Music Industry Financials

9 September 2016

Marginal costing is a traditional financial technique which is used by companies for short term decision making within the music & entertainment industry. The concept of marginal costing is concerned with the treatment of fixed costs and the relationship that exists between sales, variable costs and contribution. This technique is often used by record labels to estimate the costs which they will incur & profits they will earn per unit which is manufactured and sold.

Cost behaviour – we need to understand how costs behave at different levels of activity so that we can determine what costs should have been for a trading period and estimate costs for a future period. Cost behaviour studies the way that costs fluctuate. Two major influences on costs are volume (activity) and time. There are three types of cost: variable, fixed & semi-variable. Variable costs are those which change with the level of output or activity. For instance, if a major record label has manufactured 100,000 CD’s for a pop artist’s new album which is going to be released.

Music Industry Financials Essay Example

The bigger the quantity of CDs sold, the higher the amount of money the artist will receive as royalties. So, if the artist is under a 12% (true artist royalty) therefore receives ? 0. 76p per CD sold. If only 50,000 CDs are sold at a Published Dealer Price of ? 7. 50 they would receive ? 38,000 in royalties. Whereas, if they managed to sell 100,000 CD’s instead they would receive ? 76,000. As you can see the artist royalty increases as the sales (activity) increases. Fixed costs are those which remain constant despite changes in output or activity; however they can change over a period of time.

For instance, if a record label signed an artist and offered an advance of ? 40,000 this figure would remain fixed. Despite changes in sales & expenditure, there is still no change to the advance. Semi-variable costs are those which have both a fixed & variable element. For instance, if you have manufactured 100,000 CDs for ? 0. 50p per unit, brings the cost of production to ? 50,000. This cost remains fixed. Suddenly there is a lot of demand for the CDs but all of the CDs have been sold, so it is decided to manufacture 50,000 more CDs therefore the cost raises due to demand to a total of ? 5,000. Contribution is the difference between sales and variable costs in the marginal cost equation. This is the contribution towards fixed costs and profit. To calculate what the contribution is you take the selling price per unit and minus the variable costs from it (see example below). Selling price per unit = ? 10 Minus Variable costs = ? 3 Contribution per unit = ? 7 Breakeven analysis uses the same concept as marginal costing to calculate an estimated figure of how many units of a product need to be sold to cover all costs (this is also known as the breakeven point).

Breakeven analysis is used for various purposes including: before starting up a business to create a business plan, to make changes to a business, to measure profits and losses, to evaluate alternative methods of production. To calculate the breakeven point we need to know the: selling price, costs of product/service, variable costs per unit, overhead costs and whether they are fixed or variable. We also need to know if there are any limitations. As a minimum, the sales need to be equal to the figure of your fixed costs to make sure that you are not losing any money. For instance, if fixed costs are ? 500 per month, you would have to sell at least 357 units to ensure you break-even. ?2500 (fixed costs) ? ?7 (contribution per unit) = 357. 1428571428571 (rounded down to 357 units) Once the break-even point has been reached any additional contribution from sales will be pure profit. For instance, if one month 500 units were sold, total contribution would be ? 3,500 which would cover the ? 2500 fixed costs and then you are left over with ? 1000 profit. Break even analysis can also be used to work out how many units need to be sold to make a specific profit known as a target profit (see formulae below).

Fixed costs (? ) + Target profit (? ) ? Contribution per unit = no. of units Margin of safety is the amount which a price of a product can drop before you stop making a profit. It is also explained as the excess of actual sales over breakeven sales (expressed either as a no. of units or as a percentage). This calculation is considered important in times of recession or where the market is falling for other reasons. See the example below for explanation of how the margin of safety is calculated. Units sold = 500 Breakeven level of sales (units) = 357 Margin of Safety = 500 – 357 = 143 units 143 units ? 00 = 0. 286 x 100 = 28. 6% Sales could fall by 28. 6% before losses incurred Although these calculations are used on a daily basis by companies within the music industry, we must remember that these are all estimated figures. Music trends vary all the time, which makes the music & entertainment industry very unpredictable, as well as a volatile market to work within. In conclusion there is a lot of risk involved when investing in a product or service because the amount of sales is always a predicted figure.

Royalty revenue under the traditional deal for a single CD unit is ? . 76p. 2. Royalty revenue under the traditional deal for a single digital download is ? 0. 06p. 3. 31,579 CDs and 266,667 digital downloads. 4. Contribution per unit (CDs) is ? 4. 55p and (Digital downloads) is ? 0. 47p. 5. The recoupment point is when 39,560 CDs and 255,319 digital downloads are sold. 6. Under the traditional deal you are given a ? 40,000 advance plus a percentage of royalties from all profits made. This percentage is noted down as 16% in the contract extract, however the true royalty percentage is only 12% once you deduct the costs (container deductions at 25%).

You will not receive any of the money from sales of CDs and digital downloads until you have recouped your ? 40,000 advance. In units, this means you will have to sell 31,579 CDs and 266,667 digital downloads. Under the 50/50 net receipts deal you are also given a ? 40,000 advance plus 50% royalties, but you do not receive any money from the sales of CD’s and digital downloads until all costs are recouped then any profits from that point onwards are split 50/50. All of these costs are shared by the artist & record label.

As stated in the contract extract, costs will include ‘manufacturing, transportation, recording & any other direct costs incurred by the company relation to exploitation of the recordings’. The recoupment point in this deal is when 39,560 CDs and 255,319 digital downloads are sold. I believe personally an artist would be better off with the 50/50 net receipts deal because although the units of CDs needed to be sold is higher within this deal, once the recoupment point is reached, profits are split in half between the record label and the artist.

Whereas with the traditional deal you receive a minority of the profit and the record label receives the majority. Traditional deals are mostly used by major record labels (e. g. Universal Music Group, Warner Music Group) and are suited to mainstream pop acts because of the big marketing push. This is a big advantage of being signed to a major record label; they have a lot of money available to invest in recording, touring, video shoots & marketing and promotion.

Major record labels have been around for quite a while; therefore they have tight connections with media outlets and other companies to give you opportunities which independent record labels would never be able to offer. Therefore helping you achieve your music career goals in no time. The disadvantage is that these deals put the record label very much in the driving seat; therefore the artist will not have much control over their career or creativity of their music. Also, unless you are successful in the long term and become a massive star (e. g. Madonna) you will only receive a small percentage for your royalties from sales.

Bigger advances are normally given by major record labels with traditional deals; however this advance will be re-paid to the record label somewhere along the line. You are also less likely to receive a lot of attention from the major record label you are signed to because of the many other acts who are also signed to the label. 50/50 net receipts deals are mostly used by independent record labels (e. g. Domino, Mute) and are suited to artists whose music appeals to a niche audience.

These deals give the acts creative control because of the close working relationships between the record label and the act due to the maller size of the company. Most independent record labels will only sign an act if they genuinely like your music and believe in what you are doing, this means they will also work a lot harder for you. There is no added pressure for you to sacrifice your tastes in favour of seeking out chart success as the label understand you’re not mainstream and will not have a huge fan base. The drawbacks include the obvious lack of funds, most independent record labels do not give advances or if they do they will be very small compared to the advances which the majors offer.

Lack of money also means that there will be less marketing & distribution opportunities available to signed acts. On a positive note the recoupment and breakeven point are both exactly the same in this 50/50 net receipts deal. Calculations 1. The traditional contract extract states that artist royalty = 16% so we take this percentage and minus the container deductions which are mentioned in the extract also as 25% for ‘other configurations, including without limitation, compact discs and other distribution mediums’.

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