The recession in the music industry – a cause analysis

Filesharing is made primarily responsible for the decline in sales in the phonographic industry, especially in the CD segment (see the current IFPI Digital Music Report). However, serious research on filesharing behavior (see Huygen et al 2009, Andersen/Frenz 2007, Oberholzer-Gee/Strumpf 2007 (working-paper March 2004), Blackburn 2004) shows that filesharing use does not necessarily have a negative impact on physical and digital sales. But if this is not the case, then there must be other causes for the now decade-long recession. In the following I would like to discuss alternative explanations for the recession in the music industry and try to substantiate them empirically.

But first the facts: For 2008 the International Federation of Phonographic Industry (IFPI) reported continued reductions of both unit sales and turnover figures. Despite increases in the online and mobile digital music segement, the U.S. trade value decreased by 18.6% compared to 2007. The European market shrank by 6.3% and Latin America by 4.7%. Only the Asian market has seen a slight increase of 1.0%. Overall, however, the worldwide sales of music products were by 8.3% less in 2008 than in the previous year. Considering only physical sales, we obtain an even more dismal picture: United States: -31.2%, Europe: -11.3%, Asia: ‑4.9%, and Latin America: -10.3% from 2007 to 2008. And that’s just the last year of a whole series of bad fiscal years. In the meantime, some national music industry bodies reported figures for 2009. Argentine: a drop of 14.9% in units sold; Canada: physical unit sales fell 6.7%; France: physical sales dropped 3.4% while digital sales also dropped 1.9% due to a 41% drop in ringtone sales; Italy: overall industry turnover ‑19.0%; Japan: physical sales dropped 27%; The Netherlands: the music market is down 4.6% in value. Only two markets show a positive trend in sales figures. In Sweden overall music sales were up 10.2% in 2009, and in Australia the wholesale revenue from physical as well as digital products show a plus 4.8%.

Affected particularly severely has been the CD segment, which is still the industry’s main sales driver, even though its influence is waning (see this “The CD is dead! Long live the music download?”). In 2008, the world’s largest markets – the U.S., Japan, Britain, Germany, and France – showed declines in sales in 2008 (in million units) between 34.9% and 59.2% compared to the current best years.

Figure 1: Change in CD sales in 2008 in the largest markets and in Austria in comparison with each national market’s best year

Source: IFPI (1998-2008).

Since CD sales in the U.S., Britain, and Germany have been falling since 2000 and 1999, respectively it seems obvious to explain this decrease by pointing to the appearance of NAPSTER, which already attracted millions of users every day in the fall of 1999. However, the figures also showed that the Japanese market, the second most important market in the world, already suffered an 8.2% loss of CD sales between 1997 and 1999, but that it was up by 7.9% in 2000. In Japan sales were in decline even before the onset of NAPSTER, which industry representatives would probably explain by pointing to the emerging practice of ripping and burning CDs. For the French market no such simple explanations work. In 2001, an historic high of CD sales was measured before the recession startet in 2002, when the hype around NAPSTER was already history. However, since it is not very realictic to assume that French music consumers had not been aware of how to obtain music for free over the net until 2002, it can safely be assumed that they used NAPSTER as avidly as did consumers in other countries. Similarily, it cannot be explained why the UK-market – after a minus of 17.7% from 2000 to 2001 –was able to hold its sales level in subsequent years, despite the emergence of new P2P-filesharing systems. From 2003 to 2004 one could even observe an increase of 4.4%. In the UK, the first strong sales slumps took place only in 2007. Thus, there are empirical anomalies that put the “filesharing-thesis” into question.

Are there other causes of the current recession? To answer this question, we must go back to the time before the launch of the CD (1982/83). The continuing boom in the phonographic industry in nearly all markets came to a sudden end in the late 1970s. Especially the UK-market was hit particularly hard. Between 1977 and 1980, sales of recorded music decreased by 26.4%. In the United States the units sold declined 10.4% from 1978 to 1979, which amounted to a value-based sales drop of 11.0%. In France 8.3% less recorded music was sold between 1978 and 1980. Only in Germany and Japan sales declines were moderate with 3.4% (1978-1980) and 2.2% (1977-1978), respectively. But the recession hit the middle and small markets particularily hard. In Denmark, the sales of recorded music slumped 29,4% in 1980 compared to the previous year. In Austria the decline in sales was also serious with a minus of 13.8% from 1978 to 1979. There was hardly a country in the Western Hemisphere where recorded music sales decreased by less than 10% (Table 1).

Table 1: The drop in sales in selected countries, 1977-1980

Source: Gronow (1983: 66-69).

At the time, reports blamed the decline in recorded music sales on the world-wide recession triggered by the second oil crisis as well as the competition with other media on the one hand and, on the other hand, on privately copying music onto audio cassettes. But even contemporary authors considered these explanations insufficient. Thus, Pekka Gronow suspected in 1983 in a scientific paper in the journal of Popular Music: “Explanation has been sought in the general economic recession, the influence of private copying, and competition from other media. But perhaps records, as a mass medium, have now reached the saturation point.” (p 72). He made the point pretty well, as can be demonstrated by the subsequent analysis of sales figures for the global market of recorded music.

Table 2: The global sales development for multiple record formats

Source: IFPI (1973-2008).

The comparison of record sales by format from 1977 to 2000 shows that the music cassette dominated the period from 1984 to 1994. In the same period, the vinyl record fell into economic irrelevance. Long-play vinyl formats reached their zenith in 1981 with 1.1 billion sold worldwide. In 1984, the same number of vinyl LPs and music cassettes – 800 million units – were sold. At this point – in the second year after its launch – the CD accounted only for 20 million sold copies worldwide. In the following years, however, the CD-segment began to multiply. In 1989, more CDs were sold worldwide (600 million) than LPs (400 million). However, the music cassette was the market-leader with a historical high of 1.5 billion units sold. In 1993, the CD (1.42 billion) outperformed music cassettes (1.38 billion) and became almost the sole source of sales in the market.

If we add to this picture the sales of single-formats, a process of transformation is revealed as well, which started in the first half of the 1980s. In 1983, after years of stagnation, 27.5% more singles were sold than the year before – this time a historic high of 800 million units. In subsequent years the singles’ sales sharply slumped despite the CD single. 1993, after the CD had taken the leadership position in the market, only 410 million singles were sold. The single market had almost halved. But the bottom of the recession for the single-format was still not reached. Ten years later, in 2003, just over 233 million units sold were singles – a decrease of 70.9% (!) compared to 1983.

What happened? The overall market for recorded music had become a market for long-play formats. This reflects a business strategy that was pursued mainly by the major record companies since the late 1960s. The single was turned into a test market for yet unknown, non-established artists. Only when the first and perhaps also the second single sold quite well, an album was brought forward for the music consumers because of its good price-performance ratio compared to the single. Especially with the established acts,  single-sales played virtually no role anymore. The album had become – economically and artistically – state-of-the-art. However, the long play format – in spite of many concept albums – has the disadvantage that it contained only 1 to 3 tracks that were ultimately of interest for the buyer. The rest was considered dispensable filler. In addition, the industry stimulated the hit compilations market, which increased the flood of album productions further.

The shift from single- to long-play formats went hand in hand with a strategic reorientation, which had its roots in the second half of the 1960s: market segmentation. Previously, only 3-4 market segments existed, such as, for example, in the U.S. in the “white” pop charts, the “black” R & B charts, and perhaps the classical music segment. The labels and above all the majors had realized that they could increase the profits by a target group-specific supply policy. New market segments such as Country & Western, folk, and many types of rock music – Rock, Psychodelic Rock, Art Rock, Jazz Rock, Hard Rock, Heavy Metal etc – were established. This segmentation strategy certainly met a landscape of differentiated musical tastes, and music consumers welcomed this.

However, the segmentation strategy took on a life of its own in the 1970s. Carried on by indie labels, new innovative music genres such as punk, disco, HipHop/rap, and various forms of electronic music emerged. The market segments became smaller and smaller, and with them the profit margins shrank. What was originally conceived as a profit-maximizing instrument for the majors now worked against the inventor. The result has been already documented in declining sales figures in the late 1970s. The majors then embarked on a new strategy. The artist roster was severely reduced, and instead of serving all market segments, the majors were committed to the superstar principle. Thus, the 1980s were dominated by pop superstars like Michael Jackson, Prince, Madonna, Elton John, George Michael, Lionel Ritchie, Bruce Springsteen, etc. (see “The business modell ‘Michael Jackson'”)

In parallel development, the recorded music market was booming due to the CD. The sharp rise in sales and revenue figures, however, masked the basic problem of a highly differentiated genre-landscape, which had been fragmented by further innovations by the Indies. But that did not matter as long as the established business model worked.

But the ability to offer music tracks online over the Internet rendered this business model obsolete. The figures show that in recent years the album market turned back into a single market. While in 2008 global CD sales had already declined below the level of 1993, single-sales, due to exploding digital downloads, prospered while sales of digital albums grew slowly. Since 2004, when digital sales were reported for the first time, single sales more than quadrupled (!) to 1.5 billion units, whereas the amount of digital albums sold in the same year only comes to 113 million units. If we now compare all long-play formats (excluding music videos) with the single formats, we can see that as many long-play products (1.51 billion units) were sold as single products (1.49 billion units).

Figure 2: The development of long-play and single formats compared (1973-2008)

Source: IFPI (1973-2008).

It is clear that you cannot earn the same revenue with the same number of single units than with long-play units sold. Therefore the drop in sales is due to the conversion of an album to a single market. File-sharing can be interpreted in this context not as a cause but as a symptom of the digital revolution in the music industry. However, it should not be overlooked that the current developments (a cultural paradigm shift in the music industry and not only there) go well beyond the question of file-sharing or single- vs. album market conversion. Thus, one should not commit the error to replace one simplified explanation (blame file-sharing for the decline in record sales) with another (pointing to the transformation of the album- to a single market), because the paradigm shift is much more complex than the suggested explanations (see Tschmuck 2006). However, the “single market”-thesis contributes a much better explanation for the declining sales in the recording industry than the “filesharing” thesis.

And there is empirical evidence that file-sharing does not necessarily have a negative impact on recorded music sales. A recent Dutch study just published (see Huygen et al 2009), as well as the widely discussed study by Oberholzer-Gee/Strumpf (2004 and 2007) and the doctoral thesis of Blackburn (2004), suggest this conclusion. Blackburn’s findings that new and unknown artists benefit from the sampling effect, while star-acts suffer from filesharing, also fits into the picture. Whereas superstars have benefited in the past from selling albums, the emerging track-culture on the Internet put them under economic pressure. In contrast, newcomers can take advantage of the emerging single market and the highly fragmented and diverse genre-landscape.

To sum up, the expanding market from the 1960s to the late 1970s was based on a market segmentation strategy by establishing new music genres and long-play products as a key source of sales. But this led to smaller and less profitable market segments and subsequently to declining sales and revenues in the late 1970s. With the launch of the CD in 1982/83, the major companies focused on superstar acts, and revenues soared again in unprecedented heights in the 1980s and 1990s. One must not oversee that the CD-boom was mainly fueled by the re-release of repertoire still existing on vinyl. The superstar-orientation as well as the CD format ensured that the album became the main source of sales in the industry. The single lost its importance and finally assumed only the roll of a test market.

When these structures were confronted with the track-culture of the Internet, the album market turned once again into a less economically viable single market and caused the slump in sales of the last decade. The figures also show that the single-format, thanks to strong sales of digital downloads, is on the rise and already have matched long play-sales on a pure per unit basis. The labels’ task is now to find again a model in which music in bundled form increases not only the revenues and profits but also the music consumers’ benefits. However, this is more difficult to achieve under the prevailing conditions than the increase of mobile and online music sales based on single-tracks. If, in addition, the insight prevails that file-sharing is in fact not the cause but merely a side-effect of the current transitional phase and that it actualy represents a promotional opportunity for thus far unknown acts, then sales might increase again that thus help overcome the recession in the phonographic industry.

Sources

Andersen, Birgitte and Marion Frenz, 2007, The Impact of Music Downloads and P2P File-Sharing on the Purchase of Music: A Study for Industry Canada. University of London Working Paper.

Blackburn, David, 2004, On-line Piracy and Recorded Music Sales. Draft of a doctoral thesis in December 2004. Harvard University.

Gronow, Pekka, 1983, “The Record Industry: The Growth of a Mass Medium.” Popular Music 3: 53-75.

Huygen, Annelies et al., 2009, Ups and Downs. Economic and Cultural Effects of File Sharing on Music, Film and Games. Report commissioned by the Ministries of Education, Culture and Science, Economic Affairs and Justice of the The Netherlands.

International Federation of the Phonographic Industry (IFPI), Reports for the years 1973 to 2008. London: IFPI.

Oberholzer-Gee, Felix and Koleman Strumpf, 2004, The Effect of File Sharing on Record Sales. An Empirical Analysis. Harvard Business School Working Papers, March 2004.

Oberholzer-Gee, Felix and Koleman Strumpf, 2007,“The Effect of File Sharing on Record Sales: An Empirical Analysis.” Journal of Political Economy 115(1): 1-42.

Tschmuck, Peter, 2006, Creativity and Innovation in the Music Industry. Berlin etc.: Springer.