Sony Music to Reduce Catalog CDs from Stores

Case Type: improve profitability.
Consulting Firm: Ernst & Young first round full time job interview.
Industry Coverage: entertainment; mass media.

Case Interview Question #00826: Our client Sony Music Entertainment Inc. (sometimes also known as Sony Music or SME) is an American music corporation managed and operated by Sony Corporation of America (SCA), a subsidiary of Japanese conglomerate Sony Corporation. Headquartered in New York City, Sony Music is one of the largest music companies in the U.S.

As a large national retailer of music, the client Sony Music has historically been very profitable. However, with the rise of online music streaming, the music CDs retailing segment of their business has seen declining profits over the last couple of years. Your consulting team has been hired in by the CEO of Sony Music to help deal with this problem. How would you go about analyzing this case?

Additional Information: to be provided to candidate after relevant questions

* The client Sony Music’s annual profits used to be $80M, now it’s running minimal profit.
* Suppliers supply directly to us. There are no logistics costs.
* There are 4 other big players in the market: Universal Music Group, Warner Music Group, EMI Group, Bertelsmann Music Group. Competitors are of similar size to us, we do not know if they are making money. 2 are similar large retailers and 2 are specialized music suppliers.
* The market size for music CDs has been shrinking over the last couple of years.
* The client Sony Music holds both new releases and catalog CDs.
* The price of a New CD is 12$ and the price of a catalog CD is 15$. The cost to us of either type of CD is 10$.

Income Statement:
* Revenues from New CDs $704M
* Revenues from Catalogs $444M
* Total COGS $900M
* Store rental overhead $150M
* Labor expense $90M
* Profit: $8M

Note to Interviewer: Allow the candidate to approximate in their calculations, but keep him/her under pressure.

Possible Solution:

Candidate: Having established that the music CDs market is shrinking and we have already seen consolidation to a few big players, it is going to be hard to capture any additional market share through acquisitions or marketing ploys.

I assume that the cost we pay for a CD is similar to other players, and that we hold minimal inventory?

Interviewer: Correct.

Candidate: I would like to look at the profitability of each part of this business. Do we have any data on how the overhead costs are allocated?

Interviewer: What do you think?

Candidate: I expect that the costs will be allocated by square foot space occupied. Can you tell me how much space we have dedicated to New CDs and Catalog CDs?

Interviewer: 90% of our space is catalog CDs and 10% is used for new CDs.

Candidate: Interesting, in which case we can actually allocated those costs better and carry out an ABC analysis on each part of the business. I will assume that the labor costs are similar to each and can be divided by the number of CDs we sell.

Note: ABC analysis (or Selective Inventory Control) is an inventory categorization technique. ABC analysis divides an inventory into three categories- “A items” with very tight control and accurate records, “B items” with less tightly controlled and good records, and “C items” with the simplest controls possible and minimal records.

The ABC analysis provides a mechanism for identifying items that will have a significant impact on overall inventory cost, while also providing a mechanism for identifying different categories of stock that will require different management and controls.

Interviewer: Sounds a good assumption.

Candidate: We have $704M revenues of new releases. At a unit price of $12, this means we sell around $704M/$12 = ~60M new CDs and around $444M/$15 = ~30M catalog CDs. Hence:

So the New CD business is profitable for us, but the Catalog CD business is unprofitable.

Interviewer: OK, what are your recommendations to the client?

Candidate: The reason we are not making large profits in this segment of your business is that the Catalog CD part of the business is loosing money. The New CD business is still profitable and over the coming weeks my team is going to look at the following issues:

• whether we can optimize the space used for catalog CDs,
• whether we would lose any cross selling opportunities if we reduced/removed the catalog CDs,
• what product we can best place in the space previously occupied by catalog CDs.

Interviewer: Very good. Thank you!