Faces the Music

It has a new survival strategy. Is it enough?

It was early 1998 when Inc. (MPPP ) founder and CEO Michael L. Robertson first realized just how much the music industry had it in for him. At a conference in Los Angeles sponsored by the National Academy of Recording Arts & Sciences, Robertson stood up from the audience and announced that he had placed software in everyone's giveaway bags. The software could turn songs into MP3 files that could be sent over the Internet. He hadn't thought much about how this might be a mortal threat to the recording industry. But the crowd of grey-haired music executives clued him in. They started booing and screaming obscenities. Then "they yelled, `Sit down!"' Robertson recalls.

He sat, but he didn't back off. Ever since Robertson founded San Diego-based in 1998, he has relentlessly pursued his vision of turning the Web into a place where people can hear their favorite music anytime, anywhere. While the site is famous for featuring the work of unknowns, his most important offering now is, which allows users to store music in virtual lockers on his site, dream up their own playlists, and tap in instantly from any Web-connected device. Supported mostly by advertising revenues, in February served up 59 million tunes to nearly 1 million consumers. Its revenues for fiscal 2000 were $80.1 million, a 266% increase over 1999--though it reported a loss of $23 million.

Napster Inc. gets most of the press, but when it comes to creating a business from distributing music on the Net, at least has a shot at it. That's because Napster does little more than let individuals swap songs stored on their computers. It has no revenues--and no immediate prospects of getting any. By contrast, controls the name-brand music on its site--storing the files on its own computers and only allowing access to songs the consumer already owns. As a result, it can more easily charge for services.

CD BURN. That's the theory, anyway. Through a combination of Robertson's missteps and the music industry's resistance to change, the future of is very much in doubt. sparked a string of copyright suits that shut the service down for seven months last year. Robertson eventually settled with the five major record labels, requiring to pay them fees each time one of their songs is played. But new legal barbs just keep jabbing him. He still faces suits from a handful of smaller labels. In one case, brought by Tee Vee Toons, which represents such bands as Nine Inch Nails, a judge already ruled against, and the trial to determine damages began on Mar. 26. The past doesn't bode well for Last September, the same judge ordered it to pay a staggering $25,000 per CD to Universal Music. The ruling would have pushed into bankruptcy were it not for a settlement.

To make matters worse, it's becoming clear that the record labels intend to take over the digital distribution of music. In February, Sony (SNE ) and Universal announced a joint site, Duet, that will offer music from both labels. The scenario is eerily reminiscent of what has occurred in so many other industries, from toys to clothing: Old-line companies stumble slowly onto the Net, but they eventually put pure dot-coms out of business. That fear, plus the threat of huge legal bills, has given's stock price a bad case of the boogie-woogie flu. At just $2.40, it's down 90% in the past year.

Robertson's response: He's scrambling to come up with new revenue streams. In the past few weeks, he has added subscription "channels," offering users unlimited access to children's songs or classical pieces for fees ranging from $4.99 a month to $29.99 a year. On My., users can store up to 25 CDs for free, or up to 500 CDs for $49.95 a year. Robertson hopes to make his biggest splash by offering record labels marketing services such as e-mail campaigns to promote new album releases and concert tours.

The new strategies don't seem likely to pay off anytime soon. Credit Suisse First Boston estimates that the new subscription services will add only $1.6 million to $8 million in revenues this year. At the same time, music industry insiders say Robertson will have a hard time getting the industry to play along. "He offended the great bulk of the industry by copying their music, and now he's saying, `Gee I'd like to be in business with you,"' says attorney Lawrence Y. Iser, a specialist in copyright law at Los Angeles-based Greenberg Glusker Fields Claman Machtinger & Kinsella LLP. "It's going to be difficult."

GARAGE HEROES. Cash is crucial while the company's fortunes play out. has $98 million in the bank to spend on operations--and another $170 million set aside in a fund to cover legal expenses. The company burns about $10 million a quarter on operations, so its cash could last more than two years at the current rate. Even though its ad sales have held up so far, the economic slowdown could menace future revenues. And a major loss in court could put's finances in peril practically overnight. Even without that, analysts expect it to lose about $11 million this year.

Robertson has overcome perils and confusion before. The company got its start in 1996 when Robertson, then a computer consultant, launched Z Co., which ran a collection of search engines. Working out of his living room with two partners, he noticed an increasing number of searches for the term " MP3." Intrigued, they downloaded a few MP3 files and played them.

They knew they had hit upon an opportunity, they just weren't sure what it was. At first, Robertson dodged the recording industry altogether. His site simply listed other sites related to MP3 technology. Then Robertson started getting e-mails from amateur musicians asking if they could post their songs on Robertson complied, and the garage bands poured in. They now number more than 140,000. The garage-band service attracted consumers. And that allowed to attract some major advertisers, including a unit of Groupe Arnault, a French conglomerate, that committed to spending $120 million on advertising through 2004.

Robertson wanted more--hence My. Flush with $361 million from the company's July, 1999, initial public offering, he bought 80,000 music cds and installed them at headquarters in La Jolla, Calif. Unschooled in copyright law, he figured that if he forced consumers to prove that they already owned the CDs, he would be able to serve the music up to them over the Net without running afoul of the music publishers. Wrong. All hell broke loose when the service launched. The labels screamed "copyright infringement" and it took nine months to settle with them.

Since then, Robertson has made only a little progress in turning the recording giants into allies. For Warner Music Group, which signed on for his marketing service in February, the 900,000 regular users of the Web site and's information about their interests are a strong lure. "That's powerful information that we can use for research purposes as well as targeted promotional purposes," says Paul Vidich, an executive vice-president for Warner Music Group. Warner has done over one dozen "e-mail blasts" promoting new CDs, with a response rate averaging around 3%, which is considered excellent. Still, Warner is the only major label that's playing along.

As if he didn't have enough to worry about, Robertson encountered a new enemy on Mar. 20: the electric company. When mandatory blackouts rolled through energy-depleted Southern California, the lights went out at for more than an hour, though the Web site wasn't affected. Robertson made the best of it, taking a quick drive home to visit his family. Then the man who sees a light at the end of every tunnel, even when the electricity is off, hopped into his car and went back to the daunting task of trying to turn the new, legal into a profitable business.

By Arlene Weintraub in Los Angeles

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