Written Case #1: Sony Music Entertainment and the Evolution of the Music Industry

GBA 490-006

Dr. Marino

2/26/2015

Executive Summary

Sony Music Corporation is the American based daughter company of Sony Corporation,

a Japanese company. It was founded in 1929 under the name American Record Corporation and

was later changed to Columbia Broadcasting Company in 1938 after an acquisition. It later

started a joint venture with CBS and formed CBS/Sony Records Inc. By 1988 the company

introduced the compact disc or CD. Later in 1991, Sony absorbed CBS Records Inc. and became

Sony Music Entertainment Inc. In 2004, they created a new joint venture with Bertelsmann AG

and became Sony BMG Music Entertainment. However, four years later they bought back the 50

percent stake from BMG and went back to the name Sony Music Entertainment. In 2012, they

once again established a new joint venture with the Michael Jackson Family Trust forming

Sony/ATV Music Publishing and together acquired EMI Group, making it the largest music

publisher in the world.

Originally the music industry was primarily focused on physical performances by artists,

however, as technology has improved artists now focus primarily on recordings. Over time, the

Internet and technology has allowed these recordings to be shared and downloaded for free

through the use of piracy and digital distribution. With the introduction of Napster and iTunes,

people began using online sources for their music instead of purchasing physical albums at retail

stores. Music retail stores started to see a decline and large companies like Warehouse Music,

Tower Records, Virgin, and Circuit City were forced to file for bankruptcy and later shut down.

Through the use of new self-publishing technologies, artists are straying away from

record labels to produce more income for themselves. This has decreased the growth of large

label producers like Sony Music Entertainment. Digital distribution channels such as digital

downloads (e.g. iTunes), Internet radio (e.g. Pandora), and interactive streaming (e.g. Spotify)

are becoming extremely popular among consumers causing declining market share for record

label companies and publishing companies like Sony Music Entertainment. While the company

has attempted to combat these digital distribution channels by creating Music Unlimited, it has

had little success in competing with other popular streaming services. By establishing a joint

venture with Universal Music Group and Abu Dhabi Media to produce VEVO, Sony Music

Entertainment hopes to create long-term success.

After assessing factors in the music industry as well as factors in Sony Music

Entertainment’s internal and external environment, I have generated two specific

recommendations that will allow the company to compete long-term and increase its market

share and profitability. These recommendations are provided below.

Recommendation 1: Use digital mediums such as VEVO and Music Unlimited to form

connections with new upcoming artists.

Recommendation 2: Establish a joint venture with leaders in the music industry to create

a new technology that will provide security of digital, online data.

Recommendation 1: Use digital mediums such as VEVO and Music Unlimited to form

connections with new upcoming artists.

Due to the fact that self-publishing technologies have created low switching costs for the

record label industry, artists have begun bypassing middleman companies like Sony. Artists have

started to realize that it is often less costly and more efficient to record and publish music

themselves. If Sony doesn’t establish more benefits to their artists then eventually there will be

no need for record label and publishing companies. To combat this trend, Sony should enter into

contracts with new upcoming artists and give them the added benefit of marketing their music

through VEVO and Music Unlimited. This would be mutually beneficial for both parties and

would result in an increase in market share and profitability.

Recommendation 2: Establish a joint venture with leaders in the music industry to create a new

technology that will provide anti-piracy security of digital, online data.

The music industry has been plagued because of piracy and copyright infringements since

the introduction of the Internet and digital age. Downloading music digitally is becoming more

and more popular, and the efficiency of illegally downloading music on the Internet is becoming

easier and easier with very few likely legal repercussions. According to the Institute for Policy

Innovation, “global music piracy causes $12.5 billion of economic losses every year, 71,060 U.S.

jobs lost, a loss of $2.7 billion in workers’ earnings, and a loss of $422 million in tax revenues,

$291 million in personal income tax and $131 million in lost corporate income and tax

production taxes.” This has become a large threat to Sony as well as the music industry itself. In

order to prevent these crimes from destroying the music industry, Sony should pair up with other

industry leaders to invest in technology that will prevent the illegal downloading and sharing of

music

Exhibit 1: Dominant Economic Characteristics for the Music Industry

Market Size and Growth Rate:The music industry is made up of large record label companies and large publishing companies. The record label industry produced revenues of $7.9 billion in 2013 and it has experienced a decline of 9% annually from 2006-2011. However, from 2011-2016 the industry is expected to grow by 1.8% per year. There are currently about 231 companies in the record label industry. The publishing industry is a $4.9 billion industry and has experienced a growth of 1.6% per year from 2006-2011. Its growth is expected to increase by 3.1% annually from 2011-2016. Currently, there are around 1,528 companies in the publishing industry.

Number and Scope of Rivals:There are four major leaders that control the record label industry: Sony, Warner Music, EMI Group, and Vivendi. These four label companies make up 83% of the record label industry and 53.9% of the publishing industry. While these record label and publishing companies are considered some of Sony’s rivals, Sony considers different digital distribution channels to be its main source of rivalry and competition. These digital distribution channels include digital downloads, Internet radio, and interactive streaming. Companies such as Pandora, iTunes, Spotify, Rhapsody, and YouTube are among some of Sony’s largest rivals. The music industry competes globally. Companies and artists must be able to reach out to and appeal to consumers around the world. Technologies such as digital distribution and the Internet have allowed for a large global scope of rivalry among record labels and publishers around the world.

Product Characteristics and Differentiation:Products of competitors are becoming more and more similar over time. It is clear that digital distribution is growing increasingly. Many companies are beginning to use difference methods of digital distribution such as digital downloads, Internet radio, and interactive streaming to compete with other large corporations in the industry. As a result of less product differentiation, pricing has become extremely competitive and profit margins are declining.

Pace of Technological Change and Innovation:Before the introduction of digital alternatives, the music industry was characterized primarily by physical performances as well as recordings that were physically purchased in retail stores. It is imperative that businesses adjust their strategies and create innovative technologies in order to stay competitive with rivals in the industry. Companies should continually invest in research and development to create products that will allow them to not be susceptible to piracy and that will keep them ahead of competitors. It is extremely important that they are able to be the first to introduce new technologies and innovations before other companies can gain their own market share and brand awareness in that particular product. By doing so, they will be able to surpass their rivals and gain market share.

Exhibit 2: Five Forces Analysis

After analyzing the five forces Sony is facing within the music industry, I have concluded that the competitive forces in the music industry are moderate to strong. Rivalry and the threat of substitutes in among the highest of these forces, while supplier bargaining power is the weakest. The threat of new entrants and buyer bargaining power are moderate competitive forces in this industry. Overall, the music industry has room for massive growth and profitability and Sony Music Entertainment has the power to overcome these outside forces through the implementation of new technologies and innovations.

Rivalry: Strong Big four producers (+): Large established brands and companies must compete against

each other for market share as well as new upcoming artists. They are also competing with new mediums of digital distribution.

Self publishing (-): Many artists are using new technologies to bypass record label and publishing companies since it is typically cheaper and more efficient for the artist.

Other digital distribution channels (+): Digital mediums and innovations such as digital downloads, Internet radio, and interactive streaming are growing increasingly.

Threat of New Entrants: Moderate Entry barriers are high (+): New entrants are likely to face high competition, high

costs, revenue volatility, and regulations upon entering the market. Clients are already in contracts (+): Many popular artists are already committed to

contracts from the big four producers. New entrants may have trouble gaining profitable clientele without substantial brand equity.

Digital distribution channels are evolving (-): New technologies and digital innovations are constantly reaching and evolving the market. Companies such as iTunes, Pandora, Spotify, ect. have experienced significant growth in a short period of time.

Threat of Substitutes: Strong Innovation of digital distribution channels (+): Consumers are turning to substitutes

such as digital downloads, Internet radio, and interactive streaming. New technologies are also being created all the time by companies trying to compete in the growing digital music industry.

Piracy (+): Illegal downloads are the main substitute for other legal ways of obtaining music. They are identical to the legal versions while also being free and accessible. It is also fairly unlikely that one would face any legal repercussions for engaging in piracy.

Music on band’s websites (+): Bands such as Radiohead are beginning to self-publish their own music on the band or artist’s website allowing the artist to bypass publishing companies and cut costs.

CDs (+): While CDs seem to be decreasing heavily among consumers, some people still prefer a physical CD as a substitutes for a digital version.

Buyer Bargaining Power: Moderate Low switching costs (+): Buyers have numerous low cost and even free options to

choose from when selecting a music source.

Not a necessity for consumers to have (+): Consumers can choose to not purchase or download any music if they deem it unnecessary or just don’t want it.

Do not typically buy in bulk (-): When purchasing or downloading music digitally, many consumers choose to only purchase a select few songs from an album or artist rather than purchasing the entire album.

Supplier Bargaining Power: Weak Artists dictate supply (-): Artists have the option to record their own music and often

find that it is less costly and more efficient for them. This trend has allowed artists to bypass companies like Sony that are in the business of recording their clients music.

Large amount of potential clients (+): Companies like Sony have a large pool of potential artists that they can select to sign. This gives the artist less power since the record label or publisher could choose to go with a more popular or profitable artists.

Exhibit 3: Driving Forces

Emerging New Technology and Internet Capabilities:As new innovative products and technologies reach the music industry, new services are introduced to the market. Digital downloads, Internet radio, and interactive streaming are among some of the most competitive services on the market currently.

Increasing GlobalizationThrough use of the Internet and other mediums of digital distribution, consumers can now be reached faster and gain access to more digital music around the globe.

Changes in Industry Growth RateWhile record label and publishing companies are experiencing declining growth, the digital distribution industry has seen a rapid growth. Physical album sales in 2010 were 326.2 million which was the lowest since 1992. Digital downloads, however, experienced and 8% increase in 2011 and made up 32% of global music revenues.

Changes in Usage by ConsumersConsumers have begun to use more convenient digital alternatives to obtaining music rather than buying the physical album. Many consumers now use interactive streaming and Internet radio such as Pandora, Spotify, and YouTube as a cheaper and more convenient option. Internet radio revenue has grown by $351 million from 2003-2006. Many digital music companies are now viewing revenue from streaming as a replacement for sales.

Exhibit 4: Key Success Factors

Profitable Artists:Competing amongst other record labels and publishers for popular artists is essential to success in the industry. Gaining profitable and popular artists will make other upcoming artists want to sign as well and will create value for that company in the overall market.

Brand Equity:In the artists and consumers eyes, having a strong, well-known, and trusted brand it extremely valuable. Customers are more likely to purchase and be loyal to a company that is well respected in the industry by other consumers.

User Friendly Service:In this digital era, consumers value ease of use to be a top priority. If a company’s particular service is not as user friendly as an alternative substitute than the consumer will simply switch to a competitor.

Breadth of Product Line:Variety of songs, genres, and artists are vital to a company’s success in the music industry. If the consumer can get a wider variety of music from a competitor to the same or similar price then they are likely to switch to that service.

Technology Expertise:Consumers in this day and age are accustomed to working with technology and have become experts at using and working with it. It is important that companies have up-to-date technology and realize opportunities arising in other industries as well (e.g. smartphone capabilities) Ability to be compatible with new devices reaching the market is extremely important to the consumer.

Product Innovation:The digital distribution industry is extremely fast paced in its advancements and improvements. It is crucial that companies in the industry realize future opportunities and implement them first in the market in order to stay ahead of competitors.

Exhibit 5: Competitor Analysis

Sony’s strongest competitors are types of digital distribution channels. It is clear that digital music is the way of the future and it is vital that Sony is able to combat the following competitors to grow profitability in the long-run.

iTunes:iTunes accounts for 77.4% of digital music revenues and is expected to grow by 39% over the next three years. They were first to market when consumers began turning to online sources of music and as a result they have experienced tremendous growth and revenue. The company has also created an Internet radio and self-publishing system in order to compete with companies like Pandora and Spotify as well as the publishing companies.

Amazon and CD Baby:Amazon and CD Baby fall below iTunes with 10.5% and 4.5% respectively of digital music revenues. Both companies have also created value for artists with a self-publishing system.

Pandora:Internet radio has become increasingly popular amongst consumers and consumers with smartphones since it is accessible and can be used as a free service or paid for with a subscription. By 2014 smartphone users had reached 58% of cell phone owners in America. As of 2013 Pandora had 73.6% of the Internet radio market share with 250 million users and a revenue of $194.3 million.

Spotify and Rhapsody:Spotify and Rhapsody have experienced significant growth in the interactive streaming industry. In 2014, Spotify had 24 million users. Spotify, like Pandora, can be used limitedly for free or paid for with full access. These services allow consumers access to a wide variety of music instantly as well as the ability to create playlists and see featured artists.

YouTube:While YouTube was originally designed for video sharing, it has become very popular in the music sharing community. The company gained use of copyrights by allowing users to hear the song and then provided a link so they could purchase it legally. YouTube is likely to compete heavily with Spotify in the future as it is rumored that YouTube will come out with a similar subscription service for interactive music.

Exhibit 6: Strategic Group Map

Sony, Rhapsody, and CD Baby are sectioned in the limited, low price category. This is because they each offer a selection of fewer variety than its competitors with a price that is also higher than its competitors since each service requires some sort of purchase or monthly subscription that it more expensive than other alternatives. Additionally, these services are not available on smartphones making their use limited to computers and other sources. Pandora, Spotify, and YouTube are positioned as extreme low price competitors with much accessibility. Each can be used for free with limitations or with a subscription for full access. Each service can also be accessed through the use of a smartphone, computer, or other Internet capable device. Lastly, iTunes is in a central location with great accessibility and a wide variety of music. While iTunes users are required to purchase the music, iTunes also offers a free Internet radio. Much like iTunes, Amazon is a market share leader in digital distribution. This is primarily because of their competitive prices and success with their self-publishing system Create Space. Each company varies in certain characteristics, however, price and variety seem to be some of the most important factors to consumers in this industry.

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Exhibit 7: Financial & Performance Evaluation

2008 2009 2010 2011

Operating Profit

Margin5.36% -2.95% .44% 2.78%

Sony’s operating profit margin plummeted in 2009 most likely from the introduction of new cheaper and innovative services and from the company’s failure to compete in new market opportunities. It slowly increased from 2010 to 2011, however, it has not been able to reach the profit margin it produced in 2008. Sony also reported a loss of 9.9% on music sales while producing an increase in operating income of 6.6%. This increase was primarily due to the decrease in costs such as marketing, restructuring, and overhead.

Exhibit 8: Business Level Strategy

In the past Sony has been extremely successful and has gone through many acquisitions and business deals in order to remain a leader in the music industry. Currently Sony is a large industry leader in record labels and publishing, however, they have begun to make changes in their previous strategy to adjust to the market conditions and trend of digital distribution. They are competing with top performers such as iTunes, Amazon, Spotify, Pandora, and YouTube. Sony has positioned themselves well in the record label and publishing industry but with the increase in self-publishing, they are at risk for a major loss unless they find success in the digital distribution market. While Sony’s business level strategy has created tremendous profits and success for them in the past, they must alter it to compete with digital music companies and arising technologies and opportunities.

Exhibit 9: SWOT Analysis

Strengths: Brand Name: Sony is known for creating valuable, innovative products and continually

pleasing their customers. Awareness: They understand that digital distribution is growing rapidly and they must

enter that market to compete. They are also aware of who they must compete with. Instead of competing with the big four, they must compete with innovators in the digital distribution industry.

Significant Market Share: They have a large share of the record label and publishing

market. This will allow them to work with their current loyal customers to create valuable business opportunities in the future.

Well respected: Their customers have been loyal to the company and respect their business decisions. Ultimately, this will keep the customers coming back.

Recognized Globally: Sony is known around the world allowing them to reach consumers easily and faster than ever.

Weaknesses: Ability to adapt to trends in the market: Sony has struggling significantly to keep up

with the new digital age of music. Their creation of Music Unlimited has been somewhat unsuccessful and is falling way behind other rivals.

Decline in financial performance: Sony has experienced extreme loss in revenues and growth in their recording and publishing sectors.

Market share in digital music: They have very limited market share in the digital distribution industry. Music Unlimited has not been able to compete with companies like iTunes, Pandora, and Spotify.

Opportunities: Rapidly growing market for digital distribution channels: The market for services

such as Internet radio and interactive streaming are growing increasingly. Sony has the opportunity to get into this market and produce large and growing profits.

Availability to market artists through subscription based music services: While recording and publishing companies are seeing a decline in growth, through the ability to market their clients through a subscription based music service, they would be able to offer them a benefit that self-publishing services could not.

Threats: Piracy and copyright infringements: Consumers are able to get access to virtually any

music they could possibly want through the use of illegal downloads. This is a threat for the entire music industry since consumers are bypassing their services altogether with little to no legal punishment.

Self-publishing services: Self-publishing services like Amazon’s Create Space as well as CD Baby have made it possible for artists to record and publish music themselves cheaper and more efficiently. This is a threat to current recorders and publisher since artists may began to deem their services unnecessary.