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18 VLSELJ 63 Page 1 18 Vill. Sports & Ent. L.J. 63 Villanova Sports and Entertainment Law Journal 2011 Article *63 NEW BUSINESS MODELS FOR MUSIC Henry H. Perritt, Jr. [FNa1] Copyright (c) 2011 Villanova University; Henry H. Perritt, Jr. I. Introduction 65 II. The Problem 70 A. The Old Model 72 1. Recorded Music 72 2. Live Performances 84 3. Publishing 86 B. Effects of Technology's Latest 87 Revolution 1. Effects of the Demise of the CD 88 2. Limited Potential of Downloadable 89 Digital Files 3. Potential of Live Performances 91 © 2012 Thomson Reuters. No Claim to Orig. US Gov. Works. 18 VLSELJ 63 Page 2 18 Vill. Sports & Ent. L.J. 63 C. Law's Role 93 III. Who Makes Music Now? Why and 96 How? A. Hedonic Values 97 B. Making Money 103 1. Why Money Matters 103 2. Day Jobs and Opportunity Cost 107 C. Career Paths 111 1. Life Cycle of a Band 111 2. Two Case Studies of Successful 112 Entrepreneurship: Vampire Weekend and Fall-Out Boy a) Vampire Weekend 113 b) Fall Out Boy 118 c) Common patterns 125 3. Plateaus of Popularity 128 a) Established celebrities 128 © 2012 Thomson Reuters. No Claim to Orig. US Gov. Works. 18 VLSELJ 63 Page 3 18 Vill. Sports & Ent. L.J. 63 b) Striving Entrepreneurs 129 c) Hobbyists 131 d) Balancing the motivations 132 e) Artist exit 135 IV. Who Consumes Music and Why? 136 A. Demographics 137 B. Musical Preference 138 1. “Quality” of the Music 139 2. Vicarious Association with Celeb- 147 rity 3. Music is Modeling 148 4. Popularity of the Music 151 C. Finding What You Like 151 D. Formats 153 V. Music Market Intermediaries 154 © 2012 Thomson Reuters. No Claim to Orig. US Gov. Works. 18 VLSELJ 63 Page 4 18 Vill. Sports & Ent. L.J. 63 A. Need for Intermediaries 155 B. New Intermediaries 158 1. New Distribution Channels 158 2. New Matching Services 159 3. New intermediation technologies 162 a) Statistical Classification 162 (1) Factor analysis 162 (2) Identification 163 b) Open Source Technologies 171 4. New Intermediary Entrepreneur- 172 ship VI. Structure of the New Marketplace 173 A. Matchmaking 173 B. Role of the Bottom Tier 174 C. Breaking Through 174 D. Investment Capital 176 © 2012 Thomson Reuters. No Claim to Orig. US Gov. Works. 18 VLSELJ 63 Page 5 18 Vill. Sports & Ent. L.J. 63 1. Capital Sources 176 2. Sources of Subsidy 177 a) Cross subsidy From Day Jobs 177 b) Direct Subsidies 180 VII. Business Models: the Money Part 181 A. Elements of a Business Plan 182 1. For Musicians 183 a) Costs 183 (1) Recorded Music 183 (2) Live Performances 185 b) Revenue 186 2. For Intermediaries 188 a) Revenues: Tapping New Revenue 191 Streams (1) Live Performances 192 (2) Publishing 193 © 2012 Thomson Reuters. No Claim to Orig. US Gov. Works. 18 VLSELJ 63 Page 6 18 Vill. Sports & Ent. L.J. 63 (3) “Merch” 194 (4) Ring Tones 195 (5) Music Tracks for Movies 195 (6) Advertising 196 (7) Access to Celebrity 198 (8) Revenue Results 200 b) Costs 201 (1) Total Costs, Including Costs of 201 Tapping New Revenue Sources (2) Bribes (“payola”) 202 3. Capital Requirements and Re- 204 turn-on-Investment 4. Uncertainty 205 B. Effect of Declining Efficacy of IP 208 Protection: Making Money from Free Music VIII. Conclusion 211 © 2012 Thomson Reuters. No Claim to Orig. US Gov. Works. 18 VLSELJ 63 Page 7 18 Vill. Sports & Ent. L.J. 63 *65 I. Introduction The popular music industry is in the middle of a technology-driven revolution. It is clear that the old order has been swept away, but it is not yet clear what form the “new order” will take. The major labels are on life support and will not survive in anything like their previous form. Compact Discs are dead as a distribution medium. Copyright is unenforceable and hence essentially irrelevant except at the margins of the “new order.” Barriers to entry have been reduced dramatically as the costs of producing top-quality recordings have declined by a couple of orders of magnitude. Portable music players such as the iPod permit consumers to listen to music all the time and this enormously increases the potential demand for music. The amount of new music generated by indie musicians will increase as the demand for music increases because of its portability for consumers. Copyright protection, in the form of digital rights management (“DRM”), will become even less effective for recorded music and technological protections and will be abandoned altogether. The result will be continued downward pressure on prices for recorded music and soft demand for paid record sales. *66 Increased supply and demand mean increased search costs--how are musicians and their potential fans to find each other? As in the past, intermediaries must match consumers with the music they like, but this will happen in new ways. As music MySpace pages and independent websites proliferate, the burden of finding new music only increases. Someone has to perform the matchmaking function formerly performed by the major labels and the radio-station chains. Who will do it? In- novation and experimentation will increase as new kinds of intermediaries try to find the best way to connect musicians with their potential fans. A handful of these will become the dominant gatekeepers. The increased competition and the demise of traditional gatekeepers signal a sharp reduction in prices--approaching ze- ro--for recorded music. This means a reduced revenue stream to support anyone in the industry unless demand increases so heroically as to outpace the downward pressure on prices. This is unlikely. What business model will support the post-revolutionary space? In this climate of increasing competition, musicians and their sponsors will try to fill the revenue gap for established musicians and to support new entrants by shifting their focus to live performances, ring tones, new forms of fan-performer interactions, movie scores, and advertising. All the evidence supports the proposition that most musicians will make music; even without a business model. They say that they want to “get to the next level”--that they want to make a living from their music. But their behavior makes it clear that they will perform for pennies or for free to get their music in front of any crowd--live or virtual--even if limited to their friends and to the friends of other bands appearing on the same bill. It may become easier for a few new musicians to break through and to achieve a significant following among consumers, but most will continue to labor in obscurity. Many of them will make good music, but it will be listened to only within a modest circle of associated musicians, their families and friends. It is unlikely, however, that potential intermediaries, necessary to perform the matchmaking function, will work for free. Even if a business model is unnecessary for the musicians themselves, it is necessary for the intermediaries. [FN1] Unless such a business model can be framed, embraced, and sold to investors, the “new order” in the music industry will be one in which hundreds of thousands of *67 artists making very good music go essentially unnoticed by those who would enjoy their music. The demise of the major labels will not be the end of the “music business.” The major labels were never the true innovators. [FN2] Nevertheless they channeled capital to anonymous musicians and enabled a handful to become famous, as the labels poured money into attempts to build a following for those they adopted. The big questions about the future of popular music are who will aggregate and allocate capital? Who will perform the gate keeping, advertising and promotion functions historically performed by the major labels? Metaphorically, this is a struggle between dinosaurs and beavers, with herds of amiable and talented sloths on the fringes, providing background music. The dinosaurs--the major record labels, their defensive myths, and their lobbyists and law- © 2012 Thomson Reuters. No Claim to Orig. US Gov. Works. 18 VLSELJ 63 Page 8 18 Vill. Sports & Ent. L.J. 63 yers--are trying to crush an environmental phenomenon that threatens to make them extinct. The beavers--the indie musicians and the entrepreneurs who are experimenting with new forms of intermediation--are largely oblivious to the thrashing of the dinosaurs, and are heroically working to construct structures that work in the new marketplace. Because most beavers focus on the individual trees rather than the forest, most will fail; but some will succeed in proving the viability of a new business model. [FN3] This article is the fourth in a series by this author seeking to explore the impact of the technological revolution in the music industry. The first three built the case for three propositions concerning costs, copyright, and DRM, while this article explores the question of what economic incentives will suffice to facilitate an effective market in the absence of intellectual-property or copy protection. [FN4] It bases its analysis, in part, on empirical evidence collected from interviews with musicians and music consumers. *68 Following this introduction, the article first defines the problem; explaining why the old business models have eroded in the face of new technologies and of the changing role of the law--especially copyright law. Then, it builds on the author's work in his New Architectures article, explaining who makes music, who consumes it, and why. These sections explain that while money plays a role in the marketplace for music, it is secondary to “hedonic” factors both for musicians, who make music largely for self-expressive and self-affirmation reasons, and for consumers, who listen to music for reasons including idio- syncratic perceptions of its quality, a desire to be part of a particular crowd, and vicarious identification with or attraction to the performers.