Think of the journey a song takes to reach a fan’s ears: songwriting, recording, mixing and mastering the final product, distribution, retail, marketing, promotion and, finally, the listener. The steps in the process are stacked vertically, in sequence. A label expands horizontally -- within the same step in the sequence -- by buying other labels; a publisher does the same by buying publishing catalogs. When Spotify buys a podcast content company, it expands horizontally -- audio content is both spoken word and music. But when Spotify bought Anchor, an app for recording and uploading podcasts, it grew vertically. A company that owns labels and publishers owns two spots on the vertical sequence. A label can also sell a complementary product like a T-shirt; it might own the retail step by selling directly to the customer.
1) As music companies continue to grow, they need to buy complementary companies, rather than similar companies, in order to expand their vertical offerings for artists.
2) Smart acquisitions can help a music company decipher changes in the marketplace that might be coming down the road.
3) Acquisitions aren’t always entirely necessary, especially when two companies can share each other’s expertise through strategic investments or corporate partnerships.
So why would a music company buy a complementary company? Consider Live Nation: Not only does it produce thousands of concerts around the world, it also owns many ticketing companies -- two distinct but related businesses, two links between the fan and the music. On Oct. 21, Live Nation announced it had acquired a majority stake in Groot Hospitality, a Florida-based owner of multiple nightclubs and bars (LIV at Fontainebleau, Story, Komodo, OTL, Planta South Beach, Swan and Bar Bevy). Tickets get a fan into the venue; food and beverages are sold inside the venue. It’s a sensible purchase that helps Live Nation sell something complementary to a live performance. What used to be VIP treatment is all the more common today. Venues and festivals increasingly offer high-end hospitality like dishes created by local, celebrated chefs.
The old saying is, “If you’re not growing, you’re dying.” Today, it’s not enough to be proficient in one area. A singular focus will help build a company: Do one thing, do it very well, and then move on. But a competitive company can be well-rounded. “Expand out and build up” might have well been the record business’ battle cry of the last decade. Labels started signing artists to multi-rights deals. They also invest in related and complementary businesses: e-commerce, merchandise, concert promotion, digital marketing and digital distribution, to name a few.
Sony Music made two sensible acquisitions in the past two months. First, Sony’s merch company acquired the music merch division of The Araca Group. Second, Sony Music UK purchased music merch company Kontraband. And why not? Record labels can’t just be record labels. They diversify. They can sell complementary products. Merchandise is especially pertinent today: it can be picked, packed and shipped with CDs and LPs; and it can be listed on artist pages on YouTube and Spotify.
Scooter Braun has a vision for the future of music. In July, through his Ithaca Holdings, he purchased Big Machine Label Group, Taylor Swift’s home for her first six albums until she signed with Republic Records last November. In effect, Big Machine’s record labels are stacked on top of a management company roster that includes Justin Bieber and Ariana Grande. At the very least, Braun paid $200 million for Taylor Swift’s pre-Republic catalog and a portfolio of successful country artists. For its annual Moneymakers issue, Billboard calculated Swift’s recording catalog made $7.2 million in the United States alone in 2018; her previous album had come out in 2017. If she made another $7.2 million excluding the U.S., $200 million looks like a good price for the entire company.
But the combination offers some new opportunities. In Billboard’s Q&A with Braun and Big Machine’s Scott Borchetta, the latter twice used a word important to a merger of dissimilar companies: “Additive.” Borchetta could sign a Braun-managed artist and align the two sides’ incentives. But Braun and Big Machine might also benefit simply from sharing information and insights. Before the acquisition, some information amounted to trade secrets a company would not divulge to the other.
An acquisition can be a hedge against uncertainty about the future. If you don’t know what’s coming, buy a company that might help you figure it out. “Particularly in the media industry, there are many mergers of content and distribution,” says Meghan Busse, associate professor of strategy at Kellogg School of Management at Northwestern University. She points to Walt Disney, WarnerMedia and NBC Universal — each company thinks the future is on-demand video delivered over the internet, not cable television, so each is launching online subscription services to better compete with Netflix and Amazon Prime Video. “Part of that is some uncertainty about the future of the media landscape and people not being sure exactly the configurations of assets they'll want.” Disney is buying Comcast’s share in Hulu and will take full control of the video streaming company. Comcast’s streaming service will be helped by its purchases of Metrological and Xfinity Flex. AT&T purchased Time Warner, owner of pay channels (including HBO) and ad-supported television (such as TBS and TNT) plus sports (Turner Sports), news (CNN) and cartoons (Cartoon Network). Rather than subscribe to a suite of cable television channels, people can subscribe to any number of on-demand video services.
On Aug. 19 in South Korea, record label Big Hit Entertainment, home to supergroup BTS, acquired Superb, a video game maker with a music specialty. The purchase makes sense if Superb can provide promotional value Big Hit couldn’t get elsewhere. The two companies can create new value by collaborating on video games centered on Big Hit artists. The deal carries risk, though. Mere partnership can give Bit Hit promotional value and label-focused games. Then again, writing contracts and coordinating efforts could be too difficult without owning Superb outright. "The question is always, ‘To create those new business opportunities, can we develop them separately or do we need to bring them under the same control?’” says Busse.
Of course, people should have realistic expectations before a deal is made. Will two different companies fit together seamlessly and create new revenue opportunities that otherwise wouldn’t be obtained? Will combining two similar companies save as much money as projected? “A true synergy must entail achieving either cost savings or new revenues that are possible only because of the combination,” explain the authors of the 2009 book Curse of the Mogul, a criticism of media mergers that often destroy rather than create value. Cost synergies are common and obvious. Combining two companies saves money by eliminating redundant positions and merging operations. (When Universal Music Group bought EMI Music Recordings in 2012, it expected to save $122 million annually. When Warner Music Group purchased the Parlophone Label Group the following year, it said the combined companies would save $70 million a year.) But buyer beware! Consulting firm McKinsey found 64% of mergers failed to meet cost savings projections. Revenue synergies are more elusive. Consulting firm McKinsey estimates most mergers achieve only 70% of their expected revenue synergies.
Companies can get some benefits of an acquisition without the commitment. Tencent’s $3 billion investment for 10% of Universal would be an ultra-light version of vertical integration. Universal will continue to license music to Tencent competitors; Tencent’s offshoot streaming service, Tencent Music Entertainment, will carry the music of other record labels. The deal is unlikely to find regulatory resistance in the United States. However, reports say Tencent Music has caught the eye of regulators in China; it has exclusive licenses with the three major labels and sub-licenses to competitors at allegedly inflated rates. But Tencent is making just an investment. And after all, Warner Music Group and Sony Music have partnerships with Tencent Music Entertainment.
Tencent and Universal can benefit simply by sharing each other’s expertise. Take CD Baby, a veteran music distributor that has built itself into a vertically-aligned company -- they call it a “full stack of solutions” -- of CD manufacturing, physical and digital distribution, royalty collections, song licensing, YouTube monetization and label services like marketing and promotion. It’s like a Swiss Army knife for musicians -- except they’re not under one roof. Rather than ingest its portfolio and create a single entity, each company operates independently, CD Baby CEO Tracy Maddux tells Billboard: “The benefit to CD Baby comes from tapping into executives’ knowledge and sharing information about prospective clients.”
Companies must ask themselves if an acquisition solves problems that a partnership cannot. It’s one thing to buy similar companies and reduce combined overhead; it’s more challenging to own different parts of the production process -- called vertical integration because parts of a production process are stacked atop one another. “Do not vertically integrate unless absolutely necessary,” wrote John Stuckey and David White, partners in consulting firm McKinsey & Company, in a classic 1993 article. “This strategy is too expensive, risky and difficult to reverse.” The advice holds true today. A company should acquire when owning additional steps in the production process solves problems that contracts cannot. Electric carmaker Tesla bought a battery manufacturer to lower costs and benefit from the company’s innovative technologies.
In the past, music companies owned the major steps in the value chain -- manufacturing, production and distribution -- except for retail, setting aside CD of the month clubs and failed digital ventures. Today, ownership takes many forms. Labels still create and own recordings; publishers still own musical works. But corporate structures have changed with the times. Labels have outsourced manufacturing and distribution. More artists own the rights to their music. And because labels now take a share of artists’ other revenue streams, they have incentive to provide additional services. All three majors, as well as Live Nation, own merchandise companies that handle everything from T-shirt design to VIP ticketing on an artist’s online fan club. Labels sometimes own and operate artists’ websites and handle e-commerce. They can also manage an artist’s brand partnerships and sponsorships. On the independent side, some artist management companies have started labels. A company can combine label, publisher and management.
Being one-dimensional can look like a death sentence. Look at the commodification of digital distribution. Most any distribution company can service albums to a global range of digital service providers -- download stores, streaming services -- for about the cost of seeing a movie. To stay in business, distributors offer artists and labels a variety of services. Similarly, Kobalt administers publishing copyrights and offers a la carte label services through its AWAL distribution arm. And over the last decade, Capitol has transformed Caroline Distribution into Caroline Label Services, which provides marketing and radio promotion to albums on an individual basis. They either super-serve customers or die.
But companies must know when to turn away. The need for diversity can’t supersede the need to run a financially sound business. Often when a company is sitting on cash, it buys back shares and returns value to investors (e.g. SiriusXM’s buyback plan). As Curse of the Mogul argues, the “single most consistent reason for underperformance by media companies is bad acquisitions.”
Music companies aren’t alone. General Motors acquired a company that builds sensors for use in self-driving cars. Boeing launched a wave of joint ventures to provide upstream parts. Sure, failures are plenty -- AOL and Time Warner is the ultimate case study -- but as long as companies are feeling pinched by competitors, they are going to consider a building-up strategy.