Welcome back to my Project MAD entrepreneurial orchestra model blog series. In this third post, I’m going to talk about some ideas surrounding the financial strategy for MAD Corp., and related to that strategy, some ideas about organizational structure. I realize I still haven’t talked a lot about the actual orchestra yet, but that’s intentional – I’m picking the right horse to pull the cart.

For ease of reference here forward, I’m giving my conceptual orchestra and music school more coherent working names. I’m going to keep it really simple and just call the orchestra the City Symphony, and likewise, for my previously discussed educational subsidiary, the City Symphony Music School. Likewise, I am replacing the word Corporation in ”Musical Arts Development Corporation” with the word Foundation. This will all make more sense after reading this post. The initial founding capitalization strategy to establish the City Symphony and Music School is not the topic here.  Suffice to say that I’m well aware that to establish this enterprise as envisioned, it would take a substantial multi-million dollar investment in both facilities and operations.  While I do dream big, I do try to dream within the realm of possibility, supported by valid argument, research, evidence, and experience.

In my last post, I mentioned my firm belief that the only source of sustainable revenue for an orchestra is patron generated revenue. Orchestras that are in financial trouble today are in that position largely because their patron base has aged and deteriorated to dangerous levels, while operating costs have remained high. Philanthropy is shifting in many ways, and in several orchestras, it’s no longer sufficient to make up the difference between costs and earned income. Though the economic recession of the last few years has hurt the arts, I believe the cracks in the orchestra financial model were there long before this recent great recession started.

In this post, I’m taking the idea of expanding patron generated revenue to a whole new arena. My idea is that the Musical Arts Development Foundation should invest in non-arts related, profit-generating, business activity that earns more diversified income to help subsidize its artistic activity. When I read that the average local arts patron spends an additional $27.79 for every arts event, not including admission (and double that amount for non-local arts attending tourists), I can’t help but wonder how an orchestra might leverage more of that spending for its own benefit?

The financial strategy I’ve borrowed also relates to another of my initial MAD goals: to make programs affordable and accessible to the broadest audience possible. I stated that goal because I believe that most professional orchestras today have ticket prices that are out of control, particularly as pricing relates to new patron acquisition. New patron acquisition is not only an ongoing marketing concern, it’s a long-term survival concern. This pricing problem is further magnified by the deterioration of music education that fuels a positive predisposition toward classical music in general. As ticket prices continue to creep higher and higher, elective sampling by musically uncultivated newcomers decreases. No business can survive indefinitely without an effective strategy to acquire new customers.

So not only do I propose that MAD invest in building fundamental demand through the City Symphony Music School, I’m proposing that the MAD Foundation invest in other business activities to generate more earned income to help subsidize the artistic expenses, reducing the orchestra’s dependence on ticket sales in general, and reducing the price barrier for new patron acquisition. I realize that pricing is only one strategy for new customer acquisition, however, but I think it’s an important one. The City Symphony Music School is the more fundamental strategy for minting new patrons. I will be writing more specifically about marketing strategy in a future post.

If the City Symphony’s programs are to become as affordable and accessible as possible, the income ratio of the orchestra will need to shift further away from ticket sales. No, I am not saying that MAD will earn more through increased sales volume, or that ”increased giving” will take up the slack. I’m placing philanthropy in a new role at the MAD Foundation: as venture or project capital, not as a sustaining source of income – with the possible exception of individual giving. Again, more on development strategy, along with marketing, in an upcoming post.

It would be easy for me to say that the financial answer is to endow the orchestra up front. “Raise millions, endow the entire operation, and throw open the doors.” That sounds fantastic, but it’s not realistic.  Like tickets and annual donations, most orchestras’ endowments come from patrons, too. If the “giant endowment” solution was more feasible, a lot more orchestra boards would have done that by now.

Also, I don’t want to make the orchestra free. I believe in the value of musicians and what they do, and all people need to respect that value, and give of their time and money to experience this great music. But people won’t part with their money without believing in the value they get in return. So until such time that more people are camping out the night before City Symphony seats go on sale or they are compelled to write donation checks to keep the symphony strong, the financial strategy of the American orchestra needs a different spin.

The strategy I have in mind is a spin on endowment.  It’s not an orginal concept.  I’m borrowing a relatively new model developed by Cleveland’s Playhouse Square Foundation and Newark’s New Jersey Performing Arts Center (both of which I wrote about in a previous post).  There are a few other arts organizations that have employed a similar strategy, all in New York City: Carnegie Hall (whose Carnegie Hall Tower generates about $2 million a year for the institution), Lincoln Center’s Rose Building, and MOMA’s Museum Tower. If you haven’t guessed it by now, the strategy involves real estate. (There may be other examples out there I have not identified, I invite readers to share them with me.)

These arts organizations have invested in surrounding real estate to generate an additional source of external business income, with profits from their real estate assets being used as working capital for the arts organizations. The real estate assets are essentially quasi-endowments. The challenges of this model are 1) that real estate requires more financing up front and  requires specific expertise for the development and management of these active assets, and 2) the real estate business carries higher risk, something uncomfortable for some conservative nonprofit boards. For the first challenge, I think there are board members who would lick their chops to be part of important capital projects, especially a major development in the center of their community that nurtures a thriving arts scene, which in turn benefits their businesses and quality of life. Raising capital for bricks and mortar projects is very sexy to A-list arts boards. Finding managerial expertise for a real estate ventures is also not a significant challenge. For the second challenge, risk factors in real estate today can largely be predicted and mitigated through careful market research, precise development planning, and very strong public and private leadership. Does this put my dream within the realm of possibility? Evidence suggests that it has worked very well in Cleveland. And while Newark’s venture is still very new, it looks very promising.

According to an article in the Cleveland Plain Dealer from November, 2010, the Playhouse Square Foundation generates enough earned income (via real estate income, ticket sales at its theatres, and other internal income generating activities) to fund 90% of its $60 million operating budget.  Thirty percent of its earned income is generated from commercial real estate. Playhouse Square’s current web site states that they need to raise appoximately $4 million annually through philanthropy.  That is only about 7% of a $60 million operating budget. How does that compare to professional orchestras today that typically generate 30-50% earned income from ticket sales, and have to generate 50-70% of their income through philanthropy?

In New Jersey, the NJPAC Theatre Square Development Corporation (TSDC) was founded as a separate for-profit corporation, managed by NJPAC’s former Executive Director, Larry Goldman, who already had significant project management experience. TSDC has partnered with a successful mixed-use real estate developer to develop NJPAC’s adjacent land into a mixed-use residential and commercial development. (Their May, 2010, announcement of One Theatre Square, which includes beautiful renderings of the proposed building, is worth reading here.)  NJPAC-TSDC has accessed tax incentives and bond support from local and state governments to help finance the project. NJPAC was originally built with the vision to revitalize downtown Newark as a thriving, desirable “live, work, play” district.  NJPAC is a phenomenal case study of the arts as a revitalization catalyst and of public-private partnership.

Is it possible that an orchestra alone could build such infrastructure and investment for itself, without an arts center in the middle? I think so.

Both of these organizations started off as stand-alone non-profit arts groups. Both organizations took upon themselves the task of creating assets with economic potential around their artistic assets with the goal of sustaining their artistic missions.  Both organizations were founded as cultural and economic revitalization catalysts in depressed urban city centers. Cleveland and Newark are far from being the only American cities facing depressed conditions in their central business districts. I believe that several cities could use this model. There are several cities where a visionary orchestra board could leverage public incentives and private investment to aid in creating a mixed-use development centered around an orchestra and music school, possibly even other arts groups, too.

I haved checked into some current federal incentive programs to learn more about what opportunities are out there. Notably, I discovered that downtown Syracuse, New York, is a federally designated HUD Empowerment Zone. Syracuse is one city that recently lost its professional orchestra to Chapter 7 bankruptcy. It is also a city that needs jobs.

The presence of a major arts institution has great potential to stimulate an environment where people want to live, work, and play. Orchestras tend to be among the largest anchor arts institutions in most cities, whether or not they own their home. With this strategy, my City Symphony not only owns its performance home and Music School, but the restaurants, hotel, conference center, dry cleaners, shoe store, office building, parking garage, and/or apartment or condo complex around it. With that ownership would not only come financial strength, but more creative opportunity for reaching patrons, and earning more of their money. One of the strategic options in big business is “own your competition, too.”

I can think of dozens of creative marketing strategies that might package the symphony with lodging, food and beverage, conferences, and more.  The development of creative partnerships would be far easier with related resources at the same table.  For example, condo owners in “Symphony Square” residences might be offered some type of preferred subscription rights in the concert hall. What if a movie theatre complex were incorporated into the mix?  Not only could the MAD Foundation earn income from one of an orchestra’s primary competing art forms, but closed-circuit live simulcast concer transmissions in one theatre might make attendance attractive to younger and more casual audiences, such as families with children.  Moviegoers who expect to munch on popcorn during their entertainment would be able to do that while watching a live concert on screen, without disturbing the musicians and patrons in the acoustically live concert hall.  An adjacent conference center would be a natural fit for attracting lucrative conferences to the complex that could include use of a fine theatre, as well as access to possible conference entertainment. The potential ideas are vast.

The organizational structure I admire most follows Cleveland’s example: it would put the Musical Arts Development Foundation at the top of an organizational ladder as a parent foundation focused on fueling the fiscal engine of the entire company, with three semi-independent operating units under its care: the City Symphony itself, the City Symphony Music School, and the MAD Real Estate Division. For  efficiency, some administrative functions could be centralized under the parent company, such as HR, finance, information technology, maybe even some centralized marketing and development functions. Other functions specific to each operating unit would be naturally separated: orchestra management, music school management, and property management.  Such an organizational structure would have some interesting twists on board composition and structure.  It would certainly require a high-powered, A-list public and private stakeholder board. The Executive Committee might look like a Joint Executive Management Committee that would comprised of the officers of the parent foundation along with top leaders from each of the three operating units. Board composition and structure is a topic for another post.

I haven’t decided yet whether MAD should be a standard 501(c)(3) non-profit arts organization like Playhouse Square, a separate for-profit LLC corporation like TSDC, or perhaps the new limited liability low-profit corporation (or L3C, currently available only in a few states, created for this type of hybrid business model). For the moment, I’m leaning toward the established 501(c)(3), as it is in Cleveland.  Each commercial building in Playhouse Square’s real estate portfolio is a separate Limited Liability Corporation (for-profit LLC).  The stock of each LLC is owned by the Foundation.  Leasing and management is handled by the real estate division, which is also earning other income by offering consulting services to other commercial developers elsewhere. The LLCs pay property taxes, the Playhouse Square Foundation remains tax exempt. As the news article stated, Playhouse Square’s goal appears to be to continue owning and managing the real estate assets until such time they pay off the debt associated with development costs, sell the assets at an appreciated value, and transfer capital to a traditional endowment fund. Smart.

This financial brainstorm has inspired me to do more research into mixed-use real estate development, so I can further examine how this idea might be used to develop a stronger arts enterprise. Though I have only just started to read the volume of literature on this topic, I have learned that mixed-use development is definitely an emerging market in American real estate, being used in many cities as a response to urban sprawl and environmental sustainability.  I read one particularly interesting study published by the Commercial Real Estate Development Association’s Research Foundation, entitled Price Premiums and Mixed-Use Development, which compared commercial rental rates for office space in mixed-use developments against rental rates in single-use properties in eight major markets across the US.  In the majority of the studied cities, the authors concluded that mixed-use developments commanded higher rents than most of its competing single-use buildings, and the difference was significant enough to confirm that mixed-use development remains an “emerging market” poised for future growth. So not only could a mixed-use orchestra-anchored development be possible, its leasable space could command a premium price over its competition. I love the thought that it would cost more to live  or work next door to the City Symphony.

As exciting as all this sounds, I have not yet done enough research on mixed-use real estate to state a more specific model for my mock organization. The choice and style of buildings to include in the complex would be of paramount importance. This post is intended to simply air this financial concept as a response to what I might do to reinvent the American orchestra business model.  I’m not stating that MAD’s City Symphony and Music School is envisioned as a $60 million operation like Playhouse Square, the matter of “scale” needs to be addressed appropriate to the actual artistic vision. More ideas to come.