Spotify & The Economics of the Music Industry

Former CEO at EMI Group & Board Member at Pandora Media

Why is this interview interesting?

  • Fundamentals of a music artist deal with a record label
  • Potential pressure on the economics of the record label business
  • Spotify's strategic options to increase gross margin
  • How Spotify can replace services that A&R houses traditionally offered artists
  • Strategic rationale of the Spotify Joe Rogan deal versus Pandora's Howard Stern deal

Executive Bio

Roger Faxon

Former CEO at EMI Group & Board Member at Pandora Media

Roger has over 30 years experience in the music and publishing industry. In 1994, he joined EMI, one of the four largest record labels globally, and spent 5 years as CEO of EMI from 2007-12 just as the industry was rapidly shifting digitally. Roger has led A&R investments, negotiated deals with the largest streaming platforms, and is on the board of Pandora Media and ITV. Previously to working in the music industry, he was CEO of Sotheby’s Europe and EVP at Lucasfilm.Read more

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Interview Transcript

Roger, great to have you with us today. I think a good place to start would be if you could provide some context as to when you first joined EMI and how you’ve seen the major changes in the music industry?

I was fortunate and unfortunate in joining the music industry. I was fortunate that I got in in 1994, where the music business was soaring. I remember the CEO who hired me said, the one thing you need to know is, you have to be stupid not to make money in the music business. But fearfully, we have a lot of stupid people in the music industry. People did lose money but, largely, the market was driven in a way that people probably don’t understand. At that time, there were four major music businesses and they’d grown up by buying independent labels but, mostly, by consolidating distribution. In that period, the CD was driving meaningful growth, in sales. Music retail, music stores, were expanding at a rapid rate.

What you had was, four businesses, whose business model was, basically, shipping as much music into stores and leaving it there, as long as possible, until it sold. So the inventories started to go way up. But the businesses looked as if they were doing fantastically, because they’d get 8% to 10% growth a year, which is astounding. By 1996, 1997, you started to see the world be very different. It didn’t show at the top line, but it showed in the bottom line, within the P&L, where you saw huge amounts of inventory that was stuffed out into stores. Over time, that started to become more and more evident.

Guess what was happening at the same time? First of all, I was hired, effectively, to drive a digital change, for EMI, amongst other things. We did all sorts of things; we were very aggressive in partnering with new digital groups. Digital then is nothing like it is today. It’s like the Dark Ages and we were learning how to build fires, as opposed to other things. There were a lot of ways of thinking about how you would use the digital world, to distribute music. That was true of all major players, to one extent or another. EMI was at the forefront of it, because it was part of a conglomerate that had very large interests in digital kinds of technologies. As I say, in those two years, the underlying economics of it was starting to dissipate. Then you get to 1998 and something happens, and that’s Napster.

Napster was the first time that digital really became understood as a mortal attack on the music industry. It made absolutely clear that music could be transferred indiscriminately. That the availability of one CD, in a marketplace, could mean that the entire world could have access to the music. That’s a pretty awesome and disturbing thought. Some people, like Bertelsmann, what they thought is, what we’ll do is, we’ll grab hold of Napster and we’ll tame it; we’ll make it work for us. That was probably the most idiotic view that I could ever imagine because its whole model was free. When they tried to get them to create a business model that was related to revenue, all that happened was that they just lost their place in the market, because the market had so many others that were pirating music.

The music industry had no experience with technology. It had no experience with digital activity. They just went to the law and started to try to solve this issue by attacking every digital use that was being pirated – that was impossible – as opposed to trying to build an alternative world, an alternative that was more conducive to consumer wants and was much more as what we’re seeing today.

Music businesses, at that time and, to some extent, even today, are run by A&R people; people who choose music, in effect and help develop it. They’re not strategists, in the broader business sense. The management of the music business was aging. These were guys that made their mark in the sixties and the seventies and here we were, in the late nineties and into the 2000s. They were frozen; they didn’t know what to do, other than to just try and fight the hurricane that was coming at them, with the law. What it took for us to come out of that, which was a very long time, by the way, was for others to find a different model, to try and create a different model. It wasn’t the record companies that did that. The record companies resisted. So you first had Steve Jobs, who said, I’m going to solve your problem. Apple is going to be your digital music. The old guard didn’t understand what they were about to do with him, was to give him the keys to the business, which probably wasn’t a bad thing. I’m speaking as though I wasn’t in favor of it. But what happened was, the old guard were at a level where if Steve Jobs wanted to do something, they would just agree to what it was that he wanted to do and not create a different kind of alternative.

Essentially, the music business, which continued to sell physical goods and it even does today, gave over the digital answer to Apple. What was happening with the physical goods? The physical goods were declining at an astronomical rate, of between 7% and 12% a year, which is devastating for a business. The CD and all of the infrastructure to service physical goods had huge margins. But once the volume drops down, you can’t make it work. Every year, you try and close down pieces; you try and lose pieces of what you’re doing, so that you’re shrinking the business as fast as you can. Every music business had that same issue. There was no one who was immune. Size made the issue even more difficult. But music continued to be sold and the pirates, in many ways, created a greater level for music. The volume of participation in listening to music expanded at as much of a rate as the decline in the physical goods.

The existential question was, how do you move to a different basis on which you are going to connect with your consumers?

What was the strategy of EMI then, when you’re seeing this physical distribution decline, the market expand, because more people have access to the music, but now the profit pool is, in effect, unknown or questionable?

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Spotify & The Economics of the Music Industry(June 5, 2020)

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