Mergers for Music Giants?

Two years ago, music business insiders were predicting that the industry's "Big Five" would eventually become the "Big Four," or possibly the "Big Three."

These predictions are nearing fulfillment as the industry enters its fourth year of declining sales. Some major labels have cut their workforces by as much as 20% and are engaged in discussions to merge their operations to salvage what profits remain in the recorded music business.

In early September, Bertelsmann AG's Bertelsmann Music Group (BMG) continued discussions of a joint venture with Warner Music Group (WMG), a division of AOL Time Warner (or, as the latest corporate identity crisis would have it, simply "Time Warner"). The deal would exclude the UK's EMI Group PLC, whose own effort to merge with BMG was blocked by European Union regulators last year on the grounds that it would create a virtual monopoly over the recorded music market in Europe. EMI was also rumored to be preparing a bid for Warner; a previous attempt in January 2000 was also blocked by regulators' antitrust concerns.

By mid-September, talks between Bertelsmann and Time Warner had stalled over a TW demand that the German media conglomerate put approximately $150 million in cash into the deal. As of September 17, negotiators were at loggerheads over the values of their respective companies—WMG's strength is in its back catalog; BMG's in its recent releases—with Bertelsmann representatives reportedly reluctant to pay more than $100 million to seal the deal.

The proposed merger, estimated to be worth somewhere between $2 billion and $2.5 billion, would give the merged entity control of approximately 23% of the global market in recorded music, possibly saving as much as $220 million in marketing and operating costs in the process. An EMI/WMG linkup would yield similar results. EMI has reportedly offered to put $1 billion into such a merger, with Warner taking a 25% stake in the combined EMI-Warner Music.

Bertelsmann executives have debated whether the company should retain any interest in the music business, given the gloomy prospects for the future. "Digital piracy is still showing little evidence of slowing in IT-savvy countries such as Japan and the US," analyst Simon Baker told Annie Lawson of The Guardian. "The risk is in the next three largest markets, in the UK, Germany, and France."

By September 19, Time Warner had accelerated merger negotiations with EMI, while continuing discussions with Bertelsmann beyond an agreed-upon deadline. Disagreements between Bertelsmann representatives and their American counterparts were heated, some reports indicated.

Whichever way merger mania goes, it's clear that the music industry is battling for survival. Universal Music Group's recently announced CD price reductions, while ostensibly a boon for consumers, and a temporary boost to the UMG bottom line, will squeeze profits from already struggling independent record stores. Independent record stores provide subsistence livings for their owners in the best circumstances; with newly narrowed margins many of them won't last. Five years from now, it's likely that only major retailers—Tower Records, Virgin Megastores, Barnes & Noble, Borders Bookstores—will be doing any significant music sales. Such sales will sustain the ever-diminishing majors a bit longer as they make the transition to direct sales over the Internet with its concurrent absence of warehousing and shipping costs.

The irony is that truly direct sales, in which musicians sell directly to their fans, as some already do—completely bypassing traditional distribution deals—will ultimately complete the life cycle of one of the 20th century's most profitable businesses.