1. What value does HSS create?

To what extent does it increase expected revenues and profitability of albums and songs by new and established artists? Founded in 2002, Polyphonic HMI was established as a subsidiary of Grupo AIA to market the Companys expertise in the area of artificial-intelligence and the natural sciences (such as mathematics and physics) to the music industry via new technology referred to as Hit Song Science (HSS). The technology (HSS) analyzed the mathematical characteristics of music (by isolating aspects such as melody, tempo, pitch, rhythm and chord progression) and compared them with characteristics of past music hits making it possible to determine a songs hit potential. Recent analyses performed for music released in the U.S. suggest that Hit Song Science could achieve a success rate of 80% in predicting which songs will become hits, compared to the current industry success rate of 10% using traditional market testing techniques. Studies tend to support HSSs ability to improve record labels ability to predict which songs will become hits, determine whether to market an album and choose which songs should be released first as singles. Additionally, HSS could help determine whether it would be worthwhile to make a record for new artists and offers the opportunity to test songs and albums during the production process. This would enable producers to make tweaks throughout the process, increasing the efficiency of testing and maximizing hit potential. Ultimately, HSS creates value by offering an alternative method to existing market testing methods with higher accuracy at a lower cost. Table A gives the low, medium and high expected revenues for singles and albums with and without a Singles Top 40 hit. Taking a conservative approach, the estimated value of a single reaching the Singles Top 40 and the estimated value of a single not reaching the Singles Top 40 are $200,000 and $10,000 respectively. Given the success rate of a single becoming a hit without HSS is 10%, the expected value of a single without the use of HSS is $29,000. Given the success rate of a single becoming a hit with the use of HSS is 80%, the expected value of a single with the use of HSS is $162,000. This results in a total value-added of $133,000 per single. The conservative total valueadded from the use of HSS in predicting the success of an album with and without a Top 40 Single is $1,337,000. (See Exhibit 1 for a Full Sensitivity Analysis) In 2002, there were approximately 10,000 artists with a record contract in the U.S. and Europe, but only several hundred with some name recognition and commercial success. Tens of thousandsif not hundreds of thousandsof artists were hoping to secure such a contract. In an effort to land a record deal, unsigned artists often use demo recordings to attract music publishers attention. Labels typically receive three to four hundred demos per week (or a maximum of 19,200 per year). Thus, competition for a listening ear is fierce. Additionally, the vast majority of record labels revenues come from established artists. For example, Warner Music Groups established artists accounted for almost 90% of the $1.7 billion in revenues from newly released titles in 2003. Record labels are therefore highly incentivized to focus most of their time and energy promoting those artists who generate the majority of their revenues. This presents yet another challenge for unsigned artists as they must compete with established artists for the time and resources of record label executives. The use of HSS could, however, help unsigned artists create songs with predictive success by testing their songs hit potential and thus allow them to evaluate whether or not they can be successful in the music industry. For signed artists, the use of HSS could mean the difference between a successful career and no career at all. Often, if an artists first single underperforms it can be the end of his or her career. Artists are generally given an up-front fee, or a loan, to record their album which is to be paid back to the record label from the artists income from album sales and other artist related revenues. Additionally, artists are given a sales-based payment, typically between 5% and 15% of the records suggested retail price. In many cases, artists are given loans in the hundreds of thousands of dollars of which all must be

repaid before the artist realizes any profit from his or her album or other sales. Given the enormous amount of money it takes to create and promote an album, the cost of a failed album is extremely high. Because of this cost and the danger of underperformance, it is critical that the artist release an album that will be highly successful. The use of HSS could provide the same benefits for established artists as it does for emerging, unsigned artists, primarily increasing their potential for success. 2. Who are Polyphonics ideal customers; if you were the CEO of Polyphonic, which target market (unsigned artists, producers, record companies, others) would you pursue? Polyphonic has identified three target markets: artists, producers and record labels. Polyphonic would benefit the most from record labels, specifically A&R executives. First, record labels have the buying power to take HSS to scale and integrate the technology into their company processes for creating and selecting hits. In this way, record labels are in the best position to reveal HSSs tremendous potential. HSS offers record labels cost-savings and revenue-maximizing opportunities. As industry performance declines, as demonstrated by several years of falling music sales and rising online and offline piracy, return on investment (i.e., artists) has grown increasingly important. For record labels, the traditional testing methods used in hit-song identification are very costly. Call-out studies cost between $5000-$7000 per song while Internet Polling and Focus Group research costs $3000 and $10,000 per song respectively. HSS technology, on the other hand, can analyze an album of 10 songs for only $300 (or $30 per song). This provides cost as well as time savings allowing record labels to release songs and generate revenues much earlier. Further, record companies have a strong desire to forecast sales levels for the titles in their portfolios enabling them to determine in which artists they should invest their resources. With a success rate of 80% in predicting which titles will become hits, HSS would clearly allow record companies to maximize their revenues by focusing primarily on those artists whose titles are predicted to be successful by HSS in the music market. 3. What are benefits and drawbacks of the Hit Song Science for each player in the music industry? Who stands to gain/lose the most from this technology? How does this impact your plans? Artists: As the largest target segment, comprised of potentially 100,000 signed and unsigned artists, competition for success is tremendous. Unsigned artists could use HSS in a number of ways. Typically, a record label receives between 300 and 400 demos per week. HSS could help unsigned artists in selecting a breakthrough demo, fine tuning their sound and attracting interest from record labels. Additionally, it would allow unsigned artists the opportunity to test the hit potential of their songs and help determine if they can achieve success in the music industry. However, artists often have original ideas about the music they create which, if they truly are original, would not match the mathematical characteristics of past music hits. This could potentially lead to the dismissal of songs that do in fact have hit potential solely on the grounds that they do not match HSSs criteria for successful hit songs. Further, artists are highly concerned with the integrity and originality of their music. The use of HSS could hinder the goal of creating an original, unique sound, removing creativity from the artistic process. Signed artists are presented with similar opportunities and potential drawbacks. The use of HSS could provide them with a method of checking the hit potential of the songs given to them by producers and record labels alike, as well as those songs they write themselves. Further, the underperformance of an artists first single could mean the end of his or her career. The ability to accurately test the hit potential of a song before it is released greatly reduces the chances that the song will underperform and significantly increases the staying power of the artist. Producers comprise the second largest target segment with 20-30 top producers and thousands of independent producers. Producers are involved in many elements of the recording process, from helping

artists select music and develop a music style to overseeing recording schedules and watching over production budgets. HSS could offer producers the opportunity to test songs and albums during the production process allowing these individuals to tweak them prior to completion maximizing their hit potential. Thus, HSS would allow producers to focus on their other duties which would increase their working efficiency and effectiveness. This ability to shift their focus is especially important because of the compensation schemes set forth for producers. Inside producers typically receive a salary and royalties while outside producers receive a production fee and a negotiated royalty fee of 1% to 5% of the suggested retail price. Production fees vary significantly and are received largely dependent on the quality of the producers themselves and the quality of the artists they have produced. Thus, there is a very clear incentive to produce hit songs that will ensure the success and longevity of the artists they produce. HSS is not without its disadvantages for these producers, however. HSS would likely lead to reduced differentiation among producers and could leave producers with the perception that they are no longer responsible for the majority of the successes of the songs they have produced. It is highly likely that producers may feel replaced by technology, limiting the emotional and artistic quality of the music they produce. HSS also undermines the value the music industry places on having a good ear, historically deemed a unique gift with a premium placed on those producers who have one. The third and smallest target segment is comprised of record labels, specifically A&R executives. While the majority of the market is dominated by the majors, the top 5 record labels, there are tens of thousands small to mid-sized labels. HSS has the potential to help this target segment in significant ways. The technology could help record labels efficiently decide whether to market an album, choose which song on an album should be released as the first single and test new artists looking for a record contract. Record labels spend millions of dollars releasing a new album not knowing if there will be any demand for it or if it will get any airplay. In fact, less than 15% of music titles released were profitable in 2002. While the worldwide market for recorded music was worth over $32 billion at the retail level, about 30% of all the recorded music was produced in the U.S. As the largest in the world, the size of the U.S. retail market was well over $12 billion, or 39% of worldwide sales. Record labels typically spend about $1 million to promote singles of known artists and upwards of $300,000 in marketing expenditures for unknown artists. Generating significant airplay can easily cost $100,000 in promotion fees alone. Additionally, traditional market research techniques can cost as much as $10,000 per song. Given the magnitude of these expenses and the historically low success rates of artists, record labels are especially concerned with and focused on their return on investment (i.e., artists). The use of HSS could significantly reduce false positives and false negatives of hit song predictability resulting from traditional methods of market testing, helping to ensure the successful launch of albums and artists. Further, HSS would allow record labels to invest more confidently in new, lower-cost artists, expanding their talent base. On the other hand, there is a significant risk that record labels may become over-reliant on HSS, ignoring many artists with remarkable talent, limiting the diversity of music released by passing over music expressed in ways that differ from former successful music styles. However, the benefits of HSS appear to greatly outweigh the downsides and thus HSS seems like a worthy investment. The realities of the impact of HSS, both positive and negative, on each target segment (artists, producers and record labels) clearly dictate a focus on promoting HSS to record labels. Independent and emerging artists are often protective of their creativity and originality and would likely resist narrowing their art to a mathematical equation. Additionally, these artists typically do not have the financial means necessary to invest in HSS. Similarly, many producers may perceive a loss of their own artistry and originality as HSS removes the unique premium placed on having a good ear for hit songs. While some producers may appreciate HSS from an economic perspective, those valuing the creative side of producing music would likely resist embracing the use of HSS. Ultimately, record labels are the

stakeholders in the music industry with the least to lose and the most to gain from adopting HSS. From a purely financial perspective, record labels are in a unique position given the considerable resources available to them and the authority to dictate how those resources may be used. Further, the cost of HSS as a portion of the overall business costs, including but not limited to those costs related to finding new talent, marketing existing talent and producing and promoting records, is nominal. Yet, the benefits from the use of HSS are substantial. 4. How would you sell HSS? Polyphonic should use a differentiation strategy in positioning Hit Song Science. Its competitors are the traditional test marketing tools: Call-out studies, Internet Polling and Focus Group research. These methods are costly, time consuming and accurate, at best, 10% of the time. Polyphonic should stress the cost savings and HSSs accuracy in predicting the hit potential of a song as well as the automation and speed of use of HSS. Further, Polyphonic could try to capitalize on its successes in other business industries in an effort to highlight the Companys credibility, reliability and commitment to offering quality products. To overcome any resistance record label executives may exhibit, Polyphonic should initially market HSS as a value-adding tool to be used in conjunction with an executives gut feeling and traditional test marketing tools. Placement of HSS should be through an online website in an effort to minimize any additional overhead costs, increase consistency and reduce processing time. Further, an interactive website is similar in nature to the kinds of work that are currently performed at the record labels and adoption and implementation should therefore be relatively seamless. Polyphonic could offer a free trial to the majors, placing a cap of 10 songs (one album) at a cost of $1,500 for Polyphonic. However, given that Polyphonic is working with a shoestring budget of only $150,000 with variable costs of $30 per song (or $300 per album) and fixed costs of $500,000 per year, the Company should initially price HSS relatively low, at a roughly 30% to 40% markup ($39 $42 per song or $390 - $420 per album) to cover their variable costs, and gradually raise these prices as demand for HSS grows. Polyphonic should aim to raise its prices to $175 per song or $1,750 per album. This price benefits both Polyphonic and the record labels as the cost for record labels to test the hit potential of a song using HSS would be reduced to just over half of the lower bound cost of using traditional test marketing techniques. At the same time, this pricing strategy would bring the number of break-even units required by Polyphonic down from roughly 41,600 songs (or 4,160 albums) to just 3,500 songs (or 345 albums) per year. In a final single page, describe (succinctly) an element of the case that is similar to something a group member is dealing with at work, and how the weeks readings and Cteam discussions about the case lent direction toward a good solution for the real world (noncase) problem. The case and text readings on new product development have sparked two specific questions I plan to take to my marketing teams when back in the office next week: 1) How are we influencing the influencers (i.e., bloggers and industry specialists) in order to help support our launch of a new cat treat in the third quarter of the current fiscal year and 2) Are we using the Model of DiRffusion or some other technique to help quantify how the diffusion of innovation is driving our sales? If the marketing teams are using the latter, is this the optimal technique or would the company be better off shifting to a Model of DiRffusion?

As a demand planner for Mars, Incorporated, a national consumer packaged goods company, my team works closely with both marketers and field sales associates to forecast sales and the required production levels for the Companys 800 pet food SKUs. Out team spends much of its time striving to quantify sales revenues related to a number of different marketing and promotion avenues. Typically, we find that most of our revenues tend to be generated by or related to our marketing efforts, diffusion through word of mouth or by diffusion of innovation through the major influencers or innovators in the industry. The latter, however, has been an area in which we have not been very accurate or put a significant amount of effort into quantifying. While it is possible that marketers are using a form of the Model of DiRffusion in calculating their assumptions or inputs to the demand plan, I have never seen a specific formula used. The incorporation of a formula like the aforementioned will likely become increasingly necessary as the reliance on social media platforms to market and promote new products continues to evolve. During a recent launch of the New Pedigree dog food brand (the result of a significant ingredient upgrade), Mars invited dozens of the pet food industrys most respected influencers (bloggers, veterinarians, specialists, etc.) to its research facilities, factories and corporate offices in order to demonstrate first-hand how the Companys New Pedigree product was not only the best Pedigree recipe on the market to date, but had become a leader in pet nutrition as well. Mars is currently in the early stages of launching of a new cat treat brand, Crave. In fact, the first product was made available at select Walmart locations across the country last week. I am not aware exactly how or to what extent the marketing teams focused on a diffusion approach for this launch, but I intend to challenge them to incorporate the insights from the Pedigree revitalization efforts to be used in the Crave launch, extending into all future endeavors. My role in building the demand plan will be to attach a volume number to the diffusion assumptions generated by marketing. In connecting these principles back to the case, Polyphonic could definitely benefit from gaining the support of several respected industry leaders in launching HSS technology. Record label executives would offer the most benefit as they have the primary objective of generating revenues while producers may perceive a threat of replacement with the success of HSS. Comprised of several former music industry experts, Polyphonic already has a significant asset in the distinguished expertise of its management team. Thus, Polyphonic could leverage their existing relationships giving the Company the opportunity to gain allies for their new product launch.

Exhibit 1: Expected Value-Added Sensitivity Analysis Expected Value-Added from the use of HSS for A Single An Album Low Estimate $70,000 $210,000 Medium Estimate $133,000 $1,337,000 High Estimate $1,330,000 $27,790,000