How The Music Industry Garnered Record Profits in 2008

With Chinese Democracy topping 1.5 million in CD sales and downloads in its second week — for a two-week total of 5 million, the best ever — it is now official: the American Music Industry has never been healthier. Even in what is easily the most crippling recession most of us have seen in our lifetimes, people are buying music at a record pace.

How have they done it? According to Frederick Stamphammer, the RIAA’s Vice-President of Digitization — and the man seen by most insiders as the key figure behind the transformation of the music industry into a virtual profit machine — it was by seizing the opportunity afforded by the internet nearly 10 years ago.

“People don’t realize it,” said Stamphammer in a recent interview, “but we started planning for this back during the teen-pop era. In fact, remember when that N’Sync album sold 1.1 million copies in its first week? 50,000 of those were digital files.” Of course, he makes it seem like a slam dunk, but Stamphammer went on to say that nobody wanted to do it, but it was N’Sync guru Lou Pearlman who gave the go ahead.

There was a problem with those 50,000 songs: they were encoded with a thing called DRM — which stands for Digital Rights Management. DRM was a primitive way of restricting music so people wouldn’t share it with other people. The problem was, it was too restrictive, and after a half-century of people being able to purchase pop music and doing whatever they wished with those purchases, massive restrictions on computer files didn’t make sense to people.

“But it went screwy, or something, and after the TRL riots, we never tried that again.” What Stamphammer is referring to, of course, was a taping of N’Sync on TRL where dozens of teenage girls who had downloaded the album with DRM stormed the studio, asking for their money back. The taping had to be halted, and all was forgiven when Justin Timberlake came out and gave autographs to all of the girls.

Of course, there were still elements in the music industry who were pushing for DRM, in order to combat what they termed “piracy.” This was the era of Napster, and people were trading digital files by the millions, and causing panic in the music industry. Luckily, cooler heads prevailed.

“Napster, that was a tough one. Except I saw it as proof of the future: if people were going to download terrible-sounding files from strangers over dial-up, they might also pay to get proper versions.”

Stamphammer and his team had a couple of other insights: the first was that, in a nation of 300 million consumers, they didn’t need to sell every single copy of every single album to every single person, and the second was that — given the thousands of records released every year — they figured that all of the shouting about “piracy,” was just that, shouting. Instead, they saw it as a marketing opportunity: fans of an artist were marketing that artist to other fans. Using the most powerful tool of all: the artist’s music.

“If there was any quality in the music whatsoever, we would eventually make a sale. Most people are honest: they’ll pay a fair price for quality. And the ones that won’t, probably wouldn’t have anyway.”

And as for the people who downloaded the most music: it turned out that they were also the people who bought the most music. “For some of these guys,” points out Stamphammer, “music is an addiction, and they want to try just about everything. They end up acquiring more music than they’ll ever listen to in their lives. Certainly more music that they could ever afford to buy. But they’re also the ones who’ll run out and buy the deluxe reissues of their favorites or get one of those subscription plans from eMusic or iTunes. They always download, they always buy, and most importantly — they’re always telling everybody within earshot about their latest favorite.”

The upshot was that Stamphammer and the RIAA convinced the record labels to stop seeing file sharing as a zero sum game, and start seeing it as a marketing opportunity. With thousands of records being released every year, every bit of word of mouth would help.

Nevertheless, having determined that digital music was the wave of the future, the record industry was still loathe to take the next step: building out download stores. Too much risk. Too many unknowns. Enter Steve Jobs and iTunes.

iTunes, as you know, was an instant success. Tens of thousands of songs, playable on any device, with no restrictions whatsoever. What people don’t remember was that the original pricing was 99 cents per song, and $9.99 per album. After about a year, research showed that while people valued their downloads, they didn’t value them in the same way they valued physical media. So Steve Jobs and the record companies tried an experiment: they cut prices in half while doubling file size .49 cents per song, and $4.99 per album.

Sales quadrupled.

Naturally, others wanted a piece of the action, and since there and the mid-2000s saw the music industry partnering with other online stores: Rhapsody, Amazon, and even Napster eventually went legit. Some, like eMusic, aimed specifically at a target audience, and barely had anything to do with the major labels. Others, like the wildly profitable Spiral Frog, did nothing but sell the latest offerings from the major labels. Each online store had its own personality, own subscription plans, own target audience and music sold with no restriction.

Online sharing went through the roof. And so did online sales. Every year, they showed a profit, as billions and billions of songs were sold.

In the mean time, CD sales flagged, so the music industry did the only logical thing: they cut list prices. “Well, CD prices were always artificially inflated,” says Stamphammer, “so as the manufacturing costs went down, we convinced the labels to cut the prices on the CDs.” List prices dropped to $9.99 — $4.99 for anything over a year old — in 2004 and stayed there, and as a consequence, CD sales continued to increase slightly every year, though the old-style record stores like Tower still couldn’t compete with the new market.

Naturally, an album selling as much as Chinese Democracy did is as rare as it’s ever been: the era of the “event” album that cuts across audiences is widely over. Instead, the industry has increased sales by using the relatively cheap distribution costs for digital music to make everything available all of the time. Nearly everything that was out of print is now easy to find — cheaply — at one of the online stores. And each target audience has something new for it nearly every week.

In addition, the RIAA and record labels encouraged artists go to what they called “the Pearl Jam route,” — after the series of live CDs Pearl Jam released in the early part of the decade — and routinely record and release their concerts, often on their own websites. The artist would have the independence to act on his or her own, and the record label would get a piece of the action. They had figured out that fans can’t get enough of their favorite artists, and that self-produced downloads kept the fans excitement level high.

This spilled over, quite naturally, into demos, working tapes, early versions, anything that an artist wanted to share with or sell to the fans. Sometimes, it was near-perfect quality material; and sometimes it was seemingly contraband “leaks” that didn’t even go out via official channels.

As it turned out, it was the ongoing series of outwardly controversial “leaks” was part of what goosed sales for Chinese Democracy. “Axl orchestrated that entire thing,” says Stamphammer, “he thought that just disappearing for 17 years probably wasn’t good, so every few years, there was another set of leaks — just good enough to whet the appetite, I guess.” In the end, the pent-up buzz was so much that the few record stores that still existed opened at midnight on the release day, and several of the online store servers crashed.

So what’s next for the music industry? Higher quality downloads, for one thing. After all, one of the ongoing complaints about .mp3 files has always been sound quality, and with bandwidth increasing, storage getting cheaper, and portable devices supporting lossless formats, it only makes sense. “I think that next year, you’re going to see albums released in .flac, ogg vorbis, and yes, even straight-up .wav files. In fact, you can download a version of Chinese Democracy that’s totally uncompressed right now.”

“The only thing I know for sure is, whatever innovations are happening in digital music in the next decade, the RIAA will be right in the middle of them.”

So all in all, 2008 was another highly successful year for the music industry. “I firmly believe,” concluded Stamphammer, “that the decision to leap into the 21st century without DRM, and trust that the audience would follow, was the smartest thing we ever did. I can’t even imagine where we’d be if we hadn’t done that.”

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