The Internet Changes the World of Music, But What Comes Next?
Stockholm School of Economics
Quo Vadis Music Industry:
The Internet Changes the World of
Music, But What Comes Next?
Course: 2101
Market Systems
Fall 2002
. Major points of conflict
Today there are struggles between several different parts of the value chain. The labels are trying to stop customers from downloading free music from the Internet. This conflict is mostly between the sound carriers producers and the customers. Even the compositors of music, i.e. the artists are fighting against free downloading of their material. One example of this is Metallica who sued Napster for encouraging illegal use of their music. Napster responded by preventing the users who had downloaded Metallica songs from using the service. 1 We believe that these struggles will become more intense in the future.
Another aspect not covered in the value chain are the new competitors that have entered the market. One example of this is the Internet suppliers and the electronic industry. The electronic industry has been on the market for quite some time but first now they have become indirect competitors to the music industry by providing empty CDs, CD burners and MP3 players. These products are not illegal but are often used by consumers to get hold off, distribute and listen to illegally downloaded material. It is likely that conflict will arise between these actors and the traditional labels. In fact, as examined below this is already happening.
2. Strategies
Defining the business
A very important step in forming a strategy is defining the business. The reason behind the difficulties faced by the labels can be analysed by using the structure - conduct - performance paradigm. According to this model, performance by companies should measure up to certain criteria.
A company should provide products that are qualitatively and quantitatively what the consumer wants. Today the big music companies do not qualify on this matter. New technology makes it possible to individualize a CD. This is something that the consumer desires and that the big labels today do not offer.
A company should take advantage of progress in technology and science to provide a "superior new product" to the consumer. The big labels have instead been trying to decelerate the pace of technology progress in relevant areas.
Another area were the labels have not adjusted to changes is income equity. The labels and some artists earn large amounts of money.
In short, the music companies have not adapted to changes in demand and technology and thereby have not met the consumer demands. Instead other actors in the market have taken illegal or legal routes to do this.
Changes in basic conditions are mostly due to new technology; this has changed the market structure by increasing the size of sellers (and thus increasing their power) and has also introduced substitute products in the form of individualized, often homemade CDs. These changes are very negative to the big labels and therefore they have tried to alter the situation.
Below follows recommended strategies for some different actors in the value chain.
Compositors
The compositors now have the opportunity to skip the traditional Label part in the value chain. Smaller artists that have a big number of listeners spread on a large geographic area can use new services on the internet like mp3.com to deliver their music to the customer. For example Lagoona, a band from Porjus (a small town in the north parts of Sweden), published their first songs on the Internet in March 1997.2 The songs became very popular and today they have had over 3 million song downloads on the net.
Their strategies are to release the most of their material for free on the net with help of services like mp3.com. They also release their full albums through that services but for a small cost for the customers that choose the download them ($3.99 for an electronically based netCD).
For a band of that size and with their type of non-commercial music this is a healthy strategy. No big label would contract them because of the cost involved with marketing them in a great number of countries and the fact that people that listens to that type ...
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Their strategies are to release the most of their material for free on the net with help of services like mp3.com. They also release their full albums through that services but for a small cost for the customers that choose the download them ($3.99 for an electronically based netCD).
For a band of that size and with their type of non-commercial music this is a healthy strategy. No big label would contract them because of the cost involved with marketing them in a great number of countries and the fact that people that listens to that type of music doesn't like to pay "full price" for a CD.
Established artists could use the same services that Lagoona does. They are not depending on all of the labels functions. Commercial artists need to be marketed in the beginning of their careers. An advertising firm instead of a label could do this.
Label
The labels have to deal with two major problems, virtualisation of the sales of CD and virtualisation of the music itself. 3 The latter should be of greater importance for the labels since it poses a greater threat.
According to Porter there are three ways for a company to build its strategy - positioning, influencing the balance and exploiting the industry change. 4 Below are some examples of how these strategy methods could be used by the labels. We have chosen to view several steps in the value chain as the label. Generally not all steps in the value chain will be affected by the virtualisation of CD sales and music. One example of this is the production of the actual music that will probably still take place in a studio.
) Positioning the company
In positioning the company the industry structure is taken as given. To confront the competition in this matter we think that the labels have to alter their product. Today CDs are highly standardized and the basic product consists of the music. The music is quite simple to reproduce and spread with modern technologies. One way to differentiate the product would be to make the package more attractive to the consumer and thereby offer something more than the music. The product should be so attractive to the consumer that downloading music on the Internet is not considered an option. Differentiating the music product could cause increased barriers to entry since new companies would have to build up consumer loyalty and trust.5 It also lowers the bargaining power of consumers. 6
The label companies need to reduce the prices on their final product. The high prices on CD music make people choose the piracy options. Lowering their productions cost could accomplish this. Examples of how to do this is reducing the artist's margin, reducing the costs of sales by using more of the net based music sales and trying to use new technologies to deliver the music to the final customer. To be able to survive the companies might also have to lower their own margins. One way to do this would be to enter the e-business, more about this matter is written below.
2) Influencing the balance
This approach attempts to change the balance of the market by altering the causes of the market structure. Some problems facing the labels are increased power of the consumers and the dealers. The newly gained power of consumers can in some ways be decreased by enforcing laws concerning piracy copying, i.e. illegal download from the Internet. To do this, labels have to convince the regulators that the laws are needed - the strategy is thereby only partly in the companies' control. One problem with this approach is that there is an enormous amount of people downloading (3 million files per day is downloaded7). To get hold of each and every one of them would require a lot of resources, if even possible. Internet is very large and therefore very difficult to control. Making laws stricter could prevent some people from downloading out of fear. Enforcing laws could also lower the threat of new entrants similar to Napster due to fear of retaliation. 8
Another approach is to compensate artists for loss of income by forcing companies that import and manufacture empty CDs to pay a fee. Today this is already in use - a fee is paid for every empty CD.9 As the problem becomes bigger this fee could increase. In this manner people would not save as much money by downloading instead of purchasing.
Labels can also cooperate with Internet suppliers. One example of this is the so-called Piratbyrån - an association with representatives from the film and computer game industry that try to stop illegal downloading. Piratbyrån has recently started to cooperate with suppliers of broadband. As a result of this, several of the Internet supplier's customers were turned off from their Internet connection. 10 What has to be considered in this approach is that suppliers of Internet are indirect competitors of the music industry. They provide a service that enables their customers to illegally download free material from the Internet. If their costumers risk being shut down from the service by downloading they will probably use another Internet supplier. Therefore this strategy is most effective if all Internet suppliers agree on the same conduct. The Internet supplier also gains income from the customers' illegal downloading. If all illegal downloading stopped they would lose profit. Therefore such an agreement might be difficult to realize without legal reinforcement.
3) Exploiting industry change
The progress in technology is here to stay and this will no doubt affect the labels. The labels will probably be unable to stay in their dominant position at least not without using the available technology. The music industry should take advantage of the technology to gain profit. One way to do this is to sell CDs on the Internet and compete with the established Internet dealers. The barriers to entry for the labels in this market should be low. They are already well established and they have access to many of the resources needed. They also have access to many of the best selling artists and could use this for marketing. For example who would not be interested in chatting with Maria Carey?
The threat of new entrants is important to deal with for the labels. To compete with actors like mp3.com the CDs sold should be individualized - that is consumers should to a high extent be able to choose the contents of the CD. To do this the labels would have to cooperate. The value chain of a company selling music on the Internet would be quite different to the present value chain. For example the storage of sound carriers could be decreased since a CD would be manufactured by customer order. This strategy deals with the first problem - the virtualisation of the CDs. If labels become bigger than the other virtualised sellers their power will increase.
The labels could also make sound carriers that take advantage of compression techniques to store music. These techniques provide almost as good performance to a much lower price than regular CDs and therefore they are highly dangerous in terms of substitute products.11
The technology can also be used to fight against illegal downloading. Different techniques are available to protect CDs from being copied but the technology has also caused problems. Some CDs that are copy protected cannot be played in all CD players. By using the technology the labels are not following the specifications required for the CD trademark. Philips demands that these CDs should not use the CD logotype. Philips also makes CD burners that can burn the copy protected CDs. 12 This is one example of the new competitors the labels are facing due to the virtualisation of the product music. Another example is the previously mentioned Internet suppliers.
Customer
Probably the situation for the customer will improve with cheaper, more individualized forms of music. The customer will also gain bargaining power since the number of sellers will probably increase. The strategy for the customer is quite obvious. The customer should use the available technology to lower costs and gain benefits. Illegal copying is a way to accomplish this even though this implies some risks. Another way of doing this is to use the Internet to actively search information about different dealers and their offers.
Possible future market scenarios
Many of the activities in the value chain13 can be put aside with the help of new technology. The CDs will probably disappear as sound carriers. Some sort of memory-cards will probably replace them. These will be able to store much more information (songs) and have a much better sound quality than the CDs. Music for these cards will be available for downloading on the Internet and the technological standards will be highly developed. For example it will be possible to put the cards in a cellular phone and listen to high quality music. For this reason the need for reproduction, storage and physical transportation of the sound-carriers will disappear as well as a lot of costs.
The reduction of these costs will open up the market for many new smaller companies and the five big labels will loose their dominant position. The dominating labels are today not faced with any real competition because of the oligopoly. Seeing it from the perspective of these labels the threat of new entrants is very big according to the Porter-model.14 The threats of substitutes will however probably decline (for a while) after the market have had a chance to find its balance. This will probably be enforced by the development of standards.
The bargaining power of suppliers (i.e. artists) will probably decrease. Today, many artists make albums which actually only includes a couple of good songs and then fills them up with songs of lower quality and still manages to get them sold. They can do this because the customer is forced to buy a "package". In the future customers will be able to individualise the product that they desire and the artists will have to make each song good enough in order to be able to compete. Many new artists that today would not be able to get a record-deal and get their music to the market will gain an increased power. The bargaining power of customers will increase in many ways. They will have access to a much larger amount of songs to choose between and their demands will be more heard than today.
The oligopoly that the five big labels within this industry have today will be shattered in the future. The companies within this industry must realise this just as other institutions such as the Post Office in Sweden has. Many companies in the industrial organisation history have travelled the same path from being parts of oligopolies to being successful companies in a free market15. The big labels in the music industry must do the same thing.
In the future the companies will be able to reduce costs a lot because of the changes discussed in the value chain. Shopping on the Internet will increase in the future and it is important for the companies to position themselves for this.
3. Before and after virtualisation - aspects and discussion
The Five Forces model can make the company focus too much on what others are doing instead of exploring own paths. Also, marketing should have major focus on consumers, not competitors. On the other hand, the music industry does not seem too concerned with the costumer and in that case the model is appropriate as a descriptive device.
The value chain model might be a bit too long since all parts of it are not covered in the case. It would also be interesting to add time dimension to the value chain. Overall the value chain seems oversimplified and does not take into account horizontal and vertical relationships. These relations might be visualised better by using some sort of network model. The models used by the author do not take into account the new competitors after the virtualisation, neither the cooperation between companies.
Progress of technology and knowledge is an important aspect that is not directly covered by the models.
The view taken in the case is strictly economical and do not consider aspects such as culture. Since culture is a strong influencing force in consumer behaviour it should not be neglected. One aspect of purchasing CDs that the author does not mention is that barging records is a lifestyle for many people and for them it is very important to go in the shops, finding, spending time, listening, talk to people at the store and so on. All these factors presumably weigh up some of the authors arguments in the reality.
Dr Hutzschenreuter introduces the word music as a product in the meaning of a thing you send forth and back over the Internet. We would say that 'music' today is even more than only music! The intentions from the labels today are all about to make as much money as fast as possibly. One example that illuminates that statement is the TV-program "Pop stars" in Sweden/Europe. In this program one single label gets a lot of free marketing.
In general, our opinion is that the author made a well-illustrated and correct image of the musical industry. We think that Porters model is well known and is very suitable in this particular case. It might not be a model perfectly describing reality but it covers the most important aspects.
References
Printed sources
Porter, M.E., How competitive forces shape strategy, Harvard Business Review, March-April 1979
Scherer, F.M and Ross, D., Industrial Market Structure and Economic Performance, Boston, 1990
Internet
Mattson N. Du kan lugnt fortsätta ladda ner MP3-filer, 2002-09-11
http://www.aftonbladet.se/noje/0005/26/mp3_1.html
Skötte A., Avgift på inspelningsbara CD-skivor, 2002-09-11
http://computersweden.idg.se/text/000328-CS17
Öhman D., Piratbyrå jagar bredbandskunder, Finans Vision, 2002-09-09
Lagoona webpage
http://www.lagoonamusic.com/index2.html
Kopieringsskyddad CD inte länge CD
http://computersweden.idg.se/includes/print.asp?id=020118-CS40
Oral sources
Helgesson, Lecture 11/9 at SSE in Industrial Organisation,
Mattson
2 Lagoona webpage
3 Hutzschenreuter p 1
4 Porter p 143
5 Porter p 138
6 Porter p 141
7 Hutzschenreuter p 7
8 Porter p 139
9 Skötte
0 Öhman
1Porter p 142
2 Kopieringsskyddad CD inte längre CD, Computer Sweden
3 Hutzschenreuter p 11
4 Porter, p 141
5 Helgesson
ANDERSSON, ASHRAFI, LÖNNQVIST & ROSLUND
STOCKHOLM SCHOOL OF ECONOMICS 2007-05-02