Reference Notes: Sony Music

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Deepa Mani

Associate Professor and Executive Director, Srini Raju Centre for IT and the Networked Economy

Digital Transformations

Indian School of Business

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Course 1 of 6 in the Business Technology Management Specialization

[MUSIC] Hi, and welcome back to the module on technology-led disruptions. In the previous session, we
discussed why disruptive innovations are largely technology-led in today's business environment. We
gained insights into some of the technologies and technological innovations that are leading to
disruptive products and business models. In this session, we will see these disruptive forces play out in
the context of the music industry. We will examine constraints that operate on incumbents in the
industry, and we will talk about this in the context of the music industry in the West. But given that the
case of Sony is set in India, I will use that context as well in our discussion. Let's start with examining the
value chain in the music industry as it was before technology disruptions hit it. Specifically, I want to
focus on the state of three key stakeholders in the value chain, the artists, the recording company, and
the consumers. Let's start with the artists. Composers, lyricists, performing artists provided the raw
artistic input for the business. How were they compensated for their work? Remember, in the Indian
music industry, the film music genre dominated relative to the indie genre. In the case of the film genre,
the artists were paid a fixed compensation per song, and did not own the music. In the case of the indie
music, they were paid a royalty against the sales of their work. This was the tradition in the West as well.
Do you imagine the artists were a happy and satisfied group back then? If you're shaking your head in
disagreement, you're right. Consider the efforts of the legendary artist Prince to escape his contract with
Warner Music. The late artist changed his name to an unpronounceable symbol. He claimed that his old
contract did not apply to The Artist Formerly Known as Prince. During subsequent disputes, he appeared
in public with the word slave inscribed on his cheek to reflect his relationship with Warner Music.
Warner released him from his contract in 1995. The artist's next albums were distributed by his own
label and promoted primarily via the internet. Though sales volumes were low, the artist claimed that
his net receipts were higher than they had been with Warner before. In 1999, he returned to a major
record company signing with BMG. Why this vehement dissatisfaction? In the case of the film genre, the
artist's dissatisfaction stemmed from not owning their creative inputs. In the case of indie artists like
Prince, it stemmed from the tight control that recording companies wielded over them. Having
prominent artists like Prince under contract not only brought greater sales directly, but also helped the
recording company gain precious retail shelf space for lesser known acts or new artists that they were
trying to break into the industry. Promising new artists tend to be attracted to recording companies,
which have the best artists under contract and show a strong history of successful management.
Sometimes the demands of premier artists can undermine the profitability of a record company for that
specific act. Consequently, product managers have to balance the benefits of an artist's big name with
the costs of holding the artist under contract, read slave. But what were the recording companies doing
for the artists that enabled them to wield so much power and control? In order to answer this, let's look
at all the activities performed by the recording company. Each recording company took performing
artists under contract. It purchased musical rights from publishing houses, managed the recording
process, manufactured CDs and cassettes, distributed CDs and cassettes to retailers and other channels,
and promoted products aggressively. During this process, the company paid for all costs associated with
launching new music. Also note that the bulk of these value chain activities required large up front
investments in acquiring and promoting music. There was also significant fixed costs of production
facilities, etc that the recording companies incurred. Only large companies could amortize these costs
over several products. This was a capital intensive business, and a business of giants. Further, the nature
of the business model was that profits are concentrated in a small number of large hits, hits which are
very, very difficult to anticipate. So you're making these upfront investments without knowing or
realizing what the expected return on these investments are going to be. The case tells you that four out
of five recordings lose money. And the biggest hits sell orders of magnitude, more copies than do flops.
Large companies are able to pool the risk associated with each individual album release, and hence, are
able to survive the inevitable flops. Promotional channels also leverage this portfolio. So if I had many
hits, I would tell the radio channels, I'll give you the super hit track, give me a discount on air time for
this new artist that I'm trying to launch. In other words, the business model of recording companies was
all about creating a very large portfolio of music tracks that allowed you to diversify the risk of failure
associated with the individual tracks. And for these reasons, as I noted earlier, the recording business
was a game of giants. Consolidation had reduced the number of labels to four majors, Universal Music
Group, Sony, Warner, and EMI, all giants. So if you were a new indie artist, where would you go? To the
giant that would help you break into this industry. If you were an established artist, where would you
go? To the giant that helped you produce and distribute your music. And that's why the recording
company wielded the power that they did over the artists. Did they wield power over you, too, the
consumer? To answer that, consider how you consumed music in the pre-internet world, typically CDs.
How many songs in a CD, 10, maybe 12? How many did you like, 1, maybe 2, maybe 3. Yet, you were
restricted in your purchase where you had to buy the entire album. And innovations and consumption in
this industry, who drove them? How did the cassette evolve to the CD and so on? The recording
companies drove these innovations. So it was safe to say that the recording company was the most
powerful entity in the value chain where the customers and artists are a relatively dissatisfied, dis-
empowered lot at best. Annual sales in this industry were an all time high of $14.5 billion in the U.S. in
1999. But the first tremors of disruption were felt that very year. By 2008, sales would be down to less
than half of the year's levels. Technology would have disrupted this industry in an unprecedented
manner. Let's see how. [SOUND] The mp3 standard was globally adopted in 1992. The standard allowed
for digitization. As I said earlier, separation of music from its physical artifact, the CD. And compression
of digital music, while retaining near CD quality sound. The exchange transfer and storage of digital
music was made far more convenient than ever before. In the fall of 1998, the very year before the
music industry sales would hit an all time high, 18 year old Shawn Fanning enrolled as a freshman at
Boston's Northeastern University. Like many of his peers, Fanning wanted to study computer
programming. But aside from some basic programming techniques he had acquired, there was little
indication that Shawn Fanning was about to revolutionize the way music was distributed over the
internet. At Northeastern, Fanning quickly became bored, skipping classes and returning frequently to
his uncle's company. His lagging interest in college studies was due in part to a growing interest in a
novel idea that he had for finding mp3 music files on the internet. Fanning had become frustrated with
finding mp3s through search engines such as Lycos, which often led to broken links and missing files. His
idea was to combine a music search function with a file sharing system that would let individuals directly
trade music files with each other over the internet. By using a tool that combined the file sharing
functions of Microsoft Windows with the advanced searching and filtering capabilities of traditional
search engines. And so, Napster was born. And this is how Napster grew. What explains this growth?
Fewer search costs, greater unbundling of tracks, and lower price of music, of course. Most important,
the latent desire for control on part of consumers and users and the sense of resentment that recording
companies were ripping them off. Remember, I spoke about a very disempowered lot of consumers,
who had to consume a fixed amount of music that was thrust upon them by the recording companies.
That resentment is what led to this significant growth of Napster. The big spurt that you see from 15,000
users to 1 million was a consequence of RIAA's first suit in December 1999 that gave the company a
great deal of publicity. Napster was sued and shut down in July 2001. It was very easy to shut down
Napster. There was just one central server that you had to decommission and the platform was done.
And that was the end of Napster, but was it the end of P2P music as we know it? No. To the contrary,
the newer platforms that emerged addressed the vulnerabilities of Napster, to make it even more
difficult to end this phenomenon of disruption. Platforms like gnutella, KaZza, BitTorrent all of these
were aimed at fostering the growth of P2P music. And all of these platforms built on the latent
resentment of consumers that existed in the pre digital area. Music had been transformed forever. You
consumed precisely what you wanted and you didn't even pay for it. And what were the recording
companies doing at this time, you ask? Suing with a sense of urgent desperation. They sued the
platforms, they sued their own customers, college students, teenagers, stay at home moms. Nobody
was spared. Their entire value network stood to be disrupted in this new environment and they did not
even pause for a second to see if they would survive it or how. [SOUND] This wave of chaos continued
until the early 2000s. At that point one company came along to bring some order in all this chaos. And
that company was what we know as Apple. Apple's market capitalization shot up from $1 billion in early
2003 to over $150 billion by late 2007. What do you think transformed Apple in the early 2000's? If
you're saying iTunes ,you may be well on mark. Before the launch of iTunes, Apple was selling an
average of 113,000 iPods per quarter. By the quarter ending 2003, that figure had shot up to 735,000
units. The combined contribution of iTunes and iPod to Apple was 45% of sales. What do you think the
contribution of iTunes was? Of the $0.99 that it took for a song, $0.70 went to the music label that
owned it. $0.20 went towards the cost of credit card processing. That left Apple with about a dime of
revenue per track, from which Apple had to pay for its website, other direct and indirect costs. In
essence, iTunes gave nothing to Apple. What Jobs had created was a razor and blade business model,
only in reverse. The variable element in this case, iTunes, served as a loss leader for a profit driving
durable good, the iPod. Of course, Apple had redefined the size, look, and design of the mp3 player, but
far smarter than taking a good technology and wrapping it in a snazzy design. It took, in fact I would
argue, a good technology, and wrapped it in a great business model. Apple's value proposition was
enabling people to find and legally download high quality music files extremely easily, transfer them to
different iPods, make a few copies for their friends by burning a limited number of CDs. This was a major
reason why the iPod took off as it did. It was the front end of a very smart and highly differentiated
platform that worked for both the music industry and the consumer. And this was the point at which the
recording companies began to breathe. Could the recording companies have done this? In order to
answer that we need to understand the specific impacts of technology in this industry. Specifically we
need to understand how these technological innovation impacted the customers and artists, in addition
to the recording company. So now lets place all that we've discuss about the music industry In the
context of the disruptive innovation framework that we discuss in the earlier sessions. The music
industry was creating these very high quality products, specifically CDs that over serve the market. They
operated models of recording and production that reflected a need for very high quality audio
reproduction. However, the reality of the market was that consumers really did not require this
sophistication. In this over-served market, the mp3 made its entry. The mp3 by its very nature was a low
quality audio format. The mp3 is created through lossy data compression, a data encoding method that
compresses data by discarding some of it in order to create digital files small enough for quick
downloads and storage on portable devices. Low quality and way inferior to the CD in terms of audio
quality. However, as I noted earlier, the mp3 addressed some very real needs of consumers. Aligning
consumption with preferences for singles instead of albums. Low costs of experiencing music, low costs
of buying and storing music and the ability to meet niche tastes. And what we saw was while the early
digital music products and platforms were very low quality. The subsequent products and more
important, the business models, began to add wrappers and layers to finally intersect the mainstream
performance trajectory of the recording industry and disrupt it completely. [MUSIC]

About this Course

Information Technology (IT) is fast changing the world around us. This course will provide you
an understanding of IT-enabled changes in the business environment, and how insightful
executives leverage IT to create value and win competitive battles. The course is divided into
three parts – the first part of the course focuses on the industry impacts of technological
innovation. Here, we will explore competition and business models in the high-tech industry,
using examples of companies like Google, Apple and Facebook. We will also explore
competitive dynamics of industries that consume significant technology with emphasis on how
technology has disrupted industries such as music, media and education. The second part of the
course focuses on how IT transforms cost structures of firms by helping them build information
capabilities that significantly increase value chain efficiency. The final part of the course will
focus on the impact of IT on innovation and decision-making within firms that, ultimately
impacts revenue growth.
Skills you will gain
Business TransformationDigital StrategyBusiness ModelDisruptive Innovation