Commentaries

NARM President's Keynote Remarks To Dutch Retailers' Annual Conference

Good afternoon, everyone, and thank you to Martin for his kind introduction.

I'm delighted to be here in Holland, and to be at my first NVGD meeting. I first learned about NVGD back in 1994 when some retail organization executives got together at Midem and I had the pleasure of meeting Hans Puls. As we began talking, we all realized that even if we were from Holland, England, Germany, or the US, many of the issues and challenges we faced were the same. And we started to realize that it would be good to begin regular communication. Last year that closer communication turned into a formal organization called the Global Entertainment Retailers Alliance. Now I get to work more closely with Martin and with Theo van Sloten, and I consider this both a privilege and a pleasure.

Since GERA was formed last year, there has been one topic that has dominated our list of common concerns, and it's the same topic that preoccupies NARM retailers back in the US. I speak, of course, of e-commerce, and digital distribution. Neither represents a very big share of sales in the marketplace, but both represent the future.

While retailers in general are working feverishly to launch and fine-tune their strategies for e-commerce, music retailers also face the incredible challenge of devising strategies for a product that, because it can be digitally distributed, is vulnerable to piracy by both consumers and record labels.

I know you understand piracy of your sales from illegal CD-burning. In fact, NVGD was the first to bring CD-burning to NARM's attention over two years ago. While each country has its own idiosyncrasies of pricing, and taxation, and content availability, what we all share is a consumer dissatisfied enough with the marketplace offering to be seeking alternatives, either through CD-burning or Napster.

Napster software has now been downloaded by around 60 million people. And while we understand the attraction of free music, radio is free too. So NARM's been taking a closer look at US consumer attitudes and behaviors towards music online in an effort to try to better understand the Napster phenomenon.

First a few statistics to set the stage. By the end of last year, about 44% of the US population was online. Only 6.5% of that online population has a broadband connection, but a significant portion of kids in college have access to high speed connections at school. Not surprisingly, consumers with broadband access are almost twice as likely to use their connections for downloading music as people with slow dial-up connections. So let's look closer at those college age Napster users.

For just over 40%, the main reason they download is so they don't have to buy the CD. But they only download a whole CD about 9% of the time. 55% of the time they're downloading just a single song,and 75% of them have gone on to buy the CD anyway, at least some of the time.

Now, let's put those statistics with the sales figures for NARM retailers for last year. Our members sold ten and a half billion dollars worth of music last year which is about what we sold the year before. So music sales were flat. Napster effect? Well,

apparently whatever sales were stimulated by Napster sampling were offset by cannibalization.

What about singles sales? They fell from $195 million in 1999 to $155 million last year. RIAA said Napster killed single sales, but most of my members also blame the record companies who just stopped putting singles out. You can't sell what isn't available.

We tracked sales of digital downloads for the first time this past year. But sales were too small to measure. So let's look at what's happening with them, and why they have yet to take off.

Over 80% of NARM retailers have launched websites, and they are actively seeking to compete with Napster by offering legal content. They haven't been able to be as aggressive as they would have liked, and there are a variety of reasons. One reason that sales have been so small is that there is still a battle going on over technology. Record companies were offering content in Liquid Audio, Microsoft, Real, MusicMatch, and Winamp. There were four different codecs, six different clearing houses, and seven different hosting and delivery sources. None of these players are interoperable, so the potential for consumer confusion is enormous.

SDMI announced just last week (as I'm sure you have all heard, since the meeting was in Amsterdam) that they've been unable to reach agreement on a final security standard for digital delivery. That doesn't bode well for retailers who want to satisfy consumer demand for digitally delivered product now.

Here's another obstacle. Some of the content has come with "click wrap" agreements in which the consumer is asked to agree to all sorts of restrictions on use that they've never had to deal with before. Some of them were pretty awful and included things like agreeing that they won't donate their computer to the local library or leave it in their will when they die just because the music files were there.

Also, there weren't any guarantees on these products from the record companies, so retailers were being asked to sell something that they couldn't stand behind, and no retailer wants to be put in that position.

The biggest obstacles, however, were the business models from some of the companies. The only way for a retailer to get content from three of the five record companies is to agree to be an "agent" retailer. The record company sets the price, delivers the download, captures the customer data, and the retailer gets paid a small commission for sending the consumer to the record company. Another company uses a more traditional retailing model, but every download transaction involving their music contains a "pop-up" screen that invites the customer to sign up for a newsletter or a fan club run by the record company. Only one company has flatly stated that they aren't interested in being a retailer, and that's the company that's been for sale for the past 12 months.

Perhaps the small sales figures on downloads don't matter anymore because the record companies appear to have lost interest in downloads anyway. Certainly only a tiny fraction of their catalogs has been made available as digital downloads. Of much more interest currently is the concept of a subscription service in which the consumer pays a flat fee for on-demand music streams. What are the implications of this model for music retailers?

You probably have read about MusicNet, the joint venture owned by AOL Time Warner, BMG, EMI, and Real Networks. After the announcement, NARM wrote to the labels involved applauding the decision to make content available, and the willingness to license third parties. We asked for assurances that the licensing terms for retailers would allow them to compete with Real and AOL, MusicNet's first two customers. We hoped their view of tomorrow's marketplace included vibrant competition. I'd like to quote from the letter I got back from Dick Parsons at AOLTimeWarner:

"Dear Ms. Horovitz, Thank you for your letter of April 25th, and for sharing your views and concerns regarding MusicNet with us. Sincerely, Dick Parsons."

It is a letter that is striking for what it didn't say. It pointedly offered no assurances that Time Warner wanted retail in its future. At least MusicNet talks about licensing third parties. Duet, the joint venture between Universal and Sony, is apparently only going to be offered to other content owners.

So what are we to make of these developments? It would appear that music retailers also share the impending piracy of your sales by a whole new breed of retailers which includes your own suppliers. Record companies see digital product in tandem with digital distribution as a way not just to market, but also to sell, directly to consumers. There is an all-out effort under way to collect consumer data as fast as they can. Here are a few examples.

- invitations to join fan clubs through blow-in cards in CD's and through artist sites on the internet;

- free downloads in return for email information;

- free CD's in cereal boxes - just fill out this form;

- and, of course, hyperlinks on the CD's retailers sell take consumers to artist sites. (Sorry, there is still no ruling from the judge in our lawsuit against Sony on that practice.)

While everyone is understandably excited about the possibilities of one-to-one marketing on the Internet, I think retailers have some legitimate concerns regarding the practices of record companies in the seeking and handling of consumer data. First, there is the possibility of violating consumer privacy, an area in which Europe is far ahead of the US, and second, if everyone from the band to the label to the store is marketing to the same customer, there is the potential for over-marketing and making the customer angry.

Here's the last element of record company behavior that we at NARM find troubling. There is an effort to require license agreements even for marketing and promotional efforts in the U.S. Now, some of you believe that compensation should be paid to the record company or the songwriter for playing music that promotes the sale of the record. In the US, we've had an exemption from paying royalties for in-store play. But whether you pay royalties or not, you've never had to seek permission to promote the products you sell. At least two record companies are now asking music retailers to sign license agreements just to play 30 second clips at the point-of-sale online. We at NARM are concerned about the implications of this practice. We fear that record companies may use licensing agreements as a way to control which companies will be allowed to compete in a digitally distributed world. Companies they own, like CDNow for example, may get to do marketing and promotion denied to companies which are independent. The net effect could eliminate some retailers from the marketplace altogether.

So, thus far, I've not painted a very encouraging picture of the digital future for retailers. Piracy on one side and cannibalism on the other. But it's not all bleak. Let me point out some encouraging facts. First, several studies have shown that consumers do understand that music has value. They don't expect it to be free. They are willing to pay for downloads, and they are interested in subscription services. But they do want more control over their music, and they only want to pay for what they like. So consumer piracy can be brought under control if we get the right offering into the marketplace.

Second our research found that consumers didn't see downloading vs. buying CD's as an "either -or" proposition. They still want to maintain CD collections even while building separate collections of downloads. So we think retailers will be selling CD's for quite a while to come.

Third, consumers still love the shopping experience. Even the biggest computer fans didn't want to lose the opportunity to shop in a physical store. So for retailers, the optimum combination of the future would appear to be "bricks and clicks". We will need to satisfy consumers in both the digital and the physical medium. In that regard, I applaud the efforts of NVGD to develop the online music retail site "Platenzaak" for your members. When the record companies finally get the technology challenges of digital distribution solved, and they will, you will be ready, and you can insist on being involved.

Last, I think we shouldn't under-estimate the power of retail in selling music. Retailers will always be the most powerful content aggregators. Even Duet and MusicNet only represent about 50% each of major label content. And retailers have spent years finding a niche and developing a brand around that niche. Whether you're known for service, or selection, or price, or convenience, or beautiful stores, you have earned the trust of your consumers over the years. Now, more than ever, you must work hard to keep that trust, and to translate it into the power of the Internet.

Here's another important statistic: My members total gross volume last year was over $26 billion. Music accounted for less than half the revenue. Now to be sure, I have sales from some huge consumer electronics merchants like Best Buy , and some big book retailers like Borders, reflected in my numbers. But even specialty retailers are carrying DVD's, and greeting cards, clothing and candy, and yeah, even blank CDR's. The main message here is that US retailers are finding lots of ways to connect with their customers, more and more of which don't involve music. So be creative, and don't be afraid to experiment with new product lines that fit the lifestyles of your core customers.

Here's the last message I'd like to leave you with. The next few years are going to be messy. The product is changing. The economics of the business are changing. The laws are changing. The competitors are changing. The relationships with record companies and radio stations and even with the artists are all being tested. It would very much appear as if it will be only the strong that will survive in a digital world.

But strong does not necessarily have to mean big. It does have to mean good. So take the time now to assess your business and address everything you need to in order to be the best at whatever niche is represented by your brand.

Strong also has to mean engaged and involved. Today retail represents over 95% of the business. Now is the time when NVGD can best represent your interests before copyright owners and government. Support your organization and help them help you.

Thank you so much for inviting me to be here. And I invite you all to come see me at a NARM convention some time.