A Faustian Deal For Napster?

The file-swapping upstart could lose its peer-to-peer network in the bargain it struck with Bertelsmann

By snagging a $50 million loan from German media giant Bertelsmann in late October, Napster interim Chief Executive Hank Barry solved a number of pressing problems. He got much-needed cash to keep operations going, as well as some new credibility from a place in the Bertelsmann constellation. The file-swapping upstart also got a possible rescue from a costly legal battle with the record industry, once Napster agrees to protect music copyrights. Throw in access to the world's fourth-largest catalog of music, and Barry came out looking good.

It could turn out to be a Faustian bargain, however. Many in the music industry are wondering how Napster can fulfill its part of the deal without spoiling its key asset--the rollicking peer-to-peer network that has made the service so popular. The demands of Bertelsmann and other labels could force Napster to dramatically change its service architecture to reduce the copyright violations.

Right now, Napster runs servers that channel music seekers to the hard drives of other Napster users, where they can download at will. The songs cataloged--many of them pirated--are never actually stored on Napster's servers. That's the beauty of the peer-to-peer networking model created by Napster founder Shawn Fanning--and the reason for its smashing success.

BEAUTY OF THE SERVICE. But to accommodate the wishes of the record moguls, who want to regain control of their music, Napster will need to adopt a more centralized system. That would require lodging copyrighted content on its own servers for downloading.

Half the fun of Napster is finding obscure session tapes in MP3 format that may or may not be copyrighted, or plumbing the playlists on the PCs of people with tastes similar to your own. "You can click on some title, and a song completely different than the one you expected pops up," says Lee Black, research director at online-music consultancy Webnoize Inc. Replicating the fabric of this community may prove impossible under the scrutiny of the big labels. "I don't think you can take that away without taking away a core part of the system," says Rob Reid, CEO of online music site www.Listen.com.

Efforts by the music labels to encrypt songs and prevent their free trading over the Internet could further limit interaction among Napster users, particularly if a two-tiered system with some paid usage and some free usage emerges. "If it prohibits the consumer from doing what they want to do with their music, there's a good chance it will never be adopted," says Marc Geiger, CEO of online music site and entertainment label www.ARTISTdirect.com.

"SHORT-CIRCUIT." Instead, Geiger and other execs say, Napster should mimic models currently used in the software and cable-TV businesses. Those industries settled for weak security and persistent black-marketing, but they still prosper thanks to the high value that buyers receive. "The fact that the single most ripped-off company since Roman times is Microsoft Corp. is a pretty good indication a company can make a successful business with lots of piracy," says Listen.com's Reid. "Encryption is not the answer."

If the record industry forces Napster to rein in its peer-to-peer system, it's likely other Napster-like services would spring up, perhaps floating offshore beyond the reach of U.S. law enforcement. "If Napster does get litigated out of business, I think the industry has two or three months to replicate Napster or Scour [a similar peer-to-peer file-sharing service] experience, or they're going to find out that someone out there has created a way to short-circuit the industry forever," says Reid.

Top execs from both Napster and Bertelsmann have sworn they'll maintain the service's user experience, although they won't say how. At the same time, Bertelsmann is mulling plans to sell music through its CDNow Inc. subsidiary to Napster users. But how Barry can retain 40 million users by charging for something they're used to getting for free--while herding them into a system dictated by the very labels they're rebelling against--is the crucial question. It's perhaps one even he can't answer. For Barry, cutting a deal with a record company CEO may have been much easier than keeping 40 million Napster devotees.