Labels Lose Their Luster

The Internet is calling the tune

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Madonna signed with a booking agency, abandoning her record label.

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It suddenly feels as if the recording business is throwing up its hands and diving into the Internet mosh pit. Holdouts like Led Zeppelin are now going online, Web pioneers like Radiohead are giving away their art, artists like Madonna are leaving record labels, and labels are selling digital copies without sales-gumming restrictions.

"The industry has been hanging off the edge ... for some time," says James McQuivey, a market analyst at Forrester Research. CD sales have long been falling, down as much as 40 percent in the past seven years, taking the ground out from under record labels. But they held on, hoping tightly controlled online sales would save them. Now the growth of digital downloads has slowed.

"There is no chance anyone can still convince themselves that all we need is a few big hits," says Bruce Houghton, author of the Hypebot.com blog and longtime owner of a small New Hampshire agency that books concerts worldwide. That business of live appearances is one that may well benefit from the changes, as major record studios lose their ability to dominate fan psyche with smash-hit bands. Musicians will again be entertainers, making more money from live shows and merchandise than from being recording stars. Madonna recognized as much by signing her new contract with Live Nation, a booking agency, abandoning her Warner Music Group label. Where she once toured to sell CDs, she may give music away to sell tickets.

Class act. And that will enable small acts to survive—more bands can live comfortably by selling relatively few records, keeping fans interested through touring and the Internet. "A large middle class is emerging in music," Houghton says.

The record labels appear most at risk. Revenues and staffs will get slashed as they no longer need to cut and sell disks. But freed from distribution costs, the studios could actually become more profitable. Licensing music is still a growing business for record companies. Yet, while new outlets for music like mobile phones and video games are promising, the labels need to revive digital downloads of the songs themselves.

Rivaling iTunes. EMI led the way last spring by selling songs without copy protection on Apple's iTunes. Then, in quick succession this fall, Universal did the same with some of its catalog, Amazon and Wal-Mart began selling only music that came without restrictions, and the iTunes Store lowered its price on recordings that can be copied. Now skeptics Warner Music and Sony BMG are talking with Universal Music about a new competitor to iTunes. Their new service might allow unlimited downloads and copying for a $5 monthly fee charged not to consumers but to the makers of music players like Microsoft's Zune. "It might be the first subscription plan that would actually work," says Fred von Lohmann, an attorney at the Electronic Frontier Foundation, a group critical of copy protections used today.

Even as it opens up, the industry continues its lawsuits against users who trade songs without paying for them. Yet independent labels often give tunes to sites for free downloading to build interest in unknown groups. Radiohead is essentially doing that by letting fans choose the price—or even pay nothing—for early sales of its new album.

Traditional record sellers face other challenges. Paul McCartney recently signed with a label started by Starbucks, and Prince came under intense criticism from record retailers for recently giving away a new CD as an insert in a British tabloid. But then sales of other Prince music spiked in the weeks afterward, says Simon Dyson, an analyst with Informa Telecoms & Media in London. Such creative experimentation is rapidly overtaking the industry, Dyson says. "It's clearly a snowball effect that's underway." Record execs can only hope theirs don't melt as they rock and roll.