Select Committee on Trade and Industry Minutes of Evidence


Examination of Witnesses (Questions 360 - 383)

TUESDAY 27 APRIL 1999

MR JOHN DEACON, MR JOHN KENNEDY AND MR MARTIN MILLS

  360. I am still puzzled as to why that should affect the price. The process is the same. In fact, you are actually cutting out the middleman, are you not? If you are delivering direct, you are cutting out the wholesaler and his profit. So why should the fact that you are direct selling and direct delivering actually affect the price, particularly if you are cutting out the middleman?
  (Mr Kennedy) They have physical costs. You actually pay out cash to deliver to John o'Groats. It is more expensive to deliver there.

  361. Then so would the wholesaler. If you were selling via a wholesaler he would be doing the same process except that he would be adding a bit of margin on the top for the service, would he not?
  (Mr Kennedy) Right, but if I were delivering direct to the wholesaler I would have one-drop deliveries.

  362. But we are talking about how it impacts on the consumer at the end of the day. Presumably the wholesaler is making a delivery, as you are doing, and he is going to charge his profit on top of the costs he is paying you before the customer gets it?
  (Mr Kennedy) The bit in the report that referred to extra services included the services in delivering through the supply chain rather than particularly services to the consumer.

  363. I am obviously being a bit thick but I think if you cut out the middleman you usually make some savings, but there we are. Let us move on from that. Just comparing United Kingdom prices with United States prices, you say in evidence that "it is not surprising that, given the average volume sale in the US is much greater than a typical sale in the UK, prices are lower in the US", which seems to be logical and rather concurs with my personal experience looking at CD prices in the United States, but elsewhere you state that "there are lower than average prices across the wide range of recordings available in the UK". Which is correct? Whose prices are lower, ours or the US?
  (Mr Mills) May I answer that, speaking as somebody who travels to America a lot. Obviously there are economies of scale in the American market in records as in everything else, and, as I said, I travel to America a lot and I am used to treating the dollar and the pound as having the same value in the real world. The difference is that in America there is a much lower range of mid-price and budget range goods than there is here. Here the vast majority of the market is mid-price and budget price. In America the product comes down in price much more slowly than it does here, so across the board it is much more similar to here, if you like.

  364. So it is a different market, is what you are saying?
  (Mr Mills) It is structured differently. The average price is much closer than the list price.
  (Mr Kennedy) And that was borne out by the NERA report, which showed the average market prices in the United Kingdom, even including VAT at 17.5 per cent. rather than sales tax at 8 per cent., which showed a lower per CD price than the United States and lower than other European countries.

  365. Is this because they do not buy all the compilation products and the second time round or third time round?
  (Mr Kennedy) It is not so much because of the compilation products. They are sold at full prices because, as Mr Mills said, there is a much better mid-price and low-price market in the United Kingdom and Europe.
  (Mr Mills) It should also be said that retail mark-ups are actually lower in America. The differential between wholesalers and retailers is less in America than it is here.

  366. That is despite the fact that they have a middleman operating somewhere in the wholesale market? That seems very strange.
  (Mr Mills) That is the case.

  367. "For the domestic market, UK independent record companies price on a full average cost basis," but for your export markets you price on a marginal cost basis. Does that mean that we are actually subsidising your exports?
  (Mr Mills) No, it has two different effects. Firstly, generally speaking, when we talk about exports in the record business we are generally not talking about physical goods moving from one country to another. We are generally talking about sub-licensing and separate manufacturing sources. So for multinationals this problem is not so great as it is for independents, because for Universal, if they sell a record in the United Kingdom or if they sell a record in Spain or if they sell a record in Poland they still have a company there which is making the full margin. For independents, we sub-license and, therefore, we only get a smaller slice of the royalty, so the impact on us of an overseas sale coming back into the United Kingdom would be much greater.

  368. It would be manufactured locally?
  (Mr Mills) Yes, generally.

  369. How do you control that coming back into the United Kingdom?
  (Mr Mills) Within Europe we are used to that and that is fine. I have quite a good current example actually, which is Russia. We all know what state Russia is in at the moment. My Russian licensee is telling me that if it is going to be able to sell my CDs at all it has to price them at $6. I can think, is that a discount I can live with. Would I rather develop my Russian market and would I be happy to have those sales rather than not have them? The answer is probably yes, but if there is free movement of goods between us and Russia and those cheap Russian CDs are going to come back here, I am simply not going to make it, therefore I am not going to exploit that market.

  370. Are they on the same cost basis?
  (Mr Mills) Close enough. They are not the same, you are right, but it is not that different.

  371. Just coming back to the domestic market again, if we look around the United Kingdom some retailers are actually selling CDs quite a bit cheaper than others. Why is that? Is it just because they have more volume, they are more efficient? Where is the disparity?
  (Mr Mills) Different retailers are able to negotiate different standard discounts and also different one-off discounts, and all of us as record companies will do individual discounts.

  372. You will do individual deals with the retailers?
  (Mr Mills) Yes.

  373. And it depends on their power in the market as to what they can negotiate?
  (Mr Kennedy) And volume really.
  (Mr Mills) Yes, volume, and it is also what they will give us, if they will front-rack our products, then an increased volume, then—
  (Mr Kennedy) Also a number of retailers find music a very attractive product as—not quite a loss-leader but to bring people in.

Chairman

  374. Still going on with that, but on counterfeit goods, how many counterfeit CDs are domestically produced, do you think?
  (Mr Deacon) Not a lot domestically produced, I think. The majority of counterfeit goods come into this country from abroad and mainly at this moment anyway, I can tell you, because it changes, Bulgaria was the biggest problem. Indeed, Bulgaria was actually manufacturing one in eight of every counterfeit records in the world at one time. They have now been, if you like, chased out and it is the Ukraine that we are getting the biggest problem with, the Ukraine, Russia and China. Chris Smith is over in China at the moment, so we hope he will be able to do something about it.

  375. Could you tell us a bit about the SID, the source identification code you have suggested?
  (Mr Deacon) Yes. I cannot tell you a lot about this because, frankly, I am not a technical expert, but what it is is a source identification code that is actually inserted, as it were, in the production and what it enables investigators to do is to know where that particular CD has been manufactured and who by. What is happening at the moment internationally is that our investigators, together with countries, local authorities, are actually going around and seeing as many factories around the world as they can, and they are getting, one has to say, a fair amount of co-operation in that respect. The difficulty is, of course, another statistic which is pretty frightening, which is that, in fact, one in three CDs and tapes manufactured around the world are counterfeit, so it gives you some idea of the massive problem that the industry is faced with.

  376. Do you think that this SID code is crackable and that if someone can reproduce one aspect of a CD could they also produce a legitimate Universal stamp, as it were?
  (Mr Deacon) Yes, I am afraid to say that it is beginning to happen and with the SID code, we are now trying, I think, internationally to be one step on. You will always have this problem, I have to say, with counterfeiters, which is that if you can keep ahead of the game by up to a year you are doing pretty well but you will always, I regret to say, have that problem. Could I very quickly say on the domestic side in a way we have had some success here. Four years ago we were losing around £34 million a year to piracy, counterfeiting, bootlegging, etc. By working very closely with the customs officers and the trading standards officers we have actually now managed to reduce that to something like £15.7 million, so we have actually had some success. I think my problem here—and we can come on to this—is the problem of allowing parallel imports in. It is not that we are accusing parallel importers of being pirates. The problem is that if you get a substantial volume of records coming into the country via parallel import, the biggest problem you are getting is that customs officers, who are working overtime at the moment to try and find these highly sophisticated counterfeits, which our own forensic expert finds great difficulty finding—if you get that vast volume coming in then you are going to have very considerable problems and particularly where you get mixing, i.e. you get counterfeit goods in with, if you like, legitimately pressed goods and that we see as a very big problem.
  (Mr Kennedy) In addition, many of the main offenders in piracy are sitting on the doorstep of the EEA, so our fear would be their proximity in these circumstances.

  377. Are you suggesting then that if one in three CDs has been pirated, a number of our mainstream retailers are flogging pirated goods, by accident or design?
  (Mr Deacon) No, I am not. We do find occasionally that some retailers may have some counterfeit goods, but by and large one has to say that I do not think that is a massive problem. I think the main concern that we have is that it is not so much the retailer because the retailer actually works closely with us in many respects. Where they see something that is suspect they will let us have it. The concern I have is that those countries which are producing the most—and mainly we are talking of the CIS countries here really, the Ukraine, Russia, etc.—that is where we are going to start seeing them coming, and ironically, of course, the two countries that we were talking about where imports are coming into Australia are two countries in which we are particularly finding difficulty with pirated stuff coming in.

  378. The Consumers in Europe group said to us in evidence that they "do not accept that there is a link between the protection of copyright against fraud and the prevention of grey imports". How do you react to this? They are suggesting that you are scaremongering by putting the two alongside each other.
  (Mr Deacon) I cannot see why we are scaremongering because, after all, piracy is our biggest problem. Music is probably the easiest product which can be copied. Motor cars cannot be copied yet; motor cycles cannot be copied. Records can be copied so very easily. That is why really I think we have a perfect right to be extremely concerned about it. Also, of course, you have to bear in mind that in terms of transport, you can fit a great many records in. It is very simple.
  (Mr Kennedy) If I may add, you asked the question, would any of our retailers be currently selling pirate products. We are fairly confident that they are not because they would source their product from Europe. My own company manufactures only in the United Kingdom, France and Germany. We would be pretty certain that all of the Universal product on sale in Europe has come from one of these three factories. It becomes a much more difficult audit trail once the records start coming from Asia and the experience of Australia and New Zealand is very much mixed consignments where customs officers have found that some are genuine and some are pirate and they have thrown up their hands in horror as to how they can police that.

Mr Laxton

  379. Mr Deacon, you have expressed your concern about the problems with parallel imports and a moment ago in particular about sifting counterfeit CDs out of those. But let us be blunt about it. The whole advent of the Internet is something that you can go down all this process, express all your concerns, etc., but Internet sales of CDs imported in at considerably cheaper prices from the United States, for example, do make a whole mockery of that process. In fact, Mr Mills, there is some indication—I do not know how accurate it is—in the media that, for example, your company are looking at selling into Internet sales, because of the competition presumably from across the Atlantic?
  (Mr Mills) Yes. If I may answer that, first, I think the Internet is the broader picture and I think personally we welcome the Internet. My personal belief—though it is only a personal belief—is that the Internet is going to have the effect of levelling global prices. I suspect that within five years our prices, everyone's prices, will be within 10 per cent. either way of American prices. So I suspect this is a natural process, which personally I welcome. Obviously there is also the issue of digital sales and sales by non-physical means, which again will be a different price structure, and I welcome that. So I suspect that this global levelling of prices is a natural process in any event.
  (Mr Deacon) I tend to agree with that. I think in the longer term with digital diffusion and music being fed, as it were, down the Net, we are going to find probably that many things will even out in the longer term.
  (Mr Kennedy) You mentioned that prices were obviously cheaper in America. I am not sure that is correct in terms of Internet sales.

  380. I am not asking for evidence. I am just speaking with some direct experience.
  (Mr Kennedy) But the price you see quoted is net of sales tax, net of postage and net of import duties.

  381. I am talking prices I have paid, thank you very much, in the States that are considerably cheaper. Next time I am over there I shall take advantage of it.
  (Mr Kennedy) Sorry, when you are over there, are you talking about the Internet—

  382. Over there?
  (Mr Kennedy) In terms of prices over there I think we indicated that if you look at the basket of sales we are actually cheaper, and I completely understand that you would take advantage of the records that you want at the best prices, but in terms of Internet prices there is this misconception that it is much cheaper to order from America. You then have to add on sales tax, you have to add on import duties and you have to add on postage costs, and you always have to take into account at the moment that nobody is making a profit trading on the Internet. By the time it all settles down I believe, as Mr Mills does, that prices will settle down more globally and I would like to think in Europe we were going to try and be the trading source for products around the world rather than opening up areas for everyone else.

  Chairman: Thank you very much, gentlemen, that has been very helpful. I should warn you that the Committee is going out to the States later next month and we may well end up testing your ideas and your claims against our own experience, which will be highly selective but extremely intense, as you can imagine.

Mr Laxton

  383. If I might make a caveat to that, being the male of the species I am not someone who goes around shopping all over the place looking for the cheapest price. I know what I want, I go for it. I shall tell you when I go for it in the States I will buy each CD in Britain. Contrary to what you said, I find that the prices are considerably cheaper, irrespective of which state you are in and the differential in sales tax.
  (Mr Deacon) I do not want to prolong this but I know a lot will depend on probably the exchange rate and if you had an exchange rate coming down, a cheaper exchange rate, I think you would find it could go either way.

  Chairman: I think it depends on the tastes of the purchaser and we are not convinced that Mr Laxton buys all his Tammy Wynnette records in Nashville, but we will leave it at that for this morning. Thank you very much.





 
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