So, when we left off, we were trying to figure out where labels fit into a digital music industry. Clearly, they still have a vital role as a mediator within the industry. They can act as a filter, an aggregator, and a promoter for talent. However, they need to change their attitude about both their place in the hierarchy, and their policies both towards A&R and the economics of how music is produced.

Labels are still living in analog economic times. They’re spending a fortune recording albums, promoting them in traditional ways, manufacturing a physical product, and cultivating an expensive persona for the bands.

What they need to realize is that you can record competitive sounding records in your bedroom for free. In addition to that, you can leverage a vast distribution network in the form of the Internet, as well as using it for promotion. All for a tiny fraction of the cost of the traditional method of producing a record. Now the labels will of course say that you can’t produce superstars in that way. They’re probably right, but need I remind you of ‘the long tail’? In short, maximizing the millions of micro-markets that exist on the ‘cheap’ end of the spectrum, rather than focusing on individual mega-stars.

Now, in addition to lowering their input costs substantially, and thereby lowering the risk of their investment, labels can also broaden their rosters rather than simply putting all their eggs in one basket, so to speak. They can have the freedom to enroll more acts and create a deeper roster that occupies a bigger portion of the niche.

This is an important point: aggregation. Rather than simply having a few artists scattered across genres, labels can build up clusters of artists in the same genre and cross-sell the artists to the fans of the other bands. Labels should stop focusing on themselves as product salespeople and start envisioning themselves as content providers.

Rather than manufacturing and selling widgets (that they claim are increasingly valueless), they should be focusing on distributing that content essentially for free, and shifting their revenue stream to the audiences for that content. If music isn’t necessarily free of charge under this system, the sale of digital music doesn’t provide the bulk of the revenue so much as the audience itself (via advertising, listening preferences, cross-selling with other businesses).

We’ve seen the value that an audience can garner (look at the vast success of a company like Google, whose entire revenue stream is dependent on an online audience for advertising) – and music audiences are some of the most loyal out there. Also, we’ve seen that people are willing to volunteer their listening preferences if it means that they get something back: new music. The success of something like Last.fm (Audioscrobbler) comes to mind here.

The problem we’re seeing is that labels are refusing to embrace these new ways of approaching their business. They repeatedly resort to ridiculously restrictive DRM schemes, copy protection schemes, and lawsuits to attack file sharers. Rather than trying to nullify the effects of digitalization – the industry should be leveraging them to enhance their position, and thereby nullifying any negative effects that are inherent in a digital medium.