The people formerly known as the audience (TPFKATA) are doing more than just fact-checking newspaper stories, time-shifting TV shows and capturing breaking news on their cameraphones. They are also helping run their favorite bands, designing and voting on concert T-shirts, mixing studio albums and even voting on which cities should be included in a band’s tour.

At the vanguard of this movement of crowdsourcing music and putting the fans in control is Nettwerk Music, a record label and band management service in Vancouver, BC, that has become synonymous with digital music and alternative revenue streams. The label completely revamped itself in 2002, putting digital music and Internet promotion at the forefront and downplaying physical CD sales. Fans have been able to remix albums by Barenaked Ladies and rapper K-OS — even before his new album comes out — and Avril Lavigne has racked up millions of plays and possibly millions in revenues on YouTube.

The driving force behind the digital makeover of Nettwerk is CEO Terry McBride, a man who has helped pay legal fees for people sued by the RIAA for sharing music online. After McBride took such a strong stance for digital music — and away from CD sales — he started speaking more at conferences and talking to the media to spread his vision for a “digital valet” service. He thinks we will all end up paying $5 to $10 per month for access to all music, TV and movies, with a digital valet that knows our tastes and finds media for us.

While most music labels have been squeezed by the shift to digital music, Nettwerk has had growing revenues, McBride told me, and he expects 80% of the company’s 2008 income to be from digital and alternative revenues — and not CD sales.

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Terry McBride

“In 2007, about 70% of our sales on intellectual property was all digital, and this year it will be around 80%,” he said. “A lot of physical sales comes from our bigger artists and we do print-on-demand for our smaller artists, for their mail order or for touring…My stance on file-sharing did not match what my brethren in the music industry believed. I remember giving a keynote speech three or four years ago, and having a lot of pissed off people.”

The following is an edited transcript of my phone conversation with McBride, as he explained the revamping of his label, and the push for crowdsourcing music and having bands run their own labels.

When did you realize how important digital music would be vs. physical music and CDs?

Terry McBride: We started our whole change internally in spring or summer of 2002. We did it really quietly. We had one of these executive team summits. We looked at where everything was going. We looked at the fact that 25 million [CD] sellers would be 5 million sellers. The fact that million sellers would be quarter-million sellers. And how our existing model would work within that. Would we take the same stance, to protect the castle and fight, or was there a different way of doing it?

The interesting thing then was that we had the initial digital data to look at. We saw a lot of what was happening. And we said, ‘Where will all this be in five years, and will we be ready for it?’ There was a conscious decision made at that meeting to get out of the physical music business. So we decided to retool our whole company and over the next two years, that’s what we did. For a company that had had an attrition rate of 1% or 2%, a company of 120 or 150 people, over the next three years we had a turnover of almost 25% a year as we changed almost everything.

Rather than have a marketing team with marketing meetings, and promotion team with promotion meetings and sales team with sales meetings, we got rid of all that and created silos. We created three teams that had everything from Internet to traditional marketing to sales to IT to promotion — all in one group, and got rid of the meetings. So everything you needed for an artist was in that group. There was no heads of marketing. We shifted from 12 traditional marketing people to 3 traditional marketing people and 8 or 9 Internet marketing people.

Then we aggressively went after every DSP [digital service provider] that was interested in music that we had, and we set up a team to deal with the programming of metadata behind what we were actually doing…All of our marketing is not around albums but around bands and brands. Our marketing is about understanding the social elements of songs, of music, of emotions.

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Avril Lavigne’s Girlfriend video has more than 109 million views on YouTube

Fortunately we’re a growing business right now. We didn’t protect the castle. We also made the switch at a very good time to make the switch. Avril had broken, Coldplay had broken, Dido was doing amazing, Sarah [McLaughlin] was doing amazing. The Barenaked Ladies were doing amazing. We were flush with cash. If we made those changes now, it would be very very difficult because money is much more tight.

You have been pushing many bands to start their own labels. How did that start?

McBride: That came from a point of view of how do we get collapsed copyright. How do we get an authentic relationship between the artist and the fan? How can we remove everything that we possibly can from the relationship — or between the relationship — of the artist and the fan. Artists owning their own copyrights and being able to be in direct communication is a far more authentic relationship.

There’s a risk and reward to that. If an artist is signed to a major label, then the manager has no risk, but then you’re only getting a commission from publishing and master royalties combined, maybe a maximum of $2 [per CD sale]. With an artist [label], we had to finance it, but we were commissioning off a $5 or $6 net [per sale]. So obviously we get a much better commission, but it’s a much higher risk. With these artist imprints, it takes two to three albums for them to work.

We’ve found in the digital space, that you will sell anywhere between 25% to 50% of your volume from your catalog upon release of any new albums. So you are layering intellectual property. In the digital space, where you don’t need to buy shelf space, if you create the right metadata behind what you’re doing, and market it in an effective way — you’re not marketing the new album, you’re marketing the brand. By the time you make it to album three, you are selling as much of the catalog as the new album, but you don’t have the cost with the catalog and everything starts to make sense.

So I had to get people here to believe in this, and stop people from having a heart attack over the equity we were tying up, which we had no ownership in. But proving the model that you have have an artist like State Radio, which is a great example of an artist who makes a couple hundred thousand dollars a year from intellectual property, which will help finance the next album.

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State Radio plays Hartford, CT

Chad [Urmston of State Radio] just played to 2,800 people with a $25 ticket price in New York on the weekend. He’s marketing a brand, he’s not just marketing intellectual property. Now it all makes sense. He’s happy, he owns his future, his audience has grown with him really well. Now everything makes sense to him, where initially he was unknown and had to work from the ground up.

The Internet marketing team and his manager did a spectacular job of understanding who his tribe is and would be. Out of the eight artist imprints that we launched, seven of them are very profitable, but it took time and selling the managers on the fact that there were no commissions to be made to a certain point. If they signed an artist to a major label there was instant commissions. And it took the lawyers years to get their heads around it because they just didn’t believe in it. It’s taken time, but now the managers are looking at a very steady cash flow, and the artists aren’t fighting for their creative freedom but actually using their imagination — and those are two very different things.

For the marketers of music these days, how has their job changed? It used to be about talking to radio and retailers. Now is it about search engine optimization (SEO)?

McBride: Search engine optimization, the ability to write basic code, understanding how social networks and blogs work together, how to connect that interaction back to the sale of music or monetization of behavior or crowdsourcing music. It’s understanding all of those things, and having a very imaginative marketing plan around the artist vs. around a product. It’s really brand marketing. What are the artists’ causes? Are there cause alignments? Are there other brands we can hook up with to align our causes? And if the other brand is bigger, can we give them free music and get exposure to their audience because it’s like-minded tribes?

It’s basically social marketing. It’s understanding social tribes and peer-to-peer interaction that the social networks have taken from a small group of 20 of your peers to 250 of your peers. And not focused on recommendation engines, but the social aspect of recommendations. So it’s not a computer making the recommendation, but social groups doing it. Looking at the technology but not using it for what it was meant for. That’s what the creative arts do. The technologists build something with a certain purpose in mind, and then the creative people take what the nerds have done and take it in a completely different direction than what people saw coming.

You’re doing a lot of crowdsourcing of music, where you put out pieces of music and let people remix them. Is that about engagement and interaction more than business?

McBride: Well it’s both. We started initially with T-shirts. We found out that the T-shirts that the fans designed — even if the artists didn’t like them — the people who went to shows liked them more than the ones that the artists designed. That was consistent whether it was Barenaked Ladies, or Avril or Sarah — the fans’ T-shirts always sold more. The fans would do the designs and vote up the ones they liked, and filter them to the top, and we would take the top 3 voted designs and put them in production. And they were consistently the top sellers out there.

In 2005, we took it a step further by releasing Barenaked Ladies songs in stems [pieces of the music tracks]. That sparked the idea for the guys who created Rock Band. That was more of a remix. Now I’m more about the mix; to hell with the remix! We have an artist named K-OS, and we released all of the stems two weeks ago, and the fans have not heard the album. It’s not due out until March, so they are actually mixing the album. So we will release physically and digitally the artist version and the fan version. And when we go to radio, we will service the artist version and fan version. So we are taking it the rest of the way.

You can even take it beyond that. With K-OS, we’re thinking about having the audience vote on which 10 to 12 cities he plays in Canada. We might even take it one step further: pay as you go not as you enter. And maybe when you leave you get a copy of the fan mix for your donation, so there’s karma pricing on the exit. Let’s take this whole tribal/social interaction the whole way. Everyone including Nettwerk has dabbled with it. We have probably dabbled more than any company with a wide assortment of artists, so we have a good idea of what works and what doesn’t work. But with K-OS it’s the first time we’ve gone all the way with it.

It’s almost as if the audience is running the band.

McBride: The audience is the record company…It took a long time to educate the artist, and change the company and educate the managers. It wasn’t like you have to do this. There are still managers at Nettwerk that like signing artists to major labels, but now there are other options. And they are viable options.

If the audience becomes the record label and the artist is gaining more control, where does that leave you? Some people question whether there will be a need for record labels.

McBride: I think it depends. Artists are not going to start companies and do all the business parts of it. They just won’t do it. It would take away from their creative time. There has to be some kind of infrastructure that markets, promotes, and disseminates the intellectual property so the consumer has easy access to it. But as for which companies are going to be doing that, I think that will change. There’s also a generational aspect to this. An older audience still likes to buy CDs. Radio still plays certain artists, so if that’s the kind of tribe you’re a part of, then that’s the road you will travel.

What do you think about the ad-based service like what SpiralFrog tried to do?

McBride: It’s another model, I don’t personally think it’s going to work. It’s a business model and not a consumer model. And it’s definitely not a psychological model. This is about monetizing consumer behavior and not about trying to control where they go. So SpiralFrog is trying to create a destination, but I think you have to have the destination first and then monetize their behavior and not the other way around.

To me, the future of music is really simple. It’s cloud-based servers that have all of the music, TV, movies — whatever it might be. Very rich application-driven PDAs, whether it’s the iPhone or whatever else comes up, that has applications that I have yet to see. Like digital maids or valets, which go out and knows what your musical tastes are and your 20 friends, and finds that music and organizes it — not the actual music but the metadata so you can pull it when and how you want it. You would have a $5 or $10 per month fee for pulling it down. And that’s how it will all end up, because business cannot drive business consumption.

How free loses out is the applications and metadata that makes it really easy. I call it the “hassle factor” — for $5 to $10 you get all the music you want without the pain of having to find it. So you get the new Killers album without even knowing the new Killers album is out, and it’s automatically in your weekend listening folder because your digital valet got it for you. And if you want to know what your buddy Ken’s listening to, then the valet checks out his playlist and copies it over for you.

How did the cases turn out where you were helping legal defenses for fans being sued by the RIAA?

McBride: The latest one just settled. What was key to me was that someone started pushing back, someone pointed out that this is not good for the music business. It wasn’t a battle about copyright because I believe in copyrights. But suing your customers is the worst idea that the RIAA has ever had. And I’m a member of the RIAA, and I think that their actions hurt our business, and I was really upset that they did it. Now I think they would even say now that it wasn’t the right thing to do.

Is the concept of the Long Tail playing out in music, or are these tiny, tiny niches not really viable?

McBride: I call it a squirrelly tail, because the tail is influenced by things happening in the now. It’s not like you leave something and then 18 months later it goes down the tail. Things that you do in the current affect it and move it up the tail, so that’s why I call it the squirrelly tail. The bottom line is that if you have great metadata behind the copyrights that you put out there, and make it easy for people to find, then you can have a very vibrant catalog. If you have a new artist that has some catalog then you can squirrel that tail. You get a song placed on a TV show or movie or videogame, you can squirrel that tail. We have a team that’s all about squirrelling the tail. Digitally, the world is flat; economically, niches work.

When we signed the Weepies five years ago, people were looking at me like ‘Why are you signing a folk-rock band. We cannot get folk rock anywhere, we’ll have to buy shelf space and it will be in the back of Tower Records.’ I was like, ‘You’re not understanding what’s going to happen. Niches become flat. Instead of L.A. becoming a niche for a band, the world is becoming the niche. So if you market them right, niches can be very profitable. If you look at Old Crow Medicine Show and the Weepies, those were the first two artists we signed with that mentality, and we do great with both of those artists. They are both making an amazing living, and they are niche artists.

So it’s not about artists being in a geographical niche, but more of a niche that people like all over the world.

McBride: You know what? Sign the music you love, not music you like, not music you think will sell, because that never works. Believe me, I’ve tried that. When you sign stuff that you love, even if you think no one else will buy it, if you love it, if you work it right, you will find tens of thousands or even hundreds of thousands of people who will buy it.

We don’t have any A&R people, because we’re not out there trying to find the next big thing. People come to us. And if we find something we really love, we go after it. But chances are they came to us first. We stopped having A&R people about five years ago, and helped them find jobs somewhere else. It’s not about finding the next big thing for us; it’s about releasing music that we love, and getting out of the mindset of doing music we like that we think we can sell. We’ve gone from four years ago releasing 15 to 20 albums a year to, I think next year we’ll release close to 60. So you get an idea of what has happened here once we made that mind-shift.

*****

What do you think about Nettwerk Music’s approach to music? Should fans pay less for music and get more power to decide the mixes and tours for their favorite bands? Share your thoughts in the comments below.

Photo of State Radio by nnc07 via Flickr.

UPDATE: News is breaking that pop artist Avril Lavigne is not enamored with the work of her manager at Nettwerk, Terry McBride, and has left him for Irving Azoff. No word on whether Nettwerk’s niche and digital focus had anything to do with her decision.

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