Plan to Cut CD Prices Fails

[clandy44]

From today's WSJ:

Why a Grand Plan

To Cut CD Prices

Went Off the Track

Music Stores Put Up a Fight,

Saying Universal's Gambit

Favored Big Retail Rivals

Strategy Led to 'Hurt Feelings'

By ETHAN SMITH

Staff Reporter of THE WALL STREET JOURNAL

June 4, 2004; Page A1

The world's biggest music company, Universal Music Group, tried a bold gambit to revive the music business: slash the wholesale and suggested retail prices of its compact discs.

Universal, a unit of Vivendi Universal SA, was confident that price cuts of up to 30% would boost business for retailers and please consumers who thought CDs were too expensive. After all, that's how marketers juice up sales of cars, hamburgers and lots of other merchandise.

But today the nine-month-old initiative, dubbed JumpStart, has been scaled back -- for reasons that spotlight the industry's deep dysfunctions and its uncertain future.

With illegal Internet downloading still rampant, consumers didn't view an album with its price cut to $12.98 as much of a bargain. Moreover, many music buyers never even saw the lower prices. A wide swath of music retailers, from Virgin Entertainment Group Inc.'s Virgin Megastores to Trans World Entertainment Corp.'s FYE, either never adopted the cuts or were slow to implement them -- and pocketed the extra cash. Retail prices on Universal CDs declined just 5% between the first quarter of 2003 and the first quarter of 2004, according to research firm NPD Group Inc. -- instead of the planned 30%.

Indeed, Universal misread how music retailers -- many of them financially weakened by online piracy -- would respond to the cuts. The retailers felt the music giant's public pronouncements about the strategy were designed to force them into making cuts they couldn't afford. And they thought that the low-price plan favored their new archrivals -- megachains like Wal-Mart Stores Inc. that can afford to offer CDs at deep discounts and make up the losses with other, higher-priced products. Music stores, which usually don't carry other product lines, can't afford to discount CDs as steeply.

"They were trying to force a new pricing strategy upon us," says Martin Herrmann, a consultant with FTI Consulting Inc., which was working with the ailing Tower Records chain on a balance-sheet restructuring. Record retailers felt they were the victim of "strong-arm tactics" designed to force them to accept untenably low retail prices that squeezed their profit margins, says Don VanCleave, president of the Coalition of Independent Music Stores, which represents 70 retailers in 24 states.

Adding to the mess: Universal also stopped giving music retailers so-called co-op advertising payments. The money is supposed to be used by retailers to buy local advertising highlighting the label's current titles -- but in practice, co-op money is viewed by many in the industry as a subsidy to keep struggling retailers out of the red. Often, it pays for little more than better placement in a store, which costs the retailer nothing.

Jim Urie, president of Universal Music & Video Distribution, argues that JumpStart levels the playing field; no retailer, big or small, receives any special deals or perks. And Universal points out that the recently rejiggered version of the program, JumpStart 2.0, has been performing better than the original.

Still, he concedes, Universal's various moves "came off arrogant.... We didn't mean it that way, but hurt feelings are hurt feelings."

JumpStart hasn't dramatically improved the finances at Universal Music, where revenue decreased by 11% during the first quarter. For JumpStart to work, Universal Music needed to see a 21% lift in sales volume to offset the lower wholesale prices. A Universal executive says the company saw increases of just 8% to 13% most weeks.

JumpStart's original incarnation now looms as a large misfire in the music industry's effort to resuscitate itself. World-wide music sales continue to tumble, and even an incipient recovery in the U.S. has been far too modest to make up for the years of declines that preceded it. Internet users download millions of songs illegally every week. Legitimate downloading services such as Apple Computer Inc.'s iTunes, where albums usually run about $9.99, are promising but still in their infancy.

Double Whammy

Moreover, traditional music retailers -- which the industry relies on to stock older titles that Wal-Mart and its ilk often don't carry -- are failing at an alarming rate, thanks to the double whammy of the Internet and the discounters. Big chains such as Wherehouse Entertainment Inc. and MTS Inc.'s Tower Records have recently gone through bankruptcies, while others, such as HMV Group PLC, are planning to close their remaining U.S. stores.

Universal executives recently partially retreated from many of the price cuts and gave ground in other important areas. At the new prices, Universal executives say the company will now need about a 17% boost in volume to offset the effects of the price cuts. In the six weeks since the changes, Universal has seen a volume increase of 16.2%.

"We believe in the program," Mr. Urie says. "Parts have been successful; other parts have been less so." He acknowledges being "disappointed" with the level of cooperation from retailers.

With the Oct. 1 kickoff of JumpStart, Universal tried to do away with the industry's legacy of incentives and discounts, and instead focus on a vastly simplified pricing structure. The wholesale price of most CDs was lowered to $9.09 from $12.12, with the idea that stores would drop their retail price on new releases to a suggested $12.98. Universal Music Chairman Doug Morris said at the time that the new plan would enable most music stores to compete with the $9.99 retail price that Best Buy and other mass merchants often charge for hot new releases.

Universal was betting that other music companies would follow their lead and lower their prices as well, boosting the industry's volume and reversing a nearly four-year trend of flagging sales.

Right away there was a problem: The pricing gulf that has developed over the past decade between music-only stores and mass merchants. On average, traditional music stores charge over $1 more for any given CD than mass merchants, according to NPD Group. For new, hot titles that gap is often bigger. For example, the recent Universal CD by rapper Jay-Z, "The Black Album," sells for $14.98 on average at music stores, compared with $12.76 at mass merchants, according to NPD Group.

When JumpStart came along, with its emphasis on low, Wal-Mart-type prices, music stores quickly concluded that Universal had sided with the mass-merchant enemy. In fact, Best Buy and Wal-Mart were among the first to adopt the program.

Many music chains were hostile in part because of the abrupt way Universal announced the program. Some stores got the word when Universal e-mailed them a PowerPoint presentation. When Universal took the unusual step of trumpeting details of the new pricing policy to the press, some retailers viewed the move as an attempt to force them into going along with the new "suggested" prices, or risk a consumer backlash.

Universal was forced to scrap a plan to mark CDs with stickers touting the new $12.98 list price after meeting stiff resistance from retailers, who threatened to cover the stickers with bigger -- and higher -- price tags. Mr. Herrmann, the consultant to Tower Records, says the Universal sticker plan was viewed as a "nonstarter," adding, "The [universal] sticker was, what, half an inch? There would have been a lot of one-inch stickers" pasted over them.

Even worse for Universal, many retailers dragged their feet on passing along lower prices to consumers. Some of these delays occurred because music stores -- which have inventories far deeper than the average Target or Best Buy -- were waiting to sell off large backlogs of CDs they had bought from Universal at the old, higher prices. Other stores simply kept charging the old retail prices for discs they bought at the new, low wholesale prices, pocketing the difference.

Tower Records found the notion of committing fully to the program too risky. Mr. Herrmann says that after days of constructing economic models of the price cuts' impact, the store's executives cut prices on some titles and kept others at the old, high price. The prospect of uncertainty over CD sales in an already shaky business environment was too much to take -- particularly when the chain was planning a bankruptcy filing.

From the beginning, JumpStart's results were not nearly as dramatic as the company needed them to be. The company saw a 5.8% improvement in sales, on average, for new releases, compared with the performance of CDs released before JumpStart. Universal did best with so-called carryover CDs -- those that have been out for more than eight weeks but less than two years -- boosting sales by around 27%.

Universal fared poorly with older titles, seeing only a 3% lift. Universal executives argue that these titles have the slowest turnover rate in most stores, and so it took longer to clear out old, higher-priced stock. But that's only part of the picture. When it lowered wholesale prices, Universal also eliminated the intermittent discounts and promotions that music companies use to push their products, so stores were given no incentive to create separate displays highlighting older Universal titles.

That was frustrating for Universal because some retailers reported that price cuts actually did drive sales volume on older titles. Joe Nardone Jr., who owns the 11-store Gallery of Sound chain in Pennsylvania, says that discounted greatest-hits albums -- such as Universal's series of "Millennium Collection" titles -- have seen sales growth since the debut of JumpStart. For instance, Mr. Nardone dropped the price on The Who's Millennium Collection by $2, to $9.99, after Universal dropped the title's wholesale price to $6.06. He sold 120 copies of the album in the first three months of this year -- compared with 120 in all of 2003.

Retreat

By April, Universal had retreated from key features of the initiative. In JumpStart 2.0, the company raised wholesale prices on most titles back to $9.49, albeit still below their pre-JumpStart levels. Some "superstar" releases now wholesale for $10.35, up from $10.10, and their suggested retail prices have been raised by a dollar, to $13.98.

In the most telling sign of a retreat, the company's biggest release of the spring -- an album by D12, a rap group featuring Eminem -- was issued under old pricing guidelines, including an $18.98 list price for consumers. Universal executives say the album was technically released by a small label in which Universal is a partner, and thus the price was ultimately up to an outside partner.

Universal's other big problem is that none of the other major music companies has followed suit with across-the-board everyday low prices. "I wish there were more people on the bandwagon," says Universal's Mr. Urie. "Where we made a decision to take action, they have decided to dip their toe in the water."

Many executives at rival companies have agreed privately that prices need to come down, and some have instituted targeted cuts. In early May, Warner Music Group cut prices on over 1,700 older catalog titles, lowering the suggested cost on 1,200 of them to $9.98, and the rest to $13.98. But Warner didn't attempt to reduce incentive programs, as Universal had.

In fact, Universal's move toward standardized pricing encouraged its rivals to step up their use of co-op advertising -- which curried favor with retailers just as Universal was alienating them.

After the introduction of JumpStart, one high-level executive at a rival company recalls thinking, "We can take advantage of this, by giving the proper level of support" in the form of increased co-op payments. Steve Hicks, vice president of product at Hastings Entertainment Inc., which operates 150 stores in the West and Southwest, says that since the introduction of JumpStart, Universal competitors have roughly doubled the size of their discounting programs, including co-op and product-placement payments.

Write to Ethan Smith at ethan.smith@wsj.com

Edited June 4, 2004 by clandy44

[Peter]

Yah, I did notice and I'm very dissappointed. I think a great many people burn when it's an option and only buy when they have no source to copy. I had hoped that burning would force the big boys to reduce prices to a more reasonable level in response. However, it appears their are more interested in copy protection and suing college kids. To be expected. Oh well.