The Music Industry in the Digital Era: Toward New Contracts

Abstract

Digital piracy, although negatively altering the recorded music market, has a positive impact on other segments of the music market, such as live music or ancillary goods, because it generates a positive externality benefiting those activities. Through a 2-player strategic game between a record company and an artist, this study shows that a renegotiation of music contracts could allow the internalizing of this positive externality, while being welfare-improving for both record companies and artists. This study also shows, however, that pervasive piracy is not desirable for an artist.

Notes

¹Data available on www.riaa.com.

²The implicit assumption is that the decision to purchase concert tickets or ancillary goods is, at least to some extent, a consequence rather than a cause of CD consumption. This point, although challenged by the historical view on the causality between concert and album sales, has been adopted in a theoretical work by Gayer and Shy (2006) and seems to fit much better with recent empirical evidence (Krueger, 2005; Peitz & Waelbroeck, 2005).

³This hypothesis is consistent with the contrasting evolution of the U.S. markets for recorded music and live music between 2000 and 2007. Whereas the former fell by nearly 30%, the latter more than doubled in value.

⁴The revenue that an artist draws from its recorded music is divided into a fixed part (advance) and a variable part based on a percentage of sales (royalties). Usually, a record company indeed pays an artist an advance against royalties so he or she has money to live on while recording the album. However, the artist has to pay back this advance because, in a standard recording contract, the costs of recording and promoting an album, making a music video, and so forth are usually “recoupable expenses” that are deducted from an artist's royalties (Krasilovsky & Shemel, 2003). Hence, the advance is most often the only money an artist ever sees for a recording. Consequently, 95% of artists earn their living from live shows (Boorstin, 2004). Although, in this article, strictly speaking, we deal with the artist's revenues minus advances rather than total revenues, the fixed payments that are the advances do not affect the argument. Because artists know that they are unlikely to receive any royalties, assuming zero royalties on top of the advance is a reasonably good approximation.

⁵Even an artist who does get royalties from his or her record company usually obtains a lower income from CDs than from ancillary products. For instance, Connolly and Krueger (2007) showed that in 2002, for the top 35 richest artists as a whole, income from record sales represented less than 10% of artists' total income. As far as income from touring is concerned, it exceeds income from record sales by a ratio of 7.5 to 1.

⁶With this hypothesis, our article focuses rather on artists with a certain renown, more capable of playing the record companies off against each other to obtain a more advantageous contract. However, it should be noted that the advent of digital music has radically extended the external options for artists and, hence, their bargaining power vis-à-vis the record companies. The reduction in production and distribution costs, and also costs of promotion (with the development of the digital word-of-mouth), gives more credibility to artists who threaten to set up their own label or to access their public directly via the Internet.

⁷Since 2003, and the deal signed by EMI with Robbie Williams that gives the label a cut of the U.K. artist's merchandising, publishing, touring revenue, and sponsorship, such contracts, now called “360° contracts,” have proliferated. See, for instance, International Federation of the Phonographic Industry (2008).