Digital Distribution of Independent Music Artists: An Economic Analysis of Rights, Costs, and Market Potential

OUTLINE

List of Figures

List of Abbreviations

Abstract

1. Introduction

2. Delineation of Terms
2.1 Digital Distribution
2.2 Independent Music Artists

3. Research Background: Digital Distribution of Independent Music Artists
3.1 Market Size
3.2 Players and Value Chain
3.2.1 Artists
3.2.2 Labels
3.2.3 Aggregators
3.2.3 Digital Retailers
3.2.4 Collection Societies
3.2.5 Consumers
3.3 Revenue Split as a Business Model

4. Analytical Framework
4.1 Rights
4.1.1 The German Copyright Law and Related Rights of Independent Music Artists
4.1.2 Determinants of the Commercial Copyright Exploitation of Independent Music Artists
4.1.2.1 Digital Rights Management-Systems
4.1.2.2 Legal Copyright Enforcement
4.1.2.3 Versioning
4.2 Costs
4.2.1 Independent Music Artists Affecting Determinants of Costs
4.2.1.1 Product Quality
4.2.1.2 Promotional Effort
4.2.1.3 Distribution Intensity

5. Economic Analysis
5.1 Methodology
5.2 Economic Analysis of Rights
5.2.1 Digital Distribution in the Context of the Property Rights Theory
5.2.2 Effects of Lacking Copyright Law Enforcement
5.3 Economic Analysis of Costs
5.3.1 Production Costs
5.3.2 Marketing Costs
5.3.3 Distribution Costs
5.4 Derived Analysis of the Market Potential

6. Discussion

7. Critical Appraisal and Outlook

Bibliography

Appendix

List of Figures

Figure 1 The Digital Value Chain

Figure 2 Age Pattern of German Music Consumers with Respect to Aggregated Music Genres

Figure 3 Revenue Split as a Business Model of Independent Music Artists

Figure 4 Analytical Framework

Figure 5 Sensitivity of the profit and the social welfare improvement to piracy cost

Figure 6 Impact of Copyright Law Enforcing Determinants on the Demand for Independent Music Artists’ Work

Figure 7 Impact of Digitization on Fixed Costs for the Content Production in Relation to Product Quality

Figure 8 Impact of Rights and Costs on the Market Potential

Figure 9 Market Potential of Digital Distribution for Independent Music Artists

Figure 10 Record Companies Membership Development

List of Abbreviations

illustration not visible in this excerpt

Abstract

This thesis considers the influence of digital distribution on the independent music artists’ position in the value chain with respect to rights, costs, and market potential from the perspective of an economic analysis. It begins by delineating the relevant terms and providing a research background about the digital distribution of independent music artists. Ongoing, a new analytical framework is introduced in order to guide the economic analyses from rights and costs to the market potential, whereas direct and indirect distribution are compared from the independent music artists’ point of view. It is found that digital distribution encourages independent music artists to enter the music market without the necessity of a major label. Furthermore, digital distribution seems to be an attractive way for unpopular artists to increase their awareness regardless likely copyright infringements.

1. Introduction

The emergence of a new technology enables the transformation of products, business processes and markets. In the regarded case of the music industry, the emergence of digital distribution technologies enabled independent music artists (IMAs) to make their work publicly available. This might challenge the dominance of the few digital retailers and the highly vertically integrated major labels within the value chain, but it also calls the economic feasibility of the IMAs’ proposition into question. Deriving from that, this thesis poses the research question of how and to what extent digital distribution affects the position of independent music artists in the music industry’s value chain regarding rights, costs, and market potential.

This is a relevant issue of media management, since the digital music markets continue to grow worldwide. Furthermore, it is necessary to gain deeper knowledge about the economic role of content creators, due to the transferability to further entertainment industries. The fact that the digitalization in the music industry is in the most advanced stage compared to the others, even assigns a predictive character to the thesis’ findings.

However, the answering of the research question is not trivial, since the music industry is characterized by complex business processes and a complex market structure. In addition to that, sophisticated literature related to the research question is scarce and often lacks an economic background. Most of the published papers put the major labels in the center of attention and do not provide a focus on the artists themselves.

In order to answer the stated research question, this paper begins with a delineation of the two key terms, namely digital distribution and IMAs. The research background of chapter 3 provides detailed and recent information about the market size, the market players and their individual contribution to the value chain, as well as a revenue-split from the IMAs’ point of view. Chapter 4 introduces an analytical framework for the subsequent economic analysis in chapter 5. Finally, key findings will be discussed in chapter 6, whereas chapter 7 contains a critical appraisal and an outlook.

2. Delineation of Terms

In order to provide a comprehensive understanding of the implemented terms of this thesis, the two essential elements of this topic need to be delineated.

2.1 Digital Distribution

Currently, there is no consistent definition of digital distribution in scientific literature. Additionally, a variety of synonymous terms used for the same context (e.g. Online-Distribution, Electronic Distribution, E-Tailing, Digitization etc.) hampers transparency and comparability in the field.^[1] In particular, a clear differentiation between the distribution of online ordered physical goods and a complete web based distribution of information goods is not provided. To create consistency for this thesis, the definition of the distribution channel is hence extended to information goods exclusively. Consequently, a digital distribution channel is the set of interdependent organizations involved in the, solely web-based, process of making an information good available for use or consumption.^[2] Deriving from that, this work defines the term digital distribution as the online order, the web-based allocation, and the delivery of information goods.^[3]

In regards to the music industrial context of this work, it is obvious that the distributed good is music of independent music artists (IMAs).^[4] According to Shapiro and Varian (1999) music can be digitized and hence can be classified as an information good, which can easily be reproduced, easily transferred, easily searched, and easily stored.^[5] These considerations find support in the concept of “On-line Delivered Content“ by Loebbecke (1999).^[6]

In order to provide a sound understanding of digital distribution, this thesis focuses on the digital distribution via content downloads from web-based platforms. This form of digital distribution allows the downloading party to digitally possess the downloaded audio file after completing the download. Moreover, it is differentiated between direct distribution and indirect distribution. For content producers running the platform it is a matter of direct distribution, whereas it becomes a matter of indirect distribution if there is at least one intermediary integrated. It is also necessary to state that in addition to authorized digital download channels there are also unauthorized channels. Due to the limited scope of this work and the high practical relevance of digital downloads,^[7] further distribution models, such as streaming technology, will be not be regarded any further in this thesis.

2.2 Independent Music Artists

In order to provide a clear understanding of the term “independent music artists”, two types of delineation are distinguished. First one needs to describe the term “music artists”, which is basically an occupational title but experiences a huge variety in literature and practical life. However, a common agreement lies on the fact that music artists are the visible interpreters of a music production, performing as vocalists, instrumentalists or both.^[8]

Now the paper goes one step further and expands the term to “independent” music artists. First, this delineation underlines that the considered music artists are creators of content. Based on the German copyright act (UrhG)^[9], artists are the exclusive owners of all the rights of their content, allowing them to handle it in a completely self-determined fashion.^[10] This assumption is in accordance with the understanding of Loebbecke and Powell (2002) who implement the term “originators“ in order to describe the rights and idea-owning-entity providing content in the entertainment industry.^[11] It needs to be underlined that independent music artists do not have any contractual agreement with vertically integrated major labels. It is rather assumed that independent music artists can implement specialized intermediaries for marketing and distribution activities in order to make their content publicly available.^[12]

Additionally, one needs to state, that a single independent music artist does not necessarily need to be a single person. Moreover, the term describes content producing entities, which release their work under a common name, regardless of the amount of partaking people. Hence it is assumed that all the sub-actors participating in the music production process (composer, author, producer and interpreter) are embodied in the unit of the independent music artist.^[13] The content, which independent music artists create, are digital music files released as single tracks or entire albums.

Although the actions of independent music artists may underlie a certain creative impetus, which makes them seek for the best subjective result, it is assumed that independent music artists are profit-maximizing entities. Referring to Caves (2000), the art for arts’ sake property is, therefore, neglected.^[14]

In the next step a context-relevant classification of artists is introduced. Literature and industry professionals tend to distinguish artists by their degree of popularity and revenue. For this context, classifications are summed up to two different types of artists. On one hand, there are small artists who have a small degree of popularity and a small base of paying customers (fans). On the other hand, there are popular artists who attract a large number of customers.^[15] This differentiation provides an opportunity to assess the situational advantages and disadvantages of digital distribution regarding an artist’s career stage.^[16]

For complexity reasons and in order to provide a better reading flow, the term “independent music artists” will be abbreviated as “IMAs” in the duration of this paper.

3. Research Background: Digital Distribution of Independent Music Artists

For an adequate analysis of the IMAs’ position in the music industry affected by digital distribution, detailed background information about the economic context, in which IMAs interact, need to be provided. Hence, this chapter focuses on the market size, on the market players and their individual contribution to the value chain. Additionally, a digital distribution business model from the IMAs point-of-view is provided. It reveals the industry common revenue split and hence sets a quantitative basis for the further analytical considerations.

3.1 Market Size

The German music market is the third biggest of the world. After the sharp decline of sales beginning in 1999, deriving from illegal file sharing and piracy activities, the German music market is about to consolidate on a level of €1.67 bn. in 2011.^[17] While physical sales accounting for 80% of the overall revenues continue decreasing (-3.8%) in 2011, the digital market gains in importance (+21.2%). But although digital offers have been growing since its emergence, they do not compensate the lost revenues from the physical market.^[18]

According to the latest numbers of the Music Industry Association Germany (BVMI) digital download sales increased about 28.8% in 2011, leading to a sales volume of €203 billion. Both single track downloads sales and bundled downloads (albums or compilations) sales grew in the last year at rates of +24.7% and +36%. In 2011, German digital music consumers bought 79 mio. single tracks and 15 mio. bundled downloads, leading to revenues of €86 mio. respectively €117 mio..^[19] The most downloaded single track reached an amount of 600.000 units.^[20] Regarding the market share, one can state that 80-90% retains at the major labels and 10-20% are assigned to independent labels.^[21] Nevertheless, there is an increasing importance of independent music, which lately can be seen at the example of the independent artist “Adele”, whose album “21” sold worldwide over 17 mio. copies and hence became the most successful album of the year 2011.^[22]

3.2 Players and Value Chain

To understand the influence of digital distribution on the business processes, the basic tool of the value chain by Porter is implemented. It is adapted to the overall digital music industry and reveals the set of activities through which the different market players add value (see Figure 1). Traditional activities as the manufacturing and distribution of physical records as well as its inventory and sales are crowded out. Instead, the activities of digital distribution came up. The specific characteristics of information goods as low-cost copying without any quality loss and the low distribution costs^[23], especially in a global environment of interconnected users, increased the value of activities enforcing intellectual property rights and activities preventing illegal piracy.^[24]

The next chapters give an overview about the context relevant players and their individual contribution to the value chain.

illustration not visible in this excerpt

Fig. 1: The Digital Value Chain Source: Referring to Bockstedt et al. (2006), 19.

3.2.1 Artists

The composing of music and the writing of lyrics are the initial value creating activities in the digital value chain. The artists provide these creative activities and thereby become the exclusive copyright holders (§2UrhG) of their work. With the creation of musical ideas, artists already determine which music genre and hence which target group they address. In the case of an album, artists often construct a whole concept to which they align every following content production.^[25]

Further artists perform as instrumentalists and/or vocalist in order to transform their creative output into a digital product. For creating an adequate market quality most of the artists cooperate with a professional audio engineer. The post-production (mixing and mastering) of the recorded tracks finalizes the digital master copy i.e. the first copy.^[26] Besides the musical component of the early stages in the value chain, there occur also promotion-related productions such as cover-artwork, photo shootings and music videos, which are necessary for the process of digital distribution.^[27]

With respect to the “nobody knows” property by Caves (2000), describing the demand uncertainty for creative goods,^[28] it is hard to state, how much value has by now been created. But, nevertheless, the interaction of all parties (composers, authors, audio engineers, etc.) participating in the initial activities is vital for the creation of a market suitable and hence valuable product.^[29]

Since artists can hardly collect payments from every single user of their work, they can assign the GEMA to exercise the exploitation rights for them. Regarding the digital distribution, IMAs can provide their content to digital retailers and allow them to reproduce and distribute it.

Regarding the further steps in the value chain, the artist’s contribution traditionally was limited to some promotional activities such as giving interviews, conferences or live performances, in order to increase record sales.

But in the course of the Internet artists may also assume digital marketing and promotion activities. Especially artists’ websites and profiles in social networks gain importance, since they provide a direct channel to the customers, namely the fans. It can easily and temporarily be updated by the artists themselves and adds value in terms of customer relationship management.^[30]

Due to the facileness of modifying information goods, for instance in quality, different versions of the same first copy can easily be created. According to that and with respect to Wu, Chen (2008) artists can hence also add value by implementing versioning as an instrument of piracy protection.^[31]

Regarding the activity of digital distribution and sales, there are artists assuming these activities by distributing their music directly to consumers. Although in most cases it has a promotional or voluntary-based payment character, meaning that artists do not provide sales activities in the industry-common way of a download store.^[32] One famous example is the independent band “Radiohead” which released their seventh album on their own website.^[33]

3.2.2 Labels

In Germany there are the four major labels (Universal Music GmbH, Sony Music Entertainment GmbH, Warner Music Group Germany Holding GmbH, EMI Music Germany GmbH & Co.KG). They all are globally interacting and highly vertically integrated concerns, which traditionally dominate the physical music market. Furthermore, there is a multitude of small and medium-sized independent labels, which are less vertically integrated and mostly focused on one specific music genre. The most important ones in Germany are Edel, Indigo, Rough Trade, Soulfood Music, and Reader’s Digest.^[34]

Regarding the value chain, one can state that the majors’ interests can already influence the creative part of the production process, whereas independent labels often begin their engagement in the second stage of the value chain by financing the first copy costs.^[35] With the focus on non-physical goods, cost-intensive manufacturing of physical records becomes obsolete, leading to less value, which labels can add in the early stages of music production. In fact, labels can provide valuable actions regarding marketing and promotion, which bases on the labels’ core competences as market-experience and a broad promotion network. Furthermore, the labels do add value by providing piracy pretending and copyright enforcing activities. On the one hand this is conducted due to high financial capabilities allowing labels to employ lawyers, who legally fight copyright infringements. On the other hand there are many labels, which are members of industry associations as BVMI, Merlin or VUT. Among others, these syndicates have the aim to represent the labels’ interests in public, also in order to influence the national legislative regarding copyright infringement.

The major labels run their own distribution department to supply the digital retailers’ download stores.^[36] Initial efforts of vertical forward integration, in order to distribute directly to the consumer, did not succeed. In the digital context independent labels mostly need to implement external aggregators for placing their artists in the download stores.^[37]

3.2.3 Aggregators

The aggregators are one of the new players in the music industry. They recognized the need for legal digital offers and hence assumed tasks in the digital value chain. There are aggregators, which cooperate directly with artists (e.g. imusician, reverbnation), aggregators, which exclusively deal with independent labels (e.g. zebralution, soulfood, goodtogo), but also aggregators dealing with both parties (e.g. believe digital, recordJet, catapult). They add value to the channel by aggregating and subsequently distributing digital content (music files, artwork, meta-data, sometimes also promotional content) to the digital retailers. This process includes the archiving and the retailer specific digital encoding of the artists’ content. Moreover, aggregators provide financial transactions and billing for artists and labels. Besides the distribution, some aggregators are also integrated in retail marketing and promotion activities, in order to improve the visual placement of the artists’ content in the retailers’ download stores (e.g. placement on the cover page, genre page, etc.).^[38]

3.2.3 Digital Retailers

The two biggest digital retailers in Germany are the market leader iTunes (Apple Inc.) and its follower amazonMP3 (Amazon.com Inc.). Furthermore, there exist more than 40 other digital music retailers in the German market.

Their key activity lies in the distribution of digital content to the consumers. They maintain a download store, where consumers can virtually experience, pre-listen and purchase single tracks or entire albums per one-click (merchant-model). Hence, digital retailers assume typical distribution tasks as product presentation, information and communication, allocation, storage and sales. The relative unlimited space for digital goods storing enables retailers to maintain a broad variety of music. Even music, whose physical records have been sold-out, can be offered again if once digitized.^[39]

Regarding the marketing activities, it needs to be mentioned Apple Inc., which was able to establish a high customer loyalty. The company grew a large established customer base, by providing valuable services to customers like for instance the adaptation and integration of download store, player software and playing device. Furthermore, digital retailers adapted to the increasing mobility of its users and, thus, enabled the ubiquity of the customers’ music by providing cloud-based services as “iTunes everywhere” or “amazon cloud drive”. Moreover, there is cross-selling potential, since further product categories are offered within the same store. For instance iTunes customers can also obtain other digital products as movies, e-books, mobile apps, whereas amazon provides a broad variety of physical goods. Deriving from that, digital retailers gain individual costumer insights by tracking and analyzing their customers’ shopping behavior. Hence, digital retailers can add further value by assuming (direct) marketing activities as individually customizing advertising, products, and pricing.^[40] Considering the activity of piracy protection, the retailers can add value by entailing digital rights management systems (DRM-Systems) like digital watermarks or encryption.^[41]

3.2.4 Collection Societies

The German society for musical performance and mechanical reproduction rights (GEMA) is the unique legally authorized music collecting society in Germany. It represents the copyrights of more than 64.000 members who granted the exploitation of their copyrights to the GEMA. On behalf of its members, the GEMA collects license fees from music consumers and the industry providing blank media and devices for private reproduction and usage such as e.g. MP3-Players or hard drives.^[42] Subsequently, it distributes those fees as royalties to the IMAs, whose works have been publicly used. Since the GEMA acts as a trustee for copyright owners, it is not allowed to make any profits and hence just withholds administrative costs (14,9% in 2011) from the collected license fees.^[43] In the case of international usage of copyright protected music, collecting societies’ run mutual agreements with foreign affiliates to ensure that IMAs also receive royalties from international markets.^[44] Deriving from that, the GEMA adds value to the value chain by enforcing intellectual property rights, thus, the copyright.^[45]

[...]

---

^[1] see Ahn, Yoon (2008), 307; see Jones, Elsayed (2008), 10; see Schmidt (2007), 151-152.

^[2] see Kotler, Armstrong (2008), 335; see Kotler et al. (2011), 1003.

^[3] see Schmidt (2007), 152.

^[4] see Chapter 2.2

^[5] see Shapiro, Varian (1999), 3-4.

^[6] see Appendix A

^[7] see Wirtz (2009), 113, 497.

^[8] see Caves (2000), 61; see Clemons et al. (2003), 21; see Engh (2008), 102; see Künstlersozialversicherungsgesetz §2; see Ventroni (2008), 64; see Wirtz (2009), 496.

^[9] see Chapter 4.1

^[10] see Gopal et al. (2006), 1504; see Towse (2010), 462.

^[11] see Loebbecke, Powell (2002), 309.

^[12] see Mahlmann (2008), 166.

^[13] see Brousseau (2008), 137; see Engh (2008), 102.

^[14] see Caves (2000), 2.

^[15] see Caves (2000), 74; see Gopal et al. (2006), 1508; see Wirtz (2009), 528.

^[16] see Regner et al. (2009), 335; see Steinkrauß et al. (2008), 34-35.

^[17] see BVMI (2012c), 1.

^[18] see BVMI (2012b), 1.

^[19] see BVMI (2012b), 1.

^[20] see Media Control GfK International (2012), 1.

^[21] see Altig et al. (2008), 25; see IMPALA (2012a), 1.

^[22] see IMPALA (2012b), 1.

^[23] see Shapiro, Varian (1999), 3-4.

^[24] see Bockstedt et al.(2006), 16-19.

^[25] see Wirtz (2009), 516.

^[26] see Caves (2000), 61; see Clemons et al. (2003), 13; see Wirtz (2009), 516- 517.

^[27] see Caves (2000), 61; see Wirtz (2009), 530.

^[28] see Caves (2000), 24.

^[29] see Künne, Torkler (2008), 117-118.

^[30] see Steinkrauß et al. (2008), 31; see Wirtz (2009), 540.

^[31] see Wu, Chen (2008), 169-170.

^[32] see Regner et al. (2009), 340.

^[33] see Morrow (2009), 161-175.

^[34] see BVMI (2010), 4.

^[35] see Chapter 4.2

^[36] see Chapter 3.2.3

^[37] see Altig et al. (2008), 25.

^[38] see Zebralution (2012), 2.

^[39] see Wirtz (2010), 363.

^[40] see Clement, Schreiber (2010), 386- 387.

^[41] see Bockstedt et al.(2006), 17; see Regner et al.(2009), 335.

^[42] see GVL (2012a), 1.

^[43] see GEMA (2012a), 1-4; see GEMA (2012b), 1; see GVL (2012a), 1; see Wirtz (2009), 503-504.

^[44] see Connolly, Krueger (2008), 44.

^[45] see Caves (2000), 297.