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“We were duped – Terra Firma closes its argument against Citigroup” (news item available to subscribers only) is the headline in the London Times (3 November 2010) reporting on Terra Firma‘s case against Citigroup relating to its 2007 purchase of the music group, EMI (which they lost).

I’ve been watching this news story, and EMI, for a number of years – as an example of a classical competitive intelligence failure. In fact, it’s not just one – but two failures. The first is the failure of the once great company, EMI, while the second is the failure to check sources and do appropriate due diligence, by Guy Hand’s firm, Terra Firma. As a case study in business failures, I believe it is a classic.

EMI’s history dates back to the early days of recorded music and it was once at the pinacle of its industry. Artists on EMI labels included The Beatles, Pink Floyd, Queen, Kylie Minogue, Coldplay, Lily Allen, KT Tunstall, Robbie Williams, and many many more. I grew up listening to albums such as David Bowie’s “Ziggy Stardust“, the Beatles “Sgt. Pepper’s Lonely Heart’s Club Band” and the unforgettable “Dark Side of the Moon” from Pink Floyd (the latter during free periods in my last year at school – that dates me 🙂 )

However EMI never adjusted to the idea of music downloading and the Internet. Rather than accept that there was a new technology that meant that the old model was dead, it tried to use court case after court case to kill the emerging hydra. Rather than fighting peer-to-peer online sharing of music it should have seen it as inevitable and that this reflected a new way for distributing music.

Music sharing was not new. People would regularly tape records and CDs – and although this was a problem for the recording companies, it was usually small scale and so could be overlooked. Even if one person didn’t purchase a record, their friend had. I believe that many records would be purchased just so you could hear a decent recording – rather than the bootleg taped version, so this copying served a purpose by publicising the music.

The Internet changed this – especially when services such as Napster emerged. The view of companies such as EMI was that such services had to be smashed – and that the old models had to be preserved. This did not mean that there were no new approaches that could have been adapted, and that they had no choice: there were. Last.fm, Pandora, Spotify, boxee and iTunes are all examples of services that take account of the web, online music streaming and similar to make money (albeit not all have yet broken into profit). Each of these offers a new model for distributing music – via low-cost downloads (iTunes), to subscription services (with a mix of free and paid versions) such as Spotify – backed up by advertising. Had EMI investigated such options the problems that led to its failure and eventual sale may have been avoided.

This is the first competitive intelligence failure and lesson.

Competitive Intelligence doesn’t just look at competitors. It also looks at the competitive environment and attempts to anticipate business change. It assesses the business change – and looks at the implications, allowing decision makers to develop strategies that cope effectively with the change. EMI certainly recognized the change represented by the Internet, but failed to understand its significance and so failed to adapt to what should have been obvious i.e. that the Internet was a radical change rather than an evolutionary development.

Such change occurs periodically – but always has a massive impact on businesses that fail to adapt their business model. Classic examples include the

• development of commercial flight on shipping – why spend days sailing across the Atlantic from Europe to the USA when you can fly?
• electric light – much safer and better than gas lights or candles
• internal combustion engines and especially the mass production of cars, as initiated by the Ford motor company. The horse and cart, and all the equipment linked to horse and cart transport lost out.

The Internet was another such development. When such events (sometimes called Black Swan events) occur, only companies that recognise the threat and adapt quickly survive. EMI has failed in this – trying to stop the new models for music distribution, rather than embrace them and look for ways to make money from them.

Then we come to Guy Hands and Terra Firma’s acquisition of EMI. This is the second competitive intelligence failure – and in my view the more serious, as Terra Firma should have known better.

Private Equity firms such as Terra Firma’s make their money by buying and selling other businesses. Before purchasing a business, they need to do due diligence so that they can assess what they are buying.

Terra Firma’s court case revolved around a claim that they were mislead by Citigroup into believing that another company, Cerberus, was also bidding for EMI. They apparently were not told that Cerberus had dropped out on 19 May 2007, and so rushed through the due diligence process to ensure that they remained the prime bidder. Terra Firma claimed that David Wormsley, a Citigroup banker, had told them that Cerberus planned to place a rival bid of 262p a share and so Terra Firma offered 265p and walked away with what they thought was their prize.

Essentially there were three mistakes made here. The first was believing a single source without attempting to verify it through standard competitive intelligence approaches i.e. was Cerberus still bidding? Terra Firma relied on the word of a single individual whom they trusted, but who had a vested interest in upping the price that would have to be paid.

The second mistake was even worse. By rushing through their due diligence they didn’t investigate sufficiently the state of EMI and whether it was actually worth what they ended up paying. In fact it should not have made a difference whether or not Cerberus was bidding – if the company was not worth the price being asked then it would have been better to let a rival bidder grab it. Failure to do the due diligence meant that this assessment was not done effectively – it seems that Hands was blinded by his desire for EMI and wasn’t interested sufficiently in the process of ensuring that he got the value from his money.

The third mistake was hubris – instead of learning a well taught lesson, Hands attempted to blame Citigroup for being mislead, ignoring the old rule of Caveat Emptor . Had Terra Firma won, it would have meant that any advisor in any business sale would be at risk of being sued by purchasers who for whatever reason, failed to do adequate due diligence, and instead trusted totally the word of their advisors on what was or was not a good buy. Fortunately the court saw otherwise, and said good bye to Terra Firma’s claim.

In a way, the date of the judgement against Guy Hands is ironic – as 5th November is known as Guy Fawkes day in the United Kingdom.  Guy Fawkes attempted to blow up Parliament in 1605.  Instead of Trick-or-Treat on Halloween, British children used to make an effigy of Guy Fawkes to be burned on Guy Fawkes night, along with fireworks. Traditionally they would then use this effigy to collect money, with the chant “Penny for the Guy“.  This 5th November that slogan will have a new meaning for Terra Firma and Guy Hands.