UP AND AWAY:

AOL's Balooning Size Leaves the Southland Sitting Pretty

 

Matt Welch

The Zone News

February 2000

 

 

 

So which metropolis wins when Virginia-based America Onine merges with New York's Time Warner, which in turn joins forces with British music giant EMI?

 

Southern California, of course.

 

A major impact of last month's proposed $100 billion-plus marriage of AOL and Time Warner will likely be a vigorous kick-start of the high-speed Internet access business, as AOL's 21 million low-speed subscribers and Time Warner Cable's 12 million television customers are nudged into using the RoadRunner cable-modem service (and as other high-speed providers react to that competition). Such a proliferation of broadband would create greater demand for audio-visual Internet content, and Southern California is the world capital for filmed entertainment and a hotbed for broadband production.

 

"I think the key in all of this is that content is going to continue to drive everything on the Internet," said David Thompson, senior partner in charge of e-business at the Los Angeles office of Deloitte & Touche. "And because of the film and entertainment industry, there's a lot of talent in Southern California, particularly related to content and design."

 

Meanwhile, the $20 billion combination of Warner Music and EMI was powered by the two companies' desire to leverage their massive music libraries over the Internet, signaling a turning point in the major record labels' approach to digital distribution. While the clashes between the majors and free-download companies remain unresolved (all the major labels jointly sued MP3.com for copyright violation the same day the Warner-EMI deal was announced), the long-delayed corporate response to the Internet music explosion will have a profound effect on the Los Angeles-based record business, and on the dozens of local startups that have been thriving in the margins.

 

"This creates a tremendous opportunity for people such as us," said Al Teller, founder of the year-old new media record label Atomic Pop, and former head of both CBS Records and MCA Records. "That kind of combination to me smacks of circling the wagons. Even if they all combine into one big company, it won't make a difference. The revolution is under way, and the current oligopoly is powerless to do anything about it."

 

Even Disney, widely portrayed as a "loser" in the deal (for missing out on AOL's peerless subscriber base, and for remaining a pipsqueak in the music business), stands to benefit from its competitors' huge merger-and not just by having its stock price driven up by incessant post-deal acquisition rumors touching every major media, entertainment and Internet company.

 

"The more that broadband rolls out and becomes… a norm in both business and consumer-related areas, that's just going to give Disney more avenues to sell their content," said Collins & Co. analyst Brian Eisenbarth, who covers Disney and Viacom.

 

"It does point the world to show how important content is," Disney CEO Michael Eisner said in a Jan. 24 conference call. "I'm encouraged about open broadband access and I think it may be difficult for AOL-Time Warner to preclude competitors like Disney having access to the broadband world."

 

The spate of recent mega-mergers, if approved, continues the remarkable consolidation of the top media, music, film, Internet and telecommunications companies. Now, between them, Viacom/CBS, Disney, AOL-Time Warner, News Corporation, Bertelsmann, Seagram, General Electric, and Sony will own most of the major record labels, movie studios, television networks and cable networks in the United States and, to a lesser extent, the world.

 

Merger mania (and share price envy) has hit Hollywood, New York and Silicon Valley; every monolith looks puny compared to AOL/Time Warner's price tag (which, while fluctuating due to share price, will likely be twice as large as any other merger in history), its dominance in the ISP and cable network markets, and its competitive position in cable infrastructure, magazines, book publishing and even telecommunications. Now, Bertelsmann's Internet presence looks inadequate, Viacom seems empty without a music label, and Yahoo! looks awful lonely without any old media assets to complement its new media valuations.

 

Analysts are mixed as to whether a new wave of mergers is warranted, or even whether the apparently synergistic AOL-Time Warner deal is a good idea. Almost all, though, expect some action at the top.

 

"It would not surprise me to see some quick and significant mergers," Thompson said. "I think that always happens after a big move like this; people quickly rush out and try to build their resources and compete."

 

 

MAJOR LABELS AND THE DIGITAL 3-STEP (MP3, THAT IS)

 

The proposed merger's most significant early impact will be on the music industry. If the deals pass regulatory scrutiny, they will leave just four major worldwide record labels: Warner EMI Music, BMG Entertainment (owned by Bertelsmann), Universal Music (Seagram) and Sony Music Entertainment. Warner and EMI between them control more than one-third of the global music publishing market, and there is widespread speculation that BMG, feeling left out, will court Sony.

 

Time Warner CEO Gerald Levin declared at the AOL-Time Warner press conference that "Music, of all our businesses, is the one that will benefit the most from the Internet and the digital revolution." Warner Music and EMI executives described Internet distribution as the most powerful motive behind their merger.

 

Unlike still-embryonic developments such as streaming video and interactive television, music is already easy to consume in digital format and hugely popular on the Internet. Hollywood film studios and Santa Monica digital content companies, still waiting for tomorrow's broadband, are anxiously watching today's music wars over online copyright protection and distribution rights.

 

Those wars, despite the technology-embracing talk at the press conference, are nastier than ever. The major labels tried unsuccessfully to block the sale of an MP3-format portable player called Diamond Rio in November 1998, spent most of 1999 worrying about piracy and trying (unsuccessfully) to develop an industry-wide "Secure Digital Music Initiative," and when MP3.com introduced a service Jan. 12 allowing visitors to use the site to store and listen to CDs they own, the majors pounced with a lawsuit that seeks billions of dollars in damages.

 

Even Internet and software companies that try to win business from the majors are concerned about their tactics.

 

"I'm concerned about exclusive deals. One label will make an exclusive deal with Rio, one label with us," said Keith Gillard, content development director for Destiny Software Productions, which designs Web radio broadcasting software and is trying to sell a portable digital music player to major record labels. "We'll end up with a battle of incompatible formats, with everyone pouring more and more money into keeping the battle going."

 

Muscle-flexing demonstrations by media/entertainment giants have contributed to a palpable anxiety, in Los Angeles and elsewhere, that the wave of consolidations is threatening competition, independent activity and even freedom.

 

"I'm a bit distressed by it; I think competition is a good thing, and when you have gigantic media companies like this forming, it doesn't really foster competition," Gillard said. "We know what happens evolutionarily speaking when this happens in a habitat-life forms tend to stagnate, diversity is reduced."

 

But bigger certainly does not mean better, and media mergers are notoriously hard to make work. Both Warner Music and EMI suffered steep declines in the 1990s, Seagram has had a notoriously rough time integrating Polygram, and Disney is just now digesting ABC/Capital Cities and Internet portal Infoseek. Warner was only emerging from its Time/Life hangover when it gobbled Turner Broadcasting in 1996, and Time Warner has probably wasted more money on its ineffectual Internet play (Pathfinder) than any other old media company.

 

The big merger was portrayed as a coming-of-age for Internet culture, but AOL does not have much Net credibility, pandering as it does to Web "newbies" and attempting to draw boundaries around acceptable content. Major record companies, even in the wake of Seagram/Universal dropping hundreds of bands and thousands of employees, suffer from an expensive and disconnecting bloat.

 

"The funnel keeps narrowing at the top… and the record companies have sort of painted themselves into a corner," Atomic Pop's Teller said. "Their costs have gotten so huge, they absolutely need mega-multi-platinum albums worldwide to make a profit."

 

The gap between the gigantic, slow-moving few and the nimble many provides ample opportunity.

 

"Any time there's a consolidation down to a fewer number of companies, then there springs up a lot of entrepreneurial companies that compete," Deloitte & Touche's Thompson said. "Eventually they're bought up. …The biggest players will go down and pick out the best little companies, and then the best people will want to leave the big companies, and the cycle starts again."

 

Despite the narrowing of ownership and the widening of market share, both deals are expected to pass through regulatory hurdles. But because they impact most of the First World and plenty of the Second, the process will likely take most of this year. And, since both deals are based chiefly on stock, a sudden downturn could turn off shareholders.

 

Ironically, the merger has caused AOL to unabashedly reverse its high-profile position on one of the larger regulatory issues of the moment: open access. For years, in an attempt to crack the high-speed market, the company has spent millions of dollars trying to convince federal and local regulators to force AT&T to open its vast network of cable lines to outside Net-access competition. Now that AOL has purchased AT&T's biggest cable competitor, the company has declared that "the marketplace" is the best place to decide the issue.

 

In Los Angeles, the open access debate is scheduled for a hearing this month by the City Council's Information Technology Committee. "It's obvious that AOL, Time Warner and AT&T will do what's best for their companies," Committee Chair Alex Padilla's spokesman David Gershwin told the Los Angeles Times. "What's best for consumers may be entirely different."

 

For now, according to the Los Angeles Business Journal, MediaOne has 20,000 cable modem subscribers in the Southland, Time Warner has 8,000, GTE has 15,000 DSL accounts in California, and Pacific Bell won't disclose. Those numbers were already expected to increase exponentially before the AOL-Time Warner announcement.

 

Meanwhile, AOL's supposedly commanding lead in slower Internet access is under siege. Advertising-supported free ISPs like Westlake's NetZero -- which recently signed up its 3 millionth subscriber -- are growing faster and applying downward pressure on pricing. If AOL goes much lower than its $20 a month, all its pretty profits evaporate.

 

This kind of flux is another reason smaller companies aren't too worried about the Brave New World.

 

"Increasingly, we have more and more people doing their own thing, using their own voices, less and less is the media being controlled by the large companies," Destiny's Gillard said. "The Internet really is putting more and more power into people's hands, and these gigantic mergers and lawsuits won't be able to keep up with it. They're just going to have to adapt and find ways to incorporate the new culture rather than try and quash it." z

 

 

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