Music Downloading's New Deal

Free file-sharing services are considering ad-supported business modelsbut first, they need to win over music label foes

The threat of recording industry lawsuits has certainly given pause to peer-to-peer music file-sharing services. Few have dared show their servers on U.S. soil since the Supreme Court in 2005 ruled Grokster and Morpheus could be sued, declaring open season on companies that enable users to swap copyrighted files. On Oct. 30, even News Corp.'s (NWS) MySpace—a social-networking site known for allowing all manner of freedoms—cracked down on the use of copyrighted music, licensing technology from Gracenote that allows the site to review and block songs uploaded to the site.

But the practice of what the recording industry considers illegal music downloading is alive and thriving, thanks to lax copyright protections abroad and the experience of a generation that grew up swapping songs over superfast Internet connections. And lately it's finding a new lifeline: a business model."

This year, 300 million to 500 million files were pirated each day, according to Artistdirect, a New York company that tracks illegal downloads through its MediaDefender service, and in some cases, attempts to block them. "The user base has been chased around the Internet because the companies keep getting shut down…but this is a really stubborn, persistent phenomenon," says Eric Garland, CEO of BigChampagne, an online media measurement firm.

International Lawbreakers

Many of the new sites have cropped up in countries such as Russia and in parts of Asia, where digital copyright laws are not as clear or strictly enforced as in the U.S. The recording industry is trying to fight the overseas sites by adopting the same legal tactics that worked in the U.S. The Federation of the Phonographic Industry, a lobby group representing Eaton Vance Michigan Municipal Income Trust (EMI) and Warner Music Group (WMG), has threatened to sue the operators of Russian site, for allegedly violating copyright laws.

The site owners, however, are undeterred by the specter of litigation. Even an October announcement by U.S. officials that Allofmp3's actions could cost Russia entry into the World Trade Organization hasn't shut down the service, which charges 15 cents to 30 cents per song, compared with 99 cents a song from Apple Computer's (AAPL) iTunes Music Store.

So why can't the recording industry stop the illegal music downloading? Part of the problem has to do with culture. For a generation of music downloaders, file swapping isn't the same as stealing a CD from a store. It is seen as a legitimate social-networking phenomenon and, in some cases, a way to get even with an industry viewed as having gotten fat off of consumers.

Going Legit

However, some so-called pirate sites are voluntarily moving to the side of the Recording Industry Association of America and others in the industry. They are doing this not because of the threat of lawsuits, but because of the promise of money—namely, a share in the billions of advertising dollars moving online. To do that, they need to strike licensing agreements. Erstwhile pirate sites such as Qtrax, owned by Brilliant Technologies, are working with the recording industry to become advertiser-supported networks. The goal is to make money off of the millions who have become accustomed to free music by making users pay for songs with their time (see, 10/9/06, "Free Downloads—After This Message").

Qtrax isn't alone in pursuing ways to let users get free songs in exchange for sitting through advertising and music news. MediaServices, the parent company of Allofmp3, is exploring such a model, according to spokesman Ilya Levitov. "We're still at the phase of alpha testing," says Levitov. "When the product is ready there'll be special software which a person will download, and naturally there will be advertising on the player which will be played on the computer." eDonkey, one of the biggest so-called pirate sites, is also looking into an ad-supported model (see, 10/24/05, "A Hard Ride for eDonkey").

But going legit isn't easy for sites that once fostered illegal downloading. The music industry doesn't exactly want to embrace former foes, especially when there are sites such as SpiralFrog, which also plans an ad-supported business model—but doesn't have a history of sparring with the recording industry (see, 9/5/06 "Meet the iTunes Wannabes"). Pirate sites that have experimented with other models after being sued by the RIAA have largely failed to be profitable. Napster (NAPS), which became a subscription service, is still losing money (see, 8/3/06, "Napster on the Block?").

Industry Advantages

Brilliant Technologies CEO Allan Klepfisz says he voluntarily shut down the original Qtrax after four months, without any threat of suit, because he didn't want to sour a relationship with the industry he would eventually need as a partner. "We wanted to close it down and build a more legitimate model," he says. Qtrax is set to relaunch as an ad-supported model in January and now has licensing deals with most major labels, says Klepfisz.

Licensing is only half the battle. The next step is to convince users accustomed to free peer-to-peer networks to bother to come to sites that work in the same manner but want to deliver advertising or pitches to buy the song for 99 cents. SpiralFrog CEO Robin Kent believes users will gladly pay with their time and sift through some advertising for a guarantee that the file they are downloading is the real McCoy. "They don't mind advertising. They have grown up with advertising all their lives," says Kent.

Besides, users on peer-to-peer networks are already wasting a lot of time weeding out corrupt files on their favorite sites. Firms such as Artistdirect are hired by labels and movie studios to post dummy files and advertising on peer-to-peer networks in the guise of illegal downloads. When a user searches for an Artistdirect client's material, they are swamped with fake files that, after waiting to download, either don't do anything or deliver an advertiser-supported message with the artists or song involved. For example, in June, Artistdirect released a Jay-Z video supported by Coca-Cola (KO). The company is currently using decoying and redirecting measures with 20,000 popular music and movie titles.

Future Advertising

Qtrax's Klepfisz is not only confident users will come to free sites—he believes ad-supported models will become the dominant method of delivering music. After all, most online content, including news and video, is available for free, thanks to advertiser support. Much TV programming has been advertiser-supported for its entire existence. "It seems to us that it might be difficult for the music industry to carve itself out as the one area that isn't advertiser-supported," says Klepfisz. "We see ourselves as a very essential bridge between paying for music and a future when music is advertiser-supported."

Klepfisz's future may not be that implausible considering that pay-per-download sites have largely failed to be profitable (see, 11/21/05, "Online Music's Elusive Bottom Line"). Even Apple only sells about 15 songs a year per iPod, on average. Meanwhile, American consumers are listening to more music than ever before, according to Jupiter Research's Mark Mulligan. "They have access to more music than any generation before, but they are spending less," says Mulligan.

The peer-to-peer sites are clearly part of the reason. If the record companies can't beat them out of existence, it makes sense to try joining them and collect whatever compensation they can get from advertisers. BigChampagne's Garland says the peer-to-peer model may even become profitable through a subscription service, providing the legitimate versions have the same enormity of selection available on the LimeWires of the world. "I think it is very clear that the draw for tens of millions of people is the social-networking aspect of this and, beyond that, the exhaustive, unlimited title availability. If you can dream of it, it is somewhere out there in somebody's collection."

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