The Labels Start Turning up the Volume

The recording industry beat Napster and continues battling free file-sharers. But in slow steps, it's learning to dance to an online beat

In June, three of the five major music labels -- Universal, Sony, and Warner Music -- announced that they would make thousands of songs available for download over the Internet at the discount price of 99 cents each. Better yet, in a major about-face Warner Music agreed to let buyers of many of the songs, by both new artists and established acts such as the Red Hot Chili Peppers and Alanis Morissette, copy or transfer them to portable MP3 players. Sony and Universal's music was released in copy-protected format.

Industry analysts hailed those moves as a giant step forward -- a sign, at last, that the music establishment is beginning to "get it" when it comes to cashing in on the Internet as a distribution vehicle for music. No question, the labels' decision represented their first realistic effort to create a viable alternative to popular but illegal file-sharing networks such as KaZaA and Morpheus (heirs to Napster, now languishing in a fog of uncertainty about its future), where savvy Net surfers can download millions of individual songs without buying a whole album -- and all for free.

"In the past, fear of cannibalization" would have ruled out the 99-cent solution, says Larry Kenswil, president of Universal Music Group eLabs, the label's new media arm. "If consumers could get the single, why buy the album" the music industry worried. "That's still a concern," Kenswil confirms, "but right now, anyone can get any song for free" -- which makes getting at least some Web revenue look like a reasonable alternative to getting none.

End of story, right? Not exactly. It turns out that major retailers -- the companies that actually sell music to the public -- haven't yet signed up to promote the 99-cent downloads, either in-store or online. The reason, according to sources close to the negotiations between music companies and retailers, is the labels' onerous demands. In exchange for offering up popular songs cheap, the music companies want retailers and resellers to hand over valuable customer data -- or even let the labels handle the online transaction in its entirety.


  That way, customers who think they're purchasing from Best Buy (BBY ) or Amazon (AMZN ) would really be buying direct from Universal or Sony Music. To the retailers, introducing their customers to the music companies would be a recipe for extinction. "It's a question of kill me now or kill me later," says Pam Horowitz, president of the National Association of Recording Merchandisers, the trade group for music stores.

The stalemate demonstrates how far the music establishment still has to go in dealing with the new realities of its marketplace -- and also how far it has come. Music executives still can't restrain themselves from waging what are probably quixotic battles over who gets access to their products, and under what circumstances. As long as that continues, what has suddenly become a moribund music industry could remain stuck in neutral -- to the detriment of the labels, retailers, recording artists, and music lovers.

Yet the industry's latest move is also a sign that music executives, who, even six months ago, regarded the Internet as more a menace than an opportunity, now realize that they can't avoid embracing the digital future. Indeed, independent digital-music services such as's Rhapsody and FullAudio, plus label-backed services such as pressplay and MusicNet, all are predicting that, within 18 months, they'll be able to offer the labels' full song catalogs online -- along with the right for consumers to burn songs onto CDs and move them to portable devices.


  What may be in store, in other words, is the most fundamental change in the way music is sold since Paleolithic disc jockeys of the 1920s first started playing songs on the radio. "Once we move past this period of acrimony, we'll emerge with amazing new ways to promote and market entertainment that we couldn't have dreamed of before," says Ted Cohen, vice-president of new media for EMI.

The epiphany that may lead to all this has come less from a sudden understanding of online music's potential than the dizzying decline in sales of music CDs -- which, according to Nielsen SoundScan, have fallen 12.8% this year through Aug. 3, vs. a year earlier. And that's on top of a 10% decline for 2001. Sales of singles have plummeted 65.4% this year, clearly one motivation behind the labels' 99-cent offer.

The sales slide, it's important to note, isn't wholly attributable to online music piracy. True, the rise of Napster in 1999 taught a generation of young listeners that music could be free for the taking. But the crisis in the music industry results from a confluence of factors -- including the end of the repurchasing cycle in which millions of adults bought CD versions of albums they already had on LP or cassette, plus the tail end, for now, of the bubblegum pop craze, that saw acts such as Britney Spears and the Spice Girls sold more than 10 million albums a piece.


  The industry's crisis is also one of identity -- as described in the 16th century by Niccolo Machiavelli in The Prince. Machiavelli wrote: "Innovation makes enemies of all those who prospered under the old regime. And only lukewarm support is forthcoming from those who would prosper under the new. Their support is indifferent, partly from fear and partly because they are generally incredulous, never really trusting new things unless they have tested them by experience."

In other words, no one wants to go on record as backing a new idea until it's a proven winner. Indeed, with subscribers to paid digital-music services totaling at most 100,000 according to industry insiders -- 400,000 if you include free online radio services and pay satellite radio -- it isn't yet clear when the online music market will mature to the point of producing a return on investment.

The danger of switching business models too quickly is dramatized by what has happened to corporate execs who hitched their star to online businesses. Just the past month has witnessed the departure of AOL Time Warner's chief operating officer, Bob Pittman, who spun grand visions of the convergence of old media and new; the firing of Jean Marie Messier, the architect of Vivendi's multibillion dollar transformation from a water utility to entertainment giant; and the dismissal of Thomas Middelhoff, CEO of German media conglomerate Bertelsmann, who had championed ill-fated online ventures such as Napster to the bitter end.


  All three were punished because the Internet failed to deliver the dazzling riches they expected -- at least according to the timetable they predicted. In that environment, notes one well-placed music executive, no media baron "wants to be the one who tells Wall Street that he's betting the farm on the Internet."

The foot-dragging isn't only at the top. The record labels' distribution arms also are objecting to a wholesale embrace of digital delivery, according to industry insiders. The distributors, which sell CDs to retailers on behalf of the disparate labels in each music conglomerate, take 10% to 15% of CD revenues. If selling tunes online for 99 cents apiece causes the physical product to disappear, so will their piece of the pie. "These are very powerful people with no stake in digital distribution. They need to be part of it," says James Glicker, president of digital-music service FullAudio and former senior vice-president of BMG's Classics.

Even as the various factions inside the music companies vie for control, the industry is struggling to present itself in a more flattering light to millions of alienated consumers. That's a tall order, as illustrated by the widely repeated joke that the terrorist group Al Qaeda has better PR than the music industry. The reason: The face of the industry is its powerful lobbying group, the Recording Industry Association of America (RIAA).


  The RIAA is an odd choice for the job, given that, for the past two years, it has tried to crush the free online music services with one legal assault after another. In March, for instance, industry representatives testified on Capitol Hill in support of the Consumer Broadband & Digital Television Promotion Act, which would limit consumers' ability to mix and copy music by requiring that copyright-protection software be embedded in PCs, handheld computers, and CD players. (See BW Online 4/18/02, "High Tech vs. Hollywood on Capitol Hill"). In July, 2002, a bill was introduced by Rep. Howard Berman (D-Calif.) which, in essence, that would permit music and film companies to hack into the computers of customers they suspect of illegally trading copyrighted work. (See BW Online, 7/31/02, "Taking the Piracy Fight Too Far"). And on Aug. 9, 19 members of Congress sent a letter to Attorney General John Ashcroft imploring him to prosecute users of peer-to-peer file-sharing systems.

The RIAA has an won an impressive string of victories in the courts, but at a high price: Many music fans, especially in the critical 18-and-under age group, interpret the industry's aggressiveness as a call to arms -- and swear to react in kind. For four days beginning on July 26, for example, the RIAA Web site was rendered inaccessible by a denial-of-service attack, in which hundreds of computers overwhelm a server with requests. "This is only the beginning," says one hacker, who denies taking part in the actual attack. "We're going to bring them down."

Such talk drives execs such as Steve Vining, president of the Savoy Jazz and Denon Classics label, to see measures such as the Berman Bill as essential to fight music piracy. But even he concedes that the industry is suffering from a public-relations disaster. "We've done a miserable job of making the case that this is stealing," he says. "What we should have is an ombudsman...a warm, kindly grandfatherly type who can talk in calm tones about how, if this continues, music as we know it will disappear."


  To that end, the industry is beginning to enlist a a new generation of tech-savvy executives to make its case, rather than relying on RIAA President Hilary Rosen, whose image is that of a musical Conan the Barbarian. One of most oft-seen on the talk circuit is EMI's Ted Cohen, a certified technophile, who before joining the labels worked as a consultant at a host of music and technology companies including Napster. Cohen makes a compelling case why consumers should feel sorry for the music industry, not resent it. One of his favorite anecdotes is the story of a seller on eBay who offered up a digital jukebox stocked with top-10 hits from the last 25 years, all presumably downloaded from the Internet. The price: $400.

Giving the industry a new public face couldn't come at a more crucial time. The music industry's new online strategy needs credibility if it's to attract consumers to the labels' new and improved digital services. On July 1, one year to the day that Napster was shut down,'s Rhapsody service announced that it had secured a long-sought licensing deal with Universal Music.

The agreement anointed Rhapsody as the first independent online service to offer songs from the five major music labels: Universal, Warner Bros., Sony, BMG, and EMI. With 175,000 tunes now available, the deal eliminated one of the key issues plaguing sanctioned online services: having enough music to compete with free music-sharing networks (See BW Online, 7/1/02, "Rhapsody's Five Part Harmony"). Listen also signed two deals to distribute music via DirecTV DSL and Time Warner's RoadRunner broadband service.


  A month later, the label-backed service pressplay launched a new version. "We think [version] 2.0 signifies the first time a service is making available everything that the consumer has asked for," says Mike Bebel, CEO of pressplay. Essentially, he's right. Though pressplay lacks music from Warner and BMG, it allows subscribers to stream or download music to their heart's content for $9.95. For $17.95, they can also burn up to 10 songs per month onto CDs or transfer them to portable players. Moreover, the new service has dropped onerous restrictions. If you want to burn more than 10 songs, you can purchase download packs of five, 10, or 20. Extra songs cost just 99 cents a piece.

Even as the Establishment services improve, the file-sharing networks are becoming increasingly difficult to use. The RIAA's lawsuits have forced the most intuitive services -- Napster and AudioGalaxy -- out of business. The surviving networks, KaZaA and Morpheus, are both slower to use and riddled with low-quality files, spoofs (allegedly placed there by the record companies themselves), and computer viruses. The sites still get plenty of traffic -- the KaZaA homepage boasts that its software was downloaded almost three million times the week of Aug. 5 alone. Tech-whiz teenagers or a determined fan in search of a lost track won't be put off. But music buffs with more money than time are becoming increasingly disenchanted. "We're reaching the tipping point," says CEO Sean Ryan.

That said, the online music biz has yet to create true harmony from the music Establishment's chorus of voices. "We're building the foundation for a long-term sustainable business," declares Alan McGlade, CEO of the music industry's second official site, MusicNet. Still, he adds: "It's an evolutionary process that will go on for years."


  He's right on both counts. Acquiring the right to stream and burn music from still-stubborn labels and technophobic superstars such as Madonna remains a challenge for the music industry's nascent digital services. Bricks-and-mortar retailers and the labels have yet to negotiate a deal that determines which one will own the customer. And experiments aimed at finding ways to promote digital music from within retail stores are just beginning. "Ultimately, it's going to be a mix of physical and digital delivery" that makes the music business thrive again, says Aram Sinnreich, an independent music analyst. "That blending necessitates better cooperation between suppliers and distributors than we've seen in the past. It's a long and winding road."

There are still a lot of curves to be negotiated. The good news is that executives at the labels, retailers, and technology companies are now focused on the path ahead. Relationships are less antagonistic. Instead of fighting each other, players are realizing that what's good for the goose is also good for the gander. And they're all praying that digital music will be the golden egg they're searching for.

By Jane Black in New York

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