As audiences decline, how much longer can the Capital punishment go on?

Star performer Chris Tarrant may quit struggling radio group before the end of the year

Not long along, Capital Radio seemed to have Britain dancing at its feet. Now it is being talked about as the "ITV" of the radio world, suggesting it's in steep, structural decline.

In a shocking admission for a company that owns London's biggest music-based station, Capital 95.8 FM, it has owned up to playing the wrong sort of tunes. Its key breakfast show has seen a collapse in audience. On top of a debilitating recession in advertising, which has hurt all media companies, this is bad news for Britain's leading radio group. But it has now come out fighting, taking a risk with a new music policy and a new breakfast show in an effort to win back listeners.

Howard Bareham, the head of radio at the media buying agency Mindshare, says: "The first three months of this year are the most important [quarter] for Capital in a long time."

Capital FM used to be the gateway, in London and the surrounding areas, to the youth audience craved by advertisers. But the Chris Tarrant breakfast show's audience in London (measured by listener hours) dropped 23 per cent during the past year and its audience share dropped to 8.8 per cent for the first time – it used to be well into double digits.

It was the official Rajar listening figures for the third quarter of 2002 that showed a shock fall in audience and the fourth quarter failed to show any improvement. However, Capital FM is still the market leader by a long way and Xfm, one of its other London stations, is proving increasingly popular.

London's leading station, which provides an estimated 40 per cent of Capital's group revenues, is facing some of the same problems as ITV: fragmentation of audience and a resurgent and populist BBC. The question is whether Capital shows signs of a terminal illness – with the share price hitting a new low in recent weeks – or is it just passing through a rough patch?

David Mansfield, Capital's chief executive, says: "There has been a problem in London, we think it's fixable and we're going out to fix it."

Capital enjoyed a virtual monopoly in London, for the commercial sector, 10 years ago. That can't last forever and we have seen an inevitable erosion of a commanding position.

Phil Riley, the chief executive of rival Chrysalis Radio, says: "They [Capital] tried to own the waterfront. Over a period of time, you can't sustain that.... I'd say that 75 per cent of it [the loss in market share] was beyond their control."

Unsurprisingly, Mr Mansfield hates the unflattering comparison with ITV's situation and he has a point. Whereas the two main ITV companies, Carlton and Granada, have reached the end of the road and are stitching together a defensive merger, Capital has plenty of room for expansion. And while ITV's management is universally panned, Mr Mansfield and his team are generally well regarded.

But over the past six months the Capital Radio plc story has been clouded by its twin problem in the London market: the issue of star DJ Chris Tarrant leaving 95.8 FM and a realisation that it has been playing the wrong sort of music.

The Tarrant affair was badly handled. The "is he staying or going?" debate was a distraction and the desperation of Mr Mansfield to keep him appeared to show up a startling lack of depth of talent at the company. The 55-year-old DJ has been doing the show for a remarkable 15 years.

Tarrant finally agreed to renew his contract for another year at the end of 2002 but gossip has it that despite the £1.5m he will pocket for another stint on the breakfast show, he will only work six months in effect, because he has so much time booked off. One rumour is that he's away for April, May, July and August, during which time the cheesy Neil Fox will stand in.

According to one industry source, Tarrant may not even return after his break in March. This is vehemently disputed by Capital. In any case, the problem of replacing Tarrant will begin again at the end of this year and many in the industry say Capital should have let go of Tarrant and moved on last year. The manner of retaining him appears to be a classic fudge.

Paul Gooden, an analyst at Morgan Stanley, says: "I don't see why long term they [Capital] should have double the listeners of everybody else. They've stayed still while rivals have progressed. I'm concerned that this [decline] is a structural issue."

According to Morgan Stanley, the breakfast show not only provides 15 per cent of group revenues, it is the key to hooking listeners for the rest of the day. So getting the programme right is crucial. The sudden fall in the breakfast audience and mismanagement of the Tarrant issue has raised serious questions. The revamped breakfast show has several presenters and sees Tarrant there for fewer hours but that, along with the station's new music policy, has left the industry rather confused. And, now that 95.8 FM's audience has slipped so far, the premium paid for airtime on the station is increasingly difficult to justify.

Joanna Daly, radio advertising buyer at MediaCom, says: "They had to do something but I'd have done something more obvious and bold. No one is really too sure what's going on now."

It is a mixture of complacency at Capital and a new sharpness among its rivals that has created such a headache for Mr Mansfield. Kiss, Magic and Heart are all offering a much-improved programming, especially at breakfast time. Each of these competitors has a much more narrowly focused proposition for audiences, for instance Kiss is known for dance music, while Capital is still trying to serve the various popular music tastes of its entire target 15 to 44 age group.

Keith Pringle, the director of programming at Capital, admits 95.8 FM got too fixated on playing "pure pop" music, such as boy bands, and did not include other styles of popular music, leaving the output dull and predictable. The station has parted company with its head of music.

"We are still and always will be the number one hit music station but we are adding a certain depth to what we play ... to reflect the changing tastes of our audience. We will be playing a rich mix of pop, rock and rhythmic music. We have a unique position that allows us to play all these things."

Many question whether, in an age where audiences have more and more choice, it is possible to be all things to all people. But the fall in listeners at 95.8 FM has not meant advertisers will necessarily move their spending to other stations, as it is still the biggest and there is not the sort of ill-feeling that has seen some advertisers want to punish ITV. MediaCom's Ms Daly says Capital is still the first station advertisers mention when they want critical mass in London. Even so, competitors are sensing blood.

Tim Schoonmaker, chief executive of Emap's radio division, says: "Once Capital got below 10 per cent [London audience share], they no longer had a seemingly unassailable lead."

Rather than scrambling to defend the core business, this should be the time that Mr Mansfield is plotting to expand his empire. New ownership rules, which come into force later this year, will allow much greater sector consolidation.

"Don't believe all that nonsense others [rivals] will tell you. This is where the action is," Mr Mansfield says.