Music Lessons
Why the long knives came out for Sony BMG boss Andy Lack.
By Devin Leonard

(FORTUNE Magazine) – THE MUSIC INDUSTRY HAS ALways been a nasty place. In the early days it was dominated by rogues like Morris Levy, the record company boss who stuffed his pockets with his artists' royalties and consorted with reputed mobsters. More recently it has become a place where rappers and their posses shoot guns at one another, rockers like Jack White of the White Stripes get into barroom brawls, and label executives make sport of stabbing each other in the back. All of that is more fun, of course, than dealing with the industry's massive problems--CDs sales keep declining while digital file-sharing spirals upward.

As much as industry people sometimes detest one another, they are especially hostile to outsiders--especially outsiders who point out the industry's woes. That's what Andy Lack, CEO of Sony BMG Music Entertainment, is discovering. The former president of NBC was hired almost three years ago by his old friend Howard Stringer, now Sony's chief executive, to rejuvenate the company's money-losing music division. Lack engineered a deal that merged the music divisions of Sony and Bertelsmann's BMG in August 2004, creating the world's second-largest music company and trimming $400 million in costs. He also tried to set himself up as a major player--an industry spokesman who talked bluntly about its troubles and a reformer who would do something about them. (While other executives claimed the industry was rebounding thanks to iTunes and the like, Lack said a recovery was several years away.) "He's not afraid to take a position," says his friend Irving Azoff, manager of Sony BMG artists like Christina Aguilera and Velvet Revolver.

Along the way, however, Lack--who declined to speak to FORTUNE--has made enemies. Rival music company executives, and even some within his own company, think it is presumptuous for a newcomer to talk about transforming the industry. Lack butted heads with Apple's Steve Jobs over pricing of songs on the iTunes Music Store, sitting out the launch of iTunes in Japan and Australia. Lack also tried to combat file sharing by putting software on CDs that limited the number of copies that could be made. But the software made computers vulnerable to hackers, and Sony BMG suspended its use this month.

These aren't the only problems he encountered. The company's share of new releases in the U.S. declined from 33% to 26% in the first half of this year, according to Nielsen SoundScan. That may not be entirely Lack's fault--BMG came into the merger riding high with hits by Usher and OutKast, artists nurtured by former Arista chief LA Reid, who was fired before the merger for spending too heavily on marketing. Lack also undermined his image as a reformer by negotiating what many say was an ill-conceived contract with Bruce Springsteen.

In October, Bertelsmann suddenly informed Sony that it didn't want to renew Lack's contract when it expires in March. Negotiations are now underway that might leave him in the C-suite. But his predicament offers a fascinating glimpse of the music business's current state--and the reason 50% of mergers fail.

Music insiders have been savoring every drop of Lack's troubles. "This is Bob Morgado all over again," some executives say, referring to the former Warner Music Group chief who came to the business with no experience--he'd been a New York political operative--and who is best remembered for firing Mo Ostin, the executive who signed Jimi Hendrix and Neil Young. Morgado set off a chain of events that reduced what was then the world's largest music company to a shadow of its former self.

But this isn't the same old tale of the outsider who learns how unforgiving the music industry can be, though there is some of that. Lack has made his mistakes. The real reason his job is at risk is that he is trying to run a dysfunctional joint venture.

In hindsight, the union of Sony and BMG looks like a shotgun wedding. As CD sales have plummeted, every major music company has considered merging. How else do you grow in a shrinking business? Sony was the bigger, more prestigious of the two companies, with labels like Columbia and Epic and a catalog of perennial sellers like Miles Davis, Bob Dylan, and Johnny Cash. BMG was a smaller, scrappier organization, with RCA, Arista, and J Records, and it was dominated by the legendary Clive Davis, who has an un- canny ability to spin out hit CDs by R&B artists like Alicia Keys, teen idols like Kelly Clarkson, and graying rockers like Carlos Santana. Sony people who went to work at the company's iconic Madison Avenue headquarters looked down their noses at their BMG peers, who labored in Times Square. BMG people thought Sony relied too heavily on its catalog, while they had to break new artists and crank out hits to survive.

To further complicate things, Sony and Bertelsmann have very different views of the business. Sony has a long-term commitment because it wants to use music to sell consumer electronic devices. Bertelsmann had a fierce debate about the merger because some executives felt strongly that the company should just sell BMG and get out of music altogether.

Maybe nobody could have united the companies, but Lack's style lessened his chances. He fashioned himself as an executive in the mold of Jack Welch, for whom he'd worked at GE's NBC. And like his former boss, who sold off RCA's record division to Bertelsmann when GE acquired the company in 1985 ("We didn't like the culture in the record business," Welch wrote in Jack: Straight From the Gut), Lack gave the impression that he found the business a bit distasteful. He made it clear that he didn't want to join the flashy fraternity of executives who dominate the industry. In a high-profile appearance in Paris last May, Lack referred to Sony BMG and its competitors as "ugly ducklings." (Supporters insist that Lack is passionate about the music business.)

In July, Sony BMG COO Michael Smellie, a respected music-industry executive who had come from BMG, announced he was leaving. Smellie's official explanation was that he wanted to spend more time with his family in Australia. In truth, he was frustrated, because he was convinced Lack didn't want his input. The joint venture's nonexecutive chairman, Rolf Schmidt-Holtz, former CEO of BMG, began hearing from other executives on the BMG side who felt similarly slighted. If that weren't troubling enough, Clive Davis wrote a letter to the joint venture's board complaining that Lack hadn't resolved a big-money issue in his contract. Bertelsmann had been through costly battles with Davis in the past and didn't savor another.

The company's declining market share, Smellie's departure, and Davis's letter made Bertelsmann anxious. Then things came to a head with the Springsteen deal. In September, people familiar with the company say, Lack faxed Schmidt-Holtz a copy of a contract he had struck with the Boss. It stated that Sony BMG would pay the aging rocker more than $110 million over ten years for roughly seven CDs--$65 million up front in the first year. This was too much for Bertelsmann. Columbia sold 20 million copies of Born to Run two decades ago, but Springsteen's most recent new releases, The Rising and Devils and Dust, have sold a total of 2.8 million copies in the U.S., according to Nielsen SoundScan.

In fairness, Lack had to know he'd be damned if he were perceived as being overly generous with Springsteen, but he also had to worry about letting him go to a competitor. Perhaps Lack's biggest sin was not running the deal by the board first. Two people familiar with the agreement say he submitted it to the Sony BMG directors after he and Springsteen had finalized the deal and drunk champagne in celebration. (A company source denies this.) The directors could have refused to sign off on it, but that might have damaged Sony BMG's relationship with Springsteen and embarrassed Lack. The Bertelsmann directors blessed the contract, but they told Sony CEO Stringer to "do something" about Lack.

There was now a crisis at Sony BMG. But the joint venture partners react very differently to crisis. Bertelsmann is quick to force executives out when there are problems. That's what happened to LA Reid and former BMG CEO Strauss Zelnick. Former Bertelsmann CEO Thomas Middelhoff was given the same brusque farewell when shareholders tired of his efforts to take the company public. But Sony is a collegial company not known for moving swiftly. Look at how long it has taken to address the problems in its consumer electronics business. Stringer wasn't about to fire Lack so abruptly. And so a string of devastating leaks began to appear, starting on Oct. 10 with a story in the New York Times that detailed Bertelsmann's grievances. But the leaks only seemed to stiffen Stringer's resolve.

Stringer holds the upper hand in this supposed merger of equals. Each side controls half of the board's six seats. Sony has the right to appoint the company's CEO, and Bertelsmann has the right to fire the CEO two years into the joint venture. But the second anniversary of the company's creation doesn't come until August 2006.

Now negotiations are underway. The latest round of leaks out of Germany suggest that a deal is in the works--it may be announced before you read this--that will enhance BMG's position, perhaps by giving Schmidt-Holtz an executive post, and enable Lack to remain at the company.

Rapprochement? It may be hard to believe the two could work together after all the bile that has flowed. But in the music industry, executives who hate each other work together all the time. It's just how things are done in the business, as Andy Lack is learning the hard way.

■ DEVIN LEONARD, a senior writer at FORTUNE, can be reached at