Sony’s Synergies : Company Is Facing the First Challenges to Its Plan to Unite Hardware and Software

If Michael P. Schulhof is feeling embattled, he certainly didn’t show it one recent morning as he descended from a plush Sony Corp. helicopter, tanned and smiling after a weekend at the beach.

Schulhof, as head of Sony Software, the highest-ranking American at the giant Japanese electronics company, was bound for London on the Concorde. From there, he would pilot a Sony jet to Austria for the inauguration of a videodisc factory.

For a day, at least, he would be spared the thorny business conflicts and personal criticism he has faced since he spearheaded Sony’s acquisition of Columbia Pictures nearly two years ago. And videodiscs, which boast better picture quality than videocassette recorders, are just the sort of product that are supposed to prove the wisdom of Sony’s controversial move into movies, music and electronic publishing.

Sony’s grand strategy of linking consumer electronics hardware and entertainment software, in fact, will undergo its first series of major challenges over the next 18 months. Around Christmas, the newly named Sony Pictures Entertainment will release the Steven Spielberg epic “Hook,” complete with heavy promotions of other Sony products and video games based on the movie.

Around the same time, Sony will launch a hand-held information access device called the Data Discman that will use software from a newly formed unit called Sony Electronic Publishing.

Next year, Sony will try to follow the phenomenal success of the Walkman and the compact disc player with a new music format called the Mini Disc. And, it will also challenge Nintendo with a new video game machine.

Each of these events will test the notion that, in Schulhof’s words, “hardware and software are two wheels of the same car.” And, Sony will either burnish its reputation as an innovator that combines technical acumen with a good gut instinct for what American consumers want or face a loud chorus of “I told you so” from critics who say the company paid far too much for Columbia and created a draining conflict between two very different types of businesses.

Schulhof and Masaaki Morita, the brother of Sony Chairman Akio Morita and the head of Sony’s U.S. operations, profess to be unconcerned about achieving synergies in the short term. The company’s $10-billion debt load is comfortable for a firm that posted $25.6 billion in annual revenues last year, Schulhof says, and the true benefits of combining hardware and software will emerge only over the long haul.

Yet, financial analysts are far less sanguine about the debt, and many still are not convinced that Sony has the movie unit under control. Stories of profligate spending at Columbia abound, and the much-heralded management team of Peter Guber and Jon Peters--which Sony spent as much as $500 million to bring aboard--dissolved in May when Peters resigned as Columbia co-chairman.

Moreover, Sony has established hardware/software synergy as the central justification for its expensive foray into show business--a sharp contrast with the approach of archrival Matsushita Electric Industrial Co., which purchased MCA Inc. last year.

MCA, the parent of Universal Pictures, is considered a stable, well-run entertainment conglomerate, and there have been few changes since Matsushita assumed ownership. Inquiries about synergy between the hardware and software businesses draw little response from Matsushita officials, who don’t appear to spend much time thinking about the issue.

“Sony had a very conscious, long-term strategy to develop the synergy,” says Rodney Harada, an analyst with Merrill Lynch in Tokyo. “Matsushita had a very good deal presented to them, and it was more of an afterthought to . . . try to develop the synergy.”

And, Sony is discovering that building a smooth working relationship between Schulhof’s Manhattan-based music, movie and electronic publishing dominion--known as Sony Software--and the more workaday electronics company in suburban Park Ridge, N.J., is no easy feat.

Although software accounts for just 20% of Sony’s worldwide revenues, it has attracted most of the attention and investment in recent years--to the chagrin of some on the hardware side.

“I tell them it’s nothing personal; it’s just the nature of the industry that people like to read gossip about software,” says Schulhof, whose own careful, measured manner--he’s a physicist by training--provides little fodder for Hollywood muckrakers. “Nobody reads gossip about people who make TV sets.”

Though his primary responsibility is Sony Software, Schulhof also sits on the parent company’s board and often speaks for Sony on both hardware and software issues. Some of his pronouncements about future products have been greeted with studied silence by hardware executives, who have their own ideas about what constitutes a product announcement.

Schulhof says, for example, that Sony will support a new audiotape format being launched by Philips, but U.S. hardware chief Ron Sommer says no final decisions have been made.

Sommer, an intense, energetic Austrian native who previously headed Sony’s German unit, says there are no fundamental differences over long-term strategy. But, he bristles at the suggestion that Sony’s future growth depends on software. Hardware sales, Sommer says, are growing 15% to 20% per year as demand remains strong for hand-held video cameras, CD players and other products.

Yet corporate-wide profits were down 10% for the first fiscal quarter, Sony reported Thursday, and full-year earnings are expected to fall 10% below last year’s $829 million, though revenues are still expected to rise 10%. Sony attributed the weakness to a strong yen and intense price competition in a weak U.S. market.

Morita, Schulhof and Sommer all acknowledge some friction between the two sides of the company but maintain that it’s a normal, even healthy, case of creative tension. “Sometimes people misunderstand the culture of our company,” Morita says. “Each division is always competing with the others,” and employees at all levels are encouraged to challenge their bosses, he says.

Yet, sources inside and outside the company who asked not to be identified say there often seems to be a disconcerting lack of communication between the Manhattan and Park Ridge offices.

Such conflicts will have to be kept to a minimum if Sony’s ambitious new-product plans are to succeed. First out of the blocks, in time for Christmas shopping, will be the Data Discman. With a tiny key pad, a flip-up screen and a price of about $400, the Discman will depend heavily on the appeal of the 20-odd “titles”--including dictionaries, encyclopedias and other reference books--that Sony Electronic Publishing is developing in conjunction with major publishing houses.

Late next year, Sony will launch an even more important product, a new audio system called the Mini Disc. Featuring recordable discs that are just 2 1/2 inches across, the Mini Disc system incorporates a clever technique to prevent skipping and will be aimed primarily at the portable market now served by the Walkman.

Establishing a new audio format is no simple matter, however, and Mini Disc will face a strong challenge from Philips’ digital compact cassette (DCC) format, which will debut in the spring with the backing of Matsushita, Tandy and other electronics firms. DCC, like Mini Disc, will offer high-quality digital sound and will play conventional analog tapes in addition to new DCC tapes.

In theory, Sony’s ownership of a major record company should help establish Mini Disc, since Sony can assure that albums from its own artists, at least, will be available in the new format. Before buying CBS Records in 1988, Sony had owned part of that company’s Japanese subsidiary, and Schulhof says that was a major factor in the success of the compact disc.

But ownership of a record company did not help Sony in the case of digital audiotape (DAT), another high-quality audio format. The recording industry, fearful that DAT’s ability to produce perfect copies of digital recordings would hurt sales of prerecorded music, fought the introduction of DAT. And, Sony Music sided with its recording industry counterparts rather than its electronics parent, refusing to release its popular artists--such as Michael Jackson--in the DAT format even after Sony began marketing DAT in the United States last year.

A recent agreement between electronics vendors and record companies calling for royalty payments on digital recording equipment should clear that obstacle. But, while a number of record companies are firmly lined up behind DCC (including Philips’ Polygram subsidiary), Sony faces an uphill battle in gaining acceptance for Mini Disc.

Several record company executives said they are in principle interested in the Mini Disc but have not yet seen or heard the system and thus cannot evaluate it. “They haven’t been prepared to make any demonstrations, so I’m withholding my judgment,” said Joe Smith, president of Capitol-EMI Music. His company is enthusiastically supporting DCC.

“We have to be very cautious in bringing new formats” to the market, says Al Teller, chairman of MCA’s Music Entertainment Group. “You cannot create customer confusion.” Teller believes the time is right for DCC, which his parent company Matsushita is supporting, but is skeptical about the Mini Disc. “Introducing two new formats simultaneously--I don’t think it’s a smart thing to do.”

“So far, the evidence is that owning a record company is not sufficient to get a new format off the ground,” says Jonathan Seybold, a Malibu-based electronic media consultant. “Philips has a significant number of record companies (behind DCC), and Sony has nobody.”

Rather than trying to play hardball and refusing to release Sony Music artists on DCC, Sony is instead talking about joining the DCC bandwagon while continuing to push ahead with Mini Disc.

Sony confronts a similar dilemma in the video world, where an earlier format war between Sony’s Betamax and VHS helped persuade Sony that it was crucial to be a player in software. Sony is pushing its 8-millimeter format, which has been very successful for hand-held cameras but far less so in the VCR world, and is also trying to revive the videodisc.

Yet, analysts point out that Sony Pictures’ share of the film market is too small to make or break a format. The movie company can support the hardware side by releasing its films in 8-millimeter and disc formats, but it can hardly withhold its offerings from the far more lucrative VHS market. Bowing to market realities, Sony even sells VHS video recorders.

Sony may have even more trouble with another new hardware product, a sophisticated disc-based video game machine called the Play Station. Initially, Sony had hoped to enter the game business as an ally of Nintendo. The Play Station will be able to play new Nintendo game cartridges, and Sony had expected to supply the technology for a later generation of Nintendo disc-based games.

But, only a day after Sony announced the Play Station, Nintendo said it was teaming with Philips to develop a disc-based machine. Though neither company will comment on what went wrong, sources say Sony’s insistence on controlling the software created for its proprietary disc format led Nintendo to pull out.

Sony is counting on superior graphics and sound capabilities to give its machine an advantage over Nintendo, but it can only hope that Sony Electronic Publishing will come up with the exciting games that are the ultimate key to selling machines.

Olaf Olafsson, president of Sony Electronic Publishing, says his group will get a big boost from its links with the movie and record companies. Many successful video games rely on tie-ins with popular films or celebrities, and SEP will be able to get in on the ground floor on Sony Pictures movies such as Spielberg’s “Hook.”

Yet, it’s hardly necessary to own a movie company in order to get licensing rights to movie characters. “They have properties, but do they have decent games?” asks an executive at a competing game company.

Sony executives readily acknowledge that other areas of synergy are much further in the future. High-definition television, which Sony has long promoted as a TV and film production medium, could get a boost from Sony Pictures, but nobody expects it to be a mainstream production tool--at Sony Pictures or anywhere else--for some time.

Sony’s professional products group, meanwhile, has had to reassure buyers of its professional video equipment that they were receiving the same treatment as Sony affiliates.

Schulhof says synergies are emerging in unexpected ways. Sony audio products in Japan got a big boost after the record company buyout, he says, apparently because it lent a certain glamour to the firm. A Sony manager responsible for video equipment sales to Coca-Cola Co. served as point man for a marketing tie-in between Coke and Sony Music. Hardware company engineers can also benefit from the feedback they get from their counterparts in the music and movie units.

Peter Guber, chairman of Sony Pictures, says his company won’t make a decisive difference when it comes to specific hardware products, but links to the electronics side help to “demystify high technology and make it more accessible to the creative community.” In the long run, he says, that will lead to new outlets--like video games and multimedia computers--for the movie division’s creativity.

Still, there are doubters. One hardware executive who asked not to be identified noted that although he found all the theories about synergy “plausible,” he was still skeptical about the implementation. “I’m not sure there is a clear concept there.”

And, as Emanuel Gerard of the investment bank Gerard, Klauer, Mattison points out, the synergy issue cannot be evaluated without looking at the cost. “The question is not whether there is synergy; of course, there is some synergy,” Gerard says. “The question is whether it’s worth the price.”

He clearly thinks it is not, describing the Columbia acquisition as an “unmitigated debacle.”

Sony executives, though, remain serene in taking the 20-year view. The company will relieve some of the short-term financial pressure by selling shares in the Japanese record subsidiary, and it may raise as much as $2 billion to $3 billion within the next year with a similar offering for the U.S. entertainment businesses.

“We don’t need synergy to cover up weaknesses, but synergy can give the whole thing a turbocharge,” Sommer says. It may soon become clear whether that multibillion-dollar turbocharger was worth the price.

Sony Corp. at a Glance Headquarters: Tokyo Key executives: Akio Morita, chairman; Norio Ohga, CEO; Masaaki Morita, chairman of Sony USA; Michael P. Shulhof, president of Sony Software, and Ron Sommer, president of Sony Corp. of America. Employees: 112,900 Key products: Consumer electronics products, including TVs, VCRs, video cameras, CD players, tape recorders; professional video and audio equipment; magnetic tape and discs; computers and electronic components, and movies and records. Revenue for year ended March 31: $25.6 billion Net income: $829 million Sales by product group: video equipment, 25.1%; audio equipment, 24.4%; TVs, 15.3%; other products, 15.0%; music entertainment, 13.1%, and filmed entertainment: 7.1% Sales by geographic area: U.S., 29.2%; Japan, 26.3%; Europe, 28.1%; other, 16.4% Source: Sony Corp.

Can Sony Software Help Sell Harware? * Data Discman: Set to be available by Christmas, the Data Discman will offer easy access to electronic references such as encyclopedias. Sony Electronic Publishing must come up with lots of attractive titles to draw buyers for the $400 unit. * Mini Disc: Scheduled for release next year, the Mini Disc can record and play back music without skipping. But its success in the face of competition from a new digital tape format will require support from record companies--such as Sony Music. * 8mm Video and Video Discs: Sony’s Betamax standard lost out to VHS, in part because movie companies released more VHS films. Sony hopes owning a film company will help it do better with 8 millimeter VCRs and video disc players.