Strategy

Never Mind the Music

The music industry has undergone dramatic changes, but the world's big record labels have failed to keep pace. EMI Group, however, reckons its new ...
Janet KersnarFebruary 12, 2004

It was pop-music history in the making. Last summer, as Europe melted in a heat wave, crooner Robbie Williams scorched all records with his three-day sell-out concert at Knebworth, a 15th-century Tudor estate in the English countryside. As part of a 21-date European tour, 375,000 fans packed the concert venue, while an additional 3m people turned on their TVs to watch one of the three live performances. Riding the high of the UK’s biggest-ever concert, EMI, Williams’ record label, quickly released Robbie Williams Live at Knebworth, which became the fastest-selling CD of a live performance in the UK, as 118,000 units flew off record store shelves within the first week of its release in September. A hugely successful DVD followed. For EMI, the cash registers were humming.

So it wasn’t surprising, then, to see CFO Roger Faxon looking relaxed and cheerful, as he whipped through the UK record company’s interim numbers at a presentation in London in November. What the 54-year-old American lacked in Robbie Williams-style glitz, he made up for with happy financial news. The highlight: year-on-year sales in the six months to September 30th at the main recorded music business held steady at £760m (€1.1 billion), despite a 10% industry-wide slide in sales, and outstripped financial analysts’ forecasts.

EMI’s finance chief was clearly pleased to see the pay-off for the long months of hard work, of which the Williams concerts were just a small—albeit dazzling—part. Faxon had completed a successful debt-servicing programme, while also pushing through a tough internal restructuring and cost-cutting regime. What’s more, a bevy of deals with legal online music retailers to give consumers easier access to its digital catalogue of artists—Coldplay, Norah Jones, Radiohead, Kylie Minogue and Paul McCartney, to name a few—was putting EMI ahead of its larger rivals in the race to exploit the latest music distribution channels.

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The November gathering was a far cry from the presentation EMI gave nearly two years earlier. On February 5th 2002, the day EMI announced Faxon’s appointment as group CFO, chairman Eric Nicoli delivered a profit warning and explained how EMI was hurting along with the other music heavyweights—Vivendi’s Universal, Time Warner’s Warner Music Group, Bertelsmann’s BMG and Sony. The boom years were over. The industry’s growth trajectory ended long ago and, starting in 2001, all the big labels had been reporting heavy losses. EMI would end its fiscal year in March 2002 with a decline in group sales of 8.5% to £2.5 billion and in group Ebita of 42.6% to £191m.

The industry’s sin? Was it, as Larry Kenswill, president of Universal Music’s eLabs unit, put it last summer, that “the music industry refuses to acknowledge the public’s perceived God-given, inalienable right to free music”? Probably not. Its woes go far beyond enemy number one—music piracy. Fast-changing consumer tastes, shrinking margins and the general economic downturn were all hitting the music business hard.

Pop Flop

Given that backdrop, EMI’s turnaround seems to have all the makings of a chart-topper. As one industry expert says, EMI might come out of the current slump as the best-managed of the music companies. But just like its rivals, EMI isn’t yet out of the woods. The record labels are still trying to come to terms with the irony that, despite their woes, “music consumption is probably higher than it’s ever been,” says Mark Mulligan, a London-based senior analyst at Jupiter Research. He cites not only piracy in all its forms, but also legitimate downloading, computer games, DVDs and mobile-phone ring-tones among the many ways that music is now consumed.

With the traditional music business not expected to recover for at least another year, theories abound about the future shape of the industry. Some experts predict that the Williams concert is a sign of the times—big revenue streams coming from multi-platform exploitation of mega-star contracts. Alternatively, given that digital downloads are now outselling traditional singles sales, some analysts see the industry moving inexorably towards an all-digital world.

Of Renoir and Radiohead

Faxon learned early on how fast the music business is changing. From the company’s slick, new headquarters in west London’s Kensington neighbourhood, he recalls what he faced back in February 2002: Alain Levy and Martin Bandier, the respective heads of EMI Recorded Music and EMI Publishing, needed help restructuring their businesses. Along with a pile of debt payments that needed his immediate attention, £100m of cost savings had to be found, including cutting nearly 2,000 jobs (20% of headcount at the time) and its roster of artists by 400 (25% of the total). Though hardly radical in other industries, Faxon’s steady focus on these tough cuts had rarely, if ever, been seen among the music majors.

However, with those immediate tasks done and dusted, it’s the longer term changes that will prove more vexing for Faxon. “EMI has been demonstrating good discipline, not just looking at market share, but also at profitability,” observes Trevor Pritchard, a media analyst at Standard & Poor’s. “But to be able to repeat that year after year as [old-line music business] continues to decline is really quite tough.” The challenge for Faxon is to change EMI’s old-fashioned business model to one that can deliver sustained, profitable growth—and do it quickly.

Faxon has been here before. He spent the 1980s in senior marketing and operational roles in the turbulent film industry. While at Columbia Pictures, he found “a business that had lost its creative way and needed to focus on fewer, more creative products.” The solution “was about marketing for everything but the creative, and about how you introduce a product to a broad audience.”

From there, Faxon moved into the cut-throat world of fine art, joining Sotheby’s as managing director of its troubled European arm (well before the once-venerable auction house pleaded guilty to price fixing). “Sotheby’s issue was that the art market was in decline in 1990,” says Faxon. “It was left with an unprofitable European business and, much as [the music] business, it was not focusing entirely on the right things. In their case, they thought their success was based purely on their expertise…which is very important, but it wasn’t what differentiated them in the marketplace.” The key, Faxon saw at the time, was to make Sotheby’s “more extroverted, more outwardly focused, rather than focused on the product alone.” To that end, he copied the example set by Sotheby’s in the US and built up customer service within each of the departments.

All this resonates with Faxon’s work at EMI today. By the time he joined EMI in 1994—as senior vice president of business development and strategy, rising to finance chief of the music publishing arm—he had a good take “on what the business had to look like,” he recalls. “I had that vision for some time, I have to say.”

Until recently, EMI has been pursuing a strategy of industry consolidation—a strategy in which it has so far failed to participate, having lost out on three merger attempts since 2001. In the latest, in early December, EMI was beat in its bid to acquire Warner Music, as a consortium led by Canadian tycoon Edgar Bronfman Jr. swooped in with a $2.6 billion (€2.06 billion) offer. That topped EMI’s cash-and-shares offering by a good $900m. Meantime, Bertelmann’s BMG and Sony signed a letter of intent to merge their US and European music businesses into a 50:50 joint venture. If those deals clear regulators and other hurdles, it will leave 75% of the world’s music market in the hands of just four large groups, while EMI slips to a distant fifth in terms of market share.

Faxon insists that EMI is not sweating its failure to find a merger partner. “From our standpoint, there’s no compelling reason why we need to be involved in industry consolidation,” he says. “The reason to consolidate is to achieve significant savings, and it gives you greater opportunities to make investments more rapidly than you otherwise can. But it doesn’t give you a competitive advantage, it doesn’t help you sell more CDs or move more products off the shelves.” Nevertheless, the Warner deal would have helped cut an estimated $300m of costs.

So, what is Faxon’s vision? “The record business has been focusing on the product and the product alone. But the reality is that it isn’t just about the music. It’s about how you get the music to consumers, how you get consumers excited about a product. It might not seem like a big leap, but the conceptual shifts are massive for our business,” he explains. “My view is that we must be consumer facing. It doesn’t mean that we have to be any less creative, but we have to understand how [our business] fits into the consumer context. It no longer works to say: ‘If we make great music, they will come.’”

Yet knowing what works has confounded the big labels, most obviously in their efforts to come to terms with digital music technology. “All the record labels have been quite slow to accept that consumers don’t care where they get their music from,” asserts Rebecca Ulph Jennings, an analyst at Forrester Research. On top of that, she says, the labels badly misjudged the appeal of Napster, the online music file-sharing pioneer, and the many clones it has spawned since the industry shut it down in 2000.

The music industry’s plan recently has been to battle rather than embrace the shift to a digital marketplace—going so far as slapping lawsuits on individual music downloaders in the US, starting with a terrified 12-year-old girl in New York City. A PR disaster, insist many observers. But the record labels are unrepetent, and last month announced that their clampdown will now expand to Europe. But with or without the record labels, downloading is a hit with consumers. Forrester Research, for example, says that file sharing is responsible for nearly $700m of the $2 billion fall in CD sales since 1999.

Can’t Beat ‘Em, Join ‘Em

A glimmer of good news for the big labels arrived in the form of numbers showing that more and more consumers are paying for downloaded music. Late last year, while Nielsen NetRatings in the US was reporting that downloads via Kazaa—the biggest of the free file-sharing networks—had dropped from a high of more than 17m unique users a month in March to 7.6m in October, Apple Computer announced that its new legitimate fee-based service, iTunes Music Store, sold more than 25m songs in its first eight months.

It’s here where EMI reckons it is ahead of the pack. Faxon says that in the last four years, EMI Music has signed more than 70 licence agreements with various digital music companies and was the first label to issue licences to online music-subscription services MusicNet and Pressplay. Last spring, it also announced a major agreement with 20 European retailers to sell thousands of its artists’ music via their websites. It further expanded options for consumers by allowing legitimate copying onto portable players and burning music onto CDs. The message from EMI is clear: It is ready to support any legitimate digital distributor, whatever the format or channel.

Yet it’s questionable whether this will be enough to give EMI the boost it needs. Mulligan of Jupiter Research, for one, doesn’t believe it can. “Digital is not about to save the music industry, and digital is not about to replace the CD,” he asserts. “What it does do is help to stop the slide of sales.” In the US, Jupiter forecasts that overall digital sales will account for 12.5% of total sales by 2008, and in Europe for 5%.

Faxon is much more optimistic about EMI’s digital prospects “You have to believe that the business will evolve incrementally into a digital distribution model,” he says. “We think in five years, approximately 25% of our business will be digital, even more in some territories.” Yet this won’t include moving into digital retailing. “We’re a content business, and a content business that has to excel with respect to how we develop the product, and excel in its understanding of its consumers so that we can properly market that product. What we are not—and we have taken this view for a long time—is in the business of being the consumer interface.”

So where to go from here? Faxon says he’d like to see EMI tightening its grip on digital technology further. “We believe this business has to be digital from beginning to end,” he says. “We record digitally and service consumers digitally, but what happens in between is anything but digital.”

Echoing Faxon, John Jordan, a principal at Cap Gemini Ernst & Young, writes in a 2003 white paper: “Rather than start with the existing distribution model and attempt to digitise it, the labels have the opportunity to be the first big content industry to adapt to the rapidly emerging customer base.” The question Jordan poses is: how can they move beyond pure broadcast and mass distribution models to “use peer-to-peer dynamics to spread word-of-mouth recommendations, for example, or move content faster than any existing supply chain”?

To this end, EMI is investing £75m in new technology over the next four years. Some of that investment will be for general upgrades and consolidation of back-office IT infrastructure. But EMI is also buying into new technology that will, for example, allow it to “digitise” the production of product packaging, and set up a massive rights database to tailor rights offerings for individual clients. The company expects to see cost savings from those investments as early as next year, and estimates that they will be between £20m and £25m a year starting, in 2006.

All this should ultimately help EMI achieve greater flexibility and “a completely different focus on consumers, one that gives EMI the ability to offer music in any number of formats,” Faxon says. Even so, he adds, “there is not going to be, in my view, a single model for the way in which consumers will behave. Right now downloads are the thing that people are looking at.”

In the Groove

Beyond the digital revolution, however, there’s arguably a much more profound transformation going on at EMI. As Faxon explains, during the growth years of the 1960s, ’70s and ’80s—”when we were cash machines”—EMI was like all the other record companies, “putting employees first, then the artists and finally the shareholders.” His aim since becoming group CFO has been to turn that perspective around, so that “shareholders come first, then the artists and then the employees. It changes the way we think. If you take the shareholder view, that means you’re looking at long-term value growth.”

And that means looking at profitability. “It’s a very simple concept: We want profitable sales,” he says. “The industry—including this company before Alain [Levy was appointed CEO of EMI Recorded Music in 2001]—was focused on how do you build market share. Well, how do you build market share? You spend a lot more money, on the marketing of the releases, on videos and so on. You can take it to such an extreme that you could almost do better without the sales.” Hence EMI’s decision to put an end to that cycle in 2002 and “reduce sales by 10% in the first year of our plan—basically taking 10% of unprofitable sales out of our release schedule.” One high-profile victim of EMI’s quest for profitability: Mariah Carey. She received a $30m payoff to break her $100m contract with EMI after a disastrous album release in 2001.

And of course, EMI wants to get as much revenue as possible from the artists it has kept on its roster. Shortly after Carey’s contract ended, EMI entered into one of the biggest deals ever seen in the UK record industry when it renewed its contract with Robbie Williams.

At the time, rumours were rife that the 30-year-old singer, who had been with EMI since 1996 and had sold over 20m albums, was thinking about leaving the label. When a contract was finally signed in October 2002, EMI crowed that the deal was ground-breaking, giving the label a stake not only in Williams’ recording but also, unconventionally, in non-recording activities—including touring, publishing and merchandising. “What we negotiated was the ability to participate in the Robbie Williams ‘company,’ and that’s been very successful for us,” says Faxon.

Though EMI refuses to divulge the details of the contractual agreement, it did say when the deal was announced that the value of the contract was “way south” of the £80m figure had been bandied about by the press, and it has confirmed that Williams would have to sell 3m units of each of the six albums agreed to under the contract in order for the company to break even. So far, so good—his first album, Escapology, sold 6m units.

EMI is so pleased with the arrangement with Williams, says Faxon, that a number of other artists—largely in Asia—have signed similar deals. “It won’t change the nature of our business over the near term but it will over time, and it’s important to do so [in order to] keep the revenue streams expanding.” And that’s the new tune they’re singing at EMI.

That’s Entertainment
Market shares for the five big record labels and the independents, 2002 (the latest available figures).
EMI BMG Sony Universal Warner Indies
North America 8.9% 13.6% 14.7% 32% 14.9% 16%
Europe 16.6% 10.9% 12.9% 27.3% 11.5% 20.8%
World 12% 11.1% 14.1% 25.9% 11.9% 25%

Billboard, Top Music Hits
Events that have shaped the music industry, 1994 to 2004.

  1. Piracy
  2. New—MP3 Players and Digital Devices
  3. Non-Music Retailing
  4. Touring
  5. Consolidation of Broadcasters
  6. New—DVDs
  7. MTV
  8. Re-Entry—Contract Disputes

Sources: Cap Gemini Ernst & Young; CFO Europe