Business riffs on an electric guitar

Professor Karamanos (ESSEC) looks at the relatively young electric guitar market. He shows how the historical paths of the two leaders, Fender and Gibson, resemble each other and how these two analog leaders are facing some new digital competition

The guitar market is no small one. In 2004 it amounted to just over $2 billion, with electric guitars accounting for half the figure. Most guitars are sold in North America (50% of sales) but most of the manufacturing occurs in China (44% of units produced). Two companies dominate the electric market, Fender and Gibson, with market shares in the 40% range. As the two companies are privately held, market share and financial data can only be estimated.

After presenting some other characteristics of the guitar market, Professor Karamanos’ case (see reference below) focuses on the history of the two market leaders, showing how their paths resemble each other and indeed serve as interesting illustrations of American business trends over the last half century.

Fender
The man behind Fender guitars, Clarence Leonidas Fender (1909-1991), started out in the repair of amplifiers, radios and other electric devices. Then, teaming up with Doc Kaufman to form the Fender & Kaufman Company, he added the design and manufacturing end. Quickly, Fender felt that the manufacture of instruments held more potential than repair so he created the Fender Electric Instrument Corporation and parted ways with Kaufman.

In 1951, Fender introduced two revolutionary products, the Telecaster and the P-Bass, the first electric bass guitar. Three years later Fender followed up with the Stratocaster, featuring an innovative shape, three pickups, and tone controls.  The Stratocaster quickly became a rock guitarist favorite.  It was also during these years that Fender geared up its Californian mass-production facilities allowing it to control cost and quality.

Conglomerates were popular in the 1960s and CBS purchased Fender in 1965 for $13 million, two million more than the New York Yankees had cost them in 1964. CBS sought to increase production volumes while lowering costs. A factory was opened in Japan, the China of the 60s, and retail stores were opened in Europe. But the cost reduction efforts ultimately led to the use of lower-quality electrical hardware and purists began to turn away from the brand.

By the 1980s specialization rather than diversification was thought to generate better business performance. In 1985, the president of the Fender divison, Bill Schultz, led a leveraged buyout and implemented a new strategy with an eye to brand development. In a move toward vertical integration he bought the string manufacturer Squier. He then applied the Squier brand to a lower priced guitar thus offering an answer to the Fender copycats. In this way, Fender became the company’s high-end brand (built in the company’s  Corona (California) and Ensenada (Mexico) factories, Squier the lower-end brand (manufactured in various Asian factories).

Schultz had renamed the company Fender Musical Instruments Corporation at the time of the buyout. During the 1990s he pursued an acquisition policy befitting of the name – the firm moved into acoustic guitars (e.g.  Guild), other stringed instruments (Orpheum) and different niche guitar makers (heavy-metal with Jackson and Charvel guitars). By the time Schultz retired in 2005, Fender had worked its way to the top, with only one true rival, Gibson.

Gibson
The Gibson Corporation was founded in 1880 by Orville Gibson to manufacture a new version of the mandolin. By 1936 the company had created its first electric guitar, the ES-150, which turned into a commercial success.  In the 1950s looking for a way to compete against Fender’s new models, Gibson turned to technological differentiation. Fender guitars used a single coil solution so Gibson perfected a two-coil solution which produced a fatter tone and eliminated the hum that the single-coil option invariably created.  The patent was filed in 1955 and in 1957 Gibson released what was to become its most famous model, the Les Paul.

From then on, the destinies of the Fender and Gibson companies look strangely similar. In 1969 Gibson was swallowed up by the conglomerate wave in the form of an Ecuadoran company, ECL (later renamed Norlin).  Somewhat like what happened to Fender under CBS, quality eventually declined as the Gibson division sought to fight low-cost copycats and meet the conglomerate’s financial diktats.

In 1986, a pair of Gibson-loving businessmen, Henry Juskiewicz and Dave Berryman, bought the company for $5 million. Their first step was to rebuild the quality image of the brand. In a form of internal reverse engineering, old pickups were dismantled and operations upgraded so as to produce guitars with the 50s and 60s sound. The second step was to increase the number of models and boost production volume.

Like Fender, Gibson offered a lower-cost option with its Epiphone brand. Like Fender, it pursued an acquisition policy in acoustic guitars (Avante), natural wood basses (Tobias) and hand-crafted guitars (Valley Arts). One thing the companies do not share is their geographical grounding: Fender has its heart in the West with headquarters in Arizona and factories in California and Mexico. Gibson, on the other hand, has its headquarters and American factories in Tennessee. Now let us turn to a recent intruder that has emerged out of Southern California.

Line 6
Founded by Michel Doidic and Marcus Ryle in 1996, Line 6 is an example of a company leveraging the shift from analog systems to digital systems. Line 6’s model is to apply digital technology to amplifiers, effects processors and electric guitars. Doidic and Ryle used DSP (Digital Signal Processing) software to model the processing of guitar signals by the amplifier circuits. They patented the first digital modeling guitar amplifier, the AxSys12. While the AxSys12 modeled dozens of classic amplifiers, their next product the POD, released in 1997, addressed the problem of guitar tone.  By simulating microphones, speakers and room acoustics, it eliminated complicated recording setups.

After amps, Line 6 moved into effects pedals (ToneCore), with the same sort of success. In 2002, it took on the guitar itself with the Variax. This guitar does not use any magnetic coils thereby eliminating the noise problem altogether. It offers over twenty sound types, changeable at the twist of a selector, thereby eliminating the need for performers to transport multiple guitars. The more advanced Variax 700 model sells for around $1500 or slightly more than most Stratocasters and Les Pauls. Professor Karamanos estimates that Line 6’s revenues have yet to cross the $100 million threshold.

In the end then, this case connects three important cultural, managerial and technological evolutions. Somewhat unexpectedly, the move from acoustic to electrified music, from conglomerate-style diversification to core focus, and from analog to digital technology all come together in this story of a musical instrument.

Reference:
ECCH 309-114-1
"Line 6: Disrupting the Electric Guitar Market"
Anastasios Karamanos
ESSEC

Published March 2010