One of Middelhoff's new acquaintances--S.I. Newhouse Jr.--sold him
Random House. It has been reported that a chance encounter at Newhouse's
70th-birthday party set negotiations in motion, but the facts are more
prosaic. Newhouse was shopping his publishing house around, talking to
Time Warner (the parent of FORTUNE's publisher) and News Corp., among
others, about either a merger or partnership. When Newhouse went to see
Bertelsmann, Middelhoff made it clear from the start that he wanted all of
Random House, which is considered the crown jewel, if not the profit leader,
of publishing. An executive familiar with the negotiations says: "Although
he's gracious and extremely polite, Thomas knows just where he wants to go
and exactly how he wants to get there."
But why did Middelhoff place such a big bet on books at a time when other
moguls were pulling back? That remains a mystery to those who see trade
publishing as a low-margin, no-growth business that's not very businesslike
at all. The number of trade books sold has actually declined slightly since
1992, although publishers' revenues have grown by about 3% annually
because of price increases, according to the New York-based Book Industry
Study Group. More fundamentally, publishers are caught in a squeeze
between writers and retailers. Best-selling authors command bigger
advances. And the consolidation in retailing means that megachains Barnes &
Noble and Borders Inc. are capturing a bigger share of the sales price of
each book. "We're funding the whole business, but we're not getting a
reasonable return on our capital," says Laurence Kirshbaum, president of
Warner Books. "The business has really been out of kilter." What's more,
Manhattan book editors tend to be underpaid literary types who don't fret
much about the bottom line. You can see why some owners want out.
No matter--when run right, book publishing can be a solid business, albeit a
mature one. "Can Bertelsmann make money in books? Absolutely," says
Michael J. Wolf, senior partner for media at Booz- Allen & Hamilton, who
has advised Bertelsmann and other publishers. "This is a very aggressive
company with a very aggressive culture." Bertelsmann's North American
publishing units have been generating margins of 8% to 9%, often exceeding
the companywide financial targets, according to Peter Olson, the chairman
and CEO of the new Random House Inc., who formerly oversaw Bantam
Doubleday Dell. The newly merged publishing operation, with estimated
revenues of $1.5 billion, should do as well if not better through economies of
scale: cutting overhead, consolidating warehouses, merging back-office
functions, improving information technology, and perhaps thinning the sales
force or executive ranks. There should be room for cost cutting; before the
merger, the old Random House employed twice as many people as Bantam
Doubleday Dell to generate only about 30% more in revenues.
Olson, 48, a low-key former lawyer and banker with undergraduate,
business, and law degrees from Harvard, won't say much about his strategy,
but he will say that being bigger and leaner is better. "If you combine scale
with a very efficient infrastructure, you can have a better-margin business
than a small or medium-sized publisher," he says. But even a bulked-up
Bertelsmann will command no more than a 15% market share in trade-book
publishing; that's not enough to force writers or retailers to make structural
changes in the business.
That means the business will be mostly about execution. Bertelsmann's done
well in that regard, keeping its returns of unsold books, for example, well
below the industry average, which is a stunning 36%. (Returns cost
publishers lots of money.) For the most part, its publishers have also avoided
overpaying wildly for books that flop. While Olson says he won't impose
across-the-board reductions in titles or imprints, history suggests that
Bertelsmann will bring some business discipline to free-spending Random
House. Look at Doubleday, which gradually cut its annual list from about
600 to 350 books after being acquired by Bertelsmann. And while Olson,
who's fluent in Russian and German, likes to talk about his love of literature,
he's a decidedly pragmatic executive. "These are nonbook business people
running book publishing as a business," says an industry bigwig, who counts
himself among Bertelsmann's admirers. The trick for Olson and his people,
who thrived by selling mass-market books at Bantam Doubleday Dell, will be
to tread lightly as they assert control at Random House. The Knopf imprint,
in particular, excelled at the more delicate business of investing in literary
authors, building their careers, and awaiting a long-term payoff. Some
authors don't become moneymakers until their third or fourth book is
published.
Beyond that, Middelhoff is betting that technology will give bookselling a
boost. "If you accept the argument that content is king in the digital age, why
is that true for movies and music but not for books?" he asks. "You can
distribute books physically, by direct mail or E-commerce, but in the future,
also, why not digitally?" Already there are signs that online booksellers like
Amazon are driving backlist sales, which are more profitable than sales of
today's books. Just as cable movie channels created new markets for old
movies, the Internet could help unlock the value of the 20,000 or so titles on
the gold-plated Random House backlist, which includes literary giants like
Thomas Mann, Jean-Paul Sartre, and William Faulkner, and kids' favorites
like Dr. Seuss and Richard Scarry, as well as the entire Modern Library
collection. Long term, Middelhoff sees a growing market for those books
among the expanding middle class in Eastern Europe and Asia, who will
build up their libraries just as Germans did with their book clubs after
World War II. Through a new venture capital fund, Bertelsmann also owns a
stake in NuvoMedia, a Palo Alto startup that launched its line of electronic
books in October. That, too, could prove to be a cost-efficient way to
distribute books.
Bertelsmann's other big U.S. business is music, which, even more than book
publishing, will pose a challenge for Middelhoff. The good news is that BMG
Entertainment, the company's music arm, has grown rapidly in recent years;
its U.S. market share of current albums, a key benchmark, has climbed from
12.1% in 1993 to 13.9% so far this year, while revenues have grown from
$3.2 billion to $4.4 billion in fiscal 1998, well ahead of industry averages.
But rising talent costs, the consolidation of retailers, and economic woes in
Asia have combined to squeeze BMG's margins, which have slipped below
the company's targets. "We have only one objective with BMG," says
Middelhoff, direct as usual. "We have to improve its profitability."
The man in charge is Strauss Zelnick, 41, who, like Olson, has a law degree
and an MBA from Harvard as well as the managerial discipline to control
spending in an industry known for extravagance. "We don't have jets and
penthouses and corporate retreats and big expense accounts," he says. Since
joining BMG in 1994, Zelnick, formerly CEO of computer-games maker
Crystal Dynamics and president of the 20th Century Fox film studio, has
learned the music business in a hurry. He has reduced the head count by
nearly 20%, cut overhead, and told his labels to release fewer CDs. "The
strategy is not to throw lots of things against the wall and see what sticks, but
to focus on acts we really believe in, persevere, and make it work," he says.
And while Bertelsmann is known for its long-term thinking, Zelnick has
acted swiftly when necessary: Two years ago he fired the CEO of BMG's
music club and personally retooled the unit when operational problems and
rising direct-mail costs reduced profits. Decentralization has its limits.
More often, though, Zelnick leaves creative decisions to those running his
record labels. Nowhere is that truer than at Arista Records, the domain of
legendary music executive Clive Davis, who acts as if he still owns the
company he founded in 1975. That's fine with his nominal superiors because
Davis, at age 65, still has great "ears." The man who signed Janis Joplin to
her first record contract 31 years ago still discovers new acts and matches
pop divas like Whitney Houston and Toni Braxton with the songs they
record. "It's a one-man show," says a former Arista executive. "It's way
beyond egotism, but Clive is supersmart, and you can't argue with his track
record." Davis also manages BMG's joint ventures with producer Babyface's
LaFace Records and producer Sean "Puffy" Combs' Bad Boy Entertainment,
which have put the gentlemen from Gutersloh at the forefront of hip-hop
music.
RCA Records is thriving, too, after a long drought. (It was ridiculed for
years as the Record Cemetery of America.) CEO Bob Jamieson, a former
Polygram and CBS Records executive whose roster includes Dave Matthews,
Verve Pipe, and Natalie Imbruglia, says working for privately held
Bertelsmann lets him build long-term franchises and not worry about
short-term results. "Sometimes Wall Street, and the drive to increase stock
value, is not compatible with the creative process," Jamieson says.
"Unfortunately, some companies will rush a product to market to make a
splash in the next quarter."
That's all well and good, but music as an industry has stalled. Worldwide
demand has grown by just 2% a year for the past three years, and it isn't
likely to pick up anytime soon. The CD boom is over, and no new
technology breakthrough is on the horizon. "The industry, in its current
form, will probably never be able to return to the high-margin days of the
early 1990s," says Michael Nathanson, an industry analyst with Sanford C.
Bernstein.
This isn't just worrisome for Bertelsmann--it's bad news for Zelnick and his
team, who, like all company heads at Bertelsmann, get bonuses strictly tied to
the profits of their units. This strips a lot of politics out the company, they
say. "My executives can tell me to buzz off, but they still get their bonuses if
they make money for the company," says Zelnick. It also helps account for
the fierce independence of the units, which refuse to sacrifice their own
earnings to deliver corporate synergy. Bertelsmann's Sonopress, for
instance, is a major manufacturer of CDs, but the Bertelsmann record
companies order about 35% of their CDs from competitors. The same
dynamic operates among Bertelsmann publishers, printers, and book clubs.
"The negotiations between Bertelsmann companies are renowned for being at
least as adversarial as those with our competitors," Olson says. The absence
of central planning can lead to some absurdities: Bertelsmann's German
magazine, Stern, has distributed software for Deutsche Telekom's T-Online,
the major competitor of AOL Germany, which is half-owned by
Bertelsmann.
Middelhoff thinks the company has allowed decentralization to go too far.
"We need a little more cooperation," he says. This is especially important to
Middelhoff because he is counting on online services, electronic commerce,
and global expansion to drive Bertelsmann's growth, and the Internet tends
to erode geographic and industry boundaries. One example: AOL operations
in France, Germany, and the U.K. will be prodded to work closely with
Bertelsmann's E- commerce venture, Books Online, which is about to launch
in Europe. Similarly, Bertelsmann book and music clubs, which operate as
independent fiefdoms, will be encouraged to share membership lists and
marketing plans as they migrate their businesses to the Internet. In time,
Middelhoff wants to expand all of the company's businesses in Asia, which he
says will be the next frontier for his generation of leaders, just as the U.S.
was the battleground for Wossner. "A media company in this competitive
landscape has to be more global," Middelhoff says. "You have to grow."
So Middelhoff won't be spending lots of time in Gutersloh, even after he
settles in as CEO. In fact, he's busy right now looking at New York real
estate--he wants to buy an apartment since he plans to spend one week a
month in the city. (He's found that he can leave Gutersloh late in the
afternoon, take a private plane to Paris, hop on the Concorde, and arrive in
Manhattan in time for dinner.) Bertelsmann, meanwhile, is in the market for
a new building in Times Square, near its current office tower on Broadway
and 45th Street. The idea is to consolidate the old Random House with
Bantam Doubleday Dell, BMG, possibly the book clubs--and who knows
what else? When Middelhoff called FORTUNE as this issue went to press, he
had just come out of an all-morning negotiating session in New York. Yes,
another deal's in the works, he confided, but he couldn't say what it would
be.
{BOX}
BERTELSMANN: A LOOK AT THE BOOKS
No. 3 among the media giants... Revenues in billions, past fiscal year
TIME WARNER $24.6
DISNEY $22.5
BERTELSMANN* $15.2
VIACOM $13.2
NEWS CORP. $12.8
the company is betting on print... Revenues in billions
Books* $4.1 Magazines & newspapers $2.8 Music $4.4 Industry $1.9 TV &
radio $1.5 Multimedia $0.4
and on growth in the U.S.
U.S.* 31%
Germany 31%
Rest of Europe 30%
Other 8%
*Fiscal year 1998, does not include Random House acquisition.
Quote: With the acquisition of Random House last spring, Bertelsmann
became the largest trade-book publisher in the U.S. Ventures with producers
Babyface and "Puffy" Combs have put the gentlemen from Gutersloh at the
forefront of hip-hop. Middelhoff persuaded a reluctant Wossner to buy 5%
of America Online in 1995. Now they wish they'd bought more. Bertelsmann
is averse to debt, skeptical about synergy, and unaffected by Wall Street--not
your usual media giant.
COLOR PHOTO: PHOTOGRAPH BY GERARD RANCINAN--SYGMA At age
45, Middelhoff is the first baby-boomer CEO of a media giant. {Thomas
Middelhoff} COLOR PHOTO: SUZANNE OPTON Olson loves books, but he's
unsentimental about the need to cut costs and fatten margins. {Peter Olson}
THREE COLOR CHARTS: FORTUNE CHART {Chart not available--bar graph
comparing revenues of Time Warner, Disney, Bertelsmann, Viacom, and News
Corp.; pie chart of revenues of various divisions of Bertelsmann; pie chart of
projected growth of Bertelsmann in U.S., Germany, Europe, and elsewhere}
COLOR PHOTO: SUZANNE OPTON Music chief Zelnick runs a tight ship in a
business known for excess. {Strauss Zelnick} COLOR PHOTO: GERARD
RANCINAN--SYGMA Wossner, who made the company a force in the U.S.,
stepped down at 60. {Mark Wossner} |
