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A Musician's Minimum Sustainable Scale

This guest post comes from Fava, who blogs as The Cynical Musician.

image from www.google.com How big must you be to call yourself successful? I have no idea – it all depends on your definition of success. I propose to answer an easier question here: how big must you be to be sustainable? Unless we define success in really awkward ways, sustainability will always come first.

What does “sustainable” mean? In short: it is a state of your music business, where you are making enough money to cover your costs of running it. At this point, you are able to keep the business going without injecting additional money (of course, you might still want to do so, in order to grow).

When most businesses start up, they are losing money and it’s only to be expected. The first concrete success comes when you reach the break-even point: you might not be making a profit, but you aren’t losing money either. Sustainability is break-even superimposed over time: the ability to continue to at least break-even in the long run.

Why is this important to you? Well, unless your intention is for your music to remain a hobby funded with your day job, you’re going to have to make a break for sustainability sooner or later. This post will show you some ways of doing so, but first:

Defining the minimum sustainable scale

If you’re in business, you’re selling something – getting paid for providing it to your customers. So, how much do you need to sell (and keep selling) in order to remain sustainable?

To begin with, recall that sustainability has a time component: we’re looking at breaking even over a period of time, as opposed to at any particular point in time. Thus, our overhead costs (OC) and quantity of sales (QS) will be for the period we are considering. If we’re considering sustainability over the period of a year, we’ll be using total overheads and sales during the year.

With the above in mind, our business will be sustainable when:

OC <= QS x GPU

where GPU is Gross Profit per Unit – our margin – over the period in question.

Let’s take a closer look at this equation. The overheads are all the fixed costs of running our business, including paying ourselves for our time and effort in running it (thus removing the threat of our having to go off and do something else). By definition, overhead costs are fixed in the short run, so we can assume that this quantity will be constant over the period we are considering.

The gross profit per unit is how much money we make per unit sold, after deducting any unit (variable) costs. We will have some control over this quantity, as I will explain later.

The quantity of sales is what interests us here. How much do we need to sell to be sustainable? Let’s rework the equation:

QS = OC / GPU

The quantity of sales produced by this equation is our Minimum Sustainable Scale. If we sell at least this much, or more, our business isn’t threatened. If we cannot, we will lose money and possibly go into debt.

Sales and fanbase

The word “minimum” is important here. Let’s consider the question of selling for a moment.

In order to sell a given quantity of something, you have two choices: you can sell one unit to one customer or you can sell one customer several units (there is arguably a third option of selling one unit to several customers, but that’s just option one under a different guise). The first option means selling as many units as you have customers. The second requires a smaller customer-base for the same level of sales, but the downside is that it generally only works for perishable goods.

Is there a nice example of how this works in music? Naturally. Let’s take the period of one year as our sustainability baseline. Let’s also assume that you bring out one album per year. Selling recordings is a one-unit-per-customer option – it’s unlikely that a fan who has bought a CD or download from you will buy that same item again. Let’s further assume you play a number of shows during the same period – here you stand to potentially manage several sales per fan, since each show is a one-time item.

Thus we see that the number of album sales will correspond closely to the number of your (paying) fans. On the other hand, ticket sales will equal the size of your fanbase, multiplied by the number of shows your average fan goes to see. Thus, the minimum quantity of sales needed to sustain your music business translates into the minimum number of fans you must have.

Juggling the numbers

If you haven’t got a huge paying fanbase at the moment (and let’s be honest: hardly anyone has, these days), you’ll appreciate the need for minimise your sustainable scale. Once you’re running safely in the black, you can start looking for ways to grow your fanbase and your business, but how does one get there?

Look at the equation for minimum sustainable scale again. QS is our result and we want to keep it as low as possible. How will each of the other quantities affect it?

Obviously, the lower our overheads are, the less money we’ll need to make to cover them. Thus, Overhead Costs are proportional to our minimum required Quantity of Sales. Gross Profit per Unit is how much money we make on each sale, after deducting the cost of what we sold and the cost of selling it from whatever the customer paid us. The more money we make on each sale, the fewer sales we’ll need to make any given amount of money, thus GPU is inversely proportional to the minimum required Quantity of Sales.

From this it should be obvious that, in order to minimse the required sales volume, we should reduce our overheads, increase our margins, or both.

We said that overheads are fixed costs and indeed they are – in the short run. For instance, if you spent $10,000 recording your album (as an example), you’re stuck with this expense and have to recover it. However, if you found it hard to sell enough units to recover your production costs, you might look for ways to make the next album on a smaller budget. Even the biggest companies are now looking for ways to economise on overheads – since revenues keep shrinking – and so should you.

Gross Profit per Unit is the main quantity you’re likely to be tweaking, however, since it is a variable quantity. Except that it isn’t something you tweak directly. It is determined by two quantities and we’ll assume here that you have control over both. They are: Unit Cost and Price:

GPU = P – UC

Unit costs are what the sale cost you. You most likely paid something for whatever it is you sold, plus closing the actual sale costs something as well (perhaps you paid someone to sell it for you, or – at the very least – it cost you the time and effort needed to do so yourself).

Looking at this equation we see that in order to increase our marginal revenue we must either raise the price or lower the unit cost. Here’s where it gets a bit ugly.

While we do exercise some control over unit costs, there is a limit to what we can do with them. If you press CDs, you can get lower unit costs by ordering larger quanities – but that sets you back by a greater amount that must be recovered from sales. If you sell digital downloads, the unit cost is pretty much zero already, so there’s nothing to slash. If you sell concert tickets, the unit cost is also effectively zero, but you are faced with upfront costs requiring a minimum amount of sales in order to make any money. Keeping costs down is an area where you can definitely test your ingenuity.

The price is more readily manipulated – all we have to do is say how much we charge (with a few notable exceptions). The problem is, of course, the Law of Demand: the more we charge, the fewer units we will sell. This sets a limit to how high the margin can be and the limit is determined by the price elasticity of demand for your products.

The price elasticity of demand reflects how demand changes when you change the price. Inelastic demand means that the change in quantity sold will be smaller than the change in price (say, a 10% price hike will result in 5% fewer sales). Elastic demand is the opposite – the change in quantity demanded will be greater than the change in price (thus, a 10% increase in price might decrease demand by 20%, for example). If demand for your product is price inelastic, you can increase the price and still make more money, despite selling fewer units. If it is price elastic, it makes more sense to lower the prices, since the additional sales will offset the reduction of revenue per sale (of course, this is only true up to the point where your marginal revenue is greater than zero – that is: you are earning something per unit, after the deduction of unit costs).

Keeping this in mind, we can see that when we adjust prices in order to reduce our Minimum Sustainable Scale, we have to be mindful of how the total level of demand changes at various price points. As long as your Minimum Sustainable Scale is decreasing faster than total demand, you have room for further price increases. If total demand is changing faster than your Minimum Sustainable Scale, it’s time to think about lowering prices.

(Note: The above holds true even if your total demand is already lower than your Minimum Sustainable Scale. In a scenario where you see that demand for your products is price inelastic, but the quantity demanded is lower than what you need to sell to break even, you should be looking to increase demand by working on other elements of the Marketing Mix: your products, their distribution and promotion. Trying to increase price inelastic demand by lowering prices is counterproductive.)

Other things to keep in mind

The big thing to remember is that scale in sales terms and scale in customer-base terms are not the same thing. If you can make repeat sales to your customers, the size of your customer-base can be smaller than the number of sales you need in a given period.

We’ve already seen one mechanism at work: repeat sales of perishable goods – which in a musical context would by one-off items like live performance. Another option is selling an assortment of products to a single fan: in a best-case scenario, a super-fan might buy the record, go to a show or two and buy some merch as well. Your total income from such a fan will be the sum of gross profits on all sales to the fan during the period in question.

If you have more than one product on offer, chances are good that your fans will purchase various combinations of these products and their spending patterns can only be captured statistically. You can cope with this by optimising the margin for each product separately – that is: tweaking the price to the point where any further changes result in decreased revenue and keeping unit costs as low as possible.

Finally, I have to point out that if you distribute your recordings digitally, through standard channels, there’s little you can do in terms of maximising gross profit per unit. There are few costs you can slash (the only thing that comes to mind is the cost of distribution – some distributors take a percentage of receipts, others charge a flat fee for a period of distribution) and the price is set by the retailer. If you sell a single download on iTunes, for example, the best you can hope for in terms of marginal revenue is 70 cents. This is another reason not to confine yourself to digital distribution exclusively – physical releases are generally more flexible in terms of setting the margin.

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