The other day, as usual, I was thinking about the reasons behind the drop in album sales. It's obviously not just P2P. It's complicated.

How to explain the factors? Well, I figured there have been some lost customers over the years. They've been using P2P or have spent money on other entertainment options. Then when iTunes landed, some people started downloading single tracks instead of buying CDs (or digital albums).

I set up an Excel spreadsheet with actual data and a few parameters to find what numbers could explain the huge drop in album sales from 1999 to 2007. For the sake of simplicity, I left out ringtones and subscription revenues. This is just an example to prove a concept.

The compounded annual decline of album sales' was 5.59% from 1999 through 2003. From 2004 onward, the rate of decline was 13.2%, and that's including an 2.8% increase in 2004. That increase in the rate of decline could be due to a number of reasons. Greater broadband penetration. Late adopters to P2P. Record stores closing. But P2P and broadband existed before 2004, and record stores have been in trouble all decade.

Since the decline was greater after iTunes was launched in 2003, I figured there must be another reason for the annual rate of decline from 2004 through 2007. So I added an equation to figure out how many album sales were lost due to format substitution.

Then I used the Solver function to set equal to each other the 2007 album sales for the "Actual" and "With Both Assumptions." Solver picked a number that fit the equations I gave it and made the actual and estimated numbers converge in 2007. That number picked by Solver is the number of tracks that were purchased instead of an album.

Solver set the number of tracks lost (per album substitution) at 1.38. Translated, you can get from 1999 album sales of 938.9 million to 2007 album sales of 500.5 million if you assume album sales shrank at a constant 5.59% year and format substitution in 2004 though 2007 resulted in people trading an album purchase for 1.38 downloads. Without format substitution (assuming the rate of decline did not change) 2007 sales would have been 80 million units (17%) higher, at 580.5 million estimated versus 500.5 million actual. The estimate and actual numbers don't always line up -- it takes the actual numbers a while to drop as low as the estimate -- but by 2007 they're the same.

Of course, the assumption that sales would drop at a constant rate from 1999 to 2007 isn't the surest of bets. But album sales really started to tank after iTunes was launched, thus adding to the decline. Format substitution is more than an adequate explanation for the quicker decline.

(I started the market decline in 2000 because Napster came out that year. Album substitutions began in 2004, the year after iTunes launched and the first year for which the RIAA has data. For album sales I used RIAA data that uses shipments for CD sales. It's a good enough proxy for sales. Also I should point out that I used Soundscan's figure for 2007 album sales. The RIAA has not released album shipment data for 2007.)

By the way, 1.38 iTunes downloads has a wholesale value of just under $1. A typical album has a wholesale value in the $7 (for digital) to $12 (new release) range.

The implications are huge. Albums are the record industry's cash cow. Ringtones and subscriptions are two recent revenue streams, but they have an incredible deficit to make up. It's obvious album sales are not going to reverse course. Downloads are cooling off. Ringtones have plateaued. Subscriptions are the next great hope.