Quotes of the Day

The music business has found itself a new poster girl. Adorned with tattoos and a beehive, and blessed with a smoky voice beyond her 24 years, Amy Winehouse sat proudly atop the U.K.'s album charts this spring after scooping up five awards at the Grammys in Los Angeles. She sang her signature tune for the audience there via satellite from London: "They tried to make me go to rehab/ I said 'No, no, no.'"

In reality, though, Winehouse — following months of much publicized troubles with drugs — had checked herself in to a treatment clinic just a couple of weeks before the show. It's a path the recorded-music business knows well. Long resistant to change, it, too, has finally accepted the need for rehabilitation. The industry's woes have, for some years, been glaringly public. Rising sales of digital music can't keep pace with the fall in sales of CDs: record-company revenues from such tangible products tumbled roughly 6% in 2007, leaving firms with some $19.3 billion in total sales last year, a quarter less than in 1999. The digital market is hardly new, yet it still seems to catch major record labels dozing. Alt-rockers Radiohead last year famously distributed their album In Rainbows without the help of their former record company, EMI, instead letting fans decide how much to pay the band to download it. Meanwhile, adding to the sense that this entire industry is in flux, musicians' other means of income — from T-shirt sales to concert tours — are booming. "The whole industry is moving into a new phase," says Mark Mulligan, an analyst at JupiterResearch in London. "This isn't a blip — it's a realignment."

The major record companies have the most to sort out. The problems at EMI, the smallest of the Big Four record companies, have been getting more ink lately than its artists, which include the likes of Lily Allen and Coldplay. With EMI's slice of the world market under pressure — its share fell to 12.8% in 2006 from 13.6% the previous year — U.K. private-equity company Terra Firma acquired the firm for $6.5 billion last August. The new owner has been quick to make its mark: earlier this year EMI announced it was axing as many as 2,000 jobs in a bid to pare costs by $400 million a year. But the overhaul is not just a matter of numbers, says Guy Hands, ceo of Terra Firma and chairman of EMI: "What we are saying to artists is: The current model is broken. Unless we find a new model, new music is dead."

While EMI has had an especially tough time, it is also something of a barometer for the biggest players in the business. Universal Music, the world's largest record company, saw its revenues dip slightly last year. Low margins at Sony BMG, the industry's No. 2, have left its own music business ripe for a private-equity buyout this year, says Gerd Leonhard, a music-industry consultant in Switzerland. And shares at No. 3 Warner Music have been in freefall for months; a $16 million first-quarter loss was announced in February.

As if it weren't worrying enough that their revenues are sliding, the major record labels are also having more trouble than ever controlling their artists. Prince cut out Sony BMG last July to give away his latest CD through a U.K. newspaper, cannily betting that he'd make up for this lost income by boosting sales of highly lucrative concert tickets. And in October Madonna abandoned Warner Music to throw in her lot with Live Nation, a California-based concert promoter. "The record-label system is built on 100% control," says Leonhard, and major labels "have lost that."

So are the majors turning into minors? Despite the bad news, that fate remains some way off. Big record companies still excel at winning their bands airtime or prime space on stores' shelves. And for every rebuff from a Madonna, there's an award for a Winehouse, thanks to support from tuned-in record execs. "It's all very well to say bands can do it all themselves; some don't want to," says Max Hole, executive vice president of Universal Music Group International, which oversees Winehouse's label. Many now acting alone admit they got a leg up from a record company. "The only reason we could even get away with this," Radiohead's lead singer, Thom Yorke, said recently about selling its album directly to fans, "is that we've gone through the whole mill of the business in the first place."

Still, high-profile departures like theirs could lead fresh talent to think twice about signing to one of the majors. And persuading established artists to stick around is especially tricky when labels are asking for a bigger slice of the revenue pie. Traditionally, when record companies signed an artist, they bought into the promise of an album; an act's other sources of cash — its concerts, say, or merchandise sales — weren't any of the label's business. But now, with album sales plummeting, music companies are chasing juicier income from touring and branded goods. Part of that revenue stream figures in Live Nation's $120 million deal with Madonna. Likewise, U.S. rock group Korn now carves up its nonmusic income with EMI; Interscope Records, a U.S. label owned by Universal Music, even gets a cut from a Las Vegas nightclub endorsed by the Pussycat Dolls. The appeal for artists? Labels can pledge greater, longer-term support — and big, upfront payments in many cases — if, in return, they get a stake in almost everything their musicians sell.

But few bands can expect to score sneaker ads or globe-trotting tours. Record companies still need the music to make them money. But some 30% of the artists on EMI's books have yet to come back with a recording, and sliding CD sales mean that overall, only 3% of the label's artists are profitable. "The actual economic power of new music is declining at an extraordinary rate," says EMI's Hands. Keen to keep it alive, he is mulling changes to the way EMI's artists are rewarded. Out could go generous advances for some artists — "an excuse for us to lose more," he calls such payments. Instead, some expect him to experiment with salaries or even day rates for artists cloistered in the studio.

Would artists buy this kind of shift? Jon Webster, chief executive of the London-based Music Managers Forum, is not so sure. Far from spoiling musicians, he says, "most personal advances are to keep people alive." Squeezing out an album is an unpredictable affair, and regular pay checks might strike some artists as an unwelcome reminder to hurry up. "Creators rarely want to be sitting here watching the clock," Webster says. "The creative process doesn't work like that."

Too often, it doesn't produce money-spinning discs, either. More mature music fans might still pay up for a CD; some 2 million people outside North America bought last fall's Long Road out of Eden, for instance, the first studio album from the Eagles in decades. But supermarket muscle has driven down the retail price of compact discs. The only U.S. store selling that Eagles CD was Wal-Mart, for the bargain price of $11.88. The average price of a CD in Europe dropped by 4% between 2003 and 2006, according to PricewaterhouseCoopers. One way to maintain price levels is to offer deluxe products that pair a standard CD with a fancy book, live recording or DVD. Radiohead figured that out: aside from its pay-what-you-want download offer, the band flogged a special-edition box set of In Rainbows for $80 a piece. And a repackaged, "deluxe" version of Back To Black, bundling Winehouse's 2006 album with bonus tracks, shot to the top of Britain's album charts just this month.

Wringing more out of plastic discs won't be enough to secure the record companies' futures, though. More pressing is the need to sharpen strategies for the digital market. Record companies were slow to turn on to digital; Doug Morris, the boss of Universal Music, once slammed MP3 players as little more than "repositories for stolen music." But last year those companies saw their revenues from digital sales hit an estimated $2.9 billion, up almost eightfold since 2004. However, that's not exactly the fortissimo it may appear to be. The 38% annual growth in digital sales last year was less than half the increase seen in 2006. Music companies, says JupiterResearch's Mulligan, "are at a stage where they cannot afford to be as choosy as before" when it comes to distributing their wares.

That means easing restrictions on how downloads can be used, and on what kind of devices. You'll still need a whizzy Apple gadget to hear most of the music available from iTunes, but Amazon last September began selling tracks in the U.S. in a format compatible with most digital music players. Its catalogue of 3 million songs — culled from all four majors — will be available outside the U.S. later this year; European music fans unable to wait can from this month download such unrestricted tracks by Warner Music and EMI artists from 7digital, a U.K. music site.

To ease the pressure on their revenues, record companies may paradoxically have to offer more for free. Today's music consumers shell out hundreds of dollars on MP3 players, but they spend an average of just $20 a year on downloads. To the crucial teenage market, paying for music is as outdated as picking up a newspaper. But companies can get something in return for giving them music. Advertising-supported free music services such as Last.fm pay the major record companies from ad revenue; in return, their users can stream the companies' music for nothing. Such outlets offer record companies the chance to build a relationship with younger fans in the hope those users will later migrate to more lucrative products such as music dvds. Cell-phone users can also expect to get months of free access to a catalogue of songs. Nokia will launch its Comes With Music service later this year, reimbursing artists and their labels from expected new sales of its music-compatible phones; a similar service, available through Korean giant LG, will come out in the summer. The first record company to offer its music for both these services? Universal, led by the once skeptical Morris.

Innovation like that could also help to strangle music piracy; some 20 billion files were downloaded illegally in 2006. The music business has called on Internet Service Providers (ISPs), which host that traffic, to do more to choke it off, and an agreement was reached in France late last year requiring ISPs to stop large-scale copyright infringers. But to shake off its blues, the record business must itself continue to break old habits. Saying yes to rehab is a start, but returning to health is going to take a sustained dose of discipline and imagination.

• ADAM SMITH
• The music industry is racing to reinvent itself as the digital age renders its old business model obsolete