Online Music: Can't Get No...

The recording industry tries, and it tries, but will post-Napster models work?

An auspicious debut it wasn't. Here was RealNetworks Inc. (RNWK ) CEO Rob Glaser standing before more than 350 music executives in late July at the Sheraton in midtown Manhattan. The idea was to offer a glimpse of closely guarded MusicNet, one of the two big-league online music ventures pushing to launch this September. Glaser, whose company will provide the streaming technology, was all set to tee-up Britney Spears's hit " one more time" for the high-powered audience. But he couldn't log on to his laptop. It took an assistant to help him finally reboot. By the time Britney was through a few verses, it was clear the crowd was thoroughly underwhelmed.

The half-baked demo may be a sign of the sour notes to come when the music industry makes its first serious foray online. Now that the Napster pirating service that revolutionized the distribution of music has been shut down, the major record labels are testing the uncertain notion that folks will now pay for what they once got for free. But even before the first song gets downloaded, the two services face more obstacles than rapper Eminem at a women's rights conference. Antitrust agencies in Washington and Europe are investigating the services, Congress is considering legislation to ensure fair competition, and music publishers could sue to shut down the sites over money they say they will be owed for each song sold online. "It's just a real mess right now," says Derek Baine, editor of newsletter Music Investor, published by consultancy Kagan World Media. "I don't see how this can work."

Driving much of the concern is the fact that the two services control 85% of music sold today. MusicNet is backed by Warner Music Group (a division of AOL Time Warner), EMI Group, and BMG Entertainment (a unit of German media giant Bertelsmann). Rival pressplay is a venture of partners Universal Music Group (part of Vivendi Universal) and Sony Music Entertainment. Those combinations have regulators and Congress worried that competitors will be blocked from entering an online market that by 2010 will account for 16% of the $21 billion in U.S. music sales, projects Kagan World Media.

"FATAL FLAW." Just as problematic for the services is the fact that still-heated rivalries within the music world have so far stopped the two groups from cross-licensing music to each other. That means that for the $10 to $15 a month the services are expected to charge, a consumer might get songs from Shaggy and Blink-182 but not from the Dave Matthews Band and `N Sync. That would make each service akin to a radio that gets only half the stations. The services, at least initially, will not allow music to be burned to CDs or loaded into portable players. The tunes downloaded or streamed will expire after a certain time period. "It's absolutely a fatal flaw," says Ken C. Pohlmann, a University of Miami professor specializing in digital music.

What could complicate doing any cross-licensing deals in the future is that the two services have different business models. MusicNet will act more like a traditional record business, selling music wholesale and letting its online distributors, such as AOL, set the price to consumers. That's similar to the relationship today between music companies and a retailer such as Tower Records. By contrast, pressplay will have arrangements with its distributors more like those between airlines and travel agents. Pressplay will set its price, and its online distributors, such as MSN and, will take a commission on sales. Edgar Bronfman Jr., executive vice-chairman of pressplay partner Vivendi Universal (V ), says he wants to control pricing for fear that AOL (AOL ) will sell music at deep discounts as a loss leader for its other online businesses. "If you allow music to be used to promote other business models, it devalues music," he says.

As they prepare to test those models though, the online services face a head-banging from music composers and publishers who claim the new ventures will owe them royalties. That demand is especially ironic given the labels' recent hounding of Napster over the very same issues. This time around, the services launched by the labels are being pressured to pay as much as 7.5 cents per song sold online, the same "mechanical royalty" they pay each time a song is reproduced on a CD or cassette. Last year, the National Music Publishers Assn. sued, a Universal Music site, for failing to pay for songs. That suit is still pending. "All we are asking for is the same arrangement for the Internet that exists everywhere else in the industry," says Chris Amenita, senior vice-president of the American Society of Composers, Authors & Publishers, which collects a royalty each time a song is played on the radio or elsewhere.

MUCH ADO? Without some deal with the music publishers, the labels likely won't be able to launch the services, says Cary Sherman, general counsel of the trade group Recording Industry Assn. of America (RIAA). One way out might be for the two sides to agree to have the U.S. Copyright Office set royalty rates. But no rulemaking is likely to stop the ongoing pressure from Congress, the Justice Dept., and the European Union. Regulators say there's little evidence that the major labels are playing fair. So far, only one small independent online music company, FullAudio, has struck a licensing deal with big labels--BMG and EMI. Because the industry hasn't shown more openness to small players, Representative Chris Cannon (R-Utah) introduced legislation Aug. 3 designed to stop major labels from striking "sweetheart deals with each other." The record industry is calling for some perspective as lawmakers consider new copyright rules this fall. "With all that's going on in Congress, you would think we were talking about world hunger," says the RIAA's Sherman. "We're talking about the music industry."

For now, record execs would be happy just to get their services off the ground and start finding customers--a big challenge in itself. At its height, Napster perhaps had 70 million users, none of whom paid a cent to download nearly unlimited amounts of music and then swap files with pals. Several Napster clones still draw music fans. Pressplay and MusicNet figure consumers will pay something for a quicker service that offers secure downloads of complete songs, ensuring against the song fragments that plagued Napster. How many will sign up? Neither company offers projections. But with so many hurdles yet to cross, it may be a while before customers even know they exist.

By Ronald Grover in Los Angeles and Tom Lowry in New York, with Arlene Weintraub in Los Angeles

— With assistance by Arlene Weintraub

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