Music Industry Supply and Demand

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A thought provoking article by Brian Majeski of the US Music Trades magazine…

Demand for the full range of music products remains strong. Unfortunately, it’s not quite strong enough to absorb the output of more efficient factories and the nearly limitless inventory of used goods. Herewith, a look at how it’s impacting suppliers and retailers, along with a recap of the important events, trends, and people of 2016.

Music has never been a more integral part of the world we inhabit. Consider that in 2016, U.S. citizens streamed over a trillion songs, more than triple the level of five years ago. Or that concert ticket sales nationwide advanced 7% to an all-time high, according to Pollstar research. The U.S. Congress even gave music its full-throated endorsement, designating it part of the core curriculum. (Given the low esteem in which Washington D.C. is held, we hope that is still a good thing). In an age of accelerating obsolescence, where companies and entire industries can be wiped out by a new technology—think Blockbuster Video or the Blackberry—this type of ingrained consumer demand should be reassuring. But you’d never know it from the prevailing industry mood. A chorus of retailers and manufacturers seem to think music making is as outdated as a VHS recorder and that there is little hope for the future. Conversations center more on “challenges” than “opportunities,” reflecting a serious lack of what the economist John Maynard Keynes termed “animal spirits.”

Why such a downbeat outlook? When the dust settles, industry revenues are likely to close out 2016 slightly higher than the prior year. At a tad over $7.1 billion at retail, sales of music products aren’t enjoying meaningful growth, yet they aren’t terrible either. Part of the enthusiasm deficit can be chalked up to the lingering effects of the 2008 financial crisis: vivid memories of a near-disaster continue to inspire caution. The lack of any dramatic product breakthroughs also plays a role. We’re living in an age of refinement rather than revolution. A new finish on a guitar doesn’t generate the same level of enthusiasm or retail traffic as groundbreaking new technology. However, we suspect the primary cause of the downbeat attitude is more elemental; specifically, the law of supply and demand.

The recently concluded Presidential election, Britain’s abrupt exit from the European Union, and the flood of refugees threatening Europe’s political establishment are potent reminders that the world remains a volatile place. They have also laid bare the limitations of “big data,” analytics, artificial intelligence, and all the other high-tech forecasting tools. But in an uncertain world, the rule of supply and demand is about as absolute as Newton’s Law of Gravity. When demand exceeds supply by even a miniscule amount, prices and profits ramp up, and there are big smiles all around. Flip the scenario with supply exceeding demand, and prices plummet and the smiles vanish. For a graphic illustration of this immutable law at work, consider the oil industry. A mere 7% increase in supply has sent the price of a barrel of oil spiraling downward from $100 to $48 in a three-year time frame. It may be a stretch to compare music products and oil, yet the overabundance of supply at all levels has had a similar impact on pricing, profit margins, and attitude.

Dramatically improved efficiencies on the factory floor over the past decade, both domestically and abroad, have made it far easier to crank up factory output. Manufacturers around the world have well learned the lessons of “just-in-time” production, lean manufacturing techniques, and zero defects. As a result, the array of high-quality, high-value products in every category is unprecedented. One lesson that these otherwise astute manufacturers haven’t absorbed is the value of scarcity. Consider the case of Ferrari, by any financial metric the world’s most profitable automaker. The illustrious brand has achieved this distinction by intentionally limiting production, thereby ensuring stratospheric selling prices. For better or worse, similar discipline is lacking in the music products industry. Back orders, waiting lists, and limited supply are but a distant memory for most.

The resulting overabundance of supply, not ineffectual MAP policies, is the root cause of the margin pressure retailers complain so loudly about. Here’s how it works. In an effort to keep their factories running and meet their ambitious sales goals, suppliers offer volume-based inducements to get retailers to load up on more inventory than they may actually need. These incentives erode supplier margins, and retailers lament “one more good deal and I’ll be broke,” but they do move product. Once the goods make it to the store, retailers have no choice but to sell it any way they can, via Amazon, eBay, or Reverb, usually at advantageous pricing. Then they turn around and gripe about excessive discounting and chaotic distribution policies.

THE FLOOD OF USED GEAR

It’s easy from our vantage point, seated comfortably in front of a word processor, to decry apparently shortsighted actions on the part of retailers and manufacturers. (As critics have said to us on more than one occasion, “if you’re so smart, why don’t you show us how to do it!”) We extend a large dose of sympathy to those navigating the supply and demand imbalance. Faced with immovable financial obligations, like interest payments or fixed overhead, many have no choice but to pursue an aggressive sales strategy. Giving up margin points may not be optimal, but it’s better than having inventory languish, cash flow dry up, and angry creditors on the phone.

These tough strategy decisions aren’t the only cause of the supply and demand imbalance: there’s also the vast amount of readily available used inventory to consider. The biggest competitor the industry’s suppliers face is all their old stuff floating around in the after-market, and the fact that musicians actually like used gear. Twenty-year-old televisions, computers, or golf clubs? Worth next to nothing. Twenty-year-old guitars, horns, or keyboards? Still very much in demand. Consider that a 52-year-old Remo bass drum head recently fetched $2.1 million. The fact that it featured a Beatles logo and was used by Ringo Starr on The Ed Sullivan Show, might have had something to do with the price. Yet even gear without such a storied pedigree is in demand. Guitar Center management reports that the used instrument section is a major traffic driver on its website.

Used has always been an important component of retail sales, but the advent of digital sales platforms has made it only more so. The access to a bigger selection coupled with more reliable pricing information has unquestionably made it far easier to buy used. One indication is the continued growth of the Reverb.com platform. Now in its third year, the marketplace is on track to handle nearly $400 million in transactions, 70% of which involved used gear.

DIALING BACK SUPPLY

Unsustainable trends, by definition, can’t go on forever, and recent merger and acquisition activity suggests that the industry is gradually trying to bring supply into balance with demand. Pearl River Piano took a controlling interest in Schimmel Piano of Germany. The transaction gives China’s largest piano maker a prestigious German trademark for its fast-growing domestic market, while Schimmel benefits from production efficiencies. The Vandeweerd family, owners of the Johannus Organ Company, acquired Rodgers Organ from Roland Corporation, reducing production capacity in the crowded institutional organ market. inMusic Brands, the parent company of Alesis, Akai, Numark, Ion, and numerous other brands, continued its aggressive acquisition strategy, taking control of Rane, best known for its DJ mixers. Rane’s Seattle area production will be folded into inMusic operations. Buffet Crampon Group added to its portfolio of wind instruments, acquiring the venerable Powell flute company, based outside of Boston. The French clarinet maker also took control of its student instrument production in China, acquiring Bejing-based WIND Manufacturing. Hal Leonard acquired Music Minus One, the pioneer of play-along music products. In other acquisition activity Schilke Instruments, best-known for its professional trumpets, purchased the Greenhoe Trombone company, moving production to its Chicago facility. JAM Industries acquired Rhythm Tech tambourines, and Roland Corporation broadened its product offering, acquiring V-Moda, maker of high-end headphones.

SOME SEE OPPORTUNITY

Despite the sombre mood, a number of companies in and outside of the industry made significant investments reflecting confidence in the future of music making. Ikutaro Kakehashi, the founder of Roland Corporation and one of the architects of the MIDI standard, came out of retirement to launch ATV, a technology firm focused on new products that integrate music and video. Roli, the manufacturer of a unique keyboard instrument, raised $27 million in venture capital to ramp up production and build out a global distribution network. The previously mentioned Reverb.com received a $25 million capital infusion from private equity firm Summit Partners. The new investors see the company tripling in size over the next five years. Seidler Partners took a controlling interest in Hal Leonard Corporation, the leading print music publisher. Current management remains in place and the new investors see growth opportunities in foreign markets. Investors who purchased shares in Focusrite, the manufacturer of audio interfaces and Novation keyboard controllers, were handsomely rewarded. Revenues at the U.K.-based company surged 17% to $72 million.

In the biggest acquisition news of the year, consumer electronics giant Samsung paid $8.0 billion to acquire Harman International. Samsung’s primary interest is Harman’s automotive business, which supplies audio and “infotainment” to major car makers. It has not yet revealed plans for the pro audio division, which includes JBL, AKG, Crown, Lexicon, and Digitech.

Córdoba Group expressed confidence in the future of Guild Guitars, after having purchased the brand two years ago. A new factory was opened in Oxnard, California to handle acoustic guitar production. SIT Strings opened a new and expanded factory in Akron, Ohio. Musical Distributors Group also expanded, doubling the size of its warehouse and distribution facility in New Jersey. The D’Addario Company opened a new sawmill to process hickory for its Promark drumstick line.

FICKLE CONSUMER TASTE

Unlike the relationship between supply and demand, shifting consumer preferences are not so easily divined. Music may be a universal language, but how it is expressed is subject to unexpected change, not entirely unlike the whim of the electorate. Three years ago, publications like Rolling Stone and Wired were boldly predicting that EDM was on track become the dominant musical genre for the foreseeable future. We quoted a number of industry members offering similar forecasts. These days however, EDM is looking more like the reincarnation of the 1970s disco boom than the future. SFX, the leading dance festival promoter recently filed for bankruptcy in the wake of sharp attendance declines. Sales of EDM-related hardware and software also remain sluggish. Although the art form, which includes a multitude of sub-genres, isn’t going away, it hasn’t lived up to lofty expectations either.

The popular media has also been busy prematurely writing obituaries for the guitar, as in the case of a recent New York Times article headlined, “Is Rock and Roll Dead?” New guitar shipments are off the record level of a decade ago, but still represent the industry’s single largest product category, no doubt a reflection of the instruments’ exceptional versatility. More than in any other product category though, sales of new guitars are hampered by availability of a near unlimited inventory of used products. As of this writing, typing in “used guitar for sale” on Google yielded some 26 million results. The glut of used gear is primarily a challenge for guitar makers. Retailers report that used gear is a big customer draw and important profit centre.

Another unexpected turn of events was the renewed interest in analog synthesizers. In the early 1980s, the advent of digital sound generation technology pushed synth pioneers Moog and Sequential Circuits into bankruptcy. Last year, however, the reconstituted Sequential and Moog saw double-digit sales growth with an updated offering of the analog instruments players shunned three decades ago. Proof that if you stick around long enough, everything comes back into vogue.

STABILITY IS SEXY

When the m.i. and hi-tech segments of the industry were expanding rapidly a decade ago, some looked condescendingly on the school music segment, dismissing it as “stodgy” and “unexciting.” These days, however, the “unexciting” part of the business—inventory that doesn’t become obsolete and predictable sales—have become objects of envy. In 2016, school music was once again one of the industry’s top-performing segments. The reasons for the strong showing are numerous. Parents have an inherently favorable view of music programs, fueled in part by strong public relations efforts mounted by NAMM and others. Also, school music retail, with its rental programs and emphasis on service, has been largely insulated from disruptive online competition. The future prospects for the market were enhanced last year when NAMM lobbying efforts resulted in music being included as a core curriculum component in the Elementary and Secondary Education Act (ESEA), which guides Federal education spending. Sales of wind and stringed instruments, which have closely tracked school enrollment for at least five decades, are unlikely to experience a major growth spurt anytime soon. But the fact that they are predictable is very appealing in an unsettled world.

The internet continues to disrupt the way people shop and buy, causing no small amount of pain among brick-and-mortar retailers. J.C. Penney, American Eagle Outfitters, and Walgreens were just a few of the high-profile retailers that significantly reduced their store to the counts last year. A number of music products retailers also closed their doors. Yet the tactile nature of music and audio products ensures a place for retail showrooms for the foreseeable future. Guitar Center continued to expand, opening 11 new stores in 2016, while remodeling an additional eight; Sam Ash Music added a new showcase in San Diego; and Steinway & Sons opened an elegant new retail showroom in Manhattan, replacing the old Steinway Hall, which had been in service since 1926. South of the border, Texas-based Hermes Music took over 52 locations in Mexico with the acquisition of the Top Music and Music Club chains. “We believe strongly in retail,” said CEO Alberto Kreimerman. Further evidence that consumers still like to see and touch product could be found at Sweetwater Sound’s GearFest. The online retailer’s annual product showcase at its Fort Wayne, Indiana headquarters attracted a record 12,000 from across the U.S. “It’s exciting for them to experience the latest gear firsthand,” said CEO Chuck Surack. A new Alto Music show- room in Brooklyn provides a template for a new type of brick-and-mortar store: a boutique with a narrow focus on local recording studios.

As the year drew to a close, the Congress on International Trade in Endangered Species (CITES) tightened regulations on trade in rosewood, long the standard material for acoustic guitar backs and sides. While final regulations are still being drafted, it appears that guitar makers will need permits verifying the provenance of their rosewood in order to export finished guitars. Reaction to the regulations has been mixed. Some say it is a necessary step to ensure a stable supply of rosewood; others say it is another cumbersome and unnecessary regulation. All agree that it will have a significant impact on guitar production in the coming years.

NEWLY HUMBLE FORECASTERS

Donald Trump’s surprise election victory has sent shockwaves through the forecasting industry. The Gallup organisation is reportedly doing a top-to-bottom re-assessment of its polling methods, and WPP, the world’s largest advertising agency, is dispatching research teams to the center of the country to “better understand a segment of the population we overlooked.” While professional future gazers are re-examining their methods, the rest of the nation remains anxious about what lies ahead. A new administration, turmoil in the Middle East, a shaky European Union, advancing technology: what will it all mean? For the music products industry, the supply and demand imbalance will take time to correct and may inflict further pain. On the positive side, however, music remains part of our social fabric, and opportunity is there for those who offer consumer value.

Heeding the adage, “discretion is the better part of valour,” we will let front line experts handle the forecasting for the coming year.

www.musictrades.com