COLUMN: In April 1971 Joseph Lockwood (then chairman of EMI) fired Stanley Gortikov as president of Capitol Industries and Sal Iannucci as president of Capitol Records. As Lockwood expressed in EMI's 1971 annual report, there was “evidence of ineffective management and lack of strong cost controls. … For some years the company had enjoyed a boom period and came to rely on too few top-selling artists. … Capitol also sought new talent, without always achieving success. In some cases, substantial advances were made against contracts which have proved entirely unprofitable. … It became apparent that a total re-structuring of management was necessary.” As EMI's subsequent history shows, Lockwood's words were eerily prescient.

Lockwood replaced Gortikov and Iannucci with Bhaskar Menon. The EMI board of directors fired Lockwood in November 1974 and replaced him with John Read. In July 1978 Read appointed Menon as head of EMI Music worldwide. In December 1979 EMI was taken over by Thorn Electrical Industries for £165 million. The combined companies became Thorn EMI. Read was fired in the transition and Richard Cave became chairman, having been inherited from Thorn. Cave was fired in March 1984 and replaced by Peter Laister. Laister was fired in July 1985 under mysterious circumstances. Graham Wilkins replaced him. Wilkins was fired in September 1988 and replaced by Colin Southgate. Wilkins fired Menon in May 1988 (this may have been an anticipatory firing by Southgate). Menon's tenure as head of EMI Music effectively lasted for a decade, from 1978 – 1988. To replace Menon, Southgate hired Jim Fifield, formerly of the snack food company General Mills. I will discuss various EMI corporate issues and EMI under Fifield in subsequent posts.

Menon initially was successful. His early annual reports about Capitol's progress were full of optimism. As Figure 1 and Figure 2 to my previous post about the early history of Capitol Records show, Capitol's ROS improved substantially. “The A&R staff of thirty and artists roster of 247 were pruned drastically. More helpful, the track record of nine failures out of every ten releases was reversed, by such artists as Pink Floyd, Grand Funk Railroad, Helen Reddy, Merle Haggard, Buck Owens, and Anne Murray,” Sanjek, R. (1996) Pennies from Heaven – the American Popular Music Business in the Twentieth Century (p. 513).

There came a time however when Menon got bogged down with the same problems that had bedeviled his predecessors. It is questionable whether Capitol's acquisition of United Artists Records – the only major corporate transaction Menon undertook – was successful. In 1985 Menon told me most of Capitol's turnover during the early 1980s came from the Beatles' catalog following John Lennon's assassination; Kenny Rogers' album “The Gambler”; and the soundtrack to the movie “The Jazz Singer” by Neil Diamond; see also Haring, B. (1996) Off the Charts – Ruthless Days and Reckless Nights Inside the Music Industry (p. 17).

During Menon's regime the two dominant firms in the U.S. record business were CBS Records and the Warner Music Group (“WMG”). EMI was not a member of this duopoly. While of course it had many successes EMI was deficient in originating new artists, particularly in comparison to CBS and WMG. Reputationally Capitol was thought to be only a step above MCA, perennially in last place, Knoedelseder, W. (1993) Stiffed – A True Story of MCA, the Music Business and the Mafia (p. 6, p. 21). Because of its weak market share Capitol was vulnerable to having its most successful artists like Paul McCartney and Pink Floyd picked off by more successful companies like CBS, Dannen, F. (1990) Hit Men – Power Brokers and Fast Money Inside the Music Business (p. 79).

From my perspective there were six primary (but non-exclusive) reasons for Menon's demise. I base this speculation on discussions I have had over the years with former colleagues on Thorn-EMI's corporate staff, and my own interpretation and analysis of events.

First, as depicted at Figure 3, EMI Music's contribution to Thorn-EMI's corporate profitability during 1978 – 1988 was considerably less than its contribution to Thorn-EMI's corporate turnover, in some cases by substantial amounts. It was greater only in one year – 1982. This means EMI Music was under-performing in relationship to other Thorn-EMI corporate divisions. If a division consistently underperforms in relationship to other divisions, then the main recourse open to the firm is to replace that division's senior management. All data was compiled from EMI's annual reports; for copies, see here. For an explanation of how to interpret this kind of financial information, see here.

Second, as depicted at Figure 4, EMI's ROS was considerably less than its nearest competitors, particularly from 1984 onwards. Public information during this period is available for Warner Music Group; CBS Records (until 1987, when it was sold to Sony for $2 billion); MCA Records (which together with the rest of MCA was sold to Matsushita in 1989); and PolyGram Records (starting in 1984 when it was spun off from Philips). There is no reliable data for RCA Records (owned by Bertelsmann). The results for MCA in 1981 and 1982 strike me as being dubious in light of the company's large write-offs in 1983; MCA also reported high ROS in 1973 – 1978 only to write it off in 1979. Others share this suspicion such as Haring op. cit. (p. 100). For copies of Warner Communications annual reports, see here. For copies of CBS annual reports, see here. For copies of MCA annual reports, see here. For copies of PolyGram annual reports, see here.

Third, there was a worldwide economic recession in the early 1980s. Retailers in the U.S. were over-extended financially. Record companies had “force fed” them hundreds of thousands of records, which they returned in unprecedented quantities. Record companies had over-spent on infrastructure in order to accommodate consumer demand that never materialized, Sanjek op. cit. (p. 607); Dannen op. cit. (p. 5, p. 176). In 1987 my colleague Greg Sidak and I wrote an article called Two Factors That Reduce Record Company Profitability, which analyzes what happened in detail. There were several significant economic constraints on the record business as it then was constituted, including excessive product fabrication and returns, and the structure of artist advances and royalties. We discuss pricing strategies and trade practices that effected explicit or implicit reductions in price, such as invoice discounts and invoice dating, cooperative advertising, free goods and returns. We also consider the impact of manufacturing and distribution costs, the product life cycle of the typical pop album and its sales velocity. Rather than repeat the contents of the article I simply refer you to it in case you are interested in further details.

Menon was perceived as being slow to respond to this rapidly-changing dynamic and as part of an ancien régime. The record business did not recover until the advent of the compact disc circa 1985. Even then EMI was slow to release records by key artists such as Pink Floyd and the Beatles on CD. While EMI artists were subject to various contractual restrictions, so were major artists on other labels. They nonetheless somehow managed to persevere and bring their artists to the marketplace at a time when there was huge unsatiated demand. The advent of the CD dramatically changed the product handling characteristics and demand curves for many records, particularly catalog – which arguably was Capitol's primary strength.

Fourth, there were a number of corporate mis-steps as the scaffolding of the worldwide record business changed completely. In 1986 Sidak and I wrote an article on the Structure and Performance of the U.S. Record Industry. In it we discuss the industry as then comprised and analyze its demand factors and economic constraints. We review the performance of the then-leading firms, including Warner Brothers Records; CBS Records; EMI Records; PolyGram Records; MCA Records; and RCA Records. We also analyze the upheaval of the landscape of entertainment companies, created by mergers and acquisitions as they consolidated into multi-national behemoths. Again I refer you to the article for additional information. See also: Sanjek op. cit. (ch. 33, ch. 37); Collins, D. (1973) The Structure, Conduct and Performance of the Recording Industry in the United States; and Vlahakis, M. (1975) The Condition of Entry in the Photograph Record Industry.

Just to highlight several transactions directly affecting EMI: (1) In September 1979 Gulf & Western, which owned Paramount Pictures, negotiated to buy half of EMI for $154 million. Press announcements were issued. Menon however eventually rejected this initiative, mainly because “neither side could agree on some of the more basic details, such as how much it was all worth and whether EMI or Paramount would hold a majority on the board,” Southall, B. (2009) The Rise & Fall of EMI Records (p. 36); Sanjek op. cit. (p. 602).

Then (2) In 1984 EMI was offered the opportunity to acquire PolyGram Records, but declined to do so. PolyGram then attempted to merge with Warner Bros. EMI (and the other major record companies) successfully opposed the merger because there would have been too much market share concentration. Had PolyGram and Warner Bros. merged they would have controlled approximately 26% of the market (versus CBS, which then had approximately 22%). A merger with EMI on the other hand unquestionably would have been approved because its low market share, when combined with PolyGram's, was under regulatory guidelines.

(3) Menon also flirted with acquisition proposals from MCA and RCA. In 1971 he held “endless conversations” with MCA, which believed that Capitol's poor performance would “provide them with an inexpensive acquisition opportunity.” RCA also offered an “absurd corporate initiative to merge EMI Music with a weak and exhausted” company under RCA's leadership, Southall op. cit. (p. 36).

The failure of these proposed transactions left EMI in the precarious position of being a stand-alone firm without the support of a major multi-national media company – a recurring problem throughout EMI's later corporate history, as subsequent developments will show.

Fifth, Capitol ran into serious legal difficulties during the mid-1980s when it became a target of U.S. federal anti-trust inquiries and grand jury proceedings arising out of its use of independent promoters and payola. “Payola” is the practice of making undisclosed payments to radio stations or personnel in consideration for airplay of a record. The nature of payola and why it is an issue were incomprehensible to Thorn-EMI's board of directors in the U.K. All it knew was the company was in trouble.

Radio airplay is one of the most important factors in the success of a pop record, Negus, K. (1992) Producing Pop – Culture and Conflict in the Popular Music Industry (p. 101). In a way this is counter-intuitive because one might think the more one can hear a song on the radio the less likely one is to purchase it on record. In fact the opposite is so because radio airplay reinforces consumer impressions and activates a desire to acquire a permanent instantiation of the recording. This is as true now as it was in the 1980s as consumers amass millions of downloads from Apple's iTunes Store and file-sharing services such as bittorrent. I was involved in Capitol's response to the independent promotion investigation and became somewhat of a payola aficionado. An article I wrote with Sidak about payola, which appeared in the Harvard Journal of Law and Public Policy remains the definitive analysis of this period.

Even assuming there came a time when Thorn EMI grasped the seriousness of the payola investigations, Capitol's problem wasn't its use of independent promoters per se. Every other label was using them too. Rather the problem was Capitol's expenditures for independent promotion were highly discommensurate to sales and therefore were economically inefficient. In 1985 a label might spend over $300 thousand to promote a single record. The U.S. record industry was spending at least 30% of its pre-tax profits on independent promotion, Dannen op. cit. (p. 15).

Capitol's percentage was considerably higher. As a less-successful label Capitol was unduly dependent on independent promoters for radio airplay. The “top 40” radio format only has 40 slots; it doesn't have 41. Radio stations were biased in favor of consistent suppliers of hits rather than intermittent ones like Capitol. As a result Capitol paid a disproportionate premium for access because it had to compete in a zero-sum game against better-entrenched firms. All but a few artists lack longevity in the marketplace so they must achieve success quickly. The power of an artist's entourage of agents, managers, lawyers and accountants is tenuous and they must produce results fast.

Capitol had to demonstrate to artists (and their management) their records were a priority and spending large sums on independent radio promotion was one of the few ways to do so.

As other companies stopped using independent promoters Capitol actually became incentivized to use them even more in order to capture and retain market share. Bruce Wendell, Capitol's vice president of promotion at the time, was quoted as saying: “There's no reason in the world why I should drop indie promo men. Why should I give up one of my strengths because somebody else does?” Dannen op. cit. (p. 209). This compelling logic aside, Capitol was quick to terminate its use of independent promoters and to settle various lawsuits after the independent promotion scandal broke, Knoedelseder op. cit. (p. 215); Dannen op. cit. (p. 279, p. 299); Segrave, K. (1994) Payola in the Music Industry – A History, 1880 – 1991 (p. 199).

Capitol also was a target of a government investigation and several antitrust cases accusing it of conspiring with competitors to fix prices and impose illegal vertical marketing restrictions on its record distributor customers. In 1989 I wrote an article Three Record Industry Trade Regulation Issues discussing these cases further. Thorn-EMI was as confused about the nature, scope and extent of these actions as it was about the payola investigations. It laid the entire debacle at Menon's doorstep.

Sixth, Capitol congenitally was unable to break international acts in the U.S. market. As a corporation EMI had grown by acquiring local record companies such as Pathe Marconi in France and Electrola in Germany, Southall op. cit. (p. 25). Despite so-called “world-wide” priorities for a few key artists, various territories typically prefer to work their own artists rather than those from other countries, Negus op cit. (p. 40, p. 162). In fact local artists typically comprise some 90% of in-territory sales. Capitol rarely found it worthwhile to exercise its options on foreign records. This long had been a source of friction between Capitol and other EMI companies, Sanjek op. cit. (p. 381). Companies such as Warner Bros. and CBS, on the other hand, were better able to implement a top-down command structure.

Menon was unable to resolve this confound, which lead to unrest and disgruntlement among EMI's non-U.S. companies. While Capitol had considerable success with British artists such as Duran Duran and the Pet Shop Boys, huge international artists such as the French singer Guesch Patti and the German singer Herbert Grönemeyer were complete unknowns in the U.S. Menon's successors became slightly more adept at this sleight-of-hand; for example in April 1989 EMI was successful in breaking the Swedish band Roxette in the U.S. In 1994 EMI formed a division called “Hemisphere” through which it tried to coordinate marketing of repertoire by its various subsidiaries, re-labelled as “world music,” Negus op. cit. (p. 166).

Thanks to Bhaskar Menon for his inspired leadership during this period in Capitol's history. Next: Capitol Records lurches into the 1990s.