A Little Net Music?

AOL and EMI hook up, and the Web looks like music's next leap forward

Since America Online Inc. and Time Warner Inc. announced plans to merge, both AOL Chief Executive Stephen M. Case and Time Warner Chairman Gerald M. Levin can't seem to say enough about the important role that digital music will play in the new behemoth's efforts to dominate New Media. "We have the opportunity to create a personal jukebox in the house and the car," Case told BUSINESS WEEK recently. "Ten to 20 years from now, we'll think it was a silly notion that music was so tethered to a physical disk." Levin adds simply: "This is the takeoff point for the music business."

Apparently, there's more than merger-induced hyperbole at work. Just two weeks after announcing the record-setting deal to merge with AOL, Time Warner announced a $20 billion deal to take control of EMI Group, melding it with its Warner Music Group. EMI is the record label that first put Caruso on a platter, signed the Beatles, and is now home to such acts as the Spice Girls and Garth Brooks. Warner's list includes Madonna, Jewel, and R.E.M. The combination will give AOL Time Warner as much as 30% of the world record industry, compared with the 27% held by current No. 1, Universal Music Group, a unit of Seagram Co.

More important, it will give them the clout to impose order over the still-fragmented digital-music arena. Right now, all the music giants are scrambling around with alliances and tests for selling tunes online, anxious to figure out any way to expand sales and margins in a business growing at an uninspiring 3% or 4% a year.

READY TO GO. The timing looks good. Unlike movies and television shows, which can't really become widely distributed on the Web until high-speed broadband connections abound, it's relatively easy to download music to a computer. Better yet, almost the entire music business is aimed at the same folks who are leading the Web bandwagon: twenty-somethings and teenagers. If the AOL-Time Warner-EMI cabal plays its cards right, it could help return the industry to the go-go days of double-digit growth in the 1980s, when consumers traded in their vinyl for CDs. "Just like the record industry got a shot in the arm when CDs came along, they'll get another shot in the arm with online music," predicts AOL President Robert Pittman.

But there are plenty of kinks to be worked out--not the least of them how to get paid for music distributed across the Web, how the business model will work, and whether the other music giants will play ball with AOL. And getting to the digital domain from the world of physical distribution could be an exceedingly bumpy ride. Sales of downloaded music over the Net are expected to grow to more than $1 billion by 2004. But that's only a fraction of the $40 billion that the recorded-music industry racks up today. Translation: In their pursuit of the new online market, labels won't be too aggressive. Says Mike Farrace, vice-president of marketing at Tower Records: "So much of the majors' business is through traditional channels. They have no desire to ruin that."

On the other hand, the big music groups--Warner, EMI, Universal, Sony, and Bertelsmann--can't cede cyberspace to pirate sites that distribute illegal copies of their "content" and pay no royalties. If the industry can lead the way in online sales, it can hope to expand its markets, not just risk cannibalizing sales through music stores. Despite some investments in delivery technology, most labels have restricted the download business to promos and singles for sale via the Web.

That could change now that the biggest Net company is also going to be the biggest music company. With 22 million subscribers, there's plenty that AOL can bring to the download party. And Time Warner's 12 million-subscriber cable system is expected to provide a faster platform for downloading tunes. (A typical album could take several hours to download today using a 56-kilobit modem.) With that mass of potential customers, the new AOL Time Warner technology should clearly play a dominant role in the transition from CDs to downloading. AOL already owns leading online radio service Spinner.com and Winamp, a leading player for downloading MP3 files. "We're not looking to dictate, but to have some semblance of order in the market," says Roger Ames, Warner Music's chairman and CEO.

Certainly, there's plenty going on in the market that needs sorting out. GetMusic.com, a partnership between Bertelsmann and Seagram to promote and sell music online, has been slow in getting off the ground and may by doomed by "conflicting agendas," according to one executive close to Bertelsmann. Another partnership among Bertelsmann, Seagram, and AT&T to download music--code-named Nigel--bogged down after six months amid fights over technical snafus. Officials at both record labels claim they developed new download technologies from the project. But both companies have gone on to other partners. In one novel experiment on how the Web can be used to change the music biz, Universal is launching farmclub.com. The Web site will invite unknown acts to post their stuff with the hope of being selected to perform on a Friday night TV show on USA Network that could lead to a record deal.

By this summer, both Universal and Warner plan to begin selling music online--although both continue to wrestle with issues such as pricing. "If you charge too much, people aren't going to buy. And if you charge too little, it's hard to get prices up later when you need to," says Larry Kenswil, president of Universal eLabs.

A Little Net Music?

Sony, with feet in the hardware and content areas, could also be a leader. It's planning to release portable Walkman-like devices called Memory Sticks that can store up to two hours of downloaded music. And to cover its bases, Sony, which is working closely with Microsoft on download technology, has investments in 17 Internet companies, including Launch Media Inc., over which the company last fall allowed consumers to download two tracks from Fiona Apple's latest album. Each of these moves is small potatoes compared to the wrenching changes the music giants will have to go through. "It is a leap of faith that music downloads are going to be a big business," says Al Smith, Sony's senior vice-president of music entertainment, "but it's one that we are all having to make." Time to jump.

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