HMV’s Business Model

Title: What Is the Real ‘Business Model’ Here, (And More Importantly, How Do We Fix It)? HMV (UK): 2750 words. This paper examines the business model – and its associated problems – of HMV, the 87 year old music retailer which, in the estimation of many, has ‘…failed to adapt to a digital revolution in the music industry.’ (1) HMV’s basic business model is that of a classic non-discounting high street retailer, with all the supply chain, distribution and marketing dimensions which are contingent upon that status. Like all similar businesses, it sells intellectual property (music, books, games, software) on the assumption that it is a unique portal, through which customers must obtain the product in the form offered. Its business issues are almost all intrinsically related to this identity, and the possible solutions prescribed and limited by the same factors. It says much about HMV’s current prospects that a 3p fall in share values to 128p is seen as relatively encouraging: (2) whilst it is true that retail groups are hardly leading the stock markets at present, there are deeper and more long term problems to consider in the case of a UK music retailer such as HMV. Very little of its current difficulties are of its own design – unless a lack of responsiveness is taken into account. Sales of its staple product, music, are in general decline, as Braithwaite reports: ‘Enders Analysis, the media research company, predicts that global music sales by 2009 will be half their level at the peak of the CD boom, down from $45bn in 1997 to $23bn in 2009.’ (3) In HMV’s own assessment, the sales of physical music media may decline in value by as much as 26 per cent by 2010. (4). The contemporary financial and credit crisis is another, quite justifiable claim which HMV could make to aggrieved status. A critique of its underlaying business model reveals, however, that this is not the total picture. HMV is linked structurally to relations of production which, though not quite defunct, have certainly acquired a new form and balance over the last 10 years. Although the relationships which underpinned the latter were not of HMV’s making, it was in effect a net beneficiary of them. What is remarkable is that, to an extent greater than any other market participant, it has adhered to and even sought to re-invent the same paradigms in it current business model. As Mintzberg points out, ‘…there are dangers in looking to the future by extrapolating the needs of the present, in relying excessively on hard data, and in over-formalizing the strategy making process.’ (5) The resolution of HMV’s problems may ultimately lay in the operation of the market itself. As its own CEO has averred, a declining business and market may still yield worthwhile profits, as indeed HMV sometimes still does. (6). Moreover, there is plenty of independent analyst support as collateral for this position. As Philip Dorgan of Panmure Gordon points out, ‘Instead of waiting for its business model to implode, management has launched several initiatives which could yet see the shorts proved wrong.’ (7) Nick Bubb, analyst at Pali International, has been no less generous, reportedly stating that ‘The business has seen an amazing turnround from a year ago when HMV seemed doomed and management must get some credit for the operational initiatives which have moved things forward.’ (8). This is encouragement indeed for a business which has been on the receiving end of market pressure for at least as long as its current CEO, Simon Fox, has been in charge. In July 2008 the Financial Times dubbed it ‘the most shorted stock in the retailing sector’ when it fell 17p to 112.5p, adding that ‘…analysts continued to voice concerns about the group’s ability to prosper in the digital age.’ (9) Ultimately however the outcome is still perhaps in little doubt, except with regard to its timescale. The question is whether or not HMV can turn the architects of its demise – digital music downloads and e.commerce – to its own advantage, or whether it will retain its existing mindset. Perhaps one indication of this lays in Hooley et al.’s assessment of what the internet implies in customer relationships. ‘A significant feature of the Internet is the shift in power away from manufacturers and retailers towards customers. While the period to the middle of the twentieth century saw power concentrated in the hands of manufacturers and suppliers…the customer now typically initiates an information search, whereas in the past the manufacturer or the retailer initiated and controlled this.’(10) The key words here are power and control, as will be discussed more fully below. At the time of writing, HMV is enjoying an uncharacteristically successful period through the popularity of computer games such as Grand Theft Auto IV, Wii Fit, Mario Kart and Brain Training, and anticipates a Christmas bonus through sales of the Sony PSP console, Fifa 09 and Gears of War. (11). As Braithwaite and Stafford point out, ‘The games business, which now represents about 18 per cent of sales, saw demand for both consoles and games soar over the holiday period. HMV has sought to deal with the dwindling market for CDs by refocusing on video games, DVDs and technology products such as MP3 music players.’ (12). Its diversification into books via acquisition of Waterstones has not been quite so productive: like-for-like sales are down 1.7 per cent despite availability of the latest Harry Potter opus (13). Indeed, much depends upon the festive season for HMV: the planned supply chain improvements are being deferred to avoid any teething problems over the holidays, whilst expenditure on its projected 10 new stores has been decreased from £100 to £50. (14). The general environment is not encouraging, however. In the run-up to the peak sales period, one of HMV’s suppliers, Pinnacle Entertainment, went into administration, raising doubts over the supply of albums for eager Christmas shoppers. (15). Despite this, and the fact that ex-Woolworth’s stock will now be sold off in competition with its own offerings, HMV is hoping to repeat or exceed last year’s life-giving infusion of revenue again in 2008. The essential point here is that any resurgence achieved through computer games and the like, merely serves to emphasize HMV’s conventional business model as a retailer of particular products with a strong niche market. If Grand Theft Auto IV were suddenly available in downloadable form, HMV would have to seek another revenue stream quickly: in fact, it seems fair to say that, until it moves away from its current business model, its profitability only begins where the advance of digital technology stops. Somewhere in this elastic equation lays the future of businesses like HMV. As mentioned above, the business issues are not essentially of HMV’s making: we need to look elsewhere to understand how they have impacted upon it. The C.E.O. of Sony BMG, Rolf Schimdt-Holtz, recalled how he needed to deliver some blunt messages to senior executives when restructuring the company, arguably a classic music industry monolithic structure. “We had a situation where the executives thought they were artists.”, he pointed out. (16) Whilst this commentary may contain a good deal of invective, its terms are highly illustrative of the situation which featured throughout that industry. HMV was – and is – at the consumer facing end of a business which relied on an oligopolistic control of output, effectively focusing the available capital on a limited range of products to ensure liquidity, margins and profitability. Although the dissolution of these barriers was not deliberately intended to undermine retailers like HMV, that is the net effect. Within certain variables, the empirical circumstances of this transformation were something like this. In the pre and semi digital age (i.e., the introduction of CDs), major record labels and their ancilliary sectors such as music retailers controlled both the means of production and distribution of the product. Through their A&R departments, record company boardrooms controlled entry to the industry through control of investment capital, which they recouped through release of the product in terms distinctly advantageous to themselves. This ratio of returns was usually something like 97 per cent to 3 per cent in favour of the company. The artist meanwhile received substantially better terms – and the bulk of their earnings – through the associated publishing arrangements. As well as sharing the vast majority of the income, the labels and retailers also accrued distinct advantages through control of the inventory: they could keep their costs down by limiting both the choice of the consumer over the products selected, and the way in which they could purchase their choice. This mechanism worked in two ways: instead of being distributed across an unlimited choice of products – i.e., as many as wished to enter the marketplace, given that they had a viable product to offer – consumers could buy only those products admitted to the market by the companies. This made retailing more viable and profitable, as well as making inventory-keeping and forecasting relatively simple. Although there were always alternatives to the ‘monopolized’ media, these were never as convenient, or of as good a quality, as those in the high street. As well as controlling the product, the manufacturer and retailer derived advantages from the way it was sold, over and above the media itself. In the parlance of supply chain analysts, this amounted to a lack of a ‘bulk break’ facility, which meant that consumers had to buy the batches of products as they were marketed. In practical terms this meant paying a premium price for singles and stipulated rate for the undivided album product –another economy of scale for the vendor, another diseconomy of sale for the customer . To this had to be added the time the latter spent putting in the footfall business which their purchase required. Successive media changes had survived and even augmented these practices: for example, the advent of the CD brought the additional premium of customers renewing their vinyl purchases in the new medium to obtain better quality reproduction. As consumers were also acutely aware, the encryption of intellectual property in physical media meant there was a timescale attached to availability of specific products: they could not rely on their choice being available for very long, unless it fell into a very small category of products. The combination of digital technology and e.commerce has profoundly changed all of this: this is not to say that footfall business has disappeared, or that major record companies are not still dominant. However, it does mean that the future and form of both are in doubt, and with it, the future of businesses like HMV. Even the attempted re-interpretation of market dominance attempted by Apple’s i.Tunes has been relatively short lived, and curtailed by regulatory intervention. Apple said it had sold music at a higher price in the UK, because some major music labels charge more for distribution rights in the country. Music copyrights are negotiated on a country-by-country basis. It will now have to seek to renegotiate these deals, thanks to EC intervention. ‘Apple will reconsider its continuing relationship in the UK with any record label that does not lower its wholesale prices in the UK to the pan-European level within six months’, the company said. (17). Meanwhile, retailers like HMV may argue – quite correctly – that CD’s offer an overall better sound quality. The issue here is that no MP3 device manufacturer or download site has ever claimed aural superiority. More to the point, there is little evidence that consumers choose MP3’s on the basis of comparative sound quality So, the question which HMV needs to consider is whether are MP3’s merely sold on utility, or price? From the consumer’s perspective, one of the keys to MP3 utility is its physical media-free nature and flexibility. Individual tracks by different artists can be ‘bulk-broken’ – bought individually and more cheaply than if the entire album is purchased in CD form. DRM-governed tracks bought through i.Tunes downloads currently cost the U.K. ‘downloader’ under a pound, whilst virtual albums retail on average for two-thirds of the CD cost. So far, HMV’s response has been the introduction of ‘lifestyle’ retail centres where customers can buy drinks, and then download music in a manner stipulated by the company. As Braithwaite observes, ‘Perhaps symptomatic of HMV’s uncertain approach was the proposed download terminals. Instead of downloading music in the comfort of their own homes, consumers would be able to trek to an HMV store, download songs and burn them on to a CD – that once space-age circle of polycarbonate plastic that looks ancient in the age of the iPod.’ (18). One analyst has already dubbed this ‘rearranging the deck chairs on the Titanic’ (19). In conclusion then, it may be argued that HMV’s current business model cannot be fixed, and the only redeeming feature of its current behaviour is that – albeit in a perverse manner – it seems to acknowledge this. The periodic reification of a now markedly vernacular practice merely demonstrates that there is enough life left in the declining giant to serve consumers, shareholders and employees with a diminishing set of benefits, whilst the real alternatives become clearer. Large footfall retailing outlets cannot regain control of intellectual property sales: these will be conducted virtually, and on an increasing scale. The internet has a tendency to encourage customers to analyse prices between manufacturers and suppliers before purchasing, although this seemed to leave the i.Tunes phenomenon unhindered. HMV is –at long last, some might say – launching an MP3 digital download and stream offer on its website. (20). The opportunity for HMV is that there are still large parts of the market for which e.commerce is an unknown quantity. As Hooley et al. observe, e.commerce uptake may be differentiated into consumer categories, according to the attitude of the customer. There are ‘…Explorers – highly optimistic and innovative; Pioneers – the innovative but cautious: Skeptics – who need to have the benefits of technology proved to them: Paranoids – those who are insecure about the technology; and Laggards – those who will resist the technology…’. (21). There are enormous potential rewards for the retailer who can break down this barrier and secure the as yet untapped market share of ‘Skeptics’. It seems fair to argue that in all probability, HMV’s single greatest asset is its brand strength. That brand now needs to be attached to a new strategic model. As Mintzberg indicates , ‘Every strategic change involves some new experience, a step into the unknown, the taking of risk. Therefore no organization can ever be sure in advance whether an established competence will prove to be a strength or a weakness.’ (22) What is certain however, is that change is a necessity rather than an option for HMV at present. Footnotes 1.)Braithwaite, T., ‘HMV Chief has to face the music and dance’, Financial Times, 13th Sept 2007, INTERNET, available at https://www.ft.com/cms/s/0/a88d3096-6164-11dc-bf25-0000779fd2ac.html [viewed 5.12.08] 2.) Killgren, L., ‘HMV lifted by in-home boom’, Financial Times, 5th Sept 2008, INTERNET, available at https://www.ft.com/cms/s/0/1e67c51c-7b16-11dd-b1e2-000077b07658.html [viewed 5.12.08] 3.)Braithwaite (2007/, loc cit 4.)ibid 5.) Mintzberg, H., Ahlstrand, B., and Lampel, J., (1998), Strategy Safari: The Complete Guide Through the Wilds of Strategic Management, Prentice Hall, London, p.112 . 6.)Braithwaite (2007), loc cit. 7.)Killgren, loc cit. 8.) Braithwaite, T., and Stafford, P., ‘Games drive record HMV growth’, Financial Times, 17th January 2008, INTERNET, available at https://www.ft.com/cms/s/0/51199dae-c4ce-11dc-811a-0000779fd2ac.html [viewed 5.12.08] 9.) Braithwaite, T., and Minto, R., ‘HMV targeted despite solid results’, Financial Times, INTERNET, available at https://www.ft.com/cms/s/0/1400fea0-473f-11dd-93ca-000077b07658.html [viewed 5.12.08] 10.)Hooley, G., Saunders, J., and Piercy, N., (2004), Marketing Strategy and Competitive Position, 3rd Edition, Financial Times/Prentice Hall., p.515. 11.)Killgren, loc cit. 12.)Braithwaite and Stafford, loc cit. 13.)Killgren, loc.cit. 14.)Braithwaite and Minto, loc cit. 15.) Davoudi, S., and Braithwaite, T., ‘Collapse of Pinnacle puts independent music labels at risk’, Financial Times, 5th December 2008, INTERNET, available at https://www.ft.com/cms/s/0/b2065150-c26d-11dd-a350-000077b07658.html [viewed 5.12.08] 16.) Edgeliffe-Johnson, A., ‘Radiohead release a tactic to lift CD sales’, Financial Times, 11.10.07, INTERNET, available at https://www.ft.com/cms/s/0/0a9c779a-7797-11dc-9de8-0000779fd2ac.html [viewed 5.12.08] 17.) Laitner, S., ‘Apple bows to EU pressure and reduces iTunes prices in the UK’, Financial Times, 10th January 2008, INTERNET, available at https://www.ft.com/cms/s/0/9ade53c8-bf1d-11dc-8c61-0000779fd2ac.html [viewed 5.12.08] 18.)Braithwaite, 2007, loc cit 19.) ibid. 20.)Killgren, loc.cit. 21.)Hooley et al. op.cit., p.493 22.)Mintzberg et al., op.cit, p.34 Bibliography Braithwaite, T., ‘HMV Chief has to face the music and dance’, Financial Times, 13th Sept 2007, INTERNET, available at https://www.ft.com/cms/s/0/a88d3096-6164-11dc-bf25-0000779fd2ac.html [viewed 5.12.08] Braithwaite, T., ‘HMV to target downloads market’, Financial Times, 13th march 2007, INTERNET, available at https://www.ft.com/cms/s/2/1f047196-d13f-11db-b921-000b5df10621.html [viewed 5.12.08] Braithwaite, T., and Minto, R., ‘HMV targeted despite solid results’, Financial Times, INTERNET, available at https://www.ft.com/cms/s/0/1400fea0-473f-11dd-93ca-000077b07658.html [viewed 5.12.08] Braithwaite, T., and Salford, P., ‘Games drive record HMV growth’, Financial Times, 17th January 2008, INTERNET, available at https://www.ft.com/cms/s/0/51199dae-c4ce-11dc-811a-0000779fd2ac.html [viewed 5.12.08] Davoudi, S., and Braithwaite, T., ‘Collapse of Pinnacle puts independent music labels at risk’, Financial Times, 5th December 2008, INTERNET, available at https://www.ft.com/cms/s/0/b2065150-c26d-11dd-a350-000077b07658.html [viewed 5.12.08] Edgecliffe-Johnson, A., ‘Radiohead MP3 release a tactic to lift CD sales.’ Financial Times, 11.10.07, INTERNET, available at https://www.ft.com/cms/s/0/0a9c779a-7797-11dc-9de8-0000779fd2ac.html [viewed 5.12.08] Epstein, M.J., (2004), Implementing E.Commerce Strategies: A Guide to Corporate Success after the Dot.Com Bust, Praeger, Westport Ct. 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