Bertelsmann Plays Musical Chairs

By CHUCK PHILIPS

Nov. 28, 2000 12 AM PT

TIMES STAFF WRITER

Nearly a year ago, Bertelsmann Chairman Thomas Middelhoff bragged of a business plan that would transform the Gutersloh, Germany-based media giant into the world’s preeminent music company.

The reverberations from that pronouncement are now being felt throughout the music industry.

The 45-year-old German executive stunned rivals this month when he announced a pair of eye-popping alliances with British music behemoth EMI Group and controversial Napster Inc. He also shocked his own management team by overhauling the company’s BMG record division in a move that was designed, at least in part, to drive out BMG honchos Strauss Zelnick and Michael Dornemann.

The swiftness and the secrecy with which Middelhoff has orchestrated each step of his global plan reveals much about his shrewd management style. It’s a tale of power and manipulation that casts a cold light on the inner workings of the $40-billion music business, an industry where corporate titans rise and fall faster than hits on the pop chart.

Middelhoff’s maneuvers prompted a sudden announcement on a Sunday afternoon this month that Zelnick and Dornemann were being replaced by Rudi Gassner, a former BMG executive whom Zelnick and Dornemann had earlier forced out of the company. Zelnick declined repeated requests to be interviewed. He has disputed reports that he was ousted, saying he resigned over differences with Middelhoff on how to run the company.

If successful, Middelhoff’s efforts could rejuvenate BMG, which insiders say is expected to fall nearly $100 million short of its projected profit goals in the year ahead.

“BMG has gone through so many dramatic shake-ups,” said Michael Nathanson, a media analyst at Sanford C. Bernstein & Co. “Nevertheless, if Middelhoff pulls off this EMI merger, he will not only be sitting on top of the largest record company in the world and saving millions through cost cuts and consolidation, he will also be buying into a much more stable team of music managers.”

The following behind-the-scenes account of the sweeping changes is based on interviews with a dozen top industry figures familiar with the turmoil, including executives employed by Bertelsmann. All of these people spoke only on condition of anonymity, citing concerns about their careers.

It is well known in music-industry circles that Gassner, 57, and Zelnick, 43, have been at odds for years.

The falling-out began in 1994 when Dornemann hired Zelnick, a buttoned-down Harvard MBA with no music-business experience, to run BMG’s U.S. division. When Dornemann promoted Zelnick four years later to chief executive of the global music group, many viewed it as a slap in the face to Gassner, who had been angling for the job for more than a decade.

Their most recent rift erupted in October of last year after Zelnick disregarded Gassner’s advice on how to handle a series of disputes between BMG and two label heads--Arista Records founder Clive Davis and Zomba Music chief Clive Calder.

Zelnick told Middelhoff that BMG could save money by replacing Davis with a younger successor and could prevent pop group ‘N Sync from jumping ship to Zomba by suing Calder and seeking an injunction against the singers to block the release of their next album.

Gassner, who had run BMG’s international arm for more than a decade, disagreed. He thought BMG should try to resolve the matters quickly and quietly out of court. Zelnick brushed Gassner’s suggestion aside--some say with the intention of forcing him out.

On Jan. 5, Gassner became so enraged he decided to quit and fired off an e-mail to Middelhoff explaining why. In the e-mail, Gassner harshly criticized Zelnick’s management style--particularly his handling of the Arista and Zomba debacles, which ended up costing BMG more than $200 million.

“As someone who has spent much of his life helping to build BMG, I must warn you that the future of this company is in danger if you leave it in Strauss Zelnick’s hands,” Gassner wrote in the e-mail, a copy of which was obtained by The Times. “The Bertelsmann management should accept that it was a mistake to appoint him and consequently change the leadership.”

On Jan. 31, Bertelsmann issued a brief statement announcing Gassner’s resignation.

By April, Mark Woesnner, a veteran Bertelsmann power broker viewed as Dornemann’s mentor and protector, was considering stepping down as chairman of the corporation’s supervisory board. Insiders said that, once Woesnner left, Middelhoff would restructure BMG and push Dornemann--and possibly Zelnick--out the door.

In June, Middelhoff invited Gassner to lunch at a New York hotel. During the meal, Middelhoff stunned Gassner, asking him whether he would consider returning to BMG to replace Zelnick and Dornemann to run a restructured global-music division, according to sources close to the negotiations. The next day, Gassner e-mailed Middelhoff, accepting the offer. Middelhoff told Gassner he would get back to him as soon as he could figure out how to make it happen.

What Gassner didn’t realize was that Middelhoff had hired an executive headhunter and was already considering several other candidates for the job, including Bertelsmann veteran Arnold Bahmann and possibly Zelnick too.

In August, Middelhoff asked Zelnick whether he might be interested in taking over. By wooing both Zelnick and Gassner for the same job, Middelhoff was hedging his bets and leaving himself a backup plan. There also was another element in play: Zelnick had two years left on his existing deal and Middelhoff did not want to risk breaching his contract and paying out a huge exit package.

Middelhoff told Zelnick that the post would be more limited than the one Dornemann was vacating. BMG, he said, would soon be stripped of its manufacturing, record-club operations and digital-distribution efforts.

Middelhoff, however, failed to reveal one significant detail about his digital plans to Zelnick: He was knee-deep in secret negotiations to purchase Napster, the file-sharing service that BMG and four other record conglomerates are suing for copyright infringement.

More than a month passed before Zelnick discovered that Middelhoff had hammered out the Napster deal behind his back. Zelnick found out when Bertelsmann e-commerce chief Andreas Schmidt called to let him know that the rooftop ballroom at the St. Regis Hotel in New York had been reserved for Sept. 18 to announce the deal. A news release about the alliance had already been prepared and was scheduled to be issued at 7 a.m. the same day.

Zelnick went ballistic, according to company sources. He told Schmidt and Middelhoff that BMG could never support such an agreement, coming just days before the industry was to square off in court against Napster. Zelnick was so angry he threatened to quit, the sources said. Zelnick’s objection led Middelhoff to withdraw the offer to Napster at the eleventh hour.

The discussions with Napster, however, resumed immediately after an Oct. 2 appellate court hearing in San Francisco on the legitimacy of the file-sharing service. This time, Middelhoff included Zelnick in the talks, even though some Bertelsmann officials began telling Napster that Zelnick’s days at the company were numbered.

Through it all, Zelnick continued trying to negotiate a new contract with BMG. Unaware that Middelhoff had other candidates for the job, Zelnick started out asking for a beefed-up compensation package worth a potential $100 million, sources close to the negotiations said. Zelnick also went in believing he could win some concessions regarding the restructuring of the digital division.

Zelnick felt so confident about his future at Bertelsmann that he consented to a series of interviews with Talk magazine for a story to be published in November. The article, which was peppered with positive remarks from Middelhoff, concluded with Zelnick stating, “I have the gig.”

On Oct. 11, Middelhoff offered the post to Gassner over lunch in New York, spelling out in precise detail what the job would entail. Middelhoff and Gassner shook hands at the table and parted company vowing to keep the meeting secret.

Middelhoff had another secret too. He was on the verge of announcing an alliance with British music giant EMI Group.

It’s unclear why Middelhoff took such pains to keep Zelnick in the dark about Napster and EMI. What is clear is that Zelnick’s contract talks with Bertelsmann cratered on Oct. 19 at a BMG convention in Cannes, France.

Before flying back to the United States the next day, Zelnick notified Middelhoff that he planned to resign, giving up the chance to run what could turn out to be the world’s largest music company.

The next day, the head of human resources at Bertelsmann flew in from Germany to Gassner’s home in New York with a short-form contract. On Oct. 23, Gassner signed the offer.

Meanwhile, Zelnick and Dornemann had no idea who the successor was until Nov. 3 when an unexpected fax arrived from Germany at Zelnick’s New York office--a first draft of the official news release announcing their resignations and Gassner’s surprising return.

On the morning of Nov. 5, a Sunday, Bertelsmann announced from Munich Gassner’s return and the resignations of Zelnick and Dornemann.

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Creating a Music Giant

Combining Bertelsmann’s BMG music division with EMI would create the world’s largest record conglomerate cornering nearly 23% of the global music market. Bertelsmann’s Arista and RCA labels release CDs by such stars as OutKast, Whitney Houston, Christina Aguilera and Santana. Adding EMI to its roster would give Bertelsmann access to artists on the Priority and Hollywood-based Capitol labels, including the Beatles, the Beastie Boys, Master P and Frank Sinatra.

If Napster can be legalized, BMG could gain access to as many as 40 million Internet music fans. This would give it an unrivaled digital distribution system.

MARKET SHARE

Current worldwide market share in the music industry.

Universal: 21.5%

Sony: 14.6%

EMI Group: 13.0%

Time Warner: 12.6%

BMG*: 9.7%

Other: 28.6%

*Without Jive

WHO’S IN AT BMG

Thomas Middelhoff: Bertelsmann chief

Rudi Gassner: New BMG chairman