Business Descriptions

In 1993, Brown launched Small World Music in Nashville, Tennessee with husband Gary West and then
went on to create Compass Records in 1995. Compass Records is a small, independent artist­run company that 
established their niche in musical genres such as folk, roots, and Celtic. In the context of the 2­billion dollar 
music recording industry, Compass Records has low market share in comparison to the multi­national 
corporations dominating the business. Brown was formally an investment banker with an MBA from University
of California Los Angeles. In addition to her business knowledge and experience, Brown is also a talented 
musician who won a Grammy on her first album as a Banjo artist. By 2005, Compass Records had 50 artists on 
contract and were averaging approximately 20 releases a year, with 40% of their albums selling over 5,000 
units. Their company makes profit on approximately 80% of their titles. In May 2004, Brown and West 
acquired a recording studio, which gives them flexibility in the creative process and contributes to their low 
production costs from not having to rent out a workspace.
Key Issues Affecting the Music Industry
 Stagnated Growth in Music Industry: There has been stagnated growth since 1995 in the music recording 
industry. In 2003, it shrunk to 32 billion, down from its peak level of 40 billion in 1995.
 Small Fish in Big Sea: Large multinational corporations dominate 86% of the music industry, including 
Universal, Sony, Warner, and EMI. 
Licensing Contract vs. Recording Contract
A recording contract is an agreement whereby the label has the right to promote, own, and market 
recordings of the artist’s music, indefinitely. In contrast, a licensing contract is when a record company licensed
an artist’s finished recordings for a limited period of time. With each new client, Compass records had to 
determine whether to “produce and own” Adair Roscommon’s next album or “license” her finished recordings. 
Adair Roscommon is a new and up­and­coming folk musician artist. 

“Produce and Own” License
Pros  High return: due to increased risk  Partial risk: Right to exploit the artist’s finished 
 Lower fixed cost: Record label paid artist no up  goods for only a predetermined period of time
front payment   Lower initial investment cost: do not pay the 
 More control: label owns the rights to determine an  significant upfront investment to launch a new act
artist’s career choices.   Higher IRR
 Lower recording royalties’ cost: the record label 
can underwrite the expense of album production
Cons  Full risk: Own the rights to exploit the artist’s   Low return: due to lower risk 
music indefinitely, but unknown return.  Higher fixed costs: Record label required to pay 
 Higher initial investment cost: to launch a new  artist an up front fee (advance)
artist’s career  Less control: over artist’s decisions
 Lower IRR  Higher recording royalties’ cost: can’t underwrite 
expenses incurred 

Solutions 

Copyright 2005 by the trustees of the University of Virginia Darden School of Education
Compass Records should license Adair Roscommon’s finished music. Table 6 shows that the record label will 
return 60% licensing compared to 29% owning the artist’s material. Also, Table 6 reveals that licensing the 
material results in a higher NPV compared to owning the material. 

Table 1 Table 2
ASSUMPTIONS Pricing
Sales projections Units U.S. wholesale unit price $11.45
U.S. sales 5,000 Less distribution
U.K., Ireland, Europe sales 2,000 fee $9.05
Japan, New Zealand, Australia U.K., Ireland, Europe price (euro) EUR 7.00
sales 1,000 Euro/US$ exchange rate 1.224
Canada sales 500 U.K., Ireland, Europe price (US$) $8.57
Units sold by artist 1,500 Japan, NZ, Australia price (US$) $6.50
Total–projected sales (units) 10,000 Canada price (US$) $7.00
Inventory loss 0.3 Unit price for artist-sold units $6.00
Weighted average cost of Distribution fee 21%
capital 12%
Table 3
Marketing and promotion
Print advertising $3,000
Posters and photos 500
E-card mailings 1,000
Independent radio promoter 2,500
Retail placement 5,000
Total marketing & promo cost $12,000

CD mail-out units 2,000

Cost per mail-out unit per unit $0.50
Postage and collateral per unit $2.00
Total cost for CD mail-out $5,000

Table 4
CASH FLOWS (OWN)
Annual percentage sold 0% 75% 20% 5%
U.S. forecasted units sold 3,750 1,000 250
U.K., Ireland, Europe forecasted units sold 1,500 400 100
Japan, New Zealand, Australia forecasted units sold 750 200 50
Canada forecasted units sold 375 100 25
Units sold by artist 1,125 300 75
Total sales 61,023 16,273 4,068
Per unit
Cost of goods sold $0.90 6750 1800 450
Mechanical royalties $0.85 2,709.38 722.50 180.63
Recording-artist royalties $1.45 9,243.75 2,465 616.25
Recoupables not recovered 0 13,675
Promotion & marketing not recoupable -11000 $0 0 0
Loss on inventory $0.00 0 $2,295.00
Upfront fee (advance) 0 0 0
Copyright 2005 by the trustees of the University of Virginia Darden School of Education
Taxable income -11000 $42,319.50 $11,285.20 $(13,148.70)
Taxes @... 40% 4400 $16,927.80 $4,514.08 $5,259.48
Net operating profit after tax -6600 $25,391.70 $6,771.12 $(7,889.22)
Change in inventory ($8,471) $4,491 $1,235 $450
Change in recoupables (26,000) 9,244 2,465 616
Free cash flow (41,071) $39,126.45 $10,471.37 $9,147.03

NPV Own $8,721.47

IRR 29%

Table 5
WORKING CAPITAL
(OWN)
0 1 2 3
Assets
Inventory, incl. overage @... 30% $8,471 $3,980 $2,745 $2,295
Recoupables 26,000 16,756 14,291 13,675
$15,970
Recoupables
Production costs $20,000
Marketing & promotion (1/2) 6,000
Advance 0
Total $26,000

Table 6
CASH FLOWS (LICENSE)
APS 0% 75% 20% 5%
US forec. Units Sold 3750.00 1,000 250
UK, Ir, Eur, forec. Units 1,500 400 100
Jap, NZ, Aust. Forec. Units 750 200 50
Canada forec. Units Sold 375 100 25
Units sold by artist 1,125 300 75
Total sales 61022.63 16272.70 4068.18
Per Unit
COGS 0.9 6750 1800 450
MR 0.85 $5,418.75 1,445 361.25
RA R $1.75 11,156 2,975 744
REC NR $0.0 0 0
P& M NR -11000 $0.0 0 0
Loss on Inv. 0 0 $2,295.00
Upfront Fee -3000 0 0 0
Taxable Inc. -14000 $37,697.63 $10,052.70 $218.18
Taxes 5600 $15,079.05 $4,021.08 $(87.27)
NOPAT -8400 $22,618.58 $6,031.62 $130.91
Chan. In Inv. ($8,471) $4,491 $1,235 $450
Change in recoup. (9,500) 9,500 0 0
Copyright 2005 by the trustees of the University of Virginia Darden School of Education
 FCF ($26,371) $36,609.58 $7,266.87 $2,875.91

License NPV $14,155.99

IRR 60%

Table 7
WORKING CAPITAL (LICENSE)

0 1 2 3
Assets
$8,471 $3,980 $2,745 $2,295
9,500 0 0 0
$2,295
Recoupables
Production costs $500
Marketing & promotion (1/2) 6,000
Advance 3,000
Total $9,500

Table 8
WACC
NPV OWN NPV LICENSE
Base Case $8,721.47 $14,155.99
8.00% $11,395.66 $16,039.66
9.00% $10,701.30 $15,552.62
10.00% $10,024.57 $15,076.57
11.00% $9,364.83 $14,611.14
12.00% $8,721.47 $14,155.99
13.00% $8,093.90 $13,710.78
14.00% $7,481.56 $13,275.19
15.00% $6,883.93 $12,848.91
16.00% $6,300.50 $12,431.67

Table 9
US Sales
NPV OWN NPV LICENSE
Base Case $8,721.47 $14,155.99
3,000.00 $1,089.26 $8,865.25
3,500.00 $2,997.32 $10,227.55
4,000.00 $4,905.37 $11,556.96
4,500.00 $6,813.42 $12,856.47
5,000.00 $8,721.47 $14,155.99
5,500.00 $10,629.52 $15,455.50
Copyright 2005 by the trustees of the University of Virginia Darden School of Education
6,000.00 $12,537.57 $16,755.02
6,500.00 $14,445.62 $18,054.53
7,000.00 $16,353.67 $19,354.05

Copyright 2005 by the trustees of the University of Virginia Darden School of Education