SPECIAL REPORT: The Sony Schism

TOKYO Mon Mar 26, 2012 9:31am IST

Sony Corp's incoming CEO Kazuo Hirai speaks during a roundtable discussion with journalists at the company's headquarters in Tokyo February 9, 2012. REUTERS/Yuriko Nakao

Sony Corp's incoming CEO Kazuo Hirai speaks during a roundtable discussion with journalists at the company's headquarters in Tokyo February 9, 2012.

Credit: Reuters/Yuriko Nakao

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TOKYO (Reuters) - The Bellagio casino-hotel in Las Vegas hosted a shotgun wedding in January. The bride and groom had met just a couple hours earlier; she wore a skimpy dress, he was in powder blue coattails.

The ceremony was actually a PR stunt. But the man who brokered it, incoming Sony Corp boss Kazuo Hirai, was dead serious.

The guests were mainly journalists assembled in Vegas for the annual Consumer Electronics Show. The couple were a pair of actors hired from a local talent agency. They were supposed to represent the Internet and Sony's Bravia television sets - their match symbolizing the consummation of the company's years-long, frustrated quest to marry hardware with content.

His ability to make that union a reality, says Hirai, will define his tenure at the troubled Japanese brand.

When Hirai becomes Sony's president and CEO on April 1, he takes charge of a company facing a crisis unlike anything it has experienced in its nearly 70-year history.

It's been years since Sony has produced a new mega-hit device. Its TV business is an albatross that has accumulated losses of $10 billion. The company is on course for a fourth straight annual net loss for the year ending March 31. Efforts to connect its vast entertainment and games content with its huge menu of gadgets began way back in the 1990s - but are still a work in progress.

What has flourished at Sony, after a bumpy start, is its PlayStation business, which Hirai ran for five years. His plan is to apply the PlayStation model company wide: extend its network to the rest of the Sony gadget family to create a unified content-delivery platform. Even if not by intent, it is a model close to Apple Inc (AAPL.O) and its iTunes.

The Sony Computer Entertainment model "is a bigger concept we can grow into a bigger space," Hirai, 51, said in a group interview at the company's Tokyo headquarters last month. "Hardware drives software and software drives hardware."

Interviews with former Sony bosses and executives, as well as current managers who will be working with Hirai, paint a picture of an executive who may have the managerial and personal skills to reach a prize that eluded his two predecessors.

But they warn he faces a daunting task in marrying hardware and software in the Sony family, which remains hobbled by a schism that undid his predecessors: a rift between old-guard gadget engineers and a new guard of executives that see the future of Sony in online networks and the entertainment content they deliver.

If he succeeds, he could be the man who saved Japan's most famous company. Failure means presiding over the fall of an electronics empire that once held sway over the world's consumers. A stock slide from an already depressed price, analysts say, could make it an acquisition target or, more likely, lure in private-equity investors who could sell off packaged units of the company bit by bit.

TV STRATEGY

Hints are emerging that Hirai may begin his comeback attempt by kicking his newlywed TV bride out of the Sony home.

"I think we have issues to address around the TV business," said Andy House, the head of Sony Computer Entertainment, which he took over last year when Hirai moved on to a wider role in the company.

An option being mulled, another executive told Reuters, is to divorce TV from the rest of Sony (6758.T) and try and merge it with the battered TV businesses of Japan's other struggling set makers. Both Panasonic (6752.T) and Sharp (6753.T) are in trouble. It would be a marriage of convenience that a Japanese government anxious to safeguard jobs and spawn national champions could help forge, the executive added.

A framework for such a grand compact exists already. Last year, Sony agreed to bundle its small operations for making liquid-crystal display screens with those of Toshiba Corp (6502.T) and Hitachi Ltd (6501.T). The merged company, Japan Display, is two-thirds owned by the taxpayer-funded Innovation Network Corp of Japan.

Hirai has geek cred. As head of the videogame business, he once got hold of a specialist train-driver control to play a train simulator game, "which gave me endless fodder for geek jokes", House recalled in an interview.

He'll need that to gain the trust of engineers. They fear the company has lost its golden touch for making cutting edge gadgets in favour of the content side of the business, such as games and movies, which was nurtured under the past two chief executives, Howard Stringer and Nobuyuki Idei.

Hirai got his start in Sony's music business and isn't an engineer. But that doesn't handicap him, says Phil Molyneux, the CEO of Sony Electronics Inc in the United States.

"Let's not forget, underneath Kaz there are some very strong leaders who have engineering backgrounds," Molyneux said in a p h one interview.

But the engineering father of the PlayStation, Ken Kutaragi, warns that there is risk in Sony's "asset-light" strategy of outsourcing its manufacturing. Its Korean rivals, Samsung Electronics (005930.KS) and LG Electronics (066570.KS), could unleash a blitzkrieg of credit-card thin organic light emitting diode (OLED) TVs, he warns.

Sony in 2007 pioneered the technology with the world's first OLED TV. At only 11 inches (28 cm) and a $2,000 price tag, the XEL-1 did not make a splash in the recession. Sony ended production at the end of 2010, shifting instead to crowd-pleasing 3D TVs.

Samsung and LG, however, stuck with the concept, and their 55-inch prototypes picked up a slew of awards at the CES show in Las Vegas.

At a rumored price tag of around $10,000, they will cost 10 times an equivalent LCD set, posing a challenge to the Koreans to make them more cheaply. Hirai reckons the cost gap will ensure LCD remains the mainstay of the TV market for the next three years at least.

That could be a fatal miscalculation, says Kutaragi, Hirai's former boss at Sony Computer Entertainment.

"It's possible that OLED will beat predictions and spread faster than the switchover from cathode ray to LCD," says Kutaragi, who left Sony in 2007 but remains as a technical advisor.

SONY'S SCHISM

Sony's issues are much deeper than where to go with the TV business. Hirai faces a fundamental divide in the company that pits an old guard of engineers, mostly in Japan, against device-agnostic content champions, many of them in the movie and music centers of the United States.

The chasm opened up in the mid-1990s when Nobuyuki Idei, then leading the company, began steering Sony to content and networks. He added Hollywood's Metro-Goldwyn Mayer studio in 2005, and established New York-based Sony BMG Music Entertainment. He started a joint mobile-phone venture with Ericsson (ERICb.ST) that his successor Howard Stringer ended.

The content push at times, however, may have hobbled the hardware business.

It contributed to Sony losing its lead in music players, insists Jay Vandenbree, a former president of consumer sales at Sony Electronics in the United States. Executives from the music business, he said, raised a flag over content protection, delaying a shift to hard disc drive players, just as Apple with its iPod was positioning itself to steal the market Sony pioneered.

"I see a lot of things written saying that Sony missed the portable music trend, the hard disc player, but it's not true - they made a conscious decision not to build it," adds Vandenbree, who left Sony in 2009 for LG.

Sony missed a chance in 2001 to fix that mistake, says Satoru Maeda, a former Sony executive who created the Airboard, a progenitor of tablet PCs that the firm dropped.

Unsure the iPod music player he had just released would be the hit it was, Steve Jobs suggested an alliance with Sony in launching his iTunes store, in part to counter the might of Microsoft (MSFT.O), explained Maeda, confirming local media reports. Not wanting to upset the software giant, Sony turned him down.

AIBO KILLER

Another victim of Idei's distaste for standalone devices was the Aibo dog, a robotic pet discontinued in 2006. When he saw it for the first time in 1999, an angry Idei told the engineers they had built a 19th-century product instead of the 21st-century one he had asked for, recalls Toshi Doi, who oversaw the project and has also since left Sony.

In the 10 years Idei ran Sony before handing over to Stringer, revenue at the company doubled, with much of the extra cash coming from games, music and movies. The drive away from fabrication was the right strategy for Sony, Idei still insists.

But resistance was strong to his vision of moving away from fabrication toward content, particularly in Japan, where manufacturing and the jobs it creates are considered part of the mission of the country's major companies.

"When I was in charge of Sony, I was criticized for saying we shouldn't make panels. But when Toyota builds cars it buys the steel from Nippon Steel. The value is in the car, not the steel," says Idei, 74.

LOST FOR WORDS

In 2005, Idei handed over to Stringer, Sony's first foreign boss. The former broadcast journalist vowed to bust open Sony's silos and make content and hardware work together.

His high point came on January 4, 2008. As executives gathered in Las Vegas for the annual CES show, Toshiba raised a white flag, ending a format war between blu-ray disc technology championed by Sony and its HD DVD alternative. It allowed Stringer to claim content and hardware were finally pulling together.

Yet unable to speak Japanese and spending more time out of Japan than in, Stringer struggled to close the hardware-content rift that opened on Idei's watch. According to one high-level person in the company, Stringer could never be sure his managers in Japan listened to what he asked, understood what he said, and would act as he directed.

Sometimes he learned too late of changes that hurt Sony's business.

In 2005 managers dropped back-lit LED TVs because of cost without telling Stringer. That was one of Stringer's biggest regrets, the source said. Rival Samsung released its own version in 2009, forcing Sony to play catch-up in 2010 with a product it had had first.

Sony's engineers in Japan in the meantime grew resentful of a boss they perceived as spending too much time hobnobbing overseas and too little time paying homage to Sony's roots as a maker of hit gadgets. A dearth of new hits and the subsequent loss of market share to Apple and Samsung gave the old guard engineers ammunition to lob at the Welsh-born Stringer.

"For rank-and-file workers, his presence was almost zero," said an R&D engineer at Sony. Stringer, he said, made it to very few events where engineers explained their work to executives.

Any window for reconciliation closed in 2008. The Lehman Brothers shock and the global recession that followed forced Stringer to lay off 16,000 workers and pare $3 billion in expenses. Japan's March 11 earthquake and tsunami last year unraveled supply chains. A month later Sony came under a firestorm of criticism over the hacking of its online game accounts. Floods in Thailand last July crippled production again.

On Feb 2, Sony said it expected a 220 billion yen loss for the year ending March 31.

ENTER HIRAI

A day before that, Stringer surprised shareholders by announcing Hirai's promotion to CEO a year earlier than expected. By becoming non-executive chairman of the board, Stringer has given his hand-picked successor a free hand to have his go at marrying content and hardware.

"He is a convergence intellect for a convergence world," boasts Stringer of his protege in a phone interview. "It's a fast transition that he can accelerate because of his experiences in PlayStation which, for all the complaints some people have about him not being an engineer, is a convergence product that is a model for the future."

Hirai differs from his two content-oriented predecessors by being more of a hybrid boss. Stringer thinks it makes him better equipped to engage the engineers Sony needs to create hit gadgets to complement their network strategy.

Born in Japan, Hirai, 51, spent about 20 years in the United States, some of that as a child when his father, a banker, worked there. It's made him bilingual and bicultural, able to schmooze and charm to western corporate standards and conform to the consensus-building expectations of his fellow Japanese.

Helping him up the ladder was his success in molding 100 million online users around the PlayStation platform, in what so far is Sony's only notable success in melding content and hardware.

WORTH MORE DEAD THAN ALIVE?

The Hirai era offers reason for optimism. But some in the Sony family talk of a grimmer possible future.

Mulling the possibilities over dinner in Tokyo, a former Sony executive games out one scenario: A fund could buy Sony, he says, break it up and sell off pieces that individually are worth more than the whole.

As Sony's fortunes waned, so has its share price. In 2000, the company was valued at seven times that of Apple. During the early 1990s leadership of Norio Ohga, a trained opera singer who pioneered the switch to CDs, Sony executives once considered a takeover of Apple. Idei was among those in favor of the purchase, a former Sony manager who witnessed the discussion told Reuters.

Sony is not the only Japanese tech company stuck with a low stock price. It is, however, an easier target for acquisition than its Japanese peers. With weaker ties to its main bank than rivals such as Panasonic and Sharp, it counts fewer big lenders among its top shareholders and is more than 40 percent owned by foreigners.

Analysts' estimates value a broken-up Sony at as much as $25 billion, representing a return of around 20 percent for any buyer with the moxie to grab one of Japan's best known firms currently worth around $21 billion. That break-up valuation is based on multiples of earnings of its movie and music businesses, the consumer electronics unit, games division and insurance business.

The brand value alone is huge. London-based branding agency Interbrand estimates the Sony name is worth $9.9 billion, ranking it at 35 in its annual list of the world's most valuable brands. Samsung at 17 overtook Sony in 2005 and Apple at 8 in 2008.

"What it says to me is that if you benchmark them against the likes of Apple and Samsung, that means their market cap should be three or four times what it is now," says Jez Frampton, the CEO of Interbrand. "He (Hirai) has got a big job."

Hirai agrees. "I think that it is a very visible position, both within Japan as well as outside Japan," Hirai mused at his press roundtable in February. "It's not an easy job, I get that."

(Additional reporting by Nathan Layne, Liana Baker and Maki Shiraki; Editing by Bill Tarrant and Michael Williams)

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