Music played on a major scale: Size is fast becoming critical to success in the recording industry, as the big four gobble up the small

It's the same old song. Last week Motown, the black music company which began life on the ground floor of a house in 'Motortown' Detroit, was snapped up by PolyGram. The Dutch-controlled record group, whose interests include Deutsche Grammophon, has brought Diana Ross under the same roof as Placido Domingo, confirming a pattern of consolidation within the music industry.

Like the three other big music groups - Warner, Thorn EMI and Sony - PolyGram has been playing the same tune since the late 1980s. In a determined bid to boost its historically weak position in the US market, it bought A&M Records in 1989 and Island Records in 1990. It acquired the US distribution rights to Motown the following year, and has now taken the logical step of buying the label itself.

At first sight the dollars 301m ( pounds 202m) it paid seems a princely sum for a company with assets, before valuation of its back catalogue and less liabilities, amounting to a dollars 24m deficit. The price tag is almost five times that paid by Boston Ventures, the private investment group that bought the company from Berry Gordy, its songwriting founder, five years ago. However, it is actually in line with earlier acquisitions in an industry where good will traditionally accounts for most of a company's value.

As Anne McIvor, an analyst with Hoare Govett, points out, PolyGram paid a combined 1.48bn guilders ( pounds 462m) for A&M and Island, valuing them at 2.1 times and 2 times sales respectively. The latest acquisition values Motown at 2.25 times sales, but Ms McIvor believes this is justified by virtue of its exceptional back catalogue, which includes hits by such legendary artists as Marvin Gaye, Stevie Wonder and Smokey Robinson. If PolyGram is as successful in repackaging these as it has been at A&M and Island, she says Motown's back catalogue of 30,000 master album recordings should be worth about 360m guilders ( pounds 120m).

Equally important is the extent to which Motown will help to secure PolyGram's critical mass in the United States. In 1988, before the group hit the acquisition trail, its US market share was just 7.6 per cent. Last year, it had almost doubled to 14 per cent.

A significant American presence is vital to all four majors, since it represents by far the most important music market in the world. According to IFPI, the industry trade body, US sales accounted for dollars 8.9bn - or 31 per cent of the dollars 28.7bn worldwide sales last year. This was very nearly as much as the combined sales of the next three biggest national markets, Japan (with 15 per cent), Germany (9 per cent) and Britain (7 per cent) respectively.

Ms McIvor says there is also a clear relationship between size and profitability in the music industry, where more than 70 per cent of the total market is in the hands of the four largest groups. Warner is the largest, with 19 per cent, and has margins of 19 per cent. Thorn EMI, which boosted its market share to 17 per cent after buying Virgin Music, announced shortly afterwards that it was aiming for margins of 17 per cent - 2 per cent up on its previous target.

At the time of the acquisition in June 1992, Thorn EMI was widely regarded as having paid way over the odds for Virgin Music, with a package worth pounds 560m, including the assumption of pounds 50m of debt. At 50 times earnings, 175 times net assets and 1.7 times sales, the argument went that the deal was one Sir Colin Southgate, Thorn EMI's chairman, would eventually rue.

In fact, the total bill, including acquisition of minority interests and transaction costs, came to pounds 593m, of which only pounds 14m was deemed to be fair value. The remaining pounds 579m was good will. But in the 10 months to March 1993, Virgin Music contributed pounds 53.1m to the pounds 197m operating profits from Thorn EMI's music division, as the benefits of integration proved greater than a pessimistic City had predicted.

'Before Virgin was taken over it had got a bit unruly,' says Will Manuel, an analyst at Smith New Court. 'Thorn EMI halved the head count and reduced the roster to concentrate on the gold.' At the same time, it left Virgin Music to exploit its real strength, its proximity to street trends.

But if the City has begun to look with more favour on the high multiples being paid by the majors, the trend towards consolidation of the industry has exacted another price. With Motown now on the PolyGram turntable, the gap between the big music groups and the independents has become even more pronounced.

The independent sector has mushroomed on the back of new technology, only to be decimated by the combined effects of acquisition and recession, in addition to soaring distribution costs. 'There are literally hundreds of independents, because anyone can set up with a computer in the front room,' says Mr Manuel. 'What costs a lot is not cutting a disc but promoting it.' One industry commentator is more specific: 'To get air play on Radio One, you have to pay a plugger. That could cost as much as pounds 10,000,' he states.

As a result, some independents have concentrated on dance music, which is played in clubs rather than on the air. 'If you send out a couple of hundred records to a DJ, that would establish you in the (specialised) music charts. It costs far less than trying to break into the main charts,' Mr Manuel points out. And if an independent does not attract the attention of a major, its most promising artists soon will.

If acquisitions have eroded the independent sector, so has recession - and to a larger degree than it has the industry as a whole. In the three years to November 1992, the British Phonographic Society reported a loss in volume, though revenue was sustained at an annual average of about pounds 700m. By contrast, says Eric Longley, an analyst at Chantrey Vellacott, independent labels have seen big drops in both sales and profits.

In a survey of more than 50 British independents with combined sales exceeding pounds 40m, Mr Longley found gross turnover had fallen 15 per cent over a year. Profits were even worse hit. Total pre-tax profits for those surveyed fell from pounds 1.5m - only 3.75 per cent of turnover - the previous year, to a net loss of pounds 200,000.

Part of the problem is lack of financial focus, says Mr Longley - 43 per cent of the companies surveyed had failed to comply with the rules for reporting their results.

The independents have also been unable to benefit from the premium profit market in CD sales. 'By squeezing vinyl out of the market, the majors have effectively also squeezed out many of the independents,' he notes.

In fact, the potential for recycling old releases in digital format helps to explain the willingness of the big music groups to pay large sums for established independents such as Motown. The absence of any back catalogues on which they can cash in puts the newer independents at a disadvantage.

The problem is likely to become still more acute with the development of new digital applications. The potential for transmitting signals via cables, satellites or telephone lines, for example, means that home listeners will soon have access to the equivalent of a jukebox.

One US company has already experimented with cable networks and has plans to begin broadcasting on British television at the end of this year. Subscribers to the US service connect a receiver to their own hi-fi systems to get 26 channels of uninterrupted CD-quality sound. With such advances in the offing, the value to the majors of tying up valuable back catalogues becomes clear.

For a variety of reasons, then, the gulf between the majors and independents is likely to grow, as most of the bigger independent labels - or 'mini-majors' - are absorbed. One company that hopes to buck this trend is Echo, the new label launched by Chrysalis Group two weeks ago.

Echo is unusual in two respects. Its management already has a track record in the industry; it created Chrysalis Records, which was sold to Thorn EMI last year. It also has financial backing from its parent, unlike the many tiny companies that come and go.

Jason Guy, Echo's managing director, is talking to a number of artists, including one big name, with an eye on overseas sales. 'We aim to back three major international acts within the next three years,' he says.

'The real key to success is a back catalogue or overseas revenue. Lack of either was the reason so many mini-majors sold out or went under.'

He is too old a hand to forget the mistake one independent, Rough Trade, made when it expanded too rapidly in the US and went into voluntary liquidation. One way or another, that label sums up life in the music business.