World War I airplanes started out as unarmed scouts. Then some bright pilot took up a machine gun and shot another one down. From Jim Dunnigan's Strategy Page:

"...the Predator shot down by an Iraqi fighter recently was carrying a Stinger [anti-aircraft missile], but wasn't able to get a good shot at the Iraqi aircraft. So now the air force is looking into using Sidewinder air-to-air missiles on the MQ-9. JDAM, Maverick, Hellfire and HARM missiles, as well as unguided rockets, are also being tested on the MQ-9. The air force is finding that an aircraft that can stay in the air for over 12 hours at a time, and carries weapons, is a lot more useful than they ever thought it would be."

6:01:48 PM    

As a guy who spends a lot of time thinking about business models, it's interesting to use the recent discussions on power laws to construct an explicit framework analyzing the MP3 challenge to the music biz. Probably little original here, but it's a way of seeing why these guys react so viscerally, and just how badly screwed they are if they keep along the same path.

First, some numbers. Tim O'Reilly has estimated that the book and music businesses are similar, with about one of ten new properties seeing significant sales. A revealing interview with Jim Urie, president of Universal Music and Video Distribution, lets us get more specific for one of the largest members of the RIAA. [Update: The interview was by Tess Taylor, president of the National Association of Record Industry Professionals.] They have 16,000 titles in warehouse stock at any one time. They put out 2,092 new releases in 2000 (a number that has probably dropped since), with 700 of them representing new material from mainstream pop artists. Of these, he can get 35 SKUs into a mass retailer, Costco, at any one time. Let's reasonably assume that those are mainstream, profitable hits, and that the SKUs can be turned over twice in a year. That gives you 70 profitable titles. So within a close order of magnitude, O'Reilly is likely correct.

What's the profit and loss situation in this lineup? We can't know for sure, but I think we can assume that gold record, that's 500,000 unit sales, should be profitable. According to the RIAA database, in 2002 381 recordings went gold or better, industry wide. Mr. Urie says that every label has:

"....several artists who have a fanatic core fan base of [100-200,000] people - it's hard to make a lot of money with those kinds of acts."

Now, how do you make money in such a business? By maximizing the win. You aren't really after gold records, you want platinums, multi-platinums, and bankable artists that can do it every two years, to make up for the 90% of losers and yield a profit. How do you make that happen? Distribution. The first leverage point in the publishing business model is distribution. Mr. Urie describers a 'personal relationship' with the president of Wal-Mart, due to the half-billion dollar volume he moves through that particular channel per year, both music and video, which he believes turns Universal from must a media company and into a true consumer goods company. I've known guys from Procter & Gamble that have tougher relationships with Walmart! Now, how's it get to be this way? It's a result of:

      "...good sales programs that the customers like...."

The alternative business model that has become feasible with the Internet and MP3s has been widely discussed elsewhere, so I'll just summarize: Run as a small business. Concentrate on cash flow and early profit. Market by word of mouth and free samples. Make money off concerts, CDs and some MP3 sales. Control your own content, your packaging, your distribution. It's working for backlist artists and niche acts, so it obviously extends the range of commercial viability below the 100-200,000 unit break evens of the big boys.

So, why can't the big dogs just go away and leave the little guys and us customers alone? Or even try the trick themselves? They aren't ignorant of the possibilities. After describing the 200,000 fan acts, Mr. Urie than suggests that in the future he will be able to use the Internet to reach those fans directly, and that every label in the future will have 20 or 30 such artists, now profitable because the marketing to the reliable fan base will be so efficient. There are two reasons he won't be able to do it. The first is channel conflict. Mr. Urie again:

"...we do not want to be retailers... So everything we have done, such as digital downloading... is going to be through the customer."

And the second reason - now we finally get around to power laws. While we don't have rock solid proof, we certainly have suggestive evidence everywhere from the evolution of television, to the number of links pointing to blogs, that the small-audience tail of the power law distribution grows by displacing money and attention previously given to large audience plays, be they television broadcasters, AOL, or multi-platinum record albums. If the soundness of your business model, your portfolio risk management strategy, depends on the size of the big hits, then this is a scenario for being nibbled to death by ducks - those harmless looking niche and back label artists and their low-rent business models. What our exec wants is 20 to 30 of them on his list. What he's going to get are 3000 of them, and very few of them on his list. And the blogs? We're the word-of-mouth medium that's going to do the same thing to the media and promotional business that exists in symbiosis with the labels.

Whether the RIAA truly believes that direct theft by MP3 filesharing is the root of their problems, I have now waying of knowing. There certainly seems to be evidence that it's a wash - displacing some sales, but causing others. What is certain is it's just collateral damage compared to the mortal threat posed by channel conflict combined with the audience corrosion of a power law distribution with a much longer, commercially viable tail.
5:30:34 PM