"Do you realise we are giving away our master tapes here?"

(Robert Sandall worked as director of communications for Virgin Records from 1996 to 2002 )

There is a story doing the rounds in the US that says a lot about the state of the music business. It concerns a young rock band who decided to stop selling their CDs at concerts. Selling CDs has, for many years, been a good way for an act to reclaim the margin that would otherwise have been snaffled by a retailer. But it made no sense to this band once they discovered that by selling CDs for $10 they were cannibalising sales of their $20 T-shirts.

There are two points to note here. First, that a simple garment with a logo stamped across it, probably manufactured for pennies in a third-world sweatshop, now costs twice as much as an album of digitally pristine, highly wrought music recorded in a state of the art western studio. Second, most bands, however successful, now make their money from live work and the merchandising opportunities that go with it, rather than from recordings.

The record companies know this, which is why when EMI re-signed Robbie Williams in 2002, the £80m deal guaranteed the label a share in the profits generated by Williams's tours. Such spinoffs are often now make or break issues in contractual negotiations. Gerd Leonhard, a music business consultant, predicts that by 2010, recorded music sales will make up only 30 per cent of a successful label's revenues. The rest will be generated by artists' extra-musical brand extensions. Like those $20 T-shirts.

The artists are getting wise to this new value chain. One of the hottest new names to emerge recently, the rave metal band Enter Shikari, have refused to sign any of the deals they have been offered, instead releasing their debut album Take to the Skies on their own label, Ambush Reality, in March. In the past, these tiny, so-called "indie," labels have usually been funded by majors anxious to covertly purchase credibility for their products with a young audience. The celebrated label Creation, home to Oasis and other Britpop stars in the 1990s, was owned entirely by Sony. Had it not been, the marketing spend which turned Oasis into a huge international draw would not have been available.

But this is not the case with Ambush Reality. The marketing of Take to the Skies was undertaken largely by the band themselves, who have played nearly 700 gigs since forming in St Albans in 2003. Word of mouth, coupled with the inevitable presence on MySpace, has done the rest. In November 2006, they became only the second unsigned band (after the Darkness) to sell out the 2,000-capacity Astoria in London. Five months later, Take to the Skies entered the British album chart at number four. In May, Enter Shikari started out on their first American tour.

They have set an inspirational example, not least by their single-minded prioritising of their performances. Groups used to tour, often at a loss, to stimulate sales of their latest album. Now it's the other way around. Hence the widely reported decision earlier this year by the Crimea, a band previously signed to Warner Bros, to release their new album as a free download. The band explained this not as an anarcho-hippie gesture in support of the principle that music ought to be free, but as a sensible promotional tactic. Their hope is that by disseminating their music online, they will expand their fan base and increase their returns from touring. Having seen the small size of the cheques they got from Warner, they know where not to look for their future income.

This view is shared by a far more famous former Warner artist: Prince. Anyone attending his shows at the London O2 arena in August will receive a free copy of his latest CD, Planet Earth, as did anyone who bought the Mail on Sunday on 15th July. Prince's new label, Sony/BMG, which did not know about the deal, has withdrawn the album from British shelves.

"Record sales as we know them are in long-term decline," says music business analyst Keith Jopling. "Whereas the wider music market—live, merchandising, streaming video and music social networking—is in rude health. After seven years of gradual change, we are about to see a major shift. Record companies are, at last, in a hurry to transform themselves into proper consumer marketing companies."

The catastrophic slide in the value of recorded music, and particularly in the price consumers are prepared to pay for it, has been felt hard on the high street. HMV announced in June that its profits had halved over the past year. Soon afterwards, the discount CD chain Fopp went out of business.

The industry that for years appeared to possess a licence to print money is reeling. The "big four" labels—Sony/BMG, Warner Music, EMI and Universal—have in recent years embarked on cost-cutting operations leading to major culls of staff: EMI's recorded music division has shrunk by almost half since 2001, from 9,388 employees worldwide to 4,818 today. Meanwhile, a senior industry executive reports that of this year's breakthrough British acts, just one, Mika, will make money for his record company. This decline in fortunes has been noticed in the financial markets: EMI is being bought up by private equity group Terra Firma, for £3.2bn.

Almost as soon as the offer was accepted, Terra Firma were reported to be in discussions with Warner to offload EMI's recorded music division. The side of EMI that interested Terra Firma was its song publishing arm, the world's largest and a profitable performer. It is regarded as a safer bet because the exploitation of song copyrights is not subject to the same feasts and famines as the hitmaking process. As well as receiving around 14 per cent of the profit on any CD sale, the publisher has its fingers in other pies, such as licensing fees for films, adverts or any of the other myriad outlets which now employ music. Once upon a time, EMI's publishing arm accounted for about a third of the market value of the whole group. Now it's the only part that's worth anything to the people who venture their capital. It is no coincidence that Terra Firma's offer valued EMI at about a third, in real terms, of what it nearly fetched ten years ago when a sale to its competitor Universal was mooted.

That decline roughly mirrors what has happened over the same period to the retail price of new—as opposed to catalogue reissue—CDs. When EMI's subsidiary Virgin put out the Spice Girls debut album in 1996, it sold for around £13 in Britain, from which the company cleared more than £5 in profit. New CDs now seldom cost more than £9, from which the label can expect to make £2, if it is lucky.

Although Britons still buy more CDs per head than anyone else—2.7 in 2006—the market for recorded music is in rapid decline. In the first quarter of 2007, the market for the top-selling 200 CDs in Britain shrank by 20 per cent compared to the same period in 2006. In the US, CD sales in 2007 are down by 15 per cent, in France 25 per cent, in Canada 35 per cent. The German market, once the largest in Europe, is now no bigger than that of the Netherlands.

The market for digital downloads was worth around $981m in the US last year, around a tenth of the value of the CD market. Yet the labels' great hope is that the slump in demand for physical formats will be offset by growth in the download market. This looks wildly optimistic. The latest figures from the US reveal that while paid-for downloads are increasingly popular—up 74 per cent in 2006 on the previous year—the surge in demand is slowing. And while the total value of music sales across all formats remained more or less static in 2004 and 2005, it declined by more than 6 per cent in 2006. The trade body of the American record industry, the RIAA, optimistically predicts that by 2011, the global online music market will be worth $6.6bn; three times what it currently amounts to. This situation will, as the RIAA delicately puts it, "leave the industry better positioned to offset physical sales."

Yet however it finds itself in 2011, the underlying truth is that recorded music, on or offline, has moved from being a high-margin, "high-end" product to a low-margin, low-prestige commodity. The album, for 35 years the basic, pricey unit of the industry—such a handy way of getting fans to shell out for ten songs when they might have wanted only three or four—increasingly seems, for young consumers, a clunky, old-fashioned and uneconomical way of building a music library on a portable MP3 player.

Far better to download songs; at the iTunes music store, tracks retail for 99 cents in America and 79p here. In Britain, at the end of the 1990s, CD singles sold for £4. Of that, the artist received about 50p, while the record company took as much as £1. Under the new web-style arrangement, the artist is lucky to get 10p, and the company might gross 30p.

This destruction of the value of individual recordings explains why, even if we were to carry on buying recorded music in the quantity we did at the end of the last century, the prospects for suppliers would still be bleak. However high the record companies worldwide pile their audio products in future, the only way they will be able to sell them is cheap. In Britain, the 10 per cent of singles still sold on CD now retail for just £1.49.

Record company insiders are aghast at the demise of what was, for the last two decades of the 20th century, their golden goose. And some of them know that they were partly responsible for killing it.

Arriving on the market in 1982, just after record sales began to revive following a three-year downturn, the compact disc ushered in the biggest boom in profits the record companies had known since 7" singles gave way to 12" LPs in the late 1960s. The CD persuaded many music fans to replace their vinyl collection with digital copies of music they had already paid for. And the rise of the CD permitted record companies to double the price of their basic product without incurring a huge uplift in costs. Even allowing for the royalty paid to the joint inventors of the CD—Philips and Sony—the discs were soon being manufactured for little more than it cost to crank out vinyl records on ancient presses.

Initial anxieties that consumers might be resistant to the more expensive format proved unfounded. Research revealed that music fans were more worried about the cost of acquiring a CD player than by the price of the discs. Paying £12 (£30 in today's money) for an album that, nearly everybody agreed, sounded better and was easier to manipulate than a vinyl LP, didn't feel steep in the mid-1980s. In 1994, the CD supplanted the cassette as the most popular platform for recorded music in western markets.

Yet in some ways the CD contained the seeds of its own destruction. One of the few industry moguls to raise his voice against the digital format in its early days was the late Maurice Oberstein, an American who was latterly head of the Polygram UK (later Universal) label. "Do you realise we are giving away our master tapes here?" he asked at an industry event. At the time, everybody was too busy counting the cash to listen. But as the advent of recordable CDs kickstarted a black economy in counterfeits in the 1990s, Oberstein was proved right.

Anybody who owned a CD could indeed use it as record companies had traditionally used master tapes: to clone thousands more, and quickly, using kit available on any high street. And at home, CD burning hardware on computers made it simple to produce copies in seconds. Developing markets in South America and southeast Asia collapsed under the weight of cheap copies. More damaging was the loss of the German market. Within the space of five years, the 82m Germans turned into a nation of CD copiers, paying pfennigs for albums that once cost 40DM.

Still, the market in the rest of the west, while not exactly booming, did hold up. The next development to shake up the music industry was the emergence in the late 1990s of illegal "file-sharing" websites, such as Napster. Online piracy, often identified by the media as the wrecker of the CD business, did seem a big threat at the time, although it was difficult to find hard data to support the claim that it damaged sales. Rather like the "Home Taping is Killing Music" campaign mounted by record companies in the 1980s, the arrival of illegal file-sharing coincided with an increase in legitimate sales of recorded music in the three largest markets: America, Japan and Britain. This supported the file-sharers' defence that their activities were no more harmful to music sales than the arrival of free radio airplay in the 1930s.

Instead, it has been the iTunes era of the 21st century—the creation of a growing legitimate online trade in cheap music—that has coincided with the drop-off in CD sales. The burgeoning popularity of portable MP3 players, notably Apple's iPod, seems to be turning the compact disc into the 21st-century equivalent of shellac—the precursor to vinyl.

Yet the music industry itself must take some of the blame for the decline of the CD. For the past 15 years, free covermounts on magazines and newspapers, licensed or even paid for by record companies, have diluted the perceived value of recorded music in general and CDs in particular. The practice of dumping free music CDs on the newsstands peaked in 2004, when 454 were licensed in Britain. It may seem odd that at the same time the industry was trying, and failing, to maintain a £10 price point for its premium CD products. But for years, record companies clung to the view that covermounts were a promotional benefit to them and their artists. Just as they allowed MTV to build its business by supplying it with free videos, they did newspaper and magazine publishers a huge favour on what turned out to be a hunch.

They maintained this position even after their trade body, the BPI, showed that the only beneficiaries of such giveaways were the publications carrying them. In the mid-1990s, Mark Ellen, editor of Q, Britain's leading rock title, described a CD giveaway as "like pinning a £10 note to the cover." When the Sunday Times gave away a free CD of old Oasis songs in 2000, it registered its highest circulation ever. In the following weeks, the BPI noted, retail sales of Oasis albums actually declined. But now even newspapers and magazines seem to have lost their appetite for covermounts. Last year, Q discontinued them on the grounds that the cost of manufacturing the discs was no longer justified by a spike in circulation. No clearer sign exists that, at least for musically savvy Q readers, you can't give CDs away.

Labels now tend only to use covermounts to showcase the music of new or developing acts. But old habits die hard. In April, EMI licensed Mike Oldfield's album Tubular Bells to the Mail on Sunday. The company charged Northcliffe Newspapers £200,000 for the right to dispense 2.3m CD covermounts of Britain's 11th bestselling album ever. The deal valued Oldfield's classic—the LP that launched Virgin as a successful record label in 1973—at a little over 8p a copy. This led the head of Woolworths, one of the largest of the dwindling band of CD retailers in Britain, to ask: "And how many copies of Tubular Bells do you think we will sell this week?"

It is difficult to prove that the rising popularity and price of live music has been directly affected by the superfluity and cheapness of the recorded stuff. But it seems more than a coincidence that just as fans are spending less on the tunes they listen to at home, they will pay unprecedented sums to hear them in concert. Ticket prices, especially for A-list artists, have soared.

Back in the 1980s, a seat at a concert by a superstar cost about the same as one CD album. By contrast, last summer you could have bought Madonna's entire catalogue for less than half of what it cost to see her perform at Wembley Arena. The best seats in Madge's house went for £160. With the Rolling Stones at Twickenham last August, a decent view would have set you back £150, or £350 for a seat on the side of the stage. To put this in historical perspective, when the Stones played Wembley in 1990, they took some stick for charging £25, top whack. Now that demand for live music is on the up, nobody bothers to complain about what it costs any more. Euphoria at the news earlier this year that the Police had reformed obliterated all concerns that it would cost £90 to see them play at Twickenham in September.

This is not a local phenomenon. The $690 (£345) it cost to watch Elton John at Las Vegas in May set a new record for an American rock show. In Hong Kong last year, Robbie Williams charged £180. Even the less prosperous citizens of Chile were asked to pay £80 to watch Coldplay in Santiago's Espacio Riesco, a considerable sum in a city where the average monthly salary is around £250. Ticket inflation with smaller bands is less intense. But even a relative unknown like the American singer-songwriter Laura Veirs charged £15 for her London show at Bush Hall this July. More telling is the ubiquitous presence of touts outside low-key venues where no secondary market for tickets existed ten years ago.

Attendance at arena rock shows grew by 11 per cent in Britain last year, and looks set to rise again in 2007. The bigger the concerts, the more we seem to like them. Hence the explosion in the festival trade. In 2007, there are 450 such large-scale gatherings scheduled, ranging from the recent Glastonbury festival to the one-day Underage festival in Hackney on 10th August, which claims to be the first to be aimed exclusively at 14 to 18 year olds.

A rediscovery, or a renewed appreciation, of the communal source of music-making—and listening— must lie near the root of this upending of the music business. As personal stereos and MP3 players have grown in popularity, so has an appreciation that music isn't just something that goes on between your ears. The guitarist of the American hardcore band Anthrax expressed this rather neatly: "Our album is the menu," he explained. "The concert is the meal."

In his book e-Topia, William Mitchell relates the increasing value of shared experience to the isolating nature of electronic or online virtual worlds. "In conducting our daily transactions, we will find ourselves constantly considering the benefits of the different grades of presence that are now available to us, and weighing these against the costs," he writes. Being in the same place at the same time as a live performance, music fans appear to have decided, is the rarest and most precious presence of all.



As always, comments are welcome.