Pirates, consumers and live concert promoters are all making life tough for the major record companies. Can they survive as a significant force in the digital age?

On January 12, 2007, British music company EMI issued a press statement announcing a "re-aligning of investment priorities". The company was to shed a layer of management, absorbing the two top jobs at the recorded music division into the group executive chairman's role. The move was in response to what the statement called a "dynamic but challenging market". But it was too little, too late. A few months later the company was acquired by private equity and business recovery experts Terra Firma, in a deal worth £4.5bn.

In January 2008, EMI issued another statement. This time, the message was more dramatic: between 1,500 and 2,000 staff were to lose their jobs worldwide. Many of the company's artists were in uproar. Robbie Williams's manager compared the label with a "plantation owner", while Radiohead opted to depart from the company and release its In Rainbows album under a "pay what you think it's worth" scheme via the band's website.
But the EMI restructuring, the result of Terra Firma executives taking a hard look at the business, confirmed what many already knew: the glory days of the music business—when the emphasis was as much on excess as success—were over.

A spokesman for Terra Firma confirms that for EMI at least, it was time to put some business sense back into the music business. He says that "the sound and fury" over changes to the recorded music division ignores the small contribution it makes. "Historically, EMI's profits have come 70 per cent from music publishing and 30 per cent from recorded music. Of the 30 per cent from recorded music, back catalogue is profitable, whereas new music isn't. Only a small percentage of EMI's artists make any money."

It's a similar situation across the industry. The rule of thumb is that one in eight new signings makes money, with another two or three covering costs, and the rest losing money. A further difficulty is that once artists are established—and therefore in a position to bring in the cash—a new album might only appear once every three to five years. Having recorded an album, artists tour to promote it.

Because artists now earn more from live performances than from recorded music, managers like to keep them on the road for as long as possible. For a company such as EMI, it's possible to have a year where none of its main established artists releases a record. This is part of the reason for the continued merging of labels into bigger and bigger companies, such as Universal. If one label is having a dip, there's always a chance that one of the others will be doing well.

What's more, there is a long-term structural problem in the standard music business model, where an artist gets paid upfront to sign to a record company, with the company helping to create an album, then marketing and distributing it and recouping the advance through royalties.
The problem is that it's easy for consumers to get music for free. Online and offline piracy (illegal downloading from the internet and home copying) are endemic. Figures from British Music Rights (BMR), published last month, suggest 95 per cent of young people illegally copy from CDs, hard drives and the radio. And those who are happy to pay tend to spend less. So the revenues generated by recorded music have collapsed.

Scott Cohen, co-founder of digital rights licensing firm The Orchard, finds the record companies' inability to deal with the changing market amusing. "This has been happening since the turn of the century. After eight years, they still haven't got the message that we are living in a connected world. Digital sales are up and sales of physical product are down. Every quarter it's the same. And guess what? That's not going to change."

According to figures from the IFPI, the industry's global body, this fall in revenues from CDs, records and music cassettes has not been offset by the rise in digital sales. On top of this, industry spending patterns haven't fallen with revenues. Terra Firma CEO, Guy Hands, recently criticised some EMI labels for reckless spending on promotion: "You might as well have put a £50 note on the CD—it probably would have done better," he said.

The growth of digital music—including everything from single downloads to mobile phone ringtones—means that consumers have greater choice and control (see below). John Kennedy, chairman of the IFPI and a former boss of Universal, explains: "With digital music, we are suffering unbundling much more than we do in the physical world. People tend to buy individual tracks at a time rather than whole albums."

Kennedy is clear, though, that the biggest new threat is online piracy. "We've found from market research that kids go online in their own home using household names such as BT or AOL, or any of the others, and they are able to get music for free. All their friends are doing it, and it's strange to them as a concept that it's wrong."

The IFPI wants internet service providers (ISPs) to take more responsibility and has welcomed government action to protect record companies' intellectual property. In France, President Nicolas Sarkozy has announced an agreement under which ISPs commit to disconnect persistent copyright infringers. Similar legislation is being discussed in the UK and Sweden. Kennedy favours a "three strikes and out" approach, with persistent infringers being warned first, then suspended and finally disconnected if they keep offending.

But the ISPs are refusing to budge. In an interview with the BBC, Charles Dunstone, co-founder and chief executive of Carphone Warehouse, which runs ISP Talk Talk, made his position clear: "I cannot foresee any circumstances in which we would voluntarily disconnect a customer's account on the basis of a third party alleging a wrongdoing," he said.

At The Orchard, Cohen claims that both parties have a point. "It's good that the record companies have finally found the right focal point for their campaign," he says. "It's taken almost a decade, but finally they have understood that the point of connection is what matters. But punishing people who download stuff is stupid."

Cohen instead favours a levy on internet and mobile connections, similar to the blank media levy charged on tapes and discs in some countries. "A fee of $1 or 50p a month on every connection would make the music industry bigger than it's ever been."

With the boom in iPods and music-enabled mobile phones, more music is being consumed than ever before. Kennedy is upbeat about the success of the music industry online. "We have a $3bn digital music business, which is ahead of the film industry, or any other creative business. In spite of piracy problems, we have a strong, robust business online and in the mobile space. If we can make ground in respect of the piracy statistics, that $3bn industry would take off enormously."

Nonetheless, the truth remains that internet innovations, such as YouTube and Myspace, have taken control away from the big record companies. Control over what gets released and what stays in the bedroom has been the record companies' biggest trump card. While it's still hard to make it big without the support of a major label, there are more ways to get your music heard than ever before.

Paul Campbell is founder and CEO of Amazing Tunes, an online music service that provides a platform for undiscovered artists, offering them a means to get paid if people download their songs. Campbell says this shift away from the big record companies is good news for consumers. "The whole idea behind Amazing Tunes is that you don't need a record label anymore. We started thinking about this three years ago. Then Myspace came along. That proved there was a market for something that wasn't to do with record labels."

But last month Myspace, which is owned by Rupert Murdoch, announced plans for a joint venture with three major recording companies. Under the deal, users will pay to download music from Myspace pages. The industry's concern about the growth of Apple's iTunes online music store, which is now the world's biggest music retailer, may be allayed by an increase in competition.

Campbell is certain that the era of the all-powerful record labels will soon be over. "Record labels will be libraries of back catalogue and will be less about new music. A&R men sit in their offices with piles of tapes and CDs and listen to the first eight seconds. Why should we let these people decide? They are so prejudiced and obsessed with being cool, and there is that whole nonsense about there being a buzz around someone."

But it's not just the online sector that is threatening the dominance of the record companies. As the margins from recorded music have shrunk, artists and their managers have turned to touring to keep the money coming in. Paul Latham is president of UK music and international venues at Live Nation, the world's biggest concert promoter. Live Nation now owns or operates a huge range of venues across the world, from tiny clubs to massive arenas. "The evolution of online music, the accessibility of music and the greater use of personal stereos and mobile phones, means people are closer to music than ever. This has led to a live music boom," he says.

Live Nation has recognised the increased importance of touring in the music industry mix. In the last year, it has signed deals, each reported at over $100m, with Madonna, U2 and US rap star Jay-Z. With the exception of U2, whose records will still be released by Universal, all these deals are so-called "360-degree" deals, in which an advance is paid in return for income from all aspects of an artist's output, from recorded music and publishing, to ticket sales and merchandising. The three deals above also include sponsorship income and income from other business sources. "The advantage we have over record companies is that we have a relationship with the people who come to gigs. We know them and we can build on that relationship to market other products to them. The record companies often don't know who their customers are," says Latham.

If 360-degree deals point to a new model for the music business, it's one record companies are also keen to embrace. Says Kennedy: "We've been seeing 360-degree deals for some time. There's an inevitability about them. As it gets harder to get a return on recorded music, record companies are saying 'we're the ones that come up with the seed capital, we're the ones who take the risk'. It's ridiculous that the previous model meant the ones who take the risk only participated in some of the revenue streams."

So does this mean that the industry will get back to its bad old ways of exploiting artists? Kennedy, once one of the sharpest artist lawyers in the business, doesn't see it that way. "New artists looking for a record deal might go to one company and be told the company wants the full works and the 360-degree model. If they are a hot property they might be able to find a record company that's happy just to sign the recording rights. Either way, artists are always well represented [legally] these days."

Even in a rapidly changing environment, it is easy to predict some aspects of the future. And what is clear is that the days of the old-style music industry, run to suit the needs of large record companies, are gone. The power is with consumers. As Cohen says: "It's like encyclopedia salesmen denying that consumers want search engines. People consume digital content however, whenever and wherever they want."

You got the power

Scott Cohen, co-founder of digital rights licensing firm The Orchard, explains the power shift underway in the music business

We live in a connected world, where the consumer is in control. People want access, now. Any business model has to respond to changes in its environment and the music business needs to recognise that in a connected world consumer behaviour is different. Many of these changes run counter to the way the music business operates:

Time and location shifting—people want to listen to music when and where they want. The idea of trying to use digital rights management to control or limit usage is nonsense.

Shape shifting—consumers want to change the shape of the media they consume. Where consumers used to be happy listening to albums and watching films, they want to create their own playlists, or use music in a film for YouTube. Consumers want to create their own combinations.

Speed shifting—the music business is too slow for connected consumers. Consumers want to shrink the time from creation of content to consumption. Why should they wait two years for another Coldplay album? People will go and find something new on a website that's updated all the time. 

Price shifting—the value of digital content itself is zero. People can get it for free if they want to. The price people pay for digital media is for the services that the content is wrapped in. For a seamless download, or a logical filing system or for filtering lots of content and then highlighting the best bits.