Message to the labels: Forget Horizontal and Vertical… Think “Adjacent”

Over the past few weeks conversations with a variety of musicians, managers, technologists and label executives have revealed a common theme. Emerging digital music distribution models require record labels to seek out new ways to capture value from the artists they sign, develop and market. The value that labels capture through publishing and licensing is no longer commensurate with the value they create developing an artist’s “brand”. If labels were able to participate in merchandising and touring revenue, artist and label incentives would be better aligned. Look for more labels to demand 360 degree relationships with their artists so that they can participate in a broader range of monetization opportunities.

The popular conception has been that the music industry is an evil bear that takes over 70% of the dollars an artist generates and locks artists up in a contractual prison. In many cases though, artists maintain control over lucrative merchandising and touring revenue streams. In this model, incentives for the artist and label should, in theory, be aligned. The more a band tours and pushes merchandise, the more money they make from touring and merchandising. AND the touring and merchandising acts as a fantastic marketing vehicle for album sales, benefiting the label (and the artist).

Now introduce digital music into this industry “balance”. At first, digital music seemed like another (though frightening) distribution and retailing model that could, in effect, conform to the physical distribution model, but with lower packaging and inventory costs. There would be online distributors (with a diminished role given the absence of physical inventory) and digital retailers. Apple’s FairPlay Digital Rights Management made it at least palatable for labels to try digital music retailing. In the meantime file sharing networks were doing two things at once. #1.) they were making it possible for people to access and sample music on an on-demand basis at no cost (to the downloader). #2.) they were removing the incentive to actually purchase legal physical or digital instances of desired music. The music industry chose to battle file-sharing on the face of their copyright, rather than evolve their business model to take advantage of this new way to interact with fans. (Here is a great piece on the value of “free grazing”.

Labels are now seeing the power that social tools like MySpace, YouTube and distributable widgets have in getting artist’s work in front of more people in more contexts. Lots of albums “leak” onto file-sharing networks, but widget / embedded player models are offering a more controlled way for labels to let fans “graze” for free. The ability to sample wider varieties of music, without breaking the law, promises to grow music publishing revenues. But much of the value may be transferred to the businesses adjacent to music publishing since all of these free ways to interact with songs can begin to provide a disincentive to music sales. So touring and merchandising revenue streams stand to gain from more liberal online promotional models.

Artists should want their labels to use new technologies to market them without hesitation. Labels should want to push every button to get an artists band in front of their target market. 360 contracts, which give labels participation in the entire revenue cycle of an artist open up this type of creativity. For 360 contracts to take hold, the entire industry will have to acknowledge their importance and introduce them to the next generation of emerging artists.

Removing Friction from Online Transactions

This piece is about Transactional Friction in digital content sales. Future documents will address digital content business models more directly…
In the world of digital content sales, where optimal price points might be very low, a good business model depends on the lowest possible transactional friction. The two primary contributors to friction are transaction costs and the opportunity cost of TIME and general annoyance experienced by the user. If a near frictionless transaction environment for digital content can be developed, it promises to usher in a new era of digital content business models.

Imagine paying three cents to read a technical whitepaper or paying 10 cents to listen to the Grateful Dead, Cornell ’77, in high resolution audio. Grateful Dead

Most current digital content transaction models make this impossible. The solution has typically been to “resort to advertising” by translating page views into CPM and click-through revenue. While the ad model works as a monetization path for many types of digital content, it can be fairly limiting, especially for works that are highly attractive to a relatively small audience or in cases where the revenue from the CPM or click-through does not adequately capture the value inherent in the digital work. Ad Models do also have a significant annoyance factor associated with them, so they are not entirely frictionless for the content consumer.

Any transaction system seeks to avoid high abandonment rates since a high abandonment rate will lead to much higher subscriber/user acquisition costs which will impact long-term cash flows and can be real killers when a company is racing to acquire new customers (as in high network effect environments).

More detail on the friction creators:

    Transaction Cost:

Transaction fees for credit card and online payment system transactions are typically comprised of a fixed cost per transaction plus a percent of the total transaction value. (Google Checkout has, at least temporarily, removed this friction by offering free transaction processing through 2008 as a part of the Checkout’s launch). The fixed cost per transaction sets a natural bottom for digital content pricing.

    User Time/Annoyance Cost:

Users have a finite amount of time so a transaction system that fulfills a transaction with minimal time impact on the user should be favored. There is also a cost of user annoyance or frustration, which can lead to high abandonment rates, so systems must make the transaction as simple as possible for the user.

Here are a few of the digital content transaction models we have studied along with some pros and cons. While these are mostly web focused, they can apply to mobile and gaming environments we well.

The Stored Account Model: Users sign up and store their financial information on the vendor’s system. Future transactions do not require users to re-enter their financial information.

Examples: Amazon, iTunes Store, Fresh Direct fresh direct

Pros: Future transactions are time-efficient for the user since they only need to enter a user name and password, or possibly re-enter a subset of their purchase information for a transaction to occur. The advantage to the vendor is that they now have a “subscriber” that they can monitor and to whom they can deliver targeted recommendations over time. Once a user has put in the effort to sign up for system, they may be disinclined to spend time signing up with a competitor offering a similar service.

Cons: – This model presents a disincentive to execute the first transaction since additional user effort is required to establish an account. – The vendor still incurs a transaction cost each time a transaction is executed. – This model also requires that users reach a trust threshold with the vendor since the user’s personal information will be stored on the vendor’s system.

Stored Value Model: The user funds an account such that there is one “real” transaction where the user’s money is transferred to the vendor account. Further transactions all occur completely within the system until the stored value needs to be refilled. The transactional efficiency of this mode can be calculated as follows: Initial transaction cost/number of internal transactions conducted = new per transaction cost.

Linden MC

Examples: Amiestreet, Second Life

Pros: After the initial funding transaction, there are effectively no transaction costs for purchases within the system. Users also have a switching cost since they will have to go through some amount of effort to get their money out of a system’s “currency”. There is some incentive for the user to exhaust the account which will drive future user interaction with the site.

Cons: Users are hesitant to pre-fund an account unless a refund path seems to be low friction. Users must also be convinced that they will find enough content of value to exhaust the pre-payment amount. Please also consider the fate of BitPass who attempted to build a comprehensive stored value system and ceasd operations in January 2007.

A La Carte Purchase Model: User’s can visit a site and enter their financial information and make a purchase without having to join the site as a member.

Examples: This is a typically an option on most commerce sites.

Pros: Buyers may be more inclined to engage in the first purchase since the time required to make the purchase is limited. This model is incredibly efficient when online payment provider systems (like PayPal or Google Checkout) are used.

Cons: This model does not provide any future incentive for the user to return since there are no future user efficiencies. The user will have to go through the same procedure again and again. Very little user affinity is generated with this model.

Subscriptions Model: Users pay a recurring amount for ongoing access to an ever expanding body of content.

Examples: Rhapsody, Yahoo! Music, HBO

Pros: There is little transaction cost friction especially when quarterly or annual renewal models are employed. Revenue is less variable. Subscription pricing also takes advantage of bundle pricing models. Sites can also introduce effective switching costs (for example Rhapsody forces you to call to cancel your account which introduces a disincentive to cancel… a nasty form of lock-in).

Cons: User setup time and decision making may be more complex since users typically have a series of “packages” to choose from. Users are also making a higher level decision about a body of content, rather than an individual content element. This can lead to higher levels of abandonment. There is also the “Homer Simpson” problem. (Homer was known to put restaurants offering all you can eat specials out of business by consuming every scrap of food. In the Internet media context, if all users were streaming music from Rhapsody for every hour of every month, data costs would quickly erode margins.) Compensation models for content providers may be complex or introduce fixed costs for the vendor. Users will require new content to be available on the system which may cause fixed costs (like storage) to go up steadily over time.

Transaction Wrapping: Users who already pay for thing A can get thing B through thing A’s transaction system.

Examples: Trial Pay, Mobile Provider vending (ringtones etc.), On Demand

Pros: These models eliminate many transactional setup costs by the user. One example is, Instead of having to pay On Demand for every pay-per-view purchase, the purchase just gets tacked on to the user’s monthly cable bill. This increases the potential for impulse buying since almost NO additional work is required for the user.

Cons: this model requires a possibly complex relationship with another vendor. The primary vendor may impose a relatively high tariff per transaction, exposing the

A Cruxy Anecdote:

We have very much enjoyed developing transactional models for Second Life since it offers users a variety of low-friction ways to purchase digital content. Users can fund their avatar’s account and users can go around the Second Life virtual world buying digital content. Content can be purchased by paying a kiosk, another avatar or through real-world commerce web sites. We anticipate that users will be able to use Second Life to buy more and more “real-world” goods since this low-friction environment makes it an attractive transaction environment.

Second Life introduces another risk though since they have a market exchange for their “in-world” currency, the Linden.