Napster: New Tune, Same Chorus?

The digital-music outfit is hoping to engender buzz and pump up sales with its new offerings. But the skeptics are legion

If Napster (NAPS) ever figures out a way to turn a profit, Chris Gorog, CEO of the digital-music site, is going to have one heckuva big last laugh. Ever since he began his quest to create a digital-music powerhouse around the brand made famous in the late 1990s for online piracy, the skepticism has been unceasing. "No one I know believes they're going to survive," says one digital-music executive.

Gorog's latest move doesn't seem destined to quiet the naysayers. On May 1, the Los Angeles-based company announced a new Web-based version of its software, along with a new service that lets users listen to any song among its catalog of 2 million songs absolutely free -- so long as they don't want to listen to any one song more than five times.

While Napster's share price had risen 30% since Jan. 1, based on expectations for a Web-based service, the actual unveiling did little to keep the momentum going. The stock closed at $4.61 on May 1, virtually unchanged from its previous close.


  The idea is designed to tackle the twin problems that have caused Napster to lose $175 million on $237 million in sales over the past four years: lackluster sales growth paired with eye-popping costs. By launching this free service, Gorog hopes to get millions of consumers to come to Napster's Web site -- without having to invest nearly as much in advertising, the company's biggest discretionary cost.

Sales will get a boost, in theory, as some percentage of these consumers upgrade to Napster's for-pay services. Its basic subscription lets consumers listen to whichever songs they want on their PCs, with no limit on the number of listens and with greater sound quality than the Web-based offering, for $10 a month. It costs $15 if the songs are to be transferred to a portable music player.

The Web strategy also introduces an ad-supported plank to Gorog's strategy, since users of the free service are shown a variety of online ads. While some of the initial advertisers have past links to the company -- Samsung, for example, sells a digital-music player -- heavy-hitters including Walt Disney (DIS) and the U.S. Navy are also present.


  Piper Jaffrey analyst Gene Munster doubts Gorog's claim that ad revenue could exceed Napster's expected fiscal 2006 revenue of $112 million within a few years. He reckons advertising will add closer to $50 million to the top line in that time frame.

Any success the strategy has will hinge on whether Napster can recapture anything approaching the buzz and loyalty its namesake site had in the late 1990s. Back then, 50 million Netizens routinely swapped songs digitally for no money down, until the recording industry won legal victories that shut it down. From the time Gorog purchased the Napster brand name along with other remaining assets for $5 million in 2002, he hoped to combine the famous name with new technology that would make it simple to legally find and then pay for the music.

To that end, Napster on May 1 also unveiled technology to let anyone add a link to a song, so it can be incorporated into an e-mail, blog, or home video (and played for as many as five times). These NapsterLinks, as the company calls them, "will unleash digital music across the Web in a very powerful way," says Gorog.


  It's the kind of big claim that Gorog has become known for. Despite Apple's (AAPL) gargantuan success in digital music -- and Napster's relative insignificance -- Gorog continues to fire away at what he considers Apple's vulnerabilities. He notes that the average iPod owner buys only about 20 songs via Apple's iTunes online store. That's damning proof, Gorog says, that Apple isn't helping the music business go digital -- but rather using iTunes less to sell digital downloads and more as a means to crank up its own hardware profits as consumers rip their own CD collections or listen to MP3s from file-sharing sites.

With Napster's new free service, "we'll be able to help millions of people get out of the world of 30-second clips and of having to buy individual songs," Gorog says. "I don't think there's anything better we could do to turn people onto the pleasures of unlimited, legal access to music."

But the reality facing Napster is hardly so cheery. Even if some users of the free service decide to pay for Napster's basic offering, many current paying customers may decide to go for free instead. At the least, little evidence exists that a free offering will send sales through the roof. Since Real Networks (RNWK) unveiled the Web-based version of its own Rhapsody music service last December, the number of subscribers has grown from 1.4 million to 1.575 million -- just a slight uptick from previous growth patterns.


  And none of the new offerings solve the biggest problem: Napster's services don't work with Apple's iPod, which holds more than 70% share of the portable-music player market. As such, even free won't be a powerful lure to members of iPod nation. "My concern for Napster isn't that no one knows about them," says David Pakman, chief executive of rival service eMusic, which is compatible with the iPod because it sells music sold by independent labels that don't demand anti-piracy protections. "They claim to have the biggest brand in music -- with greater unaided recall than [Apple's] iTunes. But people are voting not to use the service. There's an issue with the product -- incompatibility with the device that everyone wants to use."

In all, Gorog's latest announcements probably don't presage a coming of age for Napster, but the start of just another scary chapter as the company fights for survival. Napster is expected to show a smaller quarterly loss when it announces fiscal fourth-quarter results on May 17, versus the year before. Still, the ambitious Gorog faces an uphill climb to profitability. "I think he's just swinging away right now" by trying many different tactics, Munster says. "But that's what he has to do."

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