MANAGING FINANCES IN THE MUSIC INDUSTRY

The financial techniques help to make decisions, control the costs, understand the risks and calculate the benefits of different activities. Understanding the cost behavior will help to manage the fixed, variable and semi-variable costs which are important to understand and determine every business success. Cost behavior refers to the way different types of production costs change when there is a change in level of production. (Accounting Explained, 2012) In the music industry, it helps to stay in control of finances for the record companies. Different record companies offer different deals according to their financial situations. A good record deal for the artist involves also a good understanding about how the costs behave within the record company.

The marginal cost is the derivative of total production costs with respect to the level of output. (Econ Model, 2012) According to the traditional finance technique, there are 3 main ways to determine how the costs behave:

Fixed costs are the costs which will not depend on the productivity of the business. They are expenses for operating the business. These costs are there even if nothing is produced, like overheads. The more units there are produced, the lower is the cost.

Variable costs depend on the productivity of the business. Variable costs increase when more units are produced and will decrease when less units are produced, can vary with the outbut. These costs stay the same per unit, but increase when produced more.

Semi-variable costs include both types of costs, fixed and variable. It can be fixed cost until a certain level of production and then go over to variable cost. For example, when CDs are transported to the shops, it is a fixed cost, but the cost of the the fuel for transport is a variable cost, because it might change. It can also be called as a mixed cost.

Identifying the different types of marginal costs help to distict and control the overall output. It is useful for short term decision making in order to decrease risks and deduce the break-even point. A realistic prediction against break-even output helps to calculate
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time when the company is going to break-even. Break-even point is when the revenue covers the expenses and the company is in 0 point. Break-even analysis helps to define the point company recoupes. It is a popular tool used by small business owners to determine how much volume of their product they must sell in order to make a profit. (Bizfinance, 2012)

Break-even point allows to control the profit and loss. It sets a clear target to the company, to where it should reach in order to make money. It helps to identify the change in variable costs and how these affect the business. There can be disadvantages if the calculation for the break-even point is invalid or the range of products is too wide to even calculate the point. (RUTC A/S Business Studies Blog, 2012) Break-even analysis assumes that the economy is strong and that the revenue and costs are a linear function, but in reality it may change and this can be the major weakness of this analysis.

The artist has been offered 2 deals. One is traditional deal and the other on is a 50/50 net receipts deal. The advance is 40,000 in both cases. The royalty rate for the artist under traditional deal is 16%. Predicted sales level is 100,000 units.

1. Royality revenue under traditional deal for CD unit. A) Net dealer price. PPD - 7.50 Discounts - 15% Net PPD - 6.38 B) Artists royalty Artist royalty - 16% Packaging deduction - 25% Actual artists royalty - 12% C) Royalty revenue - 12% of Net PPD 6.38 Royalty for a single CD unit - 0.77

2. Royalty revenue under traditional deal for digital download. A) Retail price - 0.79 Royalty revenue after packaging deduction - 12% of 0.79 Royalty for a single digital download - 0.09 3. Re-coupment point for the act under traditional deal. (60% physical, 40% digital) A) Breakeven - 40,000 (Advance) 60% physical product - 1 unit 0.77 60% of 40,000 is 24,000 and 31,169 physical units are sold 40% digital product - 1 unit 0.09
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40% of 40,000 is 16,000 and 177,778 digital units are sold Recoupment point is when 31,169 physical units and 177,778 digital units are sold. 4. Amount credited to the artist per CD unit and digital download under 50/50 deal. A) Net dealer price per CD - 6.38 Discounts - 15% Distribution Fee - 10% MCPS - 8.5% Faulties - 1% Manufacturing - 0.48 3.94 / 2 = 1.97 B) Digital download price - 0.79 Distribution fee - 40% 0.47 / 2 = 0.24 5. Re-coupment point for the act under 50/50 deal. A) Breakeven - 260,000 (Marketing & Tour support) 60% Physical - 156,000 - 79,188 units 40% Digital - 104,000 - 433,334 units

Major record labels usually offer a traditional deal while indies tend to offer 50/50 net receipts deals. Both deals have their advantages as well as defects. For some its a question of how much money is on offer. For others it is how much commitment there is for the record company. Some artists are more interested in how much control they have over what sort of record they make. (Harrison A, 2011, p. 61) The best deal for the artist happens if the label and artist understand eachothers interests. If the interests are about being in control and having freedom, it is better to choose a 50/50 deal. Usually, the 50/50 net deals do not include an hig advance, but if they do, the advance has to be recouped in order to make any money. Its easier to recoup because the revenue split is 50/50, but the artist should be certain that there are enough people aware of the artist, because indie labels can not compete with major label budgets on marketing. It is a good deal for an established artist. Major record labels offer a high advance and pay for all the recording, video and production costs. It is all recoupable and this will leave the artist in a debt. Major labels have international distribution networks and established relationships with major radio channels which are good for promotion. On the other hand, major record labels give the artist a low royalty rate in order to recoup their investment. It might be possible to never recoup for an artist. To survive under a major record label, the live performances become a vital source of income. (Harrison A, 2011, p. 63) The artists are looking for major record deals because of their marketing budget which indies do not have. It is arguable that the digital age has created cheaper marketing opportunities for indie labels - its easier to be an internet sensation than ever before. Though, if the artist wants to be appealing to masses it is better to choose a major record deal because they have more distribution channels than indies. If an artist is established and already well-known then the 50/50 net receipts deal is better, because the artist earns more money for every cd/download sold and do not need a huge budget for marketing.

Cost behavior will help to determinate the break-even point for the company. Its important to understand the distinction between fixed, variable and semi-variable costs because then it is possible to control and manage the business. Breakeven analysis is important to determine the breakeven point and to the set the targets. There are

weaknesses and strengths, which should be taken into account when calculating the breakeven point. The artist must choose a record deal which suits best with the artists needs. The traditional deals are good for the artists who are not established and want their music reach the mainstream audience. 50/50 deals are for artists who would like to be in control of the situation. It creates also an opportunity to earn more money from the sales, but the budget for marketing is comperable with what majors offer. Both deals have the pros and cons, but eventually it all depends on the artists interests.

Calculations

1. A) 7.50 - 7.50 x 15% = 6.38 B) 16% - 16% x 0.25 = 12% C) 6.38 x 12% = 0.77

2. A) 0.79 x 12% = 0.09

3. A) 40,000 x 60% = 24,000 ; 24,000 / 0.77 = 31,169 units 40,000 x 40% = 16,000 ; 16.000 / 0.09 = 177,778 units

4. A) 6.38 x 0.85 x 0.90 x 0.915 x 0.99 - 0.48 = 3.94 3.94 / 2 = 1.97 B) 0.79 x 0.6 = 0.474 0.474 / 2 = 0.24

5. A) 200,000 + 60,000 = 260,000 260,000 x 0.6 = 156,000 156,000 / 1.97 = 79,188 units 260,000 x 0.4 = 104,000 = 433,334 units

Reference list

Types of Costs by Behavior (2012) Accounting Explained. Available from: http:// accountingexplained.com/managerial/cost-behavior/ [Accessed 22 November 2012] Methods of Segregation Semi Variable Cost into Fixed Cost and Variable Cost (2010) Accounting Education. Available from: http://www.svtuition.org/2010/09/methods-ofsegregation-semi-variable.html [Accessed 22 November 2012]

Using Break-Even Analysis to Make Decisions (2012) RUTC A/S Business Studies Blog. Available from: http://rutcasbus.blogspot.co.uk/2012/11/using-break-even-analysis-tomake.html [Accessed 22 November 2012] How to Calculate Breakeven Point (2012) Biz Finance. Available from: http:// bizfinance.about.com/od/pricingyourproduct/a/Breakeven_Point.htm [Accessed 22 November 2012]

Marginal Cost (MC) Econ Model. Available from: http://www.econmodel.com/classic/terms/ mc.htm [Accessed 22 November 2012]

Harrison, A (2011) Music: The Business. 5th Edition. London. Virgin Books. p. 61 - p.63.

Bibliography list

Cox & Fardon (1997) Management of Finance. Osborne Books. Harrison, A (2011) Music: The Business. 5th Edition. London. Virgin Books. Schwartz, D. (2009) Start And Run Your Own Record Label. (Rev Ed) Billboard Books.