Disruptive Innovation and the Death of the Recording Industry

Last week I quoted a Wired article that discusses the rise of the MP3 format as a disruptive threat to the recording industry. The story of the recording industry’s decline is complicated because there are actually two different factors at work. The recording industry likes to focus on “piracy” as the main cause of its declining fortunes. But although copyright infringement has certainly done some short-term damage to the recording industry’s bottom line, I think the long-run problem facing the recording industry is a structural problem that has little to do with copyright infringement.

I’ve argued before that the recording industry and the newspaper industry are facing the same basic problem. Both industries are fundamentally in the content-distribution business. Newspapers are in the business of shipping newsprint to consumers. Record labels are in the business of shipping discs (first vinyl, then plastic) to consumers. These content-distribution technologies are to the Internet what the horse and buggy was to the internal combustion engine.

The recording industry, like the newspaper industry, likes to think of itself as being in the content-creation business. But that’s largely wishful thinking. Musicians don’t sign on to record labels because they need their help to make music—typically, musicians have been making music for years before they get their first record contract. Rather, they sign onto a label because before the Internet a record deal was the only way to distribute their music to a national audience.

It’s true that when an artist signs a recording contract, she gets some financial assistance from the labels. Some of that money often goes to pay for studio time, but a lot of it is usually spent on promotional activities. And although musicians obviously benefit from a label’s effort to promote their work, the primary beneficiary of money spent on promotion is the label itself. Here’s why: publishing a CD involves high fixed costs, so a label needs to sell thousands of copies just to break even. Hence, once the decision was made to publish a given album, the label needs to ensure that it will sell well. From a label’s perspective, publishing an album that sold 500 copies is much worse than not publishing at all.

The Internet changed that. Today, releasing an album is a virtually risk-free decision, so the lavish promotional campaigns that typified major-label album releases are no longer needed. Musicians can simply release music on their websites, or through online services like iTunes and Amazon. Musicians don’t need to do a lot of promotion if they don’t want to, but the Internet helps here, too, giving bands a number of tools to promote organic, viral growth in their fan bases.

So the investments labels make in their musicians aren’t investments that are required for music publication, they’re investments that are required for the capital-intensive process of releasing music in CD format. Now that CD distribution is being rendered obsolete, there just isn’t any need for enormous music-publishing companies. We know from Coase that large firms exist only when there are benefits (such as economies of scale) to large size that exceed the inherent inefficiencies of bureaucratic management. Distributing a CD to a national audience is an activity where size is an advantage. Recording an album and releasing it on the Internet just isn’t.

It’s true that the prevalence of copyright infringement has accelerated the decline of the recording industry. If we could somehow outlaw peer-to-peer file sharing, it would probably postpone the recording industry’s demise by a few years. But the long-run trend has little to do with copyright infringement, and everything to do with technological change. The core competence of the labels has always been shipping plastic discs across the country. The Internet is rapidly rendering that music distribution method obsolete. And so there’s every reason to expect that the firms built around that technology will themselves go out of business.

As Mike Masnick has pointed out before, the CD business is not the same thing as the music industry. The vast majority of music has always been made by people who didn’t have recording contracts, and there’s no reason to think people will stop making music in a post-CD world. Being a rock star may become somewhat less lucrative in a post-CD world, but it will still be a tremendously high-status achievement. It seems implausible that we’ll ever have a shortage of people making and publishing music.