Baby Blue Chips: Digital Music Group

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Content Is King

By Mark Larson

If digital music retailing trends continue, Sacramento-based Digital Music Group could be the local wholesale reincarnation of Tower Records.
     The already publicly traded DMG is a digital music supplier to retailers, including iTunes, RealNetworks, Napster, Yahoo Music and others. For every 99-cent DMG song sold by iTunes, DMG gets 70 cents, and iTunes gets 29 cents. DMG then pays the royalties to the artists from its take.
     Tower, the global music retailer that last year finally got run over by the bullet train of digital music downloading, was for decades the biggest name in record/CD/tape retailing.
     But during Tower’s painful dismantling the seeds of DMG were planted by an ex-Tower employee and watered in Tower’s backyard by a few million dollars from angel investors. And months before the last of Tower’s store shelves were sold off at deep discounts, last February DMG became publicly traded, yielding $33 million in cash, and was suddenly an upstart industry presence.

Well-Timed Buys
In recent months DMG added to its catalog of digital media via acquisitions; as of December, the company had 300 tracks of music to supply to digital music distributors such as iTunes and 4,000 hours of digitized old TV shows. Such acquisitions are expected to help enhance its market sway against its two competitors, New York City-based The Orchard and San Francisco-based ioda [cq].
     Such acquisitions also are expected to generate enough revenue to propel DMG into the profit column for the first time. And profit, says company CEO Mitchell Koulouris, “is top of mind for us as managers,” though he won’t predict when that is expected.
     Koulouris, 46, leads the way to his corner office at the spacious DMG headquarters on the second floor of a tree shaded two-story complex just off Garden Highway. The company has offices in Sacramento and San Francisco and employs 35, but doesn’t expect to add more staff for some time. Koulouris has always loved music, and now he’s pumped up to be running a business in the middle of it. A native of Stockton, he got a degree in broadcast journalism at San Jose State and planned for a career on the airwaves. But because he had no passion for “sticking microphones in people’s faces to get the story,” he changed course and went to work for Tower Records to be around music, a major passion in his life.
     He learned computer programming and created an inventory tracking system for Tower, the first one for the global music retailer. While there, he witnessed the fundamental business-model transformation that came with the industry’s first major format change in 1983-84, when Tower’s big bins of vinyl records and stacks of cassette tapes morphed into those dominated by CDs.
     By the early 1990s, Koulouris’ interest in computers and technology led him down another path. Seeing an information gap in the desktop computer world, Koulouris created Informant Communications, which from 1991 to 2004 published a series of magazines for Microsoft showcasing PC development tools.
All the while, Koulouris kept his eye on the retail music business, especially the evolving digital music distribution model pioneered by Napster.
     He reckoned that when digital downloading of music became the public’s preferred way of buying music, a big opportunity would emerge. He was convinced digital downloading was the most efficient way to make money selling from a deep catalog of music. So when Apple Inc.’s iTunes music store rolled out in 2003, offering music downloads to iPods, Koulouris saw it as the beginning of digital music’s breakthrough acceptance by the mainstream masses.
     And he jumped in.
     Koulouris wrote a business plan for DMG in a month during the Christmas holiday of 2003 and pitched his idea to investors. Originally framed as a digital record label, he found that didn’t have anywhere near the revenue potential of a better idea: supplying digital music to retailers from a library of portfolios. He made the change and plowed ahead.

Napster With a Rocket
John Henry Parker is a Sacramento-based executive consultant who has known Koulouris for years. He remembers sitting in his boat on the Sacramento River with Koulouris in spring 2004 and listening to him talk about the digitization of the music business.
     “He’s literally an encyclopedia when it comes to people and titles in the music business,” says Parker.
Parker watched Koulouris sharpen his ideas on the digital music market, ideas he often bounced off and refined with Parker. Koulouris predicted a rush to get music libraries digitized for the new format.
     “We likened it to a land grab,” says Parker. “It was time to take all you possibly can.”
Koulouris initially raised $2 million from Stockton developer Alex Spanos. In early 2005, he got offers from venture capitalists but found they wanted too much ownership of the company. He turned them down and looked for more private investors.
     He managed to raise another $3 million in two months. Not long after, he was approached to do a public offering. He figured that was his best option, and in the offering of February 2006, the company raised $33 million.
     Anders Brown, 36, is DMG’s chief operations officer, who from 1998 to 2004 worked for Microsoft and managed Koulouris’ Informant account with the software giant. Brown has no doubts about Koulouris’ ability to lead DMG to industry-powerhouse status.
     “If you give him a hill,” says Brown, “he’ll climb it and plant that flag every time.”
     Consultant Parker agrees.
     “He’s taken this from a raw idea and brought it together to attract really talented people,” says Parker. “A lot of people believed in his vision, and that’s what attracted a talented team. It’s going to be wildly successful.”
      Now, DMG is off to the races, looking to broaden market share via acquisitions and turn its red ink to black. And even though there are still many hurdles ahead, Koulouris has been amazed at the speed of the trip so far.
     “It’s been a rocket ride,” he says.
Not only are profitability predictions frowned upon from the head of a publicly traded company, if you make them in a newly plowed field, you aren’t likely to be accurate. That’s because there are myriad variables and unknowns in the relatively new digital music-selling industry. Catalog acquisitions can increase market share but only if their contents are enough in demand from music lovers to churn a profit. Digital music catalog purchases can easily turn out to be soft investments. “Rates of sale change,” says Koulouris.
     Koulouris notes the purchase-to-market time of a catalog of music is usually six months.
DMG feeds its music to a list of retailers. But because there is no industry digital-transmission standard, each retailer has different encoding schemes. And that makes for a lot of time-consuming, costly, and unseen formatting work to be done by the company. “People think digital music is easy,” Koulouris says. “It’s actually not.”
     In December, DMG had 180,000 tracks of music on the market, with another 120,000 tracks still in the pipeline. As the industry matures, however, more market buying patterns of downloaded content will emerge, and content acquirers such as DMG will gain more savvy about what music or videos the mass market is likely to dial into.
     “We don’t necessarily have to be the biggest,” says Koulouris of DMG’s niche, “but our goal is to grow the company as large as possible.” In September, DMG spent $5 million to buy a San Francisco competitor, Digital Rights Agency. While DMG has focused on building a deep inventory of popular music, that doesn’t necessarily mean its music is all oldies. “We’ve done a number of deals with current, contemporary, active record labels,” says Koulouris. One such label he cites is Public Image Ltd., which features “industrial” rock music from the ’70s to today. “But there’s still a lot of great old stuff out there,” he says, adding that it’s up for grabs.
     Meanwhile, video downloading ignited in 2005 with market demand for TV shows and films. The video end of the business “is just starting,” says Koulouris. To get a piece of the video segment, DMG assembled a digital video catalog of 4,000 hours of classic TV shows: “My Favorite Martian,” “I Spy,” “Peter Gunn” and vintage kid shows such as “Gumby” and “Clutch Cargo.” Ultimate-fighting shows have also been purchased.
     Mobile phones that download songs and videos are another huge revenue stream gaining momentum for DMG. It now feeds Verizon Wireless, Virgin Mobile, InfoSpace Mobile and seven others.

Connecting on Content
“More and more people are consuming content that way, especially on the video side,” says Koulouris. He cites the increasingly popular three-minute streaming videos for phones, called “mobisodes.” While Europe has a more-developed mobile phone market, it still lags far behind the United States in downloads, and that is seen as another source of future DMG revenue. But Koulouris maintains that music will remain the core focus of the company.
     And how does this new digital-music model change things for the artists? As Koulouris sees it, big-name artists are in a good position to stream their music directly to consumers via iTunes or Yahoo. “But for ordinary unsigned artists,” he says, the road to fame remains a long and winding one.

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