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BMG ENTERTAINMENT CASE ANALYSIS #33993210 June 1st, 2012 Major Changes Ahead In 1999, the global music

c industry was confronted with some major changes that posed a serious threat to the major record companies who had ruled the industry for several years. The way the industry had traditionally been run before was changing due to the Internet and other new digital technologies. The Internet put the record companies in a disposition and it posed a serious threat to their future operational and financial success. Historical Structure of the Music Industry A small number of record companies have always dominated the music industry since its inception at the turn of the century. One of the main reasons for this during the early development of the industry was because of intellectual property. Edison, Columbia and Victor all had patents on various recording devices and types of discs or cylinders on which the recordings could be recorded and played back. In order for any new firms to enter the industry, they would have to create and manufacture their own media. The initial strategy of Edison, Columbia and Victor was to produce and distribute records in order to market and sell their phonograph machines. In the early years of the music industry record companies had developed relationships with music publishers in Tin Pan Alley, an area in lower Manhattan where music publishing became centralized. Composers and lyricists were hired to write catchy lighthearted songs that would appeal to the mass market. By the 1920s, these firms shifted their focus to sell records as the primary product and not the machines. Recording royalties was the main revenue stream in the music industry. The Great Depression brought on a series of mergers and acquisitions within firms in the industry that resulted in creating three of the five major music companies that were still doing business in 1999. In 1999 the music industry was on the verge of a dramatic technological change: the Internet. The music industry was already feeling the impact of the Internet as music sales had slowly begun to move away from brick and mortar stores to online retailers. Some entertainers, such as Public Enemys Chuck D, saw the threats to these firms and forecasted that it was possible that the Internet could eliminate the need for them entirely.

There are several barriers to entry into the traditional music industry. First, it is very capital-intensive because a potential new entrant would need to establish its own manufacturing and distribution networks in order to get its products to the public. New entrants would also need to compete with established companies for top-tier, high profile performers. Without top-notch talent, it would be difficult for these companies to obtain shelf space in retail stores. A new company would also need to establish connections with radio and television programmers to get its music and videos played in order to promote sales. Finally, the risk of loss that is prevalent in this industry could be especially perilous for a new entrant: established companies report that only about 20% of recordings recoup their costs. Despite these barriers, a company that feels it has a strong pool of talent in a particular niche might choose to enter the industry, either with the intent of remaining independent or in hopes of being bought by a larger company and absorbed as a label within that company. The other impact of the structure of the traditional music industry is that it has a strong influence on the way rivalry among companies is manifested. Rival companies do not compete based on price; competition is usually based on the artists that the company signs. A&R is out scouting for the next best artist for their label and so there is no direct competition between one firm and the next. Therefore, the rivalry is based on the ability to attract and sign high-profile performers and lock them into contracts in order to produce hit records that sell to the public for several years. The Internet - Threats & Opportunities Strauss Zelnick (President and CEO) and Kevin Conroy (VP of worldwide marketing and new technology) of BMG Entertainment had to figure out the best way to strategize, organize and operate the company going forward. Consumers had always purchased music from storefront retailers in the past but now they could download individual songs and albums directly on the Internet without having to physically go to a store. The Internet allows for on-line music delivery via the telephone line and the Internet directly to the world consumer's home and that was a major threat towards the established record companies. CDs and cassette tapes had been the most common formats of music distribution but they were going to have to make room for a new format that had tremendous versatility. According to the IFPI much of the conventional sale of music on CDs and cassettes would soon be replaced. Large retail concerns estimated that as much as 15 per cent of the global sales in music shops would be replaced by on-line delivery within

the next five years. The on-line market was a golden opportunity for music companies, but only if they protected themselves by copyright. The American music organization RIAA has also warned that competition from the Internet and computer games would increase, and the market for electronic entertainment is expected to overtake the music market in the USA within a few years. The Internet and being able to download music directly from a website opened up the door for all the independent labels and artists to more easily be able to get in the music game and succeed without needing the major labels to do so. This also posed a major threat to future sales and revenues for the major companies including BMG because in order to compete with independent labels and download sites, they would have to start selling their music online for download at much lower prices than CDs. There was also the threat of piracy with all the illegal download activity by consumers. In reality, though, the Internet is much more of a threat to brick and mortar retail stores than to the core business of record companies. Music companies will no longer need to battle with retailers for shelf space in stores in order to have an outlet for their products. Instead, they can partner with online retailers who can effectively handle marketing and sales. They can also work with companies that sell downloaded music to make their artists music available through this format as well. The Internet does not, however, signal the total demise of the music industry oligarchy. The average artist will still need the infrastructure of a record company to provide him or her with music, lyrics, producers and other technical staff and marketing. Despite the growing prevalence of downloading, retail and online stores will still need the music companies to provide them with CDs. Embracing the Internet-driven Technologies BMG was one of the first major music companies to embrace the changes with the start of the Internet. They were the first major company to use downloading technology to promote the sale of CDs and cassettes and also created a set of websites geared towards several individual genres in order to engage their fans. Although they did not sell downloadable music at first, as the uses of illegal copied songs had increased without royalties being paid, the Secure Digital Music Initiative (SDMI) was created to ease digital distribution without destroying copyrights. BMG was also one of the companies that joined the SDMI, and took an active role in defining these regulations. Moreover, BMG maintained a large number of relatively small arrangements and partnerships with companies such as

Microsoft, Liquid Audio, AT&T, and so on to set the technological standards for downloadable music. As a major player in the industry, BMG as a brand, has tangible assets such as worldwide production facilities, partnership with technology companies, financial power, and having the second most market share in the industry. In addition, BMG has a technology group within the division, very successful distribution center, diversified foundation of catalogs, and the size of the company. Some of BMG's intangible assets are established brand name, strategic alliances as promotional tools, its parent Bertelsmann, the German giant media corporation gave BMG additional strength. BMG suddenly had a new set of customers to cater to that were geared towards the digital realm. They are companies like CDNow who shipped CDs and cassettes to customers who purchased orders online, storefront retailers who had begun creating a web presence (Tower, Virgin), websites that provided direct digital downloads for sale to consumers, and individuals who frequented the BMGs music websites. Recommendations BMG recognizes that one of its top priorities is to develop an online presence and to continue to respond positively to the new-aged digital environment. BMG demonstrated its commitment to the Internet by developing individual websites geared towards several different genres of music, but they also need to recognize the need to sell online music to this new customer base rather than utilize it for promo downloads only. Music that is sold digitally is most always sold in MP3 format, a compressed version of a much better music file format. The sound quality suffers because the high end and low end of the audio has been compromised in order to make the file quicker to download and easier to transport and share. A CD contains music files that are either a WAV, AAC or AIFF files -- all 3 are the same in quality. This format contains a much larger file and is much better quality of sound. It is however much more difficult to share/transfer to others via the Internet. I suggest that BMG offer both WAV files and MP3 files and have the WAV file be higher in price. Most underground independent electronic music download sites currently offer both formats for purchase. Music enthusiasts, DJs and real musicians appreciate this and will pay for better quality of sound. I know from experience being a DJ and music producer for about 17 years. Because the company initially focused on marketing and promotions geared towards selling CD or cassette tapes, they missed the golden opportunity to be ahead of the competition with selling digital songs via the web. Although their collaboration with

America On Line (AOL) was a unique strategy that was successful at connecting fans to relevant artists on the web, BMG failed to make a dominant web presence. In terms of timing, BMGs approach to the Internet was timed extremely well but they lacked the right strategy and focus. Other major record companies were able to swoop on in and fill in the gaps that BMG had left open. What they should do is create a separate digital distribution division where the sole focus is to handle the new set of customers. BMG should shut down its manufacturing facilities, and focus on digital distribution of its songs. It until now holds some valuable resources and has to make them to be competitive advantages for the firm. Technology is always changing. This means later in someday, another new technology will come out, and MP3 files would be also replaced with the new technology. As it can be seen above, when broadcast radio was prevalent, oldfashioned music record firms had to adopt the new technology. If they did not choose to do so, there were no ways to survive in the industry. Although for BMG, manufacturing and selling CDs or cassettes do provide significant revenue, the costs will eventually exceed the benefits as the format becomes obsolete. It would be beneficial for BMG to invest that money into digital productions, distributions, and spend money for research and development to innovate new technology based productions instead. Moreover, BMG also need to expand its business. Since BMG produced over 700,000 songs, and had copyrights of famous musicians, they can authorize movie or CF productions to use its songs with royalties. Again, BMG has to focus on current music market, not the old music market, and need to prepare for new technology in the future to be the first mover in this market BMG has a lot of very powerful allies with companies like Microsoft and IBM and other key companies that already provide digital downloads to customers. BMG should develop those relationships further and partner with someone to get involved in creating an online music database with user accounts. When a user purchases a song or album, it would always be stored in their account for download or listening online. With allies like Microsoft and IBM, they could connect their music clubs with a cloud site that could be hosted by IBM's servers, and Microsoft could create the database. Also, they should create an App version that would enable users to login on their smartphones to purchase or listen to their music library. I think it is important for BMG to not secure any exclusive contracts until they are more familiar with what the future holds. There is too much uncertainty at this point in the industry so it would be better for them to observe closely for a while before getting locked into anything they would have trouble getting out of.

Over the next few years, individual artists will begin to gain more and more power in the industry. They can more easily than ever, take the initiative to market and distribute their own music and receive the majority of the revenues. More artists will choose to remain independent (not affiliated with any labels), and will setup their own web sites to promote and distribute their music. The Beastie Boys, Public Enemy, and Wide Spread Panic are all good examples of artists or bands that did just that. As artists began to gain more control they also become more savvy in the business of music and needed to hire agents to manage their careers. It would be smart for BMG to properly position itself to provide these types of services. They could also change the structure of the artist contracts in hopes of keeping their most successful artists for longer. Key Takeaways