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Your Pirates Are Your Customers

(originally published by Booz & Company)

The music industry is up in arms over and, two Web services the major record labels say facilitate illegal downloading of copyrighted songs. What the record industry needs to do is stop focusing on litigation and start thinking about unbundling its products.

The large-scale piracy the major labels decry reveals an unmet need — in this case, for customization. Customers want to mix and match individual songs from different artists in the same way they can now mix and match the components of everything from Dell computers to GM cars. This is a radical departure from the music industry's reliance on prepackaged album sales, the cornerstone of its current business model.

That model must change. Consider three alternative pricing formats for digital downloads.

1. Subscription pricing. Customers pay a specified price to play songs directly from a server for a period of time. Restrictions on copying, however, would be difficult to enforce. That, plus consumers' desire for portable music, would make this option unpopular.

2. Per-unit pricing. A more likely approach is being explored by forward-thinking independent labels. Inc., for example, sells songs from a wide range of independent or small-label artists for 99 cents each. Were the major labels to follow this format and use a low price point, they could generate sales across a wide range of their catalogs, because customers would be more willing to try out non-hit songs.

3. Micro-payment pricing. Here, consumers download songs that self-erase when the paid usage period expires, after five plays or two days, for example. Currently, this type of pricing scheme is used to give users low-cost software trials and could be used similarly to induce subsequent purchases of compilations.

As major labels provide music over the Internet, their CD sales will decline. But clearly, with a little creativity, they can recover the $4 of revenue they lose on each unsold CD. In addition, digital downloads can provide benefits, such as enabling the labels to assess more accurately the demand for each artist and to gather detailed fan demographics that will allow them to market their products more effectively.

Such new price formats would have ramifications through the rest of the value chain. While royalty systems for artists and performers would need to be restructured, by far the thorniest issue concerns the structure of the distribution channels. By selling songs directly to consumers, the labels would be essentially competing with retailers. In fact, a retailers' trade group has already filed a federal antitrust lawsuit against Sony Music for venturing into online sales.

As in the PC industry, however, a massive restructuring and disintermediation of retailers will take place. Although niche offline retailers will probably survive, consolidation among bigger retailers will favor those that successfully figure out how to couple the Internet with their bricks-and-mortar stores.

The music industry's challenge is not isolated. All industries that sell potentially disaggregated content (and that means virtually anything that can be offered in the form of digital information — most assuredly all forms of publishing) will face similar problems. By clutching business models based on forced bundling, they may find themselves severely out of touch with customers.

Allen Weiss,
Allen Weiss is the David and Jeanne Tappen Fellow and associate professor of marketing at the University of Southern California. He is the editor of the Web site "Marketing on the Web" (
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