Record Industry Digital Growth Doomed by Mechanical Rates

By Richard Menta 10/5/08

100 years ago when Henry Ford introduced the Model T it became the biggest selling car of 1908. It's success came mostly from the fact that it sold for $850 that year, making it the least expensive vehicle on the market.

But just being number one was not enough for Ford, who outsold second place Buick that year, 10,202 units to 8820. He saw price as the key to big growth and strived to lower the selling price of the vehicle through efficiencies in mass production. By 1923 the price of the Model T dropped way down to $250 and the end result was it made Ford richer. Ford sold 1,831,128 in 1923. Chevrolet came in at number two, but was way behind at 323,182 cars.

I use this example not as some historical iPod parallel, but to illustrate why prices on pay digital media need to be lowered dramatically to truly succeed. The Model T is the example schools held up to school children for decades as a basic lesson in economics. Price low for mass consumption and volume will generate both greater revenues and profits.

I stated back in 2001 that the best way for the major labels to profit from digital downloads is to price them very cheap, around the ten cent mark. At that point it is easier to promote the value of paying for music as opposed to trading it for free. Indeed, the true dollar value of music has plummeted since Napster first appeared in 1999, but the traditional record industry as a whole has refused to recognize this fact let alone adjust to it. Music simply isn't the artificially scarce commodity it once was.

Many of the digital pundits I have talked to over the years have agreed with me that $0.99 a track on iTunes is too much and that the optimum price is something well below that. Unfortunately, The recent decision by the Copyright Royalty Board (CRB) updating rates for mechanicals on downloads makes the dime-a-track pricing scheme, or anything resembling it, impossible.

Recently, the CRB ruled that the mechanicals rate for each song download will remain at 9.1 cents for tracks under five minutes in length. Mechanicals are the song writers share of the sale, distributed through the Harry Fox Agency. By making these rates a fixed dollar amount rather than a percentage of the sale price of the item, it artificially inflates the purchase price. Of course, the price demands of the record labels themselves are even more inflated, but unlike a federally mandated royalty rate, these numbers can theoretically be negotiated lower as per the demands of the market.

The environment created by the industry itself has left us with a landscape where a digital track is either $0.99 or free, but little in between. (WalMart does sell tracks for $0.89 and eMusic has worked bundles with the independent labels that cost less. But, $0.99 is the defacto standard right now for major label fare). Even a quarter-a-track is unobtainable unless the labels and digital stores like iTunes are both willing to take a cut less than what Harry Fox gets.

At the $0.99 mark consumers aren't buying in big enough numbers, with the average iPod holding about a dozen paid tracks among the thousands that are stored on it. My own experience with iTunes, which I described in the article "iTunes: Still on That First $20 Gift Card" unconsciously bears this fact out. As Paul Resnikoff has noted frequently on Digital Music News, digital revenues are starting to flatten out and are therefore unlikely to compensate for the fall in sales of physical media.

Without a significant drop in prices growth in the digital arena will stagnate and the opportunity for the traditional record industry to thrive under the disruptive technologies of the Internet will be lost. We all witnessed Wall Street change forever in a few days, the disintegration of Merrill Lynch, Lehman Brothers, and Bear Stearns was that fast and unexpected. It is not unreasonable to imagine one or all the Big Four record labels disappearing within in a few years.

If any major labels do disappear, it will not be all because of file trading, either. It will come from a much more complicated and convoluted scenario, where pre-existing licensing arrangements are a major culprit, because they prevent the industry as a whole from adjusting fully to market change (at least when the players are finally able and willing to adjust).

iTunes has sold billions of songs over the past few years, but there was and still is far more money left untapped. When you buy a song file what you are buying is not a stamped product, but permission. Permission to copy a track from a sanctioned vendor. But it is just as easy if not easier from people to copy from one another. Who needs a middle man unless they offer an added value and do it at a motivating price point?

Bottom line, $0.10 tracks will never be and the one who loses the most from this is not the consumer this time. Henry would tell you that.

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