Atlantic Records' digital sales surpass CDs

By | November 26, 2008 at 2:41 PM

Since MP3s first became popular a decade ago, music industry executives have obsessed over this question: when would digital music revenue finally surpass compact disc sales?

For Atlantic Records, the label that in years past has delivered artists like Ray Charles, John Coltrane and Led Zeppelin, that time, apparently, is now.

Atlantic, a unit of Warner Music Group, says it has reached a milestone that no other major record label has hit: more than half of its music sales in the United States are now from digital products, like downloads on iTunes and ring tones for cellphones.

“We’re like a college basketball team on an 18-2 run,” said Craig Kallman, Atlantic’s chairman and chief executive.

At the Warner Music Group, Atlantic’s parent company, digital represented 27 percent of its American recorded-music revenue during the fourth quarter. (Warner does not break out financial data for its labels, but Atlantic said that digital sales accounted for about 51 percent of its revenue.)

With the milestone comes a sobering reality already familiar to newspapers and television producers. While digital delivery is becoming a bigger slice of the pie, the overall pie is shrinking fast. Analysts at Forrester Research estimate that music sales in the United States will decline to $9.2 billion in 2013, from $10.1 billion this year. That compares with $14.6 billion in 1999, according to the Recording Industry Association of America.

As a result, the hope that digital revenue will eventually compensate for declining sales of CDs – and usher in overall growth – have largely been dashed.

“It’s not at all clear that digital economics can make up for the drop in physical,” said John Rose, a former executive at EMI, the British music company, who is now a senior partner at the Boston Consulting Group.

Instead, the music industry is now hoping to find growth from a variety of other revenue streams it has not always had access to, like concert ticket sales and merchandise from artist tours. “The real question,” Mr. Rose said, “is how does the record industry change its rights structure so it captures a fairer percent of the value it creates in funding, marketing and managing the launch of artists?”

Ever since 1999, when the popular file-swapping service Napster was created, the music industry’s fate has been closely watched by other media companies – television, film and print publications like newspapers – whose traditional businesses are also under siege.

In virtually all these corners of the media world, executives are fighting to hold onto as much of their old business as possible while transitioning to digital – a difficult process that NBC Universal’s chief executive, Jeff Zucker, has described as “trading analog dollars for digital pennies.”

In each of these sectors, digital remains a small piece of the business. NBC has said it expects $1 billion in digital revenue by 2009; over all, the company’s revenue last year was more than $15 billion. Time Inc., the largest magazine publisher, with publications like Sports Illustrated, People and Fortune, said that about 9 percent of its $2.2 billion revenue in the first half of this year was derived from digital. In October, The New York Times Company said that online revenue accounted for 12.4 percent of its overall revenue.

On Tuesday, the Warner Music Group reported that digital revenue for the full fiscal year rose 39 percent, to $639 million, or 18 percent of the company’s total revenue. Over all, the company topped the expectations of Wall Street analysts – who on average were forecasting a small loss, according to Reuters – by reporting a net profit of $6 million in the fourth quarter. Revenue fell 1 percent, to $854 million.

Atlantic, whose artists include the Southern rapper T. I., the rock band Death Cab for Cutie and Kid Rock, appears to be the first of the major labels to claim that most of its revenue is coming from digital sales – and it says it has done so without seeing as steep a decline in compact disc sales as the rest of the industry.

This performance is sharply at odds with the trends in the music industry over all, where data show that sales of compact discs still account for more than two-thirds of music sales. Forrester Research does not expect digital music to reach 50 percent of the overall pie until 2011.

Analysts said they were surprised that Atlantic – with the highest overall market share in the industry this year – had such a high percentage of digital revenue.

“That’s a lot,” said David Card, a digital music analyst at Forrester Research. “That’s very high. No one is near that.”

The question, then, is whether Atlantic’s performance is an outlier or a signal that the music industry is reaching a pivot point as it moves toward a new business model.

“I think we’ve figured it out,” said Julie Greenwald, president of Atlantic Records. “It used to be that you could connect five dots and sell a million records. Now there are 20 dots you can connect to sell a million records.”

In making that transition to a digital business, the music business has become immeasurably more complicated. Replacing compact disc sales are small bits of revenue from many sources: Atlantic Records’ digital sales include ring tones, ringbacks, satellite radio, iTunes sales and subscription services. At the same time, record labels – Atlantic included – are spending less money to market artists. In the pre-Internet days, said Ms. Greenwald, “we were so flush, we did everything in the name of promotion.” Among the cutbacks are less spending to produce videos and to support publicity tours when a new album is released.

“Today you have to be like Leonard Bernstein,” said Mr. Kallman, “making sure everyone is hitting the right notes at just the right millisecond. The tipping point, if you will, is when everything converges and your timing with everything is impeccable.”

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