NARM President Pam Horovitz Addresses IRMA March 03, 2002

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Hello and thanks to Charlie and everyone at IRMA for the invitation to come speak to you all here in Tucson.

Many of you probably know that NARM just finished its own convention in San Francisco a week and a half ago. I remarked to my folks at one of our business sessions that I couldn’t remember a tougher year in the music business. I last spoke to you four years ago, in 1998. In that time, our world has changed dramatically.

I’m sure you’ve been seeing all the same statistics we have: RIAA said shipments for last year were off 7%. Singles sales are down a whopping 50%. Cassettes took another dive. Blank CDs out-sold prerecorded CDs last year, and the trend for the first two months of 2002 shows all those numbers accelerating.

But there are encouraging statistics out there as well. DVD sales continue to boom. Video games had a great Christmas.

And then there are the statistics we don’t know what to do with anymore: 50% of America is online, but only 7% have access to broadband. With all the file sharing going on, is more broadband going to be a good thing, or a disaster in the making?

One of the things I’m here to talk about today is the nature of the decision making process within the music industry and how it’s affecting us. When any of us need to make big strategic decisions, we look for a grounding in information, whether it’s information about the company, or the competition, or the customer. So inevitably, there’s some point in the decision tree where one will ask for support for a decision based on statistics.

There is, I think, some truth to the old saw about lies, damn lies, and statistics. For example, RIAA numbers were down 9% last year, but only 7% this year, so what does that mean? Certainly one implication of difficult-to-interpret statistics is that strategic decisions become ever more challenging to make, even risky, when you have only a few statistics on which to form a view. However, it’s equally hard to sit back and wait until all the facts are in -- you worry that the ship will sail without you.

At NARM, we’ve spent some time watching from the sidelines trying to understand the significance of all these statistics. We’ve become a Jupiter subscriber, and we get Webnoize, and we see the Roper stuff, and the Ipsos-Reid studies, and we’ve commissioned our own studies from Mercer and from Emerald Solutions. We’ve tried not to be too cranky whenever we see some article in the press, or some analyst’s report, where retail doesn’t even make the list of stakeholders in the outcome of digital distribution.

As I say that, it occurs to me that there’s one other group that is sometimes a forgotten player in our industry’s future, and that’s the group that’s assembled here today. You, as much as anyone, have got to be scratching your heads and wondering what to make of all the predictions and prognostications, especially those that paint a doomsday scenario for the distribution of home entertainment products via physical goods like CDs. You’ve got something in common with retailers who are getting pretty used to hearing that their days are numbered, because nobody’s going to need to go to the record store once music can get piped in to your computer on demand. Actually, Faith Popcorn told NARM that about four years ago. Four years ago we weren’t ready to hear that thinking. Today, we can’t avoid the need to understand the implications of computers as a music device.

NARM, after a period of carefully thinking about all the various statistics, and the reactions of the various industry segments to what’s happening in the marketplace, has started to draw some conclusions of our own, and we have started to advocate more aggressively for what we think needs to be happening in both the marketplace and the law. I’d like to share some of our conclusions and recommendations for the music marketplace with you today, and how we reached the decisions we have.

First, let me address the question of whether or not there will be retailers in the future. Not surprisingly, we think there will always be a role for retailers in the selling of entertainment. Let me tell you why. Over the past several months we’ve seen the introduction of the two subscription services, MusicNet and PressPlay. The good news regarding subscription services is that they are an important first step in offering the consumer a way to purchase digitally distributed music. However, we believe they have a long way to go before the consumer finds them to be a compelling marketplace offering. Besides the fact that neither service has a very good selection, there is also the problem that neither service has affiliated with a single music-retailing brand. So what, some may ask? The record companies have a chance to sell direct and they’re running with it. I’ve even heard the view from Capitol Hill that without the cost of middlemen, the consumer can benefit from lower prices.

From a retailer’s point of view, that’s a rather dubious prospect because without retailers there’s no competition in the marketplace, and therefore, no incentive to offer lower prices or anything else. In fact, neither service is offering the consumer much choice at all in the important areas of service, convenience, price, selection, ambiance, and privacy.

Today shopping at WalMart might offer you the convenience of grabbing some music while you’re knocking off other errands. But if you don’t like the selection, you can go to Tower. If Tower’s prices aren’t to your liking you might run to Best Buy. If you aren’t satisfied with the quality of information at Best Buy one can try Borders and get the latest employee picks, and if you want to be able to see what other fans thought of a title you can visit Amazon.

In an online environment every one of these retailers will have a different approach to privacy policies. Some might focus on just Liquid Audio offerings, or just promotional MP3’s, while others might want to stock everything including Real, Microsoft, Liquid, and MP3’s. One might let you listen to 30 seconds of two tracks off a new album, and another might offer samples of every track. In short, just as music is different, so are the consumers that buy it.

The valuable role that retailers play in offering the consumer choice in the marketplace has been lost in the roll out of the subscription services, and it will need to be restored before either service has a chance of succeeding. Because the record company internet divisions seem not to recognize this, NARM is supporting the Music Online Competition Act which would require companies that license their music content via the joint venture subscription services to offer the same terms and conditions in license agreements to other non-owned competitors. We think this is a necessary and logical way to guarantee that copyrighted materials are made widely available (which is, after all, one of the primary goals of copyright law) and we also think it helps to insure competition in the selling of those materials.

This lack of understanding of consumer needs is playing out in other strategic decisions as well. For example, we have been in a song driven marketplace for a number of years and yet the availability of singles continues to decline in what retailers believe is a frequently misguided attempt to drive CD sales. When there is no way for the consumer to purchase just the one song they want, why are we all surprised that they take advantage of the widely available alternative – which is a free copy from one of the various file sharing services?

Certainly, there are economic issues attached to making singles a viable product, so we recognize the need for some creative thinking. For example, maybe it’s finally time to try on site destruction of returns. We’ve already heard that one company is thinking about bundling four songs together instead of just two. Maybe that’s the new “single”. In any case, if we want to get kids into the habit of paying for music; we’ve got to provide them with a product that they want at an entry level price point.

Over the last year we’ve heard a lot about the fact that no legitimate business can compete with “free,” and that the file sharing services, starting with Napster, needed to be shut down. By extension, of course, if Napster is a contributory infringer of copyright, this means that the music fans who file share, are primary infringers, or pirates. From NARM’s perspective, we think this industry should be thinking long and hard about the viability of any approach that treats all our customers like criminals.

One new industry tactic in this regard is the copy-protected CD. NARM has recently released a position statement regarding copy-protected CDs in which we encourage the industry to adopt a “copy-management” approach rather than simple copy-protection. I’d like to explain our thinking.

First, we understand the need and the desire on the part of record companies to protect their music from piracy. But, we also recognize the fact that some copying in the marketplace by consumers and retailers, in fact, is legal. For example, if a consumer has some legally purchased CDs, and they want to reorganize these songs into a new sequence, which lots of research shows us is exactly what they want to do, this is a perfectly legal form of copying. Retailers are increasingly striving to offer pre-purchase sampling of a wider variety of titles in-store, and frequently, that means it’s necessary to copy sound samples into a database. That’s a use that we think the industry should be supporting and not trying to prevent.

Second, we have real concerns about the fact that some of these protection technologies preclude something as basic as letting the CD play on a computer. At a time when the majority of young consumers in fact use their computers more than other playback devices, is it logical to put out a product that won’t play on the preferred device?

There are other issues as well. Why is Universal putting out copy-protected CDs at retail but allowing a red-book copy CD to be burned by the consumer via PressPlay? What about the view of Philips that copy-protected CDs don’t meet their standards? How do we respond to the inquiry of Congressman Rick Boucher about the agreement reached with the recording industry under the Audio Home Recording Act that would provide for the collection of royalties in recognition of consumer copying? We can argue the details or choose to embrace the philosophy. Finally, how about the fact that virtually all the protection schemes can be hacked? Do we really want to be in a permanent game of whack-a-mole?

Ultimately, we have to ask whether adding copy-prevention to CDs will help drive sales. We at NARM don’t think it will, so we think that copy-management provides a reasonable middle-ground between copyright holder needs and consumer needs. In a nutshell, our philosophy can be summed up as “Piracy -- no! Fair use -- yes!”

In thinking this issue through, we’ve increasingly come to the conclusion that the decision tree isn’t about “free”, it’s about value. In today’s marketplace, survey after survey tells us music fans think most CDs contain only one or two good cuts. Their reluctance to pay $15 – $20 for two good cuts is evident not just through depressed sales of hit titles, but also through the increased sales of used CDs. Many retailers are concerned that the value proposition for music is no longer competitive in the consumers’ eyes. Compare DVD for example, where there is both an entry-level price via rental, and continued lowering of sell-through prices. Many retailers just shook their heads in wonder over the fact that just as “Oh Brother Where Art Thou” took off after the Grammies, the label chose to raise the price. We understand the one side of the decision, but over the long haul, is this a smart move?

I’d like to turn next to a strategic decisions involving a long range question: what’s the continued viability of physical goods in an increasingly electronic world? Clearly one of the things that Napster showed us (and Morpheus and Kazaa are proving that it wasn’t an aberration) is that there is a huge appetite for digitally distributed music, and an increased willingness and capability within at least one segment of music fans to become the manufacturing facility. College kids have computers; they know how to use them; they have access to broadband; and they understand the economics of burning their own CDs. While we’ve heard the oft quoted statistic about the 23% of downloaders who won’t pay for any subscription service, I think it’s worth throwing in a few other statistics that help round out the picture significantly.

First of all, NARM focus groups done last year show even the most die-hard downloaders don’t want to be in front of their computers non-stop. They like getting out to be with their friends, and they still like going to record stores and find the activity of shopping in a physical environment to be worthwhile. Also, several studies show that most downloaders keep buying CDs. Ipsos-Reid reports that 24% have increased their CD purchasing since they started downloading. The Mercer study supports that statistic with key findings about the value of having a CD collection, and also of supporting artists you like by purchasing their music.

However, there is an increasing body of data that shows that younger consumers dislike hauling CDs around, so that the first thing they do with them is rip the songs they want into an electronic file. Ipod, here they come. Clearly computers have changed the way consumers interact with music -- even music they legally own.

I also think we shouldn’t forget that there’s a big population of baby boomers out there who are still avid music purchasers, but who are much less “techie” than younger music fans. This group may well put increased value on not having to be bothered with having to download the music they want. For this group, a pre-recorded product may be a luxury just as candles went from being a necessity to the “poor man’s electricity” to the rich man’s luxury at the dinner table.

NARM hasn’t spent any money specifically researching the longevity of the CD. But we strongly believe in the value of consumer research and in learning more about these kind of behaviors because understanding them can help point us toward some future possibilities. While some of these consumer behaviors point to the need for a physical product for quite a long time, and maybe even always, it’s probably a given that the nature of the physical product is going to change. (Hey, why should you folks face challenges any less daunting than the rest of us?)

First, we all need to pay close attention to the new smaller formats like DataPlay or Sony’s Memory Stick that offer lots of music in a highly portable format. Those of you who went to CES this year and stopped by the Sony booth saw some incredibly imaginative packaging of music in an amazing variety of new items from jewelry to toys to peripherals. They were colorful, sleek, fun, and screamed “buy me.”

There’s no reason these cool new gizmos can’t come with pre-recorded music. How about Britney and Justin’s favorite Valentine Love Songs packaged in a heart necklace? That might require some creative bundling, and unbundling, of music. It may require more cooperation between labels and retailers. It may require more flexible licensing arrangements. It may mean a rethinking of the appropriate length of copyright, with more robust offerings deriving from a constantly replenished public domain.

I think pre-recorded music products will certainly benefit from an increased exploitation of additional material in much the way that DVD’s have benefited from the addition of celebrity interviews, storyboards, and out-takes. While music formats have been playing with this idea for over a decade, we have yet to get the same traction as DVD’s. Though, of course, DVD is the first digital configuration for movies to really get traction.

What this all means for the prospects of DVD-Audio or Super Audio CD I don’t know. There are many in the retail market who, while they have voiced support for these new formats in the past, worry that both these configurations may offer too little too late, and that we’re better off moving ahead to something new. Sometimes statistics aren’t the answer -- maybe sometimes just reading a little history on format wars should suffice.

It might also be time to move on from cassettes, quite frankly. I think the IRMA campaign to slow down the erosion of cassette sales was appropriate at the time, but I also think that going forward it will be hard for this format to survive in a marketplace that is speeding rapidly towards all things digital. The real question may be about how motivated record companies are to maintain a significant footprint for music in the physical store. With singles and cassettes disappearing quickly, and that space being given to DVD’s or to other non-music product lines, like Sponge-Bob Square Pants dolls, fewer sales becomes a self-fulfilling prophecy because you simply have fewer offerings available and therefore sales decline, so you cut back some more, and so on. It’s not that retailers want to get out of music, but when your choice is music or survival, it’s not hard to guess which one to choose.

Once you get to the point in a speech where you use the word “survival,” it’s hard to return to any sort of upbeat message about the future. Certainly this past year, when a whole host of both old line music companies and brash new dot coms bit the dust, and when those of us that are left watch downsizing happen on a weekly basis, it’s hard not wonder if your own days are numbered.

Don’t think anyone can say that music won’t survive. It’s managed to survive a lot of the music business’s mistakes in the past, from frustrating packaging, to limited availability, to a lack of information and dumb pricing. And yet every one of those mistakes also held the opportunity to fix the problem and get it right.

Let me conclude by returning again to the theme of statistics and their role in decision making. One of the statistics getting the most attention these days is the one quoted by Mike Greene at the Grammies: 3.6 billion illegal downloads per month and how this represents consumers stealing from the industry. If you figure 15 tracks per CD on average, that’s 2.88 billion CDs per year. Since around 50 million Americans have ever downloaded music according to several surveys, that translates to about 864 tracks per person per year, or 57.6 CDs. Since we know that even the folks with broadband access (and remember that’s only about 7% of US households) only average about 400 tracks a year according to several surveys, something with these numbers needs more explanation.

We at NARM aren’t comfortable asserting that all these downloads equal cannibalized sales. We’ve watched millions of consumers sample music in store, and not all of those listens translate to purchases. In fact, it may well be time to start analyzing file sharing in the context of radio play instead of CD sales. Retailers have had to compete with free music from the record clubs, or from the promotional copies given to press and radio for years. How many billions of free tracks do you think those represent?

At any rate, the consumer press uniformly responded to the assertion that millions of Americans are “thieves” with a vengeance. The weeks after the Grammy’s were filled with articles like the one in Newsweek titled, “The Customer is Always Wrong.” That in a nutshell is the challenge we’ve got. We’ve all spent the last year listening to copyright lawyers, while copyright lawyers haven’t spent any time listening to customers.

We all need to return to listening to consumers, and really listening. If we just blow them off as immoral pirates who simply want to steal music, we’ll never fix the problems we see today. But if we get back to treating customers with a bit of respect, and if we pay attention to the 24% of downloaders bought more music because of file-sharing last year, and to the 81% that are willing to pay for music, then we have a chance of turning sales around.

The legitimate consumer demands are reasonable: They don’t want to be forced to buy music they don’t want. They do want to be able to move their music with them wherever they go. They want to be able to rearrange their music and to create new playlists that meet their own specific needs for travel, or errands, or exercise, or parties, or sleep. They want fair value for their money.

In other words, they want what they’ve always wanted: different combinations of quality, portability, convenience, and price. That means there’s a role for retailers to play, as well as a role for the pre-recorded products manufactured by the companies in this room.

Thanks for your kind attention. I wish you all a successful year