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Case 2: Strangling the Fat Lady at EMI?

The music industry
The recorded music business has been under siege since high-quality
digital downloading of music from -the Web became viable for consum­
ers. Early downloads werepoor quality and difficult to undertake, but
this soon changed. The biggest disruptions have been the abi1ityof con­
sumers to access file-sharing websites and to download music without
payment (pirated copies of published music), and the Apple-led iTunes
and iPod (and now iPhone) innovation to pioneer paid music down­
loads. Importantly, Apple has used the clout of the iPod to impose low
and uniform prices on the record labels.
By 2008 the music industry was looking at revenues from all recorded
music shrinking another 10% against the previous year - following
dec1inesthroughout most of the 2000s.Important1y,the growth of digital
downloads slowed in 2007, and failed to compensate for crashing CD
sales. According to BPIfigures, sales trends have developed as below:

Physlcal sales Digitalsales

(No. of singles sold)

2003 30.9m

2004 25.5m 5.8m

2005 21.4m 26.5m

2006 13.9m 53.0m

The value of physical sales of CDs has fallen from $21.1 billion in
2005 to $15 bilIion in 2007. By contrast, while digital sales tripled in
2005 to $1.1 billion, and almost doubled in 2006 to $2.1 billion, they
rose only 38% to $2.9 bil1ion in 2007. By 2008 music sales in all forms
were at a five-year low. The dominant factor causing the music indus­
try problems remains online piracy - illegal downloads outnumber the
legal by 20 to one. In addition, analysts suggested that digital sales can
only be enhanced if record labels and telecommunication firms work
together to make it easier to listen to music on mobile phones.
The music industry initially tried to fight the disruptions it faced ­
enormous efforts to close file-sharing websites like Napster, and to
pursue consumers in legal actions for downloading pirated copies of
music - but the real search is for a sustainable business model for the
new music industry. While the music labels have been trying to protect
the CDs from which 90% of their revenues used to come, the world has
moved on. Several strategic themes are apparent:

1. Legal downloading for money • • •

The growth of digital music sales has slowed dramatically, at the
same time that CD sales have dec1ined. The biggest impact here has
been Apple's iTunes site. In addition, in 2008 MySpace joined with
three of the largest record companies to launch its own music service ­
MySpace Music. With free listening supportedby advertising and paid
downloads (and merchandise and concerttickets) the goal is to link
MySpace's huge social networking membership to the catalogues of
the largest music companies. The venture is a major challenge to the
dominance of iTunes. Nonetheless, 2008 was the first year when song­
writers and publishers eamed more from broadcasts and legal down­
loads than from sales of CDs.

2. Legal downloading for free • • •

In 2008 the latest innovation hoped to rescue the struggling recorded
music industry was the launch of alegal downloading service called
Qtrax. The Qtrax model is that it is an advertising-supported site from
-------------------._--------- --~__ ._-'_._---_.-~------
which music fans can download songs free of charge, in return for
viewing advertisements. Unlike previous similar attempts like Spiral
--
Frog, Qtrax has done licensing deals with all leading music labels
and many independents, and has a much larger online catalogue than
Apple's iTunes. A joint venture between Google and a Chinese online
music company, global music companies and dozens of small local
labels to provide free, licensed music downloads, is part of Google's
fight against Baidu.com for the Chinese online search market, but may
be a road map for the future of the music industry.

3. Disintermediation • • •
one part of the Web revolution has been the move by some artists to
publish and sell their work directly on the Web as downloads. The .
most famous example is the Arctic Monkeys' '1 Bet You Look Good on
the Dancefloor', which was the fastest-selling UK debut single of all
time, after a MySpace campaign. Established artists like Peter Gabriel
(a founder member of Genesis) have raised money to record and dis­
tribute their own albums, This trend is not restricted to rock music ­
hordes of contemporary, avant-garde, classical and jazz composers are
using the Internet to sell their creations. The attraction is to eliminate
, the label, the pub1isher and the distributor and market the music, or
the artists, direct to fans. Some Web-based offers to music fans, like
Sellaband and Slicethepie, offer 'punter equity', letting band followers
invest in their favourite artists, for example to fund recording an album.
In many ways the issue is bands as brands. Lifestyle brands like Agent
Provocateur, Diesel and Coca-Cola are looking to partner with bands
to use the music as a communications tool - in 2008 Groove Armada
left Sony BMG to sign with drinks giant Bacardi, who wilI release the
band's music through their own label and download platforms.

4. Reintermediation • • •
Mobi1e phone makers Nokia and rival Sony-Ericsson have pioneered
music downloading services for users of their phones - free in Nokia's
case. This undermines the growing position of mobi1e operators like
Orange and .Vodafone as providers of music services to their subscrib­
ers, but reflects areaction to iPhone's invasion of the mobile phone
business, bringing its links to Apple's iTunes with it. Some mobile
phone companies have invested heavi1y in their own music services ­
in the USA AT&T (with Napster), Verizon and Sprint have all gone in
this.direction. In 2007,a Iapanese pop group called GreeeeN - an anon­
ymous quartet of dental students - recorded the first song to accumu­
late one million downloads to mobile phones. Globally, there are more
downloads to mobile phones than to computers.

5. Music has no value • • •

Some conclude that recorded music no longer has a monetary value ­
it i~,~Jr_ee commodity, The money is in other aspects of the product.
FoI' example, major artists make 75% of their earnings from touring.
Live Nation is the world/s largest concert promoter - 35 million people
attend its shows every year. Live Nation is attacking the record labels
by poaching their artists and offering them a one-stop shop - making
the albums, selling the merchandise, operating the tours, running the
website, producing the videos and creating new products that link
with the act (for example, video games like Guitar Hero). It is even pos­
sible to sell albums 'on the out' - freshly-minted copies of the perform­
ance as fans leave the concert venue. The first big Live Nation signing
was Madonna in 2007, who left Warner to sign a $120 milllon ten-year
contract with Live Nation to handle every part of her business except
publishing. In 2008 Live Nation signed a $100 million deal with Irish
rockers U2 to handle the band's merchandising, digital and branding
rights, and hip-hop star Jay-Z dropped Def Jam, the label where he was
once President, for a $150 million deal with Live Nation. The Rolling
Stones were also in talks with Live Nation. In the UK, the Mama group
has asimilar model, generating income from live venues, managing
artists like Kaiser Chiefs and Franz Ferdinand, and selling concert tick­
ets and merchandise - they aim to make money not from selling CDs
but from the relationship between musicians and their fans.
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6. Why own the music? • • •

For many years Steve Jobs at Apple has maintained that people want to
buy and own music, which is the model for his iTunes site. However,
there are signs that the consumer may be moving towards subscription
services for music, like RealNetwork's Rhapsody service - the sub­
scription buys rented access to mil1ions of songs for a monthly rental.
Part of the shift is driven by the fact that people accustomed to paying
a monthly charge for their mobi1ephone may see little problem in pay­
ing a little more each month for a music subscription, to access more
music than they could ever anticipate buying. By 2008 Apple was in
talks with the record companies to sell iPods and iPhones with unlim­
ited music downloads from iTunes (consumers would pay around
a $100 higher price for the device or a subscription of $7-8 amonth)
because their main profit stream comes from the devices not the iTunes
downloads. While Nokia is offering $80 per device to music industry
partners (to be divided according to market share) to get its 'comes
with music' service started, Apple is offering the music industry only
$20 per device.
This is the context in which EMI's music business operates.

The EMI music business

Founded in 1897 as the Gramophone Company, merged with Columbia
in 1931 to create Electric and Musical Industries (EMI), anddemerged
from the Thom electrical conglomerate in 1996, EMI is one of the
world's four largest recorded music groups. It is widely seen as the
weakest of the majors. In market share, Universal holds about 25%· of
the wholesale recorded music business worldwide, Sony BG has 21~/o,
Warner MG 14%, EMI 13%, and others 27%. oo

In 2006, EMI and rival Warner were making bids for each other, but
no deal was forthcoming, as a result of clashes over management con­
trol and concerns about regulatory risks. EMI's music business was in
disarray early in 2007 - CD sales were .collapsing, the American busi­
ness was heavily in loss, their biggest recording artist was in rehab,
high profile artists were abandoning traditional arrangements to
do lucrati.ve deals with retailers, concert prornoters, or consumers
themselves, and repeated profit wamings were issued by then Chief
Executive Eric Nicoli.
At this stage, several private .equity firms in the USA expressed inter­
est in buying EMI, with Warner rumoured to be interested in buying
EMI back from a private equity takeover, later when regulatory issues
were clearer. In fact, private equity firm Terra Nova, headed by Guy
Hands, took over the music company EMI in 2007. Terra Firma paid
EJ.2 billion for the music label that includes the Beatles, Coldplay, the
Spice Girls and Robbie Williams among its stars. It was one of Europe's
.last big leveraged deals before the credit squeeze stalled cheap debt.

Terra Firma's track record

Terra Firma was spun out of the investment .bank Nomura in 2002.
Major successes for CEO Guy Hands include: Waste Recycling Group ­
making Bl billion profit from a 2006 deal; Odeon Cinemas - reviving
an ailing franchise; and Angel trains - making B450 million in a mid­
1990s turnaround. Less successful ventures include: Le Meridien - the
B1.9 billion hotel chain collapsed in 2003; Thresher off-licences - sold
at no profit after seven years of trying to tum the business around;
Rockingham - losing f:50 million on a racetrack; an excursion into tel­
evision rentals came to an ugly end with the default of Boxclever; army
homes - slammed for 'appalling conditions' for troops, though likely
to make a B2bi1lionprofit on the deal.
Insight into Hands' business approach comes from the time when
he ousted managers at the Odeon cinema chain, one of his purchases,
because he said they were always jetting off to Hollywood to see film
premieres - Hands explained: 'They thought they were in the movie
business, but actually they were in the popcom business.'
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Hands-on strategy at EMI

Eric Napoli, EMI Group chief executive, quit the company as Terra
Firma took over, leaving with around E3 mi1lion. Hands appointed a
trio of private equity executives with no music industry experience to
cover finance, business transformation and strategic relationships. His
view was that: 'You don't need people with an "ear" for hits. People
will tell you what they like. It's not magic. It is calledmarket research,'.
Tony Wadsworth, a traditional music industry executive, stepped
down as chairman and CBO of the UK business shortly before Hands'
restructuring was announced.

source: Getty Images

Hands was convinced that the EMI business model was based on
three out-of-date characteristics - believing that enough CD hits will
make enough money to cover everything else, thinking that conglom­
erates of labels benefit from economies of scale, and pushing a single
type of music onto consumers from each label. He wanted to change
EMI's bloated bureaucracy into alean, customer-focused organization,
with more talent scouts and fewer middle managers. His vision was
'Out job is to monetize music for the artist.'
Early moves by Hands were to threaten to drop music artists
who were not working hard enough and to 'unpick' its executives'
pay packages. Hands promised fundamental change in how EMI
approached the music business, waming that artists 'would have to
meet their side of the bargain. This was followed by tight restrictions
on new artist signings and marketing budgets, with substantial job
losses planned - some 30% of artists paid an advance never actually
recorded an album and 30% of CDs produced were destroyed because
of poor publicity and low sales. In the past EMI pushed its sales staff
to get CDs into shops, even if many were retumed for refund. Ruthless
cost-cutting addressed excessive mollycoddling of music stars - the
new management objected to EMI spending :fl30 mi1lion a year in a
music division that only makes E60 miUion in profits. Thousands of
artists were dropped from EMI's }4.~OOO~tr.<:>ng roster.
Weeks after the take-over, Hands faced a classic talent business
di1em.ma - whether to re-sign Radiohead, one of EMI's best-known
bands, at a time when sales were falling and he was desperate to cut
costs. Hands made a low offer and Radiohead left amid. enormous
publicity. Critics said Hands just did not understand the music busi­
ness, while others thought he understood it only too well. Radiohead
chose to launch their newest album on the Internet, inviting fans to pay
whatever they wanted for it (which tumed out generally not to be very
much - the average was about f:2.88 and two-thirds of the download­
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and Coldplay started threatening to hold back new albums because of
the uncertainty at EMI, and their managers formed the 'Black Hand
Gang' to organize protests about changes at EMI. Robbie Williams
declared himself 'on strike', putting his album on hold and refusing
to go on tour. The Rolling Stones were looking to move to Universal
after 31 years with EMI (taking their back catalogue with them), and
Paul McCartney and [oni Mitchell opted to launchtheir latest albums
through Starbucks coffee shops. In 2008, it looked like Disney - one of
the rare bright spots in the embattled music industry - wou1d be hand­
ing international distribution to Universal at the end of its contract
with EMI in 2009.
Hands has chal1enged the underlying strategic assumptions at EMI,
and has worked for amajor culture change in the company. He has
even looked at ways for bands to be sponsored, like football teams.
His strategy rests on €290m of cost cuts - with the marketing budget to
shrink from over 20% of total spending to 12-15% - and restructuring
so A&R (the Artists & Repertoire Department) is no longer responsible
for anything other than finding talent, with marketing and promotion
in a new music services division, and finance and legal in a back office
division. He believes EMI has spent too much on existing artists and
not enough on finding new ones. Nick Gatfield - responsible for the
success ofAmy Winehouseand Mika - has been hired from Universal
to run A&R in the USA and Europe. Critics say that Hands' EMI deal
is the classic example of private equity overpaying in a boom, and then
resorting to crude cost-cutting when times get tough.
Interestingly, establishing a centralized marketing function at EMI,
runs counter to practice at the music majors, where marketing is con­
trolled by the individual record labels owned by each company. It is
more akin to the model at consumer goods companies like Unilever
and Procter & Gamble.
His goal is to make EMI the world's most innovative, artist-friendly
and consumer-focused music company, working in a partnership with
artists based on transparency and trust. However, the era of mu1timil1ion
advances has ended, and rewards will be based on sales. When announc­
ing his new strategy, Mr Hands needed two hefty bodyguards to get
into the office. His conclusion on the music business was that: 'History
can teach us: everyone thought the recordable cassette was the end of the
music business - it wasn't - we justhave to re-invent the business model.'
In '2008 Hands recnatedan executive from Google to head EMI's
digital operations. Early signs were a relaxation in EMI's position on
online piracy, with possibilities for advertising-supported music down­
loads and allowing fans to put music from EMI's back catalogue on
their websites. A year after the purchase, with· sales still slipping, art­
ists in revolt, music-industry insiders and bankers believed that Hands
was about to get his fingers bumt. Meanwhile, bankers at Citigroup
were still stuck with €2.5 billion of EMI debt on their books, unsold
since the buyout.
Sources: Loretta Chao and Ethan Smith, 'Google to Strike Back at
Baidu in China', Wall Street Journal, February 6 2008, p. 32. Andrew
Edgecliffe-Iohnson and Joshua Chaffin, 'Hands Seeks to Head Off
Revolt at EMI', Financial Times, January 12/13 2008,p. 15.James Ashton
and Dominic Rushe, 'Help!', Sunday Times, [anuary 13 2008, p. 3-5.
Andrew Edgecliffe-Iohnson and Martin Arnold, 'Hands to Raise New
Equity and Cut Third of EMI Music's Staff', Financial Times, Ianuary 14
2008, p. 1. Paul Sloan, 'Keep on Rocking in the Free World', Fortune,
December 10 2007, pp. 69-72. Andrew Edgec1iffe-Johnson, 'Apple in
Talks to Sell iPod and iPhone with Unlimited Music', Financial Times,
March 19 2008,p. 1.