Last week's Senate hearing examining the Universal Music Group's pending acquisition of EMI's recorded-music division was a symphony of mission statements, missed opportunities and misinformation. Amid it all, there were some solid points made, some assertions deflated, and some bad and good acting.
First, the witnesses. If the Universal-EMI deal depended on UMG Chairman/CEO Lucian Grainge's testimony, it's hard to imagine that deal getting done. Grainge's written testimony, submitted in advance, is more forceful than what he actually said live at the hearing, but in both places he failed to connect the dots in making his case as to why the deal does not fall afoul of anti-trust concerns. Fortunately for UMG, EMI Music CEO Roger Faxon stepped up to the plate to refute some of the assertions made by the deal's critics, while Clear Channel's executive chairman Irving Azoff managed to strike a blow, although not a critical one, against Warner Music Group's attempt to see the deal undone.
On the other hand, UMG's adversaries, former WMG chairman Edgar Bronfman Jr. and Beggars Group founder Martin Mills, were very convincing in their arguments, but I am not sure that having Public Matters' Gigi Sohn on their side helped their cause. And Mills' early departure from the hearing essentially left Bronfman to finish the testimony on his own.
From his testimony and during the questioning session, Grainge made two points repeatedly: Universal will invest and reinvigorate EMI, which is a good thing; and Universal needs as many digital platforms as possible so it would be "insane" not to license music to new digital platforms.
Business Matters: Lobbying, Spending Heat Up Before Universal/EMI Senate Hearing
But Grainge's opponents kept returning to the 40% market share that, by their calculations, the EMI deal would give him, which they said would make UMG the ipso facto industry gatekeeper, with ultimate power over which services live and die -- and consequently, he would be able to singlehandedly raise prices and get favorable terms for UMG.
In his written and spoken testimony, Grainge scored cleanly by citing the two American musician organizations -- SAG-AFTRA and AFM --that endorsed UMG's acquisition of EMI, which still needs regulatory clearance from the Federal Trade Commission and the EU regulatory committee.
But elsewhere in his written testimony, he mentions both that indie labels' market share has grown to 30%, and Merlin's claim of being the fifth major -- without connecting the dots. If he is willing to note that the indies have 30% share, why didn't he further mention that EMI's and Universal's combined market share of owned repertoire in the U.S. is more like 30%, according to Billboard estimates, and not the 42% (which includes UMG-distributed labels like Big Machine, Cash Money, Hollywood and Disney and Concord) that Bronfman pounded home time and again in his testimony?
Between his written statement, live testimony, or answers to Senate questions, it is unclear why Grainge did not make the point that Universal has no say in the way its distributed indie labels -- which include Big Machine, Concord, and Hollywood and Disney Records -- price their music? Moreover, while all majors, including Warner Music Group and Sony, try to project their market power to get big advances from digital music services, A2IM and Merlin have done a good job recently in pointing out that the majors distribute indie music but do not control it -- and the latter organization makes sure DSPs understand who they represent when negotiating digital terms.
In his written testimony, Grainge touched upon the "gatekeeper" accusation, pointing to a New York Times columnist who offered the opinion that there are no more gatekeepers in music -- a weak counter-argument to the claims put forth by his adversaries. Occasionally the "no-industry-gatekeeper" statement turns out to be true, but every act who breaks through outside of the traditional label model is still regarded as a Cinderella story, and for a good reason: because the overwhelming majority of new artists still need labels to break through the clutter. In fact, later in the day, Martin Mills challenged them to name one artist who broke through without the aid of a label, noting that his XL label needed Sony's marketing power to break Adele in the U.S.
Meanwhile, Roger Faxon much more successfully connected the dots in making his case as to why UMG's acquisition of EMI won't hurt the industry. During the questioning part of testimony, Faxon recalled that in 2002 the major labels tried to control digital distribution and, in his words, it "failed dismally. It was a clarion call to an industry that thought they could control the way the consumers got music." He said the consumers broke through, which is why music companies must license their music to digital services, or they won't have a business."
Furthermore, despite many arguments to the contrary that the UMG deal will result in higher pricing, Faxon pointed out -- correctly, in my view -- that nowadays the retailers and consumers are in charge of pricing. Faxon said technology reduces the cost of entry and that the record companies can't control prices, can't control access to the consumers, and can't exert control over record promotion in social media or music-discovery tools.
Furthermore, he noted that in physical retail, at Best Buy, Target and Walmart, music makes up maybe 0.3% of their revenue, so the majors have no pricing clout with them. "If we try to raise prices, that will reduce demand and turnover per square foot," he said. "We know that if we raise prices, that will cause shelf space to decline." In order to appease those big-box merchants, labels have to lower prices to increase turns and profits for them, he added.
The average price of music is approximately half what it was a decade ago, and any move by the labels to raise prices has been met with charges of price fixing, and is usually swatted aside by the big boxes and the big digital services. When the major labels imposed minimum-advertising-pricing policies around the turn of the millennium, they were accused of price fixing. After signing a consent decree, the music industry has no MAP (minimum advertised price) policy today, while other forms of entertainment and entertainment hardware continue to have MAP policies.
When the majors agreed to a 99-cent price for a song download, the government began a price-fixing investigation. Later, when iTunes complained about Amazon's deal of the day and the labels modified their behavior when dealing with the Seattle-based merchant, the government informally investigated to see if those actions constituted price fixing.
In the one instance of where labels managed to get a price increase, from 99 cents to $1.29 for hit titles in 2009, UMG couldn't get it done by themselves. It took the threat of a powerful new digital competitor, Amazon, cutting deals with Sony, WMG and UMG for MP3 versions of songs without copyright management systems that finally got iTunes to relent on variable pricing.
Even if subscription services displace download sales, if a service charges too much, the consumer won't sign on -- and they'll have another reason to turn to illegal downloading sites. If consumers don't sign on because of price, that in turn would hurt label revenue -- so here the consumer has the power of price, not the label or service.
Live Nation executive chairman and chairman of the board Irving Azoff, speaking in defense of the deal, made a salient point on the consumer having more power than the labels nowadays.
"It used to be that bands couldn't make a professional album without the backing of a label," he said. "Labels used to be the gatekeepers to fans, but today those barriers have been blown away. The new gatekeepers are the fans."
Azoff also made the case that artists no longer need labels. "I have no doubt that labels add value, but you just don't have to have one in a world where the artist can deliver an album direct to fans themselves," he said.
That is accurate when he is referring to established artists, but for reasons detailed above, his claim of that being true for baby artists contains more smoke than a Kiss concert.
After he finished painting a picture of why artists no longer need labels, he saved his best salvo for last, landing a punch right between the eyes of the Warner Music Group.
"As for the broo-ha-ha around this deal, Mr. Bronfman has been talking about combining Warner and EMI for the better part of a decade," Azoff said. "The entire industry expected it to happen, Wall Street expected it to happen, journalists expected it to happen. Warner had a chance to outbid Universal in this process - but chose to walk away. Now, they regret their decision, and are spending millions to fight the deal. Well, I don't think the government should step in to give them another bite at the apple -- that is not how our free market economy works."
There is something to that argument: If WMG is so violently opposed to UMG owning EMI and becoming, in their opinion, the industry's gatekeeper - which will bless or condemn new music digital services -- then why didn't they factor that into what they were willing to pay? In other words, right after the deal, WMG executives privately told Billboard that they had offered $1.5 billion and weren't willing to go to $1.9 billion because they didn't want to overpay. So why didn't they consider the value of stopping UMG from becoming, in their view, the gatekeeper and add that to their valuation of EMI? If they had, they may have found $1.9 billion more palatable.
While Bronfman did not address that issue, in both testimony and in answering questions, he consistently pounded home his point that the deal makes UMG not only the gatekeeper, but that they will benefit in extracting better terms and promotional space than the other majors. And he did it without sounding repetitive.
If UMG gets more than their fair share due to their market power, then others will get less. Since promotional space in digital spurs sales, UMG's sales will grow accordingly. In other words, Bronfman is making the case that not only will the deal itself make Universal by far the dominant major, but the resulting clout from the deal will give it the power to organically, albeit unfairly, grow more dominant.
Martin Mills was very eloquent during his live testimony, while his written statement provides an in-depth argument as to why he feels the EMI-Universal deal should not be allowed to happen.
"Don't believe them," Mills said in his testimony, referring to EMI and Universal. For instance, he said don't believe them when they say that market share is not market power. "Market power is why they're doing this, the power to dominate digital services ... the power to squeeze out competition and the power to impose what Universal wants on the consumer," he said. Don't believe them when they say any young artist can become famous overnight without a label, he added. That's "simply not true," he said. "Ask them who [the overnight successes] are," Mills said.
But Mills might have overstretched when he complained during the question segment of the inquiry that Universal was the last major to climb aboard the eMusic platform, causing prices to go up. While it is true that prices did indeed go up because eMusic changed its point formula on purchases, it is well known that the indies themselves complained about eMusic's pricing, and in fact some left the service because of that pricing. Moreover, many independents were annoyed that eMusic was bringing in the majors because they felt their revenue would go down if the subscribers had more choice. Finally, they were suspicious that the majors used their clout to extract a better deal from eMusic than they give the indies -- which might have been the point Mills wanted to make, but then realized tarring Universal with causing higher prices at the service would play better with Congress.
Mills ended by noting that "There is big and too big," making clear that he believes the EMI deal will make UMG too big.
As for Public Knowledge president and CEO Gigi Sohn, she started out fine by making the case that, as more consumers demand music from the Internet, a merged UMG-EMI will have the ability to dominate the "nascent business." But during questioning she complained that the 90-year life of copyright was the equivalent of a monopoly. This clouded her point: Does she oppose the merger because it will be bad for consumers, or because her organization feels copyrights policy is too strong.
Sohn did, however, correctly challenge the majors on their claim that piracy has cut industry revenues in half over the last 10 years. While some of that revenue loss is unquestionably due to piracy, the industry also ignores how it shot itself in the foot -- something that Sohn reminded them of when she testified that the industry stopped selling singles and would only sell complete CDs: Revenues went down because consumers didn't want to pay for 10 songs when they only wanted two, was the upshot of her argument.
That's an oversimplification of why CD revenues dropped. There were many other reasons, and most of them were the result of the industry favoring short-term gain over long-term pain. In order to drive first week sales, the major labels favored merchants like Best Buy, Target and Walmart with lower pricing, more advertising dollars, and exclusive versions of albums. That tactic drove first week sales but killed music-specialty chains and hurt sales at merchants like Borders, which were forced to cut back their commitment to music. As those stores went out of business or cut back space devoted to music, it shrank the pipelines and drastically hurt overall industry sales. What's more, that cycle repeated itself at the big boxes, leaving sales at their current diminished level, which may finally be stabilizing.
Still, it's hard to quantify how much CD sales were lost to industry stupidity and how much were lost to piracy.
Then she threw in a reminder that the majors were found guilty of price-fixing in 43 states, as if industry tactics that led to revenue loss were connected to price-fixing -- a muddled argument, to say the least.
But she also brought home the point that Universal is already acting like a gatekeeper, because there is a pattern of lawsuits surrounding their actions against digital music services. She said that fear of technology "provides incentive to try to control the technology, to try to take a piece as -- as Universal has often done, of these services; charge excessive licensing rates; and deny licensing. That's really been the history of Universal: litigation, excessive licensing fees, denying licensing fees, and taking a piece of these services."
But then she too went too far, complaining that Universal sued Deezer in France because "they don't like the fact that it was supplying five free songs in their freemium tier."
Freemium was also an issue with Spotify coming to the U.S. Spotify maintained the position that it should be able to provide free music without being charged, while some labels maintained that that would give Spotify an advantage over other services and retailers. So if they still wanted to give free music to consumers, that was their choice, but they'd have to pay the labels for it; ultimately they agreed to a compromise that limited free music.
While industry participants may seem reluctant to become engaged in any conversations to justify any price increase amidst an anti-trust discussion, for the life of me, I don't understand why the industry should have free shoved down their throat, because so far, free ain't cutting it for anybody. Ad-supported services will never be the engine driving revenue to labels and artists; they will always be tertiary revenue. And if ad-supported freemium services with weak income streams ever cannibalize the industry's main revenue drivers, whether that be sales or subscription money, the industry should have the right to exit such deals and should have no qualms telling Congress, the FTC or the EU where they stand on free during antitrust hearings, without being attacked by a front for companies that make plenty of money on free content.
Alas, the politics of mergers and the government regulators' desire to win headlines at the expense of the music industry usually outweighs whatever sound arguments the industry might present in its own defense.
While the hearing provided good theatre, what's going on behind closed doors at the Federal Trade Commission and the EU Commission in the end will likely matter much more than what was said in Washington last week. So arguments like shrinking profits, which every major can cite over the last five years, may not play well with the public, but they make a convincing case to regulators.
But is that argument and others made during the hearings enough for UMG/EMI to gain the blessing of the regulatory agencies -- or at the least get the deal approved after selling off some assets? Or will other factors - like the desire of many in the industry to see WMG buy EMI's recorded-music division after all, because they believe it will make for an overall healthier competitive marketplace, not to mention some of last week's well-placed shots against the UMG/EMI deal in front of the camera - ultimately influence the regulatory agencies to stop the deal?
Time will tell which answer carries the day.