Lessons From The Mosh Pit

I generally don't pay much attention to rock music, but I'm fascinated with changes in business models. Which is why a news item late last week about Live Nation caught my eye.

Live Nation's goal has been to dominate the live music business. By gaining control of the largest network of music venues in the country and involving itself in as many aspects of the music business as possible, the concert promoter is crafting a strategy to create efficiencies and synergies that would generate higher profits and allow it to attract the best talent.

So far, it hasn't worked out that way-- not for Clear Channel, the radio broadcasting giant that launched Live Nation in 2000 with the thought that it could gain advantage by favoring its artists' songs on its radio station, and not for its current investors, who have yet to see a profit since the division was spun off as an independent company three years ago. So Live Nation executives decided that the key to success is to take the strategy of vertical integration even further and enter the parts of the business that it wasn't already in.

In the past year, Live Nation has bought a company that runs fan clubs for bands and performers, aiming to promote sales of concert tickets, CDs and fan paraphernalia, along with a major producer of that paraphernalia. It ended its longtime relationship with Ticketmaster and announced that, starting next year, it would build a nationwide computerized operation to handle its ticket sales. And it rocked the industry by signing what are known as "360" deals with Madonna, Jay-Z and U2 that will give Live Nation responsibility for not only their concerts and fan development for the next decade, but for producing and distributing some or all of their recorded music as well.

Then late last week, Live Nation announced the resignation of Michael Cohl, the famed tour promoter, as chairman and head of its live music division. According to published reports, Cohl wanted to move quickly and aggressively to lock up even more of rock's superstars with 360 deals. But fellow Canadian Michael Rapino, Live Nation's chief executive, and other directors opposed the strategy, reportedly concerned that the deals, valued at $120 million to $150 million each, were too rich for the company and its increasingly wary investors, who have watched Live Nation shares fall by nearly 50 percent since the Madonna deal was announced last August.

Conceptually, at least, these 360 deals make a lot of sense for everyone involved.

Consolidating all aspects of sales, marketing and distribution of the artists' work makes it easier to create and execute an integrated strategy -- one that strikes the best trade-off between price and volume and is structured to drive growth in those areas with a higher profit margin.

The approach allows top artists to regain some profit from their work that had been captured by overpriced intermediaries such as Ticketmaster and record labels. With a large fan base that could be tapped by e-mail or serviced with off-the-shelf software, Madonna and U2 probably don't need to pay a premium for Ticketmaster's extensive network to sell out a concert. With CD sales rapidly giving way to downloaded singles, legal and illegal, top artists are feeling less kindly toward record companies that never paid them much to begin with and have always used the profits earned from hit artists to subsidize development of new talent.

The theory of a 360 deal, then, is that by consolidating management of all aspects of the business, both Live Nation and its artists will wind up with more money. But just as important is the shift in risk that is implicit in these arrangements: The artists give Live Nation some of the profit they earn if a tour or music sales go better than expected in exchange for Live Nation's promise to pay substantial annual guarantees.

It is still to be seen, of course, whether all of this works out -- the key is in the undisclosed details of the individual contracts. Bob Lefsetz, a recording industry blogger, argues that the history of Live Nation is full of examples of synergy and vertical integration gains that never materialized. As he sees it, Live Nation was so desperate to juice up its stock price that it paid top dollar to big-name artists who have passed their prime.

But I think there is something to the idea that even rich rock stars are willing to trade the last increment of income or profit for a measure of financial certainty. That creates new business models and opportunities for companies clever enough to tap into that desire to trade risk for reward.

That's what happens anytime a farmer sells his crop forward to a food processor using futures contracts, which is happening with increasing frequency and sophistication. And it has led some companies to lease their major equipment rather than buy it, under arrangements in which they pay a fixed amount per CAT scan or ton of coal mined.

Given their precarious financial situation, the airlines are likely to move to auctioning off significant portions of their available seats to major travel agencies and tour operators. It's only a matter of time before Google begins to offer publishers a guarantee of monthly ad revenue in exchange for the exclusive right to sell all or part of their advertising inventory.

The Hamilton Project at the Brookings Institution wants to stimulate development of better financial products that would allow retirees to convert their 401 (k) nest eggs into guaranteed monthly payments for as long as they lived. And New York University economist Andrew Caplin has been pushing an idea tailor-made for the subprime crisis: a mortgage that, by combining debt with equity, provides borrowers protection against the risk that the value of their houses will go down while allowing lender/investors to share in the profits if real estate prices rise.

Whether it is rock music or housing finance, business models are always evolving in response to competition and technological change. Sometimes customers like to assume risks; at other times, they don't. At one moment, it makes more sense to bundle; at another, the winning strategy is to go a la carte. The only constant is that the big money is made by the first companies to come up with the successful new models. By the time everyone else hops onboard, the competitive advantage has been lost and it is time to change again.

Steven Pearlstein can be reached atpearlsteins@washpost.com.