IQ Interactive Special Report – Q&A with Bertelsmann Music Group CEO, Strauss Zelnick

The real threat to music companies isn’t piracy, it’s ignoring the technologies that make it possible.
The cynical might describe Bertelsmann Music Group CEO Strauss Zelnick’s glittering rƒsumƒ as a chronology of relentlessly upward opportunism. The more upbeat interpretation would cast him as the profitable embodiment of digital convergence. His wunderkind career has been an unusually broad blend of managing operations, exploiting technologies and building brand. Thanks to the Internet, Zelnick has an even more intense blend of opportunities and threats to manage. Before being recruited in 1994 to run Bertelsmann’s Music Group–whose labels include Arista and RCA with talent ranging from Annie Lennox to Sean “Puffy” Combs to The Backstreet Boys–Zelnick had run Crystal Dynamics, a video game company that he successfully sold to Time Warner, and had also been president and COO of 20th Century Fox. Prior to that, he had been president/COO of Vestron – a one-time leader in the home video business–and Columbia Pictures’ vice president of international television. Zelnick is not yet 44.
In fact, Zelnick’s versatility, flexibility and discipline as a multimedia executive gives him a perspective on the business of new media innovation that seems refreshingly contrarian for a suit: Yes, the Internet is a revolutionary medium; but no, it will neither annihilate nor eradicate existing media industries. Business will still be business, whether the dominant medium is atoms, bits or some unanticipated hybrid. Napster is not an inherently evil innovation and the record industry would be wise to pay attention to how its best customers want to use new technology to acquire new music.
While these are hardly heretical notions, Zelnick’s pragmatism lends them a heft that the shrill prognostications of Net visionaries simply lack. Zelnick runs a global $4.6 billion business that he acknowledges is being redefined by digital technologies. However, he dismisses the notion that the MP3.coms and Napsters of the world can’t be co-opted, competed or collaborated with in ways that leave companies like BMG in even more profitable shape than before. A smooth, self-aware communicator, there is nothing of the knee-jerk, shoot-from-the-lip media mogul machismo in Zelnick’s style. He understands business and he has no illusions–fanciful or fatalist–about what technology will mean to music in the coming years. Indeed, he sees what’s going on in the music industry as a precursor to what will happen to all creative content businesses this decade.

IQ: When did you understand that new Internet technologies would affect what it means to be a label?
Strauss Zelnick: I worked in Silicon Valley for a couple of years, so I arrived at BMG with a certain amount of religion about the Internet and the importance it would have for our business. Kevin Conroy–who’s our chief marketing officer–and I started talking about what BMG would do in the Internet almost five years ago. That was well in advance of the MP3 format, well in advance of, well in advance of Napster.

IQ: How concerned are you with piracy issues?
Strauss Zelnick: People have spent too much time focusing on piracy and not enough on the fact that piracy is a normal part of new entertainment businesses. While I don’t in any way mean to be cavalier about people stealing things–not the least our copyrights–I do think piracy is controllable through four means: strong legislation, which we have worldwide; enforcement, which we’re getting better at; encryption, not because encryption can stop professional piracy but because it can dissuade casual piracy; and, most importantly, the creation of legitimate alternatives. In the absence of a legitimate alternative, people will do what they have to do to get a hold of your music.

IQ: Will there be a consensus in regards to how the record industry will respond to the Napsters and the MP3s of the world?
Strauss Zelnick: In the early days of new formats there are always disagreements about how stuff is going to be developed. In the case of video, for example, there was beta versus VHS. We’re willing to work with a number of different people, and we are working with a number of different technologies. However, will both a standardized format and a standardized way of doing business emerge? Absolutely. It always does. We don’t have much of a stake in what that is. We do have a stake in standardization, though, because consumers never really show meaningful adoption of new technology and media until it’s standardized.

IQ: Are you concerned that there may not be a standard business model?
Strauss Zelnick: People don’t adopt best practices immediately, but they do over time. With minor modifications, businesses always settle down to a basic way of doing business. I do think we are going to have a number of opportunities to make money that didn’t exist previously. For example, content syndication, where previously we made promotional material and convinced other people to use it, or maybe even paid them to use it. Now people want our content and they’re paying us to use it. In that way I suppose you could argue it’s a new business model, but eventually everyone will do it the same way. Are there little changes around the edges? Yes. Just enough to keep lawyers in business, but the basic model stays the same.

IQ: Basically, your premise is that ultimately once the technical standards shake out, business processes degenerate to a commodity as well.
Strauss Zelnick: Within specific businesses. So in terms of the way music will be sold, there will be 10 new ways, versus the way business is transacted today. And not everyone will do it in the same way. In fact, everyone will probably do it slightly differently. But when you go buy a record online, you, as a consumer, should be indifferent as to the business models among the distributors–and you will be.

IQ: Let’s talk about versus versus a big store.
Strauss Zelnick: Let me give you an analogy. There are many different record retailers, but when you go into a record retailer you pretty much transact business the same way at all of them. They didn’t collude with each other to do that. They didn’t even think about best practices. But at the end of the day, an approach evolves in the market and you’re going in and buying a record. You don’t walk into a record store and someone says, “Well, to buy a record here first you need to register and fill out this card and then you need to take it to that counter and then we give you a point and then you gather up 10 of those points…”

IQ: Are you digitizing content?
Strauss Zelnick: We are completely redesigning the backbone of our systems here to create, first of all, a robust B2B environment for all of our vendors and partners, and secondly, and more importantly, to digitize all of our content–both audio and audio visual.

IQ: What does brand building mean to this new market?
Strauss Zelnick: Historically, entertainment companies don’t built their own brands. People buy entertainment based on the piece of music or the movie or the TV show or the star. The brands typically are the product or the artist, the actor, the actress. No one buys a record because it’s put out by BMG. There are exceptions, of course. Parents buy Disney material because it’s brand-name Disney, adults buy Windham Hill Music because it’s Windham Hill–and that’s one of our labels. Typically, exceptions occur when you’re packaging material consumed in a packaged way. So, for example, ESPN is a brand because it means sporting events on television; it’s a packaged group of shows. MTV is a brand–you turn on MTV because you know what you’re going to get when you get there. It’s all about music.

IQ: Well, MTV has non-music shows like The Real World.
Strauss Zelnick: They have, but now it’s a lifestyle brand. We are doing that and we were the first company to launch genre-based Web sites, which are branded places to get music and information in the particular genres. We did this five years ago because we felt that it’s very hard to develop brands and that label Web sites were not the way to get consumers. So we built Peeps Republic, which is a strong brand, and Twangthis, BUGJuice, and now GetMusic and click2music.

IQ: What kind of hits do you get?
Strauss Zelnick: We’re one of the top music sites and GetMusic has well over a million unique visitors a month. We don’t really talk about hits.

IQ: How important is cross-marketing?
Strauss Zelnick: Very important. The combination of online and offline is crucial. I think one of the mistakes that people have made building online businesses is believing that there’s some distinction in having an Internet front end to a business that makes it a business unto itself.

IQ: Your bet is that the click-and-mortar will beat the pure plays?
Strauss Zelnick: I think it’s unquestionably true. The closest analogy you can find to the Internet before the Internet became a business tool was mail order. What we found out is that ultimately mail order is really viewed as a tool that is a piece of a retailer. The Internet isn’t a business, it isn’t a business model, it isn’t even a business proposition. It’s a tool. We have to use new media as a tool to build our businesses. Most businesses will have significant Internet pieces in the next 10 years, if not sooner. Figuring out how to do that is a real issue. The reason there’s so much buzz around entertainment is since the Internet is an audio, visual and interactive medium, entertainment companies are best positioned to exploit it.
If you’re Ford Motors you can afford to wait a little bit. Eventually, when a Ford goes there, it needs to learn about entertainment. Ten years ago, what was the extent of Ford’s involvement in audio-visual content? It hired an ad agency to make TV commercials and to do print ads. Now if you’re Ford and you have a Web site and you want to sell cars on the site, you’re in the audio-visual entertainment business if you want to attract customers to that site.

IQ: When you talk to people, traditionalists, do they understand that?
Strauss Zelnick: More and more do.

IQ: Does that create interesting opportunities and alliances for BMG?
Strauss Zelnick: Yes. One of the things we’re finding is people need access to the kind of content we have to build up their unrelated businesses, and we can syndicate our content and get paid and get some equity, and can promote our artists more.

IQ: Could you be a resource for the content, the infrastructure and the interactional?
Strauss Zelnick: Unquestionably. We made a deal with where you can create electronic greeting cards using our music and our stars. Are we in the greeting cards business? Of course not. Previously, what did greeting cards use? They used animations or cartoons or photographs. Now they need audio-visual content. Do they know how to make that? No. Do we? Yes. Is this a win-win situation? Sure. We syndicate our content and we promote our artists.

IQ: Is that going to be an ancillary business or is it going to be a pillar?
Strauss Zelnick: I suspect it’s going to become a core business. One of the reasons I’m so optimistic about the music business going forward is that the actual promotional cost center becomes a profit center in and of itself.

IQ: Is Napster a threat? Are the people using Napster thieves?
Strauss Zelnick: Absolutely. Let me give you an analogy. I’ve got a very nice library at home. Say I install a Xerox machine in the library and I put a note on the front door of my home saying the door’s open, come on in, anything you like in my library you can copy it, then just put it back. That’s Napster. Is that fair use? That is absolutely not fair use. It’s fair use if a friend comes over, but if every time someone stops by I make complete copies of hundreds of books, that is simply not fair use.
The only purpose of Napster is to promote that activity. That makes Napster a copyright violation and it makes people who use Napster pirates.

IQ: How do you think Napster-type services will evolve?
Strauss Zelnick: Among other things, in its current configuration Napster has a bigger problem than [copyright] infringement. The bigger problem is how it makes money. So Napster needs to figure out a business model.

IQ: The new CEO [of Napster] calls you up and says, “We’d like to be partners. We’re prepared to do things with registration and tracking so that you can, maybe, see who some of the unexpected successes are.” Would you become partners?
Strauss Zelnick: It’s already happening. Especially since we won summary judgment in the case, I think people realize that it’s all about legitimate alternatives. In its early days, HBO was heavily pirated, too. It encrypted, it enforced, it created legitimate alternatives. I don’t have any problem saying [our first job is the] creation of a legitimate alternative. Then we can scream and yell about piracy. Having said that, infringement is infringement; it is important to defend against it.

IQ: Earlier you said that things that were once cost centers have become profit centers, but it may well be that the behavioral profiles you are able to build about the people who listen to music, etc., become more valuable than selling the music. That is the back end.
Strauss Zelnick: You’re arguing a free television or a radio argument, and it’s a good argument. The problem is, if we don’t get paid, we can’t create.

IQ: To a certain extent, between and Napster, digital music has become the canary in a coal mine in terms of privacy issues and business models. Do you feel your company’s other divisions are taking their cues from what BMG is learning?
Strauss Zelnick: Bertelsmann has a pretty savvy collection of people. I wouldn’t necessarily say that the folks at other divisions are specifically learning anything from BMG. The book guys have been way ahead of the curve at this company.

IQ: So you’ve learned from them?
Strauss Zelnick: Absolutely. Hopefully we all learn from each other. I think we all understand several things. First, that there’s an enormous opportunity to expand our business through the use of new media. Secondly, we understand the power of our consumer relationships. Thirdly, we understand the migration of our business processes from offline to online. We certainly all understand how our club businesses are evolving. For example, is the seventh- or eighth-largest e-commerce site in the world in terms of unique visitors. Did we get [to the clubs] quicker than the folks in Silicon Valley? No. But did we get there quicker then all the other media companies? Unquestionably. Take a look at the assets we have.

IQ: What do you think of the Time Warner/AOL deal?
Strauss Zelnick: I think it should be a win-win. It will come down to the execution. AOL has a superb brand and wonderful customer relationships, and has always managed to reinvent itself in time to continue to be a business leader. Time Warner has the best collection of media properties in the world. Put the two together and link up the content with the distribution in new media and do it effectively and there should be an enormous win. However, culturally those kinds of mergers are difficult to carry off, and I think many people would say that the actual Time Warner merger didn’t yield a great deal of intra-divisional cooperation. They will need to create a new culture where intra-divisional cooperation is completely internalized. That’s something AOL is good at. That’s something that Time Warner is not very good at.

IQ: In what ways are new Internet technologies going to be vehicles for finding talent?
Strauss Zelnick: Probably in ways we haven’t figured out yet. But we don’t have a bottleneck in terms of finding new talent or music. We release more than 1,000 record albums a year. We have a roster of hundreds of artists. But 95 percent of what people do in the record business fails, about 5 percent works, and only about 1 percent works in a big way. What we need to do better is take some of that great music and make more of it into hits than we do now, and I think that the biggest application for new media will be for us to do just that, and to help our competitors do the same thing.

IQ: How so?
Strauss Zelnick: For example, database marketing is very expensive to do in the offline world. It’s almost impossible to do direct marketing in an offline world to launch a new artist, but you can do it very cheaply in an online world. So, we now have a significant database of people: We know what kind of music they like because they told us, and we can market new artists
to them.

IQ: Is branding going to become more or less important to the labels in the future?
Strauss Zelnick: Less, as things grow and diversify. Arista stands for country music, it stands for black music, it stands for pop music. How can it be a brand?

IQ: What kind of ideas do you get to play with now because of the Internet?
Strauss Zelnick: Before [the Internet], you couldn’t play with direct response database marketing, because it cost too much. Let’s say 20 years ago I had your name on a database because you signed up for a fan club. The problem was, while I had your name and knew you liked the Rolling Stones and I had a new act out called Lit and I thought you might like it, if I had wanted to put together a postcard with a little sample it would have cost me $1 or $1.50 to market to you. If I got a 2 percent response rate, it cost me between $50 and $75 to grab you as a customer, and as a customer you bought something that I sold at $10 wholesale. I had a problem.
Now, we can send it in e-mail, it’s targeted to a certain demographic, it’s stratified with a sample built in, with a hypertext link to a genre-based Web site and we can do it for six cents or less per e-mail. And you can probably expect not a 2 percent conversion rate, but, because you’re so targeted, maybe you can expect a 3 percent response rate. Suddenly, now you’re looking at $1.80 to grab the customer [who will] spend $10 bucks. This is a nice piece of change.

IQ: Right. And it becomes a virtuous cycle because you’re creating communities of interest within that.
Strauss Zelnick: Well, yes, because then you send people to your Web sites and, most important, you’re giving people what they want. And any time you can figure out a way to market what they want, you create a positive customer experience. When you hit an array of people with something they don’t want, you create a negative experience.
When they see e-mails that come from us or our labels or our artists we want them to open the e-mail and be interested in what’s inside, we want them to click through and convert. There are elements of customer management that come into being in this new world that entertainment companies typically have not had to deal with.

IQ: By way of context, how many e-mails does BMG send out now versus a year ago?
Strauss Zelnick: It’s a huge number. Again, back to your point, even though we innovated in this area, everyone else is doing it, too. Why? Because we help break a new artist this way, such as an artist like Pink. Our competitors look at it and say, “Geez, how were they able to break Pink so effectively?” There was a significant online component to that plan.

IQ: What’s the difference going to be in building brands in the next five years as opposed to what it meant in the past?
Strauss Zelnick: The more things change, the more they stay the same. What will stay the same is you better have an incredibly creative culture, talented executives, great artists and the ability to market them and bring them to consumers. What will change is the underlying internal business processes, because the entire business backbone is going to become much more systems driven then ever before. It will infuse everything that we do going forward. The infrastructure becomes the business process. That is a huge change. Back office becomes the office; for example, all transactions are done on my computer. I still talk on the phone, I still meet with people in person, but I send 100 e-mails a day. It speeds things up.

IQ: How do you think pop culture as a business is going to evolve in the next few years?
Strauss Zelnick: Movies aren’t going away, TV shows aren’t going away, recorded music isn’t going away.
But the way they’re promoted, cross-promoted, integrated, the way you allocate costs, that all changes.
You’re still going to go to a movie theater to watch a movie–that’s not going to stop. Just the same way you’re still going to go to retail stores to buy clothing and cars even though you can buy them online. People like to leave their homes and do stuff they’ve always done. The fact that you can buy frozen vegetables doesn’t mean you stop eating fresh vegetables.

IQ: Is there a revolution?
Strauss Zelnick: Yes. The biggest revolution will be more at the business-process level than the consumer level. But even at the consumer level, entertainment will change markedly. There will be new kinds of entertainment that we haven’t contemplated yet that will have strong interactive components, and there will be new distribution vehicles that we haven’t contemplated before. When you listened to radio 10 years ago, you had one way to do it–over-the-air broadcast, government issue monopolies. Today there are three ways: Internet radio, via streaming mechanisms; cable radio; and broadcast radio. Tomorrow there will be even more robust Internet opportunities. Eventually we get to a world where the whole notion of channels completely goes away for both television and radio.
On the content side we’re going to see probably less a revolution and more an evolution. [On television], you’ll see new shows that maybe aren’t a half an hour, maybe they’re six minutes, maybe they’re 37 minutes. They’re not traditional over-the-air broadcast and they have interactive elements as well as narrative elements. The people who figure it out and do it in an entertaining way are going to have huge economic and creative opportunities.

IQ: Do you think that it’s marginal or significant for top executives in pop culture companies to be exposed to the diversity of new media?
Strauss Zelnick: If you are not out in the community, if you’re not out in Silicon Valley, if you’re not reading trades, if you’re not online, if you’re not talking to people who are half your age who know twice as much as you do about new media, then you’re way behind the times. I spend virtually all of my waking hours thinking about the conjunction of traditional entertainment and new technology, and I still feel woefully undereducated because the world is changing so quickly.
There are a lot of people in entertainment who do live in the past and certain elements of the past will never change. The creation of entertainment really hasn’t changed in the last 100 years in many meaningful ways. However, if you’re able to preserve a creative approach that’s rooted in history and apply to it a knowledge of and acceptance of new media and new technology, then I think you have the best opportunity to succeed in a highly competitive environment.

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