The Record Labels' Digital Future

Even as they cut a deal with MySpace for online music, the record labels are looking at other ways to make money online

On Apr. 3 the recording industry sent a clear signal about its changing attitude toward the Internet. The social networking site MySpace and three of the four major record labels unveiled MySpace Music, which will let fans listen to music online for free and buy songs for download, along with merchandise and concert tickets. Warner Music, Sony BMG, and Universal Music, the three labels that signed up for the deal, say the joint venture is an important evolution of their business model. "We think of ourselves as undergoing a very fundamental transformation from being a CD company to a multirevenue stream, multibusiness company," says Thomas Hesse, president of Sony BMG's global digital business.

Yet MySpace Music is only part of the labels' online efforts. Under pressure from plummeting CD sales, all the major record companies are experimenting with ways of making money online. Rather than just selling music, the labels are trying to make money off of advertising, promotions, and the sales of items such as concert tickets and T-shirts that they used to leave to others.

Ad-Based Model

Take Imeem. The social networking site, with about 20 million users worldwide, streams music for free on its ad-supported pages. It then shares the advertising revenue with the labels based on what songs people are listening to. Although it also receives referral fees for directing customers to Apple's (AAPL) iTunes or (AMZN) to download tracks, advertising is the main business model.

Dalton Caldwell, the chief executive at Imeem, says the labels' change in attitude just in the past few months has been dramatic. Imeem was sued by Warner Music last year; now Caldwell talks with the label's executives so frequently he has them on speed dial. Warner Music was the first of the four majors to sign on, but all have now done so. "There is a larger degree of sophistication and a willingness to embrace more cool stuff [at the labels]," he says.

Other new online business models involve using an artist's music to sell tickets, merchandise, or other ad-supported services. One that has become particularly popular is iLike, an ad-supported music discovery service with 23 million users, many of whom use it through social network Facebook. Owned in part by IAC's (IACI) Ticketmaster, iLike also notifies users when their favorite artists have shows in town, sending them to Ticketmaster to purchase seats or iTunes to buy music. "What's really exciting about the current moment in music history is that there is so much experimentation because it is not quite clear which business model will prevail," says Ali Partovi, iLike's CEO.

Seeking Social Networks

Advertising will likely play an important role. Advertisers are expected to spend nearly $30 billion online this year, a 23% increase from 2007, according to March estimates from research firm eMarketer. Much of that is going for search ads, like those offered up alongside Google (GOOG) search results, but many advertisers are interested in the potential of social networking sites. "It is obviously one of the most important phenomenons around entertainment, this social networking community effect," says Michael Nash, Warner Music's incoming head of digital strategy. "Our approach is now: What is going on here, what is the business model, and how can we be in business together?"

In November, Engadget founder Peter Rojas launched an online record label/music blog called RCRD LBL, along with label Downtown Records. Signed bands make songs available for free download or streaming on the site and are paid with a portion of ad revenues. "I am not interested in thinking of music as something that is bought or sold," said Rojas during a music panel at this year's South By Southwest Digital Festival.

Slide, a photo- and video-sharing service with more than 144 million users worldwide who use the site each month via Facebook, MySpace (NWS), and other social networks, launched an ad-supported music service two years ago. As labels have become more interested, the service has expanded from allowing users to incorporate licensed music into photo slide shows, with ads, to debuting artists' videos and songs on its "funwall" social networking application. "After the first six months, the labels started getting it and paying attention," says Tony Pham, who manages Slide's community and artist relations.

The Subscription Model

Another model that the major labels are pursuing is all-you-can-eat subscriptions. The model is attractive because it provides a steady, predictable revenue stream. Although it has yet to take off, Rhapsody, the leading subscription site, has been pushing the model for years. "The labels have always been very positive on subscriptions," says Neil Smith, Rhapsody's vice-president for marketing. "The lightbulb has not completely gone on [with consumers] but we are working on it."

The record labels are experimenting online in part because they have to. CD sales declined more than 18% in 2007 from the prior year, according to data from Nielsen SoundScan. Even with sales of digital albums and the like online, overall album sales fell nearly 10% last year. The record labels recognize that they need new revenue streams to succeed. "We are going to have very well developed business models on ad-sponsored discovery, pay-as-you go, à la carte purchases, and paying for access to a catalog of music," says Warner's Nash.

There's a future beyond Web 2.0, too. Nash thinks it may be on wireless phones: "3.0 may be that everything gets mobilized."

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