Bertelsmann’s Big Bungle

Thomas Middelhoff was the best CEO in the media business. So why did Bertelsmann fire him?

Thomas Middelhoff: CEO scapegoat?

Of all the recent victims of corporate upheaval, Thomas Middelhoff, deposed last weekend as Bertelsmann’s CEO, least deserves the punishment.

What were Middelhoff’s sins? In 2001, all the world’s largest media companies except Bertelsmann—AOL Time Warner, News Corp., Disney, Viacom, and Vivendi Universal—lost money. Middelhoff’s firm earned nearly a billion dollars after taxes. Most of Bertelsmann’s rivals are hampered by multibillion-dollar debt: The German company alone has no red ink. As recently as late May, Fortune magazine proclaimed: “Bertelsmann has a CEO who will almost certainly be in charge until 2013, when he reaches the firm’s mandatory retirement age of 60.”

It’s not that Middelhoff never made errors. Spending $340 million to acquire Fast Company magazine was indefensible. The company’s investment in Napster, while bold, has not created a viable download business. And e-commerce venture has swallowed hundreds of millions of dollars.

Still, those mistakes are picayune compared to the disasters of Bertelsmann’s rivals, like Disney’s fizzled portal or Vivendi’s laughable Vizzavi venture. Middelhoff expanded the company’s core businesses—book and magazine publishing, music—without getting mired in questionable ventures like sports teams. And while Bertelsmann traditionalists tut-tutted as Middelhoff invested heavily in the Internet, no one complained when he turned a minuscule investment in America Online into $7 billion—cashing out near the top of the market, before the bubble burst.

So, what happened? For starters, Bertelsmann is struggling in 2002 (though what media company isn’t?). Two of the company’s important divisions—publisher Random House and music label BMG—are now apparently losing money. And according to a lengthy account in today’s Wall Street Journal, Bertelsmann’s management and 81-year-old patriarch Reinhard Mohn have come in recent months to see Middelhoff as a dealmaker rather than a manager.

But the real issue is not Middelhoff’s performance, but the fearfulness of Bertelsmann’s owners. The insular Mohn family—which controls a majority of Bertelsmann stock through a foundation established in 1977—got cold feet about Middelhoff’s plan to take the company public in a few years. This must be especially exasperating for Middelhoff, because he has been publicly fighting the IPO argument for two years—and seemed to have won. His view was fairly simple: If Bertelsmann was to compete with the global big boys, then it needed the currency of stock shares in order to make acquisitions. Middelhoff is still right, even if the market is currently in a punitive mood. Removing him won’t solve any of Bertelsmann’s strategic problems.

What does Bertelsmann accomplish by staying private? Theresa Wise, a partner in the media and entertainment practice at Accenture, argues that private media companies are better at making longer-term strategic decisions. “Look at Bloomberg versus Reuters,” she says, arguing that Reuters has been hamstrung by having to constantly please outside investors.

But as Middelhoff understood, Bertelsmann needs more external pressure, not less. Many parts of the company’s businesses (especially in Germany) have been stagnant fiefdoms for decades. It’s worth recalling that while Bertelsmann is 170 years old, it spent a century as primarily a publisher of evangelical pamphlets and fairy tale books. It became a large corporation only during World War II, when it sold 20 million special “soldiers’ editions” of entertaining literature to the Wehrmacht. Seen in this context, Middelhoff’s goal of taking the company public was a way of transforming Bertelsmann into a fully modern, rational corporation.

And when the markets bounce back, privately held Bertelsmann will be saddled with the same burden Middelhoff diagnosed. There will be new record labels and publishing houses to buy, and Bertelsmann won’t have the means to purchase them. And since the 49-year-old Middelhoff is hardly about to retire quietly, it’s a safe bet he’ll be making those deals somewhere else.