E-Commerce Sending Shock Waves Through Music Industry

Simon Wright, the chief financial officer of Virgin Megastore, said this week that music distribution over the Internet could erode his company’s profits enough to drive it out of the business.

Wright’s comments came in response to the proposed merger of Time Warner’s Music Group and EMI. He is concerned that such mergers could hasten online record companies establishing their own distribution systems, thereby bypassing existing record stores.

“We need to be confident that we can generate an adequate return in the future against a background of steadily reducing retailer margins,” said Wright. “We need a proactive response from the record companies to reverse this trend and ensure a profitable future for all elements of the industry.”

Reason for Concern

While music distribution over the Internet is a commercial pipsqueak today, representing less than one percent of overall music sales, Wright has good reason to be concerned.

When AOL and Time Warner announced their proposed mega-merger on January 10th, AOL president Robert Pittman singled out music as one of the areas that he expects to benefit most from the merger — and he was not talking about selling packaged CDs to AOL’s base of 20 million subscribers.

The music industry traditionally goes to great lengths to match its distribution to consumer tastes. About 15 years ago, for example, the industry switched from distributing music on vinyl records to today’s CD format.

At the time, the change had only a minor impact on the existing distribution system. Stores had to change their shelving to maximize the storage of CDs, which had a smaller footprint than a vinyl record album.

The switch to downloaded music, however, is a different story entirely. Record companies can easily set up complete download distribution systems that bypass today’s music stores. Consumers could buy their music online and have it downloaded to their PCs to be played on MP3 players or copied on writeable CD ROM drives.

Which Way Will They Choose?

The big question is whether record companies are going to attempt to bypass existing distributors or whether they are going to work with them in developing digital distribution. This issue is what Wright alluded to when he talked about a “proactive response” from record companies.

“We are prepared to continue to invest in a dynamic ‘clicks and mortar’ proposition,” Wright said. “Record companies and music retailers should adopt a collaborative approach to the Internet to maintain a healthy and vibrant music business.”

Virgin Embraces the Internet

Wright’s comments should not be interpreted as sour grapes. It is a legitimate concern in an industry that is facing a major potential change in how music is distributed. Virgin Megastore, for example, has embraced the Internet in a number of progressive ways.

Chief among their efforts was the November launch of Jamcast.com, a Web site that facilitates direct delivery of music to personal computers. The site allows users to work in other applications on their PCs, while music files are delivered through the background and played over a live Internet connection.

Through technology called IP Multicast, the music comes through the PC — no matter what other applications are open and in use. Promised from Virgin in the near future is a system to receive music using television airwaves. All that will be necessary to receive music instantly is a TV tuner card.

Virgin Megastore is also adding Internet access, listening booths, DJ decks and cafes in its 80 retail stores worldwide.