As the recording and electronics industries face off over digital music, one company has had the uniquely uncomfortable position of standing on both sides of the issue: Sony.

 

The only company to own a major music label, a major computer manufacturer and a major consumer electronics business, Sony has been insulted by its own trade associations and has even sued a company that Sony itself had invested in. But Wharton professors and experts say Sony is in a unique position to become a leader in digital entertainment – if the company can stop fighting itself.

 

Conflicted Conglomerate

 

Tokyo-based Sony – a behemoth with $57 billion in sales in fiscal 2002 – first ran up against itself in 2000, when its music division was a plaintiff in the recording industry’s ongoing lawsuit against music-trading web site Napster. In August 2000, the Consumer Electronics Association (a trade association with Sony Electronics on its membership roster) issued a friend-of-the-court brief on the other side of the case (though Sony didn’t make an independent statement in support of Napster.)

 

The internecine conflict became even more apparent in May 2001, when the Recording Industry Association of America (a trade association to which Sony Music belongs) decided to sue digital music portal Launch.com for not seeking proper licensing for its personalized Internet radio service. Sony had been a part owner of Launch.com for more than a year at that point, having invested in the company in 1999 as part of a venture capital effort led by Fred Ehrlich, president of Sony’s new technology and business development unit. To some extent, then, Sony was suing itself.

 

Most recently, Sony has been on both the sending and receiving ends of broadsides by Hilary Rosen, the outspoken head of the RIAA. Rosen has been publicly bashing consumer electronics companies for supposedly encouraging music piracy so they can sell more CD burners. Sony belongs to the RIAA; Sony also sells CD burners.

 

Sony spokesman Rick Clancy pointed out that RIAA and CEA statements aren’t the same as Sony statements (“I can’t speak for her at all,” he says of Rosen.) But it’s clear that the two sides of Sony are participating in a very public inter-industry battle.

 

“The industries are in a dysfunctional relationship,” says Forrester Research analyst Josh Bernoff. “They’re codependent; they need each other. There is no consumer electronics industry without content, and there is no content industry without devices to play it on.”

 

Continuing Culture Clash

 

Sony’s structure may contribute to the conflict, say Wharton marketing professor Peter Fader and others. Sony started out as a Japanese electronics firm, acquiring U.S.-based CBS Records and Columbia Pictures in the late 1980s. There’s been a culture clash between the two sides ever since.

 

“Historically, this has not been a tightly-linked organization, and they have had rather autonomous business units, says Wharton management professor Daniel Levinthal. “My sense is, there’s a bit of a North America/Japan split that corresponds to the content and hardware pieces of their business.”

 

But John Nathan, a professor of Japanese at the University of California-Santa Barbara and the author of Sony: The Private Life, says Sony is able to resolve conflicts when top management deems it necessary. “It’s a little confusing to me why [Sony chairman Nobuyuki Idei] would allow these two organizations to come so dramatically into conflict,” he says.

 

Fader and Wharton management professor Eric Clemons contend that it’s not uncommon for conglomerates to run into internal conflicts. “It happens all the time, even within a single product line,” says Clemons. “Inventory people want inventory down. Sales wants it up. Production wants simple product lines and fixed schedules while sales wants the widest range of products and the greatest flexibility in ordering.”

 

On the first day of his marketing course, Fader teaches a case study where one unit of Sony is acting as a key supplier to a company competing with another unit of Sony. But what makes Sony’s current position unique (other than the publicity surrounding its collisions) is that it seems to be doing little to fix the situation, Fader says. “The difference here is that they deliberately avoid trying to capitalize on some potential synergies. They’re clearly hurting themselves.”

 

Meanwhile, Sony’s electronics side has been working to placate the music side. The company has released a string of music players with clumsy, heavy-handed copyright protection attempts. Sony Minidisc and Network Walkman products, for instance, require a convoluted “check-in/check-out” process to move songs between a PC and a portable device. The check-out process prevents users from making more than three copies of any song. It also makes the Sony products harder to use than their competitors’.

 

Meanwhile, the music side has been experimenting with CD copy protection that pointedly devalues Sony Computer’s products. Celine Dion’s CD, “A New Day Has Come,” released by Sony Music, was encoded with Key2Audio copy protection – which makes it unusable on any computer, even Sony’s own.

 

‘No Tech Lead Is Safe’

 

Though most of Sony’s profits come from electronics, this year it lost money in that business, which might help explain why Sony’s music side has such a powerful corporate voice. In the fiscal year that ended on March 31, 2002, the electronics side lost ¥8.2 billion ($62 million) on sales of ¥5.3 trillion ($40 billion), a decline of 3% over the previous fiscal year. In contrast, the music business made ¥20 billion ($152 million) on ¥643 billion ($4.8 billion) in sales, a 5% increase over fiscal 2001.

 

The music (and movie) businesses are critical to Sony’s long-term strategy, says Daniel Weiner, senior director of new technology for Sony Music and a 1999 Wharton graduate. Computer hardware is a brutal, competitive, low-margin market. If Sony can be seen as presenting a unique package of hardware, software and content, that sets the company apart.

 

“[Sony’s top management is] trying to position the business as capturing synergies, as a higher-end network and services-type business … they’re trying to tell the analyst community, don’t value us like a low-margin hardware business,” he says.

 

The two sides have come together with Pressplay, a pay-for-play music service that Fader calls “lame.” Pressplay charges a monthly fee and puts various restrictions on downloading and burning songs to CDs; users can’t burn more than two songs by any single artist in one month, for instance.

 

Sony Electronics can’t afford to be held back too much by the demands of the music side, analysts say. “This is an extremely competitive market,” Burnoff points out, warning that technology companies must pursue market opportunities aggressively. “No tech lead is safe. The margins are very tight.”

 

Fader and Levinthal think Sony Electronics should go full speed ahead – and bring the music side around to a new age of digital distribution. “If they want to do what is in their shareholders’ best interests, they should be pushing those music players out there as rapidly as possible and giving people every reason to buy them. Sony, which has been very difficult on the MP3 front, should be leading the way,” Fader says.

 

With the entertainment and electronics industries at loggerheads, Sony is in the best position to reconcile them, experts say. As Burnoff puts it: “You’re more likely to get a compromise out of Sony than out of any of these other companies because it would really like to have a solution that allows both sides of the company to be successful.”

 

Sony may yet produce that compromise. Weiner’s group within Sony is busy reengineering the company’s technology infrastructure to help the electronics and music groups work better together. For instance, links to Sony content may be integrated into Sony computer products. He says Sony will be testing its next generation of services by the end of 2003. “At the strategic level within Sony corporate, the ultimate vision is not to circle the wagons or build a wall; it’s that this stuff is all changing,” he says.

 

And a decisive move by Sony towards a new music business model could transform its industry, Fader adds. “They could do so overnight. They’re big and strong enough that the others in the industry would moan and grumble for a moment, but they’d jump on board and the industry would soar. It’s hardware and software: the easier you make it to get or use one, the more profit you can pull out of the other one.”

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