Will Music Sales Be Profitable for Record Companies in Ten Years?

by: Markham Lee

A few months ago I discussed how the real problem facing the music industry (artists, record companies and traditional music stores) was the changing economics of music sales, much more than their slowness in adopting digital music, lawsuits, etc. The idea is that consumers are actually purchasing just as much (if not more) music as the ever have, but the record companies aren't generating as much profit because the digital music revolution means that consumers can acquire significantly more music for a lot less money.

A perfect example is Real Network's (NASDAQ:RNWK) Rhapsody service. With it, a consumer could spend $15.99/month and put hundreds (if not thousands) of songs on their Mp3 player that would cost them hundreds to thousands of dollars otherwise. Apple's (NASDAQ:AAPL) iTunes improves the numbers somewhat, but there too, people can download the 2-3 songs they like the most from a particular album instead of paying the record company for the whole thing.

Think about it: in the mid 90s, $15.99 bought you a single CD and now it can buy you access to nearly every CD you could want for a single month. Alternatively, you can buy 15 songs across multiple albums that you would've had to buy in full and separately at that time.

The math here is pretty clear. I's more profitable for Universal (NYSE:GE) to sell you 10 CDs via a retail chain than it is to give you subscription access to that music or sell it to you via iTunes.

Just the other day I used Rhapsody to drop music on to my Mp3 player to create a quick workout mix. The whole process took 5-10 minutes and I had access to new music that would've cost me nearly $200 at Best Buy. I suppose you could argue that over the course of a year I'll pay close to $200 in subscription fees, but the record companies who produced the 12-15 or so albums I transferred have to share that revenue with the hundreds of other artists I'll listen to (or transfer to my Mp3) player over the next 12 months. They're getting pennies per song/album vs. the $200.00 or approximately $15.00/album they would get otherwise.

It's analogous to Toyota suddenly selling new Camrys for $100 instead of for $25,000.00.

While the audiophile in me is going to buy those CDs this weekend anyway (I only use Rhapsody for the convenience factor not as my primary source of music), I'm not the typical customer and many people my age listen to the bulk of their music via a subscription service or iTunes. As the years go by, the record companies could wind up with fewer and fewer profitable customers.

As more and more digital music services become available, as the competition causes prices to go down and/or as people just switch to the subscription model (the most economical option available), the question then becomes: Can record companies even be profitable if consumers completely abandon physical CDs for services like iTunes or Rhapsody?

Or will the revenue generated by music sales and subscriptions simply be a way to offset some of the content production costs, while the record companies look towards other venues to generate revenue? That is, will music become more analogous to network TV, where consumers receive the content for free and the network generates revenue from advertising and other sources?

It's going to be interesting to see how the record companies adapt - if they develop value-adds that encourage people to purchase physical mediums (instead or in addition to digital downloads and subscriptions), restructure the economics of digital music or just alternate ways to monetize their content. It's not so much a question of how (or the speed) at which they adopted digital music, as it is a question of how you monetize a new business model that sells your product for a fraction of its previous cost.

Honda is a great company but they would go out of business if they had to suddenly sell 40% of their Accords for $100, which is effectively what has happened to the record companies.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article.