Why Sony was right in rejecting Dan Loeb's proposal

Why Sony was right in rejecting Dan Loeb's proposal
Image: Steve.M~ (Flickr/Creative Commons)

Image: Steve.M~ (Flickr/Creative Commons)

Sony’s struggles have been widely recounted as it attempts to maintain relevance in a two speed consumer electronics space where hardware is becoming increasingly commoditised, and software and services increasingly more exclusive. Dan Loeb of Third Point – a hedge fund which owns an almost 7% stake in Sony – has been vocal in suggesting changes for the fledgling company, and as arguably Sony’s most prominent shareholder has sought action from senior management, and Sony CEO Kaz Hirai.

The topic of contention is mainly that of Sony Entertainment, an arm of Sony’s conglomerate which owns several household names in both music and video entertainment – namely Columbia Pictures and Sony Music. Dan Loeb has called for an up to 20% divestiture of Sony’s entertainment arm, saying that trading the subsidiary as a public entity would allow Sony to focus on its core business in electronics and also raise a significant amount of cash to assist Sony’s electronics business.

Sony’s apparently dire situation isn’t mitigated with Loeb naming and shaming Sony Pictures box office calamities ‘White House Down’ and ‘After Earth’ – both of which he labelled 2013’s versions of Waterworld and Ishtar. White House Down, starring Channing Tatum and Jamie Foxx was made for $150 million and managed to rake $70.7 million in U.S ticket sales and ‘After Earth’ fared little better, generating $60 million in U.S sales off a production budget of $130 million.

This all begs the question – why isn’t Dan Loeb right? Why shouldn’t Sony divest its entertainment arm? The value proposition of such a move is clear. Ironically, for a company whose brand – Sony – is synonymous with electronics, Sony’s electronics division has almost been a dead weight on the company, with its entertainment and financial services division primarily keeping the company above the water and its balance sheets out of the red. Sony’s television business has perhaps been its most obvious and publicised financial drag, only just recently seeing a quarterly profit after 12 quarters of consecutive losses. A divestiture of Sony’s entertainment arm would not only unlatch its value by freeing it from the shadows of Sony’s troublesome electronics division, but would also allow the two separate divisions to focus on the businesses at their core.

In his letter to Sony, Dan Loeb references “focus” many times and closes his letter with a powerful, if slightly melodramatic “For Sony to Change, Sony Must Focus”. Loeb suggests that Sony focuses by following through with the products and businesses where it has an industry advantage, and turning attention away from product lines and legacy businesses which generate little or no profit. Specific examples according to Loeb include personal computers and DVD recorders – both of which are commoditised businesses where he says Sony lacks a competitive edge through exorbitant pricing and an apparent lack of product breadth. On the other hand, Loeb sees profit opportunities in product lines such as the Playstation, Xperia smartphones and mirrorless cameras where Sony gains a competitive edge through powerful brand value, unique technology and superior technology. The central thesis of Loeb’s proposal is this: focus on the products that make money, forget the ones that don’t.

anyone who believes Loeb has the company’s long-term future in mind would be thoroughly mistaken

Loeb’s ‘profit first’ approach though spells danger for Sony. From a shareholder perspective where quick capital gains and dividends are demanded, Loeb’s suggestions are certainly warranted. But anyone who believes Loeb has the company’s long-term future in mind would be thoroughly mistaken. The plight of Motorola proves as a timely reminder for the potentially damaging shareholder psyche. If it weren’t for the rescue from Google, Motorola would almost certainly have descended to the realm of a tragic also-ran – wiped out from an industry it virtually created.  As mentioned in a brilliant piece by Quartz, Motorola was hell-bent on meeting periodic profit goals to appease investors instead of focusing on the bigger picture and making some short-term sacrifices to eventually reap the rewards of an industry-leading product.

As many of the businesses Sony competes in become more and more commoditised through the flood of cheap, sufficient and no-frills options, Sony runs the risk of likewise employing low-margin tactics to remain competitive in the short term. There are some warning signs, such as the overflow of Xperia smartphone models, which appears to be an attempt to be competitive by flooding the market with options as opposed to employing those same resources into making a smaller range of products which compete on their merit as opposed to scale. Fortunately, the company is still keen on investing heavily in R&D and going head to head in the high-end smartphone arena alongside the likes of the Samsung Galaxy S4 and Apple iPhone despite obviously being on the back-foot.

Likewise, in the personal computer industry where it is possible to purchase a sufficient and worthy computer for just over $500, Sony must be prepared not to be tempted to build cheap commodity products and simply rely on the value of the Sony and Vaio brands to sell computers. It’s certainly an enticing proposition; the Vaio brand is still synonymous with class and quality and would do wonders in a no-frills PC segment where the semblance of ‘quality’ is notably absent. It would generate those quick profits and create the illusion of success and progression – and would mollify the cries of those investors like Dan Loeb who are stomping their feet for better returns on their investments.

It’s no secret though that so much values lies in the assets that cannot be measured, and if Sony seriously took Dan Loeb’s advice and opted to either detract focus from less competitive products, or attempt to quickly and sharply generate profit from them, it would come at the expense of the company’s brand value and future trajectory.

Despite what Dan Loeb believes to be a liability to the company, it is imperative that Sony remains in the personal computer business as it remains a crucial part of the increasingly inevitable three-screen ecosystem – phone, tablet, computer – or potentially a two-screen ecosystem as tablets and personal computers look to become more likely to merge.

The case for keeping Sony Entertainment and Sony’s electronics division as a single entity is less compelling. The talk of synergy between Sony’s entertainment offerings and its electronics offering has been on the table ever since Akio Morita acquired Columbia Pictures, but thus far it hasn’t eventuated in anything truly fruitful. Sony Pictures unfortunately hasn’t been able to augment Sony Electronics in any way shape or form – the failure of 3D serves as the most damning evidence, proving that owning an entire film studio cannot always push adoption of new standards. Sony’s relentless push for the creation of 3D content didn’t succeed in driving the adoption of the technology which couldn’t overcome its gimmick façade.

One Sony attempts to break down the walls between divisions at Sony to promote increased interplay and integration

But a move to divest Sony Pictures would be a tragic divergence from Hirai’s ‘One Sony’ initiative, which has been rigorously pursued, even under the reign of previous CEO Sir Howard Stringer. Notorious for its siloed vertical structure, One Sony attempts to break down the walls between divisions at Sony to promote increased interplay and integration between its various disparate products in order to not only drive efficiency at the organisation, but strengthen brand unity and value. Of course there’s no guarantee that Sony Entertainment could ever bring value to Sony Electronics especially with the past well and truly against them. However it’s hard to deny that having an entertainment arm running alongside could prove a nifty competitive edge.

Hirai’s decision to keep Sony Entertainment trading with the rest of the Sony organisation may be as much sentimental as it is practical. Akio Morita, Sony’s co-founder purchased Columbia Pictures with the dream that owning content would eliminate the possibility of the company’s hardware standards being stamped out, as was the case between Sony’s BetaMax and JVC’s VHS. The dream of such interplay and cohesion is yet to be realised.

But the practical benefits are just as clear. With hardware becoming harder to differentiate and specs becoming less important, it is the software and the content that will prove the differentiator in future. A divestiture of Sony Entertainment would construct walls between the company’s entertainment and electronics division which is the opposite of what Sony needs. By ensuring walls between entertainment and electronics are minimised or eliminated, Sony ensures the scope for integration is wide open.

According to Kaz Hirai:

Content, technology, and consumer and professional products are rapidly converging, not diverging, and we therefore expect the interplay between our entertainment and electronics businesses only to increase in size and form over the coming years and to help drive the growth of Sony’s electronics business.

There are no guarantees, but with the Playstation itself being a huge needer of content and software, the potential for interplay is already obvious.

There’s no black and white trick for the company to reclaim its former glory, but for Sony to dig itself out of its hole, it may just have to dig a little deeper.

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