The Numbers: Can Indie Labels Really Make Money Through Downloads? Part 3

The Numbers: Can Indie Labels Really Make Money Through Downloads? Part 3

by Spencer Critchley

Related link: www.oreillynet.com/pub/wlg/8816

In Part 1 of this series I looked at how hard it is for an indie label to make money selling CDs. Part 2 was about how it can be even harder with iTunes. In this part, I talk about where all the money went, and about what new models, such as those based on the Long Tail, will have to be worth.

First of all, where’d the money go? As I mentioned in Part 2, even though iTunes eliminates a lot of a label’s expenses related to physical distribution, it may yield the label less money. That’s partly because iTunes, like other download services, unbundles the album format, allowing customers to buy individual songs. That’s great for customers, but given that the up front marketing costs to launch a new project are roughly equal for an album or a 99 cent single, it’s big trouble for labels.

In response to Part 2, teejay argued that because singles are so much cheaper than albums, people will buy more singles, and the increased volume will help make up for the lower price. I agree that more people are likely to buy a single, but I’m not convinced yet that the increase will be in the hundreds per cent, which is what would be needed to replace physical album sales (physical singles sales have become close to negligible). And given that cheaper digital production and distribution are leading to an explosion of new product, I’d expect the benefit from increased singles sales to be diluted by the availability of more releases, except in the case of big hits.

But there’s more to it than just unbundling. Comparing the numbers in Part 1 & 2 for CD sales vs. iTunes sales, I notice that the wholesale album price has gone down just over three dollars, from $9.50 to about $6.44 (depending on the retail price1). That might seem logical, given the savings realized by dropping physical distribution:
Postage (0.10)
Distribution Fee (1.80)
Positioning Fee (1.00)
Manufacturing (0.80)
Returns postage (0.03)
Refurbishing (0.05)
TOTAL GROSS SAVINGS (3.78)
“Gross” savings because digital distribution is not cost-free.

But have a look at this line-up of figures:
Gross distribution savings 3.78
Reduction in wholesale price to labels (9.50 - 6.44) 3.06
Apple’s gross margin (9.90 - 6.44)1 3.46

Steve Jobs showed the record companies a way to reduce their expenses and convinced them to give almost all the savings to him.2 There IS a reality distortion field! One begins to see why EMI and some other labels have begun arguing that Apple should raise its iTunes prices.

So that’s where the money went. For now, anyway, it looks as if labels have lost the advantage gained from increased distribution efficiency. So is there a way left for labels, in particular the indies, to make money? As Philipp and dannyo_152_redux have pointed out, reduced marketing expenses could be another route to profit.

This is also the promise of Wired editor Chris Anderson’s Long Tail model. Anderson says that in the digital economy hits will serve as entrees to similar non-hits that are further down the long tail of the sales curve. And he highlights the importance of filters, such as recommendations from trusted experts.

This kind of marketing can be close to free. But what’s it worth? And how much value does it have to make up? As I mentioned in Part 1, marketing expenses for indie albums that are attempting to compete in the mainstream are in the range of $100,000 to $300,000. Alternative indies can’t spend that much cash, so they do things like have their artists play lots of shows. But I’d guess that if you account for time and work, the investment is similar. I hope new forms of marketing can have comparable impact for less money, but I haven’t seen convincing details yet of how that will work. I’ll repeat what I said a little while ago in a post called “Beware Of Risk-Free Business Models”:

So far in business history, there’s been a requirement that risk and reward roughly balance… Many of the alternative models I’ve seen seem to be based on the assumption that merit is enough: people will hear good music and recommend it to their friends, who will want to buy it. But it’s at that point that the model appears to go risk-free… [the] marketing investment is the risk in the risk-reward equation. In particular, it’s the “impresario fee” for finding an artist that is extraordinary in some way and then doing all the things that have to be done to, in effect, modulate pop culture with the image and sound of this artist.

If there’s little or no risk behind a product, why will anyone want to pay for it? So far there have in fact been few money-making acts to emerge from the net, and there have by now been many attempts. It may be that the era of hit recordings is ending, as David Bowie3 and others have argued. Until now, only hits have made profits; the hope for the new models is that increased efficiencies will make non-hits profitable. But in order to make that work these models will have to overcome some powerful forces pulling in opposing directions–in particular, the conversion of music into a commodity whose unit value is approaching zero.

1. iTunes’ retail prices vary.

2. Apple is believed to make little direct net profit from music sales, but the value in iPod sales is huge. The money saved by switching to digital distribution will vary widely depending on the particular model. Running iTunes is apparently quite expensive, while P2P networks can spread expenses so thin they pretty much disappear.

3. ‘’Music itself is going to become like running water or electricity… So it’s like, just take advantage of these last few years because none of this is ever going to happen again. You’d better be prepared for doing a lot of touring because that’s really the only unique situation that’s going to be left. It’s terribly exciting. But on the other hand it doesn’t matter if you think it’s exciting or not; it’s what’s going to happen.'’–New York Times, June 9, 2002.