Bertelsmann to Oust Its Top Two Music Execs in Overhaul

Less than a week after announcing a radical alliance with Napster Inc., entertainment giant Bertelsmann plans to oust its top two music executives and overhaul its entire record division.

The dramatic shake-up announced Sunday is the first step in a massive restructuring under which the German conglomerate will strip away from Bertelsmann Music Group, or BMG, its manufacturing, direct marketing, digital distribution and record club operations and boost the music company’s efforts to sign and develop new artists.

The surprise move is an acknowledgment by Bertelsmann that the traditional, CD-driven architecture of mainstream music corporations is on the wane. It also sends a clear signal that the struggling record company--home to such pop stars as Britney Spears, ‘N Sync and the Backstreet Boys--intends to move quickly and aggressively online.

BMG Chairman Michael Dornemann and BMG Chief Executive Officer Strauss Zelnick, who have run the global record division for nearly a decade, will get out of the music group within months.

They will be replaced by Rudi Gassner, a 57-year-old BMG veteran who quit in January after a long series of disputes with Zelnick and Dornemann.

The reorganization of the record group is the brainchild of Bertelsmann Chairman Thomas Middelhoff, who, company sources say, did not notify Zelnick or Dornemann until late Friday night that Gassner was taking over. Although Gassner will return to Bertelsmann’s New York headquarters this week, he will not officially be anointed as chief executive officer until January. (Gassner will assume Dornemann’s chairman title six months later.)

Like the new alliance with Napster, Middelhoff’s restructuring takes Bertelsmann into uncharted waters and could create more problems than it might solve. Separating CD distribution from content is an experiment that has been attempted at other record companies, only to be reversed.

There also is speculation that the reorganization may actually be a ploy to position Bertelsmann to leave the music business. Why, insiders ask, would Middelhoff appoint an executive to run BMG who, according to Bertelsmann policy, must retire in less than three years? Because Middelhoff now understands he cannot deliver on his promise to transform BMG into the world’s dominant music company, sources say, he may try to sell off the music unit or merge it with a competitor such as British music company EMI Group or Japan’s Sony.

None of the parties could be reached for comment Sunday.

The decision to boot Zelnick and Dornemann follows more than a year of corporate infighting that has threatened the company’s credibility in the creative community.

The most recent clash stemmed from Middelhoff’s decision to try to transform Napster’s free file-swapping Internet site into a legal commercial venture--a deal adamantly opposed by Zelnick and Dornemann. The pact was conceived by Middelhoff and Andreas Schmidt, chief of Bertelsmann’s ECommerce group, who hammered it out secretly with Napster.

Under the arrangement, Bertelsmann will finance Napster’s transition to a fee-based service that distributes royalties to artists and their music labels.

BMG is one of five large music companies that is suing Napster for copyright infringement. The company plans to withdraw its lawsuit once Napster begins charging consumers for its file-sharing service.

Middelhoff did not notify Zelnick and Dornemann of the negotiations until the Napster deal was nearly finished. The two executives also opposed Middelhoff’s restructuring plan, which will remove the record club and other revenue streams from under the BMG umbrella.

Dornemann, who joined Bertelsmann in 1982, will step down as BMG chairman in July and relinquish his seat on the Bertelsmann board. The 55-year-old executive has recently been under fire inside the corporation for not taking a hands-on role at BMG and for not giving Zelnick guidance in corporate matters.

Tensions have been mounting for some time around Zelnick, whom critics have long characterized as a corporate suit with a penchant for self-promotion. Once praised by Bertelsmann officials for streamlining the company’s U.S. division, the 43-year-old executive has recently been criticized for alienating several of the top record chiefs at BMG who recruit and develop many of the company’s biggest acts.

For instance, Zelnick locked horns last year with both Arista Records founder Clive Davis and Zomba Group chief Clive Calder at the very time their labels were selling tens of millions of albums for BMG by such pop stars as Santana, Kenny G, ‘N Sync, Spears and the Backstreet Boys.

Zelnick battled with Davis over provisions in his upcoming contract, trying to reduce his power at Arista and eliminate his lucrative phantom equity clause. Zelnick sparred with Calder over ‘N Sync but was forced to relinquish control of the pop act’s career to Zomba after insulting the singers and then losing a court battle barring them from leaving.

‘N Sync, formerly signed to BMG’s RCA label, jumped ship for Zomba Group’s Jive Records label. The nasty legal battle ended in an out-of-court settlement that cost BMG about $4 in profit for every ‘N Sync album sold in the United States and approximately $7 per album overseas. The next album ‘N Sync delivered to Jive sold more than 10 million copies worldwide.

Middelhoff had to intervene to calm the waters with both Davis and Calder. He helped persuade Davis not to leave but to sign a new label deal with BMG that cost the company nearly $150 million.

Middelhoff also was instrumental in convincing Calder to extend his distribution deal with BMG for another year. But Calder reportedly was still so angry at Zelnick that he threatened to jump ship when his deal with BMG ends in June. Should Calder take his label elsewhere, the German conglomerate would instantly lose a third of its 19% share of the U.S. music market.

Sources say Middelhoff began contemplating a management change at BMG during the summer after Gassner quit the company. Upon his resignation, Gassner, who ran BMG’s international arm for 13 years, sent Middelhoff a blistering letter about Zelnick, criticizing his management style, sources say.

Middelhoff was not pleased that Zelnick’s corporate battles became fodder for news reports. In February, he lashed out at his company’s executives in an internal memo obtained by The Times.

“We have always maintained that we are shooting for the No. 1 position,” said Middelhoff, warning that the media giant will never achieve that goal if its “executives sit back and wait to see which tactical move and strategic alliances the executive board develops in order to master the radical changes occurring in the communications marketplace.”

“Each and every one of you has to rise to this special challenge,” added Middelhoff in the memo. “Those who still haven’t understood that that time has come jeopardize both their existence and their position at Bertelsmann.”

In July, Middelhoff secretly hired a headhunter to find a replacement for Dornemann. Despite past disagreements with Zelnick, Middelhoff initially offered him a chance to take over for Dornemann. Sources say Middelhoff also began talking to Gassner about his taking Dornemann’s job during the same period.

Negotiations with Zelnick began to fall apart in September, primarily because of differences over the restructuring plan. When Middelhoff refused to budge, Zelnick decided to resign. The job was then offered to Gassner.

This week, Middelhoff will unveil a complete overhaul of Bertelsmann, under which he will split the conglomerate into three strategic business units: content, media service and direct-to-customer arms. Middelhoff also is expected to name Arnold Bahlmann chief executive of Bertelsmann’s new investment arm, BE Capital.

The content unit will focus on music, magazines, television and book publishing and include Random House, BMG, Gruner & Jahr, RTL Television and Bertelsmann Springer Publishing. Under media services will be folded all manufacturing, printing, information technology and storage media operations. The direct-to-consumer business will cover all book and music clubs as well as Bertelsmann’s ECommerce group.