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EMI tries to compete with free - January 14, 2008

Telling anecdote in the current Economist’s the-record-companies-are-screwed rundown: In 2006, EMI invited some teenagers up to its headquarters to discuss their music listening habits. When it was over the company thanked the group and invited them to help themselves to a pile of CDs sitting on a table. None of the teens took any. Said one EMI exec who was there, according to the report, “That was the moment we realized the game was completely up.”

The Economist uses the anecdote as a hook to get into a discussion of declining CD sales at the hands of digital delivery, both legal and otherwise, which is happening even more rapidly than the industry feared (unit sales off 19% in the U.S. in 2007). But it’s also interesting for what it reveals about the nature of the downloading phenomenon—and the industry’s constant whining that “you can’t compete with free.”

For the EMI teens, at least, clearly free wasn’t the issue. They were being offered free music on CDs and they still didn’t take it. Why not? Probably because the majority of (younger) music fans today have no use for CDs as a carrier of music. They find the configuration awkward, clumsy and inconvenient, to the point where, even at no cost, it’s hardly worth the trouble to put a CD in a disc drive and rip it.

Yes, the Napster revolution was about free music. But it was also about convenience, and a rejection of having to consume and store music in 10 to 15 track packages on 5cm plastic discs. It’s probably impossible at this late date to tease out the relative importance of those two factors in kick starting the download phenomenon. But clearly “free” wasn’t the only factor at work.

The game now really does appear to be completely up for many at EMI. Several reports today detail plans by the company’s new owners, private equity outfit Terra Firma, to drastically restructure its operations, including laying off as much as a third of its 6,000-employee worldwide work force, slashing marketing costs and reducing its roster of artists under contract (WSJ, BBC, AP).

The moves are part of an effort by Terra Firma to salvage its $6.2 billion investment in EMI by bringing costs in line with declining sales. Painful as the cuts will be for many in the industry, however (some of EMI’s biggest-selling acts are apparently rebelling over the lack of planned marketing support) they probably don’t go far enough to save the label. There is a lot more cost that will have to come out of the music industry before it rights its economic ship.

The fact is record companies perform far fewer useful functions than they used to. Digital technology has reduced the costs of recordings, shouldering the cost and risk of manufacturing and distributing CDs is becoming unnecessary and a robust A&R operation is probably unsustainable without the high margins produced by packaged media.

Record companies are essentially becoming asset pools, collections of copyrights that need to be invested with other operators (i.e. licensed) in order to create value. Asset management can be a profitable business, and one that a private equity firm like Terra Firma ought to understand. It just needs to get over the idea that it’s still in the business of selling records.

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