Topic No. 1--With a Bullet : Wherehouse’s Dispute Over Used CDs Is the Talk of the Music Industry

Wherehouse Entertainment’s name is hardly music to the ears of major music company executives this week.

The Torrance chain of 339 music and video stores has become the talk of the music industry for engaging four powerful record conglomerates in an unprecedented legal fight over its right to buy and sell used compact discs. Retailers and music companies often have their differences, but rarely does this level of ill will surface publicly.

“It looks like a major war is on,” said longtime music industry lawyer Jay Cooper.

Wherehouse charged in a federal antitrust lawsuit that four of the six major music conglomerates--units of Time Warner, MCA, Thorn EMI and Sony--are pressuring the chain into abandoning its used CD business.

This week’s lawsuit came after the four companies, concerned that used CD sales will cut into sales and royalties for their artists, abruptly cut off millions of dollars in advertising money for Wherehouse to promote artists.

“They expected us to back off. That’s just not the way we’re going to run this business,” Wherehouse Chief Executive Scott Young said. (Two other major music companies--Polygram and Bertelsmann Music Group--are sitting out the battle.)

The dispute has put Wherehouse back in the public spotlight in a major way for the first time since 1988, when it eluded a hostile takeover battle launched by Burbank-based Shamrock Holdings. The company was eventually sold in a highly leveraged deal for $179 million to the buyout firm Adler & Shaykin, which sold the chain last year for $275 million to a group of institutional investors formed by Merrill Lynch Capital Partners.

Wherehouse executives describe the fray as a “David and Goliath” battle, although Wherehouse is hardly the usual David. With $450 million in annual sales, Wherehouse is one of the nation’s largest music and video chains. While it ranks far behind industry giant Blockbuster Entertainment in the video arena, in music Wherehouse remains an influential force, with an estimated 25% market share in Southern California that makes it the area’s largest music retailer.

Heading the battle is Young, a 46-year-old Miami native. Young said the decision to sell CDs came after lengthy study and frequent complaints from customers about the high price of CDs--which typically sell for $11 to $17 for new releases. Wherehouse sells used CDs for $3.99 to $9.99, after buying them for $1 to $6 in credit or up to $3.60 in cash.

Young contends that price complaints have been especially intense in economically sluggish California, where Wherehouse has 85% of its stores. “We must learn to compete with shoes, sweaters and jeans for the customer’s funds, especially when those funds are limited,” Young argues.

Young suggests that the music companies are overreacting. So far, he says, 75% of the credit customers get for their used CDs is spent on new CDs.

But others question Young’s decision to sue. “I don’t think it’s smart to get into a suit with your suppliers. It’s like biting the hand that feeds you,” said Russ Solomon, president of MTS, the parent of rival Tower Records.

All four companies being sued declined to discuss the controversy publicly. Privately, some say they fear that buying and selling used CDs--which rarely deteriorate in quality--can eventually evolve into an operation that resembles a rental business, with customers buying and taping CDs that they eventually resell.

Artists and their representatives argue that the chains make money on the original sale and on the resale, while the artist is only being paid when the CD is sold the first time. Country superstar Garth Brooks and singer-songwriter Paul Anka have publicly condemned used CD retailers.

Young acknowledges that the controversy has at least been a publicity windfall for Wherehouse. So far, no other chain wants to join in. “Publicly, I stand alone,” Young said.