Case Analysis of Mount Everest--1996

Discuss how Hit Song Science may change the business model in the
music industry? What are the implications for the music eco-system ---
how does it change the competitive landscape and who are the potential
winners and losers?

HSS would be a great help in decreasing cost in production and distribution side,
but it may also set some restrictions for creativity and performance.

Artists (Winner and Loser): Artist can check the hit potential of their songs.
However, they may lose the courage to try new component or new material.

Record Company (Winner): Since they can increase the probability of picking a
hit, they can save a lot of money in production, advertising, or marketing for
those songs which wont be popular.

Producer (Winner): The technology would lower producers work load since it can
predict whether this song would be a hit and producers can adjust their work by
it.

Retailer (Winner): The technology can streamline their SKU with limited shelf
space and thus lower their inventory pressure.

Audience (Loser): The direction and content of music is restricted, even though
the prediction is based on a combination of tens of attribute. Audience cant have
enough diversity of music and cant hear something totally new if the industry
really relies on the technology in screening process.

Lets assume HSS can provide accurate prediction for music. However, a hit
contains some factors other than music itself. Sometimes, a good artist or a
wonderful music video can still make a regular song popular. For example, would
Madonna and Michael Jackson still be so popular if no one can see their dance
and performance? I really doubt it.
Discuss the challenges to exploiting the benefits of the long tail effect as
espoused by Brynjolfsson. Will Hit Song Science or similar technologies
help the music industry exploit the benefits of the long tail effect. Is the
long tail effect applicable to all industries?

Long tail effect is especially powerful when it comes to digital network industry,
since most brick-and-mortar stores cant cover all the products due to the
physical limitation such as space and inventory cost. Thus, some smaller online
distributor can gain benefit and defeat physical channel giants by performing long
tail strategy. But, what if the major competitors are online distribution channel as
well? Information technology already enables them to perform long tail strategy
even they didnt focus on this market in the beginning. Thus, long tail strategy
may be a good choice for small company to collect the ignored markets, but this
is not so useful if other competitors can also easily perform this strategy.

Long tail effect try to overrule the 80/20 rules which focuses on putting resources
into majority market. However, long tail will fail if the potential market is not big
enough. That is to say, even we collecting ALL the minority markets, the profit is
still not good enough to support the business. In this situation, concentrating on
most resources and taking care of the majority market like 80/20 rules suggests
would be a better idea.

Long tail strategy emphasize on customization to provide high customer

satisfaction. However, the rule behind it is that the customization cost can not be
higher than profit. In most traditional industries such as manufacturing industry,
lowering cost is everything, so the variety of product line has to be limited very
carefully. Thus, long tail strategy is very hard to follow in such scenario.

Long tail effect emphasizes on collecting the revenue from all minority markets.
HSS would limit the long tail effect since it chooses so-called hit by majority
taste in music industry. Since the record company wont publish those not so
popular songs, the minority market would be squeezed and some of them may
even choose not to buy any records because they are not satisfied with the mail
stream music.
I believe long tail strategy can be applied in other industry as well. Nowadays, we
only see it happens in well-digitalized industry because of the cost issue
mentioned before. Thus, I believe there will be some specific method or
technology to fix the problem in each industry and make the minority markets
being taken good care.
Price

Polyphonic HMI has invested $600,000 in the development of the Hit Songs Science program; this is a sunk cost and does not get figured into price
calculations. The fixed costs per year associated with running Polyphonic HMI are $500,000. Variable costs arise when an album is analyzed by HSS
and that figure is $300/album or $30/song. Exhibit 4.

Given the case analysis, Polyphonics best strategy is to market the HSS system to record labels. The breakeven point will include the $500,000
dollars in fixed costs plus the variable costs of $300 per album times the amount of albums reviewed. The situation in one in which the fixed costs are
considerably higher than the variable costs so the contribution margin on a sales to record labels will be high in comparison to the variable costs.

In order to develop the correct pricing strategy, the record labels costs must be analyzed before and after HSS implementation. Given
$12,044,000,000 in US album sales at suggested retail price of $16.99, we can calculate the revenue received by the record labels. Since record labels
price to retailers is $10.50, the revenue taken in by record labels is $7,443,319,600. Exhibit 5.

The calculations show that company spend on marketing and promotion is equal to 30% of the $10.50 or $3.15 per album. Given a hypothetical
company with 20% market share of US sales, it can be expected they spend $446,599,176 on album promotion.

Polyphonic HMIs HSS program will allow record labels to better target their marketing and promotion budget. The software will identify potential top 40
singles at an 80% success rate as compared to the industry average of 10% success rate. A dramatic improvement, which will allow labels to reduce
the amount spent on marketing and subsequently increase profit margins.

Traditionally, there are about 3000 singles released per year; of which 10% make the Billboard Top 40. Roughly 300 singles make the Top 40 per year.
For the hypothetical record label with 20% market share, 600 singles will be released of which 60 will make the Top 40. If the hypothetical label
introduces the HSS system the success rate in correctly identifying Top 40 singles will move from 10% to 80%. The labels pool of singles will be
reduced from 600 to only 75 in order to maintain their market share of 60 hit singles per year. The cost saving associated with this reduction are
drastic.

Profit margins for record labels on CD sales based on 80% success rate move from 30% to 40%. Even a conservative assumption that HSS can only
predict hits at a 50% clip, will yield an 36% profit margin relative to the previously mention 30%.

For the hypothetical company the cost savings can be analyzed by subtracting new marketing costs (at 50%* success rate) of $360,852,134 from
previous (at 10% success rate) yearly marketing costs of $446,599,176. A total (yet conservative) cost saving per year of $85,747,042.

The marketing expenses for singles range from $300,000 to $1,000,000. Again using the Hit Song Science software our hypothetical company can
pare its costs drastically. Given a market share of 600 singles at a conservative cost of $300,000 the budget will be $180,000,000. Using HSS at a 50%
success rate we can determine that instead of 600 singles the company will only have to promote 120 singles and associated cost will be $36,000,000.
By doing the math the reduction in costs will be $144,000,000.

Price Floor
See Exhibit 6 for Polyphonic price floor calculations.

The price floor will be based on the projected penetration of HSS. Assuming first year penetration of 20% within the hypothetical record label the price
floor will be $5300 per album.

Price Ceiling
See Exhibit 6 for Polyphonic price ceiling calculations.
To calculate a price ceiling simply divide the total yearly savings to the record label by the #of albums analyzed. A price ceiling of $459,494 per album
will allow record companies to experience the same costs.

Final Price
A target of $50,000 per album is the recommendation.