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Universal Music Group CEO Says Record Industry is in Deep Trouble

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It's Monday afternoon, and Doug Morris, chair and CEO of Universal Music Group, is eating lunch in his private dining room at the company's Manhattan headquarters. Morris hasn't been here much in recent months, though it's hard to imagine he misses the place. For one thing, workers have been renovating the building: To reach his corner suite, you need to take an elevator to the floor above, walk down a hallway covered with plastic sheeting, and then descend a flight of stairs. For another, these are tough times for the music business. In 2006, the number of CDs sold worldwide fell 10 percent, the largest one-year drop ever -- steeper than in any of the so-called Napster-era years from 2001 to 2004. Early indications suggest that 2007 will be at least as bad. The shades in the adjoining office are drawn, making the room feel a little like a crypt -- albeit one outfitted with leather couches and tasteful art.

For the past several minutes, Morris has been listening to Rio Caraeff, executive VP in charge of the company's digital strategy, tell me how the sagging fortunes of the music industry highlight the need to diversify revenue streams. Caraeff explains that the company will eventually need to transition from running a product-based business to running a service-based one. He talks about ringtones, subscription services, and deals with mobile providers, stressing the need to raise the industry's “digital IQ."

Morris seems distracted. At 68, he looks every bit the prototypical New York big shot. What remains of his hair is slicked back along the sides of his head, and if his face is fleshier than it once was, the ever-probing, slightly combative intensity of his eyes hasn't dulled a bit. Morris has spent his entire life working with musicians and producers, finding and nurturing the talents that make his company a $7 billion-a-year business. It's safe to say that increasing his digital IQ and pondering a service-based business model aren't the topics that get him out of bed in the morning.

But digital strategies are important these days, and Morris has become entangled in them whether he wants to be or not. Over the past several years, he has been one of the most staunch and vocal proponents of aggressive copyright enforcement, at one point publicly blasting MP3 players as merely “repositories for stolen music." When he realized, after watching his grandson stream online clips, that portals weren't paying Universal for playing its music videos, Morris pulled the company's content off of Yahoo. Once the two sides came to terms, Morris went after YouTube and MySpace “copyright infringers" both, as he put it. YouTube eventually agreed to a deal; a lawsuit against MySpace is ongoing. (Licensing of videos to Web sites now nets Universal more than $20million annually.) And in November 2006, Morris parlayed Microsoft's desperation to establish a true alternative to the iPod into a $1 ransom to Universal for every Zune music player sold and that's on top of the licensing fees Microsoft pays to have Universal's songs in its Zune Marketplace online store. It's a sign of Morris' power that he is able to pressure so many players in the technology world to bend to his will.

Last summer, though, Morris seemed to change direction. After years of tightening controls on his company's content, he agreed to let Amazon.com and other online retailers sell unprotected MP3s of Universal songs. These contain none of the digital rights management software that media companies usually embed in digital files to prevent piracy. Universal wasn't the first big label to offer unprotected tracks; the EMI Group had begun selling DRM-free songs in May. But with its small market share, EMI's decision seemed unlikely to have much effect on the market. Universal, on the other hand, was setting out to change things. In particular, it hoped to end Apple's near monopoly on legal digital downloads.

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