Wade Armstrong

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A Free Business Model For the Music and Movie Industries

Posted Sunday February 11, 2007 in Business

Mark Cuban thinks that the music labels should get together and start a company to stand against Apple’s iTunes and Microsoft. I agree that the music labels, and, for good measure, the movie and tv studios need to get out from under the thumb of the tech industry, which so far has controlled the next-generation distribution channels. But for the music industry to start its own company is risky and expensive. Instead, the music industry needs to leverage this country’s great capital markets and reservoir of mobile knowledge workers to get someone else to do the hard work for them. That is, they need to outsource their risk, and they - and the movie industry - can do this without losing their returns.

First, the Problem

On February 6, Apple CEO Steve Jobs fired a big shot right across the music industry’s bow with his Thoughts on Music. In this open letter, Jobs proposes (among other things) that major labels should start distributing music without DRM.¹ While there are many reasons for Apple to put out a document like this², it’s particularly notable because:

• Apple’s not afraid of the music labels - if Apple was afraid, Jobs wouldn’t have talked about DRM-free music, since the labels have basically forced DRM on most music vendors
• Apple believes that the iTunes Music Store/iTunes/iPod combination is so powerful that it doesn’t fear losing its lock-in - currently, you can only play iTMS-bought music on iTunes and the iPod, but with DRM-free music, you could play it anywhere. Clearly Apple thinks that consumers will freely choose to play their music on iTunes and iPod.

These two points add up to a single conclusion: Apple thinks that it’s got the power, and the labels don’t. The longer things stay this way, and the more music is distributed digitally, the less of a role music labels have to play in the future of the music industry.

The movie and TV studios are in the same boat: Google’s YouTube thinks it’s so strong that, rather than actively trying to take down copyrighted material from the studios, it engages in protracted license negotiations, allows them to break down, and only takes down the copyrighted material under legal threat. That’s hardly the action of a company that feels it’s the weak party in a negotiation.

So What About Cuban’s Idea?

Cuban’s obviously 100% correct that the labels need to do something - they can’t be beholden to wealthy companies that control the channels of distribution but are not themselves beholden to the labels in any way.³ But his idea - that the labels should create a direct iTMS competitor - is just too risky to try.

It’s risky because creating a competitor is a technology problem, not a music creation and distribution problem. The music labels understand the latter two, but they haven’t shown yet that they understand technology at all. And why should they? They make music, not MP3 players. For them to put all of their eggs in one basket, and trust that they can execute in something incredibly complicated that they’ve never done before - something that even Microsoft has failed to be successful at - is just hoping too much goes well, no matter how clever the business concept is (and Cuban’s concept is fairly clever).

How to Own Music Distribution, Risk-Free

The music labels are good at at least one thing: figuring out how to make money off of licensing music to distributors. This is a great chance to leverage that skillset. It just takes a simple four-step strategic process:

1. The labels need to get together and figure out how much they can afford to license music for, when that music is digitally distributed.
2. They leverage another skillset, marketing, and collectively decide what marketing activities an online distribution channel needs to support and enable.
3. They take the output of these agreements to some hotshot consulting firm and come up with a half dozen or dozen complete business plans that meet the requirements developed in step 1 or 2.
4. The labels agree to a compulsory licensing system, like that already used in radio, in which any company that uses one of the approved business models gets to distribute content from all the major labels’ catalogs.

Armed with compulsory licensing and a complete business plan, any entrepreneur can start their own music service. Some set of entrepreneurs will be able to access venture capital to build and grow their approved music services - after all, with a solid plan, compulsory licensing, and the right entrepreneur, VCs will be happy to open the funding tap.

The market will then judge all of these companies and models. Some will succeed, others fail; but they won’t do it on the labels’ dime. The VCs and entrepreneurs will bear the entire cost and almost all of the risk of experimenting with and building new distribution systems, while the labels get to make money from compulsory licensing as their music gets out in new ways. Then, in 3-5 years, the labels can start buying the start-ups that haven’t died and that show value to the music industry. Sure, the price tag for these companies will be in the billions, but it’s worth paying that money for a proven success. And the up-front cost will be surprisingly close to $0 - just a few meetings and a couple of million to some consultants. It’s no-risk, and positive potential return.

The movie and TV studios are in an even better position to follow this plan, because online distribution of their products is so much less mature than music distribution. In such an early environment, it’s truly best to “let a hundred flowers bloom; let a hundred schools of thought contend.”

¹ DRM, which stands for Digital Rights Management, allows the copyright owner of the music to restrict the ability of the music’s consumer to do various things with the music. For instance, if you buy a song from the iTunes Music Store, Apple’s DRM implementation, FairPlay, keeps the song from playing on others’ computers, and limits the number of copies of the music you can make on CD.

² Particularly, ongoing regulatory actions in Europe questioning whether or not the iTunes Music Store-iPod combination constitutes a monopoly.

³ With radio stations and record stores, the labels and the distributors were dependent on each other. When companies like Clear Channel aggregated multiple channels, they got a lot of power and began to exert control over what music could get bought - but at least they didn’t make the stereos and TVs. Apple would.