Singing The Blues
As CD sales tank, the music industry changes its tune
By Betsy Streisand and Dan Gilgoff


With the annual Grammy Awards just a few weeks away, the heavy betting has begun. But this year it's focused not on which rap and rock stars will walk away with the most awards, but on who in the industry will still be standing by the time those little gold phonographs are handed out.

By now, the sorry state of the music business is as familiar as the harmonies of the Dixie Chicks. Sales of CDs fell almost 9 percent in 2002 and are expected to be down this year an additional 6 percent. Instead of buying music, fans are flocking to online services like Kazaa that allow users to digitally swap songs free. All five major music companies--BMG, EMI, Sony, Universal, and Warner--are either losing money or barely making any, and most analysts predict that it won't be long before consolidation forces five into four and maybe even three. Retail music outlets such as Wherehouse and Musicland are closing down by the hundreds.

Musical chairs. And heads are rolling, among them, legendary Sony Music Entertainment CEO Tommy Mottola, who launched the careers of such divas as Celine Dion, ex-wife Mariah Carey, and Jennifer Lopez. With Sony's profits slipping, Mottola was forced out in January and replaced by Andrew Lack, the former president of NBC, whose virtues include never having spent a day in the music business. Also exiting is Hilary Rosen, the industry's chief Washington lobbyist and Napster killer. Rosen recently said she will call it quits as head of the Recording Industry Association of America by the end of this year--with the industry's blessing (now the group can replace her with someone even tougher). Things have gotten so bad that Wired's February issue, featuring Led Zeppelin's flaming Hindenburg album cover under the freeloaders' creed "Rip. Mix. Burn," declares 2003 "The Year the Music Dies."

Not surprisingly, the music industry regards reports of its death as greatly exaggerated. "It's pretty difficult to kill a multibillion-dollar industry," says Lee Black, a music industry analyst with Jupiter Research. "I haven't seen one die yet." But while Black, and most in the music business, agree that it will eventually right itself, they also acknowledge that 2003 is going to be a bloodbath. "We are in for a giant upheaval," says one record company CEO. "All our business practices need to change."

To regain their footing in a digital world, music companies must find a way to market single tracks to buyers conveniently and cheaply; stave off the pirates who use services like Kazaa and divert billions in revenue from record companies each year; and cut the spiraling costs of grooming new artists. And they must win back music buyers who can't fathom why--other than greed--the Spider-Man soundtrack costs more than the Spider-Man DVD. Each of these problems is daunting. But none is more pressing than piracy.

The industry says it is moving aggressively to provide music online to counter illegal downloaders, investing more than $1 billion so far. But industry-backed subscription services like Rhapsody, Pressplay, and MusicNet came on line only in the past year. And it wasn't until November that they all had deals with the five major labels. The services charge between $10 and $20 a month and limit copying of songs. They also remove some of the pitfalls of file sharing, like downloading mislabeled or infected song files--and they make sure that artists get paid. But so far, they have signed up fewer than 100,000 custom-ers each, a pittance compared with Kazaa's service, which in one week in January was downloaded 3 million times. And many artists, including Madonna, Garth Brooks, and the Beatles, remain absent from playlists because of licensing issues.

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Singing The Blues
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Still, these sites may yet catch on. "Ultimately, I think the Internet will be a huge good thing for the industry, and they will make tons of money off of it," says Black. Sixty percent of Pressplay's free-trial members, for instance, become paying customers. And a September poll by Ipsos-Reid, a market research firm, shows that 31 percent of Americans who have downloaded music from the Internet actually paid for it, up from 27 percent last June. "But it's going to take time," says Larry Kenswil, president of Universal Music Group's eLabs division, noting that the services are only just beginning to advertise. "People are going to have to see the value of access to music rather than ownership of music."

That's a huge leap for file swappers accustomed to downloading files gratis and having their way with them. "People don't want to pay a fee to be able to burn a track to a disk and know that it is forever locked on that CD," says Eric Garland, CEO of BigChampagne, an Internet consulting firm.

Crowd pleasers. To counter that, subscription services are rich with perks like personalized music recommendations or early downloads of new releases. A pair of tracks from Jennifer Lopez's most recent album, for example, were available on Pressplay two weeks before the record landed in stores late last year. It's also a tactic labels hope to use in building direct relationships between artists and fans, thereby reducing the need for high-priced radio and MTV promotion. At Warner, selling downloads of singles on pay sites the day they are introduced on radio is becoming standard. "We might as well sell them," says Paul Vidich, an executive vice president of the Warner Music Group. "All we're doing right now with radio is driving people to Kazaa."

Meanwhile, the brick-and-mortar set is trying to rekindle its own relationship with music buyers. Last week, six big retailers including Best Buy, which closed more than 100 of its Musicland stores this year, and Wherehouse, which shuttered about 120, launched their own online music service, called Echo. The six account for about 40 percent of recorded-music sales in the United States. They plan to use their clout to strong-arm the record companies into cooperating in what they hope will become the world's largest music database, with songs from all the major and independent record labels. Users will be able to download any song for a fee and burn it onto a CD or visit a store and download songs from special kiosks directly onto portable music players. Wal-Mart, the nation's largest music retailer, is headed in the same direction. Last week, its music distributor, Anderson Merchandisers, acquired some of the assets of Liquid Audio, another online provider of digitized music. "This could be the crossover year, when the public attention to enforcement goes down and the attention to legitimate sites goes up," says the RIAA's Rosen, in a bit of uncharacteristic wishful thinking.

Fight songs. The free-music crowd, to say nothing of the technology industry, is bracing for more battles, particularly after a pro-industry decision last month by a federal judge requiring Verizon to disclose the identity of a subscriber who routinely swapped music files. Last week Kazaa sued the entertainment industry for misuse of copyrights and violating antitrust laws after the industry refused to license music and movies to file-sharing services. The suit, which is widely expected to fail, comes in response to the industry's copyright-infringement lawsuit against Kazaa and harks back to a suit Napster filed in the face of similar attacks.

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But simply reining in the file swappers won't be enough to turn things around. Companies need to tap into new sources of revenue as competition from DVDs, video games, and virtually every other source of entertainment swells. "We have to be everywhere," says Ron Shapiro, copresident of Atlantic Records, which is part of AOL Time Warner. "Young people have `remote control-itis.' You need to be on MTV when they're there, and when they turn the channel, you need to be on the commercial they've flipped to--and the one after that--and when they finally give up on TV and open a magazine, you want to be there," he says.

To that end, Celine Dion is hawking Chryslers, Shakira CDs adorn the lids of Pepsi cups, and cellphones are playing Avril Lavigne's "Sk8er Boi" when a call comes in. Analysts estimate that ring tones, for instance, the preprogrammed music on cellphones, could be a $1 billion business annually. "Ring tones is a real business, and it demonstrates that you can sell stuff for $1 or $2 a pop and people will buy a lot of it," says Vidich. CD prices also are coming down to boost sales. "It's absolutely ridiculous that a soundtrack CD should cost more than the movie," says one record executive. In fact, many record companies are selling CDs by new artists for limited periods of time for as little as $7.99. Record companies also have seriously begun eyeing the money artists earn from concerts, sponsorships, and the sales of merchandise, revenue that artists have traditionally held on to tightly. British pop idol Robbie Williams, for example, recently signed a multialbum deal with EMI worth more than $80 million. The deal gives EMI a stake in touring, merchandising, and publishing profits. Although many talent managers say their clients will resist such deals, record executives believe they are the future. "We've got to have a business model that helps keep the industry afloat," says Antonio "L.A." Reid, president of Arista Records, home to pop sensation Lavigne. "Managers may not want it, but the Robbie Williams model is the model of the future."

And though branding stars like soft drinks--or packaging their music with them--offends music purists, the economics of the industry demand it. Record labels spend millions developing and marketing artists, even though less than 1 in 10 acts signed by labels ever makes it to the Top-40 charts. And even superstars lack staying power these days, often fizzling out after a few albums. But while everyone in the industry agrees that slashing such costs is absolutely crucial, it is also next to impossible. Talent and marketing account for more than a third of all budgets, and "when a hot artist comes along, there is always going to be someone there to outbid you," says one label executive. Some firms are tightening up advances to new artists--the typical $100,000 for seven albums is shrinking to five figures, for instance. And bands whose first albums don't cover costs are immediately given the ax.

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But, ultimately, the industry will look to the music to bail it out, as it always has from disco to pop to hip-hop. "We're in a transition," says Reid. "We haven't had our new boom yet--whatever it will be. But don't count us out."

CD sales slide*

700 million CDs

[Complete chart data are not available]

2001 712

2002 650

*U.S. sales


600 500 100 0

1998 '99 '00 '01 '02

Source: Nielsen Soundscan

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