Bertelsmann’s Direct Group Hits a Few Big Bumps on the Road to Worldwide Synergy


You can’t blame Thomas Middelhoff for trying. The chief executive of German media behemoth Bertelsmann — doted on in the business pages as a Visor-toting visionary dragging an ossified corporate empire out of the Westphalian mist — has upped the ante for global synergizing in one of his company’s most sweeping reorganizations to date.

Following the lead of arch-rival AOL Time Warner, last fall Bertelsmann lumped its entire content portfolio — including Random House, BMG and Gruner + Jahr — into what’s been grandly dubbed the Bertelsmann Content Network. The idea was simple: foster cross-media synergies by sharing corporate turf. Remaining global operations were then stratified into two other divisions: Arvato AG took on printing and IT units, while the Direct Group comprised all of the company’s direct-to-customer activities.

The most motley division is this last one, officially known as DirectGroup Bertelsmann, now home to book clubs, music clubs and e-tailers including BOL and CDNow. The group also oversees Bertelsmann’s 40 percent stake in As Middelhoff struggles to turn the company’s cherished book-centric culture toward a hot-wired future, the Direct Group may be the spot where his vision proves most likely to founder.

By all accounts, the dream is a glorious one. ”Our book and music clubs,” the company proclaimed last fall, ”are in the midst of a dynamic global transformation process by which they are becoming more customer-oriented community businesses.” The Direct Group, headed by Klaus Eierhoff, would use the Internet as the ideal means of distribution; jazz up traditional clubs and direct marketing channels with e-commerce outlets; modernize hoary marketing tools; and ”exploit the potential for synergies between e-commerce and the clubs on an international scale.”

Reality isn’t so rosy. The Direct Group currently shows losses, insiders say. Clubs are suffering ”mounting competitive pressures” in all English-language markets, according to company statements, ”especially from fast-growing Internet book retailers.” The group’s e-commerce units have lost hundreds of millions of dollars in the past year alone. And at bottom, ancient rivalries among direct-to-customer divisions are making for uneasy synergies: a potential family feud between Bertelsmann’s e-commerce chief, Andreas Schmidt, and Eierhoff has raised further questions about the division’s future.

Details about the Direct Group’s conundrums are hard to come by, and few executives are in a position to speak on the record. But Middelhoff, known to be a big-picture man and not a whiz at operational nitty gritty, has acknowledged that among the gravest quandaries facing Bertelsmann is the question of what to do with its worldwide book and music clubs.

They are a potentially formidable force. As of last year, before the realignment, the book clubs had counted 28 million members worldwide, contributing 52 percent of the book division’s revenues. (Book publishers accounted for 44 percent.) Music clubs in the U.S. had another 12 million members. Though the Direct Group did not exist as such during the last accounting cycle, Bertelsmann estimates its turnover for the current fiscal year to clock in at more than $3.3 billion.

Those are big numbers, but whether they add up to a wham-bam direct-to-customer strategy is the question dogging the European book clubs — once the company’s most stable cash cow — and their English-language counterparts. ”Nearly all book clubs face profit pressure because of lower margins,” according to a Bertelsmann statement. ”The risk of increased costs to acquire rights and the possible end in the mid-term of mandatory retail book pricing systems in Germany and Spain may have an impact on profits.” Indeed, according to company financial statements, operating income in the book division last year was $26.6 million, down drastically from $120 million the year before.

Falling income was attributed to investments in Internet distribution operations, as well as expenses related to BookSpan, the joint venture with AOL Time Warner‘s Book-of-the-Month-Club, which, along with Bertelsmann’s Canadian holdings, operates some 45 book clubs. A Bertelsmann spokesman acknowledged that the clubs ”have been facing a challenging situation recently,” but added that ”we are on a very good path now to achieve our goals.” (BOMC showed an operating loss of $18 million in 1999, before it became part of BookSpan, on revenues of $321 million.) Officials envision over a hundred clubs in the coming years, on the order of the new fly-fishing club, called On the Rise, which has targeted the 6.5-million adult American angler market. Member perks for the clubs are slated to include Web-based conveniences such as customized delivery options and online chats with fellow readers.

Still, BOL and seem somewhat synergy-deprived. Though now deployed in some 16 countries, BOL is eating loads of cash — expenses are high in part because the e-tailer is operated on a country by country basis — and the results are debatable. A Direct Group spokesman insisted that BOL has achieved ”leading market positions in the countries where it is operating,” and is working on expanding its position as a media retailer, including the addition of videos, DVDs, games and software. However, the Bertelsmann spokesman said, ”There are no plans to make BOL into a comprehensive portal site, as the DirectGroup’s businesses focus exclusively on media commerce.” As the corporate parent gears up to invest a reported $3.1 billion over the next three years in online activities, industry watchers suspect that BOL may be left behind, especially if Bertelsmann eCommerce Group chief Schmidt can devise a way to parachute out of the mess while saving face for all parties involved.

BOL’s future does look brighter in Asia. In December, it launched its shop in China, created in close cooperation with that nation’s Bertelsmann Book Club, itself a joint venture that’s now up to 1.5 million members. BOL China opened with access to 110,000 Chinese-language titles, and fired up Bertelsmann brass, as well. ”BOL China is leading the way for the direct business at Bertelsmann,” Direct Group chief Eierhoff said in a statement, adding that ”the close cooperation between the Club business and BOL illustrates the multi-channel strategy of the DirectGroup.”

Meanwhile, a Direct Group spokesman pointed to active cooperation between Bertelsmann’s British BCA book club and BOL’s U.K. site. The arrangement includes links between the two organizations’ Web sites, a collaborative sci-fi promotion coming up this month and even a ”bounty per customer” paid when members from one group visit or make purchases at the other’s site (club members get a 10 percent discount at BOL, shown as a credit on their club bill). In Germany, PC terminals have been installed in club shops, with access to the BOL site. And on a larger scale, costs are being cut through a centralized purchasing unit for European clubs, especially in the areas of paper and merchandising; a common IT platform for club businesses; and a move toward compatible back-end machinery in both club and e-commerce units.

Yet synergies of any sort seem missing-in-action from Bertelsmann’s stake in There, Bertelsmann’s long tradition of going into a country and partnering with the strongest player has run afoul of the Riggio brothers, who seem intent on keeping close to the vest. The site, which last month announced layoffs of 350 employees and closed two distribution centers, reported a net loss of $275.7 million for the year, up from $102.4 million the year before. Knowledgeable sources suggest that the river of recent bad news might be calculated to drive the dot-com’s price down, all the better for the Riggios to grab it back and fully exploit some clicks-and-bricks synergies of their own.

The apparent Riggio brush-off has had peculiar effects, namely that the words ”Bertelsmann” and ”” are being increasingly uttered in the same sentence, with ”acquisition” never far behind. Amazon’s possible alliance with Wal-Mart notwithstanding, the e-tailer would of course make a prime piece of online turf for Bertelsmann’s Direct Group portfolio, particularly since Amazon’s stock price — now trading around $12 and change, off almost 90 percent from a December 1999 high that topped $106 — is approaching rock-bottom. Whispers to that effect have been heard in the halls at Random House, a source says, though Bertelsmann is certainly just one of many global conglomerates savoring the moment Amazon chief Jeff Bezos comes begging.

Complicating the acquisition scenario is Bertelsmann’s recent deal for control of the RTL broadcast group, which has paved the way for the floating of Bertelsmann shares on the stock market in three years, something analysts say will finally bring to fruition Middelhoff’s dream of taking the media giant public. The prospect of IPO-financed acquisitions, combined with the broadcast deal, points well beyond mere Web synergies. Bertelsmann already owns the biggest television company in Germany, and holds stakes in some 22 TV broadcasters in nine countries. Observers note that a studio purchase would make a smart next move. Convergence, anyone?

Back in the Direct Group, however, rivalries are causing some Middelhoff-oiled gears to gnash. Last holiday season, for example, BMG Direct chief George McMillan admitted to strategizing against competitor — and corporate confrere — CDNow. Such talk belied McMillan’s real objective, however, which was figuring out how to get CDNow under his own wing, something he has now managed to do. (In a quiet move, CDNow’s chief now reports to McMillan.) Book-vs.-music tensions must flare at times, too. ”All the backbone and infrastructure is in the hands of the music business,” says one publishing veteran. Fulfillment operations are run by music club execs, relegating books clubs to the status, in effect, of a third-party client.

A few kinks in the Direct Group reporting chain can also be seen. While music clubs and the online units report to e-commerce chief Schmidt, BookSpan president and CEO Markus Wilhelm reports to Direct Group chief Eierhoff. Hence book clubs and music clubs aren’t clicking together as much as they might. And while Schmidt reports to Eierhoff on paper, he’s lately been relishing the role of being Middelhoff’s sidekick for the Napster follies, and parlaying his knack for publicity into an enlarged e-commerce fiefdom. Trouble for BOL and questions about the stricken Napster have only exacerbated the power struggle between Schmidt and his titular boss Eierhoff. So much for synergy.

Chalk it all up to the usual reshuffling aches and pains; Bertelsmann’s e-commerce investments may pay off in good time. Yet the Direct Group’s woes seem to run deep, and signal a chink in Middelhoff’s big-picture strategy. The entire direct-to-customer gambit can be reduced to one premise: the value chain is changing, so we’re going to own every piece of it. Whatever happens, we’re covered: content, distribution and customer relationship. As the company suffers what it frankly calls ”unbelievable competitive pressure,” however, it’s clear that owning the whole value chain comes at a steep price. Even with Bertelsmann’s fabled billions, yoking those links may be more costly than anyone dared imagine.