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Larger cities will provide you with a larger client base, but obviously there will be higher overhead/cost of living issues. The inverse is true for smaller cities. Any metropolitan area with a population over 500K will invariably have multiple pro and project facilities. To beat a dead horse....dwindling record label budgets and home studios are driving down day rates and making competition fierce even in major markets.
Instead of focusing geographically, I think the real key to attracting business in this climate is the producer/studio model based around a certain sound or genre. Guys like Mike Mogus (Lincoln, Nebraska), Peter Katis (Bridgeport, CT), Trent Bell (Oklahoma City, OK) & Dave Fridman (Fredonia, NY) are doing well in smaller cities as they are known for a certain sound and attract clients worldwide due to their uniqueness.
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