BY KURT HANSON
In this week's previous issues of RAIN (here, here, and here), drawing from a speech entitled "The Future of Radio that I've been delivering at radio conferences around the world lately (and which will have its U.S. debut at our "RAIN Reader Cocktail Party" next week in Las Vegas), I've been making the following argument:

There are technological and cultural changes going on right now that will have a major impact on how consumers will access and use radio in the future. And if U.S. broadcasters react to these cultural and technological changes inappropriately, it's possible that, after the dust settles, we could see an entire new set of leading radio broadcasters!

Today, we'll look at a theory espoused by a best-selling author and Harvard professor that explains why, when it comes to new technologies, broadcasters may be betting on the wrong horse — and, by doing so, may be putting their entire companies at risk.


Great firms usually respond inappropriately
to "disruptive" technologies
According to the thesis compellingly presented by Harvard professor Clayton M. Christensen in his book The Innovator's Dilemma, there is a certain type of technological change that leads to a situation in which virtually all of the leading firms in a given industry are wiped out!

This happens, ironically, precisely because the leaders follow what are traditionally considered to be "good business practices" — e.g., being in tune with competitors, listening to customers, and investing aggressively in new technologies.

Christensen uses examples from a wide variety of different industries — including disk drives, mechanical excavators, retail, steel mills, and even manufacturers of radio devices — in which the leading firms were confronted with a specific type of "disruptive" technological change, reacted in a seemingly-appropriate manner, and totally lost their industry leadership as a result.

And I believe that today's radio group owners (Clear Channel, Infinity, Emmis, Cox, ABC, Entercom, Cumulus, SBS, Radio One, HBC, Susquehanna, Jefferson-Pilot, Citadel, Bonneville, etc.) are facing that exact type of technological change right now... and are behaving exactly in the manner that Christensen predicts!


Disk drive industry has seen five generations
of great leading firms sequentially fail
"Those who study genetics avoid studying humans," Christensen observes, because generations come along too infrequently. Instead, they study fruit flies, because they are conceived, born, mature, and die all in a single day.

Analogously, "If you want to understand why something happens in business, study the disk drive industry. Those companies are the closest thing to fruit flies that the business world has ever seen."

To summarize 66 pages into just a few paragraphs: Roughly every four years between 1975 and 1990, there was a set of a dozen or so leading firms in the disk drive industry. Each generation was faced with a new technology, they reacted using "good" business practices, and virtually all of them were wiped out (they either failed or were acquired) shortly thereafter as a result.

How in the world could this have happened? Christensen differentiates between two types of technological changes:

• "Sustaining technologies" are those that improve the performance of existing products. Industry leaders have no problems maintaining their industry leadership when faced with sustaining technological changes.
  
  
• "Disruptive technologies," on the other hand, appear on the scene offering worse performance than existing products. (Example: The first 5.25-inch disk drives were slower, had less capacity, and had a higher price per megabyte than the leaders' existing 8-inch disk drives.)

When disruptive technologies appear on the scene, the leading firms survey their best customers (which is, of course, a "good" business practice). In this example, they would have asked, "Do you have any interest in a smaller drive that's slower, has a lower capacity, and has a higher price per megabyte?"

Their best customers (in this example, minicomputer manufacturers) say "No." As a result, the leaders allocate their corporate resources elsewhere — toward sustaining technologies that eventually offer better performance than their customers are willing to pay for.

Meanwhile, a new set of small companies typically appears on the scene to develop the disruptive technology. They have a lower cost structure. They find new, small markets (in this example, the newly-emerging category of desktop PC manufacturers) that value the benefits offered by the new technology.

And then here's the key: The disruptive technology gets better! At some point (see the circle on the chart above), the disruptive technology gets good enough to meet the needs of the mass market. Meanwhile, because the industry leaders have put all their corporate resources into building performance improvements that are beyond what their customers are willing to pay for, they have failed to develop a reputation (or the skill set) in the new technology.

So that new set of small companies becomes the new set of industry leaders! And Christensen finds this pattern repeated in industry after industry — mechanical excavators, motorcycles, laser vs. ink-jet printers, insulin, radios (tubes vs. transistors (pictured)), steel mills, retailing, and many others.


Is Internet-delivered radio a disruptive technology? And are broadcasters reacting as predicted?
If you go back to Monday's issue of RAIN (here), you'll see that we discussed the strengths and weaknesses of Internet-delivered radio.

I wrote on Monday, "Note, however, that on several key attributes of performance, Internet radio is a lower-quality product — at least today, anyway — than broadcast radio. (This fact will become extremely important later this week when we look at the type of new technology that Internet radio is...)

"Specifically, most Internet radio stations today choose to stream at a bitrate that means they have worse sound quality than FM radio. And it's not portable — you can't listen in the bathroom or kitchen or in your car or on a Walkman. And the Internet-only stations typically have dead air between songs and lack such 'quality' elements as DJs and contests."

If broadcasters survey their best customers — their P-1s — they will probably find that those customers are perfectly happy with AM/FM-delivered radio. ("Would you like our programming in lower quality on computer speakers with worse DJs?" "No!")

So broadcasters are instead spending hundreds of millions of dollars investing in a sustaining technology, digital radio (a/k/a DAB or HD Radio). This will allow consumers to hear FM programming in CD quality or AM programming in FM quality, if they're willing to buy a complete new set of radio devices. (Discussed yesterday in RAIN here.)

Meanwhile, a new set of companies has emerged to develop Internet-delivered radio. They are finding new markets that value its particular set of benefits (e.g., office workers without radios at their desks, fans of niche musical formats like electronica, Americana, jazz, and Broadway, etc.). And thus webcasters like Radio@AOL, Yahoo! Launch, Radio Free Virgin, Radioio, MusicMatch, Beethoven.com, 3WK, and even our own AccuRadio are developing a skill set and a reputation among consumers for Internet-delivered radio.

This is playing out just as Christensen predicts!


Will Internet radio satisfy the mass market
just as broadcasters ask consumers to buy HD radios?
According to Christensen's theory, and it's almost certainly true, Internet radio will get better. As more consumers get broadband and bandwidth prices continue to fall, webcasters will stream at higher bitrates. With new releases of RealAudio and WindowsMedia, gaps between songs will shorten and eventually disappear. And with the rollout of Wi-Fi and new devices (again, see yesterday's RAIN), portability will happen in the not-too-distant future.

And particularly if customer priorities change, as described in Adrian Slywotzky's 1996 book, Value Migration, Internet radio's business design might be remarkably well positioned.

I guess a key question for broadcasters is whether digital radio ("HD Radio" logo pictured above right) is a perfect example of adding performance characteristics that are beyond what consumers are going to be willing to pay for. (Is FM quality perceived as unacceptable? Do listeners really want to listen to Rush Limbaugh and baseball games in stereo?)

If digital radio is such a perfect example, then the timing of HD Radio's rollout is perfect for webcasters... and potentially very bad for today's set of leading broadcasters.

(By the way, Christensen explains how a few firms in each industry survived their industry's disruptive technological revolution. Essentially, those firms spun out independent companies to commercialize the disruptive technology — companies with totally independent management and much lower cost structures. This is a path of behavior that, I believe, not a single US broadcaster has adopted. )


The future will arrive quickly
All of this "book learning" may seem like an irrelevant intellectual exercise to broadcasters who are worried about hitting this quarter's Wall Street earnings estimates. But, in fact, the future is bearing down on us very quickly.

We'll look at that issue in tomorrow's issue of RAIN.

The fifth and final installment of RAIN's "The Future of Radio" series is here. The series begins here.

The US debut of Kurt's "The Future of Radio" speech (in a slightly-condensed preview version) will take place next week in Las Vegas, immediately preceding the RAIN Reader Cocktail Party at Gordon Biersch Brewery Restaurant (Tuesday, April 7th, at the new time: 4:30 PM). To reserve a seat for the presentation, call 1-312-527-3879 or write kurt@kurthanson.com.

BY PAUL MALONEY
Record industry and webcasting representatives have reached a tentative deal on webcasting royalties that would allow Internet radio to pay 0.0762 cents per listener per song, OR 1.17 cents per aggregate tuning hour. (Subscription services would be given an additional option: 10.9% of revenue.) Their proposal has been submitted to the U.S. Copyright Office.

A press release from the Digital Media Association (DiMA), a lobbying group representing large webcasters, details the proposed deal reached with the Recording Industry Association of America (RIAA), the record industry group. The proposed plan would apply to both commercial "eligible" non-subscription and "new subscription services." The deal would not apply to noncommercial or nonprofit webcasters, AM or FM broadcasters simulcasting their on-air programming on the Internet, or those webcasters who've elected to pay royalties under the Small Webcaster Settlement Act (SWSA).

According to DiMA, among the companies that have agreed to DiMA's submission of this proposal are RealNetworks, Yahoo!, America Online, Microsoft, MusicMatch, Listen.com and FullAudio.

The proposal includes a $2,500 minimum fee for webcasters (except subscription services choosing the "percentage of revenue" deal, for whom the minimum is $5000). Notice and recordkeeping rules were not addressed in the agreement.

"The agreement is a temporary band-aid that avoids millions of dollars of legal fees associated with a broken arbitration process," said DiMA Executive Director Jonathan Potter (pictured right) in the press statement.

He went on to stress that the "stability" webcasters might gain by the proposed deal, they "remain at a competitive disadvantage to terrestrial radio by having to pay huge royalties for sound recordings that broadcasters get for free." Moreover, Potter's group supports recent Congressional efforts to revise CARP arbitrartion rules (see RAIN here), as "the arbitration process that determines these royalties is sorely in need of reform."

The Copyright Office will likely publish the proposal for review and comment, and then make its decision on whether to approve it on an industry-wide basis. While its reviewed, webcasters and copyright owners will have a chance to comment or file objections with the Copyright Office. Webcasters eligible for the SWSA will continue to maintain the option of electing to pay by that plan.

If you're planning to attend NAB 2003 in Las Vegas (April 5-10; details here), we hope you'll join us for our RAIN reader get-togther. We've reserved the patio of the Gordon Biersch Brewery Restaurant (about a $4 cab ride from the Convention Center) on Tuesday, April 8th. This year, we've also reserved a private room for the U.S. debut of Kurt's "The Future of Radio" speech for those who'd like an advance look at it. (Please note we've moved the time up a bit. The presentation will now be at 4:30pm, and cocktails at 5:00pm.) See you there!