What the Music Business Can Learn From the Gaming and Gambling Industries

Hany Nada is founding partner of GGV Capital, a global, expansion–stage venture firm based in Silicon Valley and Shanghai with $1.6B under management.

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When it comes making money, the music industry – from labels, to artists, managers, promoters and venues – is stuck in the past. While the industry has embraced digital technology for production and distribution, almost everyone still insists on selling albums and songs. And while the industry continues to plod forward with its model of selling music "products," fans have moved on. They want music for free, but are willing to pay for music "experiences."

What can the music industry do to triple revenues in the next decade? Give away recorded music for free in exchange for fan data. The trick is to stop thinking like a record store employee intent on selling albums, and start thinking like a casino boss, who knows the best way to make money is to give free perks to the top patrons so they'll spend big at the card tables.

Whales, Dolphins, and Minnows: A Segmented Monetization Strategy

Like players in a casino, each music fan has a different value based on their inclination to spend. In the casino system, fans are divided into three segments: whales, dolphins, and minnows (WDM). Whales often make up the majority of the profits in the casino industry. These are the people willing to pay substantially more for an elite experience. Since whales are substantially more profitable than minnows (the casual players who just want to hit the slots and enjoy a buffet meal), the casino industry has always catered to them. Whales are treated to amazing services, including flights, suites, rebates on losses, private chefs, and shopping sprees – all in an aim to keep them spending freely at the card tables.

Games companies also understand the WDM model.

Korean video game companies came up with the idea of giving away their products with the hope of attracting gamers. These free–to–play, or freemium, game companies treat their games like a service versus a box that ships every 18 months. Players get more of what they like and the gaming experience became engaging and "addictive." They get special updates, game currency, and virtual goods – and the players eagerly pay for these add–ons. On average, freemium companies have 10 times the number of gamers, 30 percent longer play sessions, and three to five times the total revenue of standard games –– based on data compiled by GGV, my company, from nearly 100 different companies over the past four years. This has created several Asian gaming giants like Tencent, which is now worth more than $60 billion.

Free-to-play games companies are experts at segmented monetization toward whales, dolphins, and minnows. Minnows (or free players) on average account for 90–98% of the players in a free–to play game, according to a GGV survey of nearly 100 companies, and the most successful games protect and nurture their minnows. Minnows play a very important role in the game eco–system: They are not merely cannon fodder, they are zealous fans who help attract new players through their networks, as well as experienced players that add sophisticated game play for the paying dolphins and whales.

Free–to–play games similarly treat dolphins exclusively. While they're inherently not stronger players than minnows, dolphins usually get greater levels of customization and access to premium content that minnows don't. Dolphins usually represent about 50% of the revenue generated by a game.

In free–to–play gaming, whales get white glove attention – just like the high-rollers at a casino. Whales typically represent 3-4% of the paying users for a game (or less than 0.1% of all users), according to game company sources, and account for about half of revenue. It is not uncommon for whales to spend thousands, if not tens of thousands, of dollars per month on a game. There are some social games where whales have spent over $100,000 on building virtual homebases.

Whales get special avatars and gifts, as well as exclusive opportunities to help test new games, getting personal access to development teams. For Asian websites that embrace "gameification" such as the music–driven site YY, whales who buy the most virtual goods for the musicians and video artists are thanked in official forum posts and given special gifts. Some amateur artists on YY have upwards of 300,000 fans and generate $50,000 per month in income for themselves through virtual items.

There are many examples of the WDM model: the sports industry, particularly the NFL, is perfecting the art of sports fan engagement and segmentation.

WDM in the Music Industry

To break out of the old way of monetizing music as a "product," the music industry must first start viewing music as a service, and then monetize this service with respect to whales, dolphins, and minnows.

First, artists and labels should get comfortable with the fact that some people aren't likely to pay for music, instead relying on radio, YouTube, downloads from friends, etc. But these minnows are important, because without them, you cannot attract dolphins or whales. Their sheer number means they can support an artist in an important, non-monetary way: influence.

Dolphins are the second-largest group of fans. These fans enjoy an artist's music and are willing to pay for albums and concert tickets. Dolphins typically represent half of an artists' fan-base, judging by Kickstarter data. They are concert-goers and merchandise purchasers, and they're the second most valuable group of fans for an artist in terms of monetization.

Whales are willing and able to spend vast sums of money (more than you can imagine). Whales are willing to buy plane tickets to fly to another part of the country for concerts, and they'll gladly shell out tens of thousands of dollars to personally meet the band, or even hundreds of thousands for the opportunity to host a private concert.

While whales represent a very small sample of a fan base, far less than 5% and often less than 1%, they usually represent about 50% of revenue. Artists therefore need to take great care when dealing with whales. They should nurture whales' loyalty to maintain a strong and personal relationship.

The monetization of the music industry is moving into its fourth reincarnation. The industry's attempt to directly monetize fans via the WDM model – as opposed to charging for a product – is still in its infancy. Radiohead was arguably the first widely popular band to embrace the WDM strategy in 2005 with their controversial "pay what you want" release of In Rainbows. The part Radiohead missed was how to monetize the dolphins and whales they attracted. Since then, attempts to get fans to "pay what they can" have taken root in financing engines such as Kickstarter, Indiegogo, and artist websites.

Kickstarter has been an excellent experiment in WDM monetization. So far, $53 million dollars has been raised for music on the platform since its launch, and many of its hallmark fundraising successes have been in music. Amanda Palmer's record-breaking $1.2 million campaign for her new album and tour made headlines across the world. Popular independent bands such as the Limousines, Five Iron Frenzy and many others have also been successful in raising large amounts of money directly from their fans.

If you analyze the data for Amanda Palmer's $1.2 million (see figure below), you quickly realize 48% of the money raised came from whales who only made up 4% of the fan-base. We would also argue that, if Amanda had embraced the true minnows – her fans who are absolutely unwilling to pay – she could have had netted substantially more supporters than the 25,000 paying fans who contributed to the Kickstarter project. Kickstarter is really only the beginning of digital fan patronage.

My firm is betting on music startups that adopt the WDM model. Companies such as Bandpage are helping artists and bands engage their fan base. Companies such as Spotify, MOG, Pandora, Slacker, and Soundcloud are applying free-to-play models to monetize listeners. And though it doesn't exist yet, a music-centric version of Kickstarter that could help artists smartly manage their finances, and the various tasks associated with rewarding whales, dolphins, and minnows, would be a welcome asset in the music industry.

If the music industry wants to survive, it needs to embrace new business models that focus on what's driven the consumption of music since the days of minstrels and Mozart: the emotional relationship between a fan and an artist. By treating listeners as fans instead of customers, and monetizing them accordingly, the rapid and unpredictable advance of technology becomes a tool for innovation and success instead of a menacing threat. The most recent example of Psy's $8.1M illustrates just the tip of this point.