No Such Thing As “Free”

The Media Technology Research Group of Sweden has published a fascinating study on “Usability Factors in Digital Music Distribution Services and Their Relationships with Established and New Value Chains in the Music Industry.” The name is unwieldy, but the research is powerful:

This report has evaluated the available digital music distribution services over a longer period, and analysed the underlying rules, mechanisms, theories and opinions within the music industry to find what factors are essential for a commercially successful service.

The music industry has now acknowledged digital music distribution services as a new channel, but there is still no successful commercial service today. Commercial services are competing with P2P services that offer a wide diversity of music at a minimal cost for consumers and there is a great need for the industry to find a commercial alternative that consumers will accept.

A number of factors important for a successful service have been identified. These include a relevant music selection, availability virtually as conveniently as unprotected files, usability in the form of a good search tool and logical categorisation, as well as an efficient revenue control utilising alternative revenue channels. Other important factors are copyright rules that need to be revised to become more globally coherent. The industry also needs to develop a working copy protection system that does not impose too many limitations for consumers without losing the ability to generate revenue for content owners. New pricing models are needed for consumers to accept payments for music files, and subscriptions or eventually an indirect payment method seems to be the best solution.

Digital music distribution promotes diversity in music genres and services, and ventures with superstars will be riskier and less lucrative in an uncontrolled music environment. There are a limited number of different customer groups, and services should focus on groups interested in a more diverse market offering. At the moment only P2P services offer such diversity.

Up to now, music industry strategy towards file sharing and services such as Napster and Kazaa has been counterproductive. The notion that downloading is free (and therefore involves consumers stealing from artists and record companies) is far from correct. The annual estimated spend by consumers on downloading, in the form of fees to telecom firms and ISPs far exceeds estimates of the record industry’s net annual revenue (income – costs).

When adapting from the current physical value chain, based on sales of CDs, to one including digital music distribution there are redundant steps, and a restructuring and streamlining of the value chain is necessary in the new environment. There is also the possibility to tap information from various stages of the physical value chain and take advantage of it to create new revenue sources.

Disintermediation of steps in the physical value chain can benefit creators by bringing more independence from the industry and by creating new possibilities for distribution of their music, although this is dependent on how established the artist is. New artists will still need third parties, but need not necessarily be as dependent on the industry as today.

The main conclusions:

1) Even a conservative estimate of consumers’ annual investment in acquiring music from the Internet results in figures which are far greater than the annual net revenue (income – costs) of the Record industry from selling “legal” CDs.

The heavily publicised rhetoric regarding “free music” has deflected the spotlight from the actual costs of file sharing. One of the few estimates made public up to now came from the MD of the UK-based “legal” downloading service, OD2 in 2002; this concluded that every download in the UK, on average costs 60 Euro cents.

KTH research estimates that Swedish consumers spent 117 million US dollars on such activities during 2002, and that the global figure, after a sudden fall-off with the closing of Napster, has risen from 6 billion dollars to over 11 billion dollars annually. The latter is the result of the explosive growth of programmes such as Kazaa (with over 190 million downloads of its software). These figures can be compared to estimates of the annual net revenue of the recording industry in Sweden (82 million US dollars) and globally (3.8 billion dollars per annum).

2) The Music Industry’s rhetoric a) pronounces similar accusations of criminality against both owners of illegal CD factories and teenagers using file sharing techniques to acquire music and b) maintains that Internet music is “free”. This coupled with a legal strategy which led to the closing of services such as Napster has probably been counter-productive.

3) Not every part of the music industry is suffering. Concert revenues and attendance increased 20% last year in the USA – similar trends can be seen in Sweden. Concert promoters suggest that this is largely due to the access to a wide range of music over the Internet – music in the virtual form triggers of a consumer desire to experience a physical equivalent/experience. Mainstream radio is becoming more and more streamlined (with the concentration of ownership), and listener figures have been falling since an all-time high around 1998/99. Particularly teenagers are shifting to the Internet where diversity and range of choice is the most compelling attraction.

Music publishing is thriving – in part because a share of live music revenues generated in the form of copyright fees, go to the publishers (ironically, the largest of these beneficiaries are owned by the same corporations which own the suffering and complaining record companies)

4) The generation of traffic is the most important need for firms that invest in and operate digital networks. Closing down Napster functioned as a sudden arctic cold shower for the telco industry. By and by, new forms of more decentralised file sharing applications became available, ones where the actual content which is swapped is harder to track.

It would have been much better for both the content and the telecom industries to have come to a revenue sharing agreement re incomes from P2P activities (even encouraging growth of P2P activities) than to close down services, dismissing them as “illegal”.

5) The “legal” downloading services which have not been controlled by the major record companies, have not been able to compete with the likes of Kazaa and Morpheus, not so much because of price or quality/reliability, but because they cannot offer the same range of choice.

The record industry’s own comparative offerings (PressPlay and Musicnet), though launched in 2001, are still not available in Europe, and have only a scattering of subscribers in the USA.

6) These observations are extremely important in the context of the move to 3G mobile networks. If the varying interests of operators, content owners and consumers are not accepted by all parties. If compromises are not reached, then the development of 3G entertainment services could be severely hampered. No operator will wish to end up in the courts as an alternative to suing Napster or Kazaa.

Read the whole darn thing.