If one ever wanted to see the business model those of us in the ‘music industry’ are leaving behind – whether we like it or not – check out the recent ‘Starr et al v. Sony BMG Music Entertainment et al, U.S. Second Circuit Court of Appeals, No. 08-5637.’ Its the decision of a federal appeals court in New York in response to a case filed on behalf of music downloaders who accuse the four major record labels – Sony, EMI, Warner, and Universal – of engaging in a conspiracy to fix prices and terms under which music could be sold over the Internet. The court did not render a final ruling but determined that the Plaintiffs had ‘enough factual matter (taken as true) to suggest that an agreement was made.’

I strongly recommend that AllHipHop.com readers go through the case documents for themselves (http://www.docstoc.com/docs/22474623/Starr-v-Sony-BMG), as one might be amazed at how enlightening Court cases on commerce can be (especially Supreme Court rulings dealing with the Sherman Act). But the meat of the case boils down to whether or not these four companies, said to control over 80% of all music sold in the United States of America agreed to set a ‘wholesale price floor’ for selling music at 70 cents per song and reinforced it (you know – aka ‘strongarmed’ or ‘gangstered’) through licensing agreements that restricted the availability and use of the music to forums it controlled. The Defendants argue that the four majors refused to do business with the popular online eMusic service which charged only 25 cents per song without restrictions on how users could upload music to iPods or burn to CDs.

Starr v. Sony BMG matters to me for reasons different than those of most observers.

Sure, I don’t doubt a conspiracy [by the way isn’t hilarious to know that the masses are mocked for believing in conspiracy theories when so many criminal (RICO for instance) and commercial court cases like this one revolve around it?] by the major 4, and I feel the magnetic pull of cheap or free music like everyone else. But as a Hip-Hoppreneur ™ my primary concern is the business model of the music industry and how it relates to artistic expression, entrepreneurial development and political chess-playing.

In that light, I see the case as another form of evidence of two things.

First the case shows that the power of the record label (independents too) is fading not because of the declining price of music but because it continues to ignore how to create value with music. Second, Starr v. Sony BMG also suggests to entrepreneurs and artists that the era of giving away music in order to promote oneself and using the Internet to sell only music has reached the point of diminishing returns.

We are leaving the price-war era of the music industry which saw major chain stores and Mom and Pop record stores go under, because they were sandwiched in between the demand for free music from their consumers and the restrictive pricing of record labels while needing to charge a premium in order to make a profit.

The Chain and Mom & Pops died because they really did not know what business they were in (more than just music selling) and could not transition into what I call the era of ‘freemium’ where the strongest that will survive will be those who find the right mix of both free and premium goods and services they charge for. Relying only on music sales, I believe is a death sentence that can only be delayed, not lifted.

The winners and losers will be determined by how well the major record labels on one hand; and artists and entrepreneurs on the other, create value, not just provide affordability to consumers.

A simple formula utilized by business consultant Rick Kash is the scorecard.

Any and every business needs to acquaint themselves with the mathematics.

Value = Benefits/Price

We only have to have reached seventh grade (not a given for all of us) to know that in this equation value is created in only two ways – either decrease price or increase benefits.

The basis of what record labels and most artists and entrepreneurs in the Internet era have been competing with one another on is price. But the basic laws of supply and demand make clear the outcome of that decision. When supply increases more rapidly than demand, prices must go down. The record labels have been fighting a losing battle in reversing this trend by attempting to limit the supply of music – thus making it more ‘scarce’ and therefore more valuable – and flirting with setting artificial price floors (as alleged in Starr v. Sony BMG) to keep the natural laws of economics from working and taking the price down to zero.

Music, not entirely, but in a very important commercial sense, is now essentially a commodity, no different than oil, water, gold, or rice, or cotton in its current condition. Its pricing power is determined not by its own qualities, but by external factors. Therefore it can only become more valuable, and earn a greater price, when demand for it is greater than its supply or because it makes other things more valuable.

For it to move out of its current commodity status it will have to be combined with other commodities, products and services. The immediate future of music, I hate to say it, is now something like butter, garlic and onions. Very few of us buy these items to eat them just as they are (although garlic and onions are believed to have medicinal and healing effects). But when combined as ingredients, they add and create value.

There was a time when the record labels were creating value by simply making music. Those were the days when the technology to produce, arrange and combine different sounds was expensive and exclusive (recording studios, orchestras, live bands); the expertise and network to market and promote it was a profession in and of itself (headquartered by skilled and connected marketing departments); and the distribution channel was hierarchical and spread across different geographical regions (manufacturing plants, chain stores, Mom and Pop record stores).

But over the last two decades in particular, with the advent of music television, radio formats (Hip-Hop and Urban in particular), beat machines, samplers, the Street DJ, CD, Internet, independent publicist and record promoter – the merger of technology, entrepreneurial energy, and critical mass of talent coming out of the music industry system made it easier for people to make music; consumers to access it and place it in hierarchies and categories they preferred (mixtapes, iPods and even satellite radio formats); artists to become famous (or at least create their own buzz); and music to be distributed and even sold (mp3s, downloading and e-commerce) without large infrastructure and staff.

There are still a few areas where the major record labels create value, primarily through marketing and promotional connections and expertise, and this is why we have the 360 record deal – where labels try to leverage this area as an argument to share in more of the value artists create in other areas (movies, endorsements, shows, and merchandise) which the old business model prevented record labels from sharing in. I previously wrote about this at: https://allhiphop.com/stories/editorial/archive/2009/12/08/22049697.aspx

The trend of the last 20 years – just described – has led to the rise of a special kind of entrepreneur – the independent label mogul, or business specialist – capable of performing most of the tasks of a major record label at a fraction of the costs and with a greater profit margin. The best at this kind of work I know of is my good friend Wendy Day (http://www.wendyday.com/) whose phenomenal work was recently empirically (that means with stats and math!) verified in a study by Tom Silverman which showed that a label she built and consulted – TMI Boyz – was the second largest selling independent release of the year. Explaining more of the details of the success, Wendy recently blogged of the Silverman study:

“He pointed out that in 2009, there were 1,500 independent releases in all genres. Of those 1500, only 13 releases sold over 10,000 units (that’s only $70,000 to $100,000 in wholesale sales). The #2 release was the label I consulted, TMI Boyz. They were one of the ONLY rap acts on that short list of 13, and the #1 selling rap release. And that list was based on the (inaccurate) SoundScan sales of 30,000 CDs sold. While on the road for a year and a half, TMI Boyz sold 2 mixed CDs and a full length CD. Tom’s research was based solely on the CDs that were sold at FYE stores in the mid-South. Since we weren’t focused on SoundScan, just on making money, we weren’t trying to have each sale counted. The bulk of sales were at shows, Mall parking lots, state fairs, flea markets, street corners, gas stations, car washes, high schools, clubs–anyplace where a mass of people were gathered so TMI Boyz could jump out of their wrapped van to make a sale. You may have never heard of them, but they made $1.6 million in sales in 2009. Isn’t that the best measurement of all?”

If you look at what Wendy and TMI accomplished in terms of what I have been writing about you can see that they not only made hot music but they built virtually an entire industry, and even economy, when one considers they sold what they did after the death of the Mom & Pop record store which had been critical to the success of Hip-Hop sales.

[For more of the importance of the Mom & Pop and why I described its demise as the single biggest Hip-Hop industry event of the last decade see my piece at: https://allhiphop.com/stories/editorial/archive/2009/12/22/22073303.aspx]

I could make the case that Wendy Day alone – through her efforts to educate artists, journalists and the general public; her business consultations; and her always colorful private and public confrontation of music industry practices – may have done more on the margin to help shift the paradigm in favor of independent label entrepreneurship.

The challenge now – for independents and majors – is to create value through the new dynamic of ‘community’ which social media has made easier. Simply accumulating thousands and millions of Twitter and Facebook followers and fans without a new business model in mind means that ultimately the exercise will only result in a futile effort to sell more and more people cheaper and cheaper music, while risking alienating or underwhelming supporters with meaningless ‘updates’ (there is logic to why Jay-Z shunned Twitter for so long). Already many of us know the diminishing returns of social media saturation, which will only increase.

In terms of the formula Value = Benefits/Price one can see that with social media creating communities around the brand, image and reputation of an artist’s celebrity and reality, much more than music can be sold. This is the basis of some of my marketing advice for Jay Electronica, my building with Wyclef , my writing about the new life that ‘fan clubs’ can take on; and my thoughts on the importance of an artist’s ‘story’ (read here).

By giving away some music for free or more cheaply, and making other forms of it available, along with information (placed in the right categories and hierarchies), and providing exclusive access to an artists’ celebrity and reality, a goldmine awaits us.

Of course it will mean a certain kind of artist will become ‘extinct’ while another type becomes more appealing, but more on that in the future.

It’s time to stop worrying about lowering price so much and focus more on increasing benefits.

Not all free and not all fee, but freemium.

The results can be priceless…

Cedric Muhammad is a business consultant, political strategist, and monetary economist. He is also a former GM of Wu-Tang Management and a Member of the African Union’s First Congress of African Economists. He is author of the book, The Entrepreneurial Secret (http://theEsecret.com/). His talk show, ‘The Cedric Muhammad and Black Coffee Program’ can be viewed every Wednesday from 12 to 5 PM EST (USA) at: http://www.cedricmuhammad.com/media/. He can be contacted via e-mail at: cedric(at)cmcap.com