Guest blogger Kevin Laws, former music industry consultant and current venture capitalist, returns with a second installment of his industry structural analysis.

Music companies aren't monopolies; they're just middlemen who take a cut for helping the real monopolists.

Quick, who has a bigger advance for distribution: Britney Spears or Courtney Love? (Courtney Love by far, a multi-million dollar one -- Britney was an unknown when signed by BMG's Jive label).

If the music industry is such a monopoly, why aren't music companies wildly profitable? Just for comparison with another information-based industry that has monopoly power, Microsoft's Windows division had 81% net margins last year. One of the music industry's most profitable distributors, Vivendi's Universal Music Group, hovered around 15%. Some of the others have been consistent money losers.

The two questions are related. After all, the real monopoly power in the music industry resides with the brands: Madonna, Santana, Britney. When you buy Madonna's latest CD, you don't care what label it's on (Warner, if you do care). She's free to choose a distributor, and uses that power to negotiate a great deal. Any big name you know who's been around for a long time is getting a fantastic deal from the labels and distributors.

The music companies make very little on these deals overall. They make money when an artist outperforms expectations and lose their advance when an artist underperforms. In aggregate, they only make a tiny profit or even a loss on their huge production and distribution infrastructure. More importantly, they have enough business to keep that infrastructure in place for their main moneymaking activity.

Most of the money comes from investments in new acts. This is where the monopoly power comes in - not their own, but that of the big acts that sign with them. The labels and distributors are able to use the fact that they own Counting Crows to go out and push Chumbawumba on us all. After all, the music companies are already in front of every playlist designer and store buyer in the country. The buyers are paying attention because the music companies bring them big acts. The big acts help push the small acts - e.g., I'll give you a discount on the Rolling Stones if you carry Mr. Never-heard-of-him.

Of course, the music company has signed Mr. Never-heard-of-him to a three record deal - and if the first record hits, they own the rights to the next two at knock-down prices. The acts that have the best potential and the best deals for the distributors get pushed, and those that don't get dropped by the wayside. The faustian bargain says that if you make it big, you'll make it to the other side of the divide, be a brand, and be able to name your own price after putting in your time with your current 3 record deal. If it weren't for that bargain, new acts wouldn't get marketed so aggressively.

So in essence, the distributors are merely acting as agents for acts with major monopoly power. The stars are selling their monopoly power to the new acts to help them get big. Instead of Britney the unknown going to Madonna and saying "here's a million dollars - can you include my song on your next album to promote me", the music companies step in between, pay Madonna tons of money, sell her help to Britney. Then, since Britney doesn't have any money when she starts out, they strike a deal with Britney to finance that deal in return for almost all the profits from her first three albums.

The music companies exist to funnel money from new acts to big stars, since that's where the real power is. The monopoly power is not their own - they are just middlemen taking a cut for facilitating the transaction. That's why they are not wildly profitable. They aren't the real monopoly, the stars are.

Coming Soon: RIAA Enemy #1 - Wal-Mart, not Kazaa
12:48:05 PM    

Peppercoin of Waltham, MA, a competitor of bitPass, received $4.25m in second round funding. Still not a lot in the way of market proofs for this kind of transactions, but there's bit more money being put on the table to give it a try.
12:44:10 PM