A Hard Ride For eDonkey

On the morning of June 27, Sam Yagan huddled with his partner, Jed McCaleb,
before one of the five computer screens in their dingy, one-room office in
Hoboken, NJ. Yagan, chief executive of startup MetaMachine, watched as McCaleb
clicked the refresh button on his Web browser again and again. They were waiting
for the US Supreme Court to hand down its ruling in the case Metro-Goldwyn-Mayer
Studios v Grokster-the record and movie industries’ lawsuit against a
file-sharing service that let people swap pirated copies of music and films.

Yagan and McCaleb weren’t defendants. But they marketed their own
file-sharing software, called eDonkey, which had roared past Grokster to become
the most popular service in the world. In fact, while few people over 30 have
heard of eDonkey, file-sharing on its network accounts for more than one-third
of the volume of data sent over the Web, estimates researcher CacheLogic. On
average, 3 mn people are using its software at any one time to share music and
movies. If Grokster lost, they were in deep trouble.

Late that morning they got their answer: The Supreme Court ruled unanimously
against Grokster, with Justice David H Souter writing the company’s intent to
facilitate illegal activity was “unmistakable.” The two at eDonkey
were stunned. McCaleb, the company’s 33-year-old founder, tapped a few keys,
rested his index finger on the enter button of his computer, then looked Yagan
in the eyes. “If I hit this button,” he said, “we shut the site
down. What do you want to do?” The 28-year-old Yagan graduated from Harvard
University and earned an MBA from Stanford, but no class could have prepared him
for that moment. “What do you do when the Supreme Court smashes your
business? What do you do when your business partner asks: ‘Should I just end
it all right now?”‘

Yagan and McCaleb didn’t end it all right then. Instead, they started
negotiations with the record industry and pored over their options. On Sept 28,
Yagan told a US Senate committee he had “thrown in his towel” on the
disputed service. Now he is trying to reinvent eDonkey and use its popularity as
a foundation for a legitimate business.

New Landscape
After the Grokster decision, the Recording Industry Assn of America sent
cease-and-desist letters in September to seven major services, sending them
scrambling to figure out a new business approach. What they come up with will
determine whether file-sharing becomes a respectable, legal way to market and
swap music-or whether it persists primarily as an underworld of illegal,
pirated tunes. “The [file-sharing] landscape in America is going to be
dramatically different just 30 days from now,” says Mike Weiss, CEO of
StreamCast Networks, which owns the Morpheus file-sharing service.

The record industry has an interest in eDonkey and its peers pulling off
their revamps. Music executives saw that shutting down Napster, the first major
file-sharing service, in 2000 largely backfired. A host of new services sprang
up to fill the void for swapping songs. Now, record labels are working with
Yagan and others in the hope that legit services will become attractive enough
to draw music fans away from systems for piracy. “We think [file-sharing]
has great potential and we’d like to see it succeed,” says Mitch Bainwol,
chief executive of the RIAA. “The key is providing consumers with
legitimate alternatives.”

No doubt, demand for digital music is taking off. Music downloads, from sites
such as Apple Computer’s iTunes, are expected to generate $875 mn in 2008, up
from $180 mn last year, according to JupiterResearch. Music subscriptions, from
Yahoo! and others, are on track to hit $850 mn, compared with $150 mn last year.

But can Yagan and eDonkey find a place in the new world of music? They need
to muscle their way in between successful legit services like iTunes and Yahoo
Music and still-free services like FrostWire that are developed underground by
amateurs. An even bigger barrier may be eDonkey’s existing software. While the
company can avoid being hauled into court by putting out software that complies
with the Grokster decision, its millions of users may decide to hang on to their
old eDonkey software and continue swapping files illegally.

Academic Cred
Yagan-animated, confident, and exceedingly polite-is an unlikely candidate
to be running the company responsible for more illegal music and movie transfers
than any other. Besides his academic credentials, Yagan is a serial entrepreneur
who was given the reins at MetaMachine in 2002 in part due to his success in
starting TheSpark.com out of his Harvard dorm room. By paying Harvard undergrads
to write CliffsNotes, he stocked his Web site with SparkNotes, a series of free
online study guides. The company made money from advertising on the site. Yagan
sold the business to Barnes & Noble for $3.75 mn in 2001.

eDonkey, which has continued to offer its controversial service since June,
generates revenues in two ways. It sells advertising on one version of its
software, which is available to users free of charge. Another, ad-free version
is sold to users for $19.95. Virtually everyone opts for the free version,
though that means ads flash as they search and download files. Advertising
accounts for two-thirds of its roughly $2 mn in revenues.

In future versions of its software, eDonkey will have to include technology
to detect, and charge for, copyrighted songs. So how can Yagan persuade people
to use his software if they can’t get the broad selection of free music they’re
used to? One approach he thinks is promising is akin to broadcast television,
where the content is paid for by advertising. He’s investigating technology
from a startup called INTENT MediaWorks that lets people download a song for
free if they watch or listen to an ad first. Combining that approach with
eDonkey’s many users, he thinks, could create a powerful network.

Another approach is that people refer songs to their friends and get paid a
small fee if their friends buy the tunes. Yagan isn’t sure the idea will fly,
but others are banking on it. Peer Impact pays users 5% of the price of a
download in store credit if a friend buys a recommended song. While the fees are
only a few cents, Greg Kerber, CEO of WurldMedia, which makes Peer Impact, says
they foster loyalty. “I invested in a Dave Matthews song a few weeks
ago,” he says. “I’ve already paid for the song and made 32

Yagan is also in serious discussions to merge his company with an existing
file-sharing service called iMesh. The service has already worked out agreements
with all of the major record labels to market their music, and it’s developing
social networking technology that lets people set up their own profiles online
and communicate with friends. Its music subscription service, which debuts in a
few weeks, is expected to cost less than $10 a month. If the two companies
merge, iMesh would have access to the eDonkey network and will look to convert
the user base to its new software.

Yagan is sanguine that eDonkey will evolve into something very different from
what it has been. He recently moved eDonkey’s office into Manhattan, since his
Hoboken landlord wanted to lease the space to another company. He looks tired
but upbeat. “My colleagues at the other companies are in a much different
position in their careers,” he says. “I’m 28 years old. I went to
Harvard. I went to Stanford. This is just a business to me. It isn’t like I’ve
spent my whole life getting to this moment.” Just then, his cell phone
rings. One of the new office’s computers is on the fritz. He leaves the Corona
half-full on the bar and heads back to the office.

By Burt Helm in Hoboken, NJ

Listen Up

After legal rulings against them, services for sharing music over the
Internet are evolving. Here’s a look:

NAPSTER The granddaddy of the music-swapping services was shut down in
2000 after a federal appeals court ruling. Napster resurfaced as a legitimate
music subscription service in 2003.

KAZAA Once the biggest service after Napster, Kazaa gained a bad
reputation for nasty adware. In September an Australian court ruled Kazaa must
filter out copyrighted files.

GROKSTER While it gained a high profile as a defendant in a lawsuit,
Grokster’s a small player among file-sharing services. After the US Supreme
Court decision against it, Grokster is in talks to be acquired by startup

EDONKEY The most popular file-sharing service on the Net, eDonkey is
scrambling to figure out how to go legit. One possibility: It’ll merge with
iMesh,which combines music downloads and social networking.

Leave a Reply

Your email address will not be published. Required fields are marked *