Burning Issue

The concept seems great: Place CD-burning kiosks that can manufacture out-of-stock albums in retail stores and offer customized compilations, too.

But after numerous false starts, retailers, hardware suppliers and the major labels say a quagmire of issues still threaten to overwhelm the initiative.

Even with the momentum of Starbucks leading the way with Hewlett-Packard kiosks, and despite numerous other hardware suppliers flocking to stake a claim in the market, retailers say that in-store CD manufacturing still has one big problem: an unprofitable business model.

"The kiosk business model is underwater by about 20 points," one merchant says. That means the cost structure, as a percentage of sales, is about 20 percentage points higher than projected gross profit.

Key to the equation are significant hardware costs and stringent content-usage requirements from the majors.

Installing a CD-burning kiosk in a store can run $18,000-$35,000, hardware suppliers and retailers say. The actual cost depends on which hardware supplier is chosen and how many viewing screens or tablets are placed with each machine.

The machines also require software systems to manage in-store CD burning and provide accounting. These systems add thousands of dollars in costs.

Still, at least a dozen hardware suppliers have licensed music for kiosks or are in talks to do so, and more are popping up every day.

While all parties agree costs could decline if CD-burning kiosks are mass produced, other expenses still have to be dealt with to achieve a profitable model.

As it turns out, each major label is licensing music for kiosks with its own set of strings attached.

For example, Universal Music Group wants kiosks to only use special blank CDs sold by General Electric that, depending on who you ask, cost two to five times as much as normal blank CDs.

And EMI Music wants the cover art printed on paper to be installed as the front sleeve of the jewelbox. Another major is said to have limitations on when and how much music can be made available for in-store burning.

"Each content company has its own set of rules, which when explained makes sense. But when you put them all together, it's a mess"—and an expensive one, Mike Dreese says. The CEO of Brighton, Mass.-based Newbury Comics is a member of the CD-burning task force of the National Assn. of Recording Merchandisers.

A Feb. 24 meeting in New Orleans that brought together merchants, hardware suppliers and labels to discuss CD-burning kiosks was an eye-opener for all, as each camp aired its issues.

Following that meeting, NARM's task force created a 52-item punch list that could facilitate the CD-burning initiative. It was delivered to the majors April 1 for review. NARM spokeswoman Susan L'Ecuyer declines to comment on the list, which she describes as "preliminary."

Nevertheless, task force member Ish Cuebas, director of merchandising operations at Trans World Entertainment, says, "I see signs that retail can make this a business, but we need cooperation from the hardware, software and content people."

Without some compromises, "why waste all this time and money to find out if this is a business?" Dreese asks. He suggests, "Give us one year with no barriers to find out if it's a business. Then let's talk about the rules."

So far, the 6,400-unit Starbucks chain is testing HP kiosks in dozens of stores in Austin, Los Angeles, San Francisco and its company base, Seattle.

Also, Mix & Burn, a unit of New Hope, Minn.-based Navarre, is running tests in about a dozen stores, company executive Bob French reports.

Test sites include two Trans World Entertainment stores; two Best Buy stores; one Borders Books & Music store; one Newbury Comics store; one Electric Fetus outlet; one store in the Musicland Group; one in Bound to Be Read, an independent bookstore in Minneapolis; one in a Nordstrom department store; and two at the U.S. naval base in Norfolk, Va., under the auspices of Eurpac.

John Marmaduke, chairman/CEO/president of Amarillo, Texas-based Hastings Entertainment, is all for testing CD-burning kiosks. But, he says, "we want somebody to prove there is a business model that works. We want to be a fast second but don't want to be a pioneer. I am real happy to let someone else plow that furrow."

Meanwhile, Wal-Mart is taking a different route, at least initially. It will allow customers to use their home computers to create their own compilations. Sources suggest that Anderson Merchandisers' Liquid Digital Media will make those compilations.

The Redwood, Calif.-based company was one of the first to enter into the CD-burning kiosk business back in 1999, along with RedDotNet. But that effort failed because the majors were reluctant to license their music.

Some other hardware suppliers—including MICS (based in Cambridge, Mass.); Digital Kiosk Technologies (Indianapolis); Burn a Song (Los Angeles); VMS (London); Mediaport (Salt Lake City); Starbox (Orlando, Fla.); and Touchstand, a unit of Denver-based Synergy Media Group—say they are either on the verge of placing kiosks in test stores, signing licensing deals with the majors or lining up financing.

While the field is crowded, it is clear that not all the hardware companies are ready to field kiosks with a full array of hoped-for capabilities, merchants say.

One kiosk company's system cannot handle variable pricing. Another company's unit so far can only make compilations, but not full albums. Still other companies that can manufacture albums are not ready to handle album cover artwork.

Still to be answered by all hardware suppliers is whether their kiosks will have industrial strength to withstand the wear and tear of the marketplace.

"Some seem ready to go and have their licenses in order, and others are struggling to get either the license and/or technology right, while still others are not even there," Dreese says. "But how much of it will be rubber that can meet a road somewhere is unclear."

As for the majors, it "remains to be seen how much creativity the rights holders will allow us to experiment [with] so that we can see what the consumer wants," Dreese says. "I am afraid that the labels are going to choke the golden goose before they know what kind of egg they have."

Jordan Katz, co-president of Sony BMG Sales Enterprise, agrees. "Some are overthinking it. It's a new market, and the egg has just been fertilized. Let's see what happens when retail puts marketing experience into it and we can learn together and see how it all pans out." If CD-burning kiosks works, there will be time later to revisit things and make changes, he says.

Dreese acknowledges that some standard-setting is important on the front end. "You can argue about what the standards should be, but their existence gives people something to focus on."

But Dreese thinks that the standards should be as simple as possible for the first year or two, with minimal sound and artwork requirements.

While the majors would like burned CDs to be as near to red-book quality as possible, retailers also wonder if the labels will allow the kiosk companies to equalize sound levels on customer-made compilations.

More important, at least to the hardware companies, is how the majors deliver music to them.

"Just getting the content organized has been a major undertaking," VMS executive Randall Harper says. He says standardization would greatly reduce time and costs.

When the different camps gathered at the NARM meeting, each side realized they had focused only on their own perspective of the challenges ahead.

"In the end, each party said to one another, 'Here is a bunch of line items missing from your P&L.' Each party has to make a profit, or [the initiative] could be dead," Dreese says.

The majors "were just taking [the] iTunes model and applying it to the kiosk, but there are additional costs involved," one merchant complains. These include experienced staffers to oversee the in-store manufacturing, plus the cost of the blank CD, as well as paper and ink to print packaging.



NO ONE PRICE FITS ALL

Of course, the expense structure is only one part of the profit equation. Getting pricing right is also proving to be daunting.

Naturally, pricing is tied to what the labels are charging for their content. It appears that EMI Music and Warner Music Group are applying their iTunes pricing model, with some variations, to the kiosk vendors, meaning they are charging them about 71 cents for most tracks, sources say.

Universal Music & Video Distribution also is charging 71 cents per track, but if a vendor or retailer charges more than 99 cents per track or $9.99 an album, then UMVD gets a 71% wholesale cut, sources say.

But while some think 99 cents should be the main price point for individual tracks to customers, others say there should be variable pricing on a per-track basis. For example, a superstar track would be priced at 99 cents, an established act at 79 cents and developing artists at 59 cents.

Some suggest that classics like Led Zeppelin's "Stairway to Heaven" or the newest track from Eminem might cost $1.49, with other tracks by those acts costing 99 cents and tracks from older catalog albums running 49 cents.

"Pricing would vary depending on where the album or the artist is in their life cycle," one distribution executive says. Pricing would also depend on whether a track is going to be burned to a CD or downloaded to a portable device, other executives say.

On the other hand, while sources say that Sony BMG also leans toward variable pricing on a per-track basis, it also appears to be the sole major applying the wholesale model to the album. The company supposedly is charging kiosk vendors with prices tethered to its front-line, midline and budget pricing, although each is said to be a couple of dollars cheaper than that of the corresponding packaged-goods line.

Sony BMG's Katz declines to talk about pricing, except conceptually. He says Sony BMG's approach to the kiosk is consistent with decades of experience of marketing and selling music to the consumer, whom he says is comfortable with variable pricing.

"So in the bin, you have the shrink-wrapped album with the best sound, artwork and liner notes, and that is one value proposition," he explains. "But with a kiosk, where the music is on a burned CD, perhaps with front cover art, consumers would have less artwork and liner notes, so that is a different value proposition."

If the kiosk serves as a filling station for portable devices where all the consumer gets is pure sound, that represents yet another value proposition, he says.

Consequently, the same album could have three different prices: fully loaded (prepackaged), partially loaded (kiosk) or stripped-down (digital download to computer or filling stations), Katz says.

When all the wholesale pricing models are taken into account for the kiosk, the cost for albums can range from $5.50 to $9.10, sources say. That means the top pricing tier for kiosks is about $3 below the $12.02-$12.07 that the majors charge direct accounts for prepackaged, front-line CDs.

VMS' Harper says kiosk pricing for the consumer must have an edge over prepackaged CDs.

But as things stood when NARM issued its punch list, all of the costs involved were threatening to saddle CD-burning kiosks with pricing equivalent to existing CDs.

If that's the case, Harper says, "the consumer will not adopt and buy the product, and the kiosk will fail." ••••