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the issues behind the headlines

The Business Network


Transformation
of the Media Industry
PART 1
Throughout the world, businesses are becoming much more collaborative—
with their manufacturing partners, customers, financial institutions and even
competitors. Transforming a company into a “networked business” can bring
significant benefits such as lower labor costs, shared risk, faster innovation,
greater reach, and higher productivity.

Yet unlike other industries, media companies are not so much managing
this transformation as being managed by it. Harnessing this transformation
can bring great benefits to media companies, but proceeding without a well
defined business network strategy can bring harmful dependencies. This white
paper, sponsored by SAP and written by FTI, examines the business network
transformation of media and how media executives can use this force of
change to their advantage.

Introduction
The corporate command and control structures that propelled the growth of the US industry after World War II are
now being dismantled. These ”vertically integrated” companies (which originally sought to control upstream supply
and downstream distribution) are learning to cooperate with independent suppliers and distributors to optimize
profit. These companies are foregoing absolute control through absolute ownership in exchange for lower labor
costs, faster innovation, increased market agility, deeper customer intimacy and the sharing of market risk.

What is causing this shift? Historically, in the era of the balkanized


corporation, the transaction cost of working with independent suppliers
and distributors was theoretically higher than a well run company could
achieve by providing these same services to itself. In other words, it was
more cost effective to go it alone. This thinking was first pioneered by the
famous economist, Ronald Coase. Coase theorized that the sole purpose of
the corporation was to produce goods at a lower cost, and hence higher profit, than could be achieved through
partnership arrangements. This was because these partnerships required management and layered on bureaucracy.
Coase called this the transaction cost of the partnerships. But the world is now much flatter than it was after
World War II. As countries have exposed their lower labor costs to the world, and technology has simplified
collaboration, once vertically integrated companies are now finding that the lower cost of production through
partnerships can greatly exceed the transaction cost of managing these relationships.

Today, in fact, many departments in the modern corporation exist only to manage partner relationships. Yet it is
not only labor cost savings that make the added expense of these outsourced partnerships worthwhile. Today, the
pace of innovation often makes the internal cost of R&D prohibitive. To internally create all of the new products
needed by the market would require too many R&D projects, at too much expense, and carry too much risk of
failure. Far better to collaborate with external partners, or shop the world for early innovations that the company
can facilitate to bring to market. Some companies are even leaving the innovation to the consumer, as Nike did
when it let consumers design their own shoes online. This is a way of socializing the R&D expense of shoe design.
The transaction cost of setting up the website and inserting the customer’s shoe design into the production
process, is more than offset by the customer’s willingness to pay a higher price for the innovation they desire.

THE BUSINESS NETWORK TRANSFORMATION OF MEDIA 2


Hence, in many industries, we are seeing the general shifts indicated in the chart below.

Issue “Built to Last” Companies Built to Adapt Companies


Competitive Advantage Efficiency, Stability & Distribution Differentiation, Adaptability & Speed
Reach
Mode of Operation Command & Control Connect & Collaborate
Source of Innovation Internal R&D Co-Innovation
Focus of Attention Supply Demand
Organizational Paradigm Value Chain Business Network

As the last column demonstrates, there is an ongoing shift to developing a supply network upstream and a
distribution network downstream, so that the company’s main contribution to the market is its ability to
understand and address customer needs via its business network more quickly and efficiently than its competitors.

In making this shift, each company sets itself up in a collaborative network. The speed at which this “business
network transformation” occurs is usually under the control of most companies. They control the pace of their
shift and the portions of the supply chain that get sublimated into the network of suppliers, manufacturers and
distributors. Of course, competitive pressures may impel a company to move faster than it might naturally.

The (Sometimes Involuntary) Business Network Transformation of Media


Our research shows that media companies are certainly going through a business network transformation. Yet in
many instances, this transformation is being forced upon the industry more quickly than the industry can absorb
it. Not only does this wreak havoc, but there is a significant risk that the industry “over networks” itself in an
effort to cope. By over-networking we mean potentially creating dependencies with suppliers that ultimately give
partners too much market power, or transfer too much of a companies core competencies to others. This over
networking places the media companies at risk of marginalization or commoditization.

Perhaps this transformational rock first started tumbling downhill in media with the invention of Napster, the
original music sharing site. The meteoric rise of file sharing led to the rapid loss of billions in revenue and sent the
music companies into a tail spin, losing a third of their revenue in two years. To adjust, they began to cut costs
by outsourcing—first CD manufacturing, then distribution and warehousing and finally IT. With less demand, for
example, inhouse CD manufacturing no longer made sense because the labels couldn’t keep the presses busy full
time. It was better to share the expense through outsourcing. As Coase’s transaction cost theory required, the
music companies could no longer perform these services internally more cheaply than through partnerships, so
they shed them.

But that was just the beginning of the business network transformation forced upon record companies. In music,
songs, not albums, were being stolen through Napster, and consumers were turning away from the album format.
Once unthinkable, the record companies began to unbundled the album and allow online retailers to sell music by
the song. In short order, iTunes arose and captured 70% of the online music market. Partnering with Apple became
mandatory. Steve Jobs used his market position to demand flat rate pricing of 99 cents a song and the music
companies quickly complied. Anything to stem the losses.

Mainstream News Outlets Start Linking to Other Sites


New York Times – By BRIAN STELTER Published: October 12, 2008

Embracing the hyperlink ethos of the Web to a degree radio stations, online videos and other sources. And
not seen before, news organizations are becoming The New York Times will soon offer its online readers an
more comfortable linking to competitors—acting in alternative home page with links to competitors.
effect like aggregators. The Washington Post recently
introduced a political Web site that recommends rival These experiments exemplify “link journalism,” an idea
sites. This week NBC will begin introducing Web sites that is gaining traction in other newsrooms across the
for its local TV stations with links to local newspapers, country

THE BUSINESS NETWORK TRANSFORMATION OF MEDIA 3


But as Apple has become dominant, the music companies have lost their leverage over wholesale pricing. From the
music companies’ point of view, iTune’s flat 99 cent price essentially commoditizes songs, even though music is
not, innately, a commodity. Yet Apple drove song pricing down to its marginal cost and fixed price. Content was
no longer king.

Record companies hope that other device manufacturers will come up with music players as popular as the
iPod, and weaken Apple’s grip. Since consumers don’t want to re-buy their songs if they shift to a new device,
the music companies have been forced to drop their rights protection requirements. While this creates device
interoperability and invites competition, it also invites piracy.

Major US newspapers are facing a similar problem with the commoditization of regional and national news online,
and the concurrent decline of newspaper readers. While once they controlled the upstream creation of journalistic
content and the downstream distribution through their paper presses, they no longer do. To respond, they are
forming new and diverse partnerships, with Yahoo, MSN and each other. These online collaborations promise more
viewers, but over time, pricing leverage will go to the most powerful players.

Some network transformation within media has been well planned and well executed. Movie studios, for example,
who once shot and financed their own films bore all of their own production risk. In the last 10 years they have
learned to syndicate the movies financing through partnerships with producers, directors and even actors. This
also makes the creative process more collaborative. In a hits driven business, this technique spreads the financial
risks should the movie fail, but it also reduces individual returns when the movie is a hit. This system arose as
movie production costs have skyrocketed and along with it the high cost of failure. This is an excellent example of
the shift from the old style of conducting R&D internally to a collaborative model.

“Who the hell wants to hear actors talk?”


– HM Warner, Warner Bros., 1927

However, the movie studios haven’t done so well when it comes to transforming their supply chain. The chart on
page 3 suggests that the network-transformed company shifts its focus from supply to demand. But the movie
studios have yet to make this shift successfully. The risk-sharing production scheme with producers has recently
resulted in an oversupply of movies to the market. Production syndication along with a liberal credit market has
spawned more new movies than there are opening weekends and cinema screens to show them on. In this sense
the studios have lost control of distribution since they can no longer throttle supply to match the capacity of the
distribution pipeline. They are stuck with too much new movie inventory and not enough cinematic shelf space.

While these business network transformations are often involuntary, they often have silver linings. This is because
the unwanted transformation represents a shift in the needs of the market. If the media companies can regain
their balance, which is not always easy, they can often profit from the shift. For example, the movie industry has
resisted almost every game-changing technical shift since the invention of television. TV was feared to keep movie
goers from theaters. Color TV was going to raise production costs, DVDs would reduce box office opening revenues
and rental would cannibalize DVD sales. Yet, these transformations have brought ever increasing revenues to the
studios.

In music, the shift from the album format to song sales is


monumental. Today it represents an unwanted shift in the supply
chain for the record labels, but in the end it may prove beneficial to
the labels. Here’s why. Album production costs have steadily risen
over the years, with larger advances, more tours and events, higher
marketing costs, and the need to produce a music video for MTV. Of
course the financial risk of failure has risen in kind. It is now quite
expensive to put out an album and most of them fail. Producing
songs instead of albums may now allow the music companies to test
the market with new acts at a fraction of the cost of an album and
spread their marketing budgets over more acts. This would be a shift
to a demand focused supply chain and may ultimately be a more
efficient model for the labels.

THE BUSINESS NETWORK TRANSFORMATION OF MEDIA 4


Growth of American Idol Co-Opetition
Popularity which started with In prior white papers we have described the delicate balance that must be
9 million viewers in 2002: achieved between content owners and suppliers. In essence, two parties that
form a business network to enable creation and distribution are known as
viewers TV Timeslot Rank
(in millions)
Season “compliments”. Their services compliment each other: The labels create the music;
iTunes distributes it. Newspapers provide the journalism; Yahoo puts it on their
18.69 2002 Tuesday 9:00PM #30
portal.
(Performance show)
22.77 Wednesday 9:30PM #25 Conventional economics says that while codependant, these partners are
(Results show) not necessarily equal, as we have seen with Apple. As a general strategy,
25.67 2003 Tuesday 8:00PM #5 complimentary partners often try to commoditize each other by seeking
(Performance show) alternative sources of content or distribution. When other sources exist, a party’s
24.24 Wednesday 8:30PM #3 bargaining power is enhanced, because they have a backup supplier. If the music
(Results show) companies, for example, can foster significant device competition with the iPod by
25.13 2004 Tuesday 8:00PM #2 foregoing content protection, they create alternative device suppliers and reduce
(Performance show) Apple’s pricing leverage.
28.84 Wednesday 8:30PM #3 Critically, this way of interoperating with complimentary producers in a value
(Results show)
chain may be changing via business network transformation. Minimizing the other
28.05 2005 Tuesday 8:00PM #1 guys leverage by trying to commoditize them may be “old school.” Indeed, if a
(Performance show) cooperative alliance between the partners can be achieved, then the mutual goal
30.27 Wednesday 8:00PM #3 becomes maximizing each others revenue by better serving the market collectively.
(Results show)
An interesting case in point is Amazon. Amazon has opened up its online site to
31.78 2006 Tuesday 8:00PM #1
(Performance show) used book sellers. By doing so, it captures the cost conscious consumers that might
not buy a new book and increases its inventory if a book is out of print. Of course
36.38 Wednesday 8:00PM #1
(Results show)
Amazon takes a share of these sales. The used book merchant is also better off
because they have access to a Amazon’s huge network of consumers and a first-
25.33 2007 Tuesday 8:00PM #2 class shopping site. Hence, both parties position is maximized.
(Performance show)
30.74 Wednesday 8:00PM #1 Another example of how networks can help their partners grow market share is
(Results show) the online video service Hulu. Hulu is a service developed as a consortium between
27.06 2008 Tuesday 8:00PM #1 NBC and Fox. Hulu streams shows from these networks as well as content from the
(Performance show) movie studios and some other networks. This online service allows the partners
31.66 Wednesday 9:00PM #2 to share the development cost and risk. And because it has more content, Hulu
(Results show) garners a larger audience share at lower cost than CBS or Fox could accomplish on
their own. A virtuous cycle forms where the more efficient and adaptive network
Horizontal Conspiracy and Vertical Restraint1
can deliver superior value to the consumer which attracts more viewers and more
ad revenue, which supports more investments by the partners to deliver more value
and so on.

The Consumer as Partner


We have already touched on engaging the consumer as a way of socializing R&D, as Nike has done with shoe
design. Engaging the consumer as a partner, directly or indirectly, is also happening in media, and could have
profound effects.

The hit show American Idol is a fascinating example of embedding the consumer in the process of selecting and
promoting artists. The show is produced by Fox. The consumer votes for the bands while the show is airing through
text messages from their cell phone. Their voting helps winnow out good and bad bands over the course of the
season. However, Sony BMG, the music company, has the exclusive right to sign and distribute the selected band
and the show’s runners up. This three-way partnership between the viewer, the TV network and the music company
is uniquely virtuous. The TV network engages more viewers, the viewers are given some control over the bands they
see, and they select hit bands for the music company—who thereby avoids the R&D risk of a failed album.

Another example, of course, is the newspapers that now interact with viewers and bloggers for new content. This

1 FTI is a leader in antitrust, and we are compelled to point out that horizontal monopolies can become an antitrust issue if
they become too powerful in the market.

THE BUSINESS NETWORK TRANSFORMATION OF MEDIA 5


form of social journalism has some increase risk to the newspapers because it hampers reliability, but it puts a lot
more cub reporters on the street and actively engages online readers. In this case, the bloggers are not so much
defraying R&D but participating in production.

Network-Transformed Systems
Successful orchestration of an agile and efficient business network will require a shift from internal transactional
systems to a collaborative digital distribution platform. Such a platform will be critical for media companies as
the scale of collaboration increases in terms of consumer interactions, assets (clips in addition to movies, chapters
in addition to books, etc.) and distribution partners (iTunes, Verizon, Nokia, AT&T, et al.). A collaborative digital
distribution platform should support four key capabilities as end-to-end processes (see figure below).

1. Gain Deep Consumer Insights. Media companies today have an unprecedented opportunity to become truly
demand-driven. Technologies such as set-top boxes, Internet channels, mobile devices, and social networks
capture volumes of rich data about consumers—their demographics, preferences, consumption patterns, and
location. Content owners and distributors even have the opportunity to engage in a one-to-one relationship
with the consumers, a monumental shift from the broadcast model of the past. The challenge for media
companies lies in pulling together the relevant data and extracting the actionable insights. Hence, a digital
distribution platform needs to manage the master data for numerous consumers across multiple systems
– within the company and across the business network—to provide an integrated, 360 degree view of the
consumer. Key platform capabilities such as analytics and predictive modeling can enable media companies to
gain deeper consumer insights, segment the consumers for go-to-market planning, and translate these insights
into profitable actions such as delivery of targeted content and ads to consumers.

2. Manage Content & Rights. For many media companies, balkanized content and rights tracking across
multiple legacy systems hinder visibility for themselves and for their distribution partners. Finding the right
content and understanding where, when, and how it can be distributed become a challenge to say the least,
leading to lost revenue opportunities. What media companies require is a platform that supports a central
catalog of digital assets and a rights availability and licensing engine to provide the much needed visibility
and automation. The platform should not only expose the content owners’ digital assets to their distributors
but also provide real time recommendations for an improved review, search, and selection processes in self-
service mode. With an automated ability to discover, bundle, and license the right assets, content owners and
distributors can jointly respond rapidly to the changing needs of consumers and maximize the monetization of
their assets.
Closed-loop Digital
3. Enable Digital Distribution via Multiple Channels: With the Distribution Platform:
proliferation of devices and distribution channels, media
companies need to leverage multiple touchpoints with consumers
to gain their attention and time. To support this strategy,
a digital distribution platform needs to manage a range of Manage
Consumer
formats and asset types across multiple distribution partners. Insight
The platform should also provide decision support analytics in Manage
Access Content &
planning release windows and maximizing reach and profitability Multiple Rights
across channels. Business
Models

4. Support Multiple Business Models: As revenues from traditional


business models continue to decline, media companies face Manage
Digital
pressure to pursue multiple monetization models—ad-supported, Distribution
pay-per-download, subscription, dynamic pricing, and others. In
today’s digital world, a flexible and scalable platform is required
to support the various business models and to process millions
of micro transactions daily, even hourly, to generate revenues and settle royalty payments. The digital
distribution platform should also manage both convergent invoicing for accounts receivable activities such as
consumer invoicing and payment processing, as well as accounts payable activities such as royalty payments
and settlements processes for content owners.

THE BUSINESS NETWORK TRANSFORMATION OF MEDIA 6


By deploying a collaborative digital distribution platform with the above capabilities, media companies can target
the right consumer with the right content via the most effective channels while utilizing the optimal business
models. This end-to-end-process view is essential for orchestrating a competitive advantage in this transformation
of the media industry.

Conclusion
Whether media companies are yet controlling their transition to a networked industry or being controlled by it,
it is clear that it is inevitable.

Issue “Built to Last” Media Cos. Built to Adapt Media COS.


Competitive Advantage Popular Content Relevant Content
Mode of Operation Command & Control Connect & Collaborate
Source of Innovation Internal R&D Co-Innovation, Co-Produce,
Consumer Collaboration
Focus of Attention Supply Demand
Organizational Paradigm Value Chain Business Network

The historic arms length relationship between consumers, partners and competitors is changing quickly. It is
becoming clear that there is more to be gained by through business networks. Media is becoming a one-to-one
experience with the consumer. In such a world, the competitive advantage of an entertainment company isn’t just
popular content, but relevant content. Necessarily the mode of operation must shift from command and control
to a closed loop of connections and collaboration with consumers and partners. Internal innovation is replaced
by co-innovation, co-production and consumer interaction. While historically the focus of a company’s attention
was supply, it now must shift to the demand of individual consumers. All of these shifts must be supported by a
network paradigm rather than by balkanized horizontal value chain delivery systems of the past.

Media companies should seek to put their true core competencies in the center of a new business network
framework. One that protects their market share while reducing risk and cost. Managing the partnership network
and the consumer interaction must also become a core skill. But media companies who can achieve this will be
more profitable, more relevant to the consumer, and indispensable to their partners and to the market.

For Information
Please Contact:
Bruce Benson
Senior Managing Director, Entertainment & Media
3 Times Square
11th floor
New York, NY 10036

646.453.1289 (office)
203.606.3854 (mobile)
bruce.benson@fticonsulting.com

www.fticme.com

About FTI Consulting


FTI Consulting, Inc. is a global business advisory firm dedicated to helping organizations protect and enhance enterprise value in an increasingly complex legal,
regulatory and economic environment. With more than 3,000 professionals located in most major business centers in the world, we work closely with clients
every day to anticipate, illuminate, and overcome complex business challenges in areas such as investigations, litigation, mergers and acquisitions, regulatory
issues, reputation management and restructuring. More information can be found at www.fticonsulting.com.

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