The Economist reports on the music industry’s woes:

In public, of course, music executives continued to talk a good game: recovery was just around the corner, they argued, and digital downloads would rescue the music business. But the results from 2007 confirm what EMI’s focus group showed: that the record industry’s main product, the CD, which in 2006 accounted for over 80% of total global sales, is rapidly fading away. In America, according to Nielsen SoundScan, the volume of physical albums sold dropped by 19% in 2007 from the year before-faster than anyone had expected. For the first half of 2007, sales of music on CD and other physical formats fell by 6% in Britain, by 9% in Japan, France and Spain, by 12% in Italy, 14% in Australia and 21% in Canada. (Sales were flat in Germany.) Paid digital downloads grew rapidly, but did not begin to make up for the loss of revenue from CDs. More worryingly for the industry, the growth of digital downloads appears to be slowing.

“In 2007 it became clear that the recorded-music industry is contracting and that it will be a very different beast from what it was in the 20th century,” says Mark Mulligan, an analyst at JupiterResearch. Last year several big-name artists bypassed the record labels altogether. Madonna left Warner Music to strike a deal with Live Nation, a concert promoter, and the Eagles distributed a bestselling album in America without any help from a record label. Radiohead, a British band, deserted EMI to release an album over the internet. These were isolated, unusual deals, by artists whose careers had already brought years of profits to the big music companies. But they made the labels look irrelevant and will no doubt prompt other artists to think about leaving them too.

The prime function of a record label is to scout, identify and promote talent. Distribution is obviously key to the business, but it’s largely a function of logistics and technology, and it’s tangential to the consumer’s interest in the product.

Talent identification and promotion is the real business value as far as consumers are concerned, simply because there are lots of people producing music, most of which probably wouldn’t appeal to any given person. So the role of record labels—first as a filter selecting talent, then as a megaphone promoting it—is a useful function. But this role doesn’t necessarily have to fulfilled by labels. Friends who share your musical tastes might do it, for example. But in order for your friends to turn you on to some good music, they have to be introduced to it somehow.

Social networking sites online amplify the ability of individuals to act as filters and as promoters of what they like. People list their favorite bands on sites like Myspace, and their friends can click over to the band’s profile and often listen to a few tracks for free. More people can be exposed to more music through their friends on Myspace than in real-life casual conversation, so an increasing portion of the role played by record labels is now be handled by individuals, online.

Market changes might force labels to become smaller, but the same technology that’s destroying their current business model will also let labels do more with less. If individuals are taking on more of the role of promoter, any promotion done by record labels will be amplified in a way that didn’t happen in the past. Special-interest niches can be targeted like never before, and the amateur music enthusiasts with influential online presences can be identified and courted by labels seeking to tout the next great act.

Record labels won’t disappear altogether, because there will always be a role for professional filters. Talent needs to be scouted, and promotion will always be helpful in connecting people to new music. But the balance of power in the music industry is shifting, seismically. Labels will be smaller, but they have the potential to be sleeker. And if this gives artists an opportunity to keep more of the revenue their work generates, that won’t be a bad thing.