MUSIC|MEDIA|DESIGN

The RIAA just released it’s 2005 sales numbers, spinning it as the biggest disaster since Napster. Yet while gross sales have declined by any measure, it’s impossible to paint 2005 as worse than 2004. That’s because the numbers presented by the RIAA are a pig in a poke, showing only half of the balance sheet. Left out are profits, and a breakdown on the impact of the numbers on artists and fans. When taken into account, last year’s numbers, at worst, hold the line. Well managed companies and most artists, saw real growth in profits, so the real story is the drop in costs associated with new, high-margin markets that never existed before.

Overall, gross sales of fixed media products was down by a little less than a billion dollars, or a little more than 8%. But downloads were up by a little less than half-billion dollars, from the previous year. Taken together, this means gross sales dropped by about $69 million total. That sounds like a lot, until you place it next to the $12 billion worth of music sold in total. Historically that places 2005 among the top 5 years of all time! So, no matter how you look at it, 2005 wasn’t a disappointment. To lose money in 2005 you had to be an intransigent, belligerant, anti-customer crusader, willing to put principle above profit. In other words, a major label or the RIAA.

According to Jupiter Research, the industry average splits for a $14 CD look like this: 20% goes to the retailer, 11% to distributors, 7% to marketing, and 11% of the costs are for manufacturing. That leaves 30% to be split among all rights-holders (including the label, which often took a cut on all of the previous numbers, as well as the rights, through subsidiary/sister companies). For digital downloads the retailer (Apple’s iTunes or Rhapsody) have historically lost money, resulting in a -2% figure. Don’t feel too bad for the e-tailers though: Apple exists to sell iPods, not iTunes! Beyond that, the label’s “distribution” arm or contractor snag 30% of your $0.99 purchase, 3% is spent on marketing, and the cost of goods is pegged at 4%. This leaves 65% to be split among various rights-holders! For subscription download services the numbers are slightly different, but the bottom line there is that rights-holders split 55% of the sales.

The RIAA says labels lost $69 million in sales last year, but every penny of that drop was in sales of lower-profit CDs and fixed media. But digital-delivered media grew by 174%. If we assume half of all digital sales last year came from the less-profitable subscription services, rights-holders saw profits of $302 million for 2005, versus just $109 million in 2004. While poorly managed companies might be able to squander a nearly $200 million of extra profits individually, it’s hard to believe an industry is collectively that dumb, or mismanaged. If they are that poorly managed, their wounds are self-inflicted, and of no concern to the public at large.

When we add in ring tones and other new markets with even higher profits for the label, the truth becomes clear. While gross sales may be sliding, people’s consumption of purchased music is actually UP, even by the RIAA’s own published numbers. And not by a little. In 2004 the industry sold 814 million physical units or individual products (e.g. CDs, DVDs etc), which dropped 8% to 748 million in 2005. When you add in digital sales, this decline looks different: total units amounted to 143 million in 2004 which then expanded to 383 million in 2005.
Altogether the labels sold 957 million units in 2004, versus 1131 billion units in 2005. The biggest falling categories in 2005: Vinyl, as usual, slipped more than 25%, while the CD single fell by 11%. Yet never before in the history of the music industry have 1.13 BILLION songs/albums been sold. In the industry’s salad days, they rarely cracked 1 billion units! More people bought more music in 2006 than ever before. I’m not surprised that the media ignored this critical fact.

While the RIAA and labels rightfully love the CD, consumers, shareholders, and artists would be wise to look closer. The market-driven shift away from CDs to digital-delivery media has been good for everyone. Choice is always good and positive to consumers, as well as artists. Having a product for every taste used to be a luxury, but digital delivery eliminates production/inventory, and suggests new packaging, uses, and quality options to further improve the experience. iTunes and Rhapsody don’t just offer more selection and variety than any bricks and mortar retailer, they never run out of product. There are no inventories or backorders, only sales. The resulting boom in sales demonstrates a Republican truism: removing the fixed media tax heated up the broader market. Consumers bought more music legally with the money they were saving (the gross drops).

By turning impulse into easy money the labels made more profit in 2005 on lower sales! Without returns and risky inventories to maintain, the ability to sell an entire catalog ad infinitum is suddenly reality. The implication of the RIAA’s 2005 sales numbers is undeniable and clear. They have replaced money losers and potential mark-downs with an ideal widget. Marketing, of course, remains an expense, and that expense will eventually move to digital media. The inherent efficiencies of these new models are undeniable, so the key becomes management. Good, basic business managers can transform a label’s catalog into an efficient, reliable money-press.

I saved the best for last. The shift away from the CD has not been kind to major label artists with conventional contracts that penalize their earnings in digital-delivery, and rely on the labels accounting practices to get paid. But at the other end of the spectrum, we’ve seen the emergence of a new middle class of artists. Artists who were dropped or fled the majors have discovered a comfortable living can be made simply by letting their fans know they’re alive, and making cool songs. These artists can benefit from the shift away from CD, just like major labels. Indeed, they benefit a little more: The cost of manufacturing is the single largest hurdle most independent artists face, so any relief in this area is welcome.

It’s worth mentioning that the industry’s expectation of ever-growing gross sales, alongside ever widening margins and lowered costs is unrealistic. Since 9/11 every other industry has learned to stretch margins in order to survive on lower gross sales. The Wal-Mart effect is becoming an economic law in consumer products: Over time the cost of goods must decline or perception of volume must increase to maintain volume. Smart, well managed companies make a choice: Adapt to the Wal-Mart rules or die. Adaptations are many and diverse, but successful ones do not include crippling products (copy protection, lawsuits), and collusive distribution practices that hurt sales.

The CD has been a great for artists and the industry. By any definition, it was the first new media product: Digitally stored, algorithmically coded, randomly accessible, and easily transcoded to be used any and everywhere the fan desires. These qualities transformed the entire industry and paved the way to the generation of products emerging today: Higher profit, lower cost, more easily delivered, and ever more diverse and customizable. 2005 was the first year of the modern era of music and recording. The new models brought to market last year are better for all concerned than the products they replace. Welcome to the 21st Century.