March 21, 2000

As the dates for the Recording Industry Association of America's showdowns with Napster and MP3.com quickly approach, concern about the future of the online music business is rocketing to executive levels at the major record companies.

The future of the industry’s current e-commerce business model is in doubt—and once again, the traditional music business finds itself playing catch-up with burgeoning technology companies.

The RIAA, the trade group that represents the major music industry players, filed a lawsuit last month against Napster, alleging that the controversial technology facilitates copyright infringement by allowing users to trade pirated MP3 files. Some musicians and their managers have called Napster pernicious, stating that it allows people to obtain music without compensating the artists.

The RIAA has also filed suit against MP3.com, alleging copyright infringement against the renegade music distributor’s MyMP3.com technology.

The Napster case is set for a summary judgment hearing slated for March 27, while the RIAA has filed for a summary judgment against MP3.com, which is supposed to be decided April 14.

An RIAA loss in either case could change the entire music industry’s e-commerce model. Regardless of the outcome of these two separate lawsuits, the industry’s current online plan is under enormous pressure. The biz must find a new working model now that "the genie is out of the bottle" with the Napster technology and it is "unlikely that the law can touch it," said a source familiar with the proceedings. Because of the pending litigation, spokespersons for those involved would not comment on the cases.

If the decisions go against MP3.com and Napster, the effect of the existing technology out there will still cause significant changes in the majors’ approach towards the online distribution of music.

"Napster is a company that very much wants to work with the record industry and, in particular, the major record labels," said Liz Brooks, VP Marketing, Napster, herself a major label veteran. "That would be true if there was a lawsuit or no lawsuit. Working in conjunction with the majors is important in the space we want to occupy in the landscape. That is why I was brought in to Napster; to help translate to a purely Silicon Valley company what the music industry’s needs and concerns are. This can be an unprecedented opportunity for the music business. We now have the opportunity to look at the universe of the true music fan and can observe what they want to do. The opportunities for marketing and promotion are unlimited. Our stance is not dependent on the litigation."

Sources indicate that the RIAA is likely to lose its case against Napster because the technology is already out there. In addition, there is no way to enforce a law against it as well as the fact that users are the ones who engage in any piracy that might take place via the system not Napster itself.

Napster is the wildly popular music-sharing technology founded by 19-year-old Shawn Fanning . Fanning’s company is expected to close $15 million in second-round funding shortly Last year, the company raised seed funding of $2 million from investors including Angel Investors, Valicert CEO Yosi Amram, and Excite founder Joe Kraus. Napster’s proposition was simple: users download its free software, which indexes MP3 music files on the user’s hard drive and makes them visible to other Napster users when connected to its server network.

From there, all it takes is a simple title or artist search to find other users from whom to download MP3 files. Users typically may find the latest hits through the free network, allowing them to download and listen to the music without paying. They may even select files based on the uploading user’s connection speed.

Record labels aren’t happy about illegal MP3s to begin with, so they’re livid that Napster makes it easy for the compressed music files to zip across the Internet. But Napster contends that it and the majors can co-exist, specifically in a marketing and promotional capacity. Napster can work with record labels to identify artists and songs popular with its users, acting as a sort of filter for new recording contracts.

"Napster has a stronger chance of winning than MP3.com," said an insider. "But, the RIAA are in bigger trouble if they win. All of this content with no content protection is out there. On college campuses across the country, they are not selling CDs like they used to and that’s because of Napster and MP3.com. The music industry is facing a real problem, which the law can’t address in the real world."

A loss to Napster could force a licensing deal between MP3.com and the RIAA. Napster believes that there will be changes in the way the business works and are hoping to provide a framework for the new business model. However, the RIAA’s stand has been against the sharing of MP3 files all along and its relationship with MP3.com and its CEO Michael Robertson has been strained at best. While both Napster and MP3 are looking to settle these suits, some insiders believe that MP3.com can work out a deal where both sides get mutual benefits but there is less middle ground with Napster.

"Napster and MyMP3.com are two totally different technologies," a source explained. "MyMP3.com has anti-piracy designs. When you use the system, it facilitates an end result that is legal. It’s just streaming for my own personal use. The RIAA lawsuit against MP3.com questions whether MP3.com has violated licensing and copyright laws. Napster, on the other hand, can be used for non-infringing purposes. It is software that allows a CD to be ripped and anyone can download it. That is clearly a piracy concern."

The RIAA suit against MP3.com is based on the company’s pre-existing database of steamable CDs, which the trade organization says was created without permission.

Free technology advocates contend that instead of making the program illegal, users have fair-use rights and should police themselves. Other pro-Napster forces claim that the program can be used to trade legal MP3 files and other public domain or educational sound files, so it has a valid purpose that warrants its existence.

Much of the debate has centered on absolute positions - the abolition of Napster-type technology to prohibit piracy vs. its continued existence, with speculation about how artists could still be compensated by file-sharing communities, if at all.

A middle ground could lie in an idea outlined by the Secure Digital Music Initiative, an industry consortium of music labels, software companies and technology companies, whereby a security system would govern the transfer of copyrighted material. However, the limitations such strictures would place on consumers have led some observers to deem SDMI highly impractical at best, totally unworkable at worst. It’s just too little, too late.

In related news, Gnutella, a new music-copying program that was being tested by America Online-owned Nullsoft, was scrapped last week. The Sedona, AZ-based company, which developed WinAmp and oversees AOL’s Spinner streaming player, was forced to curtail testing of its Napster-like system after a post online revealed the test site’s URL.

However the scenarios are played out, it seems quite evident that the majors again need to reinvent themselves in the face of new MP3 technology. They must get in the business of gathering consumer data about their artists’ audience, a source said. "By doing so, labels will be able to diversify their revenue streams not just from album sales, but by controlling valuable data that is sellable to concert promoters and merchandisers."