The music business’s digital challenge
Nov 1st 2000

Napster, an Internet rebel, has made peace with Bertelsmann, a big record company. The deal heralds the next stage in the digital revolution of the music industry


IT IS rare that an entire industry is threatened with change as sudden and profound as that currently faced by the music business. This is why Germany’s Bertelsmann has broken ranks with the other music giants and struck a deal with Napster, an Internet-based music-sharing service, which the record labels have been hounding through the courts as a pirate. The deal confirms that the Internet will become a major form of music distribution, and perhaps the main one. But Bertelsmann and Napster have yet to work out how they will make money from this form of distribution or keep would-be Napsters at bay.

Thomas Middelhoff, Bertelsmann’s chief executive, is convinced that the deal is a ground breaking one. “This is a call for the industry to wake up,” he said when he announced the tie-up with Napster in New York on October 31st. It will involve Bertelsmann lending Napster an undisclosed sum of money to help it transform its service. At present, its 38m users swap music files between their computers for free; in future they will be asked to pay a membership fee, part of which will be collected as royalties and paid to record companies. Bertelsmann will also make its music catalogue available on Napster’s website, and it has taken an option to buy a stake in the San Francisco-based firm.

Once the new paid-for Napster service is up and running, Bertelsmann will drop out of a lawsuit being pursued by the Recording Industry Association of America (RIAA), on behalf of the major record labels, against Napster. In July, the RIAA obtained a court injunction effectively ordering Napster to shut down. The company managed to get the order suspended pending its appeal. On October 2nd, the federal appeals court said Napster could continue providing its service while the judges deliberated. A ruling is expected soon.

Napster could still be hobbled by the court. The RIAA maintains that the new deal is consistent with its position that record labels must be properly compensated for the exchange of music files across the Internet. In its defence, Napster has argued that its file-swapping service is a technology that has a legitimate use for personal copying, much like a video-cassette recorder. Although Napster’s deal with Bertelsmann does not end its legal problems, it makes it much more likely that it will be able either to settle or strike deals with the other record companies as well.

The teenage revolutionary

Fanning: now legitimate

Napster was started in 1999 by the then 18-year-old Shawn Fanning. It does not supply music directly, but instead links together Internet users searching for specific titles, allowing them to swap music files between their personal computers. In digital form, music is easy to compress and transmit from one computer to another, even over relatively slow telephone lines. Services offering music directly to computer users, but for a fee, have been set up or are being planned by all five of the big music groups. Besides Bertelsmann, these include Sony, Universal Music, EMI and Time Warner.

Bertelsmann says that other record labels should now reassess their objection to file sharing. But the company has yet to provide details about how the new Napster service will work. A service that legitimises the swapping of music files, perhaps with enhanced features such as faster downloads and information about artists, may prove attractive to some of Napster’s users. But much will depend on the price. Napster has suggested a membership fee of perhaps $4.95 a month, although Bertelsmann says this has not been decided. The music might also contain some sort of technology which makes titles expire after a set period. Music that lasts longer would cost more.

The music industry is experimenting with various ideas to try to protect against the unauthorised copying of music. The big record labels have formed an alliance with some of the consumer electronics giants to produce a system that they claim will be able to protect against piracy. Called the Secure Digital Music Initiative (SDMI), it is supposed to use a combination of encryption systems in new digital-music recorders and players and “watermarks” in digital-music files. The SDMI’s software creates music files that lose their watermark when copied and transmitted by Internet pirates, which is said to make them impossible to play on the new machines

But there is considerable doubt that the system will work, especially with music collected by a PC. It is also far from clear if all manufacturers will use the encryption systems in their machines. Many of the producers of the first generation of digital-music devices already in the shops have not been the big firms, but relatively unknown companies from China and South Korea.

For many of Napster’s users, the main benefits of its file-swapping service are that it provides music conveniently and for free. Some people will be prepared to pay for the convenience and for good quality downloads, provided the price is right. That means the main challenge facing Bertelsmann and Napster is to produce a paid-for service which people would rather use than free sites which could copy Napster. Some of these other file-swapping services will be harder to police. Services such as Gnutella and FreeNet allow the swapping of music files between personal computers but without the use of a central service, like Napster’s. This makes it much more difficult for courts and regulators to act against them. By teaming up with Napster, Bertelsmann has accepted the inevitable: Internet distribution of music is here to stay and likely to grow enormously. But the deal does not mark the end of the music industry’s piracy problem. Music companies now have to show they have more to offer customers than free web-based services.

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