Music Industry still clueless

Wynn Quon

(This article ran in the National Post, July 29, 2005 under the title: "Musical Loss Leader".)

Item: The U.S. Supreme Court recently ruled in the case of MGM vs Grokster that peer-to-peer file sharing companies are liable if they actively promote copyright infringement.

Have you shared any music files lately? Nudge, nudge, know what I mean? MP3s? Nudge, nudge, wink, wink, say no more?

The Supreme Court decision was lauded by record companies but the ruling is really a hilarious exercise in comic irrelevance. Oh, there's lots of money to be made by the lawyers in follow-up litigation but in terms of stopping file sharing, any edict even one from the highest court in the land is about as effective as a mop in a monsoon.

Consider what's happened in the technology of file-sharing since the lawsuit was launched just two years ago: The reigning champ in file-sharing isn't Grokster, Morpheus or Kazaa. The hottest name now is BitTorrent. But good luck trying to sue, because BitTorrent isn't a company, it's a clever piece of free software created by Bram Cohen. With it you can set up your own file-sharing service overnight. It's as easy as pitching a tent. P2P companies are being overshadowed by hordes of private or semi-private file-sharing communities. And what about the simple file-sharing that goes on millions of times a day on a person-to-person basis? You don't even need BitTorrent to do that. Not when you can e-mail a song to anyone you like, or burn a DVD and fill it with 150 albums, or a put a few hundred songs on a flash drive. Yeah, that's right, try enforcing a digital Prohibition when every living room is a speakeasy.

There's great irony about Grokster having to run through the judicial gauntlet. It isn't even the worst offender when it comes to copyright violation. That honor surprisingly enough belongs to Google. As a way of speeding up Internet searches, Google takes a copy of every web page it scans. It's 8 billion pages worth of copyright violation. No one complains about the infringement because Google transmutes that raw digital content into gold for web site owners while making a tidy profit for itself.

It'd be great if record companies used the same sort of creativity and imagination to ride the waves of technological change. Instead they're clinging to the shaky notion that they can set the price for music in an age where bits and bytes are essentially free . They point excitedly to Apple's iTunes service. They lionize iTunes and their 99-cent songs for "reviving" online music. Which is pretty funny because iTunes isn't about selling songs, it's about selling more iPods. (Incidentally, the total capacity of all iPods sold so far is perhaps 30 billion songs and yet iTunes has sold only enough songs to account for about 1.5% of that capacity. So where are listeners getting the rest of their music? Nudge, nudge, wink, wink).

The optimism for online music sales is vastly misplaced. For a stark view of the bleak future for selling music online, check out . This Russian site has a library of 300,000 tracks and because of a quirk in Russian copyright law sells its wares without the oversight of the major record labels. The first thing that hits you about this site is its brutally honest pricing scheme, they charge you 2 US cents per megabyte. It's bits by the bucketsful. The second thing you notice is how deeply they're undercutting services like iTunes. A typical 4Mb MP3 song costs merely 8 cents, less than a tenth of what iTunes charges. Can you say "race to the bottom"?

The lesson that the music industry should be taking from iTunes is not that selling MP3's is viable, it's that the digital music file is the perfect loss leader. Its marginal cost of production is zero. Use it to sell something that cannot be copied (fan merchandise, live performances, endorsements, collectibles). The media (an MP3 file) is not the product. The gold lies in the emotional connection between performer and audience.

The unexploited opportunities for the music industry are legion. P2P services provide the perfect way for people to explore music. (In fact if P2P services disappeared overnight, CD sales would suffer.) The Internet is bringing millions of new music consumers online. The internationalization of music means unprecedented upside in a band's audience. Fan websites, podcasting, satellite and Internet radio are great new promotional avenues. But instead of rising to the challenge the mainstream music industry is fixated on turning back the clock. Not only that but consumers are forced to foot the bill for its sloth. Here in Canada, every time we buy a CD-R, we pay a 21-cent levy to the Copyright Board. The money is given to the Canadian Private Copying Collective (CPCC), an umbrella organization that "represents songwriters, recording artists, music publishers and record companies". Never mind that the levy is four times higher than it was five years ago. Never mind that the levy is now 100% of the cost of a blank CD. Never mind that consumers use CD-Rs for a lot of other things than music. (A significant percentage of CD-Rs are probably used for porn. Given their fervent support of intellectual property rights, I expect the CPCC will dutifully compensate the porn industry with an appropriate percentage).

Is there any hope that things will change? For the big music companies, the answer is no. Five years ago it could have gone either way. That was when music giant Bertelsmann took the brave step of investing in Napster. But instead of following up, record companies turned tail and fled in horror. We can expect nothing more from them than a continuing trail of futile lawsuits and levies. It may have the outward appearance of sound and fury but in actuality it signifies only comic demise.

Wynn Quon is chief investment analyst at Legado Associates (e-mail)