What happens when intangibles become insecure? The story is currently unfolding in the recording industry, which provides us with some valuable insights.
Why Music?
This book has made frequent reference to intangibles in the entertainment industry generally and the music business, in particular. This is not acciden- tal. The entertainment industries “grew up” with intangibles. And although music revenues are dwarfed by those of other core copyrighted industries, such as publishing and software, music has been at the forefront of the changing dynamics that technology has imposed on intangibles. The best explanation is actually pretty simple: Music is now largely digital, and digi- tal music files are small enough to be distributed (legally and illegally) via the Internet. The same cannot be said for movies—yet.
Because of this position, the recording industry has faced technological attacks on its intellectual property faster perhaps than any other industry.
Although it is true that software firms also face massive piracy threats, their property has been digital from the get-go. In this context, the record com- panies’ challenge is unique. Examining their journey and the likely out- comes completes our analysis of securitization, or in this case, the lack of it.
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Why Now?
The combined threat posed by the Internet, Napster, and the MP3 format was not the first major challenge to face the record industry. The fears voiced about the effect newly introduced high-quality cassette decks and digital audio tape recorders would have on record or CD sales sound all too familiar in the current context. Indeed, the Home Recording Act and the definition of fair use were arrived at long before MP3 existed.
However, this time it is different. Today the record industry must con- tend with not just a new format, but a new form of distribution and a new means of production. The fact that music can be shared (for profit or not) via the Internet generally, and through file-swapping software specifically, has serious economic ramifications for artists and labels. Consensus among artists, lawyers, economists and engineers is virtually impossible, but three conclusions are clear.
First, digital speed and space continue to expand rapidly (Moore’s Law)—making rather shortsighted the argument that, in terms of sound or video quality, MP3s and video via the Internet are not good substitutes for
“store-bought” CDs or DVDs. The “poor substitute” argument has all but vanished with respect to audio, but some video observers still make the claim. They will not be able to do so for long.
Second, adequate audio file protection methods—such as encryption sponsored by the Secure Digital Music Initiative (SDMI) have so far proven elusive. It is also clear that consumers expect that some amount of copying is permissible—for timeshifting, archiving, or use on different platforms.
Third, legislation against file-swapping may be ineffective or undesir- able. Although surveys have shown that in just a couple of years, consumers’
attitude toward illegal copying have swung around (from a majority think- ing piracy is acceptable to a majority now thinking it wrong), hostless archi- tecture and fragmented end users make the legal system a tricky enforcement tool. Moreover, findings of contributory liability (coming after the sites themselves) may dampen socially valuable innovation.
Insecure Future of the Labels
There is a future in online music sales, as Apple’s iTunes has made abun- dantly clear. But at the same time, the network of file-sharing is likely to become more decentralized; and increases in bandwidth capacity may fos- ter different technologies. What impact will there be on the supply of raw material, the intangible assets that the music industry needs? What impli- cations does this have for the major record labels? Some consequences of insecurity follow.
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Recording artists who can do so might switch away from recorded music and to live performance. This new product offering will not be pos- sible for all artists, since some only record and others almost exclusively tour. Yet economic forces will drive artists toward investing in the best- protected (or least infringed) form of intellectual property. This could reduce the supply of raw material for record labels; so to attract artists, royalty rates may increase, which in turn might drive down label profitability.
In the face of rapidly improving sound quality over the Web, the royal- ties artists can earn from CD sales will decline. Mechanical royalties, too, could also largely be destroyed by file-swapping over the Internet. Although digital music streaming will be easier for performance rights organizations such as BMI and American Society of Composers, Authors, and Publishers (ASCAP) to monitor than FM radio, digital file-swapping is not.
An up-front royalty scheme might involve collecting fixed fees for artists on all legitimate music sales. “Bot” software could collect download data from commercial sites, with Napster itself (or something like it) becoming the Internet’s BMI or ASCAP, allocating back the royalties col- lected on a proportional share of downloads. But bots also would have to register illegal activity—there is, of course, a propensity for hits to be pirated more than failures, so that more successful artists would have seri- ous concerns about being undercompensated in this type of scheme.
In all cases, if piracy cannot effectively be prevented, then pricing for a legitimate recording must move toward the price of an acceptable substi- tute, which is, in any event, less than it has been. Repricing can probably be viewed as resulting in decreasing margins for the record companies. Con- sumers have shown that they are willing to pay somethingfor legitimate, high-fidelity music, but it is less than the labels apparently thought.
Strategic Shift
Old habits die hard, and this is true for the record industry and consumers alike. It was not until 1991 that audio CD sales for the first time surpassed cassette sales. Even in 2000 sonically inferior cassette sales totaled $626 million. Until the last year or so, cassette players—not CD players—were standard equipment in most car audio systems.
Notwithstanding consumer entrenchment, the most important reason the major labels will not disappear is that the same technological advances that have threatened their very existence are also the forces that ensure their survival. The transfer of digital music via the Internet overwhelms con- sumers. Somebody must provide a floodgate. The market will still require
“tastemakers” to help consumers cope with choice. The major labels still could fill this role.
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There is precedent for a shift in the strategic focus of the major labels.
Fifty years ago the labels served five functions: They discovered talent, matched talent to material, recorded songs, distributed records, and pro- moted artists. In the 1960s singer-songwriters such as Sam Cooke, the Beat- les, Smokey Robinson, and Bob Dylan largely removed the matching function. Then, in the last 10 or 15 years, cheap digital recording technology largely removed the recording function; a major label recording budget was no longer necessary to make a quality record. The Internet now removes the distribution function, leaving the job of the labels to find and promote talent.
The long-run intellectual property of the record company, then, does not reside in its CDs or MP3s. Rather, it is firm-specific capital represented by the firm’s ability to find and promote talent. Consumers will pay for that ability because it reduces their own search costs. What they will be buying is (presumably better) advice. What are the margins on advice? One only needs to look to corollary advice providers—MTV, VH-1, radio, newspapers, and magazines—to get some indication of the value of subscription services.
SUMMARY
This chapter described some of the strategies that make intangibles more secure. Identifying optimal use, extending intangibles’ property characteris- tics, and identifying off–balance sheet intangibles all have the effect of mov- ing more and more proto-assets into the realm of intellectual property. We also looked at some of the recent changes in the recording industry in order to probe intangible insecurity.
Some readers may feel disappointed that we have not arrived at a list of strategic recommendations, an easy to-do checklist, that would advise
“patent all trade secrets” or “securitize all copyrights.” The reason we can- not do this easily is that prescriptive rules for managing intangibles are no more valuable than those for tangible assets. Strategies and decisions about investment need to be informed by principles of economics and finance and they are governed by accounting. In this sense, all the preceding chapters combined give readers the guidance on what to do.
In the final chapter, we work a little on a theory to explain the “most”
intangible assets of all, ephemeral assets such as charisma and beauty.
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CHAPTER 11
Conclusion
I
n Chapter 1 we gave a quick nod to the concept that people have intangi- ble assets, too. Then we talked some about the benefits of education and training, about how those were enhancements to individuals’ balance sheets and also to firms that make investments in human capital. These intangi- bles are quantifiable to some degree—perhaps not always in terms of the benefits they ultimately produce, but more easily with regard to the costs.Tuition and training are usually hard numbers.
But not all economic benefit and its ownership or control flows from what can mostly be described as investments. In some sense, we still have missed the “really” intangible assets. Nowhere in this book have we described beauty, charisma, or other personality traits. Although it is true that one can invest in beauty and charisma, many beautiful and charismatic people are just born with it. People are often successful—that is, they cre- ate economic benefits—using these other qualities not covered by account- ing rules. How can personality traits, the most ephemeral of intangible assets, be valued? How are those traits converted into something more secure? This chapter presents analysis of these most intangible of assets.