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Old-fashioned headphones resting on top of some CDs.

When it comes to music in the 21st century, CDs and old-fashioned sponge headphones are giving way to ear buds and MP3s or music recordings stored in the MP3 format on computers. (MP3 is the acronym for "MPEG-1 Audio Layer 3.")

New music formats create dilemmas

By Michael Weinbeck

Published on November 8, 2005

Fifteen years ago, consumers bought much of their music on audio cassettes but feared that new CDs would someday make cassettes obsolete. Today, consumers buy most of their music on CD and worry that MP3s (like the iPod) will soon replace the disks as the format of choice. But, in addition to the classic risk of a recording's format becoming out-of-date, today's music customers also wrestle with complicated legal issues and face a strange world of copyright law that has put record companies in the unsavory position of suing their own customers.

Between 1999 and 2003, annual sales of recorded music in the United States dropped by $2.4 billion--nearly 20 percent over only four years, according to new research by Carlson School Professors Rob Kauffman and Fred Riggins and doctoral candidate Jesse Bockstedt. At the same time, sales of online music have swelled. Apple iTunes' customer base blossomed from 861,000 in July 2003 to 4.9 million in March 2004. Meanwhile, Apple iPod sales have gone through the roof, firmly entrenching the iPod as the industry-leading MP3 player.

The growing popularity of online music downloads does not guarantee that everyone will be buying their music on the Internet in five years, Bockstedt says. In order to thrive, the record industry will have to adapt better to the complex needs of today's consumers.

"Digital music is still in its early-adopter phase," he says. "iPod and iTunes are selling to a niche market." Only eight to 10 percent of the music sold in the U.S. comes from online downloads. According to Bockstedt, the vast majority of music being purchased in this country is being purchased on CD.

There are many possible reasons why people aren't jumping on the MP3 bandwagon faster. The most likely reason, suggests Bockstedt, is the relative complexity of obtaining the songs. "You need a computer and a basic dial-up Internet connection to download music, but to really get the most value out of digital music you need a computer, an MP3 player, and a high-speed connection," he says. Acquiring all these tools to create the technological infrastructure needed to access digital music on the Internet is too daunting a task for many users.

During their study, the researchers scrutinized all the steps in the music industry's value chain; that is, all the business and production steps needed to create music and deliver it to the consumer. Not surprisingly, their research shows a shakeup in the traditional music distribution channels. Manufacturing, distributing, and brick-and-mortar stores stand to lose from the digital music revolution. Meanwhile, those who are enforcing copyright protections, developing piracy protection tools, and managing the distribution and sales of the music online have much to gain.

Stealing music

For Carlson School Professor Norman Bowie, who holds the Elmer L. Andersen Chair in Corporate Responsibility, the popularity of illegal downloads splits along generational lines. Today's younger music listeners, who are also tapped into the technology that gives them access to the illegal music files, aren't as concerned about the ethical issues wrapped up in copyright law.

Recently, Bowie was confronted by a student who wanted to know why he was so concerned about illegal music downloads in the face of global moral problems like starvation and terrorism. "He was asking a fair question," says Bowie. "My answer is that what I'm really worried about isn't illegal downloads. It's the desensitization of conscience and guilt and thinking that it's okay to lie, cheat, and steal."

Bowie believes the solution lays partly in greater interactions between record labels and their customers. "We don't hear much about a dialogue, just about crackdowns," he says. "I'm not aware that the music industry has sat down with a lot of focus groups comprised of teenagers and asked the right questions. Where are you coming from? Where are we coming from? What are the possibilities? Where can we find a win-win situation?"

Music artists also stand to profit from the trend toward digital downloads. "With the advent of digital music, artists have been able to take a do-it-yourself approach to selling their music," says Bockstedt. "In some cases, it has allowed them to bypass the record producers altogether." Online downloads have allowed groups like the Boston-based band Freezepop to develop their own fan base, promote their tour, and broker download-only deals with online music stores.

None of this means that record labels are going out of business anytime soon. But the research suggests that, to capitalize on the popularity of digital music formats, record companies are going to have to change. In a sign that these types of changes are already afoot, Warner Music Group has announced that it will launch an Internet-only music label; instead of producing full-length CDs, the label will sign artists who will release a few singles at a time every few months. The music will be distributed only online.

The researchers also predict changes for brick-and-mortar music retailers. To recapture the interest of consumers who have transitioned to online music downloads, and to keep consumers who prefer to purchase their music on CDs, retailers have begun to find ways to combine the best of both media. St. Paul-based Mix & Burn offers retailers a "music tablet" for in-store use. Customers browse samples of their favorite songs, select a playlist, and purchase a CD that they have compiled themselves. Mix & Burn technology was available in five cities in April 2005. And, according to a recent Wall Street Journal article, Starbucks is launching a coffee shop/music store fusion called Hear Music Coffeehouse. Customers will be able to shop for traditional CDs or burn their own using a 200,000-song music library owned by Starbucks.