SYNOPSIS
This dissertation takes a look at innovation drawing from the worldwide music industry. The music industry is currently facing a slump in its sales and dropping revenues worldwide. This dissertation research traces the effects of evolution of disruptive technological innovations like Napster and subsequent technologies. Napster as a community file sharing peer-to-peer application defied the traditional physical music distribution system. The dissertation paper attempts to throw light on the subsequent fallouts of the Napster effect, documenting the music industry’s dilemma and exploring a possible distribution model for the future. Such a model would anticipate the future changes like a wireless age, accelerating technology and focus on a community-based model. Also an attempt has been made to look at technological innovations as apart from firm-driven innovations. These technological innovations are capable of changing the industry complexion and are essentially freelance in nature.
THE CHANGING TECHNOLOGY ENABLED WORLD…
The I-Pod, the mp3 technology, mobile music devices… Information, entertainment and communication anytime, anywhere, on the move… Welcome to the wonders of the telecommunications era. The era of technological innovation that spurs business innovation. In the last decade technological advances have changed the way businesses function; the prime mover of the technology being the information technology and the proliferation of the Internet.
Consider another scenario. At 56kbps modem speeds all it takes to download the whole new Eminem single takes 20 minutes. And the vintage works and less seen or heard collections like those of John Lennon’s Lost Weekend are up on E Bay for auction. Amazon.com has a catalogue of CDs to rival any music showroom and has a regular clientele as well. Fans swap music online and critique it online.
In a nutshell like any other industry the worldwide music distributing and publishing industry is in a state of flux. The community that buys this music is moving online. The piracy issues racking the industry bottom lines are a matter of serious concern. Disruptive innovation is changing the complexion of the industry.
DEFINING INNOVATION
Invention is defined as the action of finding or discovering or the contrivance of a new method. Innovation is defined as the action of innovating, the change into something new, the introduction of novelties or simply the alteration of what is established. Technology is defined as the practice or application of any of the applied sciences for practical value or industrial use. A new technology can just be ideas, anything that creates a change to the way business is done. Tools and technology are not a prerequisite to innovation.
A disruptive technology or innovation is the change that topples the industry leaders. In the case of the music industry the change is a combination of the mp3 technology, the Napster innovation and the advent of mobile music.
To better understand this, lets take a closer look at the music industry. The music industry traditionally relies on the sale of music cassettes and CDs, concert tickets for its revenues. The companies invest heavily on new artists. After recording albums, the companies invest huge amounts on promos and advertisement campaigns for these new albums. This also includes a large amount of money spent on making music videos that are broadcast on a large number of music channels across the world. Also includes the cost of buying the spots and time slots on music and other channels for promotional purposes. All these must be converted into sales across the globe otherwise the money invested by the music company is sunk.
The most important component of a CD is the artist’s effort in developing that music. Artists spend a large portion of their creative energy on writing song lyrics and composing music or working with producers and A&R executives to find great songs from great writers. This task can take weeks, months, or even years. The creative ability of these artists to produce the music we love, combined with the time and energy they spend throughout that process is in itself priceless. But while the creative process is priceless, it must be compensated. Artists receive royalties on each recording, which vary according to their contract, and the songwriter gets royalties too. In addition, the label incurs additional costs in finding and signing new artists. Once an artist or group has songs composed, they must then go into the studio and begin recording. The costs of recording this work, including recording studio fees, studio musicians, sound engineers, producers and others, all must be recovered by the revenues generated by the sale of the CDs and cassettes.
The new artists often complain that the contracts the music companies with them are very exploitative in nature. But the music companies say that they invest very heavily in the new artists and their fortune to a large extent depends on the success of these newer albums. So they need to cover their costs by having exclusive agreements with the artists for all the albums that they would churn out in a specific period of time.
A lot of the music companies also make movies, in India as well as the US. Companies produce movies and in some cases they just own the marketing and distribution rights of the music. The music companies make their revenue by selling the prints to the distributors and the music cassettes and CDs in the retail market. Also once the artists become famous and well accepted, the music companies make a lot of money from ticket sales in concerts. The Rolling Stones for example still rake in concert money and the same holds true for artistes like Metallica, U2, etc…
Sale of music CDs and cassettes: In India, a CD typically cost anywhere from Rs.150 to Rs.500 and a cassette costs from Rs.50 to Rs.125. In the US the video and DVD rental business is large and also generates revenue for the music companies. There are many large company owned rental stores where movie CDs and cassettes can be hired.
According to the laws, only the music company, for which the artist has signed up, can legally sell music in the market. So this means that the companies make huge profits if the artist launched by them is a hit.
THE EXISTING MODEL DOESN’T WORK…
The problem with this business model is that it assumes that people like to buy original music and that they are willing to pay what the record companies demand, for these CDs.
Original CDs in any market are expensive. All this worked very well for music companies around the world till about mid nineties. Piracy was not a major problem in the US and European markets till the nineties. But when these companies entered the Asian markets, they were faced with large scale and rampant piracy. There was a lack of laws protecting intellectual property in most cases and in other cases there was no implementation. Small businesses would make multiple copies of the original CDs at only a fraction of the cost and sell them in the local markets for as low as only 8% to 10% of the price of an original CD.
This was a major problem in the Chinese market in the mid nineties. This hurt the music companies a lot in the form of lost revenues and reduced profits. Then the government took steps to curb this illegal sale of counterfeits in the markets. But this illegal sale of counterfeits continues on a very large scale even today in most parts of India. This has hurt the music companies a lot in the country. The accumulated losses of the industry today, stand at a staggering Rs.1800 Cr. It is feared that if the piracy and counterfeit music industry is not controlled, the music industry in the country may have to shut down in another 4 to 5 years.
Meanwhile all is not well on the US frontier as well. The (American) retail music market is valued approximately at $15 billion in annual sales. Universal Music and Video Distribution, Sony Corp. of America, Time-Warner Inc., EMI Music Distribution and Bertelsmann Music Group (BMG), the five largest distributors of recorded music who sell approximately 85 percent of all compact discs (CDs) purchased in the United States and 75% of the world market. Dominating enough by any industry standards.
With the advent and popularization of the Internet, the very fundamentals on which the music industry is based were being challenged. Traditionally, a major group of music buyers has been the 16 – 25yr age group. Most of the people in this age group are university students. So they did not quite like the idea of buying expensive CDs even if they wanted to listen to only one of the 12 or 15 songs on the CD. This effectively meant users pay $3.50 to $5.50 for one song (in the form of a single sometimes), a little too expensive. So the traditional distribution model followed by the music companies failed to address their needs. These users were not willing to pay for the music that they did not want to listen to. They wanted more choice and the traditional distribution model failed to address this. So the large community of music lovers had to look elsewhere for a solution. The Internet provided the answer.
THE FIRST SPARKS…
This generation of music lovers was very much computer literate. The Internet provided them with a new medium to exchange thoughts, ideas and data. As computers became popular and their penetration increased, technologies were developed which let people listen to and store music files as data on their computers. A bunch of new technologies were developed, the most prominent being the mp3 and p2p, or peer-to-peer networks. These coupled together were destined to change the way people listen to music.
Many free applications such as “CDEX” and “CD to Mp3” became available on the Internet which allowed users to “rip” music from audio CDs by 1997 -1998. Freelance developers developed most of these applications and students studying in universities and the developers provided them free to anyone who wanted to download them. These applications were capable of copying music from the CDs and storing them on the computer in a computer readable format called the wav file. But one problem still persisted and this was that the wav files occupied a lot of space on the computer disks for storage. This problem was solved by the popularization of the mp3 format.
A new technology called the “mp3” format, developed by the Fraunhaufer institute in Germany, was becoming popular with users. Mp3 is a compression algorithm that allows users to store music on computers such that it occupies very little space on the computers. These could be later decompressed and would produce near CD quality sound. So now the personal computer also became a media center and jukebox and people could listen to their favorite music on computers.
Soon free applications became available that could convert these wav files into mp3 files which occupied only a small fraction of the size occupied by the wav files on the computer disks. So now people could ‘rip’ music from CDs and convert it to mp3, store it on their computers, listen to it and even burn it on CDs, in the mp3, so that a conventional CD which normally holds about 12-15 songs could now hold even up to 200 songs. These CDs became very popular with computer users and it began to hurt the sales of the popular music companies.
MP3 CDs with up to 200 songs on a singe CD started becoming available in the markets in the countries where the Intellectual Property Rights and related laws were not strictly implemented. These are easily available all across India for much less, typically anything from Rs.30 to Rs.100, depending on whether it is a small town in India or the Palika Bazaar in New Delhi. These mp3 CDs are mass produced and cost very little to produce typically Rs.5 to Rs.20 depending on the technology used. These not only give the users a large number of songs at a fraction of the cost, but also a wealth of choice to the users basically redefining Value For Money. The local shopkeepers prefer to sell these because of the huge margins they get on these. Global piracy on the physical side costs the recording industry over $4 billion a year, which is a conservative estimate.
THE NAPSTER REVOLUTION, A DESTRUCTIVE INNOVATION…
Next came the IT boom. A number of dotcoms came about that allowed users to download music for free or for a small membership fee. These dotcoms were many in number and signaled bad times for the major record labels. But still online sharing of digital music was small and it did not pose a major threat to the complacent music companies and the record labels chose to conveniently ignore it. This was a typical case of the ‘roaches under the board’ theory. The music companies chose to ignore these and their number became so large that they began eating into the revenues of the major record labels. But at the same time they allowed a number of newer and lesser known artists and musicians to showcase their work, what came to be known as Garage Bands. This basically spelt danger to the dominance of the record labels and a larger say for the consumers in what the music companies churned out. The record labels failed to see the Internet as a means to listen to the consumers and to give them a larger say in the kind of music they churned out. They failed to use the Internet as an enabler and saw it as nothing more than a menace. Their online presence was nothing more than e commerce sites, with no difference in their ordinary distribution and their online distribution.
“Peer to peer” technologies forced the music industry to take notice and make changes. This technology allowed users sitting in distant corners of the globe to view lists of files on others’ computers and to even exchange them free of cost. This meant that if anyone anywhere in the world bought a music CD and stored it on their computer in the mp3 format and he made it available for sharing on a p2p, the people could just download the music free of cost, sitting anywhere in the world. A music file in the mp3 coded at near CD quality is typically about 4 to 5 megabytes in size. It takes about 25 to 30 minutes to download on a 33.6 k modem. On a faster 56 k modem it downloads even faster. All of the universities in the developed world and most of them in India have high-speed Internet connections, on which the same files can be downloaded in much lesser time like a few minutes to a few seconds. All this coupled with impending ‘broadband revolution’ challenged the distribution model of the music companies and threatens to render the traditional model obsolete. All this while the concept of the online music community was gathering momentum. What brought this to a head was Napster.
NAPSTER, THE ORIGINS
Shawn Fanning, a second year student of engineering in a US university, came up with an idea. He developed a software application he called Napster. True to its name Napster allows users to simply log into Napster servers where the application program would update a list of all mp3 files on the user’s computer. The users could send a query to the server to find a particular song or music file. The server searched a list of files on the users’ (logged on to Napster’s server) computers and sent the Internet address (IP) of the computer with the successful match to the one that generated the query. The user who generated the query could view a list of all the matching search results on the console of his computer. He could then simply choose to download that song straight from that Napster users’ computer. A very strong community of Napster users developed on the Internet. As a result the popular artistes like Dr. Dre and Metallica and others were being heard more than ever before, but none of that was reflected in the record labels’ bottom lines.
Napster Architecture
All these developments coupled with the increasing penetration of the Internet in many parts of the world prominently the USA caused a paradigm shift in the way music was distributed and shared by the people. This way the users created a whole new solution to the problem of the lack of choice. The music companies failed to note the mood of the people and preferred to stick to their conventional distribution model.
THE NAPSTER FALLOUT…
The sales of the music industry started declining after 1998. Since being put up on the Net, 32 million people joined, and with a million new signups each week, Napster was the fastest growing Internet Company. All this till the Recording Industry Association of America (RIAA) sued Napster for helping consumers infringe on music copyrights. By the end of 2000, Napster had upended music’s business model, survived a legal threat and found a sponsor in Bertelsmann, the media behemoth. Even if it wasn’t supposed to happen this way, music may finally have changed the world. Perhaps the biggest accomplishment is that Napster made peer-to-peer (P2P) computing mainstream. And Napster recently signed a deal with Bertelsmann AG that requires Napster to pay royalties when users exchange songs from Bertelsmann’s labels.
Post Napster era the piracy continues. Internet file-sharing services such as Grokster, Kazaa and Morpheus, plus rampant CD copying by consumers and organized criminal groups are making the ouster of Napster a wasted effort. More ‘genetically modified clones’ of Napster are all over the Internet.
In more bad news for the music industry, album sales declined in 2002 again, down 10.7 percent from the previous year. Nielsen SoundScan reported that in the first week that 2002 album sales fell from 763 million in 2001 to 681 million.
Overall music sales in 2001 had been down 5% — the first decline since SoundScan began tracking music sales in 1991. Apart from the Internet piracy, the slumping economy also has contributed to the decrease, although the industry historically has not suffered declines in bad economic times. In the US all music genres dipped in sales, with two exceptions: country album sales rose about 12 percent, reversing a slight decline in 2001, and jazz titles were up slightly. Essentially the genre patronized by the older (not so Internet savvy generation) is still satisfied with the old economy of the record labels. The main reason cited for the slump was the Internet piracy that is rampant all over the world in Internet music communities and file sharing over these peer-to-peer models. The younger generation of music lovers refuses to spend money, buying stuff that is available on the Internet free of cost.
According to recent surveys among a total of 2,225 music consumers between the ages of 12 and 54, commissioned by the RIAA and conducted by Peter Hart Research Associates, 23 percent of those music consumers surveyed said that they did not buy more music in 2001 because they downloaded or copied most of their music for free.
Some have questioned whether downloading results in sales displacement. In addition to the actual claims of the consumers about their own buying patterns, there has also been explosive growth in the copying of that downloaded music onto a burned CD or a portable mp3 player. In the 2001 survey, over 50 percent of those music fans that have downloaded music for free have made copies of it. Just two years ago, only 13 percent copied it onto a portable device or a CD burner.
CAN THE NAPSTER CLONES BE WISHED AWAY?
Despite Napster becoming defunct as a community file sharing application, the music industry’s sales slump continues. The simple fact is that peer-to-peer is here to stay. Since the introduction of Napster, many other similar utilities and Web sites have appeared. And most of them do not limit file sharing to just MP3s as Napster did. Some, like Gnutella, allow virtually anything to be shared.
Another feature of some of these peer-to-peer utilities is the elimination of the need for a central index server. In true peer-to-peer fashion, these utilities search each other out online. For example, as soon as a Gnutella client comes online, it says, “Hello, I’m here” to another Gnutella client. That client then tells other clients that it has already established contact with about the new one. Each of those then tell the others, who tell the others and so on. This way each client has a larger number of other clients who know it is online and what content it has available.
Gnutella Peer-to-peer Architecture
Peer-to-peer utilities that employ this decentralized approach are virtually impossible to shut down. Since there is no central server maintaining the index of users, there is no easy way to target and stop the use of the program. Many of the content developers in music, video and other industries are beginning to realize that fundamental changes in the way royalties and licensing work are vital to keep up with the revolutionary world of the Internet. Curbing piracy in such a scenario demands re-thinking of the business philosophy and the business model.
A NEW MODEL OF MUSIC DISTRIBUTION?
It is obvious that the current model of the music industry will not sustain too long. Few of the important reasons that make this physical distribution model unviable are:
1. The continued proliferation of peer-to-peer innovations that thrive on the Internet.
2. The emergence of the wireless revolution. With M-Commerce, L-Commerce coming in, in a major way, the music industry cannot expect fans to rely on radio and the physical medium like CDs and cassettes.
3. More and more new artists are debuting on the Internet, registering themselves on sites like garageband.com, leaving the music labels and agents out of the hierarchy.
The pertinent reasons mentioned above are all the effect on the emerging technologies on the existing business processes. These innovations cannot strictly be called disruptive innovations. In their own league wireless, dotcoms, new applications are enhancing innovations. They do not seek to cause a radical change in the current business model. But in conjunction with technology they can be a potent force.
A prototype that may emerge out of this technology shake-up could be on the lines of music on demand, with a membership model. The following steps document such an innovation:
1. Digital music should be made available much more easily. The users need not store any file locally. The users should be able to set up play lists using an application on their computers and should be able to listen to streaming music on their computers.
2. Adopting a membership approach, the users could either pay an annual, a lifetime or pay on a song-by-song basis. The only way the music companies can make this work would be by making the streaming and listening to music- easy, cheaper than even burning CDs and making it a wireless compatible model.
3. The music labels would have to set up websites and e-commerce applications to enable interested customers to buy the CDs. And for the rest of the customers they must be able to enable loading play lists from the websites, on a streaming basis. They would also have to collaborate with each other on sharing music files.
The most important advantage of this model would be the fact that users would get to listen to music of their choice anytime, anywhere. With the wireless technology having improved speeds and faster, effective connectivity, music streaming application will become more important. Currently wireless apps deal with downloading news, e-mails, instant messaging, FM radio, etc… Soon the demand for cheap and unlimited music is expected to come to the wireless media. A model that allows users to stream music at rates cheaper than even burning CDs, making piracy an expensive option seems the only way out. CDs would still be available on the net say at sites like amazon.com
The most obvious fallout of this model is that it renders music companies almost unnecessary. The artistes could themselves host websites and collaborate on sharing resources through a common site or search engine. The music companies would still have a role to play in terms of artiste management and music publishing for the select people who would still want to buy CDs. Concert and ticket sales would still necessarily need human intervention.
ANOTHER LOOK AT BUSINESS INNOVATIONS…
The Napster innovation was a not as such an innovation that was technologically path breaking. It was an Incremental Innovation as far as the technology went. But what set it apart was the way it challenged the music industry’s distribution model. Fanning’s contribution, conceived while he was a freshman at Boston’s Northeastern University, is a free, downloadable program that transforms PCs into servers for exchanging MP3 music files over the Net. By letting individuals tap into each other’s tunes, Napster has created the world’s biggest bootleg record collection.
Looking at theoretical models of innovation, Napster as an innovation fits the description of an architectural innovation according to the Abernathy-Clark model. Such an innovation renders technological and market capabilities obsolete.
As a Radical innovator the advent of Napster and online music file swapping, changed for good the relationships between suppliers, manufacturers, customers and complementary inventors.
Value Added Chain
A Napster innovation was high on the Radical Innovation scale for the Suppliers. As far as the manufacturer went it was just a dip in business revenues. The customer accustomed to rudimentary file swapping on the Net treated Napster at most as an Incremental Innovation. The complementary inventors had a great stake in this innovation. This breed ranged from makers of network appliances, Internet enabled mobile devices to the ISPs trying for broadband connectivity. For these stakeholders the Napster was a Radical innovation. The reason why Napster was rendered ineffective was the fact that its capability to add to the innovation value-add chain was minimal. A Napster app would not add any value to the suppliers and manufacturers. It had the potential to revolutionize the music industry by cutting profit margins to minimum, and by building online communities. But it failed not only because it was on the wrong side of law, and that it had no viable revenue model. It failed more because it had no roots in the system of the current distribution. Its ability to add to the existing infrastructure was limited.
Generally it is assumed that firms drive innovations. Firms have Research and Development laboratories where they employ scientists or technologists for focusing on research that has strategic aims and objectives. Such research coincides with the overall goals and vision of the organization. And this model also assumes that firms can keep abreast of all innovations by knowing one’s own and competitions’ R&D work.
Napster was a different kind of revolution. The fact that an eighteen-year-old computer programmer could get Bertelsmann Music Group (BMG) to take notice of the music community and sue it for piracy was a watershed event in modern corporate history, quite on the lines of the hotmail innovation being bought for millions by Microsoft. The Internet technology enables stand-alone innovations to flourish and by means of communities and sites like download.com, lets these innovators put up their innovations for the rest of the interested community to use and critique. The new age technology enabled economy equips individuals with the technology to innovate just on whim and intellect. Especially in the technology field the concept of owning innovation is outdated.
CONCLUSION
The Napster innovation goes beyond the regular scope of an innovation. There was a gap and an inherent flaw in the industry’s distribution and music selling model. Shawn Fanning was an enterprising individual who exploited it. In the technologically enabled era of enterprise, no innovation can be contained. Nor can all innovation be commissioned. Innovations may belong to communities as in case of the music industry’s case. Such Radical innovations that flirt with the law challenge existing systems and it is but appropriate that these lone inventors be given their due credit.
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