SpectatorBytes

Recently, Techcrunch had an interesting article about the death of digital divisions inside major media companies. Techcrunch argued that the slowdown in M&A will mean that  most digital initiatives will now be led by the traditional divisions rather than by “digital” divisions.

While this may be the case in the short-term, I believe that major media companies will eventually have to continue to invest in their digital divisions or even reconstitute their portfolios beyond having a single digital division. Failing to do so may create the opportunity for new media conglomerates to emerge. Google represents the first of a potential new breed of media conglomerates.

Let’s first understand what may be transpiring with the digital divisions of major media conglomerates. Digital media divisions have a valuable role inside media companies. They…

• Build scale to show traditional media divisions that there is a compelling business opportunity in digital
• Act as a catalyst for the development or acquisition of innovative products
• Adopt low-cost, more efficient business models and operational practices

Despite their value, digital media divisions face significant challenges inside big media organizations. Given that digital divisions most likely challenge existing operational practices and expose business inefficiencies, traditional divisions tend to view them as a threat. Thus, core divisions spend significant time undermining digital divisions. To do so, core divisions either tend to create parallel efforts (i.e., their own digital initiatives) whose role is to demonstrate that they are better positioned to execute or simply  refuse to engage with the new divisions operationally. The challenges confronting digital divisions inside big media reflect the difficulty traditional media businesses are having in adapting to new consumer habits and the overall impact of digital technology on their businesses.

In addition, digital divisions remain sub-scale for most of the leading media conglomerates (AOL is probably the only exception). Revenues are only just hovering around $1B dollars or below in the case of most media conglomerates. This is a small dollar amount given the overall size of media conglomerates. Big media has not invested as much in digital media as they have in the past for other initiatives (again AOL could be thought of an exception but it is not). Consider how some of the major media conglomerates got put together, i.e.,  Time Warner, ABC, NBC Universal and to a certain extent Viacom. These conglomerates are the result of several multi-billion dollar acquisitions. For example, TimeWarner acquired Turner to enter the ad-supported cable network business. ABC did the same thing with the acquisition of ESPN. NBC acquired Universal Studios, which had acquired USA Networks. All of these transactions were multi-billion dollar deals.

So, why are these conglomerates not making the same level of investment to scale their digital businesses? The main reason is that digital business models continue to evolve and are still financially unpredictable. Few consumer digital media businesses seem to offer continued long-term revenue and profit growth. Google is perhaps the only exception. This lack of predictability has made digital investments unattractive to traditional media executives.

Moreover, media companies are still adjusting to the need for sophisticated technological capabilities. Engineering cultures have not been a major part of media conglomerates. This makes acquisitions difficult for Big Media to assimilate and adequately leverage. In many cases, talented technology staffers quickly leave after acquisitions as they find big media cultures uninviting.

Nevertheless, media conglomerates need to reconstitute their portfolio of businesses if they want to survive long-term. Their portfolios need to better reflect where value is going to be created going forward. Reinventing their businesses from the inside is not an option. The required change would be too drastic for traditional media cultures to be able to nurture and scale digital initiatives internally.

This would probably lead to a couple of events going forward. If major portals such as Yahoo and AOL demonstrate a certain degree of business stability, we are likely to see major conglomerates make a move for them. The other players, who are unable to pick up any of the independent at-scale players, will probably let further consolidation take place before they jump in with larger acquisitions.

Having said that, there could also be a scenario in which media conglomerates wait too long to reconstitute their portfolios and allow the digital media companies to gain enough momentum to become the acquirers. Watch out. Interestingly, current stock market prices for big media suggest that investors already believe these companies will not get through the economic downturn unscathed.

This period will be critical for major media companies. Letting their digital divisions die is not an option if they want to come out ahead in the end.