Sony Music Introduction The current scenario confronting Dr Schramm is challenging. Schramm will need to address several issues including piracy of Sony music assets, organisational structure and artist management policies. However, the issue that arguably will impact Sony’s performance longer term is how they deal with the challenges and opportunities presented by digital music distribution. Legal digital music distribution promises a very low cost way of selling music to consumers.
If Sony Music was able to control the entire supply chain, from artist direct to consumer, the already considerable opportunities presented by digital distribution would be increased. Problem Analysis Sony Germany has just experienced a 12. 7% fall in sales, seemingly from the expanding problem of on-line piracy. Why have they encountered this problem? Are they problems that could be foreseeable or avoidable? Peter Drucker developed a concept of ‘Five Deadly Business Sins’ that should be avoided.
Using this framework, we might be able to analyse what has gone wrong and how repeating these sins can be avoided in the future regarding digital music distribution. Peter Drucker’s Five Deadly Business Sins Some of Drucker’s theories may not be applicable to businesses of varying sizes and circumstances but in this case they offer a good indicator of the source of some current problems that have the potential to get bigger in the future. While they illuminate some of the problems facing Sony, this analysis also proves useful in suggesting some directions for the future. ‘
The worship of high profit margins and premium prices’ It is quite possible that Sony’s approach to both CD pricing and on-line music pricing commits this sin. CD prices have remained the same in the face of competing products such as DVDs and video games that arguably have a superior value proposition to music in the perceptions of some consumers. (see discussion of value proposition below) If the DVD and video game markets continue to grow, with no change to the price of music, we could reasonably expect a sales decline to continue. even accounting for the affect of piracy) Additionally Sony mis-priced their initial DRK07005 Page 4 of 13 digital offering pressplay™, as a subscription service that proved very unpopular when compared with the 99c price point established by Apple iTunes. - ‘Charging for new products what the market will bear’ In a similar way that Sony may have overcharged for their traditional music product, the CD, Sony may also be part of a system that possibly overcharges for digitally distributed music.
While 99c downloads from iTunes may represent good value in comparison to CD singles, some digital albums are now priced higher than their CD counterparts, while the record companies are entertaining raising the price of singles to $1. 25 and even up to $2. 49. (Wired, 8 April 2004) This is arguably committing the sin of worshipping premium prices, but probably indicates a price that the market would bear. It would however be possibly sacrificing the growth of the digitally distributed market. ‘Cost-driven pricing’ Again related to the above sins, the major record companies are arguable guilty of this by pricing digital downloads in line with CD releases. CD pricing, as shown in Exhibit 12 of the case, includes covering costs such as manufacturing, distribution, rent and retail sales staff costs that do not apply to the digital distribution model. - ‘Slaughtering tomorrow’s opportunities on the altar of yesterday’ Sony, and indeed the music industry at large seem to be guilty of this sin.
It appears that the industry has been focused at improving sliding CD sales while largely ignoring the opportunity presented by digital distribution. While the number of people downloading pirated files from the internet was growing enormously, the majors only saw this in terms of an illegal activity. They would have been better served if they recognised this as a process that consumers enjoyed and worked to develop a legal and revenue generating way in which this could be done. - ‘Starving opportunities and feeding problems’ Sony and the majors committed this final sin and it is arguably the most damaging of all.
Had the music industry pursued and promoted a legal option for digital distribution with the same vigour with which they sued companies like Napster and the college students featured in the Pepsi/iTunes commercial they may have developed a profitable channel to the consumer that they controlled completely. As it now stands, while they have been successful to a degree at curbing online piracy growth, the services to really capitalise on the growth of legal distribution are new players such as iTunes, Rhapsody and the new Napster.
In this case we can see that sins 1, 2 and 3 are related to the pricing strategy Sony pursues with both CDs and digitally distributed music. Similarly, sins 4 and 5 are related to Sony’s willingness to embrace digital distribution as the way of the future. Both issues are of key importance to the longer term success of Sony Music and may also have a significant impact on Sony Electronics fortunes. Two forms of Judo David Yoffie and Peter Drucker both use the analogy of ‘judo’ to describe an approach to corporate strategy.
While the source of both analogies is using an opponent’s strengths against them, Drucker and Yoffie differ in some of the details of how this can be achieved. Of critical importance when considering an approach to DRK07005 Page 5 of 13 strategy defined by an opponent, is to have a clear idea of who the opponent(s) is/are for Sony with regard to digital distribution. These opponents could include: - their fellow ‘5 majors’ competing as they have in the past on the new digital playing field. ‘Indies’ (Independent labels) that previously could not compete directly (with a few exceptions such as Zomba and edel) and used a major for manufacturing and distribution, can now go straight to the consumer through digital distribution - digital distributors such as iTunes are in direct competition with the pressplay™ business. U ltimately, I believe that Sony could apply some Judo strategies to each of these opponents. David Yoffie’s ‘Judo strategy’ Yoffie describes three ‘principles’ that must be considered when employing judo strategy, each related to his judo metaphor – movement, balance and leverage.
For each of these principles he has developed a number of ‘techniques’ for achieving success. Yoffie focuses his metaphor on the image of a small opponent using the bulk and strength of their larger adversary against them. In the case of Sony, they undoubtedly fit into the category of being the big opponent that smaller competitors such as iTunes and Napster out manoeuvred. (While Apple, producer of iTunes is not small, they were certainly originally a small player in the music industry) A look at Yoffie’s approach yields some possible strategies for Sony to take, but also underlines some of the strategies used against Sony by iTunes.
The principle of ‘movement’ is to reduce the threat of attack by moving the fight to a battleground that suits you best. iTunes was certainly successful in moving to an area that the 5 majors were very uncomfortable in. The majors, including Sony, saw the internet only in the context as a facilitator of piracy, and were therefore slow to move when Apple started to sell digital music legally online. iTunes coupled with iPod has quickly established itself as the de-facto standard for digital music distribution.
Ironically Sony was initially probably best placed out of all industry players to win this position with a firm hold in both the music player and music content industries. Apple had no presence in either market before iTunes and the iPod. Despite initially being a victim from ‘movement judo strategies’, can Sony also fight back through movement? The movement technique of the ‘Puppy Dog Ploy’ – appearing non-threatening – is not an option for a big player such as Sony, and the opportunity to use the technique of ‘Follow through Fast’ has already been missed.
The technique of ‘Define the Space’ remains an option but possibly a longer term, larger scope option. Sony could possibly use its strength in consumer electronics such as TVs, stereos and walkmans to deliver music directly to these devices without the need for a PC. The online version of the Playstation3 could be used as the first step in defining this space. The principle of ‘balance’ is to avoid head-on attacks and exploit competitor momentum. In terms of the competition presented by the other ‘5 majors’, Sony could DRK07005 Page 6 of 13 efine the space in a similar way to Apple. Sony has the opportunity, unlike Universal, BMG, Warner or EMI to drive digital distribution through their electronic offerings. Rather than compete head to head with either competing digital distribution websites or applications, Sony could drive sales through its electronics products. The principle of ‘leverage’ is to use competitors strengths against them and attack them where they have trouble responding. In this way Sony could launch a two pronged attack at both Apple iTunes and the other big majors.
Using the ‘leverage your competitor’s assets’ technique, Sony could launch a service to compete directly with iTunes. This service could mimic iTunes exactly in terms of business model and could be backed with free downloads to Sony Electronics customers (through products including PlayStation, PlayStationPortable, Walkman, Sony Ericsson phones with MP3 players, Sony computers) to launch the service. Apple could follow suit and bundle free downloads with the iPod, but these free downloads would include Apple paying a fee to the rights holders – invariably one of the majors, including Sony.
Additionally Sony could price songs on their own service at the same price that tracks are wholesaled to Apple. Apple could move to match prices but would need to lose money in order to do so. With the ‘leverage your competitors’ partners’ technique, Sony could extend the above scenario by inviting the other major labels onto the new digital distribution service. Sony could in the short term offer the same royalty payments that the majors achieve through iTunes, but with no mark up. This would lead to a greater volume of sales and hence be attractive to the other majors.
Longer term, once the new service was established, Sony (as a fellow major) would be more open to price rises on individual track sales, something iTunes has been discouraging. This approach would also continue to improve the sales positions of Sony Electronics products. Yoffie also mentions the concept of a ‘sumo’ strategy that big opponents can use against smaller ones. This does in fact appear to be an option for Sony in terms of its competition with iTunes – indeed Sumo tactics ultimately closed the doors of the first version of Napster.
Sony, as a controller of a large amount of the content sold on iTunes, could deny Apple the right to sell their back catalogue or raise wholesale music prices above the retail prices on Sony’s own digital distribution service. However given Apple’s dominant position in the supply chain it seems unlikely that this would benefit Sony greatly in the short term and would probably even damage its own revenue. This scenario perhaps underlines the fact that while Sony is big, it is not a big enough player in the industry (indeed no individual record company is) to successfully play a Sumo strategy.
It may in fact be that in the future that Apple as a controller of the leading distribution channel may be able to use this dominance to dictate terms to the record labels. Apple can continue to play judo using the internal rivalry between the major labels as a means to ensure supply and dodge attack. Peter Drucker’s ‘Entrepreneurial Judo’ Drucker’s ‘Entrepreneurial Judo’ is similar to Yoffie’s judo principle of ‘Leverage’. He recommends that companies look to their opponent’s strength, and use their opponent’s likely behaviour to cling to this strength as a method to attack them.
In his writings he describes this as a strategy that “hits them where they ain’t” (Drucker 2003 p173) (Described as a completely separate strategy in the Corpedia material) DRK07005 Page 7 of 13 With regard to iTunes, one of their strengths is the degree of integration with the iPod player. Sony could use this strength against them, as iTunes and the iPod are somewhat limited by only working easily with each other. Sony could pursue an ‘open-standards’ approach to its digital offering of music and players that could allow easy inter-operability with a range of online music stores and players.
While there would be some risk in opening up both markets to competition (i. e. Non-Sony players could connect to Sony Music online, and Sony players could connect to non-Sony Music digital services), greater perceived choice may result in Sony attracting customers. Apples closed standards approach to digital music may end up costing them in a similar way to them slipping behind in the PC space. Meanwhile, third parties such as iTunes and Rhapsody have successfully pursued another of Drucker’s entrepreneurial strategies – the ‘Toll-Gate strategy’.
Drucker describes this as an ‘ecological niche’ that aims for control, rather than dominance. iTunes has been successful in establishing themselves as a key component in delivering digital music to the consumer. While they don’t meet with the Drucker description completely in that they are not ‘revelling in their anonymity’, they do not actually produce or indeed market the products they sell. The pricing issue As discussed already, digital distribution offers the opportunity to greatly reduce the costs involved in delivering music to the consumer.
There remains a question on how prices should move in relation to these costs. Value proposition: CDs vs digital distribution The move from CDs to digital distribution does alter the value proposition to the consumer. While the core product – the actual music – remains unchanged, for some consumer segments there is some value inherent in owning a physical copy of the music and in the artwork and lyrics contained in the CD booklet. While this new value proposition can be rationalised by a consumer on a per song basis, it may be more challenging where the cost of buying a CD album is the same online as it is offline. Colliano, April 16, 2004) There are a number of options available to publishers such as Sony to balance this. For example, supporting media such as CD artwork, ‘B-sides’, ‘re-mixes’ and music videos could be provided as ‘bonus’ downloads to purchasers of the digital version. The benefit of adding these features to the online music product is that they leverage existing marketing content and in digital form, it does not add to the final unit cost. Digital distribution does add some aspects of value above that found with CDs.
Brynjolfsson, Smith and Hu (2003), in a study looking at online books sales, discovered significant customer value in the variety that online stores offered. Applied to the music example this could arguably be seen in the value consumer find in selecting individual tracks from a large online catalogue of songs. (As opposed to buying an album with only a few songs they like) The implications of this are far reaching and are discussed further below in the section ‘Changing Economic characteristics – The Long Tail’. DRK07005 Page 8 of 13 Value proposition: Music vs DVDs and video games
It has been argued that the audio product of music inherently has a lower value proposition compared to the audio and visual product of DVDs and the audio, visual and interactive product of video games. (Colliano, April 16, 2004) Some CDs have attempted to address this by offering bonus interactive and visual content such as video clips and exclusive websites. This should be continued; particularly for high profile releases that Sony may need to price above the standard catalogue to cover expensive artist contracts. Strategies for approaching digital distribution andscape The new opportunities of digital distribution extend beyond the changes to individual unit costs and prices. These changes may open opportunities to completely alter the economics of the market. Drucker identifies this as one of his strategies for entrepreneurial success - “changing the economic characteristics” of a product, service or market. While Sony has not directly changed any economic characteristics, the move to a digital distribution model represents a number of fundamental changes to the recorded music value chain.
These are the changes in: - Cost structure of delivering each ‘unit’ of music to the customer - The ‘hit-driven economics’ as buying patterns move towards more obscure titles in a pattern that has been called ‘the Long Tail’ Changing economic characteristics - Changing Cost Structures Drucker identifies a change in pricing as the primary way in which an entrepreneurial strategy of changing economic characteristics can be successful. He argues, the main way that pricing can be changed is to better reflect the ‘reality of the consumer’ and price according to the value the consumer perceives.
As discussed, it is possible that the value proposition of a standard CD has diminished. The new cost structure, free of physical production, distribution and selling costs, has therefore presented the record companies an opportunity to re-price music to this revised value proposition, while still retaining profitability. Changing economic characteristics - The Long Tail The new cost structure of digitally distributed music has a profound impact when it is extended to a massive back catalogue such as the one owned by Sony.
An article by Chris Anderson in Wired magazine coined the new buzzword of ‘the Long Tail’. (The Economist, 5 May 2005) It exposes an important change in the way one views the economics of several markets such as books, films and music due to the efficiencies provided by the internet. In a traditional ‘bricks-and-mortar’ music retailer such as Wal-Mart, limited physical space restricts the number of titles that can be carried to around 39,000. Under these circumstances, around 100,000 copies of a single CD need to be shipped to cover the costs of stocking and overheads.
This has lead to the current ‘hit-driven economics’ where retailers and record companies were focused on hit titles that make up 10% of all titles that would cover the costs of stocking the other 90%. (The more traditional DRK07005 Page 9 of 13 Pareto principle of 80-20 is similarly identifiable in books and films) (Anderson 2004 p2) The online marketplace changes this dynamic dramatically. The costs of stocking CDs in a warehouse are many times lower than in a retail space. The storage of digital tracks, many times lower again meaning an essentially infinite capacity to store titles.
While the common belief is that consumers are mainly interested in spending money on the big selling, high profile artists, the huge increase in choice facilitated by digital distribution reveals different consumer behaviour. Consumer demand with online music distributors such as iTunes and Rhapsody (the business Anderson studied most closely) fairly closely follows that of a traditional retailer in regards to ‘hit records’, but as sales taper off in the physical store and eventually end at the 39,000th title (inevitably a loss making title for the physical retailer due to overhead costs), the online model continues all the way long until the last song offered. In Rhapsody’s case this is over 735,000 songs with that number growing all the time. Essentially, if a title was added to the collection it was sold. (Andersen pg2) And as indicated by the Brynjolfsson study, this process of ‘digging into the tail’ can be an attraction of the consumer in and of itself. The figure below graphically explains the long tail concept and consumer behaviour. (Note this is purely an illustration and is based on approximations not on actual data) Consumers make purchases all the way to the least most popular title, hence stretching the chart to the left.
Due to the extreme length of the tail, the area (and hence revenue) in this tail can be surprisingly large. There are a number of key factors that have lead to this phenomenon being an extremely profitable business model. - In a digital distribution model the cost of stocking the most popular title is exactly the same as the least popular. In fact after the infrastructure is set up, the marginal cost for adding a song is basically zero. There is no minimum number of songs to sell to cover its stocking cost. Internet market places make it very quick and easy for a consumer to dig deeply into the lower ranked titles. Compare this with a physical CD store. The new titles for the week are given prominence and are easily found. Similar CDs that may DRK07005 Page 10 of 13 also appeal to consumers are elsewhere in the store (or not stocked) and it is almost impossible to communicate this information to consumers. Amazon. com has found significant profits in ‘if you like this item, also consider this’ recommendations and also suggestions from other consumers.
Moving along this ‘long tail’ is then as simple as clicking a hyperlink. - The most important factor – the volume of sales found in the ‘long tail’ can be very large. Rhapsody’s cumulative sales of its top 10,000 songs sell less than songs outside the top 10,000. For Wal-Mart with only 39,000 songs, this would never be true, but for an on-line retailer this is the norm. Given the presence of ‘the Long Tail’ how can Sony take advantage of this opportunity? The first step should be to immediately move to bring all titles (regardless of perceived quality or popularity) into a digital format.
Sony has a massive “back catalogue” that can probably be instantly turned into a solid revenue stream through digital distribution. This could include consolidating back catalogues across all regions. For example, making local German artists’ titles available digitally to all other markets and vice versa. The new economics of the long tail may also alter the calculations used by the A&R department to determine whether signing a new artist is a profitable proposition. Presumably the current calculation factors in the cost of producing an album against expected sales during the album’s life time in retail stores.
As we have seen, digital distribution extends this ‘availability life time’ to ‘infinity’ (the songs will always be available as there is no cost in stocking the products). This would allow Sony to increase the ratio of 1 in 500 of artists actually signed to contracts. Even artists with more obscure appeal, would have a decent chance of finding it’s niche with digital distribution and hence it may end up that these acts are more profitable for Sony than the ‘big ticket’ artists that deliver big sales, but demand millions of dollars in up front record deals.
Additionally consumer behaviour whereby they actively search in the tail for content for their tastes reduces the need for traditional marketing spending. Alliances - Cross marketing opportunities Drucker is a strong supporter of the use of alliances in business. Ironically the alliance that could prove most beneficial for Sony Music in both the short and long term is Sony Electronics. The first three reasons outlined by Drucker as to why companies enter into alliances would apply in this case - ‘To obtain access to new technology. Sony Electronics is a leader in digital technologies that can be used in effectively distributing digital music. - ‘The way to genuine synergies. ’ Sony Electronics can offer products that push people into embracing digital distribution. Likewise, a strong digital offering from Sony Music could encourage the purchase of Sony Electronics players, phones etc. - ‘Access to people with know how’ The technical know how to get Sony Music’s catalogue online is possibly already within the company in the Electronics division.
DRK07005 Page 11 of 13 Sony has a significant competitive advantage when compared to the other 4 ‘majors’ in the industry through the synergies that can be achieved with various aspects of its larger corporation. This includes the new technologies identified in the case as competing with the music industry for a share of recreational disposable income – DVDs and video games. Additionally, Sony offers a full range of products that are used in ‘enabling’ digital music such as MP3 players, computers and cell phones.
Interestingly, Sony consumer electronics already use promotional music tracks to help sell audio products (including MP3 players), but do not necessarily use Sony Music artists. (Case pg 10) This is an obvious synergy that could be immediately taken advantage of. Similarly, Sony computers and MP3 enabled mobile phones could be sold with pre-loaded promotional tracks and links to the Sony online music store. Columbia Tri-Star DVDs and PlayStation video games could be used as vehicles for promoting Sony artists and also be used as ‘bonus’ features on their parent products.
These pathways to the consumer could also be used to promote the concept of online music sales by offering promotional downloads as seen in the Pepsi/Apple iTunes promotion. Ultimately, the existence of Drucker’s ‘genuine synergies’ is observable as the offering from both sides of the business can be improved by bundling them together and the opportunities to create a strong competitive advantage in both market spaces. The success of iPod and iTunes has been to a large degree down to how well they have complemented each other. Sony holds strong ositions in each area and could potentially end up the largest competitor to Apple. DRK07005 Page 12 of 13 Digital Distribution recommendations for Dr Schramm _ Sony Music to internally embrace digital distribution as the future of industry.
While piracy should be fought where possible, it is not to be used as a scapegoat justifying under performance. _ New digital distribution service to be established. It should mirror the successful iTunes service rather than the limited pressplay™ service currently operated by Sony and Universal. Aim will be to become a de-facto standard for digital distribution challenging iTunes. Sony should partner with other majors to also offer their music through their online service in order to achieve critical mass in the market place. _ To take advantage of ‘long tail economics’, Sony Germany should look to maximise its available digital catalogue. This will involve sourcing music from all Sony markets world wide. _ Sony Music to review A&R policies to sign more artists on a long-term basis. Profitability will come from building and exploiting back catalogues that are more easily accessed by digital-savvy consumers. _ Maintain the supply alliance with iTunes, at least in the short term.
The reach of their service cannot be matched and still offers significant profit growth potential for Sony’s back catalogue. _ Sony Music Germany to work more closely with Sony Electronics Germany. All Sony MP3 compatible players, mobile phones, computers and videogame devices to ship with music from Sony owned labels promoting the new digital distribution service. View to pushing this strategy world wide. _ Pricing of digital distributed music should take into consideration the value proposition it offers and the reduced costs involved with its distribution.