Rearchitecting the music business: Mitigating music piracy by cutting out the record companies

Disintermediation — the process of removing superfluous agents in a transaction chain — has been a major promise of e–commerce. Disintermediation offers the benefits of lowering prices to consumers and a better information–feedback loop between producers and consumers. In this paper, I propose a systematic model of disintermediation in the recorded–music business. Were such a model successful and tied to digital distribution, prices to consumers would fall considerably, artist compensation would rise, online piracy would drop, and the information–feedback loops necessary for signaling consumer tastes back to artists would become far more efficient as information asymmetries were mitigated. Such a model would leverage recommender systems as a way to determine consumer choices beyond the use of simple sales figures.

Contents

Introduction
The current business model of and cost structure in the music trade
Disintermediating music: A new framework
Barriers to implementation
Other music distribution schemes compared
Conclusion

Introduction

Even the most indifferent reader of the business and technology press is no doubt aware of the “music wars” now being fought in particular between firms in the music publication and distribution pipeline and listeners who are using peer–to–peer systems to share and trade music over the Internet illegally. Music distributors and music consumers are currently at loggerheads as a result, and accusations of criminality and rapacious business practices are pervasive, in large part because the current situation is untenable, both ideologically and commercially. Simply put, as long as consumers are asked to buy bundles of songs (called CDs) at about US$16 or more each yet can access the same content for free from the comfort of their homes, the problems of piracy and overpricing will not go away. Representatives of the music labels, led in the U.S. by the Recording Industry Association of America (RIAA) are currently following a three–pronged strategy, first suing their erstwhile customers for copyright violations, second, lobbying fiercely in the U.S. Congress to get legislation that both stiffens copyright restrictions (often violating tradition norms of “fair use”) and to outlaw certain technologies that they deem “induce” piracy, and third, leading an “education” and intimidation campaign against music piracy.

For several years the RIAA has used Web crawlers, honeypot sites, “poisoned” files, and myriad other means to collect evidence for legally pursuing music pirates. In addition, the RIAA has used lawsuits to shut down services such as Napster, and to attack software publishers such as Grokster, whose products were deemed by the U.S. Supreme Court to “facilitate” copyright violations under the 1998 Digital Millennium Copyright Act. Since the emergence of this strategy in 2002, tales of grandmothers and small children getting sued by the RIAA have become grist for the blogosphere’s disdain for the RIAA and its attorneys. The RIAA has also attempted an education campaign, providing materials on its Web site and through the channels of willing educational institutions to persuade music consumers that file sharing is stealing, and that it deprives musicians of the income they need to continue writing and performing music. This campaign assumes an identity of interest between musicians and RIAA members, yet file–sharers rarely hear musicians protesting about piracy, so that the claim of identity of interest is probably not terribly credible (see below).

It is therefore necessary to develop a new, Internet–based infrastructure for connecting consumers to musicians. ... In the process, we can well envision that the cost of a bundled set of songs — a legacy of the “CD” as a physical artifact — dropping to about US$3, while the compensation paid to musicians could rise threefold.

In this paper I will argue that the current “music wars” are a consequence of the structure and business models of the music trade, and that that structure has been rendered technologically obsolete by changes in information technology [1]. The basic function of the music industry is to connect musicians with listeners while compensating stakeholders in some rough proportion to the value they contribute to the process. As the situation stands today, the technology is available to disintermediate the music trade in a very profound way, essentially to cut out the largest claimants to the revenue stream once directed by consumers toward musicians and routed through the record companies. Certainly the record companies expend huge sums to get air play and market presence for their musician contractees, yet such efforts are guided increasingly by a “blockbuster” approach, serving only the small top layer of performers — the vast bulk of CDs released enjoy minimal promotional efforts. Those record companies have outlived their usefulness to musicians and listeners. It is therefore necessary to develop a new, Internet–based infrastructure for connecting consumers to musicians. That infrastructure exists today in only the most rudimentary form, yet one can easily envision it emerging in the next few years. In the process, we can well envision that the cost of a bundled set of songs — a legacy of the “CD” as a physical artifact — dropping to about US$3, while the compensation paid to musicians could rise threefold [2]. Though there have been no systematic studies of the price elasticity of demand for recorded music, one can well imagine at a low enough price that consumers would be willing to “go legal,” particularly when the realize that their music purchases go almost directly to the artists, thereby encouraging them to produce more material. Whether specific musicians are motivated by larger cash incentives here is irrelevant; the faster turn around time between recording sessions and royalty payments and larger payments per unit sold would be a net improvement in any case. Any recasting of the music distribution model that does not remove the record companies and the massive slice of revenue they take from consumers will continue to make piracy attractive, requiring digital–rights management software (DRM), litigation, and a continuation of the crisis in the music business.

The solution recommended here is one of disintermediation. Disintermediation in economic transactions — or rather, the promise of it — has been one of the subtle yet profound legacies of the democratization of information access and the emergent ubiquity of information thanks to the Internet and the Web. We have seen, for example, the almost–complete removal of travel agencies (and their commissions of two–five percent) as middlemen in the purchase of airline tickets as a consequence of direct–to–consumer sales; many await the disintermediation of residential real estate sales (and the five–seven percent commission real estate agents demand)(Fransisco, 2005; Darlin, 2003) [3].

The current business model of and cost structure in the music trade

Basic capitalist economic theory tells us returns to each party in a business transaction should be in rough proportion to the value they add to the product being sold. This is generally expressed in formal terms in the demand that revenue for each party be proportional to their marginal revenue product. While it is nearly impossible to have confidence in precise calculations of this sort in the music business, most observers would agree that the cut taken by the record companies is vastly outsized when compared to the value they add, in large part because of an oligopolistic structure of distribution — four major companies (soon to be three, perhaps) control over 80 percent of music distribution, and it is clear that if they do not engage in formal price collusion, they certainly engage in pattern pricing, with price increases or decreases by one major firm often followed by the others. The disproportionate size of the companies’ share of the revenue stream represents probably the strongest incentive to piracy. Not only does the scale of their share mean high prices, it offers a moral back door for piracy: downloaders can assuage their consciences by telling themselves that they’re not taking all that much from artists (usually pennies per track) [4], and ‘really sticking it to the greedy record companies.’ At this conjuncture, we will leave aside the debate concerning what percentage of pirated music actually represents lost sales, though we can be reasonably confident in assuming that a college student with 500 downloaded CDs would not otherwise have paid US$8,000 to access the same content legally.

If stakeholders should be paid for the services they render, we need to define who those parties are and what they do for what revenue. Let’s assume a physical CD retails at a storefront for US$17. The best way to allocate revenues is to take the knowns and back–calculate for the rest. It looks like this:

Payment to artist/musician US$1.30

Retail markup US$6.00

Transportation, warehousing, etc. US$2.00

[provisional total] US$9.30

Returns to artists are probably overestimated here, as recording contracts usually require that all production costs be subtracted from their cut before any artist income starts (Arnold, 2007). This leaves a residual of about US$7.70, about 46 percent of the gross, going to the record companies [5]. For that US$7.70, the record companies offer the following services:

identify and take the risk of contracting new talent;

advertise the availability of specific new content (CDs); and,

produce the physical artifact, from the studio work to pressing and packaging

Let’s now assume what costs we can forgo by moving from distributing purely digital products in place of physical CDs. Not only have file–sharers and online purchasers adapted to digital–only musical products, getting rid of the physical product is far more environmentally sound simply by not expending the resources associated with making and shipping physical CDs. Selling a digital file or package also obviates the need for a retailer (sorry, Amazon, Fnac, and Borders!). This shift thus removes US$8 immediately from the current cost of a CD. (In passing we should note that pricing schemes in current digital–distribution systems such as iTunes do not fully reflect this set of cost savings).

Now, look more closely at the three major services performed by the record labels. Like the book trade, the music trade finds itself in a situation where the vast majority of its products lose money so that it must rely on a small number of financial winners to cover the losses incurred by losers and to provide a profit sufficient to keep shareholders happy. Indeed, RIAA literature often justifies the high price of CDs as being a consequence of this costly system of pooling risks across artists — the usual argument that the vast majority of CDs lose money, and that those losses must be recouped on those that do succeed financially. But why do the labels so often misjudge their market? It seems obvious that notwithstanding test–marketing, the information–feedback loop from consumers to the labels is decidedly awkward: success or failure is only realized after the considerable costs of production, distribution, retailing, marketing, and the like have been incurred. The record labels obviously need a better way to get advance signaling from consumers [6]. This problem is made all the more difficult by the decline of traditional ways of identifying talent — the last major musical trend that percolated up from performance venues was Seattle grunge rock (Pearl Jam, Mudhoney, Nirvana, and the like) in the late 1980s. Since that time, radio play has been narrowed considerably thanks in part to the consolidation among broadcasters (ClearChannel comes to mind here) and small labels and demo tapes seldom evoke the attention of producers for the labels [7]. Below I will suggest new ways to perform this important function entirely without the participation of the record labels.

The next major activity or service performed by the record companies is that of mobilizing public awareness of the availability of new products — essentially the job of building mind–share. Keep in mind that if there’s one lesson to be learned from the recent fad for viral marketing, it is that most advertising is geared toward developing momentum for word–of–mouth buzz. This implicitly recognizes that consumers thus perform very important marketing services for the record labels, a value–generation for which they are not compensated, and at this point the private–ordering income associated with mind–share is largely captured by the distributors [8]. Expenses in this category include everything from costly music videos released to MTV, to print–ad space, to end caps on the aisles of retailers, to incentive payments doled out to retailers for product placement, not to mention the dense networks of agents and deal–makers. Ironically, most of this category of expense is, again, incurred in trying reach a tipping point at which consumers end up building most of the mind–share. Since consumer mind–share is vitally at issue in this context, below we will suggest alternative ways of developing it [9].

The last major category of record label services is in the production of the physical object. Studio work is by no means trivial, as there are preciously few musicians who can simply be taped from a sound board during a performance and reach consumer expectations of studio quality. Sound engineering, mixing, and the like require considerable skill, specialized space, and equipment. Nonetheless, we are seeing at this moment the rapid emergence of “prosumer”–level equipment and software such as Apple’s Garage Band, and that promises to reduce studio expenses — and perhaps to decentralize their venues. Production of a physical product, a packaged CD, is not necessary under a electronic–distribution framework, though consumers will presumably still like to have accoutrements such as liner notes and the like (indeed, a medium for visible copyright notices may still be needed!), desktop publishing software can accomplish the paste–up work and consumers can print such material at their own expense if they wish. In short, though actual music production remains an important service provided by the record labels, we can imagine better ways to do that.

Disintermediating music: A new framework

As noted above, shifting away from purchasing music on physical media and pricing accordingly would result in considerable cost and resource savings, well over half of that purported US$17 retail price. To accomplish the sort of disintermediation suggested here, however, requires that we build a commons–oriented music infrastructure that replaces the value–adding services the record companies now perform. In this new framework, a much reduced and decentralized set of musician–to–listener networks and a minimal set of intermediaries could replace the current top–heavy structure. Listener taste, the knowledge and shaping of which is the vital asset of the record companies, could better be measured by reputation and rating systems like those used by eBay and Amazon.com, or more recently and for music in particular, there is a burgeoning set of sites dedicated to music rating (Atkinson, 2006). Local contract–studios could provide production services. And, of course, the Internet would provide the distribution infrastructure.

Imagine one or many music–distribution Web sites, say, music.biz, with myriad genre subdomains such as jazz.music.biz, gospel.music.biz — the actual structure is unimportant as long as consumers can understand it [10]. The demo tracks (and CD–Rs) that emerging talent tries so hard to get into the hands and field of vision of record producers could simply be posted to the relevant Web sites. Jazz fans, for example, could the go to jazz.music.biz, and access the demos and, most importantly, rate and review them them; like Amazon.com, the reviewers themselves could be ranked and rated in order to increase the credibility of the ranking and rating infrastructure. Like the process of generating rankings at Google, in time the better rated material would develop a coherent position at the top of a list, but unlike Google, there would need to be a way to keep the newer postings from getting smothered by more highly–ranked older material, probably by having simply a “new material” category with one or more moving ranking criteria and time windows. Consumers could listen to samples for free as streams or download them for a small fee [11]. That fee would be recirculated to the musicians after a commission or flat fee is taken by the webmaster. A major advantage of this sort of framework is that it could well foster localism and local talent, something that globally centralized music companies do not do well. Genres of music that have little traction outside a region, whether township music near Johannesburg or country–rock in Austin, Texas, could easily be identified by artists and discovered and affirmed by listeners.

Ratings of demo material would perform the vital signaling function, the feedback loop from consumers to producers that functions so badly under the current framework. Better still, artists would get more than the simple “toggle” of sales (or not) to determine success — listener feedback would provide them with information of how best to adapt to their audiences, allowing performers to reform and hone their acts. When musicians received sufficient positive feedback from their audiences, they could then proceed to producing and releasing more material. At this point, they would probably want to avail themselves of studio services, but rather than having to fly to LA, they could go to a local (or regional) company that leases studio time or services. As the price of the requisite equipment is falling quite rapidly, one can well envision several such studios in major metropolitan areas, and one per city of a million people [12]. This, too, would tend to build and sustain local music communities.

Many musicians, however, lack the funds to pay production expenses up front. In order to solicit the financing they need, musicians could approach lenders with their rankings on the Web. Though it might take the financial services industry some time to become accustomed to writing loans based on Web scoring, in time, the rankings will function as an accurate tool for assessing risk — one that is certainly more robust than the new–artist risk–assumption and –mitigation model the record companies now use.

It is difficult at this point to anticipate how consumers will in the future prefer that their music be bundled, if at all. Based on the iTunes and Rhapsody model, we might see the unbundling of the package we think of as an album (a format that itself was sized according to the capacity of 12–inch, 33–1/3 rpm LPs a half–century ago), we can also anticipate that there will always be demand for groups of songs in a portfolio sort of format — can one imagine Miles Davis’ “So What” played outside of a set roughly equivalent to Kind of Blue? Bundled and unbundled tracks would, in any case, have slightly different business models behind them. However, such differences would be largely those of incrementalism — the expenses and risks of a bundle would be greater than that of a single, but a bundle might inherently stand better chances of gaining and maintaining mind–share [13].

Unlike the current regime of the music trade which is fraught with divisible and often (arguably) mislocated intellectual property rights [14], the framework suggested here would simplify copyright clearances (especially for innovative mash–ups and sampling, as well as for covers), as rights would presumably remain with the artists themselves. Enhanced metadata tracks on the music files consumers purchase could easily include copyright fields, as do more recent versions of tags for MP3 and FLAC files. Artists would remain free to adopt alternative licensing schemes akin to those of GPL or Creative Commons or they could stick with the traditional copyright regime, but they would rarely sign their rights away to the distributors, as they commonly do today.

Revenue flows through the proposed framework would remain fairly simple and transparent, characterized in the first instance by artists (or their managers and agents) enjoying near–direct payments from consumers. Artists themselves or their agents would themselves take responsibility for the expenses of production as outlined above, and for their income they would contract with the webmasters, who would collect the payments from consumers and (after subtraction of a fee or commission) pass them on to artists. With the significant cost reductions that would result from radical disintermediation and the complete shift from a physical to a purely digital product, a retail price for a traditional bundle of music could be as low as US$3.00. Out of that, the artist would have to pay only the studio and the webmaster; should studios or webmasters try to raise their own shares of the revenue stream, musicians could, in a newly competitive music industry environment, find new producers and sellers [15]. At US$3.00, musicians could perhaps triple their income per unit sold so that they might finally not have to tour in order to support themselves [16]. At the same time, however, the mind–share value of touring will remain, particularly in the ways it builds social capital among musicians and listeners, much as the commercial music–oriented media (Rolling Stone, MTV, VH1, etc.) will continue to perform a similar function. In both of these cases, mind–share dynamics will help reduce consumer search costs.

As suggested above, we may be able to assume — there is no way to know — that by connecting consumers more closely with the artists they enjoy, pricing music bundles at a fraction of where they now stand, and by bundling supplemental material such as liner notes with the bundles (content usually not available in the peer–to–peer channels), piracy might well decline radically [17].

Yet we do not know if disintermediation and price cutting will indeed reduce piracy; we know that it will never be eliminated. Indeed, if the original music product is born digital and purchased as a file or stream, piracy and sharing become very easy, perhaps too easy. We don’t and cannot know. Apple’s experience with iTunes is perhaps instructive here: when iTunes and its associated online store were initially rolled out, there was almost no DRM on the content. In time, however, FairPlay has steadily gotten stiffer and more restrictive, though it is a trade secret as to whether Apple implemented that DRM on its own or under pressure from the content owners [18]. Indeed, almost all major legitimate digital–download services introduced after the iTunes Music Store use some sort of DRM.

It is clear in any case that DRM in general has two salient characteristics for our discussion. First, we can be confident that there is theoretically no such thing as DRM that cannot be cracked, so content owners at best can seek “sufficiently crack–proof” as a performance standard [19]. Second, we can also assume that the effort that a user will expend in order to break a DRM scheme will drop as the cost of the protected content drops. For example, to break copy–protection (or to apply a crack) on a US$1,200 copy of Adobe Creative Suite, a user would probably be willing to go to considerable lengths and effort, yet for a US$3 music bundle, one can imagine that it might not be worth his or her time. By that token, then, were DRM deemed ultimately necessary for content under the framework presented here, it would not need to be particularly robust yet should work on all devices with all types of music files. What is more, as all of the content will have been purchased from a server, an associated server could well act to verify the legitimacy of a content file online through the use of a certificate, digital watermark, or token.

Barriers to implementation

The framework described above probably looks pretty credible in a mature state, one in which there is sufficient scale and artist–consumer buy–in and momentum to make it the “place to go” for music. Getting to that point poses several problems, largely associated with attaining sufficient mind–share and with the fact that most musicians who are well known are often locked into contracts with the major labels.

How Web–based enterprises succeed remains, despite considerable research, somewhat mysterious. eBay, Amazon, and Google all enjoyed rather rapid consumer buy–in largely, it appears, by word–of–mouth knowledge diffusion. None of those, however, required a particularly large minimum scale to operate — even when small they offered services in credible ways. With the framework offered here, however, the system really only works when there is some large (but unknown and unknowable) minimum number of both musicians and consumers offering ratings. The analogy in this case is probably best seen in terms of social networking sites such as MySpace or FaceBook, and Creative Commons and the Public Library of Science. The latter two have been available for some time now, but are only now developing a sufficient body of content to make them “essential” for their relevant potential user pools. One can anticipate considerable risk on the part of webmasters and musicians in joining such a system. For webmasters, the risk is simply the up–front costs, but for musicians the risk is that the major labels could well blacklist artists who try to evade their grip in the transition period [20].

A similar problem is obvious as we envision the sign–up and recruitment process for musicians to join the new system. Most well–known artists are not only bound to the record labels by multi–album exclusive contracts, but even new artists routinely sign “right of first refusal” clauses when they initially contract with the companies. Those clauses give the record companies exclusive first right of refusal for follow–on content offered by musicians. Few record companies would allow successful new musical acts evade those clauses, especially if the artists were to go and fuel a system that overtly undermines the record companies. As a consequence of the contractual lock–ins of major artists by record companies, one could not expect name–brand acts to join the new system very rapidly. There are only so many Janis Ians, Fiona Apples, and Ani DiFrancos around. Mind–share and momentum for the new system might therefore be difficult to come develop. Jessica Litman (2004) has suggested that a way to circumvent this problem would be to start first with a coherently niched genre of music that has fairly coherent audience boundaries — she suggested Christian rock (though one can see possible branding problems in that), but one can also imagine certain varieties of “world” music (a term used to denote non–North Atlantic content) — and build up and out from there. While that might work, the danger of becoming “ghettoized” in one niche would be considerable. At this time, we have no real solution to offer to this problem. One might worry that in the transition phase, successful artists might simply use the new system simply as an incubator and sign with the majors once they attain a sufficient mind share, much as we see bands move from minor to major labels (Indeed, artists on Garageband (http://garageband.com/) have had some success in leveraging popularity on that site into contracts with major labels). We would hope the cachet of distributing through a fashionable new online system would deter such movement (an “iPod effect” for content rather than hardware), but we can certainly assume that with artists making so much more on each sale in the new system as compared the the old system, there would be strong incentives to stay with the new.

Finally, one might argue that an alternative distribution model could adopt the current advertising model used in broadcast television and radio (Fox and Wrenn, 2001). While that might solve a number of revenue–stream problems for creative artists, measuring audience size for ads could be even more daunting than it is for Web sites that currently use that model. First, the routing of ad revenues to artists could be difficult and probably very uneven. Second, the tech–savvy types who would likely be the first adopters would probably use ad–blocking software, and that would soon become the norm. At the same time, however, targeted micro–ads of the sort Google uses might be fruitfully used to support Web–based music venues, and they might also act to develop mind–share as well. Indeed, the latter approach could well remove any need for artists to pay for postings and distribution services. Such ads could well offer notices of concerts, similar artists, and all manner of fanware, from t–shirts to audiophile software and equipment. Indeed, in an important paper, Mark Fox and Bruce Wrenn advocate a free–music, ad–supported approach, to which is added the auxiliary advantage to music companies of selling customer data, but this approach offers none of the advantages and transparency of full disintermediation, nor does it address consumer concerns about surreptitious personal data sales (Fox and Wrenn, 2001).

Other music distribution schemes compared

The past few years have witnessed the roll–out, initially very cautiously, of commercial, legal music download services. From iTunes to Rhapsody, the re–branded Napster, and the Microsoft operation associated with the Zune music player, all of these have several features (or pitfalls) in common. At the outset, none of these services disintermediate to any substantial degree — indeed, most of them simply replace the old retail layer so they maintain the current multi–layer model of intermediation, adding yet another claimant on the music industry revenue stream. Whether selling content by subscription or by piece, none of these services can offer prices low enough to mitigate the piracy problem precisely because so many parties get a cut of the action. Consequently, most such content is plagued by DRM and users routinely break the DRM in order to enforce their traditional fair use rights. Ironically, if consumers buy physical–media content through the traditional distribution channels, in practice they retain their rights to make personal back–ups, to copy to other media and to share with friends; buying the same content at slightly lower prices off the Internet, however, essentially deprives them of many of their fair use rights [21].

Apple has claimed that its margin on sales of music through the iTunes Music Store is next to nil, that it runs the service as a break–even business as a way to sell iPods and Macs. This is, of course, a radical shift away from Apple’s notorious “rip, mix, and burn” ad campaign, as it not only does not undercut the positioning of the record industry in the music distribution system, it largely serves to inscribe those firms into a solid position within the new online music industry. Apparently, Apple arm–twisted the record companies to release their content for online sales, and in doing so, Apple gave those companies the illusion that they can transition into the online world without threatening their choke–point, revenue–rich position. In short, Apple has offered the labels a new lease on life and they have taken it. Apple sells high mark–up iPods and the labels enjoy a new revenue stream, yet artists get paid almost nothing for such sales and consumers get slightly lower prices and lose some of their fair use rights. It is no surprise, then, that none of the current online music vendors have either reduced incentives for piracy or offered a better deal for musicians.

ArtistShare (http://www.artistshare.net/home/default.aspx) represents another very different emergent distribution model. Having won a 2005 Grammy award for Maria Schneider’s Concert in the Garden, ArtistShare now has considerable visibility. The ArtistShare model does disintermediate in ways similar to the framework offered here, but with a significantly different structure. It asks listeners essentially to invest in developing new musical content, apparently as a way to mitigate the artists’ risks in development expenses. What is more, the structure of listener support sought by ArtistShare is designed to encourage a long–term, sustainable financial relationship between the two parties. It also laudably assures that the artists retain their rights and enjoy much larger shares of the revenue streams than the standard model offers. At the same time, the service offers few demos, teasers, or downloads, so listeners are asked essentially to invest “sight–unseen” (or, as it were, “sound–unheard”) in specific musicians [22]. This, of course, requires that either each musician have an established positive reputation or that the branding power of the ArtistShare label lends sufficient credibility to unknown artists that they garner the requisite funding stream. In addition, as ArtistShare offers no obvious feedback or rating system, listeners are not used as a source for reality– or taste–checking the material before production or after sales. Given its business model and inherent inability to elicit mass appeal, it is hard to imagine ArtistShare as operating beyond a small niche within contemporary jazz.

Recently, an innovative new service, Pandora (http://pandora.com/), has introduced an entirely new music–searching paradigm, one termed a “music genome.” Once a person joins the ad–supported site, s/he enters the names of her favorite performers and Pandora runs a proprietary algorithm to generate a list of similar musicians [23]. The listener can then have Pandora stream that content. While Pandora’s licensing arrangements are unclear and a minimally skilled pirate can capture the streamed content, the model really only offers a somewhat robust music–discovery algorithm. It does nothing to restructure and disintermediate the music business. Like its cousin, last.fm (http://www.last.fm/), it has a listener–feedback mechanism (and indeed, last.fm has morphed into a music–based social–networking community), so it indeed slightly contributes to a grass–roots mind–sharing effort.

There are no doubt quite a few music sites for rating and downloading music within niche markets, the best of which is probably Calabash Music (http://calabashmusic.com/), which touts itself as handling “fair–trade” music within the “world” genre. Its most notable feature is that it makes available music that is often only distributed in restricted global regions. Exciting as this model is, in no way will it ever become a viable candidate to disintermediate the global music trade, thanks for the most part to its inability and/or unwillingness to expand beyond its own niche market, operating at a thin end of the long tail of the music trade.

Creative Commons (http://creativecommons.org/) is rapidly becoming a key venue for experimentation in new forms of music distribution and as a consequence, it is difficult to categorize in simple terms. At the outset, CC represents an archipelago of different sites and distribution models, unified by CC’s goal to allow musicians to opt for the sorts of copyright rules with which each feels comfortable. Additional key features include a common goal of disintermediation so that artists and listeners can connect more directly (though not in the financial sort of way as ArtistShare) and a rejection of DRM schemes that reduce listeners’ fair use rights [24]. In terms of DRM, it is clear that at the prices for which the music is offered through Creative Commons–related sites, consumers have little incentive to pirate [25].

Artists represented in the Creative Commons archipelago tend not to include big–name artists for the reasons discussed earlier — the stars are locked into contracts with the major labels. Creative Commons–related sites such as www.soundclick.com and magnatune.com (which presents Web surfers with tag lines such as, “We Are Not Evil” and “Internet Music without the Guilt”) offer a large number of free and low–priced downloads, and their distribution models are almost exclusively non–physical products. As such they do go a long way toward the framework outlined in this paper, and they perhaps underline the critical–mass problems anticipated above. At the same time, though www.soundclick.com features a ranking of sorts (rather like a Billboard chart), it and its cousins lack a systematic rating and feedback system — musicians can count clicks and downloads, but they cannot get systematic feedback. Nonetheless, the Creative Commons family of music distribution sites and models represents an important venue for innovation and experimentation.

Recently the Electronic Freedom Foundation and participants at a March, 2005 Berkman Center conference have advocated what I consider a weak solution to the problem of piracy. In a scheme not unlike Canada’s tax on blank media [26], this framework calls for a tax on all broadband connections in return for the RIAA and its motion–picture fraternal twin, the Motion Picture Association of America (MPAA), calling off its litigation against file–sharers. As part of this peace agreement, proceeds from the tax — presumably levied at the same rate on college students in dormitories as on elderly people with broadband connections — would be accumulated into a fund, then distributed to artists via the channel of the record labels. What criteria the labels would use to allocate revenues to artists remains unspecified; in decades of operation, the music publishers ASCAP and BMI have had a similar model for royalties on broadcast music and to this day, there’s no clear sense of how proceeds are allocated to artists. Similarly, the Canadian fund that has for several years accumulated the tax on blank media has yet to distribute any funds to artists thanks to a lack of a credible distribution model [27]. There is simply no available way to measure audience sizes in the world of underground piracy. The South Korean work–around, to offer virtually the entire range of music produced there for a US$5 monthly fee, could probably only work in a small market (Stross, 2007).

Schemes to tax suffer as well from a grave lack of horizontal equity. People who use broadband connections only to surf the Web and e–mail their grandchildren would pay the same tax as dorm residents who use Kazaa or BitTorrent frequently. Not only is the injustice of such a scheme unconscionable, it annihilates any demand–signaling function that a more refined system might offer, and efforts to meter downloads might well invade users’ privacy. Finally, almost any credible scheme that would allocate broadband tax revenues to record companies would almost inevitably send the largest funds to the largest players, which would then have even greater ability to lock up ever–more talent and content. In short, this sort of taxing scheme solves nothing (except perhaps clogged court dockets) and probably would only make the situation worse; it would certainly not help to lower prices and disintermediate the music business. At best it would offer a temporary truce in the copyright wars.

It is therefore clear, I believe, that while there are a number of promising alternatives to the current model of music distribution most of them suffer either from hard–wiring the existing intermediaries into a high–priced future, or from prestructured inabilities to build sufficient critical mass to become sustainable. The model proposed here tries to address many of these issues, albeit with the caveat that getting major stars will be difficult [28].

Conclusion

We have argued that the current state of the music distribution system is deplorable. With an inflated pricing structure that over–rewards some intermediaries (record companies) and squeezes others (brick–and–mortar music stores in the age of Amazon.com and iTunes), piracy has become rampant. Admittedly, we have not tried to measure demand elasticity for musical content, but we do assume that were prices low enough and the music product were to include high–quality tracks and supporting documentation, many pirates would go legal. Oddly, the success of iTunes, despite its DRM, indicates that people are willing to pay for music downloads, even at prices close to those of retail CDs, and we can probably be confident that iTunes sales to some extent mitigate piracy, particularly as they share the same modal demographic, music fans between 15 and 30 years old. This shift from piracy to purchasing could be reinforced by allowing limited access to samples, thereby creating a legal “try–before–you–buy” system. We have not discussed the possibility of unbundling music from the album format — one in which quite often a few good songs are used to sell a number of lower–interest ones — but the system proposed here opens that possibility. We also make no assertions here in the debate over whether piracy spurs or displaces licit purchases of music. That debate is currently so heavily researched yet still very bifurcated and charged that certainty remains elusive. We do know that CD sales have dropped considerably recently, in part because people spend less time listening to music (annual time listening to music has fallen from 290 hours per person in 1999 to 195 in 2004 (Halderman and Felten, (2004)), and that blockbuster artists are giving way to more modest successors. This makes any calculation of the impact of piracy on CD sales nearly impossible.

A key assumption in this presentation is that the costs associated with the current model of oligopolistic intermediation — as well as the artist lock–in that is its consequence — is at the root of the crisis in music distribution. The problem cannot be fixed without a major effort to break the grip of the music distributors over the system. If that rings a death knell for the music companies, so be it. Musicians and listeners, the core creators of value in the music business would gain enormously and a measure of economic justice would be attained. Using powerful Web tools has successfully disintermediated airplane ticket sales and may well do the same in residential real–estate sales and in both venues buyers and sellers can and will save considerable money and develop much more powerful ways to develop information links between those parties.

About the author

Bob Frost, an erstwhile historian of technology and economic historian, is currently and Associate Professor at the School of Information, University of Michigan, where he teaches an introductory course in Information Studies, as well as courses in information management, material culture, and museum studies. He is currently at work developing an ISO–compliant software system for building Web–based virtual museums.

Acknowledgements

Valuable criticism, analytical points, and comments were offered by Jessica Litman, Lawrence Lessig, Jeff Mason, Margaret Hedstrom, Tracey Hughes, Sharon Smith, Peter DiCola, and the students of Bob Frost’s Introduction to Information course. The author thanks them all, in no particular ranking.

Notes

1. In this paper I do not offer a sustained critique of the problems of traditional copyright in the digital age; Jessica Litman and Lawrence Lessig have written admirably and at length on that subject. Perhaps the best summary of views close to my own on this issue is J.P. Barlow (2000).

2. At this point I will not systematically address the potential consequences of “unbundling” — moving to a system of singles and one–off song sales in the place of CDs. That process is already well underway via iTunes and the like anyway, so it’s not directly relevant to the argument presented here. In addition, it remains unclear what balance consumers will ultimately prefer between singles and albums.

3. The film industry might currently be in a slow, yet radical process of disintermediation as the studios and distributors move toward simultaneous release of films in theaters and on DVD. When (and if) this practice becomes routine, any consumers will opt to rent new DVDs for home use at a fraction of the cost, avoiding theatrical admission fees and thereby to some extent cutting out the exhibitors. This, of course, will happen just at the time that theaters face costly conversions to digital equipment.

4. This seems to be the norm, based on testimony from musicians themselves. For example, see C. Love (2000) and [Canadian] Creators’ Copyright Coalition (2004). Wittur (2004) writes, “The cost to produce a CD en masse is about $0.50. The average price per CD: $17.99. The average amount that an artists receives: $0.12.” Calculations of this sort are difficult to make, as the costs for CDs that don’t sell well and lose money (about 90 percent of them) are implicitly spread over successful CDs and the problem of myriad chargebacks and credits to performers. Obviously, were it possible to reduce the number of money losers, perhaps through more modern market research methods, those costs would look much better.

5. As noted in the previous note, it is difficult to come up with a consensus about the cost shares for all of the stakeholders in a music CD; see B. May and M. Singer (2001), who indicate “royalties” at US$1.50–$3.00, but they are not broken out into artist’s royalties versus those of the publisher (currently US$0.20 per track) or other royalties claimants, nor (again) does this include chargebacks from the record companies. Citing a number of different and divergent sources, W. Fisher (2000) concludes that royalties to the “artist” on a US$16.98 CD are 16 percent, or US$2.71. More recently “toosday” (2005) allocates US$1.60 to “artist’s royalties.” The numbers offered here perhaps understate artist’s royalties, but if that is so, it is no more than about US$1 short.

6. For this reason, it has been rumored that the major record labels are hiring consulting firms to research file–sharing networks to find out what’s hot; see C. Dahlen (2005).

7. Complaints about the narrowing of playlists following consolidation among broadcasters are abundant, if a bit overstated (ClearChannel is now retreating and selling off stations); see R. Dotinga (2002), [San Fransisco] Youth Media Council (2002), E. Boehlert (2001), and A. Berendt, (2001). That said, recently (Q3 2006) ClearChannel’s market value has dropped considerably thanks in part to listener reaction against non–localized blandness. ClearChannel has not only sold off it concert–booking division, it’s starting to back out of a number of radio markets.

8. On private–ordering, see Israeli Internet Association (2004). Evidently, music listeners in workplaces manipulate their playlists in order to present coherent self–images to co–workers; see A. Voida, et al. (2005).

9. Research on viral marketing has indicated, oddly enough, that producer–“push” lose effectiveness very rapidly and can sometimes backfire; see Leskovec, et al. (2006).

10. Though the later versions of the ID3 tag systems enforce a canonical list of genres, many users find them ill–fitting; one can well imagine implementing folksonomies using de.licio.us to arrive at a more effective classification system.

11. We assume here that it would probably be wisest to make the samples available as streams (which require an extra step on the part of the user to make shareable), with the purchased tracks sold as stand–alone files to facilitate space– and device–shifts.

12. Al Gore has praised how new IT is reducing costs for all sorts of professional production services. See Beth Fouhy, “Gore launches TV channel for young viewers,” USA Today (5 April 2005), at http://www.usatoday.com/life/people/2005-04-05-gore-tv-channel_x.htm.

13. At the same time, however, we might also see the emergence of user recommendations and purchase tracking as a way to rebundle music, much in the ways Amazon.com advises customers that, “users who bought [what you’re buying] often buy X as well.” This would generate a more stable practice of bundling than what we see in the sharing of “party mix” CD–Rs. Umair Haque (2004) argues that bundling often forces consumers to buy uninteresting cuts that they don’t want, so file–sharing is a way for consumers to reduce those risks (“try before you buy”), as are single–track downloads of the iTunes Music Store variety.

14. Currently, copyrights on music are often held by several parties — publication rights are often held by one party, distribution rights by another, broadcast rights by another, and public performance rights by still another. The best explication of divisible copyrights in music is Demers (2006), Chapter 1. Without the mandatory licensing laws now in force in this confusion of divisible rights, performing covers of previously–released material would be impossible — a copyright thicket parallel to the patent thickets that currently hinder the biotech, IT, and home entertainment industries. Nonetheless, the re–release of older material is still often precluded by an inability to procure the appropriate rights, not to mention simply to identify the specific rights holders. Of course, much to their later dismay, many new artists simply sign their rights away in order to get a recording contract from a major company. In the process they lose control over their own creative product.

15. Granted, however, that with any user–driven recommendation, the utility of recommendations depend in large part on the number of participants; by that logic, there would be a tendency for the first site with large traffic to become a de facto monopoly, a variety of first–mover advantage common in the early days of the Web.

16. It is interesting to note that in the U.S. through the 1970s, musicians toured in order to sell their albums, from which they made the bulk of their income. As the record companies’ grip became tighter, musicians’ royalties, “taxed” by myriad expenses imposed by the record labels, largely disappeared, so that by the 1990s, touring became the major source of income for musicians. Today, with concert bookings and venues increasingly monopolized by entities such as ClearChannel’s spun–off booking agency and Ticketmaster, that income stream is now getting very thin, even as ticket prices reach new highs.

17. This is obviously an exercise in defining the demand elasticity for a product line, a task few economists would recommend without a dense experimental framework. That said, researchers might get a sense of demand elasticity by using proxies in an equation that would capture the purchases of unprotected EMI content via iTunes against the differently–priced protected content at the same outlet. See Faultline (2007).

18. The encoding method used in FairPlay also remains a trade secret (despite efforts by the French Parliament to the contrary), thereby locking iTunes Music Store purchases to the Mac and iPod.

19. Hence the retreat from a “trusted computing” architecture in Microsoft’s Vista. Not surprisingly, an operative assumption that one must always be certified to access any content or software — permissions culture, as Lawrence Lessig would have it — is not expected to glean much consumer support. Again, unless efforts by the music companies to “plug the analog hole” succeed (which is not likely, as it would require an entirely new way of connecting home entertainment components together), piracy will always be possible.

20. The rock group, Pearl Jam, dared to protest Ticketmaster’s iron grip on concert–ticket intermediation by calling for a boycott of Ticketmaster; in retaliation they were soon largely prevented from touring.

21. Some emerging legal music download services are now implementing essentially a leasing model in place of a sales model; under this framework — not unlike that Microsoft uses for its corporate clients — listeners must essentially pay “rent” on their music collections, lest the disappear thanks to self–destruct expiration dating schemes. In the U.S., revisions of the U.S. Commercial Code, commonly referred to as USCITA, are presently advocating state laws to reinforce the trend toward software and content rental schemes.

22. When a listener seeks to find out more about an individual artist, the request is redirected to that artist’s own Web site, which may or may not offer downloadable samples.

23. Pandora’s “music genome” algorithm can sometimes generate odd results, not unlike music searches directed by that ever–underdefined, non–canonical notion of genre. For example, when one enters Zap Mama, a Belgium–based group of sub–Saharan African women, Pandora generates a list dominated by U.S.–based R&B. Apparently, African, juju, and zouk are not operative variables.

24. iHoopla (http://stores.ebay.com/iHoopla) represents a disintermediation model similar to those in the Creative Commons family, replete with the same sort of “emerging” artists. It uses eBay as its sales infrastructure, but unfortunately, all tracks are encoded with the now largely–defunct SDMI DRM technique, making them incompatible with many MP3 players.

25. This is not to claim, as some have, that the social and political dynamics of DRM actually impel people to pirate music; see Flint (2007).

26. In the spring of 2005, the Dutch government considered a tax not on media, but on all MP3 players in a scheme to compensate rights holders for their purported losses due simply to the very existence of a file format! Under this law, iPod owners would pay for rights twice, first when purchasing music, then when purchasing iPods; see “Faultline” (2005).

27. In the U.S. the music industry does receive some compensation for sales that are lost to CD burning. This was made possible by the passage of the Audio Home Recording Act of 1992 (AHRA), which appears in Title 17 of the U.S. Code. Section 1004(a) allows for royalty payments of two percent of the transfer price of digital audio recording devices.

28. This difficulty might be overestimated, however. The most trying juncture is in the context of rising and potential stars signing multi–album contracts that are very much to their own disadvantage in the event that they do succeed, as intermediaries effectively lock them into long–term contracts, thus blocking them from releasing their music in other venues. A good summary of the current state of that contracting relationship is “Golias (176380)” (2005).

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Editorial history

Paper received 12 July 2006; revised 12 May 2007; accepted 10 July 2007.

“Rearchitecting the music business: Mitigating music piracy by cutting out the record companies” by Robert L. Frost is licensed under a Creative Commons Attribution-Noncommercial-Share Alike 3.0 United States License.
Permissions beyond the scope of this license may be available at rfrost@umich.edu.

Rearchitecting the music business: Mitigating music piracy by cutting out the record companies by Robert L. Frost
First Monday, volume 12, number 8 (August 2007),
URL: http://firstmonday.org/issues/issue12_8/frost/index.html

Payment to artist/musician	US$1.30
Retail markup	US$6.00
Transportation, warehousing, etc.	US$2.00
[provisional total]	US$9.30