High Fidelity with Higher Margins Online CD retailer Insound.com thrives on hard-core fans who still buy music--lots of music--in the age of digital downloads.
By Monica Khemsurov

(Business 2.0) – When the Strokes released their highly anticipated second album, Room on Fire, rabid fans didn't rush out to the nearest music store. They knew a better place to buy the CD: Insound.com, where the band's label, RCA, was reaching out to devotees with an offer that included a free 7-inch vinyl record with bonus tracks. The site rang up 2,500 preorders before the CD hit shelves, making Insound's first-week sales of the album higher than Amazon's. Says Insound president Matt Wishnow, 29, who co-founded the company five years ago, "There was disproportionate interest online, and we were a big part of that."

Since 2003, record sales have flatlined and two of the nation's largest record store chains have filed for Chapter 11 bankruptcy protection, but New York City-based Insound has bucked the trend. It climbed into the black last year on sales of about $3.8 million; this past March and April, revenue was up 25 percent year-over-year. Meanwhile, Insound has also launched a successful marketing arm that caters to companies looking to tap its knowledge of youth markets and that now brings in 40 percent of its revenue.

"Insound built itself up on the shoulders of less-known artists blocked from the traditional market," explains music industry analyst Lee Black. "When the Internet exploded as an outlet for those artists, Insound promoted itself as the place to go."

Insound is still small, no doubt about it--but its success once again shows how the Web can help niche businesses achieve the sort of scale they'd never get with a physical location. In this case, it has allowed what is essentially a quirky record store like the one John Cusack owned in the movie High Fidelity to grow into a thriving seven-figure business. By selling 350,000 mostly independent-label titles on CD and vinyl, Insound has won a following among music snobs nationwide. True, its 250,000 active customers pale in comparison with Amazon's 41 million. But consider that the kind of hard-core fan that Insound attracts buys, on average, 21 records a year, while a typical consumer's annual purchases can be counted on one hand. And though only a 10th of Insound's selections aren't available at Amazon, nearly 80 percent of Insound's sales come from these rarities. "We aren't a volume business," Wishnow says, "but we have higher margins than Amazon." How high? Try 30 to 40 percent. By contrast, Amazon has margins of less than 10 percent.

That's what Wishnow and co-founder Ari Sass envisioned back in 1998 when they hatched their plan for the site. The two met while working at Elektra Records in marketing and finance, and raised money from friends and family. They slowly built Insound's credibility by forging partnerships with distributors, labels, and artists. In return, the labels directed their customers to Insound. "Our audience is small, but they're savvy and cynical in the right way," Wishnow says.

To build buzz, the company funded Insound-branded EPs for underground bands to sell on tour and hosted after-hours rock shows at its office. The site also made sure to stock plenty of titles on vinyl, which was increasingly too cost-inefficient for local record shops to carry (vinyl accounts for 30 percent of Insound's sales). And to make the experience authentic, Insound created Cranky Sales Guy, an archetype familiar to anyone who remembers Jack Black as the High Fidelity record store clerk with attitude. E-mail him questions or submit a list of your favorite CDs and he'll respond by ridiculing your music collection--while also offering recommendations about what to buy. "It's a taste-maker site," says Nicole Blonder, national sales director at Mute Records. "People who shop there trust its opinions."

That's important, and not just to the company's retail business, Wishnow says. It's also opened up a new revenue stream. In 2001 the firm launched DrillTeam, a division that helps consumer-products companies like Sony and videogame maker Capcom reap the benefits of Insound's indie cred by creating viral marketing efforts and consulting on youth-oriented ad campaigns.

As this business grew, Wishnow brought in his old boss from Elektra, Steve Kleinberg, as CEO to oversee both parts of the company. Wishnow is now focused on expanding the site, where he plans to add paid digital content by year's end. Unlike other music retailers, he says he's not worried about downloads cutting into sales. While the music snobs who come to his site are increasingly playing the iTunes game, he knows that they, more than anyone, still covet what they can't get digitally: cover art, liner notes, and often the comforting hiss of needle on vinyl. One music executive's heresy is, apparently, another's blueprint.