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

How Wal-Mart has done more than the Internet to change the structure of the music industry

Previously, I wrote that the music distribution companies could not sustain their monopoly power (or Oligopoly as one alert blogger wrote) without the giant contracts they give to big stars. The direct implication of this observation is that Wal-Mart and other big box retailers have changed music industry structure far more than file sharing, despite getting less attention.

As I wrote before, music distributors are actually using their contracts with big stars to develop new acts that they've signed to long term contracts. They do this primarily through their control over the channels of promotion and distribution - basically, carry my new artist and you'll get a discount on the Rolling Stones. We'll get the Rolling Stones to use them as an opening act to get some publicity, we've got contacts and deals with MTV because of our big name acts, etc.

The dynamics of a new act are particularly important. Often, a great new act goes undiscovered for a long period of time, then starts to generate buzz in a few markets. Given how social a phenomena hits are, this buzz has to be nurtured and exploited by having enough product on the shelves. Only a big music distributor can guarantee that.

Wal-Mart is destroying that capability.

This is a retail operation so large its sales are measured by percent of US GDP moved every year: over 2% in 2002. Business Week just did an article this week titled "Is Wal-Mart Too Powerful" (reg. req'd.). Among other things, they carry music. Drop by any Wal-Mart and you'll see the problem the labels have: you will only see the top 200 hit albums. This means two very bad things for the music industry. First, they carry no back catalog beyond wild successes like the Beatles. This shortens the total time on the shelves of an act, reducing lifetime profits for the music company.

More importantly, they carry very few new acts, and don't accept money to feature new acts in prominent locations. This is destroying one of the big advantages of the music companies when signing new acts - the ability to push the new acts to discerning tastemakers who frequent the music stores. They can still do top-down buzz (MTV, concert tours), but have lost their ability to affect bottoms-up buzz from people discovering great new artists. Additionally, it removes their incentives to pay for the top-down buzz since they aren't on the store shelves at the moment a new fan tries to buy it.

The impact went far beyond the amount of music moved through Wal-Mart and its brethren (Target, CostCo, etc.). Suddenly, Tower Records and Sam Goody and the rest were struggling - Wal-Mart took their bread and butter, the fast-moving big hits. Everybody knew those CDs were cheaper at Wal-Mart and bought them there. This stuck the traditional retailers and music specialty stores with slow-moving too-expensive titles that wouldn't move off the shelves. After all, once it started to hit, Wal-Mart would carry it.

So the traditional music retailers started rationalizing as well - focusing on inventory turns, and moving back catalog and new artists off their shelves. However, they still couldn't compete with Wal-Mart, so they have been turning in horrible financial results and closing locations. Most recently, Tower Records is offering itself up for sale to avoid bankruptcy.

In short, this messed up the music industry's structure more than the Internet has so far. Believe it or not, just 4 short years ago the primary issue on every music company's mind was "how do we deal with Wal-Mart?" Unlike file sharing, which gets so much press, they couldn't really talk about that much in public. After all, Wal-Mart was a huge customer as well as being a huge threat to their way of business.

The most logical answer (charge them more to subsidize promoting new acts) doesn't work because of Wal-Mart's negotiating power. They actually receive better prices from the record companies than any other retail outlet or they don't carry the product. Unlike music stores, which rely on having the Rolling Stones in stock when you ask for it, Wal-Mart just cares that they have some of today's top hits on the shelves when you walk by. That means that if they don't get the price they want from the music company, they don't carry the product.

So while the industry still has the ability to generate initial interest for a hit record, they no longer have the ability to get the message out in dying music stores or capitalize on that interest quickly. This has made it very difficult to create the next Britney Spears. It still happens, of course, but the primary advantage the big music companies had over potential new entrants is disappearing. While file sharing is starting to have a significant impact, it is Wal-Mart that has done the most to damage the RIAA members so far.

Coming Soon: Tower vs. IBM: Why online distribution hasn't come to the rescue
8:37:19 AM