The money is in the merchanise

Artists no longer look to record sales to make money, says David Sinclair. Today's profit is in live shows and merchandise

The days when sales of recorded music were the most commercially significant sector of the music business are gone. It may be overstating the case - but not by much - to say that recorded music is perceived by the iPod generation in much the same way that a glass of tap water would be regarded by a customer in a restaurant. The diner knows that it costs money to put clean, fresh water on the table, but expects those costs to be absorbed elsewhere. He is unlikely to complain about the steep mark-ups involved in providing the rest of the meal but would otherwise feel aggrieved at being asked to pay for an item that is so freely and generally available.

As a generic product, recorded music, nowadays, is almost as ubiquitous as tap water. It is provided, quite legitimately, free at the point of delivery, from a variety of sources. It comes blaring out of radios and TVs, or stuck on the covers of magazines and newspapers, or streamed on MySpace and thousands of other websites. Supply far outstrips demand. And where the demand is for a specific song, or collection of songs, the illegitimate methods of acquiring them - also for free - are still widely accessible and hugely popular. BigChampagne, an American media measurement company that monitors downloading activity on the internet, has estimated that roughly one billion illegal music downloads take place every month. Anecdotal evidence suggests this may be a conservative figure.

So the news that Sony BMG, Universal, EMI and Warner Music are suing the popular file-sharing network LimeWire for "massive" infringement of copyrights is hardly surprising. Of course, unauthorised distribution of copyrighted music is wrong, and doubtless LimeWire should be forced to follow in the footsteps of previous file-sharing sites, such as Kazaa and Napster, and either become a legitimate business or face the consequences. But it is unlikely to turn the tide in the long run.

Yes, legitimate sales of downloads are on the increase, with iTunes claiming sales of close to 100 million units per month. But everyone knows that on the rare occasion when the kid with an MP3 player does pay for a download or the even rarer occasion when he ventures into a record store and actually buys a CD, the music will have been copied by half-a-dozen of his friends by the end of the week.

"I'm not a big fan of litigation," says the business analyst Celia Hirschman, the MD of One Little Indian Records, North America, and owner of Downtown Marketing. "You're never going to be able to stop illegal downloading. It's a dam that's broken in too many places. But every download that exists is quantifiable. If we could identify a way to collect the revenues for downloading from payments that are made to the internet service providers, rather than create individual download companies, that would be the way forward. Instead of trying to sue people, which I think is a lethargic, poorly planned way to change something, they need to search out for other solutions that are much simpler to use."

The results of these trends are all too predictable. In America, where sales of CDs dropped by 25 per cent between 1999 and 2005, according to the Record Industry Association of America, the physical retailing sector has gone into meltdown. According to The New York Times, 900 record stores in America have gone out of business in the last three years, a contraction of more than a third.

Yet it seems that consumers still spend about the same proportion of their disposable income on music - it is just that they no longer spend it on recorded music. The same people who baulk at paying £15 for a CD will happily pay two, three or four times that amount for the privilege of attending a live concert. When Neil Young last performed at the Hammersmith Apollo, accompanied only by the sound of his acoustic guitar, he charged £50 a ticket and sold out the venue for three nights. Madonna's rather more theatrical shows at Wembley Arena this month set a new benchmark in ticket prices: £80 for the "cheap" seats, £160 for a position close enough to the stage to see anything that was actually happening without reference to one of the giant screens. Yet all eight of her London shows were sold out too.

"I think people have a problem with spending money on an object that just isn't that special or unique," says Bernard MacMahon, the head of Lo-Max Records. "Companies have devalued the medium of the record, particularly in the design and packaging of the CD. It was designed by boffins and nerds with the sole emphasis of not having any scratches or other surface noise and being portable. But like cassettes before them, it is not a prized format. People don't feel a physical urge to buy them.

"The product is not appealing in the way that vinyl albums were, or intrinsically valuable in the same way that a ticket to a concert still is. The concert is still potentially a magical event. You're there in a room, with a group of people sharing the same experience, and close or relatively close to a performer who is there to entertain you."

Even before the Rolling Stones arrived in London this week for the UK stretch of their world tour, the group had been declared the "highest earners in live entertainment" for the year to date. Unofficial estimates place their takings so far from the A Bigger Bang tour at £79.7m. There will be some pretty hefty overheads to be covered by that sum. But it's a safe bet that the mechanical royalties from the A Bigger Bang album will represent a considerably less lucrative revenue stream. Tickets for the Stones' tour are anything up to £150 - 10 times what you would pay for their album. Compare that with the 1960s, when one of the Rolling Stones albums would have cost a guinea (£1.10), while a ticket to see them play at the local Gaumont would have been five shillings (25p).

With the festival season, especially in Europe, now providing a significant boost to the live circuit, the opportunities for acts to play before big audiences have never been better. And while fans may be reluctant to purchase a band's latest CD through the appropriate channels, they are strangely enthusiastic about lavishing a small fortune on other items of merchandise. Indeed, sales of T-shirts, programmes, posters, badges, key rings, tour jackets and various other assorted collectibles can virtually finance a tour on their own. Go to many band websites - especially those of heavy metal and other cult acts - and you will be assailed by opportunities to buy merchandise. But information about where to download their music legally, or buy one of their CDs is often much harder to find.

"Merchandising is really the way the smart acts are making their money now," MacMahon says. "I've seen bands do thousands of pounds of merchandising in one night in a small venue. You will quite often see the audience paying £10 to £15 per capita over and above what they've paid for their ticket. A good selection of T-shirts in different sizes and particularly sizes that will fit women, that's important. And records that you can't buy in the shops - maybe a live album or some other rare recordings - they will sell well to the hardcore fans."

"It's important to make a distinction between the record industry and the music industry as a whole," says Paul Williams, the managing editor of the trade magazine Music Week. "The record industry has had a tough time because global record sales have dropped year on year. But over the same period the live sector of the music industry has been booming. Every year we have to write the same story about it being yet another bumper year. It's quite hard to think of new ways to present it."

But while sales of CDs through conventional channels are now a relatively minor source of income for many acts, the album itself is still the focal point of a performer's creative activities, the peg on which everything else hangs.

"The tour will happen because there is an album to promote," Williams says. "There will be merchandise on sale during the tour, but again that opportunity for generating income is only available because of the album. Radio and TV play will be for singles that will be released because the record company is trying to push an album. So the album is still the centre of the universe in terms of the activity of the artist, but it isn't where the artist will be making their money."

This conundrum has paved the way for new business models, which have by and large strengthened the hand of the artists vis-a-vis the industry. There has been much speculation as to how Oasis and Radiohead, who have both reached the end of their current major-label contracts, will proceed. Will they follow the trailblazing deal made by Robbie Williams several years ago, and emulated more recently by the American heavy rock band Korn, whereby the record company provides an advance against other revenue streams (live performance, merchandising, etc.) as well as record sales? Or will they go the way of Mick Hucknall, who turned his back on the major labels and created his own independent organisation with which he has marketed his band, Simply Red, into a position of enviable profitability?

"Artists have figured out that, in the digital era, they don't always need the record company to do everything for them in the way that they used to," says Celia Hirschman. "In the 1960s and 1970s there was a very thick velvet rope which kept artists from understanding the economics of a record deal. Because recording technology and replication was limited to record companies, artists were isolated from the business. It wasn't until CD players could record in the average home that the curtain was lifted. People realised that now, with access to digital recording equipment themselves, they would be able to replicate the record company model with a greater degree of ability to generate revenue for themselves. So a cottage industry has blossomed." Another thing that has changed, according to Hirschman, is that in the 1960s there were only about 8,000 albums released per year in America, whereas in the new millennium there have been about 60,000 albums released per year. This tallies with statistics released this week in the UK, which show sales of musical instruments at an all-time high. Sales of guitars have doubled since 1999, with nearly a million guitars, at a value of more than £100m, sold in 2005 alone, according to the Music Industries Association. If people are no longer buying recorded music, they are making it themselves in greater numbers than ever before.

"Everyone can make their own record now," Hirschman says. "So yes, record sales are down, but I see this as a time of optimism. Artists have the ability to determine their own future, whereas in the past they had to rely almost exclusively on the record label."