New Revenue On Tap

Universal Music Group in April will quietly mark the one-year anniversary of the launch of its music TV network, International Music Feed. Nevermind that most people have never heard of the Dish Network-distributed channel, or that record companies don't have expertise in running pay TV operations.

Executives at the major labels are recognizing that surviving the implosion of the CD business requires diversification—and quick.

Efforts like IMF are by no means the norm of how labels are branching out, but they illustrate this movement's ambitions.

UMG gains a whole new way of making money that is not reliant on an album or single sale. The channel is now featured in just under 10 million satellite TV homes in the United States, and UMG is collecting 10 cents a subscriber per month.

For a global record conglomerate that reported €4.89 billion ($5.8 billion) in revenue in 2005, an additional $12 million in annual subscriber fees plus advertising revenue is a drop in the bucket. But in the world of the "new" music business the name of the game is capturing revenue anywhere and everywhere.

Four years ago the average music company made money from two sources: CD sales, and film and TV licensing. Today the major labels have more than a half-dozen revenue sources, and the list is growing.

As the latest figures from the RIAA show, most of these are related to digital music: downloads, subscription services, music videos, mobile, kiosks and more. While the size of the overall U.S. business is smaller than it was four year ago—$13.7 billion in 2001 versus $12.3 billion in 2005—new revenue streams are offsetting declines in physical goods.

"Music publishers for years have been living with multiple revenue streams," says Thomas Hesse, president of global digital business for Sony BMG. "To them, nothing is ancillary. Everything is revenue. That's how record companies are increasingly thinking about their projects. Marketing and licensing and sales are completely intertwined."

Beyond digital growth, labels are further diversifying by investing in a number of more speculative music-related ventures, including bets on film and TV operations, mobile virtual network operators and even artists themselves, via revenue-sharing deals.

"It's imperative that music companies look to as many sources of revenue as possible so we're not subject to the degrees of the market on one distribution method," says Larry Kenswil, president of UMG's eLabs division. "When CDs fell off, there weren't other things to focus on immediately to increase revenue."

The following are some of the leading areas of expansion labels are pursuing:

DOWNLOADS

MARKET SIZE: $499 million

SNAPSHOT: Driven by the success of the iPod, the music download business now ranks second to the CD as a source of revenue for recorded music companies. Individual track downloads in the United States topped $363 million in 2005, according to newly released figures from the RIAA. Digital album downloads totaled another $136 million last year.

GROWTH PROSPECTS: Strong. Digital track sales are running 89% ahead of last year at 144 million, Nielsen SoundScan reports. Credit that in large part to a big jump in iPod sales in 2005, when Apple shipped around 32 million iPods, almost quadruple the previous year's total. Analysts estimate total MP3 player shipments will grow to 78 million by 2008.



MOBILE
MARKET SIZE: $422 million

SNAPSHOT: Here's why record labels are drooling over the mobile industry: Music-related products sold via cell phones managed to almost match the industry's download business—on less than half the volume. The RIAA reports sales of 170 million units for mobile versus more than 380 million units combined sold online as tracks and album bundles.

GROWTH PROSPECTS: Enormous. Right now ringtones account for the bulk of the mobile business. International label group IFPI estimates that master ringtones comprised 87% of mobile sales on a global basis in 2005. But that mix is about to start shifting rapidly with the rising availability of third-generation phones capable of speedy, over-the-air downloads for music and video. Sprint announced in April that it sold more than 2 million downloads at $2.50 apiece since introducing its new music service in October. And Verizon is aggressively pushing video downloads from superstar artists like Shakira for $3.99 a pop. Research estimates for forward momentum in the mobile space are staggering. Worldwide, music downloads and audio streaming are expected to grow from a combined $135 million in 2005 to $1.6 billion in 2009. Global 3G phone penetration will grow from 71 million units in 2005 to 576 million in 2009. Keep an eye on the ringback business, too: iSuppli estimates that ringback sales more than doubled in 2005 to $350 million.

SUBSCRIPTION

MARKET SIZE: $149.2 million

SNAPSHOT: The tortoise business running in a field of hares, digital subscription is growing . . . slowly. By the end of last year 1.3 million consumers were paying for monthly access to digital music, the RIAA says—a strikingly small market relative to the number and profile of companies pushing it. Napster, RealNetworks, Yahoo, AOL, Virgin, iMesh, Trans World Entertainment, HMV and Cdigix are already marketing services. But there are encouraging signs. UMG reports that between August 2004 and July 2005, its subscription revenue grew at an average monthly rate of 8%, topping $1.6 million in July. And the field of players selling subscriptions is only going to get bigger. Amazon, MTV and Target are among the big brands with new services reported to be on the horizon.

GROWTH PROSPECTS: Mixed. Labels and digital music executives like the margins on a $10-$15 per month subscriber fee much better than the razor-thin returns of à la carte downloads. But so far retailers see a bigger value in the business model than consumers, who remain squeamish with the prospect of renting music—if they understand the concept at all. Portability is another problem. None of these services work with the iPod, and none of the devices that work with Microsoft's portable subscription technology have connected with consumers. Then there's the publishing problem. The Harry Fox Agency isn't granting licenses for new services until a rate is set for publishing fees connected to subscriptions. That could throw a wrench into the speed with which new retailers enter the market. HFA now wants new subscription services to pay the greater of 12% of gross revenue; a per-play penny rate; or 25% of the total amount paid by the services for all content, according to a source who has seen a proposal from HFA to a digital music company.

VIDEO DOWNLOADS

MARKET SIZE: $3.7 million

SNAPSHOT: The business is in its infancy, but music video downloading is emerging as an area of rapid expansion for labels and retailers. Leading the charge is Apple Computer, which began selling downloadable videos and iPods capable of video playback in October. Music videos from iTunes cost $1.99 apiece. Early response has been encouraging, label executives say. The industry sold just under 2 million videos in 2005. Prior to last year, videos were considered a promotional item with limited commercial value.

GROWTH PROSPECTS: Good. Music videos have been steadily selling for $1.99 a pop at the iTunes Music Store since late last year. But Apple is just now moving into higher margin packages. As part of its video bundling push, iTunes is selling "video albums" (offers of six to seven videos from an artist that have not been released as physical collections) and "vingles" (a bundled offer of a video and its corresponding single). It's also selling physical video collections originally licensed for DVD in complete sets or as à la carte downloads. Meanwhile, the number of companies selling downloadable video figures to grow quickly. Google introduced a video store featuring content from Sony BMG in January, albeit to mixed reaction. Once again Apple's competitors will have to struggle with portability problems. Only iTunes' files are compatible with the iPod. But the Windows market has a number of alternative video playback devices set to hit the market later this year.

KIOSKS

MARKET SIZE: $1 million

SNAPSHOT: The floundering kiosk concept—a retail dream since the late 1990s—received a major shot in the arm when the 6,400-unit Starbucks chain jumped into the market in 2004. The coffee giant is testing HP kiosks in dozens of stores in Austin, Los Angeles, San Francisco and its company base, Seattle. And in Starbuck's wake, other kiosk initiatives have picked up steam. Mix & Burn, a unit of New Hope, Minn.-based distributor Navarre, is running tests for its own kiosk solution in about a dozen stores around the United States, including Best Buy, Borders Books & Music, Newbury Comics, Trans World Entertainment, Electric Fetus and Nordstrom. A half-dozen other kiosk firms are targeting the market as well. Consumer response has been limited. The RIAA reports 700,000 combined singles and albums were sold via kiosks last year.

GROWTH PROSPECTS: Mixed. The idea seems great: Place CD-burning kiosks that can manufacture out-of-stock albums and customized compilations in retail stores. But after numerous false starts, retailers, hardware suppliers and major labels say a quagmire of issues threatens to overwhelm the initiative. Retailers say in-store CD manufacturing remains unprofitable because the hardware and related software systems cost too much. What's more, the labels remain divided on standards, usage rules and pricing for kiosks.

RADIO

MARKET SIZE: $40 million

SNAPSHOT: Emerging forms of radio are growing, but contentious, opportunities. Labels remain at odds with webcasters and satellite radio companies over royalty rates. Terrestrial radio does not pay a sound-recording performance royalty, but the Digital Performance Right in Sound Recordings Act and the Digital Millennium Copyright Act in the mid-1990s established such a payment for digital transmissions. SoundExchange, the organization the RIAA created to collect and negotiate digital radio royalties, and webcasters are still ironing out a new deal for sound recording use in digital performances for 2006-2010. The Digital Media Assn., which represents the webcasting divisions of companies such as Microsoft, RealNetworks, Apple and AOL, wants Internet radio broadcasters to pay recording companies and artists 5.5% of revenue, about half the current royalty rate of 10.9 %. SoundExchange wants the rate to almost triple to 30% of revenue. The issue is just as thorny with satellite companies. Sirius and XM inked a reported $80 million deal with the recording industry in 2002. That pact expires this year, and the labels have their eyes on the big bucks that XM and Sirius have doled out for sports and entertainment brands. Tensions also run high over new satellite radio devices that can record programming and double as an MP3 player.

GROWTH PROSPECTS: Mixed. Just how much money the industry makes from radio likely hinges on the outcome of arbitration cases. The webcasting fight is being argued in front of the Copyright Royalty Board, and satellite negotiations are expected to end in arbitration, too. Some Wall Street analysts expect the music industry will seek a package in the range of $1 billion. Any agreement/settlement approaching that number could meaningfully affect the way labels divvy up the revenue pie. The industry also just finalized a promising settlement deal with Sirius over its S50 device, which allows users to record programming—the labels will receive a fee for each unit sold.

AD-SUPPORTED ON-DEMAND

MARKET SIZE: N/A

SNAPSHOT: One big fish for music revenue expansion remains the global advertising market, which totals more than $300 billion. The labels are just now starting to participate in ad-based revenue through video-on-demand offerings from the likes of AOL, Yahoo and MSN. Efforts are afoot to launch ad-based, music-on-demand models in 2006 that tap into the enormous demand for free music and generate value from those who can't or won't pay.

GROWTH PROSPECTS: Mixed. VOD is expected to grow at healthy rates, but the majors may be leaving mega-cash on the table. For example, peer-to-peer monitoring service BigChampagne estimates that some 12 billion songs were downloaded through file-swapping networks last year by a worldwide audience of roughly 100 million; as of late 2005, more than 8.9 million users were on P2P networks at any given time, a 26% gain over 2004. But the devil will be in the details. Licensing, usage rights and royalty rates associated with ad-backed, audio-on-demand models still have to be worked out. It's unclear whether a legitimate, ad-supported offering will be attractive enough to lure the P2P crowd.

STRATEGIC INVESTMENTS

MARKET SIZE: N/A

SNAPSHOT: The major labels' mantra is transformation from "record companies" to "music entertainment companies." The Big Four are investing in new businesses that stretch the traditional definition of the music business. The majors are looking to participate in their acts' merch, touring and sponsorship dollars—once the artist's exclusive domain. EMI's revenue sharing pacts with Korn and Robbie Williams are the most notable examples of the trend. Elsewhere, labels are focusing on film and TV. Sony BMG launched a film unit last August that just acquired the rights to "The Sasquatch Dumpling Gang," and is expected to start production on "Reggaeton," in conjunction with Jennifer Lopez's Nuyorican Productions. UMG's Interscope Records released the 50 Cent movie "Get Rich or Die Tryin' " through its film unit last fall. The label also released a 50 Cent videogame in conjunction with VU Games. UMG is also targeting the mobile market. In August, the company announced plans to introduce its own mobile phone service, MoveU, in conjunction with Single Touch Interactive and Sprint.

GROWTH PROSPECTS: Intriguing. Execution will be key to all of these efforts. That will be no small task, given that labels must first and foremost be focused on developing hit songs—a process that has little to do with making films, providing cell phone service or selling merch. But label executives stress the need for thinking big when it comes to driving growth. Warner Music Group chairman Edgar Bronfman Jr. underscored the point at a Goldman Sachs investor conference in October, telling attendees that the health of the music business needs to be based on dollars, not units. "Twenty years ago we gave our music videos to MTV, and MTV has since created an outstanding business," he noted. "Even more recently we have been selling our songs to iPods, but we don't have a share of iPods' revenue. We have to keep thinking how we are going to monetize for our shareholders the value we are creating for so many other streams." ••••

Additional reporting by Susan Butler and Ed Christman.