Technology strikes a worrying note

CD copying and the internet are wreaking havoc, says David Brierley

THE west London office of Sir Colin Southgate, chairman of EMI, boasts a splendid wind-up gramophone. It is a potent symbol of how, over the years, technology has transformed the music industry. After the 78rpm record came the single and the LP, the cassette recorder and more recently the CD.

Now the CD itself is under threat from further technological advance and, as a result, the world's $40bn (pounds 25bn) music industry is in a state of upheaval. After years of exceptional growth both PolyGram and EMI, which account for around a quarter of the business, are now talking to suitors, and billions of pounds could be about to change hands. The rights to the finest assets in the music business - the Beatles, the Spice Girls, U2, Bob Marley and Elton John - are up for grabs.

These artistes' value currently depends on the CD. Since its invention in 1982, the metal disc has created strong demand, lowered costs and brought high margins to the music business. But cheaper copying methods and sources of digital material are proliferating; and piracy (thought to account for one-third of all CDs pressed) could swamp the industry. "It appears there is a massive technological threat to the music business," says Nigel Reed, analyst at Banque Paribas.

Officially, the industry has always denied there is a problem. Less than a year ago, Sir Colin stated: "We look forward to the future; to discovering new artistes, new genres of music and to using new technology to widen our delivery of music to all."

Philips, the inventor of the CD, last week started the bidding for PolyGram by suggesting that its 75 per cent stake in the world's largest classical music company was for sale. The pounds 6bn auction is being lead by the Canadian drinks giant Seagram, already rebuffed by EMI.

The sale represents a considerable volte-face. Coor Boonstra, Philips chairman, recently stated: "We have a strong belief in the future of PolyGram because of the growing importance of intellectual property rights."

Both music companies have problems of their own. PolyGram's first quarter profits evaporated, while EMI has been surrounded by speculation for months. It strenuously denies it is for sale, despite talks with Seagram, rumours that Sir Colin has been seeking a buyer and a very public boardroom split that resulted in the departure of Jim Fifield, the head of its recorded music arm, with a pounds 12m pay-off.

"We are not traumatised. We are not for sale. There is no leadership vacuum. The turmoil is a fantasy in somebody's mind," said Sharon Christians, EMI spokeswoman.

Nevertheless, the music industry is at a critical juncture. The Asian crisis has resulted in a sharp downturn in sales, in heavy returns and profits warnings. This is particularly disheartening. With the North American market saturated and European markets patchy, Asia was the last great hope for raising CD sales.

At the same time, price differentials between countries are under pressure as internet selling takes off. Public tastes are becoming more fickle and markets more regional. The number of international stars is declining.

New albums from expensively promoted stars such as Bryan Adams, Janet Jackson and Blur have disappointed, while golden oldies are becoming leaden. Duran Duran, who thrilled teenagers in the 1980s, have been off-loaded by EMI. Sales of classical music CDs are stagnating and prices are under pressure. Without an increase in piracy, the industry might be moving from high to lower, but more stable growth. However, piracy looks certain to increase.

"The biggest problem for the industry is CD recordables," says Ricky Adar of Cerberus, a digital music retailer. Retailing at a few hundred pounds, these machines allow consumers to make perfect copies of CDs for pounds 2 each. "If I was a teenager, I would be thinking about buying a machine, swapping CDs and making cheap copies," says Mr Reed at Banque Paribas.

As Europe's leading manu- facturer of consumer electronics, Philips would see the potential threat to copyright owners such as PolyGram. A Philips machine retailing at pounds 479 is currently Dixons' best-selling CD recordable. At the moment, blanks cost from pounds 4.

Cerberus operates on the side of the angels. It is using the new technology to offer a new retail format. Customers can hear music stored on its computer server, select tracks they want and have them recorded on newly minted CDs. A fee is paid to the copyright owners for each CD made.

"We are paying the record label more money than if they had put out the CDs themselves," says Mr Adar. Even this presents problems. Cerberus' CDs will be cheap at pounds 7.

The retail format promotes minority tastes - jazz, classical music and small labels. It does not favour the pounds 15 blockbuster CD on which companies depend for much of their profit levels.

Of course, not everybody is on the side of the angels. New, cheap technology is a godsend to bootleggers and friends of cheap CDs alike. CD recordables will become a standard feature of every hi-fi system. Because of the Asian economic crisis, the price of blank, recordable CDs has fallen to below 50p for bulk purchasers. A bootlegger could cut, market and distribute a perfect copy of a full-price CD for pounds 2 and still enjoy a 100 per cent mark-up.

The recordables are not the only threat. With demand falling dramatically in Asia, local CD manufacturers are being tempted to use their unwanted capacity for pirate pressings. The quantity of cheap, "grey" imports is already rising.

The full impact of the internet has yet to be felt. With an ISDN line it is possible to download a digital recording but it takes as long to do this as it takes to play an average-length CD. New forms of transmission, such as the cable modems currently being tested in this country, will vastly speed up the process.

Given the semi-anarchic nature of the net, it would be surprising if pop enthusiasts did not offer free copies of their favourites' work. In fact, there are already nearly 2,000 illegal juke-boxes in cyberspace. The net is not the only threat. Digital transmission by any means - satellite, radio or cable - will offer pirates and fans perfect sources for illegal copies.

The leading record companies are fighting to protect their intellectual rights by legal and technological means. This could easily be a losing battle; taping CDs has long been a popular pastime, so making CDs of CDs could well prove irresistible.

New technology always brings opportunity, as well a threat to market leaders. The companies insist that they, too, can supply consumers directly through the internet. This would be a massive boost to margins, enable copyright holders to cut out the retailer, eliminate pressing and stockholding costs and market their backlists better.

Nobody knows whether this will offset the threat of mass piracy or the costs of undermining current marketing and retailing methods. The whole structure of the industry looks certain to change. For example, it relies heavily on blockbusters to finance investment in new talent. The value of the mega-groups of the future looks certain to decay faster because of piracy. That would cut the funds available for finding and developing new talent - and reduce the royalties enjoyed by mega-stars. The decision of singers such as David Bowie and Rod Stewart to issue bonds secured on future royalties looks like a very smart move. Established stars could respond by going it alone. Once out of contract, they could market themselves directly to their audience through the internet.

There is every incentive to do so. A star like Michael Jackson receives pounds 1 per CD, equivalent to 20 per cent of the pounds 5 in royalties that accrue on a standard pounds 15 CD. Instead, he could produce, press and distribute his own CD for pounds 1. He could sell his own through the internet at pounds 10. Some industry analysts think this will be viable once the internet reaches 10 per cent of all households.

The truth is that the music industry faces radical change and nobody can be sure how it will develop. This weekend, billion-pound bets are being placed on the outcome.