INTERNET EUROPE 9 November 2000
Heidi Fitzpatrick 44 20 7260 2964 [email protected]
Music And The Internet: A Celestial Jukebox
Andrew Hogley 44 20 7260 1499 [email protected]
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Get ready to be dazzled, because it is definitely show time in the music industry. The emerging digital formats and new distribution channels, catalysed by the arrival of broadband access, will fuel new growth in the industry. The next two years are going to see rapid changes as the industry experiments with new technologies and consumer applications. However, the 38m Napster users indicate that consumers have already chosen their favoured format. We believe that the internet will be a net positive across the value chain. Although near-term revenues from digital downloads will be marginal, new business models in music distribution will capture the shift in value from the retailers to the content owners. Copyright exploitation will be one of the most attractive growth areas in the new digital era, in our view.
Executive Summary ............................................................................................................ 6
Overview of the music industry.......................................................................................... 9 ♦ Recorded music is a $40bn global market ♦ Consumer buying behaviour is changing in the digital age ♦ Diversified tastes, increasing volume output, stagnating growth = decreasing returns ♦ Digital downloads are changing the way people consume music ♦ The role of independents is becoming more prominent ♦ Complex value chain
Evolution of the online music market .............................................................................. 27 ♦ Physical distribution on the internet ♦ Digital distribution on the internet
Drivers behind digital music take-up ............................................................................... 44 ♦ Broadband take-up ♦ Availability of playback devices, wireless connectivity ♦ Availability of content
How the internet will impact music: opportunities ......................................................... 56 ♦ Multiple routes to market, every party benefits ♦ Digital distribution as a marketing tool ♦ Music on demand: new consumer applications ♦ New pricing models: Multiple, different revenue streams
How the internet will impact music: threats .................................................................... 79 ♦ Piracy and copyright confusion are holding back the industry ♦ Should music be free – or could music be free?
The European landscape .................................................................................................. 90
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Peoplesound ....................................................................................................................... 95 Clickmusic........................................................................................................................... 98 Netbeat ............................................................................................................................... 99 Vitaminic ........................................................................................................................... 101 Freetax AS ........................................................................................................................ 104 BeSonic............................................................................................................................. 105 ICrunch ............................................................................................................................. 107 Mode Intl ........................................................................................................................... 110 Popwire ............................................................................................................................. 112 Worldpop........................................................................................................................... 114
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Tornado Group Plc ............................................................................................................ 116 Poptones ........................................................................................................................... 118 Playlouder.com ................................................................................................................. 119 MP3eu.net......................................................................................................................... 121
10) Appendix .......................................................................................................................... 123 ♦
Technology made simple: How it works
Table of Figures
Figure 1: Global music sales growth, 1984-1999
Figure 2: Global Recorded Music Sales, 1983-1999 ($bn)
Figure 3: Share of global music sales, 1999
Figure 4: World CD and LP Unit Sales 1983-1999 (millions)
Figure 5: Album sales of selected artists (m)
Figure 6: Bon Jovi – album sales (unit m)
Figure 7: Number of albums launched in the UK – all formats (1990-1999)
Figure 8: Share of Top 200 Albums (US,%), 1998-1997
Figure 9: % Of Music Sales in Domestic Repertoire
Figure 10: Average repertoire origin
Figure 11: Music Company Operating Margins, 1993-1999
Figure 12: Reasons for Downloading Music
Figure 13: The Music Industry Value Chain
Figure 14: Revenue Distribution of A CD
Figure 15: Total Western European Online Penetration (% of population)
Figure 16: US online music share of total music retail
Figure 17: % Of total retail sales sold online in 2005 (Europe)
Figure 18: Average Online price of music by Madonna in various
European countries ( e) Figure 19: European Online music sales, 1999-2003E (e m)
Figure 20: US Online music sales – Digital downloads and online CD sales ($ m) 33 Figure 21: US Online Music Market ($m)
Figure 22: Estimated European Download Sales, 1999-2005E (em)
Figure 23: The effects that people who have downloaded music think
downloading will have on their CD purchasing behaviour Figure 24: Where 13-25 get their MP3s (US)
Figure 25: Music Sales by Age Group, 1998
Figure 26: Share of Total European Music Sales for Offline, Online Retail and
Digital Downloads Figure 27: UK Music, Video and DVD retail market shares
Figure 28: Obstacles for digital distribution take-up
Figure 29: Broadband Access Connections in Western Europe, 1999-2004E
Figure 30: Broadband households as a % of all households, Western Europe
Figure 31: Mobile Handsets
Figure 32: Evolution of music content online
Figure 33: MODE system
Figure 34: Programme schedule of Storm, a major UK internet radio station
Figure 35: Digital music value chain
Figure 36: CDNow: digital downloads available for sampling music before purchase
Figure 37: Everad advertising during download
Figure 38: Three ways to “micropay” by mobile phones
Figure 39: How Napster Works
Table of Figures continued
Figure 40: Gnutella user session
Figure 41: Gnutella user session
Figure 42: Levels of domestic piracy, 1999 (units)
Figure 43: What compels you to visit a web site?
Figure 44: Peoplesound.com web site
Figure 45: Peoplesound.com web site
Figure 46: Clickmusic front page
Figure 47: NetBeat web site
Figure: 48: Songs delivered per month (‘000)
Figure 49: Vitaminic UK web site
Figure 50: Besonic web site
Figure 51: iCrunch web site
Figure 52: iCrunch web site
Figure 53: Popwire web site
Figure 54: Worldpop web site
Figure 55: From Poptones web site
Figure 56: Playlouder.com web site
Figure 57: MP3.de front page
Figure 58: MP3.fr front page
Figure 59: Sound Quality in Audio Compression
Figure 60: Winamp interface
Figure 61: Skins and visualisations for Windows Media Player 7
Figure 62: Number of players downloaded since release (end of September 2000, ‘000)
Table of Figures continued
Table 1: Major domestic artists outside North America
Table 2: European Recorded Music Market Statistics (1999)
Table 3: Combined majors vs combined indies global market share (%)
Table 4: Record label market shares by region and globally, 1999
Table 5: Music Industry Value Chain: Examples and Participants
Table 6: How a band spends a $1m advance received with record deal
Table 7: European Wireless Penetration Data
Table 8: UK Media Metrix survey, entertainment category, September 2000
Table 9: Napster use among US college students
Table 10: US Media Metrix August Survey, 60 top online media sites
Table 11: Estimated European music sales through traditional retail, online
retail and digital downloads (em) Table 12: MP3.com Top 15 Downloads (7 November 2000)
Table 13: Vitaminic.co.uk Top 10 Downloads (7 November 2000)
Table 14: Impact of the internet in various points of the music industry
value chain Table 15: Major Players in DRM Base Technologies
Table 16: Major Clearinghouses
Table 17: Examples of download pricing
Digital media will be one of the biggest beneficiaries of the internet revolution ♦
With the internet, music can be distributed and consumed in a digital format. While still experimental in technology and applications, digital downloads and streaming are already the formats of choice for a large consumer group. In addition, the arrival of digitally delivered music is coinciding with other transition drivers within the music industry. Consumers are not buying music the way they used to, tastes have proliferated and the industry is launching an increasing number of products to match this. There is an abundance of music available, waiting to be channelled to the consumers.
The term MP3 is a compression format, and it competes with other formats such as Windows Media Audio and RealAudio. Compression involves encoding a music file (essentially eliminating inaudible sounds and thus reducing the file size) and decoding it again during playback. Although MP3 is the most popular format currently in the market, the music industry has not embraced it because of its lack of security. CDs can be “ripped” into MP3 files and thus distributed illegally on the internet. We believe streaming instead of downloads will initially drive growth, as streaming enables the content owner to retain control of the file.
Recorded music industry is a $40bn global market, which has been facing stagnant growth over the past few years, as the growth in the 1980s and early 1990s resulting from the CD replacement effect has worn off. The European music market is the second largest in the world with higher than average album sales per capita. Growth in Europe was flat in 1999 after 3% in 1998 (in value terms). Domestic repertoire is growing in importance, with on average 42% of European music sales being generated by local artists. The industry is essentially an oligopoly, with over 75% of sales being supplied by the five major record labels; Universal, Warner Music, EMI, BMG and Sony Music.
Music distribution on the internet has already started in physical format. Ecommerce in Europe is expected to grow over 100% annually for the next three years, according to Forrester Research. Online music retail is still a nascent market where key players have launched only recently, but Forrester Research expects online music sales to capture almost 20% of total music retail by 2005. As only 1.3% of music sales were online in 1999, there is still a lot of growth ahead. Note that CDs are one of the easiest products to merchandise online, and they are also easy to pick, pack and ship. Some online sales will be captured by wireless channels as internet-enabled handsets proliferate, however actual revenues from mcommerce will initially be small.
A growing consumer group is abandoning CDs altogether and consuming music in a digital format. Revenues from this channels are tiny: in 1999, US digital download revenues were a mere $1m, leading us to believe that in Europe they were practically non-existent. US digital download revenues are estimated to be a $1.1bn market by 2003, according to Forrester Research, and if we assume that Europe is 24 months behind US in take-up, we can extrapolate that European digital download revenues could reach EQE\
We think that current revenue figures available on downloaded music do not accurately reflect the consumer take-up. Looking at other usage metrics, it appears that there is already a huge active user base consuming music via digital downloads – they are just not paying for them. Napster, the file sharing service, has in under a year attracted over 38m users, and this compares with Amazon with
Digital downloads are experimental, but they are already popular
There are several compression formats available in addition to MP3
Music industry growth has stalled
Online sales of CDs should be 20% of total retail in 2005
We expect European download revenues of EQLQ
Huge user base but it is not paying
25m customers built over five years. Napster is already featuring among top 50 domain names in the US Media Metrix surveys. In the UK, Peoplesound.com is the 5th largest site in the Entertainment category in the September Media Metrix survey, surpassing such well-known media destinations as www.disney.co.uk and channel5.co.uk. Although it is a concern that a large user base is getting accustomed to receiving music for free, we believe that this use is still experimental, and that with improving sound quality and service applying charges will be easier. ♦
We think that broadband take-up will be the single most important driver for growth in digital music. Slow download speeds on narrowband connections cannot fully utilise the benefits of this format. In addition, we believe that availability and declining prices of playback devices will also spur growth in the format.
So far most of the content available for legitimate downloads is generated by lesser-known and/or unsigned artists. Because of the unsolved copyright issues and uncertainty over format security, the majors have so far been reluctant to make their content available for downloads. So far they have been experimenting with limited catalogues in limited distribution.
Piracy is a valid fear for the music industry. One of the biggest headaches for the industry has been the file-sharing applications such as Napster. However, we do not believe that disabling Napster is going to win the war for the music industry. First, their popularity means that new applications will keep emerging, second, the client-to-client services such as Gnutella (allowing anonymity) represent a far bigger threat than Napster does. Furthermore, as Napster the programme has been the most successful viral marketing concept in the history of the internet, the record industry might eventually find a way of exploiting this so that the copyright holders get paid. However, piracy will never be completely eliminated (currently piracy levels are 10-20%).
Complex value chain
The music industry food chain is extremely complex, consisting of several different business models in which revenues are obtained. With the arrival of the internet, this value chain is going to change. There will be new routes to market for the music, and more efficiencies to be obtained for every party in the chain. There will be opportunities for disintermediation, as well as some reintermediation. Artists can connect directly with their fans, and record labels can sell their artists themselves. New business models will emerge, in particular in music distribution, where companies providing digital fulfilment and DRM (Digital Rights Management) services are already lining up. We believe that eventually there will be a shift in value from the distributors to the copyright holders.
New routes to market for music
The key question is how will consumers acquire and consume music? We believe aggregators will be increasingly important, and that existing online and offline retailers with their customer relationships will be playing a major role in the short term (after all, this is essentially a format change). There will be several new ways for music to reach consumers, whether it is through a portal, through an etailer, through the artist site or another gateway. Music will be available on demand. Record companies will have to become increasingly like aggregators, channelling music to consumers according to their preferences.
Broadband will be the key driver
Very little mainstream content
Disabling Napster won’t eliminate piracy
New pricing models
Digital delivery of music will bring about new revenue models for the companies in the front end of the value chain. Music can be sold on a perdownload basis, or on a subscription basis. Music files can also be rented, or music can be given out for free with revenues coming from advertising. Essentially, music will start to resemble a service rather than a product, and this will result in a change in consumer mindset: music does not have to be owned, instead it can be acquired only when needed.
Demand for content will accelerate
We believe that as the number of digital channels on various platforms explodes, demand for music content is likely to reach new heights. Content exploitation will therefore become a very attractive growth area, with music publishing revenues enjoying the benefits. We also believe that this format shift will be a fundamental net positive for the music industry, accelerating growth through both increased demand and wider distribution in various platforms.
In Europe, the early stage of industry development is reflected by the diversity of business models currently on the market. What the winning model will be is still unclear, however for the near future revenues from download retail are likely to remain marginal. We would pick Peoplesound.com, NetBeat and Icrunch as the most interesting start-ups in this scene. One of the largest pure plays, Vitaminic, completed an IPO on the Nuovo Mercato in October, valuing the company at P.
Share Of Total European Music Sales For Offline, Online Retail And Digital Downloads
10% 0% 1999
OfflineIFPI, Online CDsBrothers Downloads Source: Forrester Research, Lehman Research Source: Lehman Brothers Research, Forrester Research, IFPI
Digital Music Is Hot
Industry at an inflection point
Overview of the music industry We believe digital media will be one of the biggest winners of the internet revolution. Unlike other e-volving industries, music industry is already digital: Practically all forms of media content (books, newspapers, film, music) can be transferred into a digital format ready for networked transmission, in which case the need to distribute a physical object (book, CD or a video) is eliminated - at least in theory. In practice consumer preferences dictate which distribution channels will prevail. However, what digital distribution means for these industries is transforming business models with new efficiencies in production and supply chain, in addition for consumers it means new ways of acquiring and consuming media. Although media content has already been converting into digital format for some time, only the arrival of the internet has allowed for these new business models to emerge. We are therefore in the beginning of a radical shift in how this industry operates. Recorded music is a $40bn global industry, which has over time experienced several changes in distribution and format, starting from the radio in the beginning of the century to Minidisks which came to the market three years ago. However, the internet and digital technology are likely to bring about a profound paradigm shift. This will be experienced not only in the way music is distributed and the format in which it is distributed, but also in the way it is produced and consumed. The industry is currently in the inflection point, in the very early stages of migration, with considerable instability and extreme viewpoints. Visibility of how the sector is going to settle is low.
Recorded music is a $40bn global market The music industry has always benefited from the arrival of new delivery formats. Cassette, Vinyl LP and CD have all spurred additional growth in this market, as each new format has been able to offer better sound quality and convenience, in addition consumers have not just carried on by buying new releases but also replaced their collection held in the old format (this was particularly visible at the end of 1980s – beginning of 1990s when CD’s took over vinyl). These extra sales generally offset increase in the percentage lost to piracy. Although both audio cassette and CD caused concerns for piracy, both formats ended up being a major boost for the global music industry. We think digital music can turn out to be a similar uplift, rather than the threat envisaged by the music industry. Global music market is growing at 3.4% pa
The worldwide recorded music represents a $38.5bn global market (as of 1999), and has been growing at a rate of 3.4% pa since 1991 in value terms. Between 1985 and 1991 the industry was growing at over 15% pa in value terms, whereas over the past two years the growth has dropped to under 1% pa – although as this data is not inflation-adjusted, so real growth in 1997-1999 has dropped to negative. Of this $38.5bn Europe represents around $14.6bn ( EQ DFFRXQWLQJ IRU RI JOREDO recorded music sales. The North American market is slightly larger with 39% of world record sales, and Japan is the third largest, with 17% of world record sales. Ten largest music markets in the world generate 83% of the world’s record sales (according to IFPI’s 1999 statistics). However, the reported sales figures represent only a proportion of total music consumption: a vast amount of music is consumed for free, either in the form of radio or TV broadcasts, or indirectly in films, TV programmes, advertising, videos or other products that use audio content.
Global music sales growth has stagnated
Figure 1: Global music sales growth, 1984-1999 2 5 .0 % 2 0 .0 % 1 5 .0 % 1 0 .0 % 5 .0 % 0 .0 %
- 5 .0 % - 1 0 .0 %
Figure 2: Global Recorded Music Sales, 1983-1999 ($bn) 40.0
39.6 39.9 38.0 38.2 38.5
20.0 15.0 12.0 12.0 12.3
10 Largest Music Markets (1999) Retail value % of ($ m) World Sales USA 14,251 37% Japan 6,437 17% UK 2,909 8% Germany 2,833 7% France 1,983 5% Canada 884 2% Brazil 668 2% Australia 656 2% Spain 640 2% Mexico 636 2% Total 31,897 83%
Europeans are heavy users but growth has stalled. Interestingly, per capita album sales in Western Europe, at 2.7 albums pa per person are more than three times the global average, with the British population each buying on average 4.1 albums per year (highest in the world). Seven European countries feature in the top 10 in terms of per capita album sales. As a comparison, the North American per capita album sales are 3.7 albums pa, or $47 in value terms. The European music market has seen flat to negative unit growth for the past two years, and in value terms the market was flat in 1999 after growing by 3% in 1998. A few countries in Europe are still growing fairly steadily, notably the Nordic region and certain Eastern European countries. The weak growth in 1999 in most Western European countries can partly be attributed to relatively few big-selling releases coming to the market that year compared to 1998. In 1998 the market bought the Titanic soundtrack album as well as new albums from Celine Dion, Madonna and Robbie Williams.
Most of the music market growth in mid-late 1990s can be accounted for the new format replacement effect, as consumers replaced their album collection with CDs. In the words of one record label executive: the music industry was growing by selling consumers what they already owned but this time in a different format and charging more for it. CDs overtook other formats (LPs, singles and cassettes combined) in terms of units sold in 1994, although CD players had been in the market since 1983. This demonstrates how slow the consumer adoption of new formats can be, and in the case of CDs it was driven both by CD player take-up (as prices came down) and availability of content in the new format. We think digital music will go through a similar evolutionary path, as it is in fact another format for delivering and consuming music. It is worth noting that despite digital delivery being around for two years now, worldwide CD sales are still growing at 2.8% pa in unit terms. Figure 3: Share of global music sales, 1999 Latin Australasia America Asia 2.0% 4.9% 3.4%
North America 39.4%
Africa 0.5% Middle East 0.9%
Figure 4: World CD and LP Unit Sales, 1993-1999 (millions) 2,500 CD
2,000 1,500 1,000 500
Despite industry growing annually in value terms, global volume growth (all formats) has been flat (-0.4% in 1999 and 3.8bn units). The CD replacement effect has worn off (CDs now account for 65% of all units sold worldwide), in addition reduced consumer demand in some of the emerging economies have had a negative 11
impact in volumes. Minidisc is emerging fast, and IFPI reported over one million units sold in 1999, with UK taking the largest share of this format (50% of all units sold in 1999). Cassettes still dominate in many developing markets, although overall global unit growth was down 7% in 1999.
Consumer buying behaviour is changing in the digital age Traditionally music has been about mass-market stars
Music is increasingly consumed indirectly
The technological change following the digitisation of music is being combined by changes in customer usage patterns. The 21st century music consumer relates to recorded music differently from the consumer in the 1970’s, 1980’s and 1990’s. These decades launched a series of huge mass-market stars, who received a global following and sold a large proportion of their respective label’s total annual publishing quota. Music used to be a more essential part of a lifestyle than it is today, defining the existence of Mods, Beatniks, Punks, New Romantics, Rockers and other youth culture groups. People in the “heavy user” age group, 16-40 –year olds, often identified themselves as being a fan of a certain mass-market artist, and owning an album collection used to be part of a person’s identity. Consequently, as tendency was towards mass-market artists, tastes were more unified than they are today. Young people (the heavy music users) used to listen to the same artist at the same time. Consumers today in the “heavy-user” age group are seeking new ways to define themselves, with music taking a back seat or becoming only one of the ways identities are formed (internet, video games, dance parties or extreme sports gaining in importance). Curiously, this is taking place at the same time as use of music is increasing. But the growth of music usage is becoming increasingly indirect, from owning an album collection to conscious and sub-conscious consuming of music in films, television, advertising, shops, radio channels, and other occasions. Music is also merging with brands and getting closer to consumer experiences on several levels and occasions. For example, Sting’s new single in the Jaguar advertisement worked to promote both the car and the artists. During the Sydney Olympics, Nike launched an internet radio station called Radio Free Sydney, where dance music played by DJs was streamed live around the clock. This was part of Nike’s overall marketing strategy to bring product relevant content to customers, and a good example of how music content is becoming increasingly important for brands wishing to connect with their consumers. This has implications for content owners and their revenue models, with a subtle shift from revenues from direct sales to revenues from exploitation of content rights, in the form of publishing and licensing contracts. Therefore, we believe that the content exploitation will grow substantially as distribution channels proliferate.
Stars often fail to generate repeat hits
A potential indicator of mass-market stars’ fading appeal is their ability to generate repeat hits. Several artists who have gone to score jackpots with their debut albums have seen their subsequent album sales dwindle. Many artists have become “one-hit wonders” with only a handful of stars being able to score top hits year after year. Consumer loyalty is eroding fast. Figure 5 below shows a selection of artists and unit sales of their debut and subsequent albums: most of us can remember Alanis Morissette and her huge success in the early 1990s.
Figure 5: Album sales of selected artists (m) Debut album
14 12 10 8 6 4 2 0 Hootie & The Blowfish
Boyz II Men
Pearl Jam Cranberries
Alanis Sheryl Crow Melissa Morissette Etheridge
Source: Billboard, Peoplesound.com
Of course, there is also evidence of a contrary trend, especially with artists in alternative and alternative mainstream genres. Artists that have a very targeted audience can have stable sales for each released album, however these artists are unlikely to sell in the 10m+ range (units) that well-promoted pop/rock artists frequently do. Established artists tend to have varied levels of success in subsequent releases, for example Bon Jovi in Figure 6 below.
Figure 6: Bon Jovi – album sales (units m) 15.2 16.0 14.0 10.3
6.0 4.0 2.0 0.0 Album 1
Source: Vivendi Universal
Consumer tastes have diversified
Consumer segments are becoming increasingly fragmented. Although previously a small number of world-wide stars could cater for large groups of consumers, customer tastes have since diversified and as a result, the record industry is launching an increasing number of artists to satisfy this diversity. However, for consumers, this growing array of choice means that it has become more difficult to go to a record store and pick an album. As a result, people increasingly purchase music based on mood or certain style. An indication of the growing complexity for consumers is the huge 13
growth in compilation albums, which now serve as navigators offering vital guidance. Often these compilations are also being marketed to represent a certain style: for example, the widely popular Café Del Mar –albums featured mostly lesser-known artists, but were significant in depicting a certain mood. Consumers are also becoming more willing to buy albums of unknown artists on the back of one hit song, which is a lucrative trend for content owners. More genres cover the diversity of preferences
The industry is launching an increasing number of albums
The proliferation of music genres has been one of the phenomena of the past 10 years; for example in the dance music category we now find artists in such sub-genres as Ambient, Breakbeat, Big Beat, Trance, Goa, House, Deep House, Trip-Hop, Jungle, Garage or UK Garage. Similar diversity is found in other broad genres such as rock, R&B and Country (with interesting offerings such as Neo Folk and Modern Country). There are now over 200 different recognised genres available for consumers. Dance music, which emerged at the end of 1980s, is now one of the fastest growing genres where new stars are being discovered almost on a daily basis. Again, music tastes have expanded and new genres continue to emerge in order to satisfy this. Given the wide differences in consumer tastes, it is not surprising that the number of albums launched in the industry has accelerated: Figure 7 below shows the number of albums launched in the UK between 1990 and 1999. In the UK alone, almost 20,000 new albums were released in 1999, compared to 5,500 in 1989. In the US, 38,900 new albums were released in 1999. This is a significant increase in supply in a market that is becoming increasingly fragmented. The expanding number of releases means that there are more artists chasing the market. And, partly because more artists are now taking a share of the $40bn global market, which is only growing at around 3% annually, fewer artists can command truly significant sales. It is telling that whereas in 1990, 20 best selling albums took in 22% of total global music sales, in 1999 it was 17%. Furthermore, typically less than 3% of all released albums sell more than 50,000 copies, and a large number of new releases sell only a few thousand copies. Moreover, if a record label is lucky enough to launch an artist that can produce a hit album, it is not certain that the same artist can continue producing hits, as we demonstrated in Figure 5. The industry carries an enormous back catalogue representing various artists that sold well in their time but continue to exist only in discounted compilations or in music clubs.
Figure 7: Number of albums launched in the UK – all formats (1990-1999) 19,900
Figure 8: Share of Top 200 Albums (US, %), 1988-1997
60% 50% 40% 30%
On average, 5% of artists deliver a return
Domestic repertoire is catching up. In addition, the growing popularity of domestic repertoire has resulted in an increasingly fragmented industry where tastes are scattered not only by musical genres, but also by countries. Overall globally the importance of domestic repertoire has increased steadily, and nearly 65% of all music sales are now of domestic origin, compared to 58% in 1991. Although the stars generating highest sales on a global basis tend to be North American or British, it is typically the local artists that are market leaders in their home countries. In addition, these artists are often outside the mainstream rock/pop genres. In Italy, italian rock is a genre of its own and enjoys tremendous popularity, whereas in France chansons are still enjoyed by the population across various age groups. Domestic repertoire generates a majority of music sales in most markets. International repertoire typically has a higher market share in certain European countries such as Denmark, Norway and Ireland, as well as in the Eastern European countries. Asia, Latin America and the Middle East all listen to local artists. Over 90% of US music sales consist of domestic repertoire. The large Continental markets Germany, France, Spain and Italy report around half of their music sales going to domestic artists. In Europe the share of domestic repertoire is slightly below global average, but nevertheless it has been increasing: In 1999 42% of all recorded music sales in Europe were domestic, compared to 36% in 1991. At the same time both international and classical repertoire have decreased their share. This supports the view that the music industry is not dominated by a few mass-market stars, but album sales are generated by a vast variety of domestic and international artist in a plethora of music genres. See Figure 10 for an illustration of how the share of international artists has decreased in global music sales.
Figure 9: % Of Music Sales In Domestic Repertoire US
South Korea Netherlands
Table 1: Major domestic artists outside North America Country Artist Sweden Abba Denmark Aqua Germany Rammstein Italy Andrea Bocelli UK U2 France Johnny Halliday Spain Rosana Puerto Rico Jose Feliciano Hong Kong Jacky Cheung Brazil Sandy & Junior Source: Vivendi Universal
Domestic repertoire is growing
This means that content ownership, artist acquisition and development as well as content exploitation is very much a local business, requiring local presence and expertise. In addition to consumer tastes, their access to music relies on very local distribution channels, as both retailers and media rarely cross national borders. Although local acts can provide a good source of growth for the majors, it is a doubleedged sword: music companies cannot offset promotion and development costs against a bigger market, as sales potential is limited.
Figure 10: Average repertoire origin 100%
60% 40% 20% 0%
Diversified tastes, increasing volumes, stagnating growth = decreasing returns Music is more diversified than ever. Consumers’ music tastes have expanded covering a multitude of genres and dispersing across geographies, and mass market stars are not able to pull crowds as well as they used to. In order to cover all the tastes of music, the industry is launching more new artists and more albums. However, this is taking place in a market that is seeing stagnating growth both on volume and value terms – in other words the industry is pushing more product into a contracting market. As a result, the music industry is facing diminishing returns on their artist investments.
Only 5-10% of signed artists return a profit
However, this is happening in an industry where success rate was not too impressive to start with. On average, 5-10% of all signed artists return a profit for the record label, meaning producing sufficient sales to cover investment such as advances on royalties, production and promotional costs, and even this ratio has been continuously eroding. What this means is of 100 artists (and we believe that this figure works when looking at album launches as well) launched by a record label, typically around 5 will become very big sellers, covering the losses stemming from investments in the other 90-95. And in the music industry, investments in album launches are escalating, requiring significant promotional effort such as music videos and radio campaigns. Many albums with considerable production and promotion investments have bombed, selling only a handful of copies. As a result, the record industry writes off several billion dollars each year in unrecoverable A&R investment. This also highlights how the success of an artist is very much down to luck – A&R executive’s positive opinion does not always guarantee sales. The signing decisions typically are not based on any analytical process but more on gut feel. This environment of increasing product launches and diversified tastes together with traditionally poor success rate on artist investments and stagnating music sales can only result in one thing: Music companies are witnessing declining operating margins.
Figure 11: Music Company Operating Margins, 1993-1999 21.0% 19.0% 17.0% 15.0% 13.0% 11.0% 9.0% 7.0% 1993
Source: Company reports, Lehman Brothers Research
Music industry market shares Universal 23%
Warner 13% Sony Music 15%
Fragmented market creates challenges for retailers
Local media, collection societies and legislations
The recorded music industry is dominated by five big record labels – “the five majors”. These are Universal, BMG (Bertelsmann Music Group), EMI, Sony Music, and Warner Music. The five majors cover approximately 75-80% of the global music sales, with the rest being supplied by hundreds of independent record labels. Each major label owns dozens of smaller labels, which typically specialise in a certain music genre. Universal is the largest of the five majors, with approximately 23% market share. The majors’ dominance has long been a sore point for many professionals in the music industry, which is why the independent sector continues to gain prominence in particular with some of the non-mainstream genres. The discarded merger between EMI and Time Warner was designed to create a music industry superpower with the largest market share. Market commentators have flagged other possible partners for EMI, indicating that consolidation is becoming a feature in the music industry as well. For online retailers, this market structure represents some considerable challenges. Not only are there large national differences in terms of online penetration (with Scandinavia leading and Southern Europe lagging behind), there are also large national differences in terms of what consumers are buying. As the internet is still a minority channel, any online retailer would have to have a presence in several countries in order to build scale. However, only a proportion of the catalogue is transferable across borders, and any e-tailer wishing to trade on a pan-European scale would have to manage several domestic catalogues and several supplier relationships. In addition, not only does the music bought by consumers differ considerably between the various countries, music industry structures are also local, which complicates artist development and promotion. Each country has its own copyright legislation and royalty collection society, and distribution is done on a local rather than pan-European basis. Promotion cannot be pan-European since each country has its own national media, which does not cross borders. Retail chains are also local with different channel market shares (for example, direct sales through record clubs are popular in some countries e.g. Finland). We believe that this complexity and fragmentation, which runs throughout the value chain, has been the single biggest factor deterring US operators from entering into Europe. The few that have crossed the Atlantic have in most cases had considerable challenges.
Table 2: European Recorded Music Market Statistics (1999) Company
Austria Belgium Denmark Finland France Germany Greece Iceland Ireland Italy Netherlands Norway Portugal Spain Sweden Switzerland UK
Retail Value (USD m)
322.9 342.3 263.9 128.6 1,983.4 2,832.5 98.8 17.8 113.3 607.3 522.1 260.9 176.8 639.5 356.6 277.1 2,908.9
Growth (99-98) Units USD
-6% -1% 2% -8% -4% 0% -15% 13% 2% 1% -3% -3% -9% 0% 1% -5% -5%
-7% -7% -1% -8% -8% -6% -18% 4% 0% -1% -4% -6% -5% -6% 0% -11% 2%
-3% -3% 3% -4% -4% -2% -15% 6% 5% 4% -3% -2% -1% -2% 4% -8% 4%
Per Capita album sales
2.6 2.5 3.3 2.3 2.3 2.9 0.8 2.6 2.1 1.0 2.4 3.6 1.7 1.6 2.9 3.5 4.1
% of repertoire domestic
15% 20% 35% 42% 44% 43% 59% 45% 16% 51% 27% 19% 31% 42% 25% 8% 48%
Digital downloads are changing the way people consume music New ways of buying and consuming music
In addition to what people are buying, how they are buying it is also experiencing a profound change, brought about by the arrival of internet and digital formats. We will be analysing the digital formats and how large this market really is further in the report, however the following statistics show that digital distribution of music is already reality, and it is changing the industry. •
Over 70% of US college students have downloaded music using Napster, the software that allows users swap audio files from each other’s servers.
“MP3” was the most popular search term in US search engines in June 2000
While no doubt still being experimental in usage and technology, digital distribution is already a very important music format for a certain customer group. We believe that this is the same customer group who were the first adopters of the internet in the early to mid-1990’s, and this will be followed by a more mainstream consumer. A more convenient format
Why would consumers favour digital distribution over physical format? In addition to the convenience factor, downloading music offers instant gratification, something which buying CDs over the internet cannot do, as you have to wait for days before you receive your product. Digital downloads also offer an important navigation tool as the choice in music has exploded: customers can sample music prior to purchasing by downloading audio files, which is something that is extremely difficult to do offline. This will prove to be an important factor in guiding music purchases, and may result in content owners having to repackage music. Curiously, music companies have been able to sell full CDs on the back of a few popular tracks, meaning that of the 12 tracks on a regular CD only 1 or 2 are hits or at least tracks preferred by the customer, and the reason why the CD is purchased. From a customer’s viewpoint, the remaining 9-10 practically act as space fillers. Although this is intended to be 19
eliminated by the so-called coupling clause, the storage capacity in a CD means that more tracks can be included in an album. For customers purchasing digital downloads on a per track basis means that there is no need to buy the whole CD in order to get the favoured track. Digital delivery allows customers to download only those tracks that they wish to purchase. A more customer-friendly format
In addition, for many customers record stores are “inhospitable” outlets, especially if the customer does not know what s/he wants. Merchandising is often confusing and customers sometimes find the staff too intimidating to ask for help. This is probably one reason why back catalogues tend to sell better in online CD stores: the convenient search and navigation facilities are something that do not exist in bricks & mortar stores. Some teenagers report being watched constantly with suspicion by the store staff, and thus find downloading songs from the internet a more hassle-free experience. Digital downloads are a more convenient way of storing and listening to music. Audio files can be stored in a playback device, and there is no longer a need to travel with several CDs. Customers are able to build personal mobile jukeboxes without having to own and carry a sizeable album collection. This will obviously create an entirely new way for customers to hold and own music: as digital files cannot be stored on shelves alongside traditional CDs and albums, the size of a person’s displayed album collection will no longer reflect the extent of the collection. Music does not have to be owned and held. If music files can be downloaded whenever a consumer chooses to listen to them, music can be consumed on a need-to-use basis. Figure 12: Reasons For Downloading Music Availability of hard-to-find music/genres Convenience Free music, pirated Free/cheap music, legal Curiosity "Loves Music" Other
The role of independent labels is becoming more prominent Over 3,500 independent labels in Europe
Although a majority of the world’s recorded music revenues goes to the five major labels (Universal, Sony Music, Warner Music, BMG and EMI), around 23% of the revenues are owned by hundreds of independent record labels. There are over 400 independent labels in the UK alone, and over 3,500 in Europe. Although most of these are either focused on a particular genre, small with few resources to develop and promote the artists or unable to attract marketable artists, some independent labels have grown into formidable players in the European music scene.
Several successful artists have chosen to eschew the majors as it is felt that they are too commercial and instil too much control on their portfolio of artists. The attraction in going with an independent label is often more creative freedom, in addition the majors tend to be more wary of signing music that does not appeal to the mass market. As the majors are all quoted companies (with the exception of BMG) with strict financial performance targets, artists are usually required to produce chart success immediately. However, most bands and artists do not develop that quickly, instead they require often two, three or four records before they see a lift-off (The Verve is a typical example).
Indies will grow in significance
Indies have 50% of the copyrights, but only 20% of revenues
Whereas a few years ago very few independent artists were able to launch themselves into the charts, over the past few years some of the most popular artists have started to come through the independent labels. Good examples are Oasis (Creation Records) and Prodigy (Beggar’s Banquet). As the consumer tastes become more fragmented and as the music consumer is increasingly looking for individual tastes and styles at the expense of mass-market artists, we believe that independent labels will grow in significance in the European music scene. The independent music scene is populated by thousands of artists. In Europe around 50% of the copyrights belong to independent labels, however it is probably a reflection of the type of artists going through the independent labels that only 19% of revenues are collected by the independents – although this figure varies depending on sources. In addition, because the majors have greater access to world-wide distribution, they are able to market their artists more effectively than the independents. The indies’ share of revenues tends to be even weaker in Europe, whereas in Latin America and Asia it is more prominent, because of the smaller presence by the majors. Worldwide, the combined share of all independent labels has declined over the past 10 years, which reflect the challenges resulting from smaller distribution capabilities. Globally the indies capture around 23-24% of all record sales, which has been declining since 1988, when they represented over 30% of the market. Some decline in indies' market share can be accounted for majors acquiring smaller independent labels. Table 3: Combined majors vs. combined indies global market share (%) 1988 Combined majors 69.8 Combined indies 30.2 Source: IFPI, MBI
1990 73.6 26.4
1994 73.8 26.2
1995 72.1 27.9
1996 72.8 27.2
1997 74.5 25.5
1998 75.9 24.1
1999 76.0 24.0
Table 4: Record label market shares by region and globally, 1999 BMG
Europe 11% 17% 18% Latin America 15% 11% 18% North America 12% 9% 18% SE Asia (ex Japan) 6% 8% 11% Global 11% 14% 18% Source: SoundScan, IFPI, Lehman Brothers Research
25% 22% 25% 17% 22%
12% 10% 16% 6% 13%
19% 25% 21% 53% 23%
Complex value chain Revenues are split in several ways
The music industry operates in a complex value chain consisting of several different business models in which revenues are obtained. The $40bn annual revenues are split in several ways with many involved parties taking a cut during the process. Although the most significant revenue streams come from the retail distribution of music in various formats, both the record industry and the music 21
Technology allows for more flexibility.
publishing industry receive revenues from a wealth of other forms. This ranges from the obvious such as the broadcast industries, live performance, films and any music heard on public places to the less obvious such as use on corporate presentations or video games. These uses will continue in the digital age. However, internet and digital technologies will not only restructure the value chain, entering into every link with either value adding or destroying results, but also expand the range of use as the new platforms offer new distribution opportunities. As a result, we expect to see new business models emerging as the reliance of core revenue generators such as retail sales and broadcasting decreases. With the arrival of Napster and other file sharing technologies as hugely popular consumer platforms, the industry is facing tremendous changes. There are an incredible number of moving parts, which have to be rearranged. Figure 13: The Music Industry Value Chain
Distributor Radio Station
Source: Lehman Brothers Research
Below we will provide a brief overview of each party’s role in the music industry food chain. Composer/Songwriter The songwriter is the original author of the music. Sometimes the artist or a band also acts as a songwriter, but it can be done by a separate company or individual, via various channels. The composer receives a share of the royalties.
Artists create and perform music
Publishers are the custodians of music
Artist The artist or a band is the most visible part of the value chain. Creating and performing music is their livelihood, and they want to get paid for it, whether we are talking about a struggling unknown band or a platinum-selling superstar. Traditionally the only way of getting music to the market and earning revenues from the creative process has been to get signed with a record label. The artist receives share of revenues from record sales, as well as fees from record labels. Publisher Publishers administer the copyright and look after the collection of royalties for the composers. They are essentially custodians of the songs, and represent the copyright holder and licence the musical compositions for artists to use in records, movies, television programs, films, restaurants, radio, advertising and many other uses. The copyright of a song can refer to either the lyrics and the composition, or the actual recording, and whereas specialised publishers often own the rights to the lyrics and songs, record labels often acquire rights for the actual recording. For example, if an artist wants to record a cover version of an old song, the song’s publisher would grant the licence to the song from the catalogue. Each time the song was played on the radio or each CD sold, the publisher would collect royalties, of which it would keep a portion and pass the remaining share to the artist. 22
This is an extremely lucrative business with very high margins and repetitive revenue streams. Music publishing is also one of the fastest growing revenue streams in the industry. For example, last year Vivendi Universal collected nearly $1m in publishing royalties of one song alone; “I Will Survive”. Publishing revenues come in three forms:
Major labels are vertically integrated
Mechanical royalties – this refers to royalties being generated by record sales, so each time a record is sold the publisher gets paid.
Performance royalties – royalties generated from songs played live on stage or in a public place, however also from songs broadcast on radio, television, in a cinema or over the internet
Synchronisation royalties – this is the fastest growing publishing revenue stream. It involves marrying the song (words and music) with visuals, such as in television programmes, advertising, film or videos.
Record label Record labels are powerful players in the music industry. The five majors, EMI, BMG, Warner Music, Universal Music Group and Sony Music control around 85% of the global recorded music market. Each of these labels also holds a number of minor labels which specialise in a particular genre or artist type. The major labels tend to be vertically integrated, all the way from songwriting to music publishing to distribution, therefore holding considerable power over what music is recorded and where it is distributed. The remaining 15% of the world music industry is covered by a large number of so-called independent labels, which vary in size and can represent only a handful of artists. The record labels play a major role in taking artists to the market. One of the key function is the discovery of new artists through A&R process, which provides a type of quality control for the consumers. The talent scouts employed by the record labels search the world for unsigned artists, hoping to find the next platinum-selling superstar. The time and money invested in this process is substantial.
Advances on future royalties
Once a promising artist has been identified, the record label typically provides the artist with an advance on future royalties, designed to cover the cost of living expenses, production, travel, promotion and salaries. This in a way is an underwriting fee as the record label assumes the risk of the artist never being successful. In fact, the success rate of launching new artists has radically decreased, and now around 5% of all new signings make a return on the investment. Record labels also provide producers and resources for the actual recording and production of the album. The labels bear the costs of recording studio fees, studio musicians, sound engineers and producers. In addition, large record labels have vertically integrated printing (the actual manufacturing of the CDs or albums) and distribution. Large labels usually have distribution centres that act as wholesalers, often working with the retailers on promotions and merchandising. Manufacturer Majors and other large labels usually own manufacturing facilities, such as Bertelsmann’s Sonopress. Most smaller or independent labels that are not vertically integrated have to outsource printing and manufacturing the CDs and albums (often to the companies owned by the majors). This involves pressing the albums and CDs as well as producing the packaging and artwork for the covers. 23
Distributors get the CDs to the stores
Various retail channels
Distributor The distributors get the CDs physically from the manufacturers or record companies to the retailers. They own and operate the warehouses, drive the trucks and deliver the CDs to the stores. Major labels have their own distribution networks, or they use independent, third-party distributors. Again, smaller or independent labels that are not vertically integrated typically outsource distribution to third parties, who as wholesalers work with the retail chains and other sales channels to ensure the music reaches the consumers. Retailer This is the last stage in the music value chain. The music reaches the consumers through various channels, whether it is a large-scale record store such as Virgin Megastore, a supermarket, a music club, or a specialist music shop on the high street. Radio station Radio stations often receive new music through promotions run by the record labels, as playtime in top radio programs are one of the most important ways of promoting new artists and music. Radio stations now play a very big role in the music industry value chain, and their revenues come from advertising,
Table 5: Music Industry Value Chain: Examples of Participants Songwriters
Randy Newman Madonna Holland, Dozier & Holland The Beatles Larry Bastian Oasis Don McLean Elton John Paul McCartney Moby Elton John Bjorn Ulvaeus & Benny Anderson
EMI Music Publishing Sony Music Licencing MPL Communications Warner/Chappell
EMI RPM BMG Warner Music UMG Sony Music Beggar’s Banquet Instant Karma
HMV Our Price Virgin Amazon BOL
Radio 1 Classic FM Capital Radio Kiss FM
Source: Lehman Brothers Research
Music industry lives from royalty payments The music industry food chain is traditionally complex. The $40bn annual global sales need to feed several parties, and as a result the average price that the consumer pays for a CD is split many ways. Artist gets less than 10% of the record sales
A typical contract gives the artist or band a royalty equivalent of around £1 for each CD priced at around £13. The remaining £12 is shared by other parts of the food chain. One of the fastest growing revenue streams is publishing royalties, which refers to exploitation of copyright. The songwriter and the songwriter’s publisher get a royalty payment roughly equivalent to what the artist receives, but typically 5-8%. The retailer and wholesaler each take a typical margin, and the remainder goes to printing, packaging and promotion. The figure below illustrates the revenue distribution in a typical CD.
Figure 14: Revenue Distribution Of A CD
Publisher/ Composer 8%
Distribution 15% Label 39%
Record labels take on risk
Distribution is expensive
Although it seems that record labels rake in a lion’s share of the artist’s creative work, it must be remembered that the label also assumes the risk of that particular investment failing, if that particular artist’s music does not sell. The label also bears all the costs of promoting the artists, including producing the music videos and any advertising as well as all promotional effort to get the songs played on the radio. The label also invests in potential tours, which can involve sending hundreds of people on the road for extended periods of time. In addition, the production process is extremely costly involving often sophisticated sound engineering technologies, the costs of which are born by the record label. A large share of the revenues are also spent in the distribution process, which in IDC’s example takes up 15% of the price of the CD. This is understandable given that the process is very capital intensive, involving moving pallets of CDs from the manufacturing plant on trucks to various retailers, or to wholesalers who distribute them onwards to record stores. In addition, both wholesalers and retailers retain a piece of the pie in their margins. Outside of the distribution value chain there are also several parties that are involved, all of which need to get paid: these are the artists’ managers, lawyers, and other staff, as well as the government in the form of taxes. CD manufacturing, or the printing and pressing of CDs, can be undertaken by various independent companies operating in this sector. A going rate for printing is around 65p ( SHUDEDVLFTXDOLW\&'ZLWKVRPHYROXPHVDFFRXQWHGIRULQDGGLWLRQ to this there are charges for the manufacturing of plastic covers, and printing the cover graphics. Within the music industry value chain, the fiercest opponents towards digital distribution have been the record labels, and in general the fiercest supporters have been both the consumers and the artists. This is not surprising if we look at which party has most to lose. Courtney Love, singer of the rock band Hole, presented the following calculation of how an advance of $1m for a four-member band is split and what the artist is left with:
Table 6: How a band spends a $1m advance received with a record deal $1,000,000 ($500,000) ($100,000) ($25,000) ($25,000) $350,000 ($170,000) $180,000 $45,000
Record label’s advance Cost of recording an album: production, promotion, distribution Manager’s commission Lawyer’s fee Business manager’s fee Profit Taxes Net profit Net profit per person, divided by four band members
Source: Courtney Love
Industry in transition The music industry is ripe for transformation
Music industry is a challenging industry, with its lack of visibility on revenues in new launches, and the difficulties in monetising creative work. However, even with the challenges we highlighted above, or conversely because of these challenges, we believe that the music industry is ripe for a significant paradigm shift which will come to impact the entire value chain. This will be driven both by changing consume profiles and new technologies. Digital distribution and consumption of music is here to stay, and the internet is bringing about new efficiencies and new formats, and new ways of distributing and consuming music. As a result, there will be several ways in which the industry is likely to benefit. However, as in any step change, old business models will either have to adapt or face the music. New business models will emerge, and some of these will grow to become formidable businesses.
Recorded music is a $40bn global industry, which is dominated by five major record labels: Universal, Warner Music, Sony Music, BMG and EMI.
Growth has stalled after the CD replacement effect in the late ‘80’s. Average annual growth in value terms has been around 3% since 1991 with flat volumes. However, new formats have traditionally resulted in accelerating growth in the music industry.
Choice for consumers has exploded, which makes choosing music more difficult. Domestic repertoire generates a majority of music sales in most markets, and its share is increasing. Music industry is launching an increasing number of new artists and albums. As this is happening in an environment of stagnant growth, margins have been declining.
The share of independent lables has been decreasing over time, however we believe that their role will grow in importance.
New digital formats are growing in popularity, and their appeal to consumer is convenience and versatility. In addition, free music, although mostly illegal, has been spurring growth in digital formats.
The music industry has a complex value chain and revenues are split several ways.
Evolution Of The Online Music Market Total European B2C spending forecasts ( P 200,000
Music distribution’s migration to internet has already started in physical format. Along with the rise of e-commerce, companies such as CDNow started retailing CDs online, and in just a few years internet as a retail channel has emerged as a clear challenger for the traditional retail formats. The attractions for consumers are numerous: convenience, better range, a more personalised shopping experience, better access to information and lower prices are some of the reasons why people shop online.
180,000 160,000 140,000
Physical Distribution On The Internet
19,185 2,874 8,543
Despite the recent market turmoil and some commentary predicting the doom of e-commerce, growth in online spending is going to be substantial. Internet penetration in Europe is increasing rapidly, driven by cheaper access (many ISPs are now offering access without subscription OR call charges) and internet-enabled handheld devices. IDC is estimating that half of the European population will be online by 2002. In 2004, the organisation predicts that there will be nearly a quarter of a billion online users in Europe. This will represent serious critical mass and make internet a viable contender to traditional retail channels.
2000E 2001E 2002E 2003E 2004E 2005E
Source: Forrester Research
Figure 15: Total Western European Online Penetration (% of population) 100.0% 90.0%
242m Web users in Europe by 2004
80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 1998
In Europe, Christmas 2000 will be the first e-holiday
European B2C spending will be e75bn in 2003
Moreover, these online surfers are also increasingly turning to online buyers. As there is typically a time lag from first getting connected to the internet to actually transacting online, we believe that the 2000 holiday season will see a huge pool of new online users making their first purchases. People are also becoming more confident about online security, and whereas credit card fraud was the biggest factor deterring people from making purchases online, it has now taken a back seat. Reasons for not buying are increasingly site-specific, relating to download speeds, lack of availability and, just like in offline world, customers not finding anything to buy from the range available. Forrester Research is forecasting total European business-to-consumer (B2C) online spending of bn by 2003, from bn last year. This would equal over 124% CAGR from 1997 to 2003. One can be cynical about these forecasts, but US forecasts made a couple of years back about online spending growth proved to be hugely understated. In 1996, Forrester Research forecast 1999 full year online sales to reach $4bn, and the actual sales in fourth quarter 1999 alone were $7bn. We believe 27
that the actual growth will surprise us on the upside. Therefore, despite the wellpublicised failures in the e-tail sector, we should not forget that this channel is taking market share extremely fast, and increasingly becoming consumers’ preferred way to shop for products and services. In the US, online music sales are around 3% of total music retail
Online music retail is still a nascent market, where key players have launched their operations fairly recently. CDNow launched in 1996, whereas Amazon launched its music sales in June 1998. However, this is a market that will experience a rapid migration to the internet: US forecasts expect online music sales to capture 11% of total music market by 2003 (according to Jupiter), and we have no reason to believe Europe should not be able to replicate this. Music and home entertainment products are ideally suited to the net, and not surprisingly enjoy high consumer acceptance. Music is a very information-intensive purchase category, requiring a modicum of pre-purchase research. In addition, the merchandise does not require a hands-on shopping experience (for example, it does not require trying on before purchase). For information-intensive categories, the internet offers superior browsing capabilities with search functionality and better product information, as content can include various types of editorial material, such as reviews and news articles. Figure 16: US online music share of total music retail
Source: Jupiter Communications
Music has a streamlined supply chain
For e-tailers, music has been one of the easiest categories to merchandise in the early days of e-commerce. Music as a category has the advantage of a streamlined supply chain, where established distributors and wholesalers maintain databases based on identifies similar to ISBN numbers. These can be uploaded into the back-end system. The e-tailer can outsource a large proportion of the inventory, and although it is possible to merchandise hundreds of thousands of CDs on the site, only a fraction of these are typically in the warehouse. As distributors and wholesalers normally maintain inventory on the catalogues they sell, any non-stock items can be sourced from the distributors with a fairly quick turnaround. Inventory costs can be kept low by ensuring availability of fast-selling chart albums and leaving back-catalogue to the distributors. Online merchandising is simplified by not having to tackle challenges in product presentation, in a way that, say, apparel or furniture do. At a bare minimum, online music retailers can feature a CD cover and a track list and with a basic database application be up and running. Customers do not have to see or feel the CD before purchase, as they usually have the necessary information already (have already heard the album or know the artist).
Easy to ship
Media products are among the earliest categories to migrate online. Almost one fifth of European music sales should be online in 2005.
Furthermore, music is one of the easiest categories to ship, pick and pack. Being small and light, delivery costs (which are typically charged per kilo by the fulfilment companies) can be kept low. CDs can also be posted through a regular mailbox, thus avoiding one of the biggest problems in fulfilment; customer not being at home to receive the parcel. Therefore, we are not surprised to see music and other media products being the most advanced category in terms of migration online. According to Forrester Research, nearly one fifth of all media products will be sold online in five years’ time, compared to 7% for the entire European retail sales, and 4-7% for more challenging categories such as grocery, apparel and furniture. Figure 17: % Of Total Retail Sales Sold Online In 2005 (Europe) Electronics
Leisure travel Health and beauty
Source: Forrester Research Media includes books, music, video and software. Recreation includes toys, DIY and sports equipment. Housewares includes appliances and furniture.
Pricing differences are an advantage
European online music sales will be e2.9bn in 2005
Although European e-tail carries several challenges resulting from having to execute in a fragmented market, in music category, the fragmentation of the market produces opportunities that the US e-tailers don’t have. These are found in pricing, which despite the arrival of the Euro, is far from harmonised across borders. An e-tailer operating a centralised fulfilment system should be able to source CDs from the lowest price distributor, and retrieve different product margins depending on country. CDs tend to be priced higher than average in UK and Finland and lower than average in Netherlands, Germany and Austria. See Figure 18 for an illustration of European price differences. Forrester is estimating that European online music sales will reach EQ LQ 2005, from PLQNote that Forrester Research is only expecting a 15% yearon-year growth in 2005, which is probably conservative. Comparing the 1999 data to IFPI European statistics, this indicates that 1.3% of European music sales were online in 1999. We still have a long way to go. Although we can always be sceptical towards these market research forecasts, however it is worth noting that in 1998, Jupiter Communications was forecasting $200m in US online CD sales for 1999, and the actual figure turned out to be $900m. 29
US in 18-24 months ahead
The US market is maturer, and migration to the internet is around 18-24 months ahead of Europe, although Europe is catching up very fast. Jupiter Communications estimated that over 2% of US music sales were online in 1999, again representing a huge opportunity. We believe that the growth in online music will be driven by existing sales migrating online, and this will have an increasing impact in the existing online players. Recognising this, most bricks-and-mortar retailers now have online offerings, which they have been executing with various success. Pure-plays such as Amazon and CDNow have been able to steal a lion’s share of online music sales in the US, however in Europe we believe offline retailers will play a bigger role, simply because in Europe they were more prepared for the channel migration than the US retailers were. Figure 18: Average online price of Music by Madonna in various European countries ( 18.00
12.00 10.00 8.00 6.00 4.00 2.00 0.00 Germany
Source: BOL, Amazon, various e-tailers
Figure 19: European Online Music Sales, 1999 – 2003E ( P
European online music sales should reach EQ in 2003
3,000 2,512 2,500 1,958 2,000 1,273
1,500 1,000 500
677 313 139
2000E 2001E 2002E 2003E 2004E 2005E
Source: Forrester Research
Wireless internet will capture a share of online sales In addition to wireline internet, wireless internet and m-commerce has emerged, driven by convergence of communication and digital technologies. Growth in mobile subscribers in Europe continues to exceed forecasts. Mobile commerce will in some ways act as an extension of internet usage as it stands today, but also create a revolution in terms of how online services will be used. Numerous estimates put the number of internet-enabled handsets at 500m by 2003, providing a large and vibrant market for new mobile applications and services. Although it is still early days and barriers to adoption remain (for example, the demise of the WAP standard is already under discussion), consumers are already using their mobiles and PDAs to play games, send e-mails, buy travel tickets and surf for information. With internet anywhere, services can follow the user and not be bound to when a PC is available (typically certain times of the day).
Growth in mobile subscribers is fast
Europe is leading the way in the development of this space. Industry analysts estimate that Europe is 18-24 months ahead of North America in the adoption of mobile commerce. This is not surprising, given that mobile penetration rates in Europe are considerably higher than in North America. In countries such as Finland, wireless has actually exceeded wireline penetration this year. One of the factors that has driven this is the consistency of European standards (GSM) across a large population. In the US, the opposite is true, and a hodge-podge of mobile standards has stymied mobile adoption.
Europe is ahead of US
So far online retailers have been using m-commerce mainly to generate headlines, since actual revenues from this channel are still minimal. M-commerce revenues for the entire B2C sector should not exceed P XQWLO DQG HYHQ LQ forecasters look for B2C revenues of PJHQHUDWHGE\WKLVFKDQQHO$OWKRXJKWKHVH amounts seem minuscule, we must remember that m-commerce is likely to be concentrated around a few key categories, at least in the early years of deployment. Purchases that are time-critical, that do not require configuration, and do not depend on touch & feel are likely to be the first ones to utilise this new channel. The best fitting channels are likely to be travel, event tickets and flowers, however these will not capture a major share of European e-commerce. Early m-commerce market has mostly been about small transactions, which are often impulse buys (impulse purchasing will be a big feature in this channel), such as cinema tickets.
m-commerce revenues will be small
Table 7: European Wireless Penetration Data Austria Belgium Denmark Finland France Germany Greece Italy Netherlands Norway Portugal Spain Sweden Switzerland UK AVERAGE
1998 27% 18% 36% 58% 19% 17% 18% 35% 22% 47% 31% 18% 51% 22% 22% 29%
1999 49% 32% 52% 67% 36% 29% 37% 52% 44% 62% 48% 38% 58% 43% 41% 46%
2000 61% 43% 62% 74% 46% 40% 45% 66% 56% 71% 56% 51% 69% 55% 53% 57%
2001 69% 51% 69% 80% 57% 50% 54% 73% 65% 77% 63% 59% 74% 63% 62% 64%
2002 75% 58% 73% 85% 65% 58% 60% 78% 71% 82% 69% 65% 79% 69% 69% 70%
2003 79% 64% 76% 89% 71% 65% 65% 82% 75% 85% 75% 70% 82% 74% 74% 75%
2004 82% 70% 79% 92% 77% 71% 69% 85% 79% 87% 79% 74% 85% 78% 78% 79%
2005 84% 75% 81% 94% 81% 76% 73% 88% 81% 89% 82% 78% 87% 81% 82% 82%
2006 86% 79% 83% 95% 84% 81% 77% 90% 83% 91% 85% 81% 89% 84% 85% 85%
2007 88% 82% 85% 96% 87% 85% 80% 92% 85% 92% 87% 84% 91% 86% 87% 87%
2008 90% 85% 87% 97% 90% 88% 82% 94% 87% 93% 88% 86% 93% 88% 89% 89%
2009 92% 87% 89% 98% 92% 91% 85% 95% 89% 94% 89% 88% 95% 90% 91% 91%
2010 94% 89% 91% 99% 94% 93% 87% 96% 90% 95% 90% 90% 96% 92% 92% 92%
Source: Lehman Brothers Research
Despite market turmoil, the “C” in B2C e-commerce is growing: Forrester Research forecasts EQLQFRQVXPHURQOLQHVSHQGLQJLQ(XURSHLQ.
Internet users are beginning to represent critical mass. IDC estimates that half of the European population will be online in 2002.
Online music is still a nascent market. In the US the internet is currently estimated to capture just over 3% of total music sales.
CDs are an ideal product for online merchandising. In the European music category, over PVKRXOGEHVROGRQOLQHLQ Almost 20% of European music sales should be online in 2005, according to Forrester Research.
Digital Distribution On The Internet Digital distribution visibility still poor
US: Only $1m in paid downloads in 1999
While majority of the population is still getting accustomed to migrating their shopping online, a growing consumer group is abandoning physical music altogether and acquiring and consuming music in digital format. We have already seen the massive user groups attracted to file sharing applications such as Napster. However, revenues from digitally distributed music are only now beginning to emerge. We acknowledge the difficulty in estimating the market growth with any degree of accuracy because as with any new format and technology, visibility is very poor, especially when revenues are still some five years from representing any meaningful scale. Several research institutions have published their own estimates, which we can use as the first benchmark in determining the role of digital distribution in this category. In 1999, Americans spent a mere $1m in paid digital downloads, a drop in the ocean compared to the total US music sales of $14.3bn. Of total online music sales, this would represent 0.1%. Most of this spending was concentrated among 3-4 leading players in the industry, such as MP3.com and Emusic (Emusic reported $675,000 in revenues for the 1999 calendar year, but most of this was from advertising). Download sales are therefore still very marginal, although Forrester Research expects digital downloads to start catching up with CD sales from 2003 onwards. Forrester Research expects digital downloads to be a $1.1bn market in the US in 2003, compared to $6.7bn in online CD sales. Figure 20: US Online Music Sales – Digital Downloads and Online CD Sales ($m) 6,695
$7,000 $6,000 $5,000
$3,000 $2,000 $1,000
Online CD sales
Source: Forrester Research
Subscription revenues should overtake download revenues
Online subscriptions are estimated to be the killer application Recent estimates from Jupiter suggest that in the US, digitally distributed music revenues should come to around $1.5bn by 2005. Jupiter also assigns estimates for revenues generated by digital subscriptions, which they see as overtaking downloads as the channel’s primary revenue model. In Jupiter’s forecasts, revenues from internet music subscriptions should be close to $1bn pa, compared to just over $500m generated by digital downloads. The growth in subscription revenues is likely to follow closely on the heels of broadband access growth, and streaming is probably going to be the primary distribution technology in this business model. In this study, online sales of physical products would still be over double the sales from digital downloads in 2005.
Figure 21: US Online Music Market ($m) $6,000
Total US Online music spending
$5,000 4,219 3,853
$2,000 1,4701,431 980
$1,000 387 387
Source: Jupiter Communications
The European market could be e0.6bn in 2005
As for Europe, no reliable forecasts exist, however if we extrapolate the US digital music take-up and assume that Europe is a year behind US in this development, we can estimate that European paid download sales would be 6bn in 2005 (using Forrester Research’s estimates for online music sales). This data would show that substantial sales from digital downloads are still some two years away, and that we are currently in a stage similar to where e-tail in general was in around 1997. Although at the moment Europe is probably some 24 months behind us in terms of digital music take-up, we think that Europe will close the gap in 2002-2003, so our post-2003 estimates could be conservative. First download revenues should be recorded this year, and in 2001 a total of PVKRXOGEHVROGLQGLJLWDOGRZQORDGVLQ(XURSH Extrapolating Jupiter Communication’s forecasts give us somewhat more optimistic revenue forecasts. European revenues from digitally distributed music could be P in 2000. In any case, as the European music market is roughly the same size as US (US music market takes up 37% of total world sales compared to 34% for Europe), digitally distributed music should eventually reach same levels of revenues in the two markets.
UK, France, Germany and Benelux will be largest markets
We think most of these early download revenues will be concentrated in the four key European music markets, UK, France, Germany and Benelux. We expect UK to lead the way in digital download take-up, because of the country’s leadership position in international music and because of UK’s high music consumption (4.1 albums per capita is the highest of the world). In addition, we expect Scandinavia to play a role in the first phase in Europe, because of the region’s large pool of technology-savvy consumers. Also, the speed of take-up will also be driven by the fact that there is a strong correlation between the demographic profile of a “heavy user” music consumer, and the early adopters of new technology. 15-25 –year olds are the largest music consumer group in the world, with a heavy appetite for new artists and new music experiences. This consumer group has also been the first one to get logged onto the internet, and they are also likely to spend significant amount of time online.
Internet users and heavy music users are a perfect match
In addition, because music files eat a lot of bandwidth, the consumer group most likely to be able to use them in a recreational context are students linked with high-speed connections provided by their universities. As most downloaded music currently on the net is free, it is not surprising that college students have been the first consumer group to embrace this new format. Figure 22: Estimated European Download Sales, 1999-2005E ( P 637.6
700.0 600.0 413.1
Source: Forrester Research, Lehman Brothers Research
Huge volumes are downloaded, but they are not paid for
10% of US adults download music
70% of US college students use Napster at least once a month
Are pirated downloads replacing CD sales?
The revenues derived from downloading are still marginal. However, if we analyse sales together with other usage metrics, we find that there already exists a huge active community of people who consume music via digital downloads – they are just not paying for them. So far digital downloads have primarily been free of charge, either because they are illegal copies, or because they are being used as promotions tools by music companies or e-tailers. Download take-up is already substantial –however it is not paid for We think that the current revenue figures available on downloaded music on the internet are far from accurate in describing the size of the consumer group involved in using music this way. Because most of the digital music currently being downloaded is free, looking at revenues alone does not reflect the popularity of this format accurately. In a recent survey conducted by IDC, over 40% of households in the US had downloaded music from the internet, but of these only half had paid for them. This would suggest an audience of 50 million people in the US alone. A survey by Angus Reid Group found that 10% of America adults currently download music from the internet (survey was based on 750 online users). A survey by Webnoize found that over 70% of American college students use Napster at least once a month and 57% use it weekly. Interestingly, most students listen to files through Napster without saving them, indicating that there is already a consumer group coming up the curve that is getting accustomed to music as a service and not something that you have to physically own. This is a vital shift in consumer habits that is going to drive the growth in many new pricing models currently being deployed in this channel. The question now stands whether music downloaded free of charge (in other words, pirated digital files) is being used to replace CD consumption and legitimate music purchases. Data available is still very sketchy. However, the shockwaves that Napster has sent throughout the music industry seem to have some 35
ground, since the digital rights management group Reciprocal found that record stores within five miles of 3,000 college campuses in the US showed a 4% drop in sales in just over two years. During the same period, the US record industry as a whole enjoyed annual growth of 8%. A note of caution – the study was paid for by Reciprocal, who has a deep interest in legitimate download sales, not file sharing.
Top 50 European domains, August 2000 Unique Digital Visitors Media (000) Reach % 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50
YAHOO.COM MSN.COM T-ONLINE.DE LYCOS.COM ALTAVISTA.COM AOL.COM LYCOS.DE MSN.CO.UK YAHOO.DE YAHOO.CO.UK BIGBROTHER.COM NETSCAPE.COM DEMON.NET WEB.DE FREENET.DE XOOM.COM BBC.CO.UK YAHOO.FR ABOUT.COM CHANNEL4.COM VIRGIN.NET GO.COM MSN.DE EXCITE.CO.UK LYCOS.CO.UK EXCITE.COM WINDOWSMEDIA.COM FIREBALL.DE VOILA.FR RTL.DE AOL.DE UKPLUS.CO.UK LINEONE.NET AOL.CO.UK NAPSTER.COM MOORHUHN.BILD.DE NETBROADCASTER.CO NETSCAPE.DE GO2NET.COM COMPUSERVE.COM MP3.COM AOL.FR MSN.FR SUPANET.COM PEOPLESOUND.COM NOMADE.FR THEGLOBE.COM BANANALOTTO.FR SPEEDYCLICK.COM STERN.DE
Source: Media Metrix
8,021 7,111 4,339 3,267 3,207 2,874 2,676 2,658 2,406 2,339 1,936 1,850 1,770 1,758 1,641 1,541 1,539 1,500 1,334 1,328 1,325 1,269 1,235 1,208 1,156 1,141 1,101 1,099 1,019 1,002 954 882 867 806 748 744 741 721 641 638 579 567 547 524 522 509 484 473 453 448
33.0 29.2 17.8 13.4 13.2 11.8 11.0 10.9 9.9 9.6 8.0 7.6 7.3 7.2 6.7 6.3 6.3 6.2 5.5 5.5 5.4 5.2 5.1 5.0 4.8 4.7 4.5 4.5 4.2 4.1 3.9 3.6 3.6 3.3 3.1 3.1 3.0 3.0 2.6 2.6 2.4 2.3 2.3 2.2 2.1 2.1 2.0 1.9 1.9 1.8
On the other hand, some sources cite that using digital downloads is more likely to increase music sales in traditional formats: digital download users tend to listen to tracks on the internet first and then go and purchase the CD. For example, a study by Jupiter Communications found that people who use Napster are 45% more likely to have increased their music buying than non-users. Similarly a study by Angus Reid Group found that 64% of people downloading music will not by any more or any less music than what they already do. In the same study, 22% of downloaders said that they will buy more music as a result of being able to download it from the internet – compared to 12% saying that they are likely to buy less.
Figure 23: The effects that people who have downloaded music think downloading will have on their CD purchasing behaviour
Will buy less 12%
Don’t know 2%
Will buy more 22%
No effect 64%
Source: Angus Reid Group, July 2000
This indicates that by making digital downloads available, consumers are more likely to purchase music they would not have otherwise been tempted to sample. The jury is still out on whether free downloads will in the end be detrimental to the music industry. Our view is that they will do the opposite – not only will they enable diverse exploitation of music content in a multitude of platforms, but they are likely to stimulate demand by promoting music more intensively. In addition, free music can already be obtained with the physical format- by copying cassette tapes, however this has not had a destructive impact on the music industry’s growth Magex, the digital rights management company estimates that more than 3 million copyright infringing files are downloaded every day. In their research they estimate that more than 4.2m internet users in the US own 91m pirated music files. Another study estimated that in 1999 there were one billion illegal downloads of copyrighted music. The music industry could lose $10bn by 2003 to pirated music being downloaded from the estimated 500 websites that currently offer illegal MP3 files, according to Magex. We think this amount is probably vastly overestimated, in addition this type of scaremongering tends to come from the companies who are most likely to benefit from piracy fears, namely digital rights management (DRM) companies and providers of secure digital distribution services. We are not contesting their estimate on user numbers, however we would like to note that in 1999 when 36
supposedly over a billion files were downloaded free and illegally from the internet, US music sales grew by 8% on value terms and 5% in units. Looking at Media Metrix traffic statistics, MP3.com was ranked no 27 in the Entertainment category in the US in August with 3,229,000 unique visitors. This puts it ahead of MTV.com which had 2,988,000 unique visitors and immediately behind Broadcast.com, Uproar.com and Macromedia. In August MP3.com reported an average of 167,000 unique visitors a day, and a total of 38m listens (songs delivered online: played or saved) during the month of August. This traffic already represents significant critical mass considering that the available songs posted on site are those of lesser-known artists. Napster has over 38m members
Napster has achieved an unprecedented growth in user numbers. In just over 12 months, the company started by Shaun Fanning in his university dorm room has attracted over 38 million members. This exceeds the customer base of Amazon (25m), which the company has built over five years. Napster in the US is visited by on average 80,000 web users per day, according to Media Metrix, and it first arrived in the coveted top 50 list at 47th position in July. This represents the fastest growth generated by viral marketing in the history of the World Wide Web, and a fastest growing site in the history of Media Metrix audience measurement service. The site is used monthly by 6% of the US online population, an unprecedented scale for what is still viewed very much as a counter-culture service. Table 8: UK Media Metrix survey, entertainment category, August 2000 Rank
1 2 3 4 5 6 7 8 9 10
Virgin.net Bigbrother.com Channel4.com Windowsmedia.com Peoplesound.com WWF.com Bananalotto.co.uk Channel5.com Netbroadcaster.com IWIN.com
Unique Visitors (‘000) 1120 1055 735 450 404 261 242 237 229 221
Reach % 10.3 9.7 6.7 4.1 3.7 2.4 2.2 2.2 2.1 2.0
Avg Minutes Per Month 10.6 17.5 4.6 3.6 2.0 15.1 53.3 9.4 0.8 1.5 5.9 -
Source: Media Metrix
In Europe, online music sites rank high in traffic surveys
In Europe, it is still early days and very few home-grown sites feature in the audience surveys. However, we think it is significant that in the Entertainment category, three of the top 10 sites were online music sites (note that we have categorised Napster in Entertainment although Media Metrix categorises it in Services). Home-grown talent is beating the US sites: Peoplesound.com was the 5th most popular site in the Entertainment category in the UK in September with 404,000 unique visitors, driven by successful marketing (Note that in April Peoplesound.com ranked 8th). MP3.com was number 9 in this category with 231,000 unique visitors. Peoplesound was ranked no 47 overall in the UK survey of online properties, topping such online brands as Scoot, LetsBuyIt.com, eBookers or Looksmart. Note that we attach a health warning into the European Media Metrix statistics. The survey still excludes office usage from its audience measurement, therefore understating traffic across the board, in addition the European sample sizes are still very small which increases the margin for error even more. However, we think even these audience statistics indicate that the early European consumer base is already flocking to digital download sites, and is clearly beginning to sample this new format. 37
Consumers opt for free download
Huge user base already exists The user numbers extracted from Media Metrix audience studies and available market research indicate that there is a large group of people who are getting accustomed to receiving music free of charge. Some are questioning whether digital downloads will ever create viable business opportunities as consumers don’t seem to be willing to pay for them. From a consumer’s standpoint, if the same track is available free on Napster or one of the many sites hosting digital downloads, most are probably going to opt for the free version. Another indication of consumers’ preferences is that Napster, which is free of charge, has practically taken ownership of the digital download sector amongst the 13-25 age bracket: 70% of people in this age group get their MP3 downloads from the service, compared to 12% from MP3.com. As only $1m of revenues was generated by paid downloads in 1999, this enormous file traffic is almost entirely free of charge. Figure 24: Where 13-25 get their MP3s (US)
Napster 70% Source: Element, June 2000
Young music consumers are driving new formats
People in the 10-35 year demographic group are the biggest consumers of music. 60% of all music sales go to people aged under 35, and 25% of total music sales go to the 10-19 age group. This young and very wired consumer group is therefore driving new formats. We think the propensity towards free downloads is closely linked with the fact that college students and other young people are still the largest user group for digital downloads. This group tends to have very little respect for proprietary rights, but similarly to software piracy, as people move up the income curve and into older age brackets, the resistance towards paying for intellectual property decreases. Young people are the early adopters in this new delivery method, unlike CD, which was first adopted by high-income audiophiles because of the expensive hardware required. As the format becomes more widespread amongst a wider demographic base, we think consumers will get accustomed to treating downloads like regular CDs bought from a store and pay for them. In a June 2000 survey of US college students, 74.4% of those who use Napster daily would be willing to pay $15 a month for the service, and almost half of those who use it only once a month would be willing to pay the charge. In addition, the fact that many young people are unable to obtain credit cards has probably played a part in the resistance towards paying for digital downloads.
Figure 25: Music Sales By Age Group, 1998
45+ years 18%