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Value-Added Chain

The Big Six, now the Big Five, have strategically accommodated for these changes, widening and buying more distribution channels and buying more and more labels. Their response to the internet revolution remains the next major decision facing these companies. As we have seen, EMI and Time Warner have responded by merging in 2000. The major players have realized that this vertical and horizontal integration brings them more of the profits in the supply chain. We can see this profitability directly in the following simplified value added chain. We can see that the artist makes only a fragment of the cost of a CD. The labels only start paying the artists their royalty of, say, $2.00 per copy in what is known as "the post-recoupment phase". For example, if a company spends $300,000 in total production and marketing costs and $200,000 of those dollars are recoupable production and marketing costs, the artist will then need sales of 100,000 units for their royalties to add up and make up for the remaining cost. By that point, the label has made over $300,000 in actual profits after paying publisher royalties and manufacturing costs while the artist is just beginning to make a profit. And this is just for a low selling album! The record companies are making the profits, and by owning more parts of the supply chain, they can make even more profits by narrowing the costs of production.

  Pre-Recoupment Post-Recoupment
Wholesale price $10.50 $10.50
Less: Manufacturing costs $2.00 $2.00
Artist and producer royalties $0.00 $2.00


Mechanical royalties $0.70 $0.70


Distributor charges $1.50 $1.50
    Gross margin $6.30 $4.30

This chart represents the value added chain beginning with the distributor and ignoring the actual price of the CD sold by the retail location to the customer. This price can vary and we must also consider that distributors can directly reach their customers through record clubs or the internet. Distributors are often located in the same place as manufacturers, thus decreasing costs even more between these two places in the supply chain.

Because the labels are making the profits, they want to sign on as many artists as possible to increase their chances of finding a billboard hit, while still making a substantial profit from small successes. Also, they want to reach out to more and more customers. They can do this because they are able to provide people with a more diverse variety of music and because, with such money and power, they are able to quickly establish distribution networks in new markets, especially in the international market.

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Last Update: April 5, 2000