Net Nightmare For The Music Biz

Despite piracy woes, Web distribution seems unstoppable

Last September, Capitol Records caused a stir when it offered for download a new single by Duran Duran over the Internet for 99 cents. Never before had a major label sold music digitally over the Web. It quickly turned into a nightmare: Record retailers were outraged, credit-card companies carped, and questions about copyrights and antipiracy measures proved as thorny as ever. So this April, when Capitol releases a new album by one of its biggest stars, Bonnie Raitt, sales will come the old-fashioned way--through local record stores. "We're taking a breather," says Liz Heller, executive vice-president of Capitol Records Inc.

But for Raitt's cyber-savvy fans, Capitol's change of strategy won't matter much. As soon as Raitt's CD is released, most of her new songs will be posted on underground, unauthorized Web sites known as MP3 sites (named after an audio-compression scheme). Hundreds of these sites--some illegally offering copyrighted material, others legally presenting uncopyrighted music, with advertising from big companies such as Intel Inc.--offer thousands of songs for free. They can be downloaded in minutes, stored on hard disks, and transferred to recordable CDs. They're the rage on college campuses, where students spend hours making compilations to swap with friends.

MP3 sites have yet to make a noticeable dent in CD sales. But their growing popularity, fueled by the spread of high-bandwidth Internet connections and recordable-CD players as cheap as $200, is causing alarm in the music industry. Electronic distribution of music is coming fast, and it will alter industry fundamentals that have changed little since the days of 78s. Just last week, PolyGram CEO Alain M. Levy announced he is forming a board-level committee to examine the impact of the Net.

POWER SHIFT. What's certain is that artists will gain power, while record companies' huge assets and power bases in manufacturing and distribution, as well as relationships with retailers, will become less important. "The balance of power will change," said Thomas Dolby Robertson, a musician and chief executive of Headspace Inc., a San Mateo (Calif.) venture that develops technology to deliver music over the Internet.

Fearful as they are of the threats, major labels acknowledge the opportunities and are taking tentative steps into the digital realm. Sony Music, Warner Music, and PolyGram have begun to put up sites that take orders online and send customers CDs through the mail. Most also offer audio samples--but only in "streaming" formats that can't be stored. New York-based Jupiter Communications Co. estimates that the online retail business will grow to $1.7 billion by 2002, or 7.5% of the overall music market, up from $50 million in 1997.

But with security still lacking--and fearful of straining their ties to retailers--the six majors (Bertelsmann, EMI-Capitol, Universal, PolyGram, Sony Music, and Warner Music) are sticking to promotional use, stopping well short of commercial downloads. But by doing this, they risk missing the boat, just as film studios did in the early 1980s when they opposed the VCR, only to cede lucrative distribution and retail markets to Blockbuster Entertainment and others. "The major record labels have taken their heads out of the sand but still have their feet in concrete," said Tom McPartland, president and CEO of TCI Music Inc., an affiliate of cable giant Tele-Communications Inc. that delivers music digitally via satellite, cable, or the Internet.

Instead, smaller, more entrepreneurial companies are setting the pace. Liquid Audio Inc. in Redwood, Calif., and AT&T unit A2B are promoting new software systems that compress, encrypt, and track music delivered over the Net. N2K Inc., which runs the popular MusicBlvd retail Web site, cooperated with David Bowie in 1996 to deliver more than 300,000 free downloads of a single. Last July, it went commercial and has since electronically distributed more than 4,000 99 cents singles by artists affiliated with independent labels. "It's still more proof of concept than anything else," says N2K CEO Larry Rosen. "But the idea definitely makes sense."

BIGGER SELECTION. If their concerns about piracy and control can be solved, record companies could win big with digital delivery. In addition to lower costs, they'll be able to target individual fans to promote albums, concerts, or merchandise. And while most of the thousands of CDs in print are not available in most stores, the Internet will enable labels to sell entire catalogs to anyone, anytime, anywhere. There will be new marketing tools, too: Already, some CDs direct consumers to Web sites that unlock additional music on the disk. "We think digital distribution and the Net provide great opportunities, and we love that," said Cary Sherman, senior executive vice-president for the Recording Industry Assn. (RIAA).

Still, policing this market will be difficult. The RIAA has only three full-time staffers searching for illegal MP3 sites. They send out five or six cease-and-desist letters daily. In January, the RIAA settled three separate federal lawsuits against MP3 operators, waiving millions of dollars in damages as long as the defendants stop pirating music. But with more than 30,000 music Web sites, Sherman concedes that "it's extremely difficult to enforce." That's why the industry prefers technological solutions, using better tools to ferret out Web pirates and enlisting the cooperation of Internet service providers and hardware makers in preventing illegal distribution.

Long term, such devices are certain to emerge. Meanwhile, record companies face a difficult transition. They'll remain kings of content but will have to begin embracing the new paradigm even as it undermines current sources of power and profit. And in the online realm, labels have little value as brands: Aside from a few genre-specific labels such as Blue Note, Motown, and Deutsche Grammophon, consumers don't associate artists with their record companies. So label-independent sites such as N2K and CDnow are better positioned to offer a wide selection. To stay ahead, the big record companies will have to move to a new beat.

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