Publishers are repeating the daft mistakes of the dead music giants

Faced with the threat from e-books, traditional publishers have decided they need to get bigger. We've seen this mistake before, says Matthew Lynn - and it will cost the publishers dearly.

An industry is going through a seismic change. New electronic devices are revolutionising the market. And the big, traditional players decide the only way they can stay in business is to get a lot bigger very quickly through a series of mega-deals.

Eight years ago, that was a description of the music business. Right now, it is a description of the publishing industry. This week, Pearson announced plans to merge its Penguin unit with German media giant Bertelsmann's Random House division. Already Rupert Murdoch's News Corporation has tabled a £1bn rival offer for Penguin, to combine it with Harper Collins instead. Pearson favours Bertelsmann but, with the deal subject to a year-long investigation by the competition authorities, anything could happen.

What is extraordinary is that the publishing bosses seem intent on repeating the music industry's mistakes wasting five years locked up with investment bankers and competition lawyers instead of working out their response to the rise of e-books. Even worse, the City seems to be letting Pearson get away with what is clearly a catastrophic response to the challenges facing the industry. Instead, Pearson's investors should tell it to forget about bids and deals and get on with re-inventing their businesses for a digital future.

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When the iPod was launched late in 2001, it turned the music industry upside down. There were already MP3 players around, but the slick Apple device persuaded the mass market to switch from listening to music on CDs via hi-fi systems to listening via a small white object over headphones.

For a major FTSE company, as the UK's leading music business EMI still was in those days, that was a huge challenge. It had to figure out what it was for in a world without record shops, and how todeal with how Apple had emerged as the dominant force in its industry. What it decided to do was get a lot bigger. Over the next five years, it attempted a series of mergers. As early as 2000 it planned a deal with Warner. It had another go with Warner in 2002 and, when that failed, tried to merge with Bertelsmann in 2004, before handing itself over to Guy Hands' Terra Firma private-equity firm in 2007.

But the kind of financial engineering that private-equity houses specialise in was about as useful in running a record business as a classics degree is for fixing a computer. Terra Firma lost control of EMI to its bankers, and what remained of the business was sold off. It was a catastrophe.

When Amazon launched the first Kindle in November 2007, it kick-started the same process in publishing. The market is rapidly switching from printed books to the electronic version, just as it did in music. Book shops will disappear, just as CD shops have. Amazon will become the industry's dominant force, just as Apple is in music. The publishers have an advantage, however. Since the music industry has already been down this path, it can learn from its mistakes. And yet it seems intent on repeating them.

The proposed Penguin and Random House tie-up is the kind of monster only an investment banker desperate for a year-end bonus could think a good idea. It will be a complex beast, 47% owned by Pearson, and 53% by Bertelsmann. Pearson will keep the Penguin name to use in its education division, while Bertelsmann will retains its publishing assets in its home market.

Rupert Murdoch, who even at 81 still knows how to make mischief, has already proposed a counter-offer and so long as that is on the table, the deal will be in the balance. Don't be surprised if another media giant crashes the party with a third offer.

There are two big problems with the deal, however. The first is that there is more chance of Gordon Brown coming back as prime minister than there is of this merger going through. The new company will have at least 27% of the British market and 25% of the American. The authorities won't allow it, for the same reason they didn't allow EMI to merge with Warner. It will be too big.

Even if it was allowed, its rivals would challenge it in court. Secondly, size isn't the problem. When a new technology comes along, the traditional players don't get put out of business because they are too small. It is usually the reverse they are too big and bureaucratic to respond quickly.

That matters. Like music, publishing is a major British industry. This country has a huge amount of writing talent and English is the world's language. British books have always been a big export industry and with emerging markets such as India hungry for e-books, it should be getting even bigger.

If Pearson and Bertelsmann's management don't get it, then it is up to their shareholders to tell them. The City should be sending a simple message to these companies: mergers and deals won't fix anything concentrate on getting the transition to digital right instead. If you don't, the UK industry will disappear. And so will whatever value there is in the shares of the industry's traditional players.

Matthew Lynn

Matthew Lynn is a columnist for Bloomberg, and writes weekly commentary syndicated in papers such as the Daily Telegraph, Die Welt, the Sydney Morning Herald, the South China Morning Post and the Miami Herald. He is also an associate editor of Spectator Business, and a regular contributor to The Spectator. Before that, he worked for the business section of the Sunday Times for ten years. 

He has written books on finance and financial topics, including Bust: Greece, The Euro and The Sovereign Debt Crisis and The Long Depression: The Slump of 2008 to 2031. Matthew is also the author of the Death Force series of military thrillers and the founder of Lume Books, an independent publisher.