Music piracy and the investment drought

For several years now Britain's music industry has been obsessed with the problem of illegal downloading.  Last December the BPI, the trade body representing all the major record labels as well as many independents, produced an authoritative report, 'Digital Music Nation 2010'.  Based on research by two respected market research companies, the report painted a picture of a burgeoning new, vibrant digital music sector in the UK.  But the real story - made clear in BPI press releases - was about music piracy.  In fact, variants on the word 'illegal' appear in the report more than 70 times.

We have looked at the arguments about illegal downloading in earlier posts, noting that the industry can't always be trusted with the facts.  But while one of the arguments was about piracy destroying jobs, the BPI also stressed the impact on investment.  Looking at the word count again, variants on the word invest, investment, investor, etc. crop up 30 times in this report.  The BPI identifies two main problems: firstly that outside investors will take their cash to sectors where this kind of theft is not endemic; and secondly that record companies themselves will be unable to continue to invest in supporting new musical talent.

This latter point was made by Andrew Lloyd Webber who told a House of Lords debate that music piracy in Britain was undermining the industry to such an extent that in ten years it would be unlikely that a band such as the Beatles would emerge (reported in the Daily Telegraph).  More recently the Daily Mail's Business Editor described how before rampant piracy there was "cash to invest in new performers and to keep the creative juices flowing by paying good royalties to established singers, orchestras and musicians".  Now, though, illegal downloading "has made it all but impossible to sustain heavy investment in new artists."

As has been noted earlier, EMI's new focus on business and profits when private equity group Terra Firma acquired the firm in 2007, was followed quickly by the departure of Radiohead, The Rolling Stones, Paul McCartney, Queen and Pink Floyd.

But what does "heavy investment in new artists" consist of?

When a record label 'discovers' a new act they will attempt to 'sign' them.  Typically this involves offering a sum of money in exchange for the band signing a contract.  What many bands don't realize is that this cash is an advance on future album, touring and single sales.  The record label's costs in putting the band in the studio, in recording, editing, pressing, distributing, marketing... the list goes on... invariably go against the band's account on the debit side.  Now they owe the record label for the original advance, plus a whole raft of costs (perhaps even the "flowers and fruit" lavished by EMI's management?) associated with getting them airplay.

The record label will argue - with some justification - that their investment is in the production values added to the recordings, in the marketing expertise that will get the new band airplay, in the strategic insights which will identify market segments that the band would never have been aware of.  With luck sales will flood in and in time royalties will have finally overtaken costs, and the band will finally really start earning.

More likely, though, it will be time to make the second album - more costs, more expenses.  It was no surprise that many of EMI's major acts walked - these lucky individuals were in credit and could afford to take their business elsewhere.  The majority of musical acts have no choice: they are heavily in debt to their record company and are committed to putting out a new album every two years or so.

What other industry has this approach to 'investment' in new business assets?  Almost all of the risk is borne by the artists, not the record label.  It is like supermarket giant Tesco telling a farmer that he must bear the cost of supplying produce, packaging it, distributing it, paying all of Tesco's overheads - and that in time the farmer might start to get some revenue of his own.  The only equivalent I can think of is the book publishing sector.

Both music and publishing seem to have a business model where elements of commercial risk are skewed towards the artist rather than the company.  In the cases of both music and publishing there are now digital alternatives: artists no longer need the sort of support mechanisms that were offered in the 20th century.
 
A few musicians such as Paul McCartney and Radiohead have been able to break out of this cycle of debt as their products have had international success.  Most, though, have little choice.  In genres such as folk and jazz, musicians remain in debt to their record labels all their working lives.

EMI is being throttled by music pirates!

EMI was founded 80 years ago and has grown into one of the 'big four' of the recorded music industry (with Universal, Sony and Warner).  Now, though, it is in the hands of its bankers (Citigroup) and a buyer is sought.  What went wrong? 

Earlier this month Britain's Daily Mail had no doubt.  A picture slogan spells it out: "the future of recording giant EMI is being undermined by Google" (the Mail's argument is that because music pirates show up in Google searches, then Google is complicit in music piracy).  In an extraordinary outburst the Mail rants that "digital piracy ... has made it all but impossible to sustain heavy investment in new artists".

Similar points were made in the NME recently, under the headline "EMI's Plight Proves It - Downloading Has Murdered the Music Business", and the BBC identified downloading as one of a range of problems undermining the company.  The Daily Mail agrees about other factors - it also blames "the aftermath of the financial crisis", ignoring the fact that the reason Citigroup has acquired EMI is that the previous owners (private equity investorsTerra Firma) had been unable to keep up the payments.  When Terra Firma bought EMI in August 2007 the financial crisis had yet to hit the headlines, and EMI was in desperate financial straights anyway.

Back then, Terrra Firma's Guy Hands identified a host of problems at EMI, but illegal downloading didn't appear to be one of them.  An article in GQ reported how an audit found that London staff had spend £700,000 on taxis in a year, and that some executive salaries were as much as double the market rate.  The Guardian reported that expenses were running at the rate of £100 million, including what Hands euphemistically referred to as "flowers and fruit".

The new owners were realistic enough to recognise that the music business was changing: to survive and prosper (like many of the newer independent labels) it would need to bring its costs base down in proportion to the size of the business.  The new CEO Guy Hands believed that he could add value to EMI by working its assets harder.  But as Neil McCormick in the Daily Telegraph pointed out, these assets were the musicians, and they didn't take kindly to being treated as balance sheet items.   "Radiohead, The Rolling Stones and ex-Beatle Sir Paul McCartney were amongst the most high profile of EMI’s artists to take themselves elsewhere in a huff."  Later they were joined by Queen and Pink Floyd (who had a separate legal dispute over royalties). Veteran EMI insider and producer George Martin voice their frustration "I understood Paul McCartney's frustration when he quit EMI... The old production teams had broken up; recordings seemed to be manipulated by a faceless committee. One-on-one contact no longer seemed to be applied."

Even Hands' allies saw the difficulties (without highlighting music piracy among these): the new chairman of EMI's holding company, former Director-General of the BBC Lord Birt told the House of Lords that EMI "has been slower than most to reinvent itself and to take advantage of new opportunities for discovering talent and better serving businesses and consumers" (Daily Telegraph)

EMI is a long-established company in a market that has been subject to disruptive changes.  It has failed to adapt to the digital era, and in recent times has been focused on business to the detriment of its artists and audiences.  The Daily Mail is wide of the mark talking about piracy making it impossible to sustain heavy investment in artists: EMI wasn't even able to hold on to the major artists it had. Music piracy has clearly affected EMI, but as I noted in an earlier posting, illegal copying of music has been endemic since the 1970s - EMI's heydey.

Besides, there is some evidence that persistent illegal downloaders are also often the biggest purchasers of recorded music.  How do we know this?  It's all in the Daily Mail.  I wish they would make their minds up.