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Rhapsody's Five-Part Harmony

One year to the day after online file-sharing service Napster shut down, another digital-music service is hitting the big time. On July 1, announced that its Rhapsody music-subscription service had secured a much-sought-after licensing deal with Universal Music. The agreement anoints Rhapsody as the first online service to offer songs from the five major music labels: Universal, Warner Bros., Sony, BMG, and EMI. Together, that group controls more than 85% of the $13 billion U.S. music market.

Rhapsody, which many reviewers regard as the best online-music service to date, now offers its subscribers unlimited streaming access to more than 175,000 tracks and 14,000 albums (see BW Online, 11/30/01, "Rhapsody in Green?" and 12/28/01, "Pay-to-Play Music: Lots of Missed Notes"). Subscribers can already download and burn classical tracks to a CD. Rhapsody hopes to offer the same ability across its library by fall.

But the deal says as much about the music labels as it does about For three years, record executives have taken divergent approaches to online music, seeing it first as something to be ignored, then something to be stamped out. Universal's decision to catch the online-music wave by licensing its repertoire to demonstrates that the tide is turning. On June 28, CEO Sean Ryan spoke to BusinessWeek Online's Jane Black about what the deal heralds for and the online-music business. Edited excerpts of their conversation follow:

Q: Why is this such an important announcement for

A: The deal not only brings Universal's 30% market share to Rhapsody but it also improves [the service's] usefulness to the consumer by an infinite amount. It removes [the lack of] content as an issue. And that has been the overriding problem in digital music.

Q: What does it say about the record labels' view of digital music?

A: The labels' thought process has been changing for three years. Three years ago, they saw the Internet and wished it would go away. It had no benefits to their business, and it was causing changes to their plans. Two years ago, they saw the Internet was not going to go away, but they saw that it was primarily used for copyright theft. And it was in those days.

What this announcement shows is that the tune is starting to change to: "Hey, the Internet still can be used for copyright theft, but let's take a look at it as another distribution channel." That's especially important because their physical business is under such assault. Now, they're saying, "Let's use the Net as a way to increase revenue and get additional content out to new people."

Just the way video rentals and pay-per view have helped the movie business by expanding the overall revenue pie, digital music is going to help the labels.

Q: Isn't it also possible that the labels are just tipping their hat to the Justice Dept., which for months has been investigating whether they were colluding to exclude independent digital-music services like Rhapsody?

A: Make no mistake: I think they're doing this out of self-interest. There are three components. One is to have a legitimate alternative to piracy. Two is to look for alternative sources of revenue beyond the physical retail, which is taking a beating right now. And three, there's no question, there's a Justice Dept. investigation going on to make sure there's a level playing field, and that's putting pressure on them. But I don't think it's solely that latter one. It's a mixture.

Q: It has taken a long time to get deals with all the labels. What were the main bones of contention?

A: The Universal negotiations took 16 months. And the majority of the negotiations with the other labels took 9 to 12. Of course, there were discussions over financials. But more important, there were negotiations over what rights are inherent from a device perspective. We all see in the next two to three years that music will move away from the PC into stereos, into televisions, into cell phones and cars. And it's a setting up parameters and descriptions of what those rights entail.

So first, we've argued for rights to [the music labels'] entire catalog -- none of these partial-catalog deals. Second, we wanted the ability to offer unlimited access. We think it's crucial that you put no limits on the amount of times people want to listen to music -- just like HBO doesn't limit the number of programs you can watch. And third, we felt that it was important to take it into account wireless devices.

It took time because, as I mentioned earlier, this has been a period of time when the labels have been evolving and getting used to digital-music services in general. For us, it has been a period of time when they were coming to terms with our unique all-you-can-eat streaming proposition, which is quite different than limited, tethered downloads that other services [such as label-backed MusicNet and pressplay] offer. We're moving past that.

Now, the conversations are mostly about how we can clear more content and how can we promote artists -- as opposed to the last 12 months when they seemed to focus on how we could yell and scream at each other. That's what's exciting about this change. We're now talking about ways to work together rather than trying to explain why we don't cannibalize their business. There are plenty of illegal services that are cannibalizing their business.

Q: Could Listen's deal undermine popular music file-sharing services such as KaZaA and Morpheus?

A: I believe that a combination of factors will erode usage of the file-sharing services. On the positive side, our getting all the content will give people incentives to switch to an easier-to-use, well-priced service. On the negative side, we've begun to see the file-sharing services put everything from popup ads to spyware onto their services. Users are also at risk of computer viruses.

More important, you're starting to see the beginnings of decoy-style efforts, where people are putting false files into the networks that appear to be popular songs but are not.

What we've found from personal usage and our survey of users is that the P2P [peer-to-peer systems such as Morpheus] networks are starting to get harder to use. It doesn't mean that if you're really dedicated and you want to spend time rooting through people's hard drives, you can't. Piracy is going to be with us for a long time to come. But a mainstream enthusiast consumer who won't spend two hours trying to save $5 or $10 will start switching over to Rhapsody, which has all the music and is easy to use.

It's similar to how AOL throughout the boom period fought off the free ISPs. Everyone wondered why anyone would go to AOL when you could get it free. But they went to AOL because it was a better service, and it was priced correctly.

Q: So if this is Online Music 2.0, what can we expect and when?

A: Well, starting July 1, you'll see us with all the music. And people talk about features and benefits a lot, but when we survey our consumers, they want the music. If you don't have the music, it doesn't matter how many features and benefits you have. Having all the music will take care of the audience that listens to music primarily through the computer.

However, to push this into the mainstream, there's no question that we have to increase portability and ownership aspects. So what I believe you'll see, starting in at the end of the third quarter, [is] much more widespread CD burning at a lower cost. Those kinds of contracts are sitting on our desks right now. And you'll see announcements as early as next week.

By the fourth quarter, you'll see our first wireless offering. You'll be able to subscribe to Rhapsody through the PC, but you'll be able to take your music with you and listen to it on your phone. You'll simply take your playlist off Rhapsody and be able to walk down the street and play it on your phone -- assuming you live where there's an advanced network and you have a sophisticated phone.

In 2003, we'll see the big push into the mainstream.

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