Last man standing (part 1)
The received wisdom about the collapse of the British entertainment chain HMV and its acquisition by the distress specialists Hilco is that it didn’t see the internet coming. And doh! Actually, the truth has a lot more to do with economics and the way finance dominates business. This long post is broken into two parts: part 2 is here.
The immediate cause of HMV’s collapse, of course, was the British recession, which has gone on longer than anyone expected, and the economy is now teetering on the edge of an unprecedented triple dip recession. Here’s the NIESR chart showing comparative GDP since the pre-recession peak for the past six recessions. The black line at the bottom is the current recession, and yes, this chart should be on the wall of every economic policymaker in the UK.
The Bank of England Chief Economist Spencer Dale put some numbers on this in a speech just before Christmas.
[P]rivate sector productivity … is around 15% below the level implied by a continuation of its pre-crisis trend. Over the same period, real product wages … have fallen by a similar amount. A quite remarkable degree of real wage adjustment. The fall in the terms of trade and the rise in VAT mean that real wages measured in terms of consumer prices – the so-called real consumption wage … have had to fall even further. No wonder that people are finding life tough.
It’s just worth spelling this out. Real incomes have fallen by close to 10% since the financial crisis, and are are about 15% lower than they would have been had the economy stayed on trend. And in practice it’s worse than either of those figures suggest because more expensive imported goods and the VAT increase means relative prices have gone up while wages have fallen.
In turn, the reason for this is that it turns out that the economic multiplier that informed austerity economics was wrong. The theory was that the multiplier associated with public spending cuts was 0.5 – so each pound taken out of public spending would shrink the economy by just 50p. It turns out – and this is from a research paper (opens pdf) by economists at the archpriests of deficit reduction, the IMF – that the multiplier is larger (between 0.9 and 1.7). So every £1 taken out of the economy in public spending cuts shrinks the economy by between 90p and £1.70, and so the economy shrinks faster and further than expected. (John Lanchester explains all of this very well in a recent essay at the LRB).
But there are other reasons, too, which have as much to do with the history of HMV and its former parent company EMI as the changing fortunes of the hard-format entertainment market. This is a story of businesses that are as interested in financial engineering as doing business.
HMV, for most of its life, was just a brand, which became part of EMI when its owner, The Gramophone Company, merged with the Columbia Gramophone Company in 1931. Spooling on fifty years, to 1979, and EMI merged with Thorn, an electricals manufacturer and retailer. And spool on another seventeen, to 1996. By this stage HMV, as an entertainment retailer, was one of three businesses within the overall group; Thorn and EMI (with HMV) were demerged, amid much shareholder excitement. This was the rationale (opens pdf):
Following the Demerger, each group will be able to operate independently, taking into account its own distinctive strategic objectives, operational needs and philosophies, capital and dividend requirements, personnel needs and resources and product development and marketing policies. In addition, the Demerger will enable both groups to introduce share-based employee incentive plans, which will more directly reflect the performance of individual businesses and enhance the retention and motivation of employees.
Like many such assertions made by company Boards during the 1990s (such as the de-mutualisations in the financial services sector) this had more to do with looting the businesses (sorry, that should read “better utilising the businesses’ capital”) than improving their performance as businesses.
Within two years, Thorn had been acquired by the Japanese group Nomura who sold most of it on to the private equity company. Terra Firma. EMI, for its part, spun out HMV in 1998 (private equity took a majority stake) and sold most of the rest of its stake when HMV floated on the stock exchange in 2002. It would have generated cash on both occasions but didn’t use the money well, being acquired in 2007 by Terra Firma (yes, private equity again), who sold it on to Citgroup (the bank, which held much of its debt) which then sold parts to different music industry buyers.
You might think there’s a story about the decline of Britain’s commercial and industrial base here, and you wouldn’t be wrong. HMV for its part continued to pick up record shops when the opportunity arose, acquired the bookseller Waterstones in 1998 and the smaller Ottakars chain later (the Ottakars assets were merged with Waterstones), and eventually, realising that music retail was slipping away, spent money acquiring music venues (such as Hammersmith Apollo). As its core entertainment retail business was squeezed, it sold these off to raise cash: Waterstones went in 2011 and the venues during 2012. One of the striking things about researching this story is that concerns about HMV’s debt levels have dominated since 2011, when it was partly re-financed by its bankers. Financial engineers love debt – it allows them to do all sorts of fungible things with balance sheets – but the combination of debt-funded business and falling sales is almost always fatal. As Simon Bowers blogged in the Guardian,
From that moment onwards  HMV was to limp on as a corporate creature all but controlled by its debt commitments. A zombie.