Eurolabels Have To Wake Up And Smell The Gnutella

The debate in the US over Napster, which allows people to trade music files from one another’s computers via the Internet, is affecting more than just disgruntled college students and sullen heavy metal bands. European record labels, conscious of the overwhelming tide of digital free-trading that’s sprouted in the past year, are looking at making fundamental changes in the way they deliver products via the Internet.

What’s at the Heart
Napster, and sites like it, allow users to take a CD recording they own, copy it to their hard disk in a format called MP3, which affords low file size while maintaining the CD recording standard sampling rate of 44.1 Khz. The Napster site then allows others to download the file from the user’s computer, at no cost to either party.

The record labels are panicked because this setup kicks the traditional business model of the industry in the teeth. The record industry’s model is intricate and has taken the labels years to perfect. Artists write (or sometimes just perform) the music, and sign contracts with the label to produce “albums”.

The artists or the record label then hires a producer, who works with the artists in the recording studio to perform and record each song. The producer shapes the work to fit a vision that is, in the best cases, a perfect fusion of the artist’s vision and the record label’s commercial interests. The record label takes the completed master recordings, which they own; copies them to media (CD, tape, or vinyl); and packages, markets, and distributes through its network of retailers and direct sales outlets. Of the wholesale price, the record label grabs the lion’s share and brush a few crumbs toward the artist and producer. Retailers then bring home fat profits from slapping on a multiple of the wholesale price.

So, with the advent of music available online, the traditional model is at risk of evaporating for not only the record labels and retailers but the artists as well. “When you sign an agreement as an artist,” said entertainment attorney and artist representative Harry J Getzov, who represents, among other people, The Jerky Boys, “you give away, if you’re lucky, 85% of your work – and actually, after packaging and other deductions that have been built in over the years, it’s often less than that.”

Enormous Potential
Online music is not a small market. A recent report by e-commerce research group Jupiter Communications found that online commerce revenues for Western Europe would rise eight-fold by 2005, from a current €8 billion to €64 billion; the number of European online buyers would increase from the current 20 million to 85 million. In 1999, music comprised 44% of European online purchases. But as music downloading proliferates, the current leading distributors could find themselves at the wrong end of hot new competition.

“It’s been clear for the past five years that music distribution would change tremendously,” said Michael Blok, senior analyst with Rabo Securities, “At this point, consumers are saying, €Why would I pay $25 for a bundled product of two or three songs I like, and two or three that I don’t? Out of that $25, about $14 goes to the record store, packaging, shipping, etc, etc.”

The Opportunity For Online Music Retailers
“When someone hears a song on the radio,” said Blok, “and they want that song, they go to Napster and download it free. But Napster, while unreliable, slow and of mixed quality, is such an excellent concept. The labels just have to offer something better: reliability, high quality, and value added. Then if someone forced me to pay 50 cents for the same service, I would easily do it cause I get better quality and extra services I would love.”

Jupiter analyst Stacey Herron agrees. “Napster’s popularity with music fans demonstrates the constant demand for online music,” wrote Herron in her report, “but represents only one aspect of the future of online music. Labels and artists should take a cue from Napster’s success and work towards releasing more comprehensive catalogs of music online. They should also move away from the goal of charging fees to download individual songs and towards more flexible distribution and payment models.”

Those extra services are exactly what the record labels must do to survive instead of filing lawsuits in an effort to stave off the inevitable. Consumers polled by Jupiter said that the most important aspects to them were quality and virus protection. Offering that, in addition to exclusive content, artist interviews and chats, and other services, is the only way to get the music lovers to pay for what is currently free and probably illegal.

Bertelsmann Leads The Way
Record labels are gradually coming around to embrace the Jeannie that’s already well out of the bottle. As usual, Bertelsmann is moving fast in this space to make music download align with its stated strategy. “Our core strategic focus is on further development of our positions in our different content markets,” said Bertelsmann spokesman Markus Payer, “so on the technological side, we’re working to digitize all our content.”

Bertelsmann owns BMG, the world’s fourth largest music label, and has a stake in Lycos Europe. Last month, BMG Entertainment Group bought struggling online CD retailer CDNow for $117 million. Last week, Bertelsmann, BMG and Lycos Europe announced that they would establish on August 17, allowing German-speakers access to MP3-formatted music content.

Publicly traded European record labels in the online music retailing space, such as EMI Group PLC, Vivendi (through its purchase of Universal, including the Universal Music Group); BMG, owned by quasi-public Bertelsmann, which sells profit participation shares; and AOL, through its Time-Warner merger, could all benefit significantly if they learn to transform their business model. And they must move quickly. Napster, while raising the ire of the RIAA and such plausible champions of justice as Metallica, is not alone. Other websites allowing such trading are springing up daily, such as Scour, which offered as of this writing almost 2.5 million music files, Gnutella, and Freenet.