Collapsing the supply chain

Bill Stensrud has another interesting post up on his Businss of Classical Music blog; this time about the supply chain for recorded music. I find his analysis of what’s happened to that supply chain more compelling than his predictions for the future, however.

The music recording industry involves a number of discrete businesses. These businesses link together in a sophisticated way to create a “supply chain”. Historically, the collaborative effort of these businesses created a viable economic ecosystem and an acceptable financial return for all participants.
The recording industry supply chain starts with the composers and performers. They create and perform the music.

Next step in the supply chain is the labels. They finance, record, manufacture, promote and market the music.

The next step is the distributors. They take CDs in bulk from the labels, warehouse them and ship them, on demand, to retailers or directly to the consumers.

The last step is the retailers. They put the CD on the (physical or virtual) shelf and sell it directly to the consumer. They collect the money….

No industry can exist without a healthy supply chain. The CD recording industry supply chain is VERY unhealthy and getting worse by the day. No one in the supply chain can make an adequate financial return. Without a supply chain – or at least without the current supply chain – what happens to the recording industry?

This is very interesting stuff and well worth reading in its entirety for anyone involved in the production and sale of symphonic electronic media. Stensrud then talks about the future:

Some people put their faith in legal, purchased, digital downloads. Apple totally dominates the legal download business. From an article in the New York Times, November 9, 2006:

“A recent study estimated that Apple has sold an average of 20 songs per iPod — a fraction of its capacity. The rest of consumers’ music files — 95 percent or more — come from ripped CDs, possibly including discs from their own collections, and illegal file-trading networks, the study said.”…

If you think Apple is in the business of selling music you are seriously deluded. Apple is in the business of selling iPods. Selling music is a necessary sideshow for Apple and, with 75% + of the market they barely break even. I personally spent 2 years as an investor in and manager of a major legal download business. I can tell you from painful personal experience that there is no long term opportunity in competing with Apple and selling digital downloads. The margins are razor thin and the market is shrinking… the supply chain for digital downloads is no healthier that the supply chain for CD sales.

The definition of “business” observed that the ultimate objective of a business is to earn a financial return. A supply chain is only as strong as its weakest link. For a supply chain to operate successfully all participants must make an adequate financial return. We define the recorded music supply chain as a system where recorded music is created by performers and composers, paid for by consumers and there is adequate financial return to create and maintain a healthy supply chain. There is no prospect of this supply chain enduring through the next decade.

I think Stensrud is overly pessimistic, although I agree with his overall conclusion that there’s not a lot of money to be made directly in the production and sale of classical and/or symphonic media. The key to making the economics work is, I believe, the further collapsing of the supply chain.

The emerging download supply chain looks like this:

  • Artist pays for production of product
  • Distributor (IODA, for example) takes product, does some minimal processing on it, and makes it available to online stores (IODA provides content to over 100 online stores of varying types and specialties). For this, they take a small cut of the revenue received from the stores.
  • Online stores take product from distributor, do even less processing of it, and take not as small a cut of the gross sales for their work.

Two things are noteworthy about this model. First, there is no physical inventory, which hugely reduces everyone’s costs for production, storage and distribution. Amazon’s S3 service charges about $0.10 per month to store an uncompressed CD-quality (ie 16/44.1) file of one hour of music, and about the same to download that file to one end-user. It costs nothing to manufacture the file from the master, as the file and the master are the same entity. By contrast, manufacturing CDs in quantity (including packaging) appears to somewhat less than $1.00 per copy. And, of course, there is no shipping of boxes of CDs to distributors or to retail outlets – and no shipping back of unsold inventory.

Second, no one is getting paid upfront, except perhaps the technical personnel involved in production of the master (audio engineering and mastering). The headline artist is not getting paid upfront (maybe not really a change over the past practice of the record companies, with their “advances” against ever-expanding expenses). Side musicians might be getting paid upfront, but not usually the members of the group (assuming the group is the headline artist). The distributor is not getting paid upfront. And the online store is not getting paid upfront.

There is nothing intrinsically unviable about this model. To the extent that the processing required by the distributor and the online store can be pushed onto the artist (which already happens to some extent) and/or be automated, the marginal costs to run the distributor and online store become very low indeed. Unlike the CD/record company model, it is not necessary to have a few recordings become mega-hits in order to subsidize the rest of the business.

I suspect that this model will soon be simplified further by eliminating, or at least minimizing the role of, the distributor. Three American orchestras are already running their own online stores (Boston, Milwaukee, and Philadelphia, although Milwaukee is using its distributor, IODA, to do so). It’s not hard. And someone, somewhere is going to come up with a template (as IODA has done for its labels) that will enable any artist to run their own store very cheaply.

It may be that even the aggregation role that the online stores play is will become redundant as well. Except for the iTunes Music Store, it’s not clear what value-added most of the online stores bring to the party. The only reason iTMS is an exception is because of the perfect integration of the server software (iTMS), the client software (iTunes), and the hardware (the iPod). All that’s really necessary for others to hitch on to this wagon is a way of integrating their stores with iTunes.

If every artist has their own online store, the key to making it all work will likely be Google, or something like Google. The difficulty will not be delivering product to the consumer; the problem will be enabling the consumer to find it in what’s going to seem like an exponentially growing haystack.

At the end of the day, however, Stensrud (as well as those of us who have been saying this for years) is likely to be correct in the belief that the real value of electronic media for artists will be in promoting what they sell in their day jobs:

The power of music as a promotional tool is enormous. The best way for artists, performers and composers to leverage the recording of music in the internet age is to use it to promote their performance-based income opportunities. In this application recorded music has enormous potential if it can be created and distributed at low enough costs to justify its promotional value.

Oddly enough, for most orchestras this has always been the case.

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