For years, music lovers have been complaining about high CD prices. If a CD costs as much to have manufactured as a vinyl record, their logic goes, then why does it cost so much more to buy?
The response from record labels has been to raise CD prices even higher. Rod Stewart's new CD, "A Spanner in the Works" (Warner Brothers), which arrived in stores last month, is a good example. It carries a $16.98 list price, the same as most CD's by established stars, and more than 100 times the cost of the materials used to manufacture it.
Why the discrepancy, and where does all the profit go?
The journey for what was to become the Mr. Stewart's new CD began months ago at the giant offshore oil field of Marjan, Saudi Arabia, and wound its way through Chevron's oil refinery and chemical company in Pascagoula, Miss., a General Electric plastics factory in Pittsfield, Mass., and WEA Manufacturing in Oliphant, Pa., where 10 to 15 cents' worth of raw materials were converted into "A Spanner in the Works." (By comparison, the raw materials necessary to make a single vinyl album cost 40 cents.) The plastic and paper used to manufacture the jewel box and CD booklet for the Stewart CD (at a company called Ivy Hill in Louisville, Ky.) rang in at around 30 cents.
Because Time Warner owns WEA and Ivy Hill, Warner Brothers Records does not have to buy its CD's from them, as an independent record company would at a cost ranging from 75 cents to $1.10 a disk.
"In the early days of compact disks in the 80's, CD's cost between $3 and $4 to get manufactured," said David Grant, the vice president of sales at WEA. "But as CD making processes have become more automated and capacity has been added, CD costs have come down and the market has steadied."
James Shelton, the president and owner of Europadisk, the only CD, vinyl and cassette manufacturing plant in Manhattan, said his side of the business was not lucrative. "The large profit margin is at the record company level," he said, "because we sell CD's for 75 cents. And in addition to raw materials and the cost of the machines and labor, we have to pay a royalty to three different inventors on every single CD we manufacture." (Three electronics companies, Philips, Thompson and Discovision, have patents on different parts of CD manufacturing.)
While "A Spanner in the Works" CD's moved from WEA Manufacturing to its distribution warehouses in Atlanta, Chicago, Los Angeles and Philadelphia, Warner Brothers made two quick decisions: what the disk's wholesale price would be and what the suggested list price for retailers would be. Warner Brothers decided to distribute "A Spanner in the Works" to large record chains for $10.72 to $11.20. (Smaller stores had to buy the CD from independent distributors, which raised the price an additional 5 to 10 percent.)
This 2,000 percent markup may seem extraordinary, but manufacturing is not Time Warner's only expense. The really big costs of CD's derive from marketing, promotion, artists' fees, royalties and, often, an arbitrary markup representing a calculated guess at what the market will bear. The recording process alone for "A Spanner in the Works" cost just shy of a $1 million.
In addition, the royalties Time Warner pays Mr. Stewart are based not on the retail price, not the wholesale. (On average, Mr. Stewart makes $2.50 per disk sold.) Time Warner also has a record label to run, and -- thanks in part to the extra revenue from CD's -- has put substantially more money into marketing costs in the last decade.
Setting prices "is very arbitrary," said a top executive at a major label, who described his company's pricing policies only on condition of anonymity. "We're trying to raise CD prices," he said. "The reason for this is that our costs are escalating in such a marginal way, everything from marketing to promoting to signing bands. It costs $400,000 to $600,000 to sign a band. The first video costs a minimum of $50,000. Touring is more expensive, and people's salaries are a lot higher. Our profit margins are being squeezed.
"It's a very speculative business that we're in. If a label can break one new band a year, they're having a good year. The first 300,000 to 500,000 copies a record label sells of most CD's don't make money. That's 80 percent of all records that don't make money; the other 20 percent have to pay for the 80 percent."
Last year, the Federal Trade Commission subpoenaed the heads of several record labels as part of an investigation to determine whether the major CD distribution companies were fixing prices; a spokeswoman for the commission would not comment on whether the investigation was still in progress.
Some consumers said they thought record companies were trying to make American prices equivalent to those in Europe and Japan, where CD's cost the equivalent of $25 to $30. Record-label executives didn't disagree but said they believed that in a few years the price of a CD would level out at $20. Currently, when a CD is sold, 35 percent of the retail price goes to the store, 27 percent to the record company, 16 percent to the artist, 13 percent to the manufacturer and 9 percent to the distributor.
A record-industry analyst, speaking on condition of anonymity, said suggested CD prices had been rising $1 a year. "Around 1992, Michael Bolton's 'Timeless (The Classics)' was the first to go from $15.98 to $16.98 because Columbia said it was a special extended-play greatest-hits collection," he said. "Then Capitol went to $17.98 with the Frank Sinatra 'Duets,' saying it was a special project full of superstars. They call it an event price, a single one-time high list price. But the other labels always follow, and it becomes the new standard price. Most recently, it happened with the Page-Plant and the 'Three Tenors' albums on Atlantic last year at $19.98."
Most stores ignore suggested list prices and follow their own policy for pricing compact disks, but since increases in this amount correspond to wholesale price increases, they are significant. "A Spanner in the Works" was sold to retailers for around $11 with a suggested list price of $16.98, but few stores put it on sale at that price. In Manhattan, Bondy's Records is charging $11.98, Tower Records and HMV Records $12.98, and Colony Record and Radio Center $19.98. Elsewhere, the CD costs $12.99 at Wherehouse Entertainment in Los Angeles and at Sam Goody in Westport, Conn. Wal-Mart in Athens, Ga., is selling it for $11.88, and Best Buy in Miami for $9.99. (The Best Buy chain, which also sells home electronics, reportedly sells CD's near or even below cost to lure customers into stores.)
In the next few months, after "A Spanner in the Works" is no longer considered a new release, its price will creep up $2 to $6 at most of these stores. At Tower, the price will rise to $15.99 in accordance with a chainwide pricing grid called a cost-to-list conversion sheet; at Wherehouse Entertainment it will climb to $16.99, and at Sam Goody it will be $17.99. (Record stores make more money than it appears: in exchange for playing music by new bands in their store, putting posters in their windows or placing record company ads in their in-store magazine, they are often given CD's to sell.)
Jim Freeman, the regional manager at HMV Records' home office in Stamford, Conn., explained how the record chain determines its CD prices. "There are three factors," he said. "The first is the manufacturer's suggested list price. The second is what the competition is selling it for. The third is what's called the blended running margin" (jargon for a 30 to 35 percent price increase).
Per unit, CD's are one of the least profitable items a record store carries. Cassettes, for example, are sold at 41 percent profit, at least six percentage points more than a CD. "We make a greater dollar amount on CD's than other related items, but only because we sell so many," Mr. Freeman said. "I think the customer is actually getting really cool value for their $15. The Page-Plant CD had a full 70 minutes of music, which is the equivalent of two LP's of music and actually costs about the same as a double LP." (Mr. Stewart's CD has 55 minutes of music.)
Arnold Stiefel, who has managed Mr. Stewart's career for 13 years, said music and money don't correspond so easily. "The whole concept of value received for any entertainment endeavor is hopeless," he said. "If you're getting 55 minutes of Rod Stewart on 'A Spanner in the Works' and you love the CD, you've got a great deal. If you think it's noise, maybe you'd have paid double the price not to have it. However, I can personally warrant that 'A Spanner in the Works' will last longer than $16.98 worth of gas. And just think: they came from the same place."
