Music and the Internet

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INTERNET

EUROPE

Music And The Internet:

A Celestial Jukebox

q Get ready to be dazzled, because it is definitely show time in the music industry. The emerging digital formats and new distribution channels, catalysed by the arrival of broadband access, will fuel new growth in the industry.

q The next two years are going to see rapid changes as the industry experiments with new technologies and consumer applications. However, the 38m Napster users indicate that consumers have already chosen their favoured format. We believe that the internet will be a net positive across the value chain.

q Although near-term revenues from digital downloads will be marginal, new business models in music distribution will capture the shift in value from the 9 November 2000 EUROPEAN INTERNET

Heidi Fitzpatrick

44 20 7260 2964 [email protected]

Andrew Hogley

44 20 7260 1499 [email protected]

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1) Executive Summary ... 6

2) Overview of the music industry... 9

♦ Recorded music is a $40bn global market ♦ Consumer buying behaviour is changing in the digital age ♦ Diversified tastes, increasing volume output, stagnating growth = decreasing returns ♦ Digital downloads are changing the way people consume music ♦ The role of independents is becoming more prominent ♦ Complex value chain 3) Evolution of the online music market ... 27

♦ Physical distribution on the internet ♦ Digital distribution on the internet 4) Drivers behind digital music take-up ... 44

♦ Broadband take-up ♦ Availability of playback devices, wireless connectivity ♦ Availability of content 5) How the internet will impact music: opportunities ... 56

♦ Multiple routes to market, every party benefits ♦ Digital distribution as a marketing tool ♦ Music on demand: new consumer applications ♦ New pricing models: Multiple, different revenue streams 6) How the internet will impact music: threats ... 79

♦ Piracy and copyright confusion are holding back the industry ♦ Should music be free – or could music be free? 7) The European landscape ... 90

8) Conclusion... 92 9) Company profiles: q Peoplesound ... 95 q Clickmusic... 98 q Netbeat ... 99 q Vitaminic ... 101 q Freetax AS ... 104 q BeSonic... 105 q ICrunch ... 107 q Mode Intl ... 110 q Popwire ... 112 q Worldpop... 114

Table of Figures

continued

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Table 1: Major domestic artists outside North America 16 Table 2: European Recorded Music Market Statistics (1999) 19 Table 3: Combined majors vs combined indies global market share (%) 21 Table 4: Record label market shares by region and globally, 1999 21 Table 5: Music Industry Value Chain: Examples and Participants 24 Table 6: How a band spends a $1m advance received with record deal 26

Table 7: European Wireless Penetration Data 31

Table 8: UK Media Metrix survey, entertainment category, September 2000 37

Table 9: Napster use among US college students 39

Table 10: US Media Metrix August Survey, 60 top online media sites 40 Table 11: Estimated European music sales through traditional retail, online 42 retail and digital downloads (em)

Table 12: MP3.com Top 15 Downloads (7 November 2000) 52 Table 13: Vitaminic.co.uk Top 10 Downloads (7 November 2000) 52 Table 14: Impact of the internet in various points of the music industry 56 value chain

Table 15: Major Players in DRM Base Technologies 63

Table 16: Major Clearinghouses 63

Table 17: Examples of download pricing 71

Table of Figures

continued

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Digital media will be one of the biggest beneficiaries of the

internet revolution

♦ With the internet, music can be distributed and consumed in a digital format. While still experimental in technology and applications, digital downloads and streaming are already the formats of choice for a large consumer group. In addition, the arrival of digitally delivered music is coinciding with other transition drivers within the music industry. Consumers are not buying music the way they used to, tastes have proliferated and the industry is launching an increasing number of products to match this. There is an abundance of music available, waiting to be channelled to the consumers.

♦ The term MP3 is a compression format, and it competes with other formats such as Windows Media Audio and RealAudio. Compression involves encoding a music file (essentially eliminating inaudible sounds and thus reducing the file size) and decoding it again during playback. Although MP3 is the most popular format currently in the market, the music industry has not embraced it because of its lack of security. CDs can be “ripped” into MP3 files and thus distributed illegally on the internet. We believe streaming instead of downloads will initially drive growth, as streaming enables the content owner to retain control of the file.

♦ Recorded music industry is a $40bn global market, which has been facing stagnant growth over the past few years, as the growth in the 1980s and early 1990s resulting from the CD replacement effect has worn off. The European music market is the second largest in the world with higher than average album sales per capita. Growth in Europe was flat in 1999 after 3% in 1998 (in value terms). Domestic repertoire is growing in importance, with on average 42% of European music sales being generated by local artists. The industry is essentially an oligopoly, with over 75% of sales being supplied by the five major record labels; Universal, Warner Music, EMI, BMG and Sony Music.

♦ Music distribution on the internet has already started in physical format. E-commerce in Europe is expected to grow over 100% annually for the next three years, according to Forrester Research. Online music retail is still a nascent market where key players have launched only recently, but Forrester Research expects online music sales to capture almost 20% of total music retail by 2005. As only 1.3% of music sales were online in 1999, there is still a lot of growth ahead. Note that CDs are one of the easiest products to merchandise online, and they are also easy to pick, pack and ship. Some online sales will be captured by wireless channels as internet-enabled handsets proliferate, however actual revenues from m-commerce will initially be small.

♦ A growing consumer group is abandoning CDs altogether and consuming music in a digital format. Revenues from this channels are tiny: in 1999, US digital download revenues were a mere $1m, leading us to believe that in Europe they were practically non-existent. US digital download revenues are estimated to be a $1.1bn market by 2003, according to Forrester Research, and if we assume that Europe is 24 months behind US in take-up, we can extrapolate that European digital download revenues could reach EQE\

♦ We think that current revenue figures available on downloaded music do not accurately reflect the consumer take-up. Looking at other usage metrics, it appears that there is already a huge active user base consuming music via digital

Executive

Summary

Digital downloads are experimental, but they are already popular

There are several compression formats available in addition to MP3

Music industry growth has stalled Online sales of CDs should be 20% of total retail in 2005 We expect European download revenues of  EQLQ

Huge user base but it is not paying

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25m customers built over five years. Napster is already featuring among top 50 domain names in the US Media Metrix surveys. In the UK, Peoplesound.com is the 5th largest site in the Entertainment category in the September Media Metrix survey, surpassing such well-known media destinations as www.disney.co.uk and channel5.co.uk. Although it is a concern that a large user base is getting accustomed to receiving music for free, we believe that this use is still experimental, and that with improving sound quality and service applying charges will be easier.

♦ We think that broadband take-up will be the single most important driver for growth in digital music. Slow download speeds on narrowband connections cannot fully utilise the benefits of this format. In addition, we believe that availability and declining prices of playback devices will also spur growth in the format.

♦ So far most of the content available for legitimate downloads is generated by lesser-known and/or unsigned artists. Because of the unsolved copyright issues and uncertainty over format security, the majors have so far been reluctant to make their content available for downloads. So far they have been experimenting with limited catalogues in limited distribution.

♦ Piracy is a valid fear for the music industry. One of the biggest headaches for the industry has been the file-sharing applications such as Napster. However, we do not believe that disabling Napster is going to win the war for the music industry. First, their popularity means that new applications will keep emerging, second, the client-to-client services such as Gnutella (allowing anonymity) represent a far bigger threat than Napster does. Furthermore, as Napster the programme has been the most successful viral marketing concept in the history of the internet, the record industry might eventually find a way of exploiting this so that the copyright holders get paid. However, piracy will never be completely eliminated (currently piracy levels are 10-20%).

♦ The music industry food chain is extremely complex, consisting of several different business models in which revenues are obtained. With the arrival of the internet, this value chain is going to change. There will be new routes to market for the music, and more efficiencies to be obtained for every party in the chain. There will be opportunities for disintermediation, as well as some re-intermediation. Artists can connect directly with their fans, and record labels can sell their artists themselves. New business models will emerge, in particular in music distribution, where companies providing digital fulfilment and DRM (Digital Rights Management) services are already lining up. We believe that eventually there will be a shift in value from the distributors to the copyright holders.

♦ The key question is how will consumers acquire and consume music? We believe aggregators will be increasingly important, and that existing online and offline retailers with their customer relationships will be playing a major role in the short term (after all, this is essentially a format change). There will be several new ways for music to reach consumers, whether it is through a portal, through an e-tailer, through the artist site or another gateway. Music will be available on demand. Record companies will have to become increasingly like aggregators, channelling music to consumers according to their preferences.

Broadband will be the key driver

Very little mainstream content

Disabling Napster won’t eliminate piracy

Complex value chain

New routes to market for music

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♦ Digital delivery of music will bring about new revenue models for the companies in the front end of the value chain. Music can be sold on a per-download basis, or on a subscription basis. Music files can also be rented, or music can be given out for free with revenues coming from advertising. Essentially, music will start to resemble a service rather than a product, and this will result in a change in consumer mindset: music does not have to be owned, instead it can be acquired only when needed.

♦ We believe that as the number of digital channels on various platforms explodes, demand for music content is likely to reach new heights. Content exploitation will therefore become a very attractive growth area, with music publishing revenues enjoying the benefits. We also believe that this format shift will be a fundamental net positive for the music industry, accelerating growth through both increased demand and wider distribution in various platforms. ♦ In Europe, the early stage of industry development is reflected by the

diversity of business models currently on the market. What the winning model will be is still unclear, however for the near future revenues from download retail are likely to remain marginal. We would pick Peoplesound.com, NetBeat and Icrunch as the most interesting start-ups in this scene. One of the largest pure plays, Vitaminic, completed an IPO on the Nuovo Mercato in October, valuing the company at P.

Share Of Total European Music Sales For Offline, Online Retail And Digital Downloads

Source: Forrester Research, IFPI, Lehman Brothers Research Source: Lehman Brothers Research, Forrester Research, IFPI

New pricing models

Demand for content will accelerate 99% 97% _94% 89% _82% 77% _71% 65% _60% 53% 46% 38% 1% 9% 13% _16% 19% 21% _23% 24% 26% 27% 1% 2% _3% 14% _18% 3% 6% 5% _7% _9% 11% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

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Overview of the music industry

We believe digital media will be one of the biggest winners of the internet revolution. Unlike other e-volving industries, music industry is already digital: Practically all forms of media content (books, newspapers, film, music) can be transferred into a digital format ready for networked transmission, in which case the need to distribute a physical object (book, CD or a video) is eliminated - at least in theory. In practice consumer preferences dictate which distribution channels will prevail. However, what digital distribution means for these industries is transforming business models with new efficiencies in production and supply chain, in addition for consumers it means new ways of acquiring and consuming media. Although media content has already been converting into digital format for some time, only the arrival of the internet has allowed for these new business models to emerge. We are therefore in the beginning of a radical shift in how this industry operates.

Recorded music is a $40bn global industry, which has over time experienced several changes in distribution and format, starting from the radio in the beginning of the century to Minidisks which came to the market three years ago. However, the internet and digital technology are likely to bring about a profound paradigm shift. This will be experienced not only in the way music is distributed and the format in which it is distributed, but also in the way it is produced and consumed. The industry is currently in the inflection point, in the very early stages of migration, with considerable instability and extreme viewpoints. Visibility of how the sector is going to settle is low.

Recorded music is a $40bn global market

The music industry has always benefited from the arrival of new delivery formats. Cassette, Vinyl LP and CD have all spurred additional growth in this market, as each new format has been able to offer better sound quality and convenience, in addition consumers have not just carried on by buying new releases but also replaced their collection held in the old format (this was particularly visible at the end of 1980s – beginning of 1990s when CD’s took over vinyl). These extra sales generally offset increase in the percentage lost to piracy. Although both audio cassette and CD caused concerns for piracy, both formats ended up being a major boost for the global music industry. We think digital music can turn out to be a similar uplift, rather than the threat envisaged by the music industry.

The worldwide recorded music represents a $38.5bn global market (as of 1999), and has been growing at a rate of 3.4% pa since 1991 in value terms. Between 1985 and 1991 the industry was growing at over 15% pa in value terms, whereas over the past two years the growth has dropped to under 1% pa – although as this data is not inflation-adjusted, so real growth in 1997-1999 has dropped to negative. Of this $38.5bn Europe represents around $14.6bn ( EQ DFFRXQWLQJ IRU RI JOREDO recorded music sales. The North American market is slightly larger with 39% of world record sales, and Japan is the third largest, with 17% of world record sales. Ten largest music markets in the world generate 83% of the world’s record sales (according to IFPI’s 1999 statistics). However, the reported sales figures represent only a proportion of total music consumption: a vast amount of music is consumed for free, either in the form of radio or TV broadcasts, or indirectly in films, TV programmes, advertising, videos or other products that use audio content.

Digital Music Is

Hot

Industry at an inflection point

Global music market is growing at 3.4% pa

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Figure 1: Global music sales growth, 1984-1999

Source: IFPI

Figure 2: Global Recorded Music Sales, 1983-1999 ($bn)

Source: IFPI

Europeans are heavy users but growth has stalled. Interestingly, per capita album sales in Western Europe, at 2.7 albums pa per person are more than three times the global average, with the British population each buying on average 4.1 albums per year (highest in the world). Seven European countries feature in the top 10 in terms of per capita album sales. As a comparison, the North American per capita album sales are 3.7 albums pa, or $47 in value terms. The European music market has seen flat to negative unit growth for the past two years, and in value terms the market was flat in 1999 after growing by 3% in 1998. A few countries in Europe are still growing fairly steadily, notably the Nordic region and certain Eastern European countries. The weak growth in 1999 in most Western European countries can partly be attributed to relatively few big-selling releases coming to the market that year compared to 1998. In 1998 the market bought the Titanic soundtrack album as well as new albums from Celine Dion, Madonna and Robbie Williams.

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Global music sales growth has stagnated

Retail value % of ($ m) World Sales USA 14,251 37% Japan 6,437 17% UK 2,909 8% Germany 2,833 7% France 1,983 5% Canada 884 2% Brazil 668 2% Australia 656 2% Spain 640 2% Mexico 636 2% Total 31,897 83% 10 Largest Music Markets (1999) Source: IFPI - 1 0 .0 % - 5 .0 % 0 .0 % 5 .0 % 1 0 .0 % 1 5 .0 % 2 0 .0 % 2 5 .0 % 1 984 1986 1988 1990 1992 1994 1996 1998

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Most of the music market growth in mid-late 1990s can be accounted for the new format replacement effect, as consumers replaced their album collection with CDs. In the words of one record label executive: the music industry was growing by selling consumers what they already owned but this time in a different format and charging more for it. CDs overtook other formats (LPs, singles and cassettes combined) in terms of units sold in 1994, although CD players had been in the market since 1983. This demonstrates how slow the consumer adoption of new formats can be, and in the case of CDs it was driven both by CD player take-up (as prices came down) and availability of content in the new format. We think digital music will go through a similar evolutionary path, as it is in fact another format for delivering and consuming music. It is worth noting that despite digital delivery being around for two years now, world-wide CD sales are still growing at 2.8% pa in unit terms.

Figure 3: Share of global music sales, 1999

Source: IFPI

Figure 4: World CD and LP Unit Sales, 1993-1999 (millions)

Source: IFPI

Despite industry growing annually in value terms, global volume growth (all formats) has been flat (-0.4% in 1999 and 3.8bn units). The CD replacement effect has worn off (CDs now account for 65% of all units sold worldwide), in addition reduced consumer demand in some of the emerging economies have had a negative

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impact in volumes. Minidisc is emerging fast, and IFPI reported over one million units sold in 1999, with UK taking the largest share of this format (50% of all units sold in 1999). Cassettes still dominate in many developing markets, although overall global unit growth was down 7% in 1999.

Consumer buying behaviour is changing in the digital age

The technological change following the digitisation of music is being combined by changes in customer usage patterns. The 21st century music consumer relates to recorded music differently from the consumer in the 1970’s, 1980’s and 1990’s. These decades launched a series of huge mass-market stars, who received a global following and sold a large proportion of their respective label’s total annual publishing quota. Music used to be a more essential part of a lifestyle than it is today, defining the existence of Mods, Beatniks, Punks, New Romantics, Rockers and other youth culture groups. People in the “heavy user” age group, 16-40 –year olds, often identified themselves as being a fan of a certain mass-market artist, and owning an album collection used to be part of a person’s identity. Consequently, as tendency was towards mass-market artists, tastes were more unified than they are today. Young people (the heavy music users) used to listen to the same artist at the same time. Consumers today in the “heavy-user” age group are seeking new ways to define themselves, with music taking a back seat or becoming only one of the ways identities are formed (internet, video games, dance parties or extreme sports gaining in importance). Curiously, this is taking place at the same time as use of music is increasing. But the growth of music usage is becoming increasingly indirect, from owning an album collection to conscious and sub-conscious consuming of music in films, television, advertising, shops, radio channels, and other occasions. Music is also merging with brands and getting closer to consumer experiences on several levels and occasions. For example, Sting’s new single in the Jaguar advertisement worked to promote both the car and the artists. During the Sydney Olympics, Nike launched an internet radio station called Radio Free Sydney, where dance music played by DJs was streamed live around the clock. This was part of Nike’s overall marketing strategy to bring product relevant content to customers, and a good example of how music content is becoming increasingly important for brands wishing to connect with their consumers. This has implications for content owners and their revenue models, with a subtle shift from revenues from direct sales to revenues from exploitation of content rights, in the form of publishing and licensing contracts. Therefore, we believe that the content exploitation will grow substantially as distribution channels proliferate.

A potential indicator of mass-market stars’ fading appeal is their ability to generate repeat hits. Several artists who have gone to score jackpots with their debut albums have seen their subsequent album sales dwindle. Many artists have become “one-hit wonders” with only a handful of stars being able to score top hits year after year. Consumer loyalty is eroding fast. Figure 5 below shows a selection of artists and unit sales of their debut and subsequent albums: most of us can remember Alanis Morissette and her huge success in the early 1990s.

Traditionally music has been about mass-market stars

Music is increasingly consumed indirectly

Stars often fail to generate repeat hits

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Figure 5: Album sales of selected artists (m)

Source: Billboard, Peoplesound.com

Of course, there is also evidence of a contrary trend, especially with artists in alternative and alternative mainstream genres. Artists that have a very targeted audience can have stable sales for each released album, however these artists are unlikely to sell in the 10m+ range (units) that well-promoted pop/rock artists frequently do. Established artists tend to have varied levels of success in subsequent releases, for example Bon Jovi in Figure 6 below.

Figure 6: Bon Jovi – album sales (units m)

Source: Vivendi Universal

Consumer segments are becoming increasingly fragmented. Although previously a small number of world-wide stars could cater for large groups of consumers, customer tastes have since diversified and as a result, the record industry is launching an increasing number of artists to satisfy this diversity. However, for consumers, this growing array of choice means that it has become more difficult to go to a record store and pick an album. As a result, people increasingly purchase music based on mood or certain style. An indication of the growing complexity for consumers is the huge

0 2 4 6 8 10 12 14 16 Hootie & The Blowfish

Boyz II Men TLC Pearl Jam Cranberries Alanis Morissette

Sheryl Crow Melissa Etheridge Debut album 2nd 3rd 4th 7.0 10.3 15.2 6.4 5.6 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0

Album 1 Album 2 Album 3 Album 4 Album 5

Consumer tastes have diversified

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growth in compilation albums, which now serve as navigators offering vital guidance. Often these compilations are also being marketed to represent a certain style: for example, the widely popular Café Del Mar –albums featured mostly lesser-known artists, but were significant in depicting a certain mood. Consumers are also becoming more willing to buy albums of unknown artists on the back of one hit song, which is a lucrative trend for content owners.

The proliferation of music genres has been one of the phenomena of the past 10 years; for example in the dance music category we now find artists in such sub-genres as Ambient, Breakbeat, Big Beat, Trance, Goa, House, Deep House, Trip-Hop, Jungle, Garage or UK Garage. Similar diversity is found in other broad genres such as rock, R&B and Country (with interesting offerings such as Neo Folk and Modern Country). There are now over 200 different recognised genres available for consumers. Dance music, which emerged at the end of 1980s, is now one of the fastest growing genres where new stars are being discovered almost on a daily basis. Again, music tastes have expanded and new genres continue to emerge in order to satisfy this.

Given the wide differences in consumer tastes, it is not surprising that the number of albums launched in the industry has accelerated: Figure 7 below shows the number of albums launched in the UK between 1990 and 1999. In the UK alone, almost 20,000 new albums were released in 1999, compared to 5,500 in 1989. In the US, 38,900 new albums were released in 1999. This is a significant increase in supply in a market that is becoming increasingly fragmented. The expanding number of releases means that there are more artists chasing the market. And, partly because more artists are now taking a share of the $40bn global market, which is only growing at around 3% annually, fewer artists can command truly significant sales. It is telling that whereas in 1990, 20 best selling albums took in 22% of total global music sales, in 1999 it was 17%. Furthermore, typically less than 3% of all released albums sell more than 50,000 copies, and a large number of new releases sell only a few thousand copies. Moreover, if a record label is lucky enough to launch an artist that can produce a hit album, it is not certain that the same artist can continue producing hits, as we demonstrated in Figure 5. The industry carries an enormous back catalogue representing various artists that sold well in their time but continue to exist only in discounted compilations or in music clubs.

Figure 7: Number of albums launched in the UK – all formats (1990-1999)

Source: BPI 11,021 10,141 11,988 10,716 11,654 13,551 15,393 18,386 17,597 19,900 5,000 7,000 9,000 11,000 13,000 15,000 17,000 19,000 21,000 199 0 199 1 199 2 199 3 199 4 199 5 199 6 199 7 199 8 199 9

More genres cover the diversity of preferences

The industry is

launching an increasing number of albums

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Figure 8: Share of Top 200 Albums (US, %), 1988-1997 75 21 4 57 36 7 60 26 14 60 33 7 63 27 10 65 24 11 57 27 16 49 28.5 22.5 54.5 23.5 22 44 32 24 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97

Established Artists Debut Albums Compilations/Soundtracks

Source: IDC

Domestic repertoire is catching up. In addition, the growing popularity of domestic repertoire has resulted in an increasingly fragmented industry where tastes are scattered not only by musical genres, but also by countries. Overall globally the importance of domestic repertoire has increased steadily, and nearly 65% of all music sales are now of domestic origin, compared to 58% in 1991. Although the stars generating highest sales on a global basis tend to be North American or British, it is typically the local artists that are market leaders in their home countries. In addition, these artists are often outside the mainstream rock/pop genres. In Italy, italian rock is a genre of its own and enjoys tremendous popularity, whereas in France chansons are still enjoyed by the population across various age groups.

Domestic repertoire generates a majority of music sales in most markets. International repertoire typically has a higher market share in certain European countries such as Denmark, Norway and Ireland, as well as in the Eastern European countries. Asia, Latin America and the Middle East all listen to local artists. Over 90% of US music sales consist of domestic repertoire. The large Continental markets Germany, France, Spain and Italy report around half of their music sales going to domestic artists. In Europe the share of domestic repertoire is slightly below global average, but nevertheless it has been increasing: In 1999 42% of all recorded music sales in Europe were domestic, compared to 36% in 1991. At the same time both international and classical repertoire have decreased their share.

This supports the view that the music industry is not dominated by a few mass-market stars, but album sales are generated by a vast variety of domestic and international artist in a plethora of music genres. See Figure 10 for an illustration of how the share of international artists has decreased in global music sales.

On average, 5% of artists deliver a return

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Figure 9: % Of Music Sales In Domestic Repertoire 20% 24% 25% 27% 39% 42% 43% 44% 48% 57% 61% 73% 78% 79% 82% 91% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Australia South Africa Sweden Netherlands South Korea Spain Germany France UK Mexico Argentina Brazil Japan Turkey Thailand US Source: IFPI

Table 1: Major domestic artists outside North America

Country Artist

Sweden Abba

Denmark Aqua

Germany Rammstein

Italy Andrea Bocelli

UK U2

France Johnny Halliday

Spain Rosana

Puerto Rico Jose Feliciano

Hong Kong Jacky Cheung

Brazil Sandy & Junior

Source: Vivendi Universal

This means that content ownership, artist acquisition and development as well as content exploitation is very much a local business, requiring local presence and expertise. In addition to consumer tastes, their access to music relies on very local distribution channels, as both retailers and media rarely cross national borders. Although local acts can provide a good source of growth for the majors, it is a double-edged sword: music companies cannot offset promotion and development costs against a bigger market, as sales potential is limited.

Domestic repertoire is growing

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Figure 10: Average repertoire origin

Source: IFPI

Diversified tastes, increasing volumes, stagnating growth =

decreasing returns

Music is more diversified than ever. Consumers’ music tastes have expanded covering a multitude of genres and dispersing across geographies, and mass market stars are not able to pull crowds as well as they used to. In order to cover all the tastes of music, the industry is launching more new artists and more albums. However, this is taking place in a market that is seeing stagnating growth both on volume and value terms – in other words the industry is pushing more product into a contracting market. As a result, the music industry is facing diminishing returns on their artist investments. However, this is happening in an industry where success rate was not too impressive to start with. On average, 5-10% of all signed artists return a profit for the record label, meaning producing sufficient sales to cover investment such as advances on royalties, production and promotional costs, and even this ratio has been continuously eroding. What this means is of 100 artists (and we believe that this figure works when looking at album launches as well) launched by a record label, typically around 5 will become very big sellers, covering the losses stemming from investments in the other 90-95. And in the music industry, investments in album launches are escalating, requiring significant promotional effort such as music videos and radio campaigns. Many albums with considerable production and promotion investments have bombed, selling only a handful of copies. As a result, the record industry writes off several billion dollars each year in unrecoverable A&R investment. This also highlights how the success of an artist is very much down to luck – A&R executive’s positive opinion does not always guarantee sales. The signing decisions typically are not based on any analytical process but more on gut feel.

This environment of increasing product launches and diversified tastes together with traditionally poor success rate on artist investments and stagnating music sales can only result in one thing: Music companies are witnessing declining operating margins.

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Domestic International Classical

Only 5-10% of signed artists return a profit

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Figure 11: Music Company Operating Margins, 1993-1999 7.0% 9.0% 11.0% 13.0% 15.0% 17.0% 19.0% 21.0% 1993 1994 1995 1996 1997 1998 1999

Sony Music Warner Music EMI Music Source: Company reports, Lehman Brothers Research

The recorded music industry is dominated by five big record labels – “the five majors”. These are Universal, BMG (Bertelsmann Music Group), EMI, Sony Music, and Warner Music. The five majors cover approximately 75-80% of the global music sales, with the rest being supplied by hundreds of independent record labels. Each major label owns dozens of smaller labels, which typically specialise in a certain music genre. Universal is the largest of the five majors, with approximately 23% market share. The majors’ dominance has long been a sore point for many professionals in the music industry, which is why the independent sector continues to gain prominence in particular with some of the non-mainstream genres. The discarded merger between EMI and Time Warner was designed to create a music industry superpower with the largest market share. Market commentators have flagged other possible partners for EMI, indicating that consolidation is becoming a feature in the music industry as well. For online retailers, this market structure represents some considerable challenges. Not only are there large national differences in terms of online penetration (with Scandinavia leading and Southern Europe lagging behind), there are also large national differences in terms of what consumers are buying. As the internet is still a minority channel, any online retailer would have to have a presence in several countries in order to build scale. However, only a proportion of the catalogue is transferable across borders, and any e-tailer wishing to trade on a pan-European scale would have to manage several domestic catalogues and several supplier relationships.

In addition, not only does the music bought by consumers differ considerably between the various countries, music industry structures are also local, which complicates artist development and promotion. Each country has its own copyright legislation and royalty collection society, and distribution is done on a local rather than pan-European basis. Promotion cannot be pan-European since each country has its own national media, which does not cross borders. Retail chains are also local with different channel market shares (for example, direct sales through record clubs are popular in some countries e.g. Finland). We believe that this complexity and fragmentation, which runs throughout the value chain, has been the single biggest factor deterring US operators from entering into Europe. The few that have crossed the Atlantic have in most cases had considerable challenges.

Local media, collection societies and legislations

Universal 23% EMI 14% Sony Music 15% Others 23% BMG 12% Warner 13%

Music industry market shares

Fragmented market creates challenges for retailers

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Table 2: European Recorded Music Market Statistics (1999)

Retail Per % of

Value Growth (99-98) Capita repertoire

Company (USD m) Units USD Local album sales domestic

Austria 322.9 -6% -7% -3% 2.6 15% Belgium 342.3 -1% -7% -3% 2.5 20% Denmark 263.9 2% -1% 3% 3.3 35% Finland 128.6 -8% -8% -4% 2.3 42% France 1,983.4 -4% -8% -4% 2.3 44% Germany 2,832.5 0% -6% -2% 2.9 43% Greece 98.8 -15% -18% -15% 0.8 59% Iceland 17.8 13% 4% 6% 2.6 45% Ireland 113.3 2% 0% 5% 2.1 16% Italy 607.3 1% -1% 4% 1.0 51% Netherlands 522.1 -3% -4% -3% 2.4 27% Norway 260.9 -3% -6% -2% 3.6 19% Portugal 176.8 -9% -5% -1% 1.7 31% Spain 639.5 0% -6% -2% 1.6 42% Sweden 356.6 1% 0% 4% 2.9 25% Switzerland 277.1 -5% -11% -8% 3.5 8% UK 2,908.9 -5% 2% 4% 4.1 48% Source: IFPI

Digital downloads are changing the way people consume

music

In addition to what people are buying, how they are buying it is also experiencing a profound change, brought about by the arrival of internet and digital formats. We will be analysing the digital formats and how large this market really is further in the report, however the following statistics show that digital distribution of music is already reality, and it is changing the industry.

• Over 70% of US college students have downloaded music using Napster, the software that allows users swap audio files from each other’s servers.

• “MP3” was the most popular search term in US search engines in June 2000 While no doubt still being experimental in usage and technology, digital distribution is already a very important music format for a certain customer group. We believe that this is the same customer group who were the first adopters of the internet in the early to mid-1990’s, and this will be followed by a more mainstream consumer.

Why would consumers favour digital distribution over physical format? In addition to the convenience factor, downloading music offers instant gratification, something which buying CDs over the internet cannot do, as you have to wait for days before you receive your product. Digital downloads also offer an important navigation tool as the choice in music has exploded: customers can sample music prior to purchasing by downloading audio files, which is something that is extremely difficult to do offline. This will prove to be an important factor in guiding music purchases, and may result in content owners having to repackage music. Curiously, music companies have been able to sell full CDs on the back of a few popular tracks, meaning that of the 12 tracks on a regular CD only 1 or 2 are hits or at least tracks preferred by the customer, and the reason why the CD is purchased. From a customer’s viewpoint, the remaining 9-10 practically act as space fillers. Although this is intended to be New ways of buying and

consuming music

A more convenient format

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eliminated by the so-called coupling clause, the storage capacity in a CD means that more tracks can be included in an album. For customers purchasing digital downloads on a per track basis means that there is no need to buy the whole CD in order to get the favoured track. Digital delivery allows customers to download only those tracks that they wish to purchase.

In addition, for many customers record stores are “inhospitable” outlets, especially if the customer does not know what s/he wants. Merchandising is often confusing and customers sometimes find the staff too intimidating to ask for help. This is probably one reason why back catalogues tend to sell better in online CD stores: the convenient search and navigation facilities are something that do not exist in bricks & mortar stores. Some teenagers report being watched constantly with suspicion by the store staff, and thus find downloading songs from the internet a more hassle-free experience.

Digital downloads are a more convenient way of storing and listening to music. Audio files can be stored in a playback device, and there is no longer a need to travel with several CDs. Customers are able to build personal mobile jukeboxes without having to own and carry a sizeable album collection. This will obviously create an entirely new way for customers to hold and own music: as digital files cannot be stored on shelves alongside traditional CDs and albums, the size of a person’s displayed album collection will no longer reflect the extent of the collection. Music does not have to be owned and held. If music files can be downloaded whenever a consumer chooses to listen to them, music can be consumed on a need-to-use basis.

Figure 12: Reasons For Downloading Music

Source: IDC

The role of independent labels is becoming more prominent

Although a majority of the world’s recorded music revenues goes to the five major labels (Universal, Sony Music, Warner Music, BMG and EMI), around 23% of the revenues are owned by hundreds of independent record labels. There are over 400 independent labels in the UK alone, and over 3,500 in Europe. Although most of these are either focused on a particular genre, small with few resources to develop and promote the artists or unable to attract marketable artists, some independent labels have grown into formidable players in the European music scene.

0% 5% 10% 15% 20% 25%

Other "Loves Music" Curiosity Free/cheap music, legal Free music, pirated Convenience Availability of hard-to-find music/genres A more customer-friendly

format

Convenient storage

Over 3,500 independent labels in Europe

(22)

Several successful artists have chosen to eschew the majors as it is felt that they are too commercial and instil too much control on their portfolio of artists. The attraction in going with an independent label is often more creative freedom, in addition the majors tend to be more wary of signing music that does not appeal to the mass market. As the majors are all quoted companies (with the exception of BMG) with strict financial performance targets, artists are usually required to produce chart success immediately. However, most bands and artists do not develop that quickly, instead they require often two, three or four records before they see a lift-off (The Verve is a typical example). Whereas a few years ago very few independent artists were able to launch themselves into the charts, over the past few years some of the most popular artists have started to come through the independent labels. Good examples are Oasis (Creation Records) and Prodigy (Beggar’s Banquet). As the consumer tastes become more fragmented and as the music consumer is increasingly looking for individual tastes and styles at the expense of mass-market artists, we believe that independent labels will grow in significance in the European music scene.

The independent music scene is populated by thousands of artists. In Europe around 50% of the copyrights belong to independent labels, however it is probably a reflection of the type of artists going through the independent labels that only 19% of revenues are collected by the independents – although this figure varies depending on sources. In addition, because the majors have greater access to world-wide distribution, they are able to market their artists more effectively than the independents. The indies’ share of revenues tends to be even weaker in Europe, whereas in Latin America and Asia it is more prominent, because of the smaller presence by the majors. Worldwide, the combined share of all independent labels has declined over the past 10 years, which reflect the challenges resulting from smaller distribution capabilities. Globally the indies capture around 23-24% of all record sales, which has been declining since 1988, when they represented over 30% of the market. Some decline in indies' market share can be accounted for majors acquiring smaller independent labels.

Table 3: Combined majors vs. combined indies global market share (%)

1988 1990 1994 1995 1996 1997 1998 1999

Combined majors 69.8 73.6 73.8 72.1 72.8 74.5 75.9 76.0 Combined indies 30.2 26.4 26.2 27.9 27.2 25.5 24.1 24.0 Source: IFPI, MBI

Table 4: Record label market shares by region and globally, 1999

BMG EMI Sony Universal Warner Indies

Europe 11% 17% 18% 25% 12% 19%

Latin America 15% 11% 18% 22% 10% 25%

North America 12% 9% 18% 25% 16% 21%

SE Asia (ex Japan) 6% 8% 11% 17% 6% 53%

Global 11% 14% 18% 22% 13% 23%

Source: SoundScan, IFPI, Lehman Brothers Research

Complex value chain

The music industry operates in a complex value chain consisting of several different business models in which revenues are obtained. The $40bn annual revenues are split in several ways with many involved parties taking a cut during the process. Although the most significant revenue streams come from the retail distribution of music in various formats, both the record industry and the music Indies will grow in significance

Indies have 50% of the copyrights, but only 20% of revenues

Revenues are split in several ways

(23)

publishing industry receive revenues from a wealth of other forms. This ranges from the obvious such as the broadcast industries, live performance, films and any music heard on public places to the less obvious such as use on corporate presentations or video games. These uses will continue in the digital age. However, internet and digital technologies will not only restructure the value chain, entering into every link with either value adding or destroying results, but also expand the range of use as the new platforms offer new distribution opportunities. As a result, we expect to see new business models emerging as the reliance of core revenue generators such as retail sales and broadcasting decreases. With the arrival of Napster and other file sharing technologies as hugely popular consumer platforms, the industry is facing tremendous changes. There are an incredible number of moving parts, which have to be rearranged.

Figure 13: The Music Industry Value Chain

Source: Lehman Brothers Research

Below we will provide a brief overview of each party’s role in the music industry food chain.

Composer/Songwriter

The songwriter is the original author of the music. Sometimes the artist or a band also acts as a songwriter, but it can be done by a separate company or individual, via various channels. The composer receives a share of the royalties.

Artist

The artist or a band is the most visible part of the value chain. Creating and performing music is their livelihood, and they want to get paid for it, whether we are talking about a struggling unknown band or a platinum-selling superstar. Traditionally the only way of getting music to the market and earning revenues from the creative process has been to get signed with a record label. The artist receives share of revenues from record sales, as well as fees from record labels.

Publisher

Publishers administer the copyright and look after the collection of royalties for the composers. They are essentially custodians of the songs, and represent the copyright holder and licence the musical compositions for artists to use in records, movies, television programs, films, restaurants, radio, advertising and many other uses. The copyright of a song can refer to either the lyrics and the composition, or the actual recording, and whereas specialised publishers often own the rights to the lyrics and songs, record labels often acquire rights for the actual recording. For example, if an artist wants to record a cover version of an old song, the song’s publisher would grant the licence to the song from the catalogue. Each time the song was played on the radio or each CD sold, the publisher would collect royalties, of which it would keep a portion and pass the remaining share to the artist.

Artist

Composer Publisher Record

Label Manufacturer Distributor

Retailer

Radio Station

Con sumer Technology allows for more

flexibility.

Artists create and perform music

Publishers are the custodians of music

(24)

This is an extremely lucrative business with very high margins and repetitive revenue streams. Music publishing is also one of the fastest growing revenue streams in the industry. For example, last year Vivendi Universal collected nearly $1m in publishing royalties of one song alone; “I Will Survive”. Publishing revenues come in three forms: ♦ Mechanical royalties – this refers to royalties being generated by record sales, so

each time a record is sold the publisher gets paid.

♦ Performance royalties – royalties generated from songs played live on stage or in a public place, however also from songs broadcast on radio, television, in a cinema or over the internet

♦ Synchronisation royalties – this is the fastest growing publishing revenue stream. It involves marrying the song (words and music) with visuals, such as in television programmes, advertising, film or videos.

Record label

Record labels are powerful players in the music industry. The five majors, EMI, BMG, Warner Music, Universal Music Group and Sony Music control around 85% of the global recorded music market. Each of these labels also holds a number of minor labels which specialise in a particular genre or artist type. The major labels tend to be vertically integrated, all the way from songwriting to music publishing to distribution, therefore holding considerable power over what music is recorded and where it is distributed. The remaining 15% of the world music industry is covered by a large number of so-called independent labels, which vary in size and can represent only a handful of artists.

The record labels play a major role in taking artists to the market. One of the key function is the discovery of new artists through A&R process, which provides a type of quality control for the consumers. The talent scouts employed by the record labels search the world for unsigned artists, hoping to find the next platinum-selling superstar. The time and money invested in this process is substantial.

Once a promising artist has been identified, the record label typically provides the artist with an advance on future royalties, designed to cover the cost of living expenses, production, travel, promotion and salaries. This in a way is an underwriting fee as the record label assumes the risk of the artist never being successful. In fact, the success rate of launching new artists has radically decreased, and now around 5% of all new signings make a return on the investment.

Record labels also provide producers and resources for the actual recording and production of the album. The labels bear the costs of recording studio fees, studio musicians, sound engineers and producers. In addition, large record labels have vertically integrated printing (the actual manufacturing of the CDs or albums) and distribution. Large labels usually have distribution centres that act as wholesalers, often working with the retailers on promotions and merchandising.

Manufacturer

Majors and other large labels usually own manufacturing facilities, such as Bertelsmann’s Sonopress. Most smaller or independent labels that are not vertically integrated have to outsource printing and manufacturing the CDs and albums (often to the companies owned by the majors). This involves pressing the albums and CDs as well as producing the packaging and artwork for the covers.

Major labels are vertically integrated

Advances on future royalties

(25)

Distributor

The distributors get the CDs physically from the manufacturers or record companies to the retailers. They own and operate the warehouses, drive the trucks and deliver the CDs to the stores. Major labels have their own distribution networks, or they use independent, third-party distributors. Again, smaller or independent labels that are not vertically integrated typically outsource distribution to third parties, who as wholesalers work with the retail chains and other sales channels to ensure the music reaches the consumers.

Retailer

This is the last stage in the music value chain. The music reaches the consumers through various channels, whether it is a large-scale record store such as Virgin Megastore, a supermarket, a music club, or a specialist music shop on the high street. Radio station

Radio stations often receive new music through promotions run by the record labels, as playtime in top radio programs are one of the most important ways of promoting new artists and music. Radio stations now play a very big role in the music industry value chain, and their revenues come from advertising,

Table 5: Music Industry Value Chain: Examples of Participants

Songwriters Artists Publishers Labels Manufacturers Distributors Retailers Radio St.

Randy Newman Madonna EMI Music Publishing EMI RPM Valley Media HMV Radio 1

Holland, Dozier & Sony Music Licencing BMG Our Price Classic FM

Holland The Beatles MPL Communications Warner Music Virgin Capital Radio

Larry Bastian Oasis Warner/Chappell UMG Amazon Kiss FM

Don McLean Elton John Sony Music BOL

Paul McCartney Moby Beggar’s Banquet

Elton John Instant Karma

Bjorn Ulvaeus & Benny Anderson Source: Lehman Brothers Research

Music industry lives from royalty payments

The music industry food chain is traditionally complex. The $40bn annual global sales need to feed several parties, and as a result the average price that the consumer pays for a CD is split many ways.

A typical contract gives the artist or band a royalty equivalent of around £1 for each CD priced at around £13. The remaining £12 is shared by other parts of the food chain. One of the fastest growing revenue streams is publishing royalties, which refers to exploitation of copyright. The songwriter and the songwriter’s publisher get a royalty payment roughly equivalent to what the artist receives, but typically 5-8%. The retailer and wholesaler each take a typical margin, and the remainder goes to printing, packaging and promotion. The figure below illustrates the revenue distribution in a typical CD.

Distributors get the CDs to the stores

Artist gets less than 10% of the record sales

(26)

Figure 14: Revenue Distribution Of A CD Artist 8% _Print/press 15% Distribution 15% Label 39% Retailer 15% Publisher/ Composer 8% Source: IDC

Although it seems that record labels rake in a lion’s share of the artist’s creative work, it must be remembered that the label also assumes the risk of that particular investment failing, if that particular artist’s music does not sell. The label also bears all the costs of promoting the artists, including producing the music videos and any advertising as well as all promotional effort to get the songs played on the radio. The label also invests in potential tours, which can involve sending hundreds of people on the road for extended periods of time. In addition, the production process is extremely costly involving often sophisticated sound engineering technologies, the costs of which are born by the record label.

A large share of the revenues are also spent in the distribution process, which in IDC’s example takes up 15% of the price of the CD. This is understandable given that the process is very capital intensive, involving moving pallets of CDs from the manufacturing plant on trucks to various retailers, or to wholesalers who distribute them onwards to record stores. In addition, both wholesalers and retailers retain a piece of the pie in their margins. Outside of the distribution value chain there are also several parties that are involved, all of which need to get paid: these are the artists’ managers, lawyers, and other staff, as well as the government in the form of taxes.

CD manufacturing, or the printing and pressing of CDs, can be undertaken by various independent companies operating in this sector. A going rate for printing is around 65p ( SHUDEDVLFTXDOLW\&'ZLWKVRPHYROXPHVDFFRXQWHGIRULQDGGLWLRQ to this there are charges for the manufacturing of plastic covers, and printing the cover graphics.

Within the music industry value chain, the fiercest opponents towards digital distribution have been the record labels, and in general the fiercest supporters have been both the consumers and the artists. This is not surprising if we look at which party has most to lose. Courtney Love, singer of the rock band Hole, presented the following calculation of how an advance of $1m for a four-member band is split and what the artist is left with:

Record labels take on risk

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Table 6: How a band spends a $1m advance received with a record deal

$1,000,000 Record label’s advance

($500,000) Cost of recording an album: production, promotion, distribution ($100,000) Manager’s commission

($25,000) Lawyer’s fee

($25,000) Business manager’s fee $350,000 Profit

($170,000) Taxes $180,000 Net profit

$45,000 Net profit per person, divided by four band members Source: Courtney Love

Industry in transition

Music industry is a challenging industry, with its lack of visibility on revenues in new launches, and the difficulties in monetising creative work. However, even with the challenges we highlighted above, or conversely because of these challenges, we believe that the music industry is ripe for a significant paradigm shift which will come to impact the entire value chain. This will be driven both by changing consume profiles and new technologies. Digital distribution and consumption of music is here to stay, and the internet is bringing about new efficiencies and new formats, and new ways of distributing and consuming music. As a result, there will be several ways in which the industry is likely to benefit. However, as in any step change, old business models will either have to adapt or face the music. New business models will emerge, and some of these will grow to become formidable businesses.

The music industry is ripe for transformation

Key Thoughts:

Recorded music is a $40bn global industry, which is dominated by five major record labels: Universal, Warner Music, Sony Music, BMG and EMI.

Growth has stalled after the CD replacement effect in the late ‘80’s. Average annual growth in value terms has been around 3% since 1991 with flat volumes. However, new formats have traditionally resulted in accelerating growth in the music industry.

Choice for consumers has exploded, which makes choosing music more difficult.

Domestic repertoire generates a majority of music sales in most markets, and its share is increasing.

Music industry is launching an increasing number of new artists and albums. As this is happening in

an environment of stagnant growth, margins have been declining.

The share of independent lables has been decreasing over time, however we believe that their role will grow in importance.

New digital formats are growing in popularity, and their appeal to consumer is convenience and versatility. In addition, free music, although mostly illegal, has been spurring growth in digital formats.

The music industry has a complex value chain and revenues are split several ways.

(28)

Physical Distribution On The Internet

Music distribution’s migration to internet has already started in physical format. Along with the rise of e-commerce, companies such as CDNow started retailing CDs online, and in just a few years internet as a retail channel has emerged as a clear challenger for the traditional retail formats. The attractions for consumers are numerous: convenience, better range, a more personalised shopping experience, better access to information and lower prices are some of the reasons why people shop online. Despite the recent market turmoil and some commentary predicting the doom of e-commerce, growth in online spending is going to be substantial. Internet penetration in Europe is increasing rapidly, driven by cheaper access (many ISPs are now offering access without subscription OR call charges) and internet-enabled handheld devices. IDC is estimating that half of the European population will be online by 2002. In 2004, the organisation predicts that there will be nearly a quarter of a billion online users in Europe. This will represent serious critical mass and make internet a viable contender to traditional retail channels.

Figure 15: Total Western European Online Penetration (% of population)

Source: IDC

Moreover, these online surfers are also increasingly turning to online buyers. As there is typically a time lag from first getting connected to the internet to actually transacting online, we believe that the 2000 holiday season will see a huge pool of new online users making their first purchases. People are also becoming more confident about online security, and whereas credit card fraud was the biggest factor deterring people from making purchases online, it has now taken a back seat. Reasons for not buying are increasingly site-specific, relating to download speeds, lack of availability and, just like in offline world, customers not finding anything to buy from the range available.

Forrester Research is forecasting total European business-to-consumer (B2C) online spending of bn by 2003, from bn last year. This would equal over 124% CAGR from 1997 to 2003. One can be cynical about these forecasts, but US forecasts made a couple of years back about online spending growth proved to be hugely understated. In 1996, Forrester Research forecast 1999 full year online sales to reach $4bn, and the actual sales in fourth quarter 1999 alone were $7bn. We believe

Evolution Of The

Online Music

Market

Source: Forrester Research Total European B2C spending forecasts ( P 2,874 8,543 19,185 40,152 74,849 122,561 183,292 0 20,000 40,000 60,000 80,000 100,000 120,000 140,000 160,000 180,000 200,000

1999 2000E 2001E 2002E 2003E 2004E 2005E

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% 100.0% 1998 1999 2000 2001 2002 2003 2004 In Europe, Christmas 2000 will be the first e-holiday

European B2C spending will be e75bn in 2003

242m Web users in Europe by 2004

(29)

that the actual growth will surprise us on the upside. Therefore, despite the well-publicised failures in the e-tail sector, we should not forget that this channel is taking market share extremely fast, and increasingly becoming consumers’ preferred way to shop for products and services.

Online music retail is still a nascent market, where key players have launched their operations fairly recently. CDNow launched in 1996, whereas Amazon launched its music sales in June 1998. However, this is a market that will experience a rapid migration to the internet: US forecasts expect online music sales to capture 11% of total music market by 2003 (according to Jupiter), and we have no reason to believe Europe should not be able to replicate this. Music and home entertainment products are ideally suited to the net, and not surprisingly enjoy high consumer acceptance. Music is a very information-intensive purchase category, requiring a modicum of pre-purchase research. In addition, the merchandise does not require a hands-on shopping experience (for example, it does not require trying on before purchase). For information-intensive categories, the internet offers superior browsing capabilities with search functionality and better product information, as content can include various types of editorial material, such as reviews and news articles.

Figure 16: US online music share of total music retail

Source: Jupiter Communications

For e-tailers, music has been one of the easiest categories to merchandise in the early days of e-commerce. Music as a category has the advantage of a streamlined supply chain, where established distributors and wholesalers maintain databases based on identifies similar to ISBN numbers. These can be uploaded into the back-end system. The e-tailer can outsource a large proportion of the inventory, and although it is possible to merchandise hundreds of thousands of CDs on the site, only a fraction of these are typically in the warehouse. As distributors and wholesalers normally maintain inventory on the catalogues they sell, any non-stock items can be sourced from the distributors with a fairly quick turnaround. Inventory costs can be kept low by ensuring availability of fast-selling chart albums and leaving back-catalogue to the distributors. Online merchandising is simplified by not having to tackle challenges in product presentation, in a way that, say, apparel or furniture do. At a bare minimum, online music retailers can feature a CD cover and a track list and with a basic database application be up and running. Customers do not have to see or feel the CD before purchase, as they usually have the necessary information already (have already heard the album or know the artist).

In the US, online music sales are around 3% of total music retail 0.3% 1.0% 2.0% 3.3% 5.4% 9.2% 11.0% 0% 2% 4% 6% 8% 10% 12%

1997 1998 1999 2000E 2001E 2002E 2003E

Music has a streamlined supply chain

Music and the Internet

INTERNET

EUROPE