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Music industry slump accelerated in 2005

Posted by iMark - 2005-12-18

It all seemed so promising for the music business heading into 2005. CD sales were up, albeit ever so slightly, for the first time in four years. Legitimate purchases of downloads and ringtones for the first time totaled in hundreds of millions of dollars. And file traders and peer-to-peer network operators were on the run from industry lawsuits. The seeds of recorded-music's recovery from  Napster, it appeared, had been sown at long last.
 
But a funny thing happened in year two of the industry's anticipated comeback story: The turnaround never materialized.

During the last 12 months, CD sales took two steps back, rather than one step forward, retreating about 8% to 2003 unit volume levels, according to Nielsen SoundScan. Even with blossoming digital download sales factored in, total music sales are still running behind 2004 by 4%.

Industry executives are grappling with the vexing question of just what went wrong in the last year. Some blame the sales letdown on the dearth of superstar product in 2005. Other industry watchers point to growing cannibalization by iPods and CD burning. Still others say the digital music market is developing too slowly, even with its gains.

This much is clear: All the label restructurings, anti-piracy efforts, aggressive pricing strategies and increased digital distribution sales were not enough to save the music business from itself in 2005.

If anything, recorded-music companies were confronted with the reality that no magic-bullet solutions exist to their problems, as many of their heavily hyped initiatives fell short of expectations in the near term.

The popularity of iPod and iTunes did not create a new dominant music format. Label executives are expressing concern that despite a 150% increase in digital track sales in 2005, driven by Apple Computer, iTunes is not developing quickly enough to offset the flagging CD business. Internet piracy did not decline significantly in the wake of the Supreme Court's ruling against Grokster in July.

CD content protection not only failed to stop unauthorized copying of music, it emerged as a liability for labels distributing the technology. DualDiscs have not caught the imagination of consumers or the industry at large as the savior of physical product, despite favorable reviews. Concerns over demand, production costs and compatibility have many labels cool to the concept.

The merger of Sony and BMG did not shift the balance of power among the major labels. And the initial public offering of Warner Music Group was not a home run payday for investors.

WARNING SIGNS

As 2006 approaches, improving operations, reviving physical sales, fanning digital music commerce and stamping out casual piracy remain monumental challenges for an industry in wrenching transition.

The warning signs that something was amiss in 2005 were apparent from the get-go.

The album business was already skidding badly by the close of 2004. A 7% gain in overall industry sales as of mid-September that year had dwindled to a razor-thin 1.6% margin by the end of 2004.

The downward spiral only continued as 2005 opened. First-quarter album sales stumbled out of the gate, dipping 9% year over year in part because a blockbuster Valentine's Day/Grammy Award selling period -- a key lynchpin of 2004's success -- never materialized.

As 2005's sales sputtered, distraction was the dominant theme for three of the four major labels. Warner Music was busy prepping for its initial public offering, EMI was feeling the pressure of delivering hit product on a time schedule that matched the agenda of its investors, and Sony BMG was bogged down integrating its operations -- an effort that was hamstrung as executives from the old Sony and BMG entities were locked in internal power struggles for turf in the new company.

Further adding to the industry's distractions was New York Attorney General Eliot Spitzer's looming investigation into pay-for-play practices. Sony BMG and Warner Music would settle with Spitzer's office by year's end, agreeing to change their promotion practices and make charitable donations, but they did not admit any wrongdoing.

Avoiding these headlines was market leader Universal Music Group, which reached new heights of market-share dominance with a string of hits from 50 Cent, Kanye West, the Game, the Black Eyed Peas, the Pussycat Dolls, Gwen Stefani and others.

Warner Music's IPO and the challenges of operating a music label as a public company dominated headlines in the first half of the year. The label group raised $554.2 million in the May 11 deal -- 20% less than its initial target.

The deal sparked soul searching throughout the industry, as many executives winced at the high-profile collision of art and commerce. To ready itself for the IPO, the company cut deep into its cost structure, stripping out more than $250 million in overhead, a move that caused much hand-wringing in the industry and among leading Warner acts like Linkin Park, which wanted to get out of its contract but appeared to have made peace with the label by year's end.

But perhaps the biggest impact of the deal is that it clouded the potential for a much-anticipated merger with EMI. The IPO's inability to create a strong currency has raised questions over who would be the buyer and who would be the seller in a proposed transaction.

Infighting at Sony BMG ruled the headlines in the second half of 2005. As the year came to a close, BMG and Sony executives were engaged in open warfare over the future of Sony BMG CEO Andrew Lack. Lack's contract is up in March, and Bertelsmann executives want to replace him in favor of chairman Rolf Schmidt-Holtz when the deal is up, if not sooner. Sources close to Lack maintain that he is not going anywhere.

So far the merger has failed to live up to expectations. The combination initially was expected to challenge UMG's position as the industry kingpin. Sony BMG's combined pre-merger market share of 30.2% overshadowed UMG's 27.1%. But after a year of aggressive cost-cutting and integration efforts, the company is still running second to UMG in terms of market share, partially because of a cooling off of the once red hot Zomba Group, home of Britney Spears and R. Kelly.

The last straw for Bertelsmann executives came in July when Sony BMG COO Michael Smellie -- the highest-ranking former BMG executive involved in the day-to-day operations of the joint venture -- announced plans to exit the company at year's end, and Lack indicated he wanted to eliminate the position. Bertelsmann execs were also unhappy with Lack's renewal of Bruce Springsteen's contract, which sources value at $100 million. The situation remains in flux.



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