Commentary: Online music post-Napster

A revolution is brewing in the music industry, and the major distribution companies, which have the most to lose, must negotiate very tricky waters.

We believe the biggest potential change

	See news story: Record labels subscribe to online music deal

would be if one of the other electronic distribution players becomes a music label--contracting directly with the artists, promoting them, and distributing their music electronically over the Web. Music distribution is very inefficient, and it accounts for more than 50 percent of the cost of each CD, while the artists get a very small amount.

Napster or one of its peers could eliminate most of these costs. They could cut the cost of a CD by a third and still pay the artists twice what they are getting today. That is what the big music companies should really be afraid of--and this is their motivation for developments like Monday's announcement of the MusicNet online distribution venture by RealNetworks and several of the major record companies.

This revolution would create a vastly different music industry in which the actual recordings would cost very little and may have very little profit associated with them. Online music labels would make most of their money selling items associated with the artists--concert tickets, clothing, souvenirs. This would demand a radically different business model from the one supporting the music labels today.

The problem for any would-be music revolutionaries, however, is that they need big-name artists to attract the large sales that would trigger the revolution. Only a fraction of the music-buying public is technically equipped to download and play digital music files today, and the public will be willing to make that investment only if the music they most want is available online and at a much lower cost than CDs in a retail store.

Few top artists are likely to be willing to drop their contracts with their present distributors and move to an online service, even if they get twice their fee today for each recording sold. However, there are plenty of up-and-coming artists out there building their audiences by themselves. Not all of them can get recording contracts, and the industry is replete with stories of groups that achieved success on their own. These groups could turn to online music distributors when they cannot get recording contracts.

MTV as music label
The question then becomes, what Web-based distributor has the promotional clout to create a new Britney Spears? Napster in its present form could not, and now that it is owned by Bertelsmann, it is unlikely to try. MTV could--at least in theory.

Currently, pop music is sold via the television at least as much as the radio. MTV has an extensive Web site where it sells CDs, clothing, games, videos and other materials associated with the pop groups. It gives away free promotional downloads of music and sells full digital downloads of albums. However, its digital albums are sold only in a secure, new format, not in the unsecured MP3 format, and they cost the same as CDs to avoid undercutting the huge music distribution system. For those two reasons, they are unlikely to become popular.

But if MTV chose to become a music label in its own right, it could sign artists, promote them on its channel, and sell the digital recordings for a fraction of the price of CDs. Another possible candidate is Disney, which does not have its own music distribution business and which has a reputation as being artist-friendly. However, so far Disney has not given any public sign of interest in entering the music business.

The music distributors would much rather see their industry evolve slowly with albums sold on the Internet at the full retail price using a highly secure format that demands special hardware to play. This will give them huge profits from any electronic sales, but whether they will pass any of that extra money onto the artists remains questionable.

They also may take an intermediate step--distributing the music digitally to retail stores, which then burn CDs on demand for customers. This will eliminate the problems of overstocking and shoplifting, but again it is doubtful that any savings in distribution costs will be passed on either to customers or to the artists.

Too expensive at any price?
The question is whether it is already too late for the distributors, as the notion of free music on the Web has already been established. The question is whether many people will be willing to pay anything for Web-delivered music. Napster may be close to under control, but Gnutella and similar technologies, which do not use a central database, will be much harder to corral.

Business consumers distributing their own intellectual content should carefully watch the developments in the music industry--and in the book publishing industry, which is facing the same kind of digital revolution. Whether these industries evolve or undergo a sudden revolution, the method of distributing intellectual content and the business model behind it is clearly changing. Businesses need to be ready to adapt to a model of higher volumes and lower unit prices with highly streamlined distribution systems and value-add services that move beyond just the CD or book.

For individuals buying music, this is good news. Whether by evolution or revolution, new channels are beginning to appear to deliver the music they want.

Meta Group analysts Val Sribar, Peter Burris, William Zachmann, David Cearley and Dale Kutnick contributed to this report.

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