Nettwerk: Digital Marketing in the Music Industry

Cristina BeghianTamara DabicAakash Dang

Danial EsseltineDenise Kam

Matthew Spencer

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Table of ContentsExecutive Summary……………………………………………………………………………...3PEST Analysis……………………………………………………………………………………44 Cs Analysis……………………………………………………………………………………...4SWOT Analysis…………………………………………………………………………………..4Positioning Statement……………………………………………………………………………5Target Market and Segmentation………………………………………………………………54 Ps Analysis……………………………………………………………………………………...6Recommendation…………………………………………………………………………………6Implementation…………………………………………………………………………………..7Contingency Plan………………………………………………………………………………...8Expected Results and Likelihood of Success…………………………………………………...8

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Executive SummaryConsidering that Polyphonic is essentially a venture capital firm for bands, the primary

concern is generating a return that corresponds with a typical VC investment. Polyphonic needs to generate lucrative cash flows from its bands in order to yield a positive net income, and attract desirable acts in the future. Given that industry profits are under high pressure, this issue is of high importance and high urgency. In addition, the $20 million seed capital limits how much money Polyphonic can give to each artist and the number of artists it can invest in. While this issue is of high importance, it is not urgent. There are ways to evaluate Polyphonic’s investment strategy which will allow for adjustments. Lastly, once capital has been invested in an artist, Polyphonic is limited to a ten year cash flow. This issue is of high importance but low urgency as it will not affect the firm in the short term.

It is recommended that Polyphonic be launched, requiring artists to use the founders’ resources (Nettwerk and ATC). The founders will be able to exploit a new business model but will not be exposed to the same degree of financial risk as in the original Polyphonic model. This alternative allows the revenues to be reinvested in funding additional artists or existing artists in the future. A sensitivity analysis was performed taking into account a range of values for 2 independent variables (the usage of founder resources and the average gross revenue for band activities). The expected average annual return over 10 years was 94% (see Exhibit I)

Polyphonic will set up negotiations with the companies of the three founders. This will create a partnership between Polyphonic and the founders, such that artists will be required to use their services unless proof is provided that external partners are superior in quality or value.

Artist selection will occur in three rounds of 20 artists over three years. 50% of recruited artists will be those dropped from their record label, and the other 50% will be new artists. If there is insufficient artist interest at the end of year one, Polyphonic should adjust its revenue sharing model to a 30/70 split favoring the artist. Assuming the 25% of expended budget is directed towards founders’ resources (a pessimistic assumption), Polyphonic should still yield an average return of 61% over 10 years (See Exhibit H) It should also reevaluate its recruitment strategy and expand the pool of potential artists to those with 60 000 – 120 000 unit sales.

After the first three years, a rolling selection of five artists per year will occur. At the end of year one, the effectiveness of the program will be evaluated to determine whether enough revenue is being generated to continue

A monetary reserve will be implemented for artists who have success rates of over $200,000 in annual revenue for two or more consecutive years. These reserves will hold $1,000,000 per artist for awareness bumps. If the artist requires an additional advance for awareness bumps, a contract extension of five years is required.

If the 20 signed artists are unable to reach $1,000,000 by the end of 2010, no new artists will be signed in 2011. Instead, artists that attained revenue of over $90,000 will have the option of being extended additional advances based on their expansion strategy. Also, a laddered approach will be implemented beginning in 2013 when bands will be offered advances of $100,000 per year for three years given that artists maintain a certain level of success each year.

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PEST Analysis

Political: Though most downloaded music is pirated, the legal costs of pursuing piracy are high.

Economic: Album sales are declining and a greater proportion of revenues are generated from

live tours, merchandise sales, and licensing agreements.

Social: Consumer preferences and behaviors are changing. Consumers are less willing to buy

albums, instead opting to purchase artist singles or subscriptions to streaming services.

Geography is less of a barrier, making the world a niche for artists.

Technological Blogs and social media are inexpensive marketing tools for artists. They have also

eliminated geographic barriers to music promotion. The rise of online streamlining services has

increased the share of revenue generated from license sales. For all PEST impacts, see Exhibit A.

4Cs

Company: Polyphonic is a first mover business model in the music industry and takes advantage

of the turbulent market. The founders have success related to touring and the long-tail strategy.

Competitors: The illegal market for downloading music is putting downward pressure on profit.

Customers: Digital dissemination has caused a shift in the demand for music. Consumers require

content in formats that suits their individual needs. This includes live performances, record

singles, full albums, streamed libraries, and full discographies. In addition they require a variety

of sales channels from digital download services to product offerings in big box stores.

Collaborators: The three founders and the expertise they bring. No major labels, but included are

contractors for services ranging from distribution to promotion to merchandising.

SWOT Analysis

Polyphonic was established by industry experts including the founder of Nettwerk, a

large independent label. The company could leverage Nettwek’s legacy as an innovator capable

of responding to changing market conditions. Polyphonic could attract artists eager to retain

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control of their own marketing strategy, and reap the benefits of a more lucrative profit sharing

agreement. Polyphonic would capitalize on the use of social media and the internet to help artists

reach a broader audience.

The venture would limit Polyphonic to ten years of cash flows for each artist, and the

ROI is not high enough to attract most venture capitalists. Further, the seed capital invested in

Polyphonic limits how many artists can be signed and the amount that can be given to each artist.

Polyphonic sees the turbulence in the industry as an opportunity. If the artist is successful

through Polyphonic, there is potential to earn higher revenues. Further, Polyphonic’s unique

profit sharing agreement may attract artists that already generate large sales volumes.

This business model is untested, so there is the potential that artists may not generate

enough sales. For a full SWOT synopsis, see Exhibit B.

Positioning Statement

Polyphonic is a first mover venture capital firm that gives artists the capital and flexibility

to hire services at their discretion. Polyphonic could exploit copyrights for 10 years and share in

revenues in exchange for capital and more earnings for artists, cutting out the middle man.

Target Market and Segmentation

The target market is artists who have either been dropped by major labels or are new.

These artists would cater to music listeners aged 15 to 50 because these listeners spend time on

the internet downloading music and using social media. The age range of listeners is large since

different music artists cater to differing demographics. This would allow Polyphonic to identify

tastemakers for particular genres. This will also be a way to feed these tastemakers with inside

information about artists with pre-release songs and advance information of tours. These

tastemakers will use social media to promote the artists and encourage people to attend concerts.

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4Ps

Product: Polyphonic is offering a cash advance and net revenues would be split. Polyphonic

would receive a 10 year life cycle for artists. The success of an artist using the long tail effect

would mean that fans and tastemakers would need to be successful especially with social media.

Price: Digitized music and the Internet would combine to create new, low-cost ways to promote

music. Since music labels typically took a larger portion of profits, artists could now get a larger

profit per song even when setting a lower price for single songs as evidenced by Radiohead.

Promotion: Listening habits were changing. Fans are consuming music in the form of single-

songs and are downloading music for free. City-to-city marketing would matter less, the network

of like-minded individuals, globally, begins to matter more. For example, targeting the top 500

bloggers by giving them free music to write about will have a large effect on exposure.

Place: Polyphonic should focus on using social media (Facebook, MySpace) to keep fans up to

date with information on tours and releases. Also, artist websites will have sample clips of music.

Recommendation

Each alternative was evaluated by analyzing its advantages and disadvantages and using a

decision matrix, as seen in Exhibits D and E. Polyphonic will be launched with the requirement

that artists use the founders’ resources. The founders will be able to exploit a new model but will

not be exposed to the same degree of financial risk as in the original model. This alternative

allows the revenues to be reinvested in funding additional artists and existing artists have the

opportunity to obtain more funding in the future. If artists have a strong desire to use third party

resources, requests may be submitted and will be evaluated on a case-by-case basis. A

sensitivity analysis based on the percentage of budget directed to Nettwerk and ATC showed

that given annual revenue of 90K, artists using in-house resources only 25% (Pessimistic) of the

time generated an average annual return of 90%, while artists using 50% (Likely) generated a

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94% return, and artists using 75% (optimistic) earned a 97% return. See Exhibits G and I for

calculations.

Implementation Plan

A four-phase implementation plan will be executed from August 2009 and December 2021, and

will include periodic evaluations. Responsibilities and timelines are outlined in Exhibit F.

Preliminary set-up and negotiations: Polyphonic will set up negotiations with the companies of

the three founders. These negotiations will create a partnership between Polyphonic and the

founders, such that artists will be required to use their services unless proof is provided that

external partners are superior in quality or value. The partners will return 10% of the revenue

made from the artists in order to increase ROI to 94% under a realistic scenario (see Exhibit G).

Primary artist recruitment and selection: Artist selection will occur in three rounds of 20 artists

over three years. 50% of recruited artists will be those dropped from their record label, while the

other 50% will be new artists to have a balanced mix. Applicants will be sought by talent scouts

and online social media and webcasters. All artists are required to interview, propose a plan for

the $300,000 over 10 years and have an awareness bump strategy. The top 20 ranked artists that

can demonstrate that they can re-pay the $300,000 will be awarded the advance. If there is not

enough artist interest by the end of year one, contingency plan 1 will be implemented.

Rolling artist selection: After the first three years, a rolling selection of five artists per year will

occur to ensure polyphonic will have continued revenue beyond the 10 year mark of the original

20 artists, and reduce the risks associated with the long-tail to produce successful artists.

Evaluation: Yearly results will be used to measure the effectiveness of the program. At the end

of year one, the effectiveness of the program will be evaluated to determine whether enough

revenue is being generated to continue or be replaced by contingency plan 2. Success is indicated

by attainment of $1,000,000 in the first year; and $1,200,000 in the second year.

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Awareness bumps and contract extensions: A monetary reserve will be implemented for artists

who have success rates of over $200,000 in annual revenue for two or more consecutive years.

These reserves will hold $1,000,000 per artist for awareness bumps. If the artist requires an

additional advance for awareness bumps, a contract extension of five years is required. Exhibit C

outlines the maximum advance and expected return.

Contingency Plan

Contingency Plan 1: If polyphonic is unable to sign 20 suitable artists, a contingency plan will

be implemented evaluating the recruitment strategy to include a broader range of artists (between

60,000 and 120,000 unit sales) that were dropped from a major label and increasing flexibility

for artists to seek out services and have a lower revenue split of 30-70 in favor of the artist to

make Polyphonic more attractive to the artists. The impact on Average Annual Return is 61%

(see Exhibit H).

Contingency Plan 2: If the artist pool is unable to collectively earn $1,000,000 in revenue by the

end of 2010, no new artists will be signed in 2011. Instead, artists that attained revenue of over

$90,000 will have the option of being extended additional advances based on their expansion

strategy. Also, a laddered approach will be implemented beginning in 2013 when bands will be

offered advances of $100,000 per year for three years given that artists maintain a certain level of

success each year.

Expected Results and Likelihood of Success

The expected return is 94% based on Exhibit I. In the most pessimistic scenario, where

average annual revenue falls 25% to $67,500 and only 25% of founders’ resources are used, the

expected annual return is still 55%. In the most optimistic scenario, where revenues are 125% of

expected and 75% of budget is allocated to founders resources, the expected annual return is

132%.

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Exhibit A: PEST AnalysisPolitical Economic

Legal cost of pursuing music piracy is not worthwhile

Obligations to pay royalties “Indies” have simpler contracts than

major labels

More revenue generated from shows, merchandise, and licensing rather than album sales and royalties

Recession means less income to spend on non-staple items

Social Technological Consumer preferences and behaviors

are changing (e.g. buying single songs versus buying entire albums)

Geography is less of a barrier meaning the world is now a niche for an artist

Technologically savvy demographic Audience: people with computers,

download access, ability to save music on hard drives, ipods, phones, etc.

New revenue stream from availability of different avenues to access music (e.g. apps, Spotify, Slacker etc.)

Can enter into new revenue sharing contracts with these new avenues

Album sales are less dependent on traditional marketing techniques

Digital transformation of music files (i.e. storage, sharing implications)

Exhibit B: SWOT AnalysisStrengths Weaknesses

Successful founders Artists would be in control of finances Adapts to changes in market demands Collapsed copyright Founders are industry experts Would allow for strong use of social

media (e.g. MySpace, Facebook) Artists can increase revenues

ROI is not high enough for traditional returns for venture capitalists

Polyphonic is limited to a ten year cash flow once an artist is signed

Opportunities Threats Turbulence in the industry Potential for higher than expected sales Could attract higher volume selling

bands/artists

Untested business model Potential of not generating enough sales

Exhibit C: Awareness-Bump Funding

Time in contractExpected return based on 1 year

(^) return* (thousand dollars)Provided Funding based on 1 year

(^) return (thousand dollars)Pre-extension

Post-extension 200 ^ 500 ^ 800 ^ 200 ^ 500 ^ 800 ^

5 10 1000 2500 4000 500 1250 20004 9 900 2250 3600 450 1125 18003 8 800 2000 3200 400 1000 16002 7 700 1750 2800 350 875 1400

1 6 600 1500 2400 300 750 1200*Excluding the impact of awareness bump

Exhibit D: Advantages and Disadvantages of Alternatives

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Do not launch Polyphonic ventureAdvantages Disadvantages

$20M seed capital not foregone No financial risk for founders

Potential to lose out on profitable business model

Move forward with Polyphonic as isAdvantages Disadvantages

Highly flexible for artists Innovative, new business model

Low ROI Risk of unsuccessful artists Low budget Limited cash flows

Artists must use founders’ resourcesAdvantages Disadvantages

Higher ROI Mitigates risk with use of experienced industry

professionals Successful artists can obtain more funding in

the future Rolling artists funding provides increased

profits

Less flexibility for artists No suitable artists Unsuccessful artists

Exhibit E: Decision Matrix

Weight No Polyphonic

Polyphonic as described

Collaboration

ROI 0.5 2 1 3

10-year cash flows 0.3 2 1 2

Limited start-up capital

0.2 1 1 2

Total 1.0 1.8 1.0 2.5

If the alternative has a risk of low ROI, it is rated 1. The Collaboration is rated 3 as it mitigates this risk. If there is potential for cash-flows past the 10-year period, the alternative receives a high rating. If the alternative increases the allocation of capital, it is rated higher.

Exhibit F: Implementation TimelineAction Phase Timeline Responsible PartiesPreliminary set-up and negotiations Aug 2009 – Dec 2009 Three founders and

finance department.Primary artist recruitment & selection Jan 2010 – Dec 2013 Talent scouts, social

network media expertsRolling artist selection Ongoing from Jan 2014 Talent scouts, social

network media expertsEvaluation Ongoing from Jan 2011 Three foundersAwareness bumps and contract extension Ongoing from Jan 2012 Finance department

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Exhibit G Alternative: Partnership – Realistic Scenario (50/50 rev split & 50% usage of founders

resources)

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Assumptions

Assumption: 10% of the revenue brought in to Nettwerk is returned to Polyphonic

% of Nettwerk resources used by artists: 50%

Investment in Artists $300,000

Total Investment in Artist $18,000,000

Average Annual Revenue per Artist $90,000

Average Annual Revenue per Artist for Polyphonic $45,000

Initial capital available to Polyphonic $20,000,000

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Exhibit H Alternative: Partnership – Pessimistic Scenario (70/30 rev split & 25% usage of founders resources)

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Assumptions

Assumption: 10% of the revenue brought in to Nettwerk is returned to Polyphonic

% of Nettwerk resources used by artists: 25%

Number of Artists Signed 60

Total Investment in Artist $18,000,000

Revenue per Artist $90,000

Revenue per Artist for Polyphonic (assuming 30-70 split) $27,000

Initial capital available to Polyphonic $20,000,000

Exhibit I: Sensitivity Analysis on ROI (Based on 50/50 profit sharing)

Based on weightings of 25% for optimistic scenarios, 50% for realistic scenarios, and 25% for pessimistic scenarios, our expected return on investment is 94%.