On the Up Beat

Bob Daly and Terry Semel concede that if they were judged on the results of their first full year of running Time Warner’s record division, the evaluation might be harsh.

Profit has plunged nearly 30% this year at the Warner Music Group, the nation’s leading music company, and shareholders are bracing for more bad news in early 1998. The corporation’s flagship label, Warner Bros. Records, has broken few new acts and also has failed to rally its aging superstar roster to deliver new collections in time for the Christmas rush.

In the United States, Warner’s share of the $12-billion music market has shrunk to 20.5% from 22% in 1995, according to SoundScan. And things look even worse overseas, where Warner’s international division--particularly in Britain and Japan--is floundering and expected this year to fall about $100 million under budget, sources said. Record club sales around the globe have plummeted too.

Music has been one of Time Warner’s biggest cash cows and the downturn threatens to blunt a brilliant year for the company, whose other businesses--except film--are reporting record results.

“1997 has been tough. I’m not going to tell you it wasn’t,” said Daly, who along with Semel took over last year as co-chairs of Warner Music Group following a brutal corporate battle that cost the company a group of top music executives and a stake in hot Interscope Records. “Our numbers are off from last year for a lot of reasons. And we still have to get over a down fourth quarter and probably a down first quarter next year. But we knew from day one that this was going to be a period of transition. I guarantee you we won’t be having this same conversation next year.”

*

Widely considered the most formidable partnership in Hollywood, Daly and Semel came to the music division with a successful track record in film, where they have worked together at Warner Bros. Studio for the last 17 years. They remain in charge of a multibillion-dollar entertainment empire that includes Time Warner’s movie, television, retail store and theme park sectors.

While this has raised concerns that Daly and Semel may be stretched too thin, most observers credit the executives with restoring order to the music group, which had been paralyzed by two years of corporate chaos.

In their first extensive interview since taking charge of the record division, Daly and Semel talked about their lack of experience in the music field and the difficulties they have encountered in getting Warner Music on track.

Despite its declining fortunes, Warner Music--which includes Warner Bros. Records, Elektra Entertainment and the Atlantic Group--is doing better than everybody else. This week, the Burbank-based corporation continues to dominate sales in the U.S. with 40 albums on Billboard’s Top 200 chart by such acts as Prodigy, Fleetwood Mac, Metallica, Missy Elliott, Busta Rhymes, Jewel, Matchbox 20 and LeAnn Rimes.

While the Warner Bros. label may be in trouble, Elektra is expected to post strong results and Atlantic is poised to end 1997 as the top-selling label in the U.S.

“For the past two years, it’s like everybody has been rooting for Warner’s dominance in America to disappear,” said Semel, 55. “It’s pretty jarring when you change the entire management of a corporation at one time and we certainly have had our share of problems. But the last time I looked, we were still the leading company in the U.S.”

One reason Warner Music remains No. 1, employees and competitors agree, is that Time Warner chief Gerald Levin assigned Daly and Semel to the job. Their appointment followed two years of turmoil that gutted the management team and shattered the morale of thousands of employees.

By the time Daly and Semel arrived, former chairmen Robert Morgado and Michael Fuchs had alienated many of Warner’s biggest stars by firing or forcing out nearly a dozen of the company’s top executives including Mo Ostin, Lenny Waronker, Doug Morris, Danny Goldberg and Jimmy Iovine. Most of those individuals, now working for Warner’s competitors, say they would probably still be with the corporation had Daly and Semel taken over sooner.

It took six months of hands-on management, Daly and Semel said, to ease the concerns of the corporation’s shell-shocked staff and artist roster as well as to gain the trust of its new executive team of Russ Thyret, Sylvia Rhone and Val Azzoli.

When they took over, said Daly, 61, “we knew a lot about business and dealing with creative talent, but we knew nothing about music. When you sit across the table from Mo Ostin or Doug Morris or [Arista’s] Clive Davis, you’re looking at guys who have been in the business their entire lives, guys who know every little nuance from way back when. Probably our biggest weakness is tackling this learning curve. But we are figuring it out as we go along, and believe me, we know a hell of a lot more now than we did two years ago.”

*

Semel said a lack of experience isn’t always a drawback.

“The good thing about it is that we are not set in our ways,” Semel said. “We get in these meetings and people say, ‘Well, we do it that way because that’s the way it has always been done.’ But you know what? That’s not a good enough reason if what you’re doing isn’t working.”

Daly and Semel are reviewing the way Warner markets, promotes and distributes music to consumers. After learning that the labels were shipping unrealistic volumes of albums to boost quarterly projections, Daly and Semel reorganized the manufacturing and distribution system to allow orders to be turned around in just four days--the same amount of time it takes to restock video releases in Time Warner’s film division.

Daly and Semel are also paying closer attention to the way Warner Music spends its marketing dollars. They think their labels should put out fewer albums so that the company can better focus its resources and energy on marketing each project. They also think it is unwise to produce hundreds of music videos each year that never see the light of day on MTV, VH-1 or BET.

*

Semel said that the industry practice of giving away singles to retailers to inflate a song’s ranking on the pop chart is “ridiculous.” He and Daly are also scrutinizing the millions of dollars that Warner sinks annually into retail price-and-positioning fees and independent promotion.

“We are definitely not getting the kind of results we want for the amount of money we are spending,” Semel said. “This is the only consumer-driven business that, by and large, does not devote much energy or money speaking directly to the consumer.”

Last summer, Warner boosted the sales of Jewel’s eponymous debut by running ads on network and cable television. Daly said the company plans to aggressively expand its commitment to TV ads for mid-level and superstar acts on Warner’s roster.

Daly and Semel also have started to tap into Time Warner’s entertainment empire for marketing opportunities. Music videos by Warner acts are now being screened at Time Warner’s Six Flags amusement parks for visitors waiting in line. They run nonstop in Warner Bros. retail stores and on a giant outdoor screen overlooking a new Warner outlet on the Ginza strip, a chic shopping district in Japan. The company began using Warner recording acts as guest hosts on the WB-TV network this summer and soon will start including ads for Warner albums at the start of video releases.

But none of those innovations will matter if Daly and Semel can’t put Warner’s flagship label back on the map as a potent creative force--and critics question whether they can.

The company, which sources say suffers from a bloated staff and over-the-hill artist roster, hasn’t broken a cutting-edge act in ages. A joint venture with Madonna’s tiny Maverick Records label--which employs a tenth of the staff working at Warner Bros.--provided the company with its only recent breakthroughs: Alanis Morrissette and Prodigy. (Cash flow generated from those hits, however, must be shared with Maverick.)

*

Last month, Daly and Semel hired former Virgin Records executive Phil Quartararo to help Thyret resuscitate the Warner Bros. label. Sources say Quartararo and Thyret have been given a mandate to evaluate the operation and report in 60 days.

Daly and Semel refused to comment on speculation that the label’s Warner and Reprise divisions could be consolidated.

The delay in product from Warner Bros. superstars Madonna and Eric Clapton undercut Warner overseas. But Daly and Semel know it’s going to take more than a few American hits to fix the troubled international sector.

Warner Music trails far behind PolyGram and Sony Corp. as an international power primarily because, unlike at those two corporations, Warner’s foreign operation--as set up by former chairman Morgado--is a separate entity from its U.S. division. Before Daly and Semel arrived, Warner’s domestic and foreign arms often acted like warring factions, making it difficult to coordinate global marketing campaigns and to sign indigenous talent.

“There was a huge wall between the U.S. and foreign when we took over,” Daly said. “Warner certainly wasn’t like Sony, which appears to be a tight, seamless global unit. It was like two different companies here. We’ve tried to break down that wall and I think we’ve made a lot of progress.”

In Japan, the world’s second-biggest market, Warner accounts for just 5% of the market--trailing far behind Sony, PolyGram and EMI. Daly and Semel restructured Warner’s Japanese operation last year, hiring a new executive team and investing in new artists. They hope to see results within a year.

Warner’s anemic British operation is also in need of an overhaul. The division has had as much trouble as the company’s flagship label in breaking acts. Morale in the UK office is said to be sinking as fast as its profit base.

Daly and Semel refused to comment on what they plan to do in the UK except to say that they are seeking ways to improve performance in the British market, where EMI and Sony recently scored a flurry of hits with albums by such new acts as the Spice Girls and Oasis.

With all this on their plate, it is easy to see why some people think Daly and Semel, though well-liked and respected by most everyone inside the organization, may be stretched too thin.

“I’ll be honest with you, we’ve worked real hard over the last two years,” Daly said. “More than I thought we would have to. The first year was more difficult because the management was devastated when we arrived. It took some time for us to learn the ropes and to bring everyone back together and rebuild the company--right at a moment when the industry was down. But as each month goes by, it gets easier and easier.”

Adds Semel: “It’s not like we’re out there signing acts. I don’t really understand all this talk about us being spread too thin. People act like it’s just one person running two companies. If Bob and I divided up tomorrow and one of us ran music and one of us ran film, nobody would say a word.”

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Low Notes

Time Warner has come to depend on strong earnings from Warner Music Group to help pay off its heavy debt load. Projections show both revenue and cash flow dropping in 1997:

REVENUE, In billions: $3.6**

CASH FLOW, In millions: $541**

* Cash flow, or EBITDA, is widely used in the entertainment business as an indicator whether a business is financially robust. It is an accounting figure based on earnings before interest, taxes, depreciation and amortization.

** Projections

Source: Time Warner, industry sources