13 October 2004

Wal-Mart -- one more reason for music labels to go digital

Rolling Stone has a great article on music sales and how Wal-Mart is changing the economic landscape for labels:

"[M]aking sure Wal-Mart is happy remains one of the music industry's major priorities. That's because if Wal-Mart cut back on music, industry sales would suffer severely -- though Wal-Mart's shareholders would barely bat an eye. While Wal-Mart represents nearly twenty percent of major-label music sales, music represents only about two percent of Wal-Mart's total sales. 'If they got out of selling music, it would mean nothing to them,' says another label executive. 'This keeps me awake at night.'

... Gary Severson, Wal-Mart's senior vice president and general merchandise manager in charge of the chain's entertainment section, did allude to the dispute about music prices. 'The labels price things based on what they believe they can get -- a pricing philosophy a lot of industries have,' he says. 'But we like to price things as cheaply as we possibly can, rather than charge as much as we can get. It's a big difference in philosophy, and we try to help other people see that.'

Wal-Mart appears to have far more leverage than all the music labels combined when it comes to pricing. Wal-Mart is 20% of music sales in the US -- music labels believe their CDs must be carried by Wal-Mart to be multi-million copy hits.

However, only 2% of Wal-Mart's sales come to music, so Wal-Mart could tell the labels to drop dead if it chose.

At least, that's what the labels think. But it's possible that Wal-Mart's position is weaker than the labels realize.

By cutting music sales, Wal-Mart would lose customers who are drawn in by CDs. Not just any customers, but the high-profit ones -- the ones who buy stereos, electronics, and other new-fangled high-margin gewgaws.

Second, by cutting music sales, Wal-Mart stores could become less efficient and more expensive to operate. Here's how; the 2% in music sales is high-turnover, and each CD takes a tiny amount of shelf space. Cutting into music sales would lower inventory turnover, a key Wal-Mart metric, while forcing Wal-Mart to put something in the shelf-space now empty of music, and whatever it is, it is likely to sit on the shelves longer, take up more room, and just be a dog compared to CDs. This would increase Wal-Mart's inventory costs (it would have lower margin or lower turnover items replacing music) which would in turn hurt its stock price.

At the same time these internal problems are occuring, Wal-Mart's dropping music or only carrying a fraction of its current music titles, would give its competitors (Target, K-Mart) an enormous advantage.

If I were a major label exec, I would would persuade the other labels of Wal-Mart's weak position and suggest strongly that I intended to call Wal-Mart's bluff if pressed.

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