The Internet will eventually become the primary mechanism for selling recorded music. Such a change in distribution might alter the corporate makeup of the industry, since Internet distribution allows a producer of any size to compete more effectively against major record companies. On the other hand, finding and nurturing talent, suggesting producers, and publicizing recordings may still be sufficiently important that the record labels will continue to dominate the market.
The most prominent claim of a shakeup in the music industry business model is the British rock band Radiohead’s online experiment last October. The band left their label, EMI and produced and distributed its album, In Rainbows, directly to music fans using a “name your own price” (NYOP) mechanism for downloads.
There is nothing inherently novel in successful artists trying to jettison their publishers. Charles Dickens, for example, decided he could make more money producing and selling A Christmas Carol without his publisher. He went a bit nuts choosing opulent paper and bindings, however, and did very poorly financially.
Usage of the NYOP mechanism is more novel and is facilitated by the automation of Internet sales. Because such a move by a major band was sure to generate a huge amount of positive publicity, it seemed it might be a good idea, at least as a one-off. NYOP, in general, is almost surely a money loser, but Radiohead was only using an NYOP system for a small part of the market, the download market, and only for a short time. Further, the downloaded version was of a lower quality than the later, normally priced version, presumably increasing the likelihood that downloads would not decrease later sales.
According to consumer research firm comScore, 62 percent of downloaders paid nothing, and another 17 percent paid a pittance, a dollar or two. While Radiohead suggests that comScore’s estimates are incorrect, the band hasn’t backed that up with its own figures.
This stunt has since been repeated (using a slightly different hook, but producing similar results) by Trent Reznor, the creative force behind rock band Nine Inch Nails. Unlike Radiohead, Reznor reported the results of his experiment allowing free downloads of a Saul Williams album. In this case, fans could get an album with higher audio quality for $5 or a lower quality one for free. The result? Only 18 percent of downloaders paid the $5.
Reznor’s 18 percent figure falls within comScore’s 16 to 22 percent of downloaders who made payments to Radiohead of more than $5. The higher audio quality of the $5 version of Williams’s album should have led to a higher share of payments relative to Radiohead's. So when Radiohead claimed that comScore’s estimate was “wholly inaccurate,” what that may have meant was that comScore’s results presented an overly optimistic picture of revenues. The outcome of these experiments supports what most people instinctively know: NYOP is not a good business model.
This leaves us with two final questions:
First, did Radiohead benefit from the NYOP download experiment?
On the one hand, the publicity from the experiment should have increased CD sales. However, if normal CD purchasers switched to the online product, sales could have been hurt. Initial information released last week shows Radiohead's album led the charts in its first full week. Unfortunately for Radiohead, sales of this album were only one third of the first week’s sales of its prior album. So it is possible that the downloads may have cut into sales more than Radiohead anticipated.
Second, did Radiohead benefit from leaving its label?
It is certainly too early to know. But if numbers are ever made public, we can’t just compare the size of two sets of figures. Since Radiohead took on all the business risks when it left the record company, it must earn higher amounts, on average, to compensate for its greater risk. $6 million in the hand (EMI’s reported advance, spurned by Radiohead) is worth more than a possible $6 million in the bush. To financially break even, in a risk-adjusted sense, Radiohead would need to earn more from its distribution than it would have received from the record company.
What can we conclude?
We’ve yet to see any earthshaking evidence on changes in sound recording business models due to the Internet. We can point to two important changes in the market, however. First, we have a large increase in piracy, which has dealt a devastating blow to the industry and has decreased the importance of music sales relative to concert revenues. Second is the rise of Apple Inc. (Nasdaq: AAPL) as a major retailer. It is a bit naïve to believe, as most commentators on the Radiohead experiment seem to have hoped, that we will see successful new business models based on asking for donations. Our current business pricing models have worked for centuries. And the Internet doesn’t change that.
— Stan Liebowitz, Ashbel Smith Professor of Economics, University of Texas