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The brief career of Carly Hennessey: a look at the economics of pop music.

CASE DESCRIPTION

The two primary topics in this case study are the matching concept which underlies accrual accounting and types of cost behavior patterns for management decision making. The case is appropriate for upper-level accounting majors. With two sets of discussion questions, it could be used in either the first intermediate accounting course or the upper-level managerial course. Either the financial or managerial approaches to the case can be taught in two class hours. Both approaches will require about three to four hours of outside preparation by students.

CASE SYNOPSIS

In this case, students examine financial and managerial accounting concepts in an identifiable setting, the pop music industry. As background to the accounting issues, students get an introduction to the pop music industry through a brief look at two years in the recording life of a sixteen-year old newcomer artist. The industry is revealed through a look at the terms of recording contracts, production and promotion costs and pressures, and the music distribution system. Students can listen to several songs and see the artist's promotional video on the Web as part of the background material.

The primary financial accounting issue is how recording studios account for production and promotion costs for albums of new and untested recording artists. Students decide whether such costs should be treated as revenue expenditures and expensed as incurred or capital expenditures to be deferred to future periods. Students will discover that most new releases never approach even a break-even volume of sales which makes the likelihood of future revenues extremely unlikely. Ultimately, a recommendation is required as to when advances to the artist and the sizeable recording and promotional costs for her album should be recognized. Student activities include accessing the corporate Web site, locating corporate accounting policies regarding music promotion and production costs, researching some GAAP rules for the music industry and discovering a practical application of some basic financial accounting theory.

The managerial accounting issues revolve around cost behavior patterns and break-even analysis. The issues of fixed, variable, mixed, and discretionary fixed costs are introduced. Using the industry's average break-even level of sales, students are asked to approximate the variable costs for CDs and project what happens to variable costs and record company revenues as sales exceed the break-even level.

CASE

Billboard Magazine (April 7, 2001): Carly Hennessy, "I'm Gonna Blow Your Mind": "Fresh from his work on Rod Stewart's latest album, producer/one-time New Radical Gregg Alexander lends his songwriting/production skills to the other side of the demographic spectrum with teen newcomer Carly Hennessy.... this track is infused with such rapturous spirit; "I'm Gonna Blow Your Mind (Really Want to Kiss You) is a playful, affection-filled romp; ... accentuated by a rollicking up-tempo beat, organic instrumentation and the impressive, playful vocals of Dublin native Hennessy; ... the most promising debut track we've heard this year". CT (Billboard, April 2001). These were the initial review comments in early 2001 for the song "I'm Gonna Blow Your Mind" by newcomer Carly Hennessy. To promote her first release, MCA Records spent $250,000 on a promotional video, $200,000 for independent promoters, and $100,000 on "imaging" costs for Ms. Hennessy and $150,000 for a four-week promotional tour. [To hear "I'm Gonna Blow Your Mind" and watch the video, go to: http://www.mcarecords.com/ .]

In 1999, Ms. Hennessy signed a recording contract with MCA (a subsidiary of the French company Vivendi Universal). In her native Ireland she had enjoyed success as a child singer (releasing a Christmas album at age 10) and actress (performing all over Europe in "Les Miserables" at age 13). At age 16, Ms. Hennessy dropped out of high school and came to Los Angeles with her father. Her demo disc caught the ear of an executive at MCA Records who was looking to capitalize on the then current trend toward younger pop artists such as Britney Spears and 'N Sync. MCA originally planned to start Ms. Hennessy in the pop market and then develop her into a more adult sound along the lines of Celine Dion.

Carly signed a six-album contract with MCA. Up front she received a $100,000 cash advance against the first album, $5,000 per month in living expenses and the use of a car. The label would own the music and advance all of the promotion and recording costs. For Ms. Hennessy to earn more, the studio would first have to recover the advances and living expenses, all recording costs and one-half of any video production costs (See Appendix A for more information on contract terms for recording artists).

Record companies argue that such terms are needed since they are taking most of the risk with new, and even, veteran artists. Since sales of 500,000 and 700,000 copies are needed to break even, statistics show that only about 5 percent of albums ever reach profitability. For example, in 2001, of the 6,455 new titles released by the top five music labels, only 112 titles sold over 500,000 copies; only 60 titles sold over 1 million copies [Source: SoundScan]. Record labels depend on a few very big hits to absorb the costs of all releases. Therefore, labels feel justified in tying new and unproven artists to a minimum number of releases and recouping their development costs from artist royalties.

The first album was completed by the end of 1999. However, neither Carly nor the company was happy with the results. Everyone felt that it was too adult sounding and too serious for the teen market. However, MCA still believed in her ultimate success as a recording artist. In early 2000, MCA hired new producers and writers to rerecord the album from the beginning. By the end of the year, however, the new album was still not completed.

At this point, feeling the pressure of having already committed a lot of time and money to the effort, MCA decided to release her first single. In early 2001, the song "I'm Gonna Blow Your Mind" was released. Despite some limited, positive reactions from the press and the radio industry, the song didn't get much air time. Typical industry impressions were along the lines of "too mature for pop radio", "too pop-sounding for adult top 40" and "... it just didn't have that sound that seemed like it would kick in" (Ordonez, 2002). The promotional video was dropped after a lackluster test run on Nickelodeon. Sales of the title were very disappointing.

With the production schedule for the first album falling ever further behind, a new, more veteran manager was hired in early 2001. A release date of November 2001 was set for the album with both spending and production speeded up to meet the deadline. Additional production costs of $650,000 brought MCA's total investment in the album to about $1 million which is considered high for a first effort. However, everyone involved thought that the upcoming album, "Ultimate High", had the makings of a hit.

To overcome Ms. Hennessy's limited name recognition with the public, MCA committed additional resources in a hurried-up promotional campaign for the album. As part of the promotion, a single from the album, "Beautiful You" was released mid-2001

Billboard Magazine (October, 29, 2001): Carly Hennessy, "Beautiful You": "Carly Hennessy got off to a promising start with her launch single "I'm Gonna Blow Your Mind". Unfortunately, she got lost in radio's marked turn away from youthful pop, and the song went largely unnoticed.... this equally compelling follow-up ... 'Beautiful You' is a buoyant outing, spirited and optimistic with an adhesive chorus fully capable of locking itself tightly in the memory. A spray of guitars and some "nah, nah, nahs" throughout give it added gusto. These guys have done their jobs; now, MCA, it's up to you to make sure radio gets the message." CT (Billboard, October, 29, 2001) ... Despite some favorable reviews like Billboard's and MCA's spending of almost $500,000 on promotion for "Beautiful You", it got even less air time than "Mind". Hopes for a concert tour by Ms. Hennessy were abandoned. Not counting advances and living costs, MCA's investment in Ms. Hennessy was over $2 million.

For a variety of reasons, this was not a very favorable climate for new pop artists to be attempting a breakthrough. In the pop music industry (unlike rock, classical and soul music) successful songs need to be instant hits since they are given little time to "grow" into a success. "Early and often" exposure is crucial. This puts tremendous pressure on pre-release and early promotional efforts for the title and the artist.

For songs to be successful, they need a lot of radio air time. But, deregulation of radio station ownership had left the industry dominated by a few big players with a focus on profits. Local stations are under pressure to only play those songs that seemed like immediate hits leaving little time for new songs to "catch on". Air time for new artists is at a premium or restricted to smaller stations.

Large discount retailers (e.g. Wal-Mart) are the fastest growing segment of retail music sales. Unlike traditional music stores, discounters stock a large volume of only a limited number of titles. They stock huge inventories of successful, proven artists but aren't willing to take a chance on new, unproven artists. In this environment, record companies have a harder time getting new and untested titles on the shelves.

World-wide music sales (the U. S. accounts for two-thirds) had been in decline since 1996 and continued dropping another five percent in 2001. The movement from vinyl records to CDs sparked a sales boom that had all but ended by the mid-1990s and no similar sales-generating trend had taken its place. But, perhaps most importantly, pop music had been unable to find new, hugely-popular artists who could continually sell multi-millions of albums. In 2001, for the first time since 1966, no album sold over five million copies (Goldsmith & Ordonez, 2002). Even Britney Spears' latest album only sold one-third as many copies as her first album three years earlier (Nielsen SoundScan)!

Into this market, MCA released Carly Hennessy's single "Beautiful You". Together, her first two singles ("Mind" and "Beautiful You") only sold about 17,000 copies.

Billboard Magazine (August 3, 2001): Hennessy's High: With a successful career as a child actor/ model already under her belt, Irish teenager Carly Hennessy now turns her attention to music. Her MCA debut, "Ultimate High", features the A-list songwriting and production talents of the New Radicals' Gregg Alexander and Danielle Brisebois. The lead single is "I'm Gonna Blow Your Mind". Nick Kelly (Kelly, 2002).

At last, the album "Ultimate High" was released in late 2001. Billboard's review pointedly talks more about the production and writing team and the artist's earlier successes rather than her success or promise as a singer. As it turned out, this review was accurately prophetic of the market's reaction to the album. [To hear "Ultimate High", go to: www.mcarecords.com .]

Following the failure of her first two singles, limited air time and lukewarm press, retailers stayed away from the album. Only about 10,000 copies were even ordered. The album generated sales of less than $5,000 (about 400 copies) in its first three months (MusicReviewer.com). To some production executives at MCA, it appeared that Ms. Hennessy's music wasn't rejected by the public; it just never "made it to the public".

After almost three years, MCA had invested well over $2 million in developing and promoting Carly Hennessy. As a last effort, MCA released "I'm Gonna Blow Your Mind" in Europe in early 2002. In hopes of promoting her in a more favorable market, the album, "Ultimate High", would be released there later.

Meanwhile, Ms. Hennessy vacated her apartment in Los Angeles, turned in her car and moved back to Ireland where she is currently getting ready for the European promotional tour for the album. She is still hopeful that it takes more than one album for artists to find a place in popular music.

APPENDIX A: SUMMARY OF TYPICAL CONTRACT TERMS FOR RECORDING ARTISTS

Standard terms for a new artist's first recording contract lock them into a minimum number of albums or a number of years (usually one year is guaranteed; company has option for "pick-ups" of other years). This prevents the artist from signing with any other label regardless of their success. However, it doesn't prevent the label from "dropping" the artist at any time by ceasing to produce or promote the artist's music (Ordonez, 2002). Only after proving themselves in the marketplace can artists dictate better terms. In fact, after some successful releases, it's customary for artists to renegotiate their contracts to more favorable terms.

In the recording industry, record companies must sell between 500,000 and 700,000 albums in order to break even. Recording artists typically earn royalties at the industry standard of 15 percent of sales. Out of that 15 percent however, the artist must absorb additional costs for various promoters, managers and other company fees. At best, artists "net" only about 75 percent of the "gross" royalty. Under the best of circumstances, new artists could expect to make no more than $.80 to $1.00 per album.

Typically the record company "fronts" the sizeable recording, producing, packaging, manufacturing, promotion, and royalties for other writers and artists. These costs are then recouped from the recording artist's royalties. For example, quality producers can sign for a royalty of 3 percent of retail sales. This is paid initially by the record company but ultimately it goes against the artist's 15 percent royalty. The same policy controls many other promotional and touring costs.

There are various other reasons why artists get only a portion of the agreed on 15 percent of retail price for CDs sold. In some contracts, companies charge a "packaging deduction" against retail sales before computing artist royalties. For example, with a 25 percent packaging deduction, the artist only earns their 15 percent royalty on 75 percent of retail. Record companies usually don't pay artist royalties on "free" copies sent with press kits and other promotional giveaways. And, occasionally, artist royalties are only paid on 90 percent of CD sales to cover breakage, returns, etc. (Lathrop & Pettigrew, 1999). Some artist contracts provide for "cross-collateralization" where any costs not recovered on one record are charged against subsequent releases until all costs are recovered (Wassman, 1997).
Table 3: APPENDIX B-CD PRICING and RECORDING & PROMOTION COSTS

Source: Lathrop & Pettigrew. (1999) This Business of Music, Marketing
& Promotion, New York: Billboard Books

Pricing Revenue to the recording company is the distributors'
 wholesale price which ranges from 45%-60% of retail.
 New CDs sell at full retail for around $17.99 each.
 Discounted prices might be $11.99 or on the low end,
 about $9.99 or lower.

Recording-- The largest record companies have their own recording
Studio Time studios and these costs are included as part of
 corporate overhead. Other artists rent studio time
 for the recording, overdubbing, mixing, etc. Hourly
 rental rates run from $35 to $300. A ten-track CD
 might require 15 hours per song or 150 hours of
 studio time.

Recording-- Nonunion musicians may cost $25 per hour; union scale
Musicians is $100 per hour; "name" artists may get as much as
 $300 per hour. A ten-track CD might require as much
 as 250 hours of musician time.

Recording-- The producer oversees and directs all aspects of the
Producer recording process. Costs range from $200 to $1000 per
 track or a royalty up of to 3 percent. High-end
 producers might cost $50,000 or more for a CD.

Recording-- The engineer handles the technical recording aspects.
Engineer Costs $25 to $50 per hour.

Recording-- Costs range from $200 to $500 per CD.
Media

Recording-- Final polishing of the recorded tracks necessary for
Mastering the finished "master" copy. Includes evening out the
Packaging audio levels and tone. Ranges from $600 to $2400 per
 CD. Costs will depend on the colors, graphic designs,
 size of enclosures, printing, image reproductions,
 etc.; perhaps $.15 to $.90 per CD.

Manufacturing Reproduction of master recording costs around $1 per
 CD.

Promotion This is the most unpredictable of the total costs
 since most of these expenditures are discretionary.
 Costs include press kits (from $.50 to $3.00 each),
 collateral (posters, bumper stickers, post cards,
 etc.), mailing lists, mailing costs, publicity
 campaign, advertising, tour support. Total costs
 might run from $2,000 on the low end to well over
 $50,000 per release.

Royalties These are percentages paid to certain participants in
 the project. Depending on the terms, amounts are
 based on sales or distribution. Royalties to the
 primary artist run from 10 to 15 percent of retail
 selling price for CDs sold. Up front advances to the
 artist are deducted from future royalties earned but
 unrecovered advances do not have to be repaid.
 Mechanical royalties are paid for use of material
 written by others. Payments are $.071 per song or
 $1.35 per minute of playing time per CD made and
 distributed.


REFERENCES

About Carly Hennessy. Retrieved July 2002 from http://www.springolo.com/artists/carlyhennessy.html.

Billboard (2001, April 7). Carly hennessy: i'm gonna blow your mind, 20.

Billboard (2001, October 29). Carly hennessy: beautiful you, 30.

Carly Hennessy--Ultimate High. Retrieved July 2002 from http://www.music-reviewer.com/04_02/hennessy.htm

Financial Accounting Standards Board (1981, November). Statement of Financial Accounting Standard No. 50-Financial Reporting in the Record and Music Industry.

Financial Accounting Standards Board (1985, December). Statement of Financial Accounting Concepts No. 6--Elements of Financial Accounting Standards.

Gardner, E. (2002, August 29). Britney past her peak, USA Today, 1D, 2D.

Goldsmith, C. & J. Ordonez. (2002, September 6). Levy jolts emi: can he reform music industry?, The Wall Street Journal, B1, B2.

Kelly, N. (2002, August 3). Hennessy's high, Billboard, 37.

Lathrop, T. & J. Pettigrew. (1999). This Business of Music, Marketing & Promotion, New York: Billboard Books.

Ordonez, J. (2002, February 26). Behind the music, MCA spent millions on carly hennessy- haven't heard of her? The Wall Street Journal, A1, A10.

Wassman, D. (1997). The Music Business--Career Opportunities and Self Defense (Second Edition), New York: Three Rivers Press.

Richard H. Fern, Eastern Kentucky University
 Table 1: FINANCIAL ACCOUNTING DISCUSSION QUESTIONS

1 Based on the trends in the popular music industry over the past
 few years, briefly discuss the likelihood of any new artist
 generating at least a "break-even" level of sales for a debut
 album.

2 In your opinion, at what point during the first two-year period
 of her contract (1999-2001) could MCA executives reliably
 predict the success or failure of Ms. Hennessy's recording
 career? Justify your answer.

3 MCA Records is a subsidiary of Vivendi Universal SA (a French
 company). At Vivendi's Web site, locate the most recent set of
 financial statements (Form 20-F filed with the SEC). Scan
 Footnote No. 1 for a description of their revenue and expense
 recognition policies related to their music holdings (look for:
 Revenues and Costs--Music).

4 Put yourself in the role of the controller for MCA. Prepare a
 brief report recommending the proper accounting for the costs
 related to the Carly Hennessy project over the years 1999-2001.
 In your report, be specific as to when you think the costs
 should be recognized as expenses. Make any reasonable
 assumptions necessary to make your recommendations complete but
 please identify any assumptions that you make.

 Table 2: MANAGERIAL ACCOUNTING DISCUSSION QUESTIONS

1 What does the term "break even" mean? How does a company compute
 its break-even sales level? On average, about how many copies of
 a new release have to be sold before the record company breaks
 even?

2 In general, what determines whether a business' costs follow
 either fixed or variable cost patterns? Identify the main costs
 in the Case (see Appendices A and B) as primarily either a fixed
 or variable costs for the recording industry. Give reasons for
 your choices.

3 What are some other possible cost behaviors other than pure
 fixed and pure variable costs? Give examples of each related to
 the recording industry.

4 Based on your response to question 1 and 2, compute the
 approximate variable cost for MCA records related to the CD
 "Ultimate High". Assume that all costs are either pure fixed or
 pure variable costs. Does this variable cost per CD seem
 reasonable? Why or why not? What costs do you think would be
 included in the variable cost amount? (In this analysis,
 consider all costs incurred by MCA up to the album's release
 date as costs related to the CD.)

5 After a CD reaches the break-even level of sales, what happens
 to the record company's costs? Is this a change in the fixed
 costs or variable costs? Explain. Using the data for the album
 "Ultimate High", discuss MCA's potential profit on the next
 100,000 copies sold above the BE level of sales. How might
 various provisions in the artist's contract affect this profit?
 Explain.
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Title Annotation:CASES
Author:Fern, Richard H.
Publication:Journal of the International Academy for Case Studies
Article Type:Case study
Date:May 1, 2004
Words:3488
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