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by Arik Johnson

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Napster Part I of II: Napster Lives On -- Record Labels Face A Brave New World

Competitive Implications: Napster & The Changing Nature Of Intellectual Property

Although it might be amusing to hear Metallica and Dr. Dre rattle on about their "intellectual" property, the fact remains that, the very nature of the music industry, and all copyrighted creative work for that matter (books, movies, et cetera), has changed forever.

For those of you who've been living in a cave the past 9 months since trade groups launched a lawsuit to shut down the free MP3 music-sharing service, Napster (www.napster.com) is considered perhaps the single most insidious force for copyright infringement the world has ever known -- if not directly for all artists, then certainly for record labels. Incidentally, even if Napster is "shut down" users will still be able to continue using the service through a network of servers kept alive through a program called "Napigator" (www.napigator.com).

While the Recording Industry Association of America (www.riaa.org) was hoping that shoplifting would return as their greatest source of lost revenues, Napster survived its July 28th, eleventh-hour stay of a ruling two days before by Ninth U.S. District Court Judge Marilyn Hall Patel's that Napster must effectively shut down its service. Since the earlier ruling, Napster fans furiously retrieved files in the two days in between (apparently not aware of Napigator), and overloaded other services providing similar services such as Scour (www.scour.net) and Gnutella (www.gnutella.wego.com).

Napster is a software program and centralized database that acts as both a "client" and a "server" allowing PC users with the software installed, numbering some 20 million worldwide, to "share files" (songs) stored on their computer in MP3 format. FYI, MP3 itself is a relatively mature technology that preserves near CD-quality sound representation while minimizing file size, making storage and downloading much less troublesome. And, under the "fair use" clause of U.S. copyright law, music owners can "rip" or convert their CD or other music collections to cassette, another CD burn or MP3 format, made fairly easy to download to portable players like Diamond Multimedia's RIO player or even palm-size PCs and other consumer electronics.

The devilish implications arise when you consider that each user who "owns" music is also sharing those files with anyone else using the Napster software to search for and retrieve a copy of that file as well; especially files they don't already own under a fair use copyright license. The enabling forces of de facto copyright infringement has meant that dozens of universities and even some ISPs have been forced to shut down and regulate use of the software - something that, if the music industry has its way, the government will force users to do by law.

Now, MP3 format itself or even the concept of copying music to other media is not illegal as illustrated by fair use. The software itself is really nothing more than an idiot-proof "FTP" client/server application, long since used around the Internet for file transfers. The danger of Napster comes from within the easy-to-use interface and the users themselves -- their desire to get something for nothing or to share what they've paid for "from each according to his means to each according to his need", as the Marxists would tell us -- a sort of digital collective where information wants to be free.

Can Napster, and its ilk, now rising up to fill a potential vacuum in the music piracy market if the service is shuttered, be stopped? Not likely... the proverbial horse is out of the barn. The technology in the form of software and the central idea of ripping off record companies has proliferated and become an extremely hip use of the Internet; and, perhaps more importantly, consumer attitudes about the value of creative property have declined precipitously, at least among active Napster users.

A bigger question is if Napster should be stopped? Ask your teenagers, they're almost certainly either using it or have friends who do. It's a fantasy that music sharing over the Internet can be stopped by the courts, but more importantly it removes the recording industry's incentive to create products and services that customers obviously want - less expensive music downloads. And, the RIAA might be inviting political intervention in Internet affairs -- for everything from legislating anti-piracy technology on PCs and consumer electronics to trying to enforce the Internet equivalent of the 55-mile-an-hour speed limit.

The forces at work here represent a fundamental shift in the ways in which music is distributed - something countless industries have learned from and either adapted to or perished. The labels need to figure out how to leverage Napster's 20 million users rather than anger them further.

Still, the record labels and even a few artists themselves had hoped the fad would wear off, but in less than a year, use of the software has grown more quickly than other equally popular services, such as instant messaging, because users have always felt CDs were too expensive anyhow. The problem for the labels is even greater because, many artists don't have a problem with Napster, either -- much of their revenue isn't derived from album sales anyhow, at least not in the early "starving artist" days; most bands have an account that tracks to sales of new albums against revenues from live performances and future record sales as a loss that they must pay back anyhow to cover recording and studio costs, marketing and distribution. So, most artists don't make much money on album sales to begin with. In fact, musician-endorsed bootlegging has created more than a few legendary acts such as today's Phish and the psychedelia-fueled Grateful Dead. Likewise, many new and emerging acts love the idea of Napster, including popular alt-rock bands like Limp Bizkit, Radiohead and Offspring -- albeit those attitudes might change when a "touch of gray" takes away some of the live-performance revenues coming from all that consumer awareness and goodwill.

The "Big Five" record labels have had their own problems setting up for digital downloading of music, which many have pointed to as a chief reason for the proliferation of Napster-like services. With an absence of standards and agreement by the labels in terms of digital "rights management" protection and reluctance by the industry to collaborate on the weak argument of raising the ire of federal antitrust regulators. That might already be a problem... While we're on the subject of anti-competitive behavior, the RIAA's "Big Five" record companies have been put on the defense themselves lately as 28 U.S. states filed suit against the companies for allegedly price fixing against discount electronics superstores beginning in 1995 as retailers like Best Buy and Target began selling CDs at below retail cost as loss leaders to drive aisle traffic into stores for other purchases. The stakes are pretty high -- and confirms suspicions of consumers that CDs are overpriced; the labels could be forced to repay five-years worth of fat profit margins, a sum that could be as much as $1 to$2 sold since '95 - a half-billion dollars by the most modest of estimates.

The labels have been tenuous in their initiatives in moving towards digital distribution of music. Here's a quick summation of the current strategies of the Big Five:

1. BMG has failed to deliver the bulk of its music catalog for secure downloading over the Net, but in June became the first big label to license on-demand streaming of digital music through start-up Musicbank. Its promised to deliver more "later this summer" which might include a partnership with Lycos (who had its own MP3 troubles last year with the industry) and is a partner of BMG's parent company Bertelsmann who also recently bailed out ailing CDnow. Also has part of the $100 Million equity investment in ARTISTdirect.

2. EMI launched its digital distribution scheme in July with the online release of 100 albums and another 100 singles and licensed its catalog to MP3.com. While the price tag of $3.99 per song is steep and tunes are tough to find on CDnow and other services, EMI executives admit they're not "expecting huge sales". The only one of the big five left our of the ARTISTdirect equity investment.

3. Sony was the pioneer of the big boys releasing some 50 singles in May and partnering with Universal to bring to market a streaming music subscription service. A strategy of aggressive investment in sites like Gig.com and Audiobase plus remote storage services plans are complimented by its hardware presence selling MP3 players, PCs and other multimedia devices to consumers, leaves Sony positioned to build relationships with customers in both the hardware and content areas. Also has part of the $100 Million equity investment in ARTISTdirect.

4. Universal has released about 60 "Bluematter" singles (which also include multimedia such as photos and artist bios) after having given up on its partnership with BMG to sell music through their jointly developed "Nigel" service, and also has a streaming license agreement in place with Musicbank. The largest label in terms of sales, Universal has the most to lose from digital distribution -- and one of the most reluctant in the music industry to embrace the new technology. Also has part of the $100 Million equity investment in ARTISTdirect.

5. Warner was one of the first labels to license its catalog to MP3.com, joining BMG, but won't have a "meaningful offering" until the end of the year. The largest factor facing the company is the pending merger between parent Time Warner and AOL (which also controls the original developers of Gnutella, an MP3 system that has become a Napster-like "open source" network without a centralized server system or a simple interface, but a giant audience of users and no one to sue. Also has part of the $100 Million equity investment in ARTISTdirect.

"I am happy and grateful that we do not have to turn away our 20 million users and that we can continue to help artists," said Shawn Fanning, founder of Napster. In the statement released on their Web site, CEO Hank Barry tried to focus on the company's new commitment to working with the RIAA and said, "I believe the Napster technology can help everyone involved in music -- including artists, consumers and the industry. New technologies can be a win-win situation if we work together on building new models -- and we at Napster are eager to do so."

A somewhat deflated RIAA issued its own take on Judge Patel's ruling. Citing the enormous Napster traffic the injunction created, CEO Hilary Rosen said, "It's frustrating, of course, that tens of millions of daily infringements occurring on Napster will be able to continue, at least temporarily. In fact, since the district court issued its order, the illegal downloading of copyrighted music openly encouraged by Napster has probably exceeded all previous records."

Napster is not out of the woods yet, however. The stay of the injunction only lasts until September, to give the Court of Appeals time to better review the case. Meanwhile, the RIAA has the option of filing an appeal with the Ninth Circuit Court of Appeals or with the U.S Supreme Court.

So, what's a huge, bloated industry to do? What are the implications for other intellectually propertied sectors? Next week, we'll take a look at some of the strategies necessary as the players in this opera position themselves to either get rich or go broke.