Posted by: hdemott | April 24, 2010

The VC and The Music Industry: Not As Different As You Might Imagine

The music industries and the VC world have often been compared. Both worlds fund unknown or start up artists (yes engineers and marketers are artists) in the hope that the art they fund will catch on with the public – and they – and the artists will make a financial killing from their initial investment.

The return profile is somewhat similar in that one mega company – or mega band can make up for all sorts of companies and bands that were funded and never made it. One Lady Gaga, or one U2  – one Google or YouTube  – can make up for all the mistakes that came before and then some. Sure there are some singles and doubles in there – companies and bands where you get your bait back – and plenty where it is a total write off – but the winners dominate – we see them in the public – we feel theri presence on the balance sheets and income statements.

For years both of these undertakings were highly risky ventures. The A&R folks at music labels were like high priests – divining who had talent and who had no chance. Just as the core of investors on Sand Hill Road vet thousands of companies a year – so do the labels.

But in recent years – times have changed – and with these changes should come greater opportunities and perhaps less risk.

In the past – there was a ton of friction in both systems. To make a record cost a lot of money – and distribution was a nightmare. unless you were getting airplay – you were not getting heard and if no one can hear you – how do you ever become a breakout artist. Same on the net. Servers were expensive, real estate was expensive, bandwidth was ruinous etc…

But all of that has changed recently. Bands can record cheaply just as engineers can build and host services quicker than ever through the use of prolific API’s, AWS and extremely inexpensive bandwidth. All of these things is flattening the world – and making it easier and easier to gain traction in the marketplace with your product – whether it be a consumer facing web service or a great rock record.

This in turn, makes it easier for the sources of funding to figure out who is going to make it and who is not. There’s a lot less guesswork in the job when you already have thousands of users or an equal number of fans. As a result of this – one would think that the hit rate among venture investing should increase over time – as should the hit rate with A&R at a record label. Their businesses should get less lumpy – and more driven by middle of the road returns.

All that said, just as it is easier to discern who has “it”, it is just as easy for your competitors to determine the same thing – as it is far more obvious these days. Which of course brings in more capital – great for the company or band – but serves to drive down returns for the capital sources.

What you get is lower returns, but a better batting average. More singles and doubles – fewer triples and home runs.

As Tim Westegren of Pandora refers to it – an artists middle class.

It’s also an investors middle class.

Get used to it.

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Responses

  1. This is a great parallel to draw. I have only one disagreement. I think this new ecosystem will also produce more Googles and YouTubes.

  2. It very well might. Keep adding more and more disruptive and innovative companies – keep funding more and more hard working artists (and I use the term here as Seth Godin uses it in Linchpin – kind of stuck on that book mentally right now) and there are bound to be more winners emerging. The question I always have is whether these winners can keep enough of a moat around their business to stave off fast followers and others like them. In the past distribution costs and FCC licenses – cable infrastructure and massive production facilities kept the media elite safely ensconced (and truth is they aren’t exactly suffering quite yet). Those barriers have largely been broken down – but if one can do it – than many can.


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