QUESTION 1

Draw the “bricks and mortar” value chain by which records, tapes and CDs are created,

distributed, and sold in retail stores. Use formats similar to Exhibits 2.1 to 2.5, and write a

one-page description of how this value chain works and how each player makes money.

Answer:

Traditional Music Distribution Value Chain (Bricks and Mortar)

Content
Creation: Production / Sales & Distribution Wholesale Retailers Customers
Artists / Publishers Manufacturers Marketing (Pack & (Sales to (Sales to
Producers / (Recording) (Publicity) ship) Retailers) customers) (End Users)
Composers /
Ghostwriters

The process begins with the talent pool which includes artists, producers, composers,

ghostwriters and among others. These artists are then contracted to a international record label

to produce music recordings such as Sony BMG, Universal, Warner and EMI are examples of

large music companies that own smaller record labels. The rest of the record label industry is

made up of independent labels such as Sub-Pop, Epitaph, and Muse Music. Record labels add to

the artist’s product by augmenting it with marketing campaigns, promotions, concerts, and most

importantly, access to and bargaining power with distributors. Artists often find it beneficially

to leverage the resources of a record label in order to reserve shelf-space amongst retailers. Best

Buy and Wal-Mart are the two largest brick and mortar (versus digital) music retailers. The big

four own their own distribution channels while smaller independent record labels rely on

separate systems of distribution. Finally, the music is finally delivered to the end-user or the

consumer. Though there are many separate steps in the value chain, many record labels and

music groups, including the “Big Four” participate in several of these stages. For instance, Sony

BMG may enter into a contract with an artist, then publish, manufacture, and distribute that

artist’s work. Please refer the diagram for more details.

QUESTION 2

Develop an alternative value chain structure for this industry, and justify your

recommendations. Use formats similar to Exhibits 2.1 to 2.5, abd write a one-page

description of how this value chain works and how everyone makes money.

Answer:

Digital (Online) Distribution Value Chain

Online Music Store

Rights clearance
and royalties

Artists and record Hosting in server

/proprietary &
industry digitised format
Network and Device
Content Provider
Creation:
Artists / Production Sales & Digital record Delivery Device:
Producers / Marketing encoding over Handphone /
Composers / (Publicity) networks iPod /
Ghostwriters Portable
Device etc
Jukebox sotware /
iTunes /
RealPlayer etc.

Billing / Fee

Digital Content Creation Digital Asset Digital

Management Networks/Devices

Digital technologies in the music market will drive changes in the underlying market structure

and value chain. The adoption and diffusion of digital music, reduction in “distance” between

artists and consumers, wide distribution networks through the online channel, reduced costs of
replication and production and copyright protection and piracy issues will affect the music

market structure.

For digital music, the creation and recording of music and the signing and promotion of artists

represent the gathering and organizing steps. Selection and synthesis occur when the artists

and/or record labels produce digital recordings. Distribution of information occurs over the

Internet when consumers purchase digital music files from a distributor and download or stream

content.

Intermediaries are economic agents that facilitate transactions between suppliers and buyers.

They set market-clearing prices, make purchase and sales decisions, manage inventories, supply

information and coordinate transactions. Their role in the music market is changing as a result

of the digital music format. Physical retailers are being replaced by digital music retailers.

Manufactures and distributors are becoming obsolete as record labels, producers and artists can

go directly to digital music retailers without producing a physical product, reducing the

“distance” between the music supplier and the consumer.

The added value to the music product from manufacturing and distribution is decreasing, but

digital music retailers add new value. With Internet distribution and music piracy, they can now

add value through marketing, promotions, copyrighting and licensing. There is also value added

through enforcement of IP rights and piracy prevention. As a result, the channel power

dynamics change. Plus, there will be new incentives as the roles of the players in the value

chain shift. The changed value chain is likely to be affected by issues that relate to IP rights.

Though digital music also has advantages over physical formats, the product is incomplete.

Digital music does not include some of the important attributes of the physical CD. These

include artwork, lyrics, liner notes, and additional content found in enhanced CDs (video

games, desktop wallpaper, video clips). But these can be made available in a digital form for
value chain distribution of digital music and the price digital music offer much cheaper

compared to analogue music and easy excess to the consumers. Under the income derive from

digital music which is the two main pricing strategies for digital music: pay per song download

and subscription services, these also should include monthly subscription and pre-payment

credit. There are many opportunities to explore consumers’ willingness to pay in the context of

illegal file sharing and piracy in the digital music value chain.
QUESTION 3

Explain and compare the role of operations in the two value chain structures you developed

in question 1 and 2.

Answer:

There are two main value chains structures :

Brick and Mortar Value Chain For Traditional Music Industry

Artists /
Producers / Publishers Manufacturers Distributors Retailers Customers
Composers /
Ghostwriters

Brick and Mortar Value Chain For Digital Music Industry

Artists / Producers /
Composers / Publishers Retailers Customers
Ghostwriters

The principal physical distribution channel of the recording music industry value chain has been

standardized with a final physical media as CD's among other products. Unfortunately with

the Internet and digital technology the recording music industry has been one of the most

affected by companies like KAZZA, Morpheus, Grokster, Gnutella, and the like, which are all

based in peer to peer networks or just selling music without taking care of the copyrights.

When a person buys a CD, that person is acquiring a product that represents all contributions of

a chain that are part of the music industry. The price that is paid for a CD compensates all the
contributors involved in the production of the CD. The value chain for the music recording

industry consists in basically a few components:

Artists or Singers

Publisher / Recording: Studios such as Universal Music, Sony Music, Warner Music, BMG or

EMI

Manufacturing: CD Manufacturers

Marketing: Advertisement, catalogues, tours, concerts, Interviews, etc

Distribution: Transportation, Packaging from manufacturing to distributors.

Indirect distribution through traditional channels: chain music stores and chain bookstores.

Indirect distribution through nontraditional channels such as gift stores, independent business

entity.

Retailing: Carried by major label and internet superstores until products become popular with

particular segments. It is important to know that there are other types of distribution channels

like radio stations which use music to make profits. These companies are known as professional

users of music and in order to use any kind of music they have to pay fees for doing so.

In this way some of the factors that make part of the recording music industry value chain are

facing decreases in their sales and revenues.

According to the forecast of iResearch, the global digital music market will remain on the fast

track, and the market value by 2010 is expected to hit a record high of USD12 billion. The

current bullish global digital music market is attracting a flock of industry heavyweights.

Backed by the success of its iPod music player and iTunes music store, Apple’s performance in
the marketplace has been nothing short of spectacular, making it the envy of all its rivals. The

software giant, Microsoft, has likewise thrown its hat into the competitive digital music arena

by recently launching its MSN Music online music service. It further plans to establish an

industry chain alliance, which will be centered on “Plays for Sure”. As a conventional

retailer, Wal-Mart has also taken a hand in digital distribution. Apart from these household

names, a wide array of professional service providers, have also emerged in recent months to

join the ever growing digital music competitive arena.

Thus, one might say, that the digital music market is abuzz with various kinds of players. With

the development of value-added telecom services, carriers are also beginning to tap into the

digital music gold mine (market), and have quickly found their feet in this highly lucrative

market with the introduction of their knockout product – the Ringtone. According to the report,

the revenue for mobile music alone, by 2009, is expected to reach USD 9.3 billion. So,

indubitably, digital music will become a virtual gold mine for telecom carriers and the music

industry. When compared with conventional music, as well as allowing people to listen to

music on a trial basis and buy downloads anytime and anywhere, digital music also features

greater pricing flexibility, a new sales model based on the sale of a single track, as well as a

wide variety of value-added services. Hence, with the continuous development of the 3G & 4G

network, the potential of the digital music market will certainly continue to be further explored

and exploited.
 Herewith the summary of comparison the value chain for music industry :
Elements Production Marketing Distribution Consumption
Function Invention Understanding what the Delivery of music to Playback,
Writing market wants, tuning consumers management
Performance content style and
Recording content, presenting
Editing music to the market
Programming through appropriate
channels, driving
demand
Member of The artists The artists themselves: Retailers: shelf space, CE: CD players, home
the Value themselves: at the center of what the customer support, in- stereo, etc.
Chain Central to fans want, and live store marketing,
production, May performance is a key transactions (for now PC/IT: software players
be involved in method of marketing lets not worry about the
any or all of the credit card processing Automotive: as
functions Live venues: same companies, POS integrated into the car
software, etc)
and other
Producers: Radio: a business unto
transportation
enhance the itself, but also a key Distributors: move
quality of the enabler for promoting content to retailers
created work music to the mass
through market. Duplication
understanding of
the creative Merchandisers: again, Wholesalers
process and business into itself but t-
bringing together shirts and posters play a Labels: fund a large part
the right people big role in marketing of this process
to make it work.
Print media: business
Value added also provides reviews
providers: make and advertisements that
the content better drive consumer
adoption and
Songwriters: as information
important as the
artists in many Retail channels: in-store
cases marketing can be very
important
Set musicians
Sound / studio Grassroots / street
engineers teams: increasingly
important
The labels:
provide funding The labels: provide
to bring the right funding, and:
elements together
A&R – refine product to
meet market demand
Marketing – present
message through
appropriate channels

Advertisement,
catalogues, tours,
 concerts, Interviews, etc
Output A musical work Targeted product, A CD on the shelf, Consumption in
of varying increased demand, transactions to multiple locations
degrees of quality informed market consumers including traditional and
digital
Digital Software enables P2P: can enable nearly Can enable costless Increased storage and
Music production at costless presentation of copying and distribution portability – virtually all
Marketing lower costs and content to marketplace of content to all the music you could
higher rate. consumers ever want can be
Portals and filters: carried in the palm of
More people can similar to print media in your hand.
have access to the analog world – but
more powerful can have broader reach
Leverage commodity IT
tools – increase at much lower costs
equipment for storage
quality of
offering at a Filters and matching media
much lower final techniques (Amazon
cost effect) – can radicalize Convergence makes
segment by dramatically everything into an audio
increasing the quality of device (cell phone,
match between digital camera, coffee
consumers and product maker, etc.)
and can be virtually
costless at scale (see
Launch.com)

Streaming radio – to the

extent that
programming is done by
humans this is virtually
identical to existing
broadcast radio
Effect on Costs of Value of analog value Everything except for Devices no longer tied
Analog production chain segments can be retail undermined to media or content
Model reduced completely eliminated
in a strong DM Retail at risk or at center De-prioritize value or
Greater supply at scenario. depending on business even location of
higher levels of model medium in favor of
quality possible Under any content
(particularly at circumstances, costs of
the bottom-end of marketing can be
the spectrum) reduced considerably
(and effectiveness of
existing marketing
channels and techniques
diluted by alternative
channels)
Digital Music Value Chain : Opportunities

Total cost structure can be greatly reduced throughout the value chain which is interference

from middle parties had been cut off.

Currently it costs millions (assume $2.5 MM) to bring a CD through the value chain to retail.

Eliminating marketing and distribution costs can more than cut this in half.

Using Digital Media production tools, all but the highest levels of production can be achieved

for a fraction of the price.

In principle, cost-structure can be reduced to the amount necessary to provide incentive to

human factors in production.

Socio/Psychological factors aside, estimate that total costs could be reduced certain extent for a

mid to high end album

Enhanced marketing and distribution can dramatically increase both the quantity of music

consumed as well as the quality of the experience.

Expanded consumption mechanisms can increase the ways and locations for music

consumption. Music everywhere.

Digital Music focus on unique product quality which is personally satisfied or meet the needs of

certain market consumers and increase in volume of sales. More people listen, download and

share the music thru various devices so it increase total sales or revenue to the related industry.
Digital Music Value Chain: Obstacles

Cannibalization: Analoge Music is a billion-dollar industry. To the extent that Digital Music

cannibalizes that industry, content owners will resist transition to Digital Music which is give

the power of choose to the consumers.

Although efficiency provided by Digital Music should increase margins for music distribution,

that same efficiency could also dramatically decrease the size of the pie.

Power Struggle: because they are the principal source of risk funding (and marketing), labels

have a strong position in Analoge Music. Disintermediation or risk of disintermediation due to

Digital Music will cause strong resistance (or modification of Digital Music)

Copyright: existing copyright laws put emphasis on maximum exploitation of content, not on

most efficient production and dissemination. This could prevent adoption of Digital Music.

Digital Music: Conclusion and Recommendation

An effort should be made to catalyze the key elements of Digital Music necessary to make it

into a vital force.

Any effort that requires participation from the existing major copyright holders will be

suboptimal due to their vested interest in Analogue Music (and need to dominate any Digital

Music value chain).

Recommendation that Digital Music focus on building a Digital Music market that is beside and

alternative to the Analogue Music (and Analogue Music-derivative markets). This Digital

Music market will attempt to start from the core strengths of Digital Music and build-out rather
than using Digital Music as an add-on to the Analogue Music world. Specifically, this market

will consist of the following:

Key technologies for costless marketing and distribution of digital music.

A critical-mass of content and consumer participation with this technology.

An economic model targeting total value of compensation to the production elements in the

value chain for the equivalent of an "album" at some degree of scale.

As comparable of value chain in music industry herewith the different and similarity of the both

products in the music industries and the change of business structure in the global era.

PLAYER CONVENTIONAL VALUE DIGITAL MUSIC VALUE POWER CHANGE

FLOWS FLOWS

PLAYER Music composition Composition, More control of

CONVENTIONAL (creativity) performance (creativity) production, distr.
Artist VAS DIGITAL
MUSIC VALUE Recording of music Recordings, Potential increase in
FLOWS POWER performances, profits
CHANGE Performances and appearance
appearances Decreased copyright
Production and protection
distribution
arrangements
Copyright enforcement Copyright enforcement Loss of control over
Label and production and
Production Produce, mfg. of Marketing, promotion, distribution
Company recorded music advertising
Potential decrease in
Distribution, mktg., profits
promotion
 Limited intellectual Intellectual property Increase control over
IP Rights property rights enforcement the legal distribution of
Enforcement digital music
Body rights enforcement Piracy prevention

Prosecution of music
piracy cases

Traditional Distribution to customer None Loss of customers/sales

Retailer Advertising

Digital Music None Distribution to customer Growth of digital music

Retailer Advertising market

Services Potential increase in

(recommendations, profits
search, etc.)
Increased competition

Consumer Purchase music in Choice: purchase New supply channel

physical format physical format or digital More product choices
format or pirate digital More power over prices
format