Recap of Economics in Old Media
If you recall, we discussed the economics of artists in music and publishing in the Amazon/Hachette post. Basically, artists and writers typically get a 15–25% of revenues. The low proportion is largely justified by the fact that the labels/publishers pay for a significant portion of the production, marketing and distribution costs of the product and often provide financing to artists (e.g. advances).
Economics in the New Media Framework
Many artists had hoped the reduction in production, promotion and distribution costs in a digital world would mean they would receive a higher proportion of the revenues. This expectation has been met with mixed results. I know from conversations with industry folk that artist royalties have been rising across different media. However, the change has been gradual and minor—a couple of percentage points here and there for artists willing and able to negotiate.
We previously discussed two major interlinked reasons for this phenomenon:
- Many costs are not actually lower in the digital world: development requires fixed costs and promotion is as difficult if not more in a crowded digital world
- With often declining revenues/unit in the digital world, labels/publishers are challenged due to their higher fixed costs and are not able to pass on more of the savings.
However, there is also a third reason created by the structure of the internet for why artists are not benefiting in the digital media world.
Power of Two-Sided Networks
At this point, most of us familiar with networks and “network effects” and how powerful they can be. In digital markets, it’s much easier to build massive scale networks quickly and once you reach scale, you become very difficult to disintermediate. Facebook has over 1.2B active users. While new products are chipping away at Facebook’s lead, they are not yet making a meaningful dent because people want to be where their friends are and it’s difficult change the behavior of 1B people. Moreover, Facebook’s lead allows them the resources to buyout potential threats (see: Instagram, Whatsapp).
What’s better than a one-sided network like Facebook? A two-sided network with traction. Online marketplaces are a classic example of two-sided networks: consumers come because there are merchants and merchants come because there are consumers and on and on. It creates a virtuous cycle of growth. Two-sided networks are even more difficult to disintermediate than regular networks. For example, Alibaba in China has an impressive 80%+ market share.
Two-Sided Networks in Creative Industries
The market for stock and commissioned images historically used to be dominated by Getty Images and Corbis. Getty paid its artists a royalty of 20 to 30%. Getty neglected the lower revenue per unit stock photography which allowed Shutterstock to build a marketplace for stock images. The network quickly gained scale with nearly 40 million images, ~1 million buyers and 55,000 contributors. Guess how much Shutterstock pays in royalties? The same 20–30% (Average was 27% in 2013).
Why doesn’t someone set-up a website that pays artists more? They have tried. But it usually doesn’t work because people (esp. buyers) don’t move easily, which makes artists loathe to move. Meanwhile, the upstart has to match the infrastructure and service of the leader. If the network doesn’t reach scale in a reasonable amount of time, investors lose faith and the company closes shop.
Implications for Artists
Are all market participants doomed because of two-sided networks? No, because large markets will always attract more competitors willing to invest and wait to gain scale. For example in retail, leader eBay gave-up its crown to Amazon because Amazon built a larger network of customers from its direct sales and leveraged that customer network to attract third-party merchants. However, this required a massive investment from Amazon, an investment justified by the size of the US retail market. Another benefit for participants in large markets is that the platforms will limit distribution fees to discourage excessive competition: Amazon/eBay’s fees are 8–10%, Apple iTunes’ fee is 30%, and YouTube’s is 45%.
The same may not hold true for smaller markets: Shutterstock is charging a fee of 73% (inverse of royalty). In another example, Amazon is offering 70% royalty for self-publishing. They already have scale in terms of readers, but once they reach scale in authors, where did you think the eventual royalty rate will settle? This network is even harder to disintermediate because of the device lock-in—Kindle is quickly becoming our universal reader.
I think the reality—for better or worse—is that in more niche markets, it may always be the case that most of the value in the ecosystem will accrue to the marketplace rather than the participants.
Thank you for reading this far. Feel free to leave a note or tweet me your thoughts @sri_batchu.