15. Analysis of the cost structure

  1. A record company has to basically assume the following costs of product: manufacturing and purchase costs, royalties paid to artists, copyrights paid to publishing collecting societies, warehousing and distribution. In addition, a record company will have marketing and promotional expenditures and will cover its overhead costs.
  2. The recorded music industry is not very capital intensive and total costs are normally fairly proportional to sales. Royalties to artists are generally payable as a percentage of PPD, net of approved discounts and free goods. “Overhead” is the only item that is not directly proportional to sales, although it is often considered as such in financial analyses.
  3. Considering that the cost structure is principally proportional to sales, it may be estimated that a decrease in price by 20% should be followed by an additional demand of 25% to maintain the same net profit. Similarly, a decrease in price by 30% should be followed by an additional demand of 43%.
  4. Additionally, starting to propose low prices for music albums could lead customers to anticipate a drastic market-wide price reduction and could lead to the danger of price downturn spiral for major record companies.
  5. It might explain why they have not tried to develop a significantly more aggressive pricing policy than the current one, while it is recognized that customers react very positively to a temporary price decrease.
  6. In addition, record companies have mixed feelings with regard to the impact of decreasing price of their albums. One company notably submitted that decreasing the price of CDs from for example EUR 15.90 retail to EUR 9 for new releases would not make a particular CD sell more, as the alternative is free illegal download from the internet, which would be unaffected by that sort of price decrease. In that context, it could be argued that it may be a sound business strategy for recording companies not to respond to the collapse of demand by a sharp decrease in price, especially at a time when the on-line market is still not providing enough revenues to compensate for the losses endured in the physical market.
  7. It can also be noted that in 2003, Universal launched in the United States its Jumpstart initiative aiming at decreasing retail prices of albums. This initiative is the largest initiative of this kind reported in recent years. However, it was not as successful as expected by Universal, notably because the lower net wholesale prices were not fully passed to end consumers, and because these end consumers did not increase their purchases of albums to such an extent as to cover the loss of profit margin on each CD. This experience on the US market has certainly contributed to the record companies limiting the testing of new low-price schemes in Europe.
  8. Footnote featuring Shakira: “Oral Fixation Vol2” ranked No 6 in the German charts in November 2005, left the charts in May 2006 and then again ranked No 4 in June 2006.This unusual comeback was at least partly due to the modification of one or several tracks in the original album, combined with the artist performing at the Soccer world cup in Germany.

This item is part of the series of posts based on the European Antitrust Agency 2007 Music Industry Analysis for the Sony BMG Case. It’s home page is here.

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