to create product, that is also the bad news: the resulting flood of content drives the average value down.
Related cases:
Digital tools made audio production and audio-for-film & video production faster and cheaper. That allowed more people to enter those markets, but also drove down the rates anyone was able to charge, while driving up the amount of work they were expected to accomplish in a given period of time.
Similarly, in music for film, TV & games, the huge supply of inexpensively made master recordings by hungry musicians has been driving down the rates for licensed music to the point where (unless you're talking about music by a hit artist) it may hardly be worth the time it takes to talk about licensing a piece of music (let alone creating it), since the fee will likely be a few hundred dollars. As with indie records, it looks to me like the people making money licensing music are the aggregators of this increasingly cheap content, not (in most cases) the creators. And even with aggregators you're looking at a commodity business that requires large scale and a lot of automation in order to be very profitable.
I don't think these are problems are insoluble, but I think they're going to take some work, including a lot of experimentation.
Product vs. service
I think it's important to consider what digitalization means not only for distribution but also for the production process. You are ably arguing albums vs. singles. However, both concepts rely on music as a static product.
Maybe exclusively centering around albums and singles is a thing of the past, when music and other digital content was tethered to a physical medium such as a CD or tape.
An interesting experiment is the e-label by Warner Music "in which artists will release music in clusters of three songs every few months rather than a CD every few years" (Cf. http://news.com.com/2102-1027_3-5841355.html?tag=st.util.print).
Don't you think that this could fundamentally change the algebra? I think artists' increased and constant activity could prompt consumers to buy more songs. And artists are probably challenged do deliver higher-quality content - after all, they can't hide "weak" songs on albums and get that revenue anyway.
Music can also be an on-top service. For example, game developer Electronic Arts has established an own label which is to release popular game music. Again, in this case there are neither albums nor singles.
oops - looks like you skewed the figures there
I said :
"In your calculations you neglected to consider that the number of people who will be at least 1 single is greater than the number of people who will buy an album."
You said :
"That seems quite possible, especially if marketing changes to be focused on selling singles rather than albums."
Quite Possible? Please!
It is a basic law of economics! Cheaper smaller stuff sells to more customers than bigger expensive stuff.. this is pretty basic to any business from selling lemonade to PC's.
"In my scenarios I assumed that interest in an album marketed at this level would be roughly equal to interest in the single(s) from that album, since most marketing is currently focused on selling albums, not singles."
Marketing is not directly related to sales - price and availability inevitably are. This is key. Why do you think you can buy pizza by the slice and ice cream by the scoop?
"Also, the explosion of content made possible by the lowered cost of entry seems likely to dilute the market for any individual single. So even if more people are willing to buy a 99 cent single than a $9.90 album, it might still be hard to make good money."
Yes - this is better for the Indies who can play on a more level playing field than traditionally - particularly as filesharing and internet radio allows people to try before they buy.
Market forces will dictate that those who can manage their cash flow and provide a supply of good music will benefit, those who can't will suffer. This is a good thing. If you can't manage your cashflow and produce decent music then the world is better off when you go back to work on the till at HMV.
Small Independents
Interesting points. I agree that indies have to focus more on live performance and other alternatives, and I hope the increased flexibility of digital ends up enabling a more indie-friendly environment, which I think may come about as people figure out how to adapt business models. The resale of contracts is something I hadn't given much attention to. Thanks!
oops - looks like you skewed the figures there
I checked my calculations again and did find a couple of errors, but I don't think they affect my argument.
The mistakes: I realized that just prorating the album price for single sales is inaccurate, since albums sell for $9.90 and songs are $0.99 each. And although I wrote that artist & producer royalties are calculated on 130% of the wholesale price, somehow I entered 140% in my spreadsheet, which incorrectly added 10 cents per album to the label's costs. I've fixed the relevant numbers in the post.
In response to your points:
You said: Traditionally you pay more per track for a single than an album, there is no reason for this to be different when selling mp3's online.
The price for MP3 singles is already well established: It's 99 cents on iTunes (by far the dominant service), lower on most competing services. 99 cents per song compared to $9.90 per album is not a very large premium, unless there are lots of songs on the album.
Labels have traditionally worked hard to sell singles in order to a) promote albums, b) get a higher margin, c) sell something rather than nothing to people who don't want the album.
Labels in the US have been abandoning the physical singles market for a long time, and that market is now very small. For 2004, The RIAA reports US CD album unit sales of 766.9 million, and CD single unit sales of 3.1 million (see http://www.riaa.com/news/newsletter/032105.asp).
In your calculations you neglected to consider that the number of people who will be at least 1 single is greater than the number of people who will buy an album.
That seems quite possible, especially if marketing changes to be focused on selling singles rather than albums. In my scenarios I assumed that interest in an album marketed at this level would be roughly equal to interest in the single(s) from that album, since most marketing is currently focused on selling albums, not singles. (Labels market singles to radio in order to promote album sales, but they don't make money from radio; publishers and songwriters do). One obstacle that I think will have to be overcome if there's a shift towards singles is that a similar marketing investment probably has to be made to draw attention to an artist's new release whether it's an album or a single, but with quite a lot less money to be made from the single. Also, the explosion of content made possible by the lowered cost of entry seems likely to dilute the market for any individual single. So even if more people are willing to buy a 99 cent single than a $9.90 album, it might still be hard to make good money. I hope it works out to be a good business, but I don't think we know enough yet to be sure that it will.
Also you are forgetting that online sales are often in addition to traditional sales and somebody may buy only 1 or 2 tracks online (or even god forbid hear them for free or get an illict copy) before buying the complete album on CD.
I'm not sure how we know that that's actually happening often enough to offset declining CD sales--can you point me to a reference? US CD album sales have been declining every year since 2000 except for an uptick in 2004 (I believe the trend is down again this year), and meanwhile digital sales are rising fast. It seems likely to me that digital sales are taking over from CD sales, similarly to how CD sales took over from vinyl sales.
It looks to me that you had already decided what result you wanted, and fudged the figures and maths until you got it.
I really want downloading to work out to be a good business, especially if it helps artists get a better deal. But I'm also trying to distinguish what I can actually see so far from what I hope turns out to be true.
Small Independents
Having read the original and the follow-up, I think the assumption I would challenge is about getting product into the stores and buying advertising. As someone who was doing original music in the late 80s, my observation is that an independent label relies on the artists to co-promote and market via performance, mailing lists, and (nowadays) web sites. Direct marketing (and mail order back in the day) to prior customers when the independent signs compatible artists for a specific genre is far more cost effective than trying to reach those customers through retail outlets.
Now thinking about baseball teams in the dark days of the reserve clause, minor and major league teams also realized revenues through selling contracts to bigger, wealthier teams. To look at revenue as strictly items downloaded or in retail misses the other opportunities to realize revenue. An independent record company should perhaps keep in mind Sam Phillips and Sun Records (or the Chess Brothers or other regional independents) who found talent, recorded single after single to see what hits, and then profited on the sale of the masters and recording contract. Let's also note that it's easier to find the capital for a two song session than for an entire album's worth of recording, let alone the issue of how quickly can a band write and record 10 great tracks.
The road for independents has always been rough. My sense is that a developing model of digital single downloads holds more flexibility for an independent than the old model where vinyl or shiny disks are pressed and held in inventory waiting for a possible customer. Independents are supposed to be closer to the street, doesn't digital offer a more rapid way to respond to demand?
oops - looks like you skewed the figures there
You've overlooked two pretty important details here.
Traditionally you pay more per track for a single than an album, there is no reason for this to be different when selling mp3's online.
Labels have traditionally worked hard to sell singles in order to a) promote albums, b) get a higher margin, c) sell something rather than nothing to people who don't want the album.
There is no reason for this to change.
In your calculations you neglected to consider that the number of people who will be at least 1 single is greater than the number of people who will buy an album.
Thats a pretty fundamental part of pricing and doing business - the number of people who will buy a product will decrease as cost increases and vice versa - and it is better to sell 20 singles at a dollar each than 2 albums at 7 dollars each.
Also you are forgetting that online sales are often in addition to traditional sales and somebody may buy only 1 or 2 tracks online (or even god forbid hear them for free or get an illict copy) before buying the complete album on CD.
It looks to me that you had already decided what result you wanted, and fudged the figures and maths until you got it.
Poor show - please try and do better than pulling this stuff out of thin air