Record labels hope advertisers can offset royalty losses

Embracing change comes hard for industry used to having control

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HONG KONG--Music consumption in China is soaring.

But revenues for the global music industry are not, sending record companies on a desperate search to figure out how to monetize music consumption in a digital media world, and avoid going out of business.

The music business “is in a crisis,” warned Paul McGuinness, U2’s manager, in the opening address at last week’s Music Matters Asia/Pacific conference in Hong Kong.

“Growth of digital sales is not offsetting the decline of physical CDs. Sales of the blockbuster artists that have traditionally funded investment in large rosters have sunk dramatically. There has been real pain right across our business.”

“We have a broken model in China. I can’t sell ringtones and I can’t sell records, so I can’t pump money into the market. And I don’t see a vision to fix the system,” agreed another speaker, Calvin Wong, exec VP, Asia at Warner Music.

One possible solution, speculated speakers like Linkin Park's manager, Rob McDermott, is sponsorship, finding advertisers to provide an alternative source of income for artists, managers and labels, by sharing the costs of promoting an artist, putting on gigs, and paying to use tracks. Will marketers step in to fund new acts and develop talent, a role traditionally played by the labels?

Yes and no. One of China’s largest youth advertisers, PepsiCo, for example, already incorporates music in its marketing by working with local artists such as Wu Ke Qun, Huang Xiao Ming and Louis Koo.

“We have and will continue to sponsor new and established artists as part of our ongoing marketing campaigns,” said Shanghai-based Harry Hui, chief marketing officer, Greater China for the U.S. company’s beverages business unit. Mr. Hui is also the former president, Southeast Asia of Vivendi's Universal Music division. “But I have yet to see a music company organized and structured around an advertising revenue model that’s operating successfully in China.”

Greater brand involvement in music may simply accelerate the situation that many record labels are trying to avoid. Record companies don’t like the idea of giving away recorded music, a source of income.

But marketers “are more than happy to give music away because it is only a promotional tool. [It is] one of the many strategies they employ to direct people towards their own products or services,” said Nick Barham, Shanghai-based planning director, China at Nike’s agency, Wieden + Kennedy.

There’s no guarantee that brand sponsorship will lead to increased sales in a market like China, where the recorded music market struggles, added Mr. Barham. “Rather than supporting record companies, [advertisers] could end up being their competitors. [They] are increasingly interested in signing up artists and owning their work, rather than buying tracks from labels.”

Mobile downloads outstrip CD sales

There’s no question that music is a powerful marketing tool in Asia/Pacific. The region accounts for 40% of the world’s digital music consumption, according to PricewaterhouseCoopers, and is expected to account for 33% of the total global music market by 2011.

More than half of Chinese mobile phone users now buy music through phones, while physical formats such as CDs are facing a steady decline--down 7.9% in 2007, the largest drop in the last five years.

Passion for music, both western and local, among Asians is at an all-time high, according to Ian Stewart, senior VP of Viacom Branded Solutions & MTV Networks International in Singapore. Sixty-six percent of Asians are listening to more music now that it’s digital and nearly half believe all their music will be digital in the future, according to the third Music Matters survey, conducted by MTV and TNS. But most consume music that has been acquired illegally.

When revenue does go into internet and mobile music sales, however, it is siphoned off by other parties--cable operators, mobile phone handset manufacturers, peer-to-peer software companies and mobile phone and internet service providers.

These companies “have turned their heads the other way, watched their subscriptions grow, and profited handsomely,” said Mr. McGuinness. ISPs and mobile operators are “the business partners of the future” for the recorded music business, “but they are going to have to share the money in a way that reflects what music is doing for their business.”

The fees brought in by companies like Chinese portal Sina will be “pretty strong” in 2008, said William Bao Bean, a partner at SoftBank China & India Holdings in Shanghai. “We’re looking at a decent rise in sales of mobile music from wireless service providers and carriers, but little of the profit goes to music providers. Chinese do pay for [digital music], they don’t pay you,” he told hundreds of music and entertainment executives in the Grand Hyatt’s ballroom. Finding profits in the digital landscape will mean "making the industry cool again."

Battles with Baidu

While the issues facing the music industry are global, the scale of China, the world’s largest mobile phone and internet market, has moved it to the front burner for the industry.

In the last month, 68% of Chinese downloaded music to a mobile phone, the highest rate in Asia, according to the MTV/TNS survey. In Hong Kong, the figure is 54% and in Taiwan, 46%. Seventy-six percent of Chinese have replaced an MP3 player with a mobile phone, compared to 74% in Hong Kong and 64% in Taiwan. The situation is likely to increase after the 3G version of Apple’s iPhone is introduced in Greater China, starting in Hong Kong next month.

One problem facing labels is the lack of support and enforcement provided by China's regulators and lawmakers. They remain largely indifferent and ineffective on the piracy issue, despite repeated attempts by record companies to take action against companies like NASDAQ-listed search engine Baidu. Search engines account for more than half of internet music piracy in China, and Baidu is responsible for about three quarters of that, according to the International Federation of the Phonographic Industry.

This month, the industry’s Music Copyright Society of China and top music labels Universal Music, Warner Music and Sony BMG launched yet another assault against Baidu, known as the “Google of China,” for allowing the illegal downloading and sharing of music.

This time, they warned the nation's top search engine that it risked losing ad contracts if it didn’t try to stamp out music piracy on its site, a notion that prompts laughter from advertisers.

“I doubt most marketers would see it as their responsibility,” said Mr. Barham. “Unless marketers are directly losing revenue from music file sharing, why would they step in?”

“I don’t think they’ll get anywhere, the labels don’t have the money or resources to make a dent in Baidu’s business,” said another Chinese advertiser, who asked not to be identified.

Two years ago, seven international music labels lost a lawsuit against Baidu but in a landmark ruling in December 2007, Beijing’s final appeals court found Yahoo! China guilty of facilitating mass copyright infringement. That victory has led to new actions by the record labels against Baidu this year, including a lawsuit filed in early February 2008.

Legal complaints have been lodged against mainland telecoms like China Mobile, which “makes hundreds of millions of dollars each year from sales of ringtones and ringback tones, yet pays a miniscule fraction of that to performers, producers and composers. That to me is not a fair business partnership,” said Mr. McGuinness.

The legal system provides limited help. Even when Chinese courts rule in favor of international record companies in lawsuits against companies like Baidu and Yahoo, business practices seldom change. The organizers of the Olympic Games in Beijing have also turned a blind eye to infractions by Sohu, the official Internet Service Provider of the Olympic Games, even though the portal operates a major copyright-abusing download service.

The industry’s complaint, recalled Mr. McGuinness, was “met with stony silence.”

Offer an experience, not music

Record companies are left to forge revenue-sharing deals with ISPs and carriers as well as sponsors, solutions that don’t sit well with companies that profited handsomely in the days before digital media.

The sponsorship model already has a few fans, such as Mr. McDermott. "You’ve got to think out of the box,” he said at Music Matters during a heated debate about China. “Why not put ringtones and music into the price of the concert ticket, so people get more familiar with new acts? Fans only want the experience. They don’t care about the rest.”

It’s harder to find advocates for working with ISPs rather than against them, even though digital media has helped the music industry by making tunes more popular and accessible for consumers. It has certainly helped artists like John Mayer, whose fame grew through file trading and an early internet-only album, Room for Squares.

While many executives say ISPs don’t want to make deals, music industry commentator Bob Lefsetz thinks they will, “If they stop being told they’re guilty and legal services are proffered to them, that they can charge for and profit from.”

Given the lack of success that record labels have had curbing Internet Service Providers like Baidu and China Mobile, that day is a long way off.
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