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Saying the band Gnarls Barkley is big in Britain would be an understatement. When the duo, singer Cee-Lo and DJ Danger Mouse, released their song Crazy, it hit No. 1 on the British singles charts before the album even arrived in stores. The song stayed so popular that, after nine weeks at the top of the charts, the label decided to remove it from the charts in preparation for the second Gnarls Barkley single, set for release in July.
The excitement surrounding Gnarls' album, St. Elsewhere, which includes Crazy, has since spread to the U.S. At press time, Crazy was No. 4 on iTunes' most-downloaded songs overall and No. 1 in the alternative category, and St. Elsewhere had climbed to No. 11 on the Billboard music chart. (Click to listen to the song or watch a video of the band.)
DAVID AND GOLIATH. But a major label didn't release the album. Instead, the job went to a startup named Downtown Records, which opened its doors in January, 2006. Despite having shipped half a million Gnarls Barkley albums, Downtown is still running lean, with nine full-time employees split between Los Angeles and New York City.
Downtown's success as a small label is becoming less of an anomaly in the music industry in recent years. The rise of social networking sites like MySpace.com and their importance to little-known music acts has been well documented (see BusinessWeek.com, 12/12/05, "The MySpace Generation"). But entrepreneurs like Josh Deutsch, Downtown's CEO, are taking advantage of other forces to compete with the major labels and their teams of marketers, distributors, and executives.
A number of phenomena are helping the little guy score big hits. For one, the shift from physical CD sales to digital downloads almost universally favors the smaller label because it lifts the burden of distribution and other overhead costs. And when they score a big hit, many smaller labels are now forming flexible partnerships with majors to get the distribution they need, when they need it.
HIGHER SURVIVAL RATE. The success of legal, pay-per-download services like Apple's (AAPL) iTunes has helped many previously obscure artists and labels get heard—and bought. And they can do it with minimal overhead and almost no marketing (see BusinessWeek.com, 2/6/2006, "Rockers, Keep Your Day Jobs").
"[Today,] there are a lot more labels that are able to survive and earn a lot more money on their own," says Paul Resnikoff, founder and editor of Digital Music News, a digital music newsletter and research group founded in 2004.
Sales of both singles and albums have palpably shifted from physical CD purchases to digital downloads. In 2004, the number of singles downloaded totaled 139.4 million, according to the Record Industry Association of America. In 2005, that number grew to 366.9 million—a 163.3% increase. Albums grew by an even larger percentage, from 4.6 million, to 13.6 million, a 198.5% increase.
ILLEGAL—AND HELPFUL? Labels like Downtown are succeeding in the face of a struggling industry. The U.S. recording industry has shrunk from $12.5 billion in 1996 to less than $12.3 billion in 2005, according to the Record Industry Association of America.
With the boom in legal online music sales, many fear that an illegal file-sharing culture has stunted the larger music industry's growth. "At any given moment, there are 10 million people across the globe sharing music illegally online," according to Resnikoff, who says that number has shrunk in recent years.
But smaller, independent labels say the quality of their music and artists makes them less vulnerable to online pirating than their major-label counterparts. In fact, Deutsch says the buzz generated by kids sharing music online actually helps long-term sales.
NURTURERS. Small labels find their strength in the passion for developing a few great artists with the potential for long and fruitful careers. Octone Records, founded in 2000, which (like Downtown) was funded by private investors, has signed only five artists, including Grammy-winning act Maroon 5. David Boxenbaum, co-founder and general manager of Octone, says his label's size (eight employees) and freedom from the pressure of quarterly earnings reports allows his staff to focus on making each project as good as it can be.
Deutsch and Boxenbaum say smaller is better for developing great artists, especially since consolidation within the recording industry has hurt talent-development funding at the majors. That's why execs like Deutsch, who was senior vice-president of A&R at Virgin Records for three years and executive vice-president at Elektra Records for seven years, as well as Boxenbaum's co-founder James Diener, a former VP at Columbia Records, savor the freedom to develop artists at their own pace (see BusinessWeek.com, 5/22/06, "Facing the Digital Music").
When experienced execs go out on their own, they bring their industry connections along, often forming partnerships with major labels and distributors. For instance, Downtown enjoys a distribution and joint venture deal with ADA (Alternative Distribution Alliance), a division of Atlantic Records' parent company, Warner Music Group. That's how St. Elsewhere has made it into Wal-Mart (WMT) and Best Buy (BBY). But the record labels are still independently owned.
KEEPING EQUITY. Until recently, partnering with a major label meant surrendering control or being bought out. Now distribution deals allow smaller labels to maintain maximum control while getting maximum exposure for their artists. "On a daily basis, relationships [formed within the mainstream record business] can pay huge dividends," Deutsch says.
It's not new for a major to buy an independent label and incorporate the artists into a larger machine, but many independents are choosing to retain full management and decision-making rights. "Since we've had financing and veteran staff, we're able to compete without giving up equity," says Deutsch.
The digital phenomenon may soon let smaller labels compete without help. Until then, many concede that if they can't beat them, they'll join them—at least partially. "You have to partner with a major to be able to sell 300,000 to 500,000 records," says Gregg Latterman, president and founder of 12-employee Aware Records, a record company based in Chicago that was bought by Sony (SNE) in 1996. Latterman says his deal with Sony suits him, since it allows him to concentrate on what he loves: discovering and developing successful artists who make great albums.
NOT LIKE INDIES. In the last five years, Boxenbaum says Octone has averaged just one album release per year and has had good to great success with two of its artists, mild success with one, and less success with the other two. "Our whole strategy is to superserve the records we have. We're batting about .500, which is a lot better than the major [record labels]," says Boxenbaum.
Octone, Downtown, and others like them are different from traditional "indie" labels, which are either fiercely independent or representing a specific type of music. They tend to operate like a major, just on a smaller scale, with a fiercer dedication to the craft of making music.
"We feel like the record business in general needs to reconcile itself with new economics," says Deutsch. As they score mainstream successes with acts like Maroon 5 and Gnarls Barkley, savvy small labels are proving the big leagues aren't just for the majors anymore.
Gangemi is a reporter for BusinessWeek Online in New York
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