Education and research institutions in North America have become temples of specialization. The process of dividing the world into distinct areas of observation and understanding may have found its beginnings in 18th century Scotland, but it was in America’s great technological upheaval known as the Industrial Revolution that such specialization found its home. It is no coincidence then that one of the earliest disciplines created by the 18th century Scottish pioneers is perhaps the most inaccessible disciple to inquiring minds from the outside. In 1776, as the American Revolution was being ignited, a moral philosopher at the University of Edinburgh invented the field of economics with a very literary account of how aggregate wealth is created. Such is the lucidity of Adam Smith’s account that it is still a source of insight to regain one’s bearings in the field of what, in his own time, came to be called “political economy.” Its mathematical complexity is rivaled only by physics, making its leading edge inaccessible to the laymen.

I am thinking about this particular inaccessibility after reading this week’s news that CD sales have slipped downward (18.8 percent) for yet another year and that Nielson SoundScan is still asserting that some of the decline is attributable to “illegal file-sharing.” There have been several studies proving this wrong. There are many theories as to why album sales have declined, taking the legacy record industry along with it. There is no study proving an exact reason for the decline, and there will probably never need to be; some adductive reasoning is all it takes to decipher the cause. Read some of my former rants if you need a refresher on my opinion. Basically, the reasons all fall under the umbrella of illegal file-sharing. The industry has put resources into fighting against file-sharing at the expense of devoting resources to adapting its business model to a changing market.

Why the approach to their business has not changed is beyond me. There is no shortage of consultants available to kindly point out to the executives that the market in which they sell their product has changed forever. Recently, however, Universal Music’s CEO, Doug Morris, claimed a lack of technology experts on his payroll has led to he and his peer labels missing the sea change in their market. I thought I would lend a helping hand, if they care to listen: two brilliant studies released by economists in 2007 found no statistical link between file-sharing and album sales. In case the big labels also do not employ people who can read the conclusions of an academic journal, much less understand the mathematic models devised to draw those conclusions, I shall very simply boil the conclusions down so that even an A&R rep can understand. Disclaimer: this may still be above Doug Morris’s head.

First, some “number porn,” or what economists might call “context.” I prefer the phrase “number porn.” (Then again, I usually prefer phrases with the word “porn” in them.) Between 1999 and 2003, more than 14 percent of music sales shifted from record stores to retailers, like Walmart, precipitating a decline in product shipped (a leading indicator of a market shift. Oops, missed that one.) The number of albums shipped during this period fell by 301 million, while album sales fell by only 99 million (we call this a lagging indicator of impending doom.) In 2002 alone the music industry sold 803 million CDs, which was a loss of 80 million from the previous year. This period followed a long period of unusually high album sales, most likely the result of consumers replacing aging formats with CDs. For the 1999 to 2003 period, DVD and VHS sales increased by more than $5 billion and video game sales increased by 40 percent, more than enough to account for the $2.6 billion loss in albums over the same period (we call this a change in consumer spending patterns.) From there the trend merely worsened. Between 2000 and 2005, the number of compact discs shipped in the US fell by 25 percent to 705 million units.

The two studies mentioned here are the results of first rate scholarship. One was published in the Journal of Political Economy, the most prestigious and technical economics publication in the world, by scholars from Harvard and the University of Kansas. It uses mounds of aggregated data collected from the peer-to-peer networks and album sales data, and compares them using a highly complex model in an attempt to find a link between file-sharing and album sales in the US. Another was a study published in November in Intellectual Property Policy by two University of London School of Management economists, which makes the first attempt to understand the same links with a large form survey approach fitted to an econometric model. This study attempts to find a link between file-sharing and sales in the Canadian market.

The JPE study not only factored into their model such interesting scenarios as comparing file-sharing activity and sales during German university holidays, but also summer months in the US (even today more college students in the US have access to high-speed internet connections at school than at home, but in 1999 this was more exaggerated.) They also adjusted their model to compare the sharing and sales data from specific years. In all the various scenarios of the model they were unable to find statistical links between file-sharing and album sales. The conclusions are so powerful they are worth quoting:

“Using detailed records of transfers of digital music files, we find that file sharing has had no statistically significant effect on purchases of the average album in our sample.”

And:

“Relying on our five most precise estimates, we conclude that the impact could not have been larger than 6.0 million albums. While file sharers downloaded billions of files in 2002, the consequences for the industry amounted to no more than 0.7 percent of sales.”

And:

“…music sales have been flat or even rising in major markets with a quickly growing file-sharing population. For example, in 2005 retail music sales rose in four of the five largest national markets. Third, in the United States the entire drop in 2005 album sales is due to losses at a single firm, the recently merged Sony-BMG, which has experienced severe postmerger integration difficulties. But the sheer magnitude of P2P activity, the billions of songs down-loaded each year, suggests that the added social welfare from file sharing is likely to be high.”

The IPP study found similar results from a completely different research approach. The Canadian study found evidence to support the conclusion that file-sharing had an impact on the population of Canada as a whole. The data from the study did show that among the sub-population of Canadians that actually engaged in file-sharing, there was a strong positive relationship between P2P file-sharing and CD purchasing. “That is, among Canadians actually engaged in it, P2P file-sharing increases CD purchasing. We estimate that the effect of one additional P2P download per month is to increase music purchasing by 0.44 CDs per year.” Perhaps the most interesting find in the study (for those interested in applying gained knowledge to improve their business model), is that people who pay for legal downloads and own mp3 players appear less likely to purchase traditional product, like CDs. (We call this proof, however small, of a change in consumer spending patterns.)

The economists who authored the JPE paper offer a bit of sage-like perspective on the whole saga that has been the industry’s relentless towing of the “file-sharing is why we are failing as a business” line:

“The entertainment industry’s opposition to file-sharing is not a priori evidence that file-sharing imposes economic damages. The industry has often blocked new technologies that later become sources of profit. For example, Motion Picture Association of America President Jack Valenti argued that ‘the VCR is to the American film producer and the American public as the Boston strangler is to the woman home alone.’ By 2004, 72 percent of domestic industry revenues came from rentals or sales of videotapes and digital video discs. Other examples include the record industry’s initial opposition to radio in the 1920s and 1930s and to home taping in the 1980s.”

Three words can describe what good scholarship can do to a bullshit argument: nail-in-coffin!

In 2008 there is, however, a ray of hope once again. It seems some people at the Big Four can read and interpret findings. Perhaps Doug has started hiring. While CD sales are down 18.8 percent, album sales are only down 14.9 percent. In a market place where the consumer can buy just the one hit, pushing albums with just one good song (still standard practice at the Big Four), will yield you single songs and not album sales. Indeed single track download sales are up 45 percent, selling 844.1 million in 2007, including 43 million the last week alone (thanks mostly to all those fucking iTunes gift cards every parent seemed hell bent on putting in stockings). Total music sales for all formats and configurations (including music videos) was up 14.7 percent to $1.37 billion in sales. So maybe the labels will shut the fuck up about file-sharing.

For now, all four major labels have stated that this year they will make DRM-free tracks available through at least one online distributor, which is a HUGE step. Still, if I ever go get my PhD in economics, I have a great example of market failure for my dissertation.

» Last Week: A Banner Year for the Music Industry