Saving the Music Industry: 360 Degree Contracts, Coordination Failure, and Game Theory in the Music Business
It is generally accepted that in its present form the music industry as a profitable business is failing. Sales of physical units are down some 10% since 2001 and although digital sales have helped buoy the ship to a certain degree, the industry as a whole is still facing a downturn. Recently, a slew of top name bands and artists have begun to chafe at the normal release schedules and structure of the major record labels opting either to release their music on their own or through a smaller label (Radiohead), dropping all connections to labels (Nine Inch Nails), or signing a new type of record deal known as a 360° contract (Madonna).
360° contracts are, in their simplest form, an agreement between the artist and the label in which the parties agree to share profits from physical album, tour ticket, merchandise, and other sales relating to the artist. Up until this time record labels have mainly been chained to receiving revenue only from the physical sales of CDs, DVDs, records, tapes, and digital downloads of their artists’ music. The revenue streams from touring, merchandising (for the most part), and any other income generating ventures which are brought in by the artist are kept by the artist. This has been the way the industry has worked for more than half of a century.
Unfortunately for the labels, this model is no longer viable. The downturn in the physical sales of albums and the inability of digital downloads to make up the ground lost to free downloads is simply too much for the labels to bear and it is showing. More often than ever, labels are putting all of their eggs in one basket, choosing to play it safe by releasing uninspired, paint-by-the-numbers, contrived music recorded and performed by interchangeable and utterly forgettable musicians. This is also not helping the cause of the music industry. A complete lack of real talent, creativity, and/or difference is causing most real music lovers to repel even further away from the mainstream and what the major labels have to offer. There was a time when major labels broke important, groundbreaking bands whose vision not only sold albums, but which helped morph music through its many waves. Now we are given Lindsay Lohan, Hillary Duff, Britney Spears, and The Backstreet Boys. Packaged goods which sell for a short time, but which ultimately have little to no staying power and which only further separate the major labels from the people they should be targeting: 14-35 year old music lovers.
The Merits of 360 Degrees
Of course, the industry’s music signing tastes are really better suited for another, less specific article. The question being pondered here is whether or not 360° contracts are good for the industry and if they are an actual option.
The reality is that 360° contracts do net the labels more profit. This can be easily seen when you consider a band selling 100,000 albums at $10 a piece and 100,000 tickets at $10 a piece. Using a traditional contract (and assuming the band pockets a generous 20% of every CD sale) the band will make $1.2 million. The record company would generate $800,000 of revenue (readers will forgive the obviously laughable revenue divisions; it is simply much easier to illustrate this way).
Now let’s see what happens under a 360° contract with which the company takes 20% of ticket sales and offers the band 30% of CD sales. The band will make revenues of $1.1 million and the record label will receive $900,000. This shows that the label has increased revenues by $100,000. So why aren’t all the labels out there signing bands to 360° contracts?
The answer is simple: musicians are not stupid. Why would an artist decide to sign a 360° contract which lowers their amount of income? They wouldn’t. The only way a band would sign a 360° contract is if the amount of revenue they give up in ticket sales is matched by an identical increase in CD sales. Obviously this would end with the label making no extra money and the 360° contract being completely pointless.
Profitability or Coordination Failure?
There is only one way in which the industry could use 360° contracts to create increased income: require all contracts to be 360° deals. If suddenly, all at once, every artist was only offered a 360° contract which allowed the label to increase revenue by way of the example above then artists would have no choice but to acquiesce and sign such contracts. This is not a completely efficient outcome for the musicians, but from an industry standpoint it would be absolutely wonderful.
Of course, there is a large hole in this logic: it would take all of the labels working together to happen. This creates a possibility for coordination failure, one of the most basic principles involved in Game Theory. Let us assume that the industry attempts to institute a voluntary 360° contract program because it would be best for everyone involved. Now let’s also assume that one of the major labels decides that instead of instituting the 360° deals they are going to offer traditional contracts. This sneaky label would end up with the power to pick which and how many bands they would like to sign, increasing their share of the market and increasing profitability by the simple fact that they have the best talent. This is best illustrated in a 2 player game table:
The table is read as follows: Rain Records’ payoffs are the first of the two numbers in each cell. Mercury Records’ payoffs are the second number.
The payoffs are shown as simple numbers to simply indicate higher payoffs and lower payoffs with 3 being the best and 0 being the worst. This sort of game is known as the Prisoner’s Dilemma game because it ends with a Nash Equilibrium which is not the most efficient outcome for both parties.
This type of payoff structure will always end with both players, Rain Records and Mercury Records (who could also be thought of as simply the rest of the industry) choosing their dominant strategies. What’s important is to find the best responses. When Rain Records chooses the 360 contract Mercury’s best response is to choose Traditional because the payoff of 3 is better than the payoff of 2 (if they both choose 360). Identically, if Mercury Records chooses the 360 play, then Rain’s best response is to choose traditional (again, 3 is better than 2). Finally, if either plays Traditional then the other’s best response is also Traditional (1 is better than 0).
Thus, both players (in this case labels) will choose traditional contracts, resulting in no improvement in the situation. The only possible way the industry could win with 360 contracts would be to somehow come up with a way in which they all complied with the 360 structure.
Alternative Thinking:
There are other thoughts to consider here. For one there is the possibility that if an act signed a 360 deal there could be a scenario in which both the record company and the band were made better off. This is possible if one believes that once the incentive structure is changed for the band and for the label they will act in mutually beneficial ways. For example, since bands will begin to receive a larger chunk of the profits of their physical album sales they would most likely act in ways which sought to increase sales. This could be increased personal appearances, publicity deals, less leaking of albums onto the internet, more support for protection from ripping and piracy, etc. Similarly, the label, now that it will be receiving revenue from merchandise and ticket sales for live shows, would attempt to create more income by tirelessly promoting their artist, creating more merchandising opportunities, and attempting to sign bands whose appeal will translate well to live audiences. These mutually beneficial actions could spur on sales of all areas of the band’s portfolio and result in increased revenue streams for both the artist and the label.
The Beginning of the Revolution?
Madonna recently signed a 10 year deal with Live Nation worth an estimated 120 million dollars: an absolutely jaw-droppingly huge deal. Some have speculated that Madge has seen the writing on the wall and believes that the 360° deal is central to improving sales of all of her considerable enterprises. It is thought that the above thinking about mutually beneficial actions is part of the reason that Madonna would agree to give up some of the income from her massively profitable tours.
Unfortunately, the real reasons are most likely much more about age and overpaying than anything else. Live Nation is paying Madonna such a large amount that it is unlikely that it will see any sort of boost to its profitability over signing her to a traditional contract. They paid for Madonna’s name because they are a fledgling label attempting to make a name for themselves as innovators and major players in the music industry. For Madonna the deal was too much to pass up. The overpayment, coupled with the fact that Madonna will be 60(!) when the contract ends makes it idiot-proof. Madonna probably does not mind giving up some of her tour revenue when she realizes that most 58-60 year olds, no matter how physically, mentally, and kabbalah-ly fit, are not monster draws on the live tour circuit and if they are, they are not able to play the amount of dates or physically demanding shows which bring in the major money Madonna’s tours usually do. Madonna is not stupid, she knows she is getting older and she has cashed in brilliantly.
Conclusion
So what does all of this analysis truly reveal about the future of the music industry? Unfortunately, a lot less than those who support 360° contracts would hope for. Of course, the industry could do quite well with these types of deals but they would simply have to demand market wide compliance with 360° contracts while avoiding the temptation to stray into traditional realms in order to get a leg up on the competition.
-Luke Barnard
|
360° contracts are, in their simplest form, an agreement between the artist and the label in which the parties agree to share profits from physical album, tour ticket, merchandise, and other sales relating to the artist. Up until this time record labels have mainly been chained to receiving revenue only from the physical sales of CDs, DVDs, records, tapes, and digital downloads of their artists’ music. The revenue streams from touring, merchandising (for the most part), and any other income generating ventures which are brought in by the artist are kept by the artist. This has been the way the industry has worked for more than half of a century.
Unfortunately for the labels, this model is no longer viable. The downturn in the physical sales of albums and the inability of digital downloads to make up the ground lost to free downloads is simply too much for the labels to bear and it is showing. More often than ever, labels are putting all of their eggs in one basket, choosing to play it safe by releasing uninspired, paint-by-the-numbers, contrived music recorded and performed by interchangeable and utterly forgettable musicians. This is also not helping the cause of the music industry. A complete lack of real talent, creativity, and/or difference is causing most real music lovers to repel even further away from the mainstream and what the major labels have to offer. There was a time when major labels broke important, groundbreaking bands whose vision not only sold albums, but which helped morph music through its many waves. Now we are given Lindsay Lohan, Hillary Duff, Britney Spears, and The Backstreet Boys. Packaged goods which sell for a short time, but which ultimately have little to no staying power and which only further separate the major labels from the people they should be targeting: 14-35 year old music lovers.
The Merits of 360 Degrees
Of course, the industry’s music signing tastes are really better suited for another, less specific article. The question being pondered here is whether or not 360° contracts are good for the industry and if they are an actual option.
The reality is that 360° contracts do net the labels more profit. This can be easily seen when you consider a band selling 100,000 albums at $10 a piece and 100,000 tickets at $10 a piece. Using a traditional contract (and assuming the band pockets a generous 20% of every CD sale) the band will make $1.2 million. The record company would generate $800,000 of revenue (readers will forgive the obviously laughable revenue divisions; it is simply much easier to illustrate this way).
Now let’s see what happens under a 360° contract with which the company takes 20% of ticket sales and offers the band 30% of CD sales. The band will make revenues of $1.1 million and the record label will receive $900,000. This shows that the label has increased revenues by $100,000. So why aren’t all the labels out there signing bands to 360° contracts?
The answer is simple: musicians are not stupid. Why would an artist decide to sign a 360° contract which lowers their amount of income? They wouldn’t. The only way a band would sign a 360° contract is if the amount of revenue they give up in ticket sales is matched by an identical increase in CD sales. Obviously this would end with the label making no extra money and the 360° contract being completely pointless.
Profitability or Coordination Failure?
There is only one way in which the industry could use 360° contracts to create increased income: require all contracts to be 360° deals. If suddenly, all at once, every artist was only offered a 360° contract which allowed the label to increase revenue by way of the example above then artists would have no choice but to acquiesce and sign such contracts. This is not a completely efficient outcome for the musicians, but from an industry standpoint it would be absolutely wonderful.
Of course, there is a large hole in this logic: it would take all of the labels working together to happen. This creates a possibility for coordination failure, one of the most basic principles involved in Game Theory. Let us assume that the industry attempts to institute a voluntary 360° contract program because it would be best for everyone involved. Now let’s also assume that one of the major labels decides that instead of instituting the 360° deals they are going to offer traditional contracts. This sneaky label would end up with the power to pick which and how many bands they would like to sign, increasing their share of the market and increasing profitability by the simple fact that they have the best talent. This is best illustrated in a 2 player game table:
The table is read as follows: Rain Records’ payoffs are the first of the two numbers in each cell. Mercury Records’ payoffs are the second number.
The payoffs are shown as simple numbers to simply indicate higher payoffs and lower payoffs with 3 being the best and 0 being the worst. This sort of game is known as the Prisoner’s Dilemma game because it ends with a Nash Equilibrium which is not the most efficient outcome for both parties.
This type of payoff structure will always end with both players, Rain Records and Mercury Records (who could also be thought of as simply the rest of the industry) choosing their dominant strategies. What’s important is to find the best responses. When Rain Records chooses the 360 contract Mercury’s best response is to choose Traditional because the payoff of 3 is better than the payoff of 2 (if they both choose 360). Identically, if Mercury Records chooses the 360 play, then Rain’s best response is to choose traditional (again, 3 is better than 2). Finally, if either plays Traditional then the other’s best response is also Traditional (1 is better than 0).
Thus, both players (in this case labels) will choose traditional contracts, resulting in no improvement in the situation. The only possible way the industry could win with 360 contracts would be to somehow come up with a way in which they all complied with the 360 structure.
Alternative Thinking:
There are other thoughts to consider here. For one there is the possibility that if an act signed a 360 deal there could be a scenario in which both the record company and the band were made better off. This is possible if one believes that once the incentive structure is changed for the band and for the label they will act in mutually beneficial ways. For example, since bands will begin to receive a larger chunk of the profits of their physical album sales they would most likely act in ways which sought to increase sales. This could be increased personal appearances, publicity deals, less leaking of albums onto the internet, more support for protection from ripping and piracy, etc. Similarly, the label, now that it will be receiving revenue from merchandise and ticket sales for live shows, would attempt to create more income by tirelessly promoting their artist, creating more merchandising opportunities, and attempting to sign bands whose appeal will translate well to live audiences. These mutually beneficial actions could spur on sales of all areas of the band’s portfolio and result in increased revenue streams for both the artist and the label.
The Beginning of the Revolution?
Madonna recently signed a 10 year deal with Live Nation worth an estimated 120 million dollars: an absolutely jaw-droppingly huge deal. Some have speculated that Madge has seen the writing on the wall and believes that the 360° deal is central to improving sales of all of her considerable enterprises. It is thought that the above thinking about mutually beneficial actions is part of the reason that Madonna would agree to give up some of the income from her massively profitable tours.
Unfortunately, the real reasons are most likely much more about age and overpaying than anything else. Live Nation is paying Madonna such a large amount that it is unlikely that it will see any sort of boost to its profitability over signing her to a traditional contract. They paid for Madonna’s name because they are a fledgling label attempting to make a name for themselves as innovators and major players in the music industry. For Madonna the deal was too much to pass up. The overpayment, coupled with the fact that Madonna will be 60(!) when the contract ends makes it idiot-proof. Madonna probably does not mind giving up some of her tour revenue when she realizes that most 58-60 year olds, no matter how physically, mentally, and kabbalah-ly fit, are not monster draws on the live tour circuit and if they are, they are not able to play the amount of dates or physically demanding shows which bring in the major money Madonna’s tours usually do. Madonna is not stupid, she knows she is getting older and she has cashed in brilliantly.
Conclusion
So what does all of this analysis truly reveal about the future of the music industry? Unfortunately, a lot less than those who support 360° contracts would hope for. Of course, the industry could do quite well with these types of deals but they would simply have to demand market wide compliance with 360° contracts while avoiding the temptation to stray into traditional realms in order to get a leg up on the competition.
-Luke Barnard
|
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