CD BABY: BUYOUT OR BAILOUT?
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One Indie Giant Takes Over Another.
A Community Of 150,000 Hang In The Balance.

By Moses Avalon

Derek Sivers, Founder of CD Baby, claims he sold to Disc Makers because their VP, Tony Van Veen is his friend and would best serve the existing client base.  But upon closer examination, the reality might be a bit less earthy.  Sivers may have had little choice.

Was CD Baby financially healthy at the time of the sale?  No question.  The company’s profits were in the millions.  So why then was the rumor mill swarming for years of Sivers’ desire to sell the company on the cheap?  And why is there no evidence of any other tendered offers to acquire CD Baby, other than Disc Makers?

Could it be because most of CD Baby clients were losing money with the e-tailing portion of the service; or the two separate class-actions (that I know of) that were steeping (but never filed) over their digital distribution contracts?

For those caught up in the financial metrics the debate is just about cash: did Disc Makers overpay for a lemon, or steal CD Baby for a song?  With an undisclosed price, that many in-the-know speculate was in the low seven figures, why would a CD manufacturer want a to buy a CD e-store/digital rights aggregator in an age where physical CD sales are diminishing and digital distribution options are increasing?

But, for those still using CD Baby as the liaison between their music and the public, the issue is as basic as a classic rock lyric, “Should I stay or should I go, now.”

What changes will Disc Makers implement?  Will they be forcing CD Baby artists to use Disc Makers for manufacturing?  Can the new owner possibly walk in the legendary shoes of the beloved creator, Derek Sivers?

If this community of 150,000 clients (not 250,000, as cdbaby.com misstates) wishes to extract any usable data from this event, they will need to put down the bong, put business first and take a hard look at Mr. Sivers’ track record over his ten-year reign.  In other words, it’s not Sivers’ strengths that lie in understanding how the take-over will effect CD Baby clients, but his weaknesses, versus those of Tony Van Veen.

PRE SCRIPT: MY PROBLEM

The web has given everyone a level playing field for opinions and many in this space don’t seem to be able to separate constructive un-spinning analysis from antagonistic ranting.  So, how can I do my job, be critical, but without sounding as if I am making it personal? Answer: I don’t know. No matter how professional I’ve tried to make my analysis in the past, somehow a CD Baby fanatic always seems to twist it into hostile blog-fodder. 

Reality can be a bitter pill to swallow, but all I care about--ALL I CARE ABOUT--is your money and how you can make more of it with your music.  Sometimes that means taking an unpopular stand, like when I (and many lawyers on this list) disagreed with Derek over some language in his digital distribution contract in 2003.  My article, intended only to help people make an informed decision, started an avalanche of lies that put many of you in a bitter, “choose sides” scenario.

Hopefully, this time around, if we disagree, we can keep a level head and maybe--just maybe--we can all learn something from each other. Kumbaya.

 

NOTE: This is a big subject.  To break it up, I’m writing two articles.  The first, this one, will focus on CD Baby’s past and their actual, un-spun track record for the physical CD fulfillment service.

Part II, in the next issue of Moses Supposes, I will focus on CD Baby’s other services: HostBaby; digital distribution and who is behind the deal and how the company will now function differently.

And away we go...

PART I: UN-SPINNING THE CD BABY DREAM BOOT
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Or, “E-tailing? Distribution? Whatever you call it, it’s all good (for me).”

What CD Baby offered in terms of their e-tailing/fulfillment service (which was often inaccurately referred to as “distribution” of physical product) was pretty damn good; they paid consistently and there was a time when they were the best fulfillment solution available on the cheap.

But those days had past years ago.  Since 2004 many things CD Baby offered could be replaced simply with free plug-in e-commerce solutions, or a MySpace account, which offered superior marketing opportunities through social networking.

Founder, Derek Sivers knew this and did his best to come up with ways for clients and prospective clients to be excited about being “on CD Baby”; largely announcements on his blog that touted how much money they were distributing; a number that rose each year, without fail, as did the number of clients.  Then there were the pseudo deals with MP3.com, Soncap and finally, Best Buy-- we’ll get to that one later.

Regardless of the success or failure of these “deals,” the idea of them was smart.  It created client confidence and helped the CD Baby client forget an important fact: CD Baby was pricey.  So pricey that most clients didn’t profit.

It would be an absurd stretch to imply that Sivers didn’t want his clients to make money on CD Baby. I’m sure he did.  However, it’s not a stretch to point out that helping them sell more CDs would have seriously re-shaped his bottom line and thus the selling price of the company.  This may have affected his priorities.

It is mathematically impossible for you to be making more money off of me, than I am making money FROM you.  Think about auto insurance.  How can an insurance company make a profit if you pay them $50/month and they pay when you have an accident that costs $2500 to fix?  Don’t they lose money?  Well, no, because most people don’t have accidents, and for those that do, the deductible offsets the loss.  The CD Baby business model was similar.  Let’s look at some numbers.

--Cost of CD pressing: $1.50 (assuming you order between 500 and 1000 units)
--Shipping to CD Baby: $1 per unit (five unit minimum)
--CD Baby’s fulfillment fee: $4
Total cost to the client per unit: $6.50.

On top of this, CD Baby’s start up fees (the “deductible” in this comparison) per title of $35 plus $20 for a bar code (which was a “sub-code” not an actual UPC code) puts the client into a scenario where presuming a CD sells for an average of $10, they have to sell between 12-18 units per title to just to break even.

Think that was easy to do?  Here are some alarming statistics:

Nielson SoundScan--the leading company that tracks retail CD sales (and whose data is chiefly responsible for how the Billboard charts are composed) in 2004 reported that of the CD Baby titles they tracked, only about 700 titles registered more than 12 units sold on the popular service that year.  CD Baby claimed about 70,000 titles at that time.  Meaning, 69,300 titles lost money.  In other words, only 1-4% of the titles were in the black.

Quadrupling the numbers over the following three years, to track with CD Baby’s expansion, we still get only 2800 titles passing the profit threshold and over 247,200 titles-- not.  (Note:  it is possible that there were titles NOT tracked by SoundScan that sold a great deal and, therefore, would upset these metrics.  But it’s not likely.)

Did Sivers ever misrepresent this fact?  Not really.  He promoted heavily that CD Baby disbursed about $4,000,000 a year in CD sales.  Most simply didn’t do the math.  With about 250,000 titles in their current CD catalog (not “artists,” as misstated on cdbaby.com), that nets out to about $16 per title, while taking in between $35-$55 for the set up fees for each title and charging $4 per unit for fulfillment.

At an average of $45 in set-up fees per title and $4 fulfillment for each sale, CD Baby should have been making about $5.4 Million a year from CD sales and set up fees.  (Before overhead.) If you include digital sales the number rises to between $10-15 million a year. Van Veen confirmed this range.

These margins beat most auto insurance companies.  Meanwhile, the vast majority of their CD sales fulfillment clients were not realizing value, they paid their average employee something around $15 an hour and their average senior executive less than $100K a year.  So, for CD Baby’s owners, this business was VERY lucrative, and in my opinion should have been sold for something just shy of $30,000,000.  (If my information about the sale price is true, Van Veen stole this puppy from his “friend.”)

And what happiness do the top 4% of CD fulfillment clients have to look forward to?  I know, because several of them are my clients.  One emailed me about this article and wrote, “I’m concerned [about the take-over].  We sold about 10 CDs a week through them and I considered CD Baby partially responsible for our success.”

I wrote back, “So you paid CD Baby $40 a week for five years-- $10,400 basically to make trips to the post office ([$4 per CD] X 10 X 52 X 5).  CD Baby did little to drive traffic to your site or help sell those CDs and for about half the price you could’ve paid someone to run to the post office, saving you about $5,000 for promotion or your next production.”

And that’s not even including my client’s costs for sending the CDs to CD Baby’s warehouse. (About $1 each. Tack on another $2,600 in costs.)

When speaking to Van Veen about these statistics he seemed shocked.  He confessed that he had not done an analysis for the 96% stat prior to the purchase but said, sounding skeptical, “I would be surprised if only 4% are breaking even or making money.”

How will Van Veen make more clients profitable?  Because of the lateral integration between the two companies he could now offer CD baby clients a deal on manufacturing.  “We’ll never force [CD Baby] artists to make their CDs with Disc Makers in order to use CD Baby.  Never ever.” But he might offer an incentive that could cut the vig back about $1 or so.  Van Veen told me he is contemplating such an offer.

But this is nickels and dimes.  Van Veen has something sexier on his agenda.  He will do what the old CD Baby apparently never did much of for their clients-- market.

PARADISE LOST

Some of the large failure rate could have been remedied years ago if only CD Baby had invested just a little of their considerable profits on mainstream advertising.

Now, I can hear you screaming through the web, “But CD Baby advertised everywhere.”

Did they?

In the old regime, CD Baby advertised in music trades.  Result: the general public was not that familiar with CD Baby’s e-store.  From CD Baby’s own site: “That's why as a [CD Baby] customer, I usually end up discovering new music and buying it from Amazon or iTunes and not CD Baby”  Ask an average Joe, if you need more proof.

Why didn’t Sivers, whose marketing prowess seems formidable, confront this?  The logical deduction is because he was not trying to compete with, well, his competition: Amazon, Barnes & Noble, etc.  Marketing music to the general public is very expensive, requiring ads in main-stream papers and pricey banners on key sites.  Rather, Sivers’ choices for advertising  were targeted at the music community, selling essentially a “sense of belonging” to emerging artists.  It worked.  He’s good.

Many CD Baby clients were outspoken about the fact that they didn’t care if they sold product.  They simply liked being part of the “anti-label community.”  It was way cool to say “I’m on CD Baby.”  Shoot, you could have made a mint just selling a t-shirt with that tag line in 2003.  Sivers had tapped into a zeitgeist.  A cultural commodity much needed in the indie space:  the desire to feel like you’re not alone with your music in the swallowing sea. 

But according to sources, in Portland, behind the scenes at CD Baby Central, the staff had serious concerns.

Around late 2005 Derek was starting to resemble less than the charismatic front man and more of an absentee landlord.  His role in the day-to-day operations of the company diminished and many ideas for improvement advanced from staff passed over.  One of which was partnering with a big retail outlet.  Then, in 2006, Sivers announced a deal with Best Buy to carry CD Baby product.  This created a bit of buzz.

But pushing CDs in 2006 to a company that uses CDs as loss leader seemed to be investing in a decaying system.  In addition, my sources close to the Disc Makers acquisition told me that no evidence of a deal with Best Buy was revealed during the due diligence process.  Much like the rumors of several important entities (like Amazon.com) bidding to buy CD Baby, the deal to have Best Buy distribute CD Baby product was largely a specter of wishful thinking.

Van Veen: “There are certain ways that Derek ran the business that were non conventional.  You need to offer guidelines and be there to support your staff and help do the day-to-day strategy. We will be more hands on and on-site… [and] we will spend more on marketing than the previous ownership.”

LAND OF TONY

If Van Veen is going to keep his word, he’ll need to address the look & feel elements of cdbaby.com and bring them into the web 2.0 spectrum.

Van Veen: “[Right now] when you visit cdbaby.com there is no enticement to stay and browse. We need to do a better job of making the store an attractive place to come and discover new and exciting music, with best seller lists, featured artist spotlights, promo tracks, and more.”

(Sounds like iTunes junior.  Could be fun.)

Van Veen: “We will also be focusing on partnerships that make CD Baby artists available on sites beyond just cdbaby.com.  One of the first things we’re going to be doing is pursuing a partnership with Amazon, giving our clients far greater traffic potential.”

Another idea advanced from CD Baby staff that Van Veen will be implementing, “--a ‘buy my CD’ or ‘download this album’ widget that can be dropped into MySpace and Facebook pages and makes CD and download sales easier.”

In addition, there is a new initiative by Disc Makers: Elite Artist Services.  This division’s mission is to supply an alternative for Heritage artists whose long-term contracts on major labels is up for renewal.  Instead of re-signing another plantation grinder, they will now be able to sell CDs and downloads directly to their established fan-base.

If Van Veen links the CD Baby artists to this platform, they will be getting residual exposure to people shopping for acts like Crosby, Stills & Nash, making a move on the Indie tip.

APPLES TO APPLES, DUST TO DUST

Is it fair to make comparisons between Derek and Tony?  Probably not.  Tony Van Veen went to the prestigious Wharton School of Business.  Before starting CD Baby, Sivers, from what can be gathered, worked in a circus.  For this expert’s money, that means Derek is far more qualified. 

That’s why it seems obvious that CD Baby’s greatest asset might have been Sivers himself-- an asset that was not part of Disc Maker’s acquisition.

What kind of leader will Van Veen be to this new minion 150,000 strong?  Will he be emulating the Sivers MO; showing up at every music business shindig, pimping the Baby, being your friend and buying you dinner?  Probably not.  He’s more of a behind-the-scenes deal maker.

And so, CD Baby’s CD fulfillment clients, will, for once, have to cast their loyalty using factors that are not emotional.  Now, they will have to base their allegiance on results.

The Kool Aid has left the building.

--Moses Avalon

PART II: (in the next week – or there abouts)

--What up with HostBaby: will it still suck?

--Digital distribution:  Will the contracts and service improve?  How will Van Veen fend off the lawsuits?

-- What companies are behind the take-over and who stands to profit in the long run?

--PLUS – Your questions to Van Veen answered.

--Other secrets revealed.

END