Cashville USA

(Fortune Magazine) -- It's the Tuesday after Thanksgiving, and a handful of country music's biggest names have gathered backstage at the Mercy Lounge, an upstairs club in the Cannery Row section of Nashville. The cramped space has a post-collegiate feel: Pizza boxes are piled high on the kitchen counter, and a tin tub full of ice and beer sits in the corner near the bar.

The occasion is the induction of veteran country star John Anderson into the Muzik Mafia. Anderson has enjoyed several No. 1 hits during his career, and the Muzik Mafia is a collective of country artists that began gathering for jam sessions five years ago and has appeared on MTV Network's Country Music Television (CMT).

Saturday Night Lights: Nashville's Honky Tonk row on a Saturday night last fall.

More from Fortune

Will Mmmhops be a hit? NBA confirms L.A. Clippers sale to ex-Microsoft CEO Steve Ballmer FBI and SEC probe into Carl Icahn and golfer Phil Mickelson

FORTUNE 500 Current Issue Subscribe to Fortune

Backstage, John Rich, one-half of the duo Big & Rich and a Muzik Mafia founder, is talking about the fun he's having in the studio recording AC/DC covers. Gretchen Wilson, whose best-known hit song is "Redneck Woman," is holding court in the kitchen.

Around midnight Jon Bon Jovi and Richie Sambora saunter in. The veteran rockers have been in Nashville almost nonstop since August, following the band's worldwide tour. They are recording a country album. But it is not just the dulcet tones of the dobro that have lured the Jersey boys south of the Mason-Dixon Line: It is also the ka-ching of the cash register.

Since Napster launched in mid-1999 and sent the record industry into a tailspin, country music has more than held its own: According to Nielsen SoundScan data, country album sales grew more than 12 percent between 2000 and 2005, a time that saw the overall industry decline more than 20 percent.

Through mid-December, sales were up 2 percent, which is impressive when compared with a 20 percent slide in sales of rap albums. Rascal Flatts was the bestselling band last year in any genre, boasting a better debut week than rapper Jay-Z's comeback album. "[Country] is a growth stock in an industry that has no growth in traditional sales," says Andrew Lack, chairman of music giant SonyBMG.

There are other indicators of country's financial heat. Erstwhile rap mogul Lyor Cohen, CEO of Warner Music U.S (Charts)., whose contributions to pop culture include nurturing the careers of Public Enemy, Jay-Z and Ja Rule, is hunting for an executive to open a new Nashville outpost under the Atlantic Records banner.

"When I started going to Nashville in the 1970s, it was a very different economic model for country music than it is today," says attorney Joel Katz, arguably the leading dealmaker on the scene. "What was happening 30 to 35 years ago was there was a double standard compared to what pop artists would be paid in New York. Now a country artist gets paid the same as, if not more than, a pop artist in 2006."

Katz works out of an office in Atlanta rife with the bric-a-brac collected during three decades as an entertainment lawyer - a signed Yogi Berra shin guard, a Grammy award, and a photo of him with the record producer Dallas Austin. Austin had a brush with notoriety last summer when The New York Times reported how Katz had teamed with Utah Senator Orrin Hatch - a sometime songwriter who is also a Katz client - to secure Austin's freedom from a prison in Dubai, where he had been arrested for cocaine possession.

Katz may work 250 miles away in Atlanta, but he is in the thick of Music City commerce. He represents artists ranging from George Strait to Willie Nelson as well as many of the top-label executives, including the heads of the Nashville divisions of Universal Music, Warner Bros. and SonyBMG, and the general manager of Country Music Television.

He is not surprised that the major labels and rock artists are looking toward the Nashville skyline to boost sales. "It's very profitable - in an industry that needs revenue and profitability," he says.

Part of the allure is country's lower cost base, which brings fatter margins to the table - a fact that country executives say has earned them respect from their bicoastal bosses at a time of industry penny-pinching. According to estimates from one label executive, the average country album costs $300,000 to $350,000 to record, compared with $500,000 to $1.5 million for a pop record. To market an album in country costs about $500,000 to $1 million, about half what a pop album runs.

While record companies don't break out financials for their Nashville divisions, one major country label is poised to earn roughly $40 million on revenue of close to $120 million this year, or a hefty 33 percent profit margin, according to a source familiar with the label's finances. By contrast, this source said, a rock label would be "thrilled" to earn a 15 percent margin.

Another reason for country's success is the genre's ability to sell CDs, not just downloadable singles. When Joe Galante, the head of SonyBMG Nashville, visits local malls, he notices that the floors of cars in the parking lot are still littered with CDs. "In the pop world they're more worried about ringtones and downloads," he says. "That's not the worry here. The thing we're worried about is building careers."

Career building is not just talk. When I was in town, I sat in a meeting at Capitol Records Nashville at which the label's CEO, Mike Dungan, and his staff were puzzling over ways to revive the sagging fortunes of Eric Church - a country rocker in the mold of one of the label's biggest stars, Keith Urban. After raves from critics, Church's album - which came out in July - failed to sell well. Instead of dropping the artist, Dungan and his team were cooking up ideas to reach the female demo.

Jon Bon Jovi has noticed the mellower feeling of the local scene. "Nights like last night you just don't see elsewhere," he says of the Muzik Mafia jam session as he sips a sugar-free Red Bull at Blackbird Studios, where he's putting the finishing touches on his album. "These are all artists with record deals. And people are getting drunk, telling jokes, getting on stage."

Last year the band got a sense of country's potential with the song "Who Says You Can't Go Home," a duet with Jennifer Nettles of Sugarland. The genesis of Bon Jovi's crossover project was an appearance with Nettles on CMT's Crossroads, which pairs country hitmakers with artists from other genres. The song hit the top of the country charts.

"If you point to how CMT has changed the business, we've stirred the pot a bit," says Brian Philips, head of CMT. Crossroads is the top-rated show at the network, which has seen its ratings go up 74 percent among viewers aged 18 to 49 in the past five years.

After the success of "Who Says You Can't Go Home," Bon Jovi wanted to record a whole album like it. "[The album] is us with a little more twang to it," he says. Fittingly, the album's producer is Dann Huff, a Nashville native, who returned to Music City in 1990 after he gave up trying to become a rock star in Los Angeles. He now is the go-to guy for artists looking for crossover appeal (and someone who has the bandwidth to produce albums for both Megadeth and Faith Hill simultaneously).

Even for a band like Bon Jovi, which still has a massive fan base - some 2.2 million fans bought tickets during last year's tour - going country is a way to extend their reach. Says Huff: "As long as they're not perceived to be pandering to country, they have a shot at getting some new fans." Which, for the band and its record label, should mean even more money in the bank.

Neglected Napster: No buyer in sight