A War Over Instruments
Ace Music was acquired in late 1995 by Mark Begelman, a founder of the huge and wildly successful Office Depot retailing chain. Since that time he has been laying the groundwork for an ambitious national Music and Recording Super Store (MARS) chain (see accompanying story). As of this writing, MARS locations are open in Dallas, Atlanta, and Tampa; however, the financial statements released only document the performance of the Miami operations, and thus provide a unique insight into the impact of multiple “superstores” in a single trading area.
Guitar Center, Sam Ash, and Ace Music carry virtually the same product lines, the only significant difference being that Guitar Center doesn’t stock any wind instruments; yet there are significant differences in gross margin performance at the three operations. Through a combination of creative merchandising, aggressive promotion, and generous concessions from manufacturers, Guitar Center manages to extract the most money from the customer, generating a gross profit of over 30% chainwide. How much over 30% is difficult to quantify, given that the company lumps occupancy expense and unspecified “buying expenses” in with the cost of goods sold. People familiar with Sam Ash operations report that the company has a chainwide gross profit of approximately 28%; however, with Ace Music operating on a 19.5% margin, it’s difficult to imagine that the Guitar Center and Sam Ash stores in Miami are doing much better, let alone matching the performance of their stores in other regions.
“Even though Guitar Center and Ash have come to town, Ace has been around a long time and has a strong following,” explained one sales rep. “They may have given up some ground, but they still do over $20.0 million in sales. There’s no way you can do that much business in a market like Miami without affecting the other stores in town, especially when you’re cutting prices to the bone.”
Other signs also strongly suggest that intensified competition has taken a toll on all three operations. Sales reps report exceptionally high staff turnover at Ace, Guitar Center, and Sam Ash. “Everyone pays salespeople using a commission based on a percentage of gross margin,” said one rep. “The problem is that the margins are so narrow, you have a problem where salespeople work their tail off 11 hours a day, six days a week, for minimum wage. It’s easy to understand why they quit after a few weeks.”
A critical element of retail involves presenting an image to the buying public. Mindful of maintaining that image, virtually every store operator in Miami, Sam Ash and Guitar Center included, is on the record saying that they have been unaffected by the current slugfest and that their business has either “achieved” or “exceeded” budget. Bob Zobel, Ace Music’s chief financial officer, is the exception, candidly noting, “Both sales and gross profits continued to be adversely affected by direct competition from Guitar Center and Sam Ash Music, who opened nearly 100,000 square feet of retail space in south Florida during 1996, and Thoroughbred Music, an independent competitor in central Florida who opened a 26,000-square-foot store in the Orlando area over the Thanksgiving weekend.” Privately, a number of retailers seem to share Zobel’s assessment of the marketplace. “It’s a battle of attrition, with everyone selling things at cost hoping for the other guy to go out of business first,” said one.
The Role Of Population
The current retail situation in Miami is the result of shifting population trends, several people hatching the same strategy simultaneously, and mere chance. In 1970 Florida was the eighth most populous state in the United States. Thanks to a huge influx of Northerners, by 1990 it had moved up to the fourth most populous state, trailing only California, Texas, and New York. Yet despite this dramatic population growth, the size and scope of the state’s music retailers, particularly on the East Coast, had remained virtually static.
Ace Music of Miami had been founded in 1947 by Gustav Rubin, and, through a combination of aggressive selling and shrewd financial management, it grew to become the dominant player in the greater Miami area. In 1971 the business was taken over by Gustav’s son Fred. At its peak two years ago, the four Ace locations generated sales of $27.0 million and ranked as the 12th largest retailer in the country. Although the Ace was highly profitable, earning a reported 10% pre-tax profit on sales, its stores were dated and in need of major renovation, and the company lacked much of the promotional skill and polish of comparable retailers in other markets.
Eyeing The Same Prize
Simultaneously sensing an expansion opportunity in Miami, both Sam Ash Music and Guitar Center made overtures to Fred Rubin in 1995 about purchasing Ace. When the talks failed, both laid plans for opening their own stores. Ash opened first on May 31 with a 25,000-square-foot store in Margate, a northern suburb of Miami, and a massive 44,000-square-foot store on the highly traveled Palmetto Parkway on the north side of Miami. A month later Guitar Center held a grand opening that drew 4,000 for a 25,000-square-foot store in Hallendale, situated on Highway 95, midway between the two Ash locations. A month later a second 20,000-square-foot Guitar Center store was opened in Kendall Square, a suburb south of Miami.
Months before Ash and Guitar Center opened in Miami, Rubin sold 90% of Ace Music to Mark Begelman for $7.5 million in cash. Initially, Begelman told local reporters that he planned to use Ace Music as the nucleus for a national m.i. retail chain; however, as plans for his proposed 66-store chain took shape, Ace seemed more like a footnote than the foundation. Begelman’s new stores, which operate under the MARS banner, bear no relation in size, layout, or staffing policies to the Ace stores in Miami. Furthermore, MARS Music has indicated that it will “terminate certain existing leases during the year ended January 31, 1998,” suggesting that some of the original Ace locations are soon to be shuttered.
As competitive as music retail is at present, the current situation in Miami suggests that things could become worse before they get better. It also raises questions about the national expansion ambitious of players like Guitar Center and Sam Ash. If, as the Miami experience indicates, too many “superstores” in a market curtail profitability, will there be enough profits to fund future growth or make investors happy?
When Mark Begelman paid $7.5 million for 90% of Ace Music, effectively valuing the company at $8.33 million, he bought $4.8 million of inventory and other hard assets and $3.5 million of good will. After Begelman’s first full year of operation, accountants recommended writing off the good will, resulting in an extraordinary charge to earnings of $3.5 million. “The level of competition suggests that sales and gross profits in the four original Ace Music stores may have suffered longer-term impairment,” the report concluded. “So, the company has decided to write off the remaining good will from the Ace Music acquisition.” A $3.5 million charge against earnings is the first casualty of stepped-up competition in Miami, but probably not the last.