Joining Forces

It's not hard to understand DeTullio's need to spread the risk of a new royalty platform. He knew the cost of developing the system would be substantial—somewhere in the neighborhood of $35 million, he estimated. And DeTullio was fully aware of the fate of his predecessor, who had chosen to go it alone. "Universal put a lot of time and money into the thing and got nothing, and yet the third party they hired made a lot of money," DeTullio says. "I've been a consultant before, so I know that the trick these days is to convince the vendor to get a little more skin in the game."

Exigen, a San Francisco-based software and services firm best known for its back-office applications used by insurance and brokerage houses, came to the table with the most aggressive proposal. With the financial backing of Lightspeed Venture Partners, of Menlo Park, Calif.—which agreed to pony up enough to give them 50 percent of the resulting enterprise—Exigen proposed creating an entirely new company, to be called Royalty Services, with Universal and Warner each owning 25 percent. Exigen would provide the development and consulting expertise, but not own equity in the company. It was far more vendor involvement than DeTullio or Gal had expected. And it proved to be the winning proposal. "They took it to the next level," DeTullio says.

For Warner and Universal, the decision was easy. They stand to get a custom-built answer to their prayers, at a fraction of the cost of doing it themselves. If the system is going to cost $35 million no matter who builds it, then why not pay for only a quarter of that. "My motivation for doing this was simple," Henny says. "I wanted to get the best system at the lowest cost."

As for Lightspeed, the 50 percent equity stake in the new venture was born of a different motivation. As one of the lead investors in Exigen, Lightspeed believes that the market opportunity for this kind of "business-process utility" is enormous, and not just in the music business. Exigen, EDS Corp. and Sydney, Australia-based Westpac Banking Corp. have already created a similar BPU to address mortgage processing. A BPU, as defined by Exigen, is any software that reduces costs by aggregating common transactions across many companies in the same industry. "There is an existing market for royalty processing, and having two committed customers from Day One with a combined 42 percent market share doesn't hurt," says Ken Elefant, senior associate at Lightspeed. "But there is a plethora of industries in which you can set up these BPUs. Anything that's transaction-intensive creates an opportunity. But it requires collaboration between CIOs, and many layers of the organization must buy into it."

In the case of Warner and Universal, the process of "co-competition," went smoothly. But in other industries the adoption of these business-process collaborations has been slow. "It's a valuable way to take undifferentiated structural systems and achieve economies of scale," says Nick Carr, author of Does IT Matter? (Harvard Business School Press, 2004). "But there is considerable resistance. There is still some nervousness about giving up control."

Creating a new company makes the most sense when the process in question is specific to a particular industry. Broader processes that are the same no matter what industry is using them, such as payroll, have already been outsourced to business-process outsourcing giants such as ADP Inc., which can achieve greater savings through massive economies of scale. Other horizontal processes, such as customer service and accounting, are increasingly being sent offshore to take advantage of cheaper labor. The uniqueness of royalty processing to the music business, combined with the domination of the market by just four companies, made it ripe for this kind of joint venture.