The Fall of DRM
In an effort to combat piracy the music industry has experimented with alternatives in the physical medium on which music is sold as well as piracy thwarting technological blocks. First, the industry tried to upgrade from the standard CD format to more difficult to pirate high audio quality SACD or DVD-Audio albums. These were largely viewed as superfluous and costly because they often required the purchase of a new player to listen to them. Next, the industry adopted DRM, a technological system limiting the total number of devices a song would play on. This system failed because fans continued to illegally download millions of mp3s and quickly found ways to convert their DRM protected files to unlocked mp3s. Barney Wragg, head of digital music for EMI and former Senior Vice President for digital music at Universal Music, had an epiphany in summer of 2006, “I realized that as an industry we’d kind of been smoking crack.” After eight years of fighting the mp3, major labels were beginning to accept that selling DRM-free music was necessary for survival and, with Mr. Wragg pioneering the way, EMI was the first major label to become DRM-free. Other major labels were soon to follow. Universal Music abandoned DRM in summer of 2007, and a few months later Warner and Sony BMG had no choice but to join the movement by making their entire catalogs available DRM-free via Amazon.
Upon realizing that no adequate technological protection system existed to effectively stop piracy, the record industry shifted its approach. Rather than protecting their music files with DRM or by threat of litigation, record labels would simply provide enough incentives to induce consumers to purchase CDs. Once such incentive is added value content. Alicia Keys’s hit album As I Am was released in late 2007 chock-full of added content, including: 30-second audio files for ringtones and ringbacks, mobilephone wallpapers, and digital videos, which were also distributed through YouTube and MySpace. Inducement through added content proved to be a smash for Ms. Keys when As I Am sold more than 3.5 million copies. Ian Rogers, former general manager of Yahoo! Music, articulated it well when he said “[t]he record companies are all realizing they’re not in the CD business anymore.”
Much to the surprise and luck of the record business, another income stream emerged. The ringtone began in the 1990s using a low quality synthesis technology driven by MIDI enabling mobile phones to synthesize popular melodies. Being that these ringtones were not using real audio snippets off of the records they emulated, royalty money was only available to the composers and publishers, not the labels. In the early 2000s “Real Tones” began to replace MIDI ringtones. This second generation was far superior in quality because it used snippets of the actual records. As a result, ringtone revenues jumped from $68 million in 2003 to $600 million in 2006. This was an incredible surprise to the record industry. “We see no sign of it slowing down right now, that’s for sure,” Rio Caraeff, vice president of Universal’s US mobile division, said in late 2006. Some ringtones are generating millions in revenue. For example, the Black Eyed Peas’ “My Humps” sold more than 2 million ringtones, helping to foster album sales, which topped over 6.5 million copies. Similarly, T-Pain’s “Buy U A Drank” sold 2.3 million ringtones. Some in the industry are skeptical of the explosive growth of the ringtone and do not see it as a long-term income stream. Peter Paterno, attorney for mega-stars like Metallica and Dr. Dre., wonders “what’s wrong with a [traditional] ring?” He added, “[i]t doesn’t seem like anything that’s going to have long-term sustained growth.” Mark Donovan, senior analyst for M:Metrics, a trusted source of mobile media measurement, argues “[r]ingtones are fashion,” implying a short lifespan.
Others contend the cell phone may supplant the music market from the iPod. In support of this belief, Apple released the Wi-Fi Music Store for the iPhone September 9, 2007. The data in Apple’s Form 10-Q report shows net sales of the iPhone and related products and services were $1.2 billion in the first quarter of 2009 with iPhone handset unit sales totaling 4.4 million. Unit sales of iPhone increased 2.0 million or 88% during the first quarter of 2009 compared to the same quarter in 2008. This is a substantial amount of growth in the number of handsets in the hands of consumers. Net sales of other music related products and services increased $203 million or 25% during the first quarter of 2009 over the same quarter in 2008 primarily because of double-digit growth in net sales from the iTunes Store. This indicates more and more consumers are turning to the digital domain to make their music purchases. Once these digital domain purchasers fully converge with the millions of handset owners, the potential number of exclusively mobile phone based music transactions will be astronomical. This demonstrates a high rate of growth potential of the cellular sector of the music business further supporting the assertion that mobile phones may be the dominant transaction point for the record labels of the near future.
Another approach to the mobile phone music market came from Nokia. The Nokia “Comes with Music” program, currently only available outside of the US, enables users to download all the music content they want for a year. This subscription model provides the consumer the benefit of incredible unparalleled access without the gateway of a transaction. The cost of content is absorbed in either the device’s price point or service charges allowing consumers to feel like the music is free. This model is also record label friendly because it allows for heavy DRM to exist on the device. A number of major labels have embraced this concept including Universal, Sony BMG and Warner.
In response to the dramatic shifts occurring in the music industry, record labels were forced to rethink every aspect of the way they do business. Labels decided to drastically change the structure of their relationships with their artists. This was the birth of what is popularly referred to as the 360 deal. Traditional record deals limited record companies profit participation to the revenues derived from the intellectual property of the sound recording of an artist’s music. To contrast, a 360 deal allows a record label to share in all the vertical revenue streams of an artist, including the profitable areas of touring and merchandising. This lucrative territory has been off-limits to labels because it is where most artists are able to make their living.
Some artists and artist-advocates vehemently oppose this trend. Panos Panay, CEO of Sonicbids, an artist promotion utility assisting over 200,000 bands, strongly discourages 360 deals. He argues that 360 deals are nothing new, referring to a time when Motown groups like the Temptations and the Jackson 5 were owned by the record labels. He adds that the craze toward 360 deals for huge mega-stars is not the right direction for the future of the industry. Rather, the future is in supporting the “niche-reaching artistic middle class.” Companies like Live Nation paying 9-digit advances for bloated stars past their record selling prime is a terrible business model and the falling value of Live Nation stock is evidence that financial analysts may agree.
Proponents of the 360 deal movement argue the benefits outweigh the costs. The largest benefit brought about is an greater incentive for record labels to invest in the long-term success of the artist in each vertical revenue stream. This structure is more reminiscent of a business partnership than a record deal. In 2005 the band Paramore signed a 360 deal with Atlantic Records. Paramore’s singer Hayley Williams had this to say about their deal, “[y]ou have to sacrifice to get somewhere. You have to give up pieces of something to get back something from your work…feels like a great partnership.” Paramore has since become one of the hottest young rock bands in American, selling more than 350,000 copies of its Riot! CD. How much of that success is attributed to the greater incentive for Atlantic Records or the talent of Paramore is not known.
[Photo by jbonnain @Flickr]
 Knopper, supra note 53.
 See http://www.mmetrics.com/about/overview.aspx (last visited April 2, 2009).
 Knopper, supra note 53.
 See Apple Inc., Form 10-Q: Quarterly Report for Quarter One of Fiscal Year 2009, available at http://media.corporate-ir.net/media_files/IROL/10/107357/09/AAPL_10Q_Q1FY09.pdf (last visited April 15, 2009).
 Knopper, supra note 53.
 See http://www.sonicbids.com/About/WhatIsSonicbids.aspx (last visited 4/29/2009).
 Panos Panay, 360 Deals Are Not The Future (2008). Available at http://panosbrew.sonicbids.com/360-deals-are-not-the-future/ (last visited 4/29/2009).
 Jeff Leeds, The New Deal: Band As Brand, New York Times (November 11, 2007). Available at http://www.nytimes.com/2007/11/11/arts/music/11leed.html?_r=1&pagewanted=all (last visited April 15, 2009).
 Knopper, supra note 53.