Deconstructing Pop Culture

Deconstructing Pop Culture header image

Special Markets

August 4th, 2012 by David Kronemyer · 2 Comments

If you’re a recording artist and your record company starts talking about “Special Markets,” run as fast as you can in the other direction. When I was Vice President of Capitol Records, this was one of the divisions reporting through its distribution company. Though used by all record companies as a descriptor for a certain type of activity, I am not sure exactly how this name came about. Certainly there was nothing “special” about what these divisions did, nor the “markets” they addressed. Rather, at Capitol (and elsewhere), the Special Markets group essentially engaged in four activities: (1) licensing masters for use in movies, television shows and commercials; (2) licensing masters to other record companies and entities for various purposes; (3) compiling masters into collections used as premiums, for example by car dealers or as consumer product company sales incentives; and (4) the sale of an ultra low-budget line of records.

The first two functions are legitimate record company activities. The latter two, however, result in significant depreciation of the master sound recordings unfortunate enough to be included in such a product. Over the years, for example, Capitol Special Markets had prostituted Capitol’s recordings by Nat “King” Cole by releasing numerous compilations that were sold everywhere from drug stores to car washes. This resulted in the catastrophic diminution of Cole’s stature and the salability of full-price records. I select Cole simply as a familiar example because I had extensive and contentious dealings with the Cole Estate regarding this problem (here is a copy of Nat Cole’s original contract with Capitol):

Nat Cole contract with Capitol Records

Dozens of other artists, however, similarly were situated. Here is a copy of a Special Markets new release advertisement (undated), identifying some of the new victims at the time:

Special Markets – New Release Catalog

What to do with its back catalog presents a vexing problem for major record companies, which own hundreds of thousands of masters. Only a miniscule percentage of them have any commercial value. Some catalog artists always will remain a priority; at Capitol, for example, it was The Beatles. For Sony, it might be Michael Jackson. Such artists, however, are the exception, not the rule. In economic terms there is a curve of marginal utility, where consumer preference for records by an old artist (occasionally referred to somewhat pejoratively as a “veteran” artist) intersects with the record company’s cost to make them available. This cost includes marginal costs such as physical replication of the masters, and marketing, advertising and promotion. It includes fixed costs such as remastering and artwork design. Then, there also is opportunity cost. Instead of repackaging old masters, record company management could be engaging in potentially more lucrative work with new, more commercially demanded artists. From a retail standpoint, only a limited amount of open-to-buy funding is available at any given time, thus money allocated to records by old artists displaces money that could be spent on new artists.

This is how Special Markets groups gain traction – by navigating below the curve. Barring extraordinary circumstances (such as use of the master in a hit movie, or death of an artist with elevated notoriety), it is impossible to increase consumer demand for old artists in any meaningful fashion. All of the consumer marketing impressions that ever will be created, already have been created. This means the only way to sell their records is to force the wholesale price point down as low as practicable – often, less than 10% of the wholesale price of a full-price record. The retailer then is free to sell the record at a market-clearing price, which frequently is more than an inferred corresponding retail price, because in fact the record was more popular than the record company thought. In such event, the record company has miscalculated demand, and is deprived of entrepreneurial rents. Even so, Special Markets groups can be incredibly profitable; during FY1985 – FY1993 at Capitol, for example, Special Markets’ return on sales (ROS) ranged from 10.3% to 25%. This presents a tempting situation for record companies to cede masters to Special Markets groups even though, on margin, some full price sales still might remain.

Another response to the dilemma of what to do with old artists was the specialty re-release company. The best example at Capitol was Rhino Records. Rhino’s approach was to release premium compilations, which carefully were compiled as an overview of an artist’s entire career, or a specialized genre or musical theme. Rhino successfully adopted this curatorial style of approach, and became known for its taste and ingenuity. Special Markets frequently undertook to assemble and manufacture these compilations on Rhino’s behalf, licensing not only controlled masters, but also licensing in (or “leasing”) masters from other record companies. There was considerable reciprocity among Special Markets divisions of the major record companies, enabling fluidity in these cross-licensing arrangements. The record company with the most masters included in the package was the one, which took the initiative to assemble and manufacture the finished product. Although it later went off to fame and fortune by specializing in rap music, Capitol’s relationship with Priority Records also started off in this fashion. Priority’s first hit record was an oldies compilation entitled “California Raisins,” compiled, assembled and manufactured by Special Markets.

Even these types of packages, though, severely were constrained by supply and demand factors. In some instances it might make more sense for the record company to re-release the record on its own. While I can’t recall if this ever actually happened, one of Rhino’s theoretical concerns was that Capitol would “steal its ideas” and take advantage of Rhino’s own marketing research. In some instances it might make more sense for the record company simply to ignore both the record and any licensing requests for it. The internal cost just to keep track of what was going on far exceeded any revenue that potentially might be derived from any kind of transaction. With lesser known companies, there always was the potential the company might under-report or not revenue, or even use or license the master for prohibited purposes outside the scope of the original license. In his book “Stiffed: A true story of MCA, the music business, and the Mafia” (1994), author William Knoedelseder alleged this was done by licensee John LaMonte, owner of a record company called “Out of the Past;” I can recall several other circumstances, where this was alleged to have taken place.

The precise point of intersection of the demand versus cost curve varies, depending on the record company’s valuation of its catalog. In principle, it ought to be possible for a record company to devise a dynamic price point for each and every record it sells, depending on consumer demand and the sum of the record company’s marginal, fixed and opportunity costs. The record company should be able to decide if it is more profitable to make its own records, to license the masters out, to sell at full price, or not to sell at all. With the advent of sales on the www and aggregators such as iTunes, in principle this should be even more practical. In practice, however, records tend to fall into only a few pricing tiers or tranches.

A particularly vexing category is the artist who no longer is a front-line priority, but who has not yet descended into a classification of near-worthlessness. Records by these artists often are sold at a “mid-line” price, typically, around 50% – 65% of the wholesale price for a front-line artist. At various times throughout the year – upwards of half the year – they are sold for even less, through invoice discount, free goods and deferred payment programs. They frequently are bundled and sold as a commodity in huge retail syndications. They records typically are sold, though without much enthusiasm, by the record company’s front-line sales staff.

These problems were exacerbated at Capitol, which at various times for a variety of reasons had difficulty breaking front-line artists. This correspondingly enhanced the viability of its back catalog. Records that may have been forgotten suddenly became economically feasible propositions – not so much in terms of retail or consumer demand, but rather by lowering the criteria for deciding which records met this criterion. If a record company’s front-line records aren’t selling, then it stands to reason it should be able to harvest more of its back catalog and release records by artists who, on margin, might become worth resurrecting. Frequently these artists carry unrecouped debit balances, meaning the record company doesn’t even have to pay artist royalties on the sale (though it still would owe mechanical copyright royalties). It simply is reimbursing itself for previous advances it has made to the artist.

I particularly remember one instance of this. Capitol recently had signed Bonnie Raitt, and had released her record “Nick of Time.” I walked into Tower Records on Sunset Boulevard. There was a small stack of “Nick of Time” records off to the side of the store. At the front of the store, however, one was confronted with massive stacks of the records Bonnie Raitt previously had released on Warner Bros., accompanied by stand-up figurines, posters, flyers, and other promotional materials. Warner Bros. in effect was piggy-backing on Capitol’s marketing efforts, and doing a much better job of selling Ms. Raitt’s back catalog, then Capitol was at selling her new release.

At Capitol, for some time Jack Reynolds had been in charge of Special Markets. Shortly after his arrival (as set forth at this post), Russ Bach fired Reynolds and hired Eli Okun. Okun was a specialist in these types of packages, having previously worked for the legendary Al Schulman at CBS Records. Later, I collaborated with Okun to acquire the Laurie Records Catalog; certain assets of Philadelphia International Records, owned by Kenneth Gamble and Leon Huff; and creating a specialized re-release label called The Right Stuff. I was a consistent critic of Capitol’s approach to Special Markets. Here is a copy of a white-paper I wrote about the Special Markets issue:

Special Markets White Paper

After I left Capitol, it undertook a thorough review of its catalog sales. Concluding its catalog may be worth more than it initially had thought, the company formed a new division called EMI-Capitol Entertainment Properties, run by Bruce Kirkland; Okun reported to Kirkland, I’m sure to his chagrin. Here is a copy of the press release:

Press Release Announcing New Catalog Group

Okun lasted at Capitol-EMI, in various configurations, until 2008.