Media conglomerates

Tangled webs
May 23rd 2002
From The Economist print edition

Columbia Journalism Review tracks media ownership.

Massive, widely spread media groups are in disgrace. But
their strategy can work—if spun in the right way

SUMMER in Hollywood begins with the race for the season's
blockbuster. This year there are two contenders: “Star Wars:
Episode II—Attack of the Clones”, which took $80m in America on
its opening weekend; and “Spider-Man”, which sold a
record-breaking $115m-worth of tickets in its first three days in
America. As the action figures and lunch-boxes are swept from
shop shelves in the inevitable Star Wars and Spider-Man crazes,
this pair of films might look like typical products of the mighty
marketing machines that lie at the heart of today's media
conglomerates.

Yet, oddly, both were released by media groups that do not fit
strictly inside the conglomerates' inner sanctum. Sony, whose
Columbia TriStar made “Spider-Man”, may be a films-to-electronics
giant, but it lacks any of the American broadcast, cable or
Internet distribution that are held to be critical to the promotion of
content these days. “Attack of the Clones”, though distributed by
20th Century Fox, part of a conglomerate, was made by LucasFilm,
an independent studio.

These successes from outside the core media conglomerates come
at a time of revived scepticism about the very notion of such
integrated groups. A couple of recent headlines sum up the mood:
“Big Media Mergers Raise Big Doubts: Is ‘Synergy' Achievable—or
Even Desirable?” (the Washington Post); and “The Big Fix:
Suddenly, the turn-of-the-millennium lust for media-world
consolidation seems absurd” (New York magazine).

Part of the disillusion reflects gloom over the groups' share prices.
The markets have battered the media giants, taking aim
particularly at AOL Time Warner and Vivendi Universal (see chart).
Each of these has had to make vast write-downs of assets bought
at inflated prices at the height of the media and Internet bubble.
Shareholders who turned up to last week's AOL Time Warner
annual meeting—at which Jerry Levin, the man who engineered the
merger of Time Warner with AOL in January 2000, handed over to
Richard Parsons—were livid. “We were conned,” fumed one.
Investors in Vivendi have given its boss, Jean-Marie Messier, an
even harder time. Its American shareholders mutter darkly about
whether he has a future in his current job.

Another part of this growing
clamour is to do with
inflated expectations about
the potential of these
groups. The disillusion is
embodied by AOL Time
Warner. Two years ago,
when AOL cleverly took
advantage of its
extravagant share price to
combine with Time Warner,
Mr Levin proclaimed “a new
paradigm” in media. It was
not just the addition of a
small new-media distribution
channel to a vast group of
old-media assets, but a
fusion of equals to bring about a redefinition of media itself.
Today, the contribution of AOL to the group is put somewhat
differently. In Mr Parsons's first speech as the group's new boss,
he identified his first priority: revitalising and turning round the
troubled AOL.

Mixed in with the current blaze of short-term negative publicity
about media conglomerates is a more general questioning of their
longer-term purpose. There is a sense that the concept of an
integrated media group, rather than just the price paid to build one
up, is no longer right. Some industry observers have begun to
wonder whether groups such as Vivendi, so painstakingly and
expensively pieced together, would not be better off broken up.
This week Libération, a French newspaper, reported that some of
Vivendi's French board members were considering promoting just
such a plan.

Inflated expectations

Yet it is essential to distinguish between the broad idea of putting
content and distribution together, and the specific way in which
some of the troubled media giants have done it. Of the six big
groups—AOL Time Warner, Vivendi, Viacom, News Corporation,
Disney and Bertelsmann—and the one hybrid—Sony—the first two
have been the most criticised. They are also the pair that
embraced new media most enthusiastically. Overestimating the
transforming force of new distribution platforms has been the
source of much disillusionment.

AOL Time Warner's folly was to have both overhyped and
underdelivered. As Mr Parsons put it last week: “We've learned the
lesson of overpromising.” Adding the distribution outlet of AOL to
the entertainment businesses—Warner Brothers film and television,
Warner Music, Home Box Office's television series and films, Time
Inc magazines—was not in itself foolish. AOL, after all, has 34m
subscribers whose eyes tend to fall on whatever content is parked
on the service provider's home page.

What was foolish, however, was to make such heroic claims for it.
AOL was supposed to inject new-media dynamism into what were
seen as frumpy old businesses, such as TV shows or music. With
revenues in 2001 of $8.7 billion, just 23% of the group's total, AOL
has turned out instead to be just another distribution channel:
handy to have, certainly, but not in itself revolutionary.

This is not to say that AOL delivers no promotional punch. When
Warner Brothers released the first “Harry Potter” film last year, it
was an instant success, helping to propel the studio to the top of
the Hollywood league table. At the time, AOL ran promotions and
competitions on its websites, designed to supply tantalising extras
to AOL “members”. The same will happen next month, when
Warner Brothers releases “Scooby-Doo”, a
part-computer-animated film based on a classic animated TV
series.

Just as with “Spider-Man” and the latest “Star Wars” movie,
however, these films were “pre-sold”: everybody knew about them
before they were made, let alone released. A better test of what
AOL can really bring to the party is whether it can lift a mediocre
piece of content. “Cats & Dogs”, for instance, a forgettable
part-animated children's film that Warner Brothers released last
year, might have sunk into obscurity had AOL not picked it up and,
as Bob Pittman, the group's chief operating officer, puts it, “turned
the firehose” on it. AOL stuck images and news about the film on
its welcome screen and devised competitions and games around it.
The movie made a respectable $93m at the American box office.

Nowadays the heads of all the various bits of AOL Time Warner
meet every fortnight to discuss ways of co-operating, and a
helping hand from a sister division is more readily secured. Such
extra promotion is not a bad outcome of the merger. But it is a far
cry from the dazzling force for innovation and transformation that
was once promised.

A similar case of heroic futurology afflicted Vivendi's Mr Messier.
Parts of the conglomerate that he built up—in publishing, films,
music and pay-TV—fit nicely into the traditional model. But what
captured Mr Messier's imagination was the idea of combining his
first-class entertainment businesses with his European-based
interactive television, mobile-telephone and Internet portal
operations, to provide a dizzying new multi-media experience. A
track from Eminem or Shania Twain, say, released on a group
record label, would be zapped to a mobile telephone; a clip from
the group's latest Universal movie downloaded to a handheld
device.

One day, some of this might actually happen. But for now Mr
Messier has gathered an incomplete set of assets. Not only is it
entirely unclear what the group's sewage-treatment and utilities
businesses deliver to the mix; but the new-media distribution
channels have also yet to prove their usefulness. It has been hard
enough to persuade users to pay for music online, let alone via a
portable wireless device.

For all these shortcomings, the troubles with new media at AOL
Time Warner and Vivendi do not by themselves undermine the case
for media conglomeration. This is because, if unleashed
appropriately, two potent forces apply particularly strongly to the
media industry: economies of scale and vertical integration.

The force is with you

The first force works with media because, unlike toothpaste or
cornflakes, there is little extra cost in distributing a piece of
content to 10m viewers or to 5m. As Christopher Dixon of UBS
Warburg, an investment bank, argues: “The media business is all
about the ability to spread the cost of content across as broad a
distribution network as possible.” Once the cost of making a TV
show has been recovered, the revenue gleaned from anybody else
who can be persuaded to watch it flows straight to the bottom
line.

That is why American broadcast networks have been so keen to
create or to acquire sister cable channels on which they can
repackage their content. Such channels helped News Corporation,
for instance, to draw bigger audiences to “24”, a cleverly crafted
drama series set in a counter-terrorism unit. Made by Fox
television and aired on the Fox network, the series is repeated
throughout the week on FX, Fox's cable channel. The principle also
applies internationally. MTV, for instance, owned by Viacom, has
already attracted its best-ever American audiences to “The
Osbournes”, an oddly compelling reality-TV show depicting the
baffling antics of a former heavy-metal singer and his family. MTV
now plans to show the hit series on its channels around the world.

Moreover, scale helps a media group to afford the escalating cost
of content. The more the industry is driven by the need to create
hits and brands that stand out from the crowd, the more crucial it
is to be able to afford the sort of content that will catch the eye,
or lure the subscriber. The collapse of several small European
pay-TV operators recently, partly under the cost of the rights to
movies and sport, only underlines the disadvantages of being
small.

The second force is the clout that comes from putting together
content and distribution. If any company controls enough of both,
it can promote its own content and control access to other
people's. In the everyday negotiations that take place over the
lunch tables of Beverly Hills or mid-town Manhattan, such leverage
can crank up bargaining power. A network, for instance, might
agree to buy a TV series for another year from a television
production company, but only if that company's sister cable
channel buys a couple of films from the network's sister Hollywood
studio.

Without such power,
independent content makers
find it hard to get their stuff
on air. Writers, for one, now
have far fewer doors to
knock on. Fully 70% of all
spending on American
screenwriting is done by six
media giants. Solo
entertainment groups fear
exclusion. Sensing the
danger, EMI, an
independent British record
company, has in recent
years twice tried and
failed—each time on competition grounds—to merge with a record
company belonging to one of the conglomerates. It is now losing
market share. Part of Vivendi's trouble today is precisely that it
lacks a decent distribution channel in America.

More than this, a vertically integrated company can, if cleverly
managed, transform a creative business into an exercise in brand
management. Disney pioneered the practice, turning animated films
such as “The Lion King” and “Toy Story” into lucrative product
lines pumped through various distribution channels. When Warner
Brothers releases “Scooby-Doo”, all the bits of the group will swing
behind it: the Cartoon Network will run old episodes; new episodes
will be shown on the WB network; and the soundtrack will be
released under a Warner Music record label. Already, the
entertainment division has been staging “live” Scooby shows.

Bertelsmann's boss, Thomas Middelhoff, has reorganised his
company's structure precisely to capture these benefits. The
group has a “chief creative officer”, whose job is to promote
cross-fertilisation; it awards “synergy” prizes each year; and it
runs “universities” to help managers dream up ideas together.

One of its current successes is “Pop Idol”, a TV talent contest
judged by viewers. Its format was devised by Fremantle Media,
Bertelsmann's production house; the winner secures a recording
contract with BMG, the group's record company; and the series is
expected to be shown in Germany on Bertelsmann's broadcaster,
RTL. After taking Britain by storm, the show is due to be seen in
America this summer. “The question no longer is whether
co-operation among the divisions makes sense,” says Ewald
Walgenbach, Bertelsmann's chief operating officer, “but only how
great the advantages from such co-operation can be.”

Not all in the family

There are nonetheless limits to the advantages of media
conglomeration. Crudely, they fall into three categories. The first
is that exclusive favouritism can be counter-productive. The
supplier of good content wants to get it in front of the best
audience available, which is not necessarily the one that happens
to be accessible to the same media group.

Warner Brothers Television, for instance, shows “Friends”, its hit
comedy series, on the mighty NBC (owned by General Electric),
not on its own far smaller sister network, the WB. Even “Pop Idol”,
Bertelsmann's favourite synergy example, was shown in Britain not
on Channel Five, a broadcast channel that the German giant
controls, but on ITV, a rival channel that has far bigger audiences.
Equally, a distributor cannot afford to supply only content made
in-house. No user of AOL Music, for instance, an online music
service, wants to be limited to music recorded only on Warner
Music labels.

The second limit concerns businesses whose raw material is
editorial opinion. In theory, magazines or newspapers sound like
natural marketing outlets for content produced by a sister division.
AOL Time Warner, for instance, owns Time Inc, whose titles
include Entertainment Weekly and Teen People as well as Time
and Fortune. Yet the credibility of such magazines would be
undermined were they seen as a promotional tool.

For this reason, Time Inc, under its exacting boss, Don Logan,
jealously guards its editorial independence, as do publications
belonging to Bertelsmann's Gruner + Jahr. Indeed, some of the
fiercest editorial criticism can come from these groups' own
publications. “The Mess at AOL Time Warner” was the title of a
harsh look at its parent company that appeared in a recent issue
of Fortune magazine.

The third constraint has to do with the nature of creativity and
size. The big Hollywood studios and their sister TV production
houses may have the budgets to afford the special-effects films or
glossy, well-crafted series that European content-makers would
die for. But there are drawbacks to scale too. Independent
screenwriters argue that creativity has been stifled now that the
broadcast networks have been swallowed up, with production
houses, into giant conglomerates. “The vital marketplace of ideas
is paralysed by a system of preferential treatment”, argued a
recent report by the Writers Guild of America. Some media bosses
are beginning to raise the same question. Peter Chernin, the
president of News Corporation, put it forcefully earlier this year:
“All the benefits of size, whether it's leverage, synergy or scope,
are fundamentally the enemies of creativity.”

Hollywood studios have tried to manage this by allowing
autonomous boutiques to flourish within their conglomerate
structure, designed to nurture a more creative, less formulaic,
spirit. It is a pattern that has characterised creative industries
throughout their short history as mass-entertainment media. The
record industry has for years been built on this model: small
independent labels (such as Island Records), which are better at
spotting new artists, are bought by the big guys (in its case
Polygram, now part of Universal), which then begin the search for
small independents again. It can work in TV too: HBO is given
freedom within AOL Time Warner, for instance, to create
challenging new drama, such as “The Sopranos” and “Six Feet
Under”.

This solution may sometimes work well. Indeed, some of the most
ground-breaking drama now comes from television companies
within conglomerates. It does not necessarily help spread the risk,
however. In television, for instance, the broadcast networks used
to share the cost of developing new shows with separately owned
production houses. In a year when an increasing number of pilots
have been developed in-house, the broadcast networks are not
only relying more on the creativity of their sister studios, but are
shouldering more of the financial risk. Most of the pilots now
produced for Disney's ABC network, for instance, have been made
in-house. So Disney is trying to turn round the fortunes of its
lagging broadcast network, which has struggled since “Who Wants
to Be a Millionaire?” fell in the ratings, largely at its own expense.

For all the constraints of operating within the media
conglomerates, life in the entertainment industry remains
extremely hard for those stuck forever on the outside. Over time,
the media giants, as they have grown, have managed to renew
their creative vigour by constantly hoovering up new, independent
companies as they emerge—and trying to preserve their creative
spirit thereafter. These days, any independent content-provider
that does not somehow hook into this structure will struggle to be
noticed. And what's the point of creative brilliance locked in a
distributor's bottom drawer?

The hits that media conglomerates manufacture may not always
qualify as great contributions to world culture. But in an
entertainment business which is increasingly fed by such hits, the
conglomerates will usually be best-placed both to create and to
exploit them.