Strategy: The Big Merge

The email arrived in the middle of the night.

At 3:22 a.m. on the morning of Oct. 29, as the East Coast was battening down the hatches in preparation for Superstorm Sandy, Stuart Applebaum, executive VP of communications at Random House, Inc., delivered the news in the form of a press release and a letter from Markus Dohle, chairman and CEO of Random House.

"Bertelsmann and Pearson to Combine Book Businesses," trumpeted the press release.
"Today we begin an exciting new chapter for our company," began Dohle's letter. "Bertelsmann has just concluded negotiations with Pearson, the parent company of the Penguin Book Group, to form a future new partnership …"

The news itself was certainly no surprise. That Penguin and Random House were talking merger had been the buzz of the rumor mill for the few weeks prior and, an 11th hour bid by Rupert Murdoch's HarperCollins notwithstanding, had become all but fait accompli in the days prior. According to those in the know, the publishing powerhouses had been in discussions for some time. That the official word arrived as America's publishing capital was about to be pummeled by an atmospheric event so unprecedented meteorologists needed new nomenclature, though, made it all seem a little more heavy.

The Big Six would be no more. And suddenly Random Penguin—heretofore a fanciful, zen-like amalgamation of syllables—was a thing. Not yet a reality, because these things take time, but an agreement. An agreement announced in an email on a dark and rainy night.

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Of course, between now and when the transaction is closed (likely late 2013 pending regulatory approval), official news about the Random House Penguin venture is expected to be scarce. And yet questions abound. Why did two of the biggest players in book publishing throw in their lot together? Will further contraction occur in its wake? Will this give the new entity more leverage in its negotiations with mighty Amazon? And if so, will it be enough to matter?

We rang up four industry experts and asked them what—if anything—it all means for publishers and publishing.

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The Inside Guy

Peter McCarthy

Founder and Principal Consultant

McCarthy Digital

Peter McCarthy is a publishing vet and marketing pro whose CV includes lengthy runs at both Penguin (VP, executive director Penguin Group USA online from 1998-2005) and Random House (VP, director of marketing innovation from 2005-2011), so he's got unique insights on what makes each company tick.

"I think many of the executives see it as a way to grow," says McCarthy of the overarching motivation. "When they combine—and I don't have the precise numbers—they'll have anywhere between 25 and 40 percent of the market depending on if they have hits in a given year."

That kind of size will, of course, give them "leverage with people in the value chain. With Amazon in terms of negotiation, and, I don't think they would want to talk too much about this, but the bigger the pipe, the more negotiation power they have with authors and agents."

So in a way, to take McCarthy's view on things, the inherent growth involved in merging two giant publishing companies is intended to save money.

"When you read the press releases, everything is mentioned as Bertelsmann and Pearson having made these decisions," he says. "Basically, the trade book publishers are viewed as constant providers of anywhere between a nine and 12 percent margin on an annual basis. I think what's going on here is downward price pressure on ebooks—and whether or not it's real is another question, but there's a perception of downward price pressure—combined with a perception of a flat marketplace in terms of unit sales. If you're selling the same amount of product but for a lower price, decreased revenues is the conclusion one draws. The only way you can preserve margins is by cutting costs."

McCarthy sees one of the biggest challenges for the companies as they come together is a difference in culture. Random House, for instance, "is extremely decentralized" while "Penguin is very much a centralized command and control kind of environment."

During his time at Random House, says McCarthy, "it was pretty rare to have a meeting at which you find people from different divisions. Generally speaking, I'd go to a Crown meeting and then a Knopf meeting and so forth."

At Penguin, says McCarthy, "most of the strategic decisions are made centrally, but the culture is less corporate, more of a roll-up-our-sleeves culture. Leaner in general and much more scrappy." He adds, "Often forgotten is when Putnam and Penguin merged, it was Putnam's management that took over the company. Putnam was not the sort of white-heeled shop that Penguin was. There are two cultures down at Penguin. People look at merging Random House with Penguin, a white-heeled publisher of classics. But it's way more complicated than that. Six entities from the Random House side and two or three entities from the Penguin side."

While there are many risks inherent in a move of this size—from the perception of being seen as slow-footed and not innovative to lowered morale in back-office departments that are often targeted during consolidation—McCarthy says the biggest risk is talent.

"Suddenly your best people … are involved in merger activities, figuring out new partnerships, shifting their focus," he says. "It might not just be a year. It takes a lot of meetings to integrate two companies of this scale."

That said, McCarthy says he thinks the move makes perfect sense. "People are trying to read a lot into it … but I think any attempt to read this as an extreme change in the business is a misread. It's consolidation, just like the publishing industry has experienced every year I've been in it."

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The Skeptic

Michael Norris

Senior Analyst

Simba Information

Some observers are more optimistic than others. Color Michael Norris less optimistic. "The only real innovative thing that may come out of this is the combined firm will have a lot more content to study, so they can better see what works and what doesn't with print and digital distribution," says Michael Norris, an astute observer of book buying trends in his role with Simba Information. "If they can combine easily and in a short time, that could be a good payoff."

Echoing Peter McCarthy's thoughts on the effort it will take talented people to work on organizational issues, Norris sees this as a potential stumbling block for two publishers he regards as quite innovative in their own right.

"I think this merger is high risk and low reward," says Norris. "The two companies have been very innovative by themselves in the digital space and combining them won't necessarily make them twice as innovative."

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As with any move like this, there's an opportunity cost among other risks. "The publishing business will continue to transform while Penguin Random House figures out who gets what title and who gets to lead," says Norris. "Not only will they have to hold onto their talent with both hands during the transition, but the industry may be different by the time they are fully integrated, and then they'll be playing catch-up."

As to why this is happening, Norris thinks the move was not born of a strategic need, but rather "because someone at either Pearson or Bertelsmann finally figured out that ebooks aren't going to step in and save the industry and wanted out of the consumer books business."

Norris emphasizes that he hopes the new entity will be successful, but qualifies that he'll be measuring that success against a different yardstick than shareholders will: "on the extent that they can get more people who don't buy books to buy one book. Simba estimates over 100 million adults didn't buy a single, solitary book in the last 12 months, and everyone in the industry needs to start figuring out how to make content worth the wait instead of simply shortening the distance between the voracious reader and the cash register."

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The Pragmatist

Michael Cairns

Chief Revenue Officer

SharedBook

According to industry vet Michael Cairns, there will, of course, be big operational challenges in maintaining the business momentum on both sides. "But most of the execs are going to know that," says Cairns. "I suspect many have gone through something like this before."

Cairns, who was on hand for the merger that formed Price­Waterhouse­Coopers in 1998, figures this deal will go down relatively smoothly.

"Pearson and Random House have been talking about this for a while. They've been intellectualizing it for a lot longer than Simon & Schuster and HarperCollins [have] should they end up together," says Cairns, referring to reported preliminary merger talks between two more of publishing's titans.

Why are mergers and acquisitions on everyone's minds?

"I think because they believe scale is going to be the only way that they can really compete," figures Cairns. "They need to extract more revenue out of their assets, and by combining operations, they'll be able to push more content and more physical units through their operations."

Cairns cites physical properties, such as warehouses. "We know volumes in physical books are declining. They need to fill up that space with something, and it would be good if they could find other books. They'll be in a position where they'll have much greater volume and get more value out of the assets that they already own.

"My own view is that it's going to happen without too much of a hiccup," he says. "What happens next with other trade publishers is going to be interesting to see. In addition to rumors about HarperCollins and Simon & Schuster, says Cairns, "Hachette has always been suggested to have a lot of money to spend if they wanted to spend it."

With regard to the notion that the new entity will enjoy leverage over Amazon, Cairns is doubtful. "We've seen how aggressive Amazon can be in negotiating with publishers, turning the tables on them, turning off their buy button, things of that sort. I think that at best there'll be some type of equilibrium. … They've all got to sell books. Random Penguin is going to end up with a great stable of authors and that's going to be valuable, and Amazon wants to be selling them."

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The Futurist

Peter Brantley

A director at the Internet Archives

Convener of the Books In Browsers conference

There is a sense in some segments of the industry that for publishers to thrive in the emerging digital world, nimbleness and a facility with emerging technology will be paramount. And those are not qualities Peter Brantley, he of the Internet Archives and the Books In Browsers conference, sees emerging from moves like this.

"The type of merger we just saw and that we will be seeing are overwhelmingly defensive," says Brantley. "I'm not going to suggest that any of these companies are going to turn into nimble, fleet-footed examples of publishing innovation. But it's hard to fault companies for thinking this is a rational path for them."

While size helps with the scale piece of the publishing equation, it's not generally conducive to rapid response. And the speed at which technology changes existing business and distribution models doesn't appear to be decelerating.

"For digital, you don't need size," says Brantley. "You need an ability to hire good software engineers and UX [user experience] designers, and to work rapidly with creative people to put new concepts out in the marketplace. Publishers need to be rethinking delivery and interaction, and I don't think those companies are putting themselves in a position to do that more efficiently."

Publishers will need to partner not just with each other, but with companies that can help them "reach down into the fabric where the power resides," says Brantley, referring to the Internet and wresting control of distribution—and customer interaction—from the walled gardens the Apples, Amazons and Googles have created. "How can publishing, broadly defined, take advantage of the mechanisms of network facilities? The underlying Internet. How can you create a more open, direct-to-consumer engagement without being dependent on the tech gardens that obviously work very well in many cases, but that create lock-in?"

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In the future, figures Brantley, the mergers that matter won't be between, say, two publishers. "We'll see a whole range of different kinds of companies merging. Very transitional companies like Book Shout or Own Shelf are seeking to provide in a very contemporary way a vendor-neutral bookshelf, a place to aggregate the content and move it out of the proprietary platforms that companies provide."

The sense one gets from speaking to industry vets is that, although the merger is and will continue to be news, publishers have joined forces, consolidated, acquired and consumed one another for years. Anyone remember when Fawcett was an independent entity? Fawcett is now part of Ballantine, which is in turn part of Random House. How about Putnam? Or Avery? Or Crown?

While the merger of two big publishers may not substantially change the industry or the supply-chain dynamics that are stressing it, what happens on the fringe might be where we see the innovation that does. And with fewer big publishers competing for authorial talent, some think, this could actually be a boon for indie publishers and new publishing initiatives. BB