As owners of a music company whose roster of pop acts includes acts as diverse as Mariah Carey, Marilyn Manson, Elton John and Lady Gaga, Vivendi’s directors are used to doing business in a sometimes irrational world.

But its failure to cope with the unpredictable behaviour of rivals in the telecoms business has left the French group and its chief executive Jean-Bernard Lévy looking vulnerable at home.

Outside France, Vivendi is best known as a media business, owner of Universal Music and Activision Blizzard, the world’s largest music and computer game companies by sales.

But it makes most of its revenues and profits from the unglamorous business of telecoms, largely in France. And it is there that it is struggling. Vivendi’s domestic telecoms company, SFR, is under attack from an upstart rival, Free Mobile, which has cut prices to a level the industry would have thought impossible a few months ago.

For Mr Lévy, the situation has become so alarming that he has ousted SFR’s longstanding chief executive, Frank Esser, and taken direct control of the company. As a colleague says: “Jean-Bernard is going to personally take the fight to Free.”

The stakes are high because it was only last year that he sanctioned the €7.8bn purchase of a 44 per cent holding in SFR from Vodafone, its former joint venture partner.

Mr Lévy says Vivendi profits would have fallen in 2011 without the SFR purchase. But some analysts and investors have criticised the deal – valued at 6.2 times SFR’s 2010 operating earnings – because the arrival of Free Mobile, owned by French billionaire Xavier Niel’s company Iliad, was known about at the time.

Claudio Aspesi, a Bernstein analyst, says such criticism is unjustified given that many Vivendi shareholders applauded the deal when it was announced. “The markets have misjudged just as much as anyone else the impact of Iliad,” he says.

While the new low-cost rival was no surprise to Mr Lévy, the aggression of Free’s pricing caught the French telecoms industry on the hop. Free is offering limited mobile phone services to customers of its fixed-line business at no charge.

French regulators estimate that Free has won at least 2m customers from rivals, including France Telecom and Bouygues. Its launch led to a profit warning and slashed dividend at Vivendi.

Mr Lévy is furious about a deal whereby Free is paying to use France Telecom’s network, which he believes has let the upstart offer prices that should be unsustainable.

That deal has provided France Telecom, the leading French telephone company on all measures, with a hedge against Free’s impact which some analysts estimate could be worth €2bn over six years. France Telecom shares have fallen about 10 per cent since Free’s January launch, compared with 20 per cent at Vivendi.

France Telecom insiders say Mr Lévy’s criticisms are sour grapes and he spoke to Mr Niel about a possible deal. Vivendi says it did talk to Free, but only offered the use of its inferior second-generation network.

For Mr Aspesi, Vivendi’s surprised reaction to the impact of France Telecom’s deal with Free shows how easily it can be outwitted by rivals acting unpredictably. “Vivendi is very good at being extremely rational,” he says. “But they struggle whenever anyone behaves in an apparently irrational way.”

Mr Lévy, a telecoms engineer by background, has to work out how to cut costs at SFR while devising a marketing strategy to convince customers that his network’s quality makes it worth a higher fee.

He must also steer another deal that will define his term; Universal’s $1.9bn purchase of EMI’s recorded music business, through a lengthy European antitrust probe. Mr Lévy will be hoping for no more unwelcome surprises this year.

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