The record label as venture capital firm

The music industry may finally be ready for the radical move of putting recorded music and artist management under one roof - and Bronfman's Warner Music Group could lead the way, says Fortune's Tim Arango.

By Tim Arango, Fortune writer

NEW YORK (Fortune) -- Three years ago, a couple of economists rankled the music industry when they released a report that ran counter to all common sense by concluding that swapping music for free on the Internet did not hurt sales of compact discs.

The study, by economists at Harvard Business School and the University of North Carolina at Chapel Hill, was hardly the last word on the issue - proving right Nobel prizewinning playwright George Bernard Shaw's assertion that, "if all the economists were laid end to end, they wouldn't reach a conclusion."

Today, it is easy to reach this conclusion: Eight years after the launch of Napster (Charts) and the industry upheaval it induced, the record business is still very much in transition as it grapples with how to survive in the Internet age. Fresh data out this week from the Recording Industry Association of America paints a grim picture of the industry's plight. In 2006 the industry sold $9.2 billion worth of compact discs in the United States, down 13 percent from a year ago. But to truly grasp the tenuous situation of the record business, let's compare the numbers to 1999, when Napster was introduced. In that year the total value of music sold was $14.6 billion. In 2006, the combined value of music sold in both physical and digital form was $11.5 billion.

In other words, even with the proliferation of paid download services such as Apple's (Charts, Fortune 500) iTunes, the industry sold 21.2 percent less product last year than it did in 1999. (Globally, the picture is no brighter. The industry has lost 23 percent of its compact disc sales -- which still account for roughly 85 percent of all music sold -- from 2000 to 2006.)

But some important pieces of the overall music economy -- which the International Federation of the Phonographic Industry values at close to $100 billion -- are growing. The key for the record industry is to tap in to revenue sources that have historically been off limits, such as touring and merchandise. The live concert business, for example, is flourishing. Revenue from North American concert tours grew 16 percent last year to a record $3.6 billion, according to industry trade publication Pollstar.

Labels have been keen to get a piece of this broader music pie. U.K. music giant EMI, for one, has made high profile deals with artists such as Korn and Robbie Williams for a cut of touring. EMI has also hopped into bed with talent management agency The Firm, launching a record label in which all sides - artist, manager and record label - split profits from all areas of the business.

Now, a big industry player is closing in on another type of union that would tap into new revenue outlets -- and if it's successful offer a new economic model for the major record companies. Warner Music Group, which was acquired by Edgar Bronfman Jr. and several private equity outfits in 2003 from Time Warner (Charts, Fortune 500) for $2.6 billion, is inching toward a deal to acquire Front Line Management, the nation's largest artist management firm, owned by the famed manager Irving Azoff. The firm represents a slew of big-name artists, everyone from Christina Aguilera to Van Halen to Aerosmith. (The deal has been rumored for months within the industry, but sources tell me that talks have lately gained momentum).

"In this post-consolidation era, it is definitely groundbreaking for a worldwide record company to do that," said Fred Davis, a prominent entertainment industry attorney.

Can record companies and artist management firms, which have long had an adversarial relationship, coexist under the same roof? The idea has its skeptics, and any deal is sure to be controversial. "The management business and the record business have always had an antagonistic relationship," said one high-level music industry executive. "The manager's job is to work for the artist. If you're an artist, do you want your manager working for your record company?"

Artists have always been protective of their non-recorded music revenue, but they are starting to realize that they may need to cut the record company in on non-recorded music income in order to maintain recording contracts. And advocates of the idea stress that there would have to remain a church and state relationship between labels and managers - and managers might even guide artists to other labels.

"If the investment required to establish a band is the same, but the rewards to record companies are dwindling, than we have to be willing to explore new economic relationships," said Davis. "That may include participation in other non-recorded music streams of income."

If desperate times call for desperate measures, perhaps a complete revamping of the economic model is in order. Instead of running a business that revolves around contracting with an artist to distribute recorded music in its various forms -- CDs, digital files, whatever it may be -- what if labels behaved as though they were venture capital firms, in which entrepreneurs, or artists, in this case, tap in to their patron's deep pockets and expertise to exploit all areas of the business? That's the idea behind merging record companies with artist management firms -- and it looks like the theory will be soon put into practice on a very large scale.

If successful, the industry could find a robust new revenue stream even if people keep stealing music on the Internet. Top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.