Retailer's Used CDs are Oldies but Goodies
By Matthew Benjamin of IBD
Now that music lovers have finished swapping their Beatles and Led Zeppelin records for compact discs, the way consumers are buying music is rapidly changing.
Many aren't willing to fork over $15 for a new CD anymore and are finding other ways to enhance their collections.
CD Warehouse Inc., is playing into that trend. The company owns and franchises 160 stores that buy and sell used CDs. It opened 50 outlets in 1997.
By purchasing used discs for $1 to $4 and reselling them for $6 to $9 the stores see profit margins of 60% plus. A third of revenue comes from new-CD sales, which generate traffic margins of under 20%.
That mix of business has helped CD Warehouse thrive at a time when most record stores are floundering.
Ten record chains have filed for Chapter 11 bankruptcy protection since '94. Musicland Stores Corp., the nation's largest music retailer and owner of Sam Goody, closed 106 stores last year.
Why?
"Too many stores and too little management" explained PaineWebber analyst Craid Bibb. "People had replaced their vinyl with CDs and music retailers weren't really watching the vinyl replacement cycle closely enough. So right after demand peaked, they were still opening stores.
Also, a controversial strategy by Best Buy Co. and Circuit City Stores Inc., drove CD prices - and margins - through the floor. The electronics chains began using ultralow CD prices in the early 90's to lure customers, hoping they would then buy big-ticket items like computers and VCRs.
That pricing pressure, coupled with a lack of big music hits in recent years devastated the retail music industry - and created a secondary market in used discs.
"Anybody whose total core business is based in the new-CD market is hurting. There's just not any margin there," said CD Warehouse Chairman and CEO Jerry Grizzle.
CD Warehouse went public in January '97. It used the $5 million it raised through the IPO to buy the assets of Compact Disks International Ltd., which had about 100 franchised stores.
Since then, it's opened 60 more stores and plans to have 200 by year end.
But the company is careful to keep its focus, targeting strip malls with well known anchors, such as Target or Wal-mart stores, and avoiding high rent spaces like shopping malls and downtown areas.
"I don't think mall locations are conducive to our type of business," Grizzle said. "I can't imagine a customer carrying a sack of CDs through the mall to find me and trade with me. So we've got to have that direct access right out of their care and into our store."
To attract franchise partners, CD Warehouse provides proprietary software that makes it easy to run a store. After a used CD's bar code is scanned, the system provides the recommended purchase and resale prices, as well as marketing and inventory information. The database contains over 70,000 CD titles.
Grizzle considers the program to be the company's most valuable asset.
"I spent 25 years in the food business. I wouldn't have known that Pink Floyd's "Dark Side of the Moon" had been on the Billboard Top 100 chart for 25 years," he said. "With our software, I wouldn't have to. All I have to do is scan the bar-code, and it would tell me that I need to pay the maximum price to buy that piece of music."
The software also can spare entrepreneurs costly mistakes. "It tells you what not to buy, so you're not wasting your capital, and you're not junking up your inventory with stuff that won't move." Grizzle said.
It costs a franchisee about $100,000 to open a store, $15,000 of which goes to CD Warehouse. The company then receives 5% of the store's revenue.
CD Warehouse's earnings rose 119% last year to 23 cents a share. Revenue jumped 82% to $9.1 million. System while revenue, including franchisees' sales climbed 34% to $35.5 million.
Possible pitfalls include a change in music technology. But Grizzle thinks there will be a secondary market for any new medium. "It's technology that got me here," he said. "When somebody finally comes out with something better than a compact disc, we'll just make a (secondary) market in it."
More ominous is the threat posed by online retailer such as Cdnow Inc., and Music Boulevard, a unit of N2K Inc. Though the Internet accounted ro less than 1% of total music sales last year, Forrester Research expects the online segment to exceed 28% by 2002.
"Online is taking market share very rapidly," analyst Bib said. "The prices are great, and they have basically every album in print."
CD Warehouse is updating its system for online sales. The company will list the inventories of all its stores on the Web and compete by offering used CD's at lower prices.
"We have a real particular niche that we're going to fill, and we're going to stay right in there," said Grizzle.
CD Warehouse earned nine cents a share in the fourth quarter, up 350% from two cents a year ago. Revenue rose 47% to 2.8 million. The company trades as CDWI near 9 «.
(Excerpted From IBD, New America Section, 5/1/98) |
