Can fee music compete with free?

Summary:The recording industry, with the help of Silicon Valley entrepreneurs, is betting it can use technology in new ways to stem the tide of piracy -- and boost record labels' revenue.

Like techno-termites, computer users who swap free recordings are gnawing at the foundations of the music industry. Most use a service called Napster, which has triggered a piracy plague that could sweep into books, movies, photography and software.

Such file-sharing technologies may be impossible to stamp out, eating into the CD sales that are the industry's main source of revenue. Why, after all, would people pay $15.99 for a CD in a store if they can use Napster and programs like it to download the same music for free, and then play it on their PC or a cute portable device -- or turn it into a CD themselves?

"At the end of the day, the music industry as we now know it is over," declares Avram Miller, a former Intel Corp. vice president with close ties to the entertainment industry.

But the recording industry -- with the help of some Silicon Valley entrepreneurs -- believe they can use technology in new ways to stem the tide of piracy. And they're betting that their innovations will eventually boost record labels' revenue as well.

For the past two years, the five major labels -- Universal, Sony (sne), BMG, Warner and EMI -- have been preparing to sell authorized downloads of popular recordings via services that are expected to begin rolling out this summer. To make the digital downloads attractive, and make life harder for those who pirate its products, the industry is preparing a series of carrot-and-stick programs. It is also quietly devising plans for other digital services, some of which are based on the same fundamental principle behind Napster.

'All you need is one virus to kill your hard drive for you to say, "this free stuff isn't free,"'|Paul Vidich, Time Warner Inc. "This isn't a question of survivability," insists Strauss Zelnick, CEO of Bertelsmann AG's BMG Entertainment unit. "It's a question of the market for our products vastly expanding." And Vivendi SA's proposed acquisition of Universal Music Group's parent, Seagram Co., expected to be announced Tuesday, also signals confidence in the industry's ability to use the Internet to grow.

The most intriguing concept under development is turning each personal computer into a kind of vending machine -- and each user into a sales representative for the industry. The idea, long proposed by such entrepreneurs as Victor Shear of InterTrust Technologies Corp., uses a Napster-esque approach to sharing data and software that enforces usage rules imposed by copyright holders.

Napster Inc., a closely held startup based in San Mateo, Calif., took off because of a technology called peer-to-peer file sharing. Instead of placing data in a central repository or on a Web site, which would easily be overrun with user requests, individual PCs are linked into a network of decentralized silos, storing and passing along music or any other intellectual property expressible in bits of data. Napster also developed a directory to help consumers find others willing to let strangers scour their hard drives for music files.

'We are eager to work with all constituencies who are interested in the Napster community.'|Hank Berry, Napster CEO Napster itself is battling copyright-infringement suits by record labels and such groups as Metallica. It just hired lawyer David Boies, lead attorney for the Justice Department in the Microsoft case, to defend it. But despite its high-stakes legal troubles, it maintains it can ultimately coexist with the labels' pay-for-play plans.

"There are lots of business models at play here, and they may be compatible in surprising ways," said Napster CEO Hank Berry in an e-mail exchange. "We are eager to work with all constituencies who are interested in the Napster community."

Some kind of cooperation could happen, of course, but the industry already has plans of its own. BMG has been working for several years to structure a commercial download system that uses both retail channels and sales efforts by "music fans themselves," said Kevin Conroy, the company's president of new technology. Fans could pass on downloaded albums through e-mail or put their downloads into Napster-style file-sharing directories.

Unlike Napster and its offshoots, the authorized downloads would be encoded so fans would have to pay to play them. But record executives say that people who start a chain of sales could receive rewards, such as early access to new music or commissions that could be used as credits on future music purchases.

Other new-wave services are in the offing. Under licenses with startup companies, music companies hope to get added royalties when people use Web storage lockers to tap into music they already own. Some labels are also likely to experiment with services that offer a range of music for a monthly subscription fee.

"The Internet allows you to reach people in so many new fresh ways," said Ken Berry, CEO of EMI Recorded Music, a unit of EMI Group PLC (emipy). "That's a huge opportunity."

But such assessments assume the industry can overcome some high hurdles. It is easy, for example, to encrypt a new musical recording so that people need special software or hardware to listen to it and have to pay to unlock the file. Or they might have to listen to advertising or live with conditions such as a restriction on sharing or on playing songs more than a few times. Sony Corp.'s Sony Music Entertainment unit has already begun selling singles for $2.49 each via downloading.

Yet any recording destined for a mass audience must also be distributed on CDs that can be played on standard players. And conventional CDs are easily ripped, or transferred to the file format known as MP3, which means free music.

One response is to distribute CDs, or other digital fare, with some extra bits called watermarks that act like a brand on cattle. Record labels and consumer-device makers have negotiated a set of specifications that use watermark technology to hinder the spread of piracy, starting with new portable music players and the PC software needed to use them.

Under the first phase of the plan, the devices will play users' MP3 files as well as the authorized recordings that are identified by watermarks. But a second generation of software won't let the devices play recordings that don't contain the watermarks, explains David Leibowitz, chairman of Verance Corp., whose watermark technology will be used with portable devices.

Like techno-termites, computer users who swap free recordings are gnawing at the foundations of the music industry. Most use a service called Napster, which has triggered a piracy plague that could sweep into books, movies, photography and software.

Such file-sharing technologies may be impossible to stamp out, eating into the CD sales that are the industry's main source of revenue. Why, after all, would people pay $15.99 for a CD in a store if they can use Napster and programs like it to download the same music for free, and then play it on their PC or a cute portable device -- or turn it into a CD themselves?

"At the end of the day, the music industry as we now know it is over," declares Avram Miller, a former Intel Corp. vice president with close ties to the entertainment industry.

But the recording industry -- with the help of some Silicon Valley entrepreneurs -- believe they can use technology in new ways to stem the tide of piracy. And they're betting that their innovations will eventually boost record labels' revenue as well.

For the past two years, the five major labels -- Universal, Sony (sne), BMG, Warner and EMI -- have been preparing to sell authorized downloads of popular recordings via services that are expected to begin rolling out this summer. To make the digital downloads attractive, and make life harder for those who pirate its products, the industry is preparing a series of carrot-and-stick programs. It is also quietly devising plans for other digital services, some of which are based on the same fundamental principle behind Napster.

'All you need is one virus to kill your hard drive for you to say, "this free stuff isn't free,"'|Paul Vidich, Time Warner Inc. "This isn't a question of survivability," insists Strauss Zelnick, CEO of Bertelsmann AG's BMG Entertainment unit. "It's a question of the market for our products vastly expanding." And Vivendi SA's proposed acquisition of Universal Music Group's parent, Seagram Co., expected to be announced Tuesday, also signals confidence in the industry's ability to use the Internet to grow.

The most intriguing concept under development is turning each personal computer into a kind of vending machine -- and each user into a sales representative for the industry. The idea, long proposed by such entrepreneurs as Victor Shear of InterTrust Technologies Corp., uses a Napster-esque approach to sharing data and software that enforces usage rules imposed by copyright holders.

Napster Inc., a closely held startup based in San Mateo, Calif., took off because of a technology called peer-to-peer file sharing. Instead of placing data in a central repository or on a Web site, which would easily be overrun with user requests, individual PCs are linked into a network of decentralized silos, storing and passing along music or any other intellectual property expressible in bits of data. Napster also developed a directory to help consumers find others willing to let strangers scour their hard drives for music files.

'We are eager to work with all constituencies who are interested in the Napster community.'|Hank Berry, Napster CEO Napster itself is battling copyright-infringement suits by record labels and such groups as Metallica. It just hired lawyer David Boies, lead attorney for the Justice Department in the Microsoft case, to defend it. But despite its high-stakes legal troubles, it maintains it can ultimately coexist with the labels' pay-for-play plans.

"There are lots of business models at play here, and they may be compatible in surprising ways," said Napster CEO Hank Berry in an e-mail exchange. "We are eager to work with all constituencies who are interested in the Napster community."

Some kind of cooperation could happen, of course, but the industry already has plans of its own. BMG has been working for several years to structure a commercial download system that uses both retail channels and sales efforts by "music fans themselves," said Kevin Conroy, the company's president of new technology. Fans could pass on downloaded albums through e-mail or put their downloads into Napster-style file-sharing directories.

Unlike Napster and its offshoots, the authorized downloads would be encoded so fans would have to pay to play them. But record executives say that people who start a chain of sales could receive rewards, such as early access to new music or commissions that could be used as credits on future music purchases.

Other new-wave services are in the offing. Under licenses with startup companies, music companies hope to get added royalties when people use Web storage lockers to tap into music they already own. Some labels are also likely to experiment with services that offer a range of music for a monthly subscription fee.

"The Internet allows you to reach people in so many new fresh ways," said Ken Berry, CEO of EMI Recorded Music, a unit of EMI Group PLC (emipy). "That's a huge opportunity."

But such assessments assume the industry can overcome some high hurdles. It is easy, for example, to encrypt a new musical recording so that people need special software or hardware to listen to it and have to pay to unlock the file. Or they might have to listen to advertising or live with conditions such as a restriction on sharing or on playing songs more than a few times. Sony Corp.'s Sony Music Entertainment unit has already begun selling singles for $2.49 each via downloading.

Yet any recording destined for a mass audience must also be distributed on CDs that can be played on standard players. And conventional CDs are easily ripped, or transferred to the file format known as MP3, which means free music.

One response is to distribute CDs, or other digital fare, with some extra bits called watermarks that act like a brand on cattle. Record labels and consumer-device makers have negotiated a set of specifications that use watermark technology to hinder the spread of piracy, starting with new portable music players and the PC software needed to use them.

Under the first phase of the plan, the devices will play users' MP3 files as well as the authorized recordings that are identified by watermarks. But a second generation of software won't let the devices play recordings that don't contain the watermarks, explains David Leibowitz, chairman of Verance Corp., whose watermark technology will be used with portable devices.

Getting people to upgrade to the limited-function software could be tricky. But record makers and their allies are counting on a series of carrots and sticks:

Cool content. Some blockbuster recordings will likely be exclusively available -- or available first -- in protected computer formats.

Bundling. Shear predicts some CDs will have a dozen or so conventional tracks, plus perhaps two more that can be decoded only with software that complies with record-industry standards.

Nifty hardware. Some attractive players for downloaded music -- for cars, pockets or stereo cabinets -- will be designed to encourage use of watermarked recordings.

Extras. Some authorized recordings may come with graphics and video interviews that won't be available if the music is pirated.

Sound quality. New formats take up less drive space and sound considerably better, backers say.

Download dangers. Decentralized peer-to-peer services, such as Napster and its offshoots, theoretically open up consumers' computers to problems. "All you need is one virus to kill your hard drive for you to say, 'this free stuff isn't free,'" said Paul Vidich, executive vice president of Warner Music Group, a unit of Time Warner Inc. (twx).

Liability. Record labels haven't sued many individual downloaders yet, in part because consumers have few lawful ways to buy big-name artists' music online. That may change once legal downloads are available. "We will take our fight to every territory, in every court in every venue," Edgar Bronfman Jr., CEO of Seagram, said during a recent speech in which he vowed to use new technology tools to track down pirates.

Napster is a relatively easy target for such tools, because it keeps a directory that can be used to shut off individual users or shut the service itself down. It's less clear how the industry will track down users of systems like Gnutella, which isn't based on a central directory.

Another debate concerns the packaging and pricing of new Internet services and questions about whether such schemes might hurt industry revenue or stimulate new demand.

Some companies, for example, are considering prepaid services that would allow consumers to pay $10 a month to download a specified number of musical tracks. Other proposed services would let consumers pay a flat fee for as much music as they wanted, a structure that proponents believe would reduce the incentive for piracy. Sony Music Entertainment and Universal recently announced a joint venture to develop such a service.

EMI's Ken Berry said his company is interested in such new models but has "concerns" about schemes that would reduce the price of music. Dave Goldberg, a former record executive who heads Internet music company Launch Media Inc., is more enthusiastic. He argues that if all 100 million people who actively listen to music pay $10 a month for unlimited quantities of new music, the wholesale revenue will equal what's generated by the record companies now.

There is little disagreement, at least, about the need for action in the wake of Napster. Talal Shamoon, an InterTrust senior vice president, likens the labels' situation to somebody with a forest fire at his back and a river to ford to reach safety.

"We used to have polite conversations with the labels six months to a year ago," said Vincent Pluvinage, CEO of Preview Systems Inc., another maker of content-protection products in Sunnyvale, Calif. Since Napster came on the scene, "they return our calls in 24 hours."

Getting people to upgrade to the limited-function software could be tricky. But record makers and their allies are counting on a series of carrots and sticks:

Cool content. Some blockbuster recordings will likely be exclusively available -- or available first -- in protected computer formats.

Bundling. Shear predicts some CDs will have a dozen or so conventional tracks, plus perhaps two more that can be decoded only with software that complies with record-industry standards.

Nifty hardware. Some attractive players for downloaded music -- for cars, pockets or stereo cabinets -- will be designed to encourage use of watermarked recordings.

Extras. Some authorized recordings may come with graphics and video interviews that won't be available if the music is pirated.

Sound quality. New formats take up less drive space and sound considerably better, backers say.

Download dangers. Decentralized peer-to-peer services, such as Napster and its offshoots, theoretically open up consumers' computers to problems. "All you need is one virus to kill your hard drive for you to say, 'this free stuff isn't free,'" said Paul Vidich, executive vice president of Warner Music Group, a unit of Time Warner Inc. (twx).

Liability. Record labels haven't sued many individual downloaders yet, in part because consumers have few lawful ways to buy big-name artists' music online. That may change once legal downloads are available. "We will take our fight to every territory, in every court in every venue," Edgar Bronfman Jr., CEO of Seagram, said during a recent speech in which he vowed to use new technology tools to track down pirates.

Napster is a relatively easy target for such tools, because it keeps a directory that can be used to shut off individual users or shut the service itself down. It's less clear how the industry will track down users of systems like Gnutella, which isn't based on a central directory.

Another debate concerns the packaging and pricing of new Internet services and questions about whether such schemes might hurt industry revenue or stimulate new demand.

Some companies, for example, are considering prepaid services that would allow consumers to pay $10 a month to download a specified number of musical tracks. Other proposed services would let consumers pay a flat fee for as much music as they wanted, a structure that proponents believe would reduce the incentive for piracy. Sony Music Entertainment and Universal recently announced a joint venture to develop such a service.

EMI's Ken Berry said his company is interested in such new models but has "concerns" about schemes that would reduce the price of music. Dave Goldberg, a former record executive who heads Internet music company Launch Media Inc., is more enthusiastic. He argues that if all 100 million people who actively listen to music pay $10 a month for unlimited quantities of new music, the wholesale revenue will equal what's generated by the record companies now.

There is little disagreement, at least, about the need for action in the wake of Napster. Talal Shamoon, an InterTrust senior vice president, likens the labels' situation to somebody with a forest fire at his back and a river to ford to reach safety.

"We used to have polite conversations with the labels six months to a year ago," said Vincent Pluvinage, CEO of Preview Systems Inc., another maker of content-protection products in Sunnyvale, Calif. Since Napster came on the scene, "they return our calls in 24 hours."

Topics: Piracy, PCs

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