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Napster and the changing nature of intellectual property

This article appears in the issue October 2000 [Volume 9, Issue 8]

Creative work, consumer attitude and industry reaction

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 (books, movies, etc.) for that matter, has changed forever.

Less than a year ago, trade groups launched a lawsuit to shut down Napster--the free MP3 music-sharing service. Napster is considered to be perhaps the single most insidious force for copyright infringement ever--if not directly for artists, then certainly for record labels.

While the Recording Industry Association of America had hoped that shoplifting would return as its greatest source of lost revenues, Napster survived its July 28, eleventh-hour stay of a ruling two days earlier by Ninth U.S. District Court Judge Marilyn Hall Patel that it must shut down its service. Between the two rulings, Napster fans furiously retrieved files and overloaded other services providing similar offerings such as Scour and Gnutella. 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.

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 computers in MP3 format. 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--especially files they don't already own under a fair use copyright license. The enabling forces of de facto copyright infringement have meant that dozens of universities and even some ISPs have been forced to 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 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 and the central idea of ripping off record companies have 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 this: Should Napster be stopped? Ask your teen-agers; 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-mph 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. The problem for the labels is even greater because of the fact that many artists don't have a problem with Napster. More revenue is derived from other sources such as live performances than from album sales--at least in the early days of their careers--because of recording and studio fees and marketing and distribution costs. 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--although 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. There have been disagreement and an absence of standards by the labels regarding digital rights management protection, and reluctance by the industry to collaborate based on the weak argument that collaboration will raise the ire of federal antitrust regulators.

In fact, 28 U.S. states filed suit against the Big Five for allegedly price fixing against discount electronics superstores like Best Buy and Target, which had begun selling CDs below retail cost to drive traffic into the stores for other purchases. The stakes are pretty high and the situation confirms the suspicions of consumers that CDs are overpriced. The labels could be forced to repay five years of fat profits--a half-billion dollars by modest estimates.

Big Five plans

The labels have been tenuous in their initiatives to move toward digital distribution of music. Here's a quick summary 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. It has promised to deliver more later this year, which might include a partnership with Lycos. Lycos had its own MP3 troubles last year, and is a partner of BMG's parent company Bertelsmann, which recently bailed out ailing Cdnow. BMG 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. EMI is 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.com, and 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. Sony has part of the investment in Artistdirect.

4. Universal has released about 60 Bluematter singles (a new digital music product) 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 is one of the most reluctant in the music industry to embrace the new technology. It also has part of the investment in Artistdirect.

5. Warner was one of the first labels to license its catalog to MP3.com, joining BMG, but it 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). Warner also has an investment in Artistdirect.

Win-win

"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, following the stay of Judge Patel's shutdown ruling.

In a statement released on the 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 was only expected to last 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.

Sales booster, not buster?

So how does the music industry move forward? The only logical path is for the music industry to partner with the likes of Napster.

If Napster falls, more threatening alternatives eventually will develop similar, user-friendly interfaces to satisfy the consumer demand for cheap and/or free music on the Net. So far, the reason Napster has attracted such a tremendous following is its easy interface and the word of mouth from first-mover advantage that makes intellectual property broadly available. Bigger threats will replace Napster if the RIAA shuts it down.

Napster's 20 million users are, arguably, the most rabid music fans on the planet, long since alienated by $18 CDs churned out by artists largely perceived as arrogant and spoiled, and marketed by money-hungry multinationals that could care less about creativity. Could the industry benefit from those music customers who have been shown in recent research to actually buy more music because of their sampling on Napster?

Digital music on the Internet will never go away. Suing every user who downloads a song without buying it is the information highway's equivalent of enforcing a speed limit that everyone will break.

However, research shows that music fans don't want to break the law and, if presented with an appropriate price point (perhaps between 25 and 75 cents per song), the majority of users will stop stealing music and pay the pittance in licensing fees necessary to support artists' creative efforts, if not record companies outright. Given a reasonable alternative, the majority of today's music pirates will be customers.

The music industry has yet to offer a satisfactory alternative to meet the desire of music lovers to pay less for CDs. They usually only want one or two tunes on each album but are forced to buy "filler" in a 10- to 15-song album. Also, some potentially revolutionary developments are underway. For example, MP3.com is moving in partnership with Outernet to open a string of 15 music stores and entertainment complexes where fans can use kiosks to burn custom CDs for as little as $1 per track.

Napster's concentration of music fans gives record labels an unprecedented opportunity to market music online and presents a perfect laboratory for testing subscription-based services. Possibilities even include using upcoming digital rights management technology to watermark each song and limit it to a certain number of free plays, or basing subscriptions on a limited number of downloads plus unlimited streaming. A user's entire discography would be available to target-market similar artists, saving millions of dollars in research to find out what users are listening to.

One possible industry solution that is a potential point of weakness in the labels' ongoing strategy lies in the Secure Digital Music Initiative or SDMI. More than 100 companies, many members of the RIAA, have supported the idea of stamping a special digital watermark on all music released on CDs. If someone makes a pirated digital version of that music, players equipped with SDMI protection features will prevent the illegal songs from being played.

Although it sounds like a fantastic idea, you'd have to get hardware makers to voluntarily limit features of their products in an intensely competitive market--a point that might ultimately result in government regulatory action. Furthermore, how long would such a system persevere in an age where armies of 19-year-old college students live for the opportunity to crack such schemes? Consider the fate of the supposedly unbreakable DVD format and the Motion Picture Association 's attempt to stop the publisher of hacker periodical 2600 from distributing information about cracking DVD encryption. While Jack Valenti & Company are likely to win their case to shut down distribution on the site, there are hundreds of alternative sites where the software is still available. Digital rights management is no solution when it can be cracked--an eventuality that would require pretty creative thinking on the part of SDMI partners.

Napster never would have existed had the labels fulfilled demand for individual songs, in MP3 format, from major artists. In the old days, the industry used to sell singles without the filler of the rest of an album. Why can't an old idea be brought back for a new age? It would mean reorganization of the entire business model, but the system is broken. That's why Napster and its clones have propagated so successfully.

At the very least, the music industry must license its libraries to a third party. Napster just has a head start in the form of an intensely loyal following, a database with a vast amount of user information and an easy-to-use interface. But until labels relax control over their music libraries, there is little chance of building a viable online marketplace for legitimate music. Most music consumers don't know or care which labels distribute their favorite artists, so the labels should distinguish themselves by offering users value over the free alternatives.

For now, the strategy of many labels is streaming, which allows them to control their libraries because the stream is never actually downloaded. That strategy, however, will ultimately fail as consumers realize that portability requires a constant Internet connection in a pocket-sized package--alternatives only currently offered by MP3 players and some PDAs and smart wireless phones. And if they handle the pricing structure like they have in the past, don't look for such services to catch on..

If you think music fans won't move to other services, consider this--within 60 minutes of the announcement of Judge Patel's anti-Napster ruling, more than 31,000 new users had logged on to the lesser-known service called Scour Exchange and had shared more than 2 million songs. Furthermore, an RIAA boycott, organized by Napster users, banned the purchase of CDs while Napster was shut down. That amounts to millions of music fans making their voices heard in the form of boycotting the very companies that want to be patronized. Napster, too, has been growing--to the tune of a full million new users per month. At those numbers, users will find an alternative.

The music business has changed forever, and the industry must now figure out how to compete with free.


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