Can’t Get No...

An auspicious debut it wasn’t. Here was RealNetworks CEO Rob Glaser

standing before more than 350 music executives in late July at the Sheraton in

midtown Manhattan. The idea was to offer a glimpse of closely guarded MusicNet,

one of the two big-league on-line music ventures pushing to launch this

September. Glaser, whose company will provide the streaming technology, was all

set to tee-up Britney Spears’s hit "...baby one more time" for the

high-powered audience. But he couldn’t log on to his laptop. It took an

assistant to help him finally reboot. By the time Britney was through a few

verses, it was clear the crowd was thoroughly underwhelmed.

The half-baked demo may be a sign of the sour notes to come when the music

industry makes its first serious foray on-line. Now that the Napster pirating

service that revolutionized the distribution of music has been shut down; the

major record labels are testing the uncertain notion that folks will now pay for

what they once got for free. But even before the first song gets downloaded, the

two services are facing obstacles. Antitrust agencies in Washington and Europe

are investigating the services, Congress is considering legislation to ensure

fair competition, and music publishers could sue to shut down the sites over

money they say they will be owed for each song sold on-line. It’s just a real

mess right now.

Driving much of the concern is the fact that the two services control 85% of

music sold today. MusicNet is backed by Warner Music Group (a division of AOL

Time Warner), EMI Group, and BMG Entertainment (a unit of German media giant

Bertelsmann). Rival pressplay is a venture of partners Universal Music Group

(part of Vivendi Universal) and Sony Music Entertainment. Those combinations

have regulators and Congress worried that competitors will be blocked from

entering an on-line market that by 2010 will account for 16% of the $21 billion

in US music sales, projects Kagan World Media.

Fatal flaw

Just as problematic for the services is the fact that

still-heated rivalries within the music world have so far stopped the two groups

from cross-licensing music to each other. That means that for the $10 to $15 a

month the services are expected to charge, a consumer might get songs from

Shaggy and Blink-182 but not from the Dave Matthews Band and ‘N Sync. That

would make each service akin to a radio that gets only half the stations. The

services, at least initially, will not allow music to be burned to CDs or loaded

into portable players. The tunes downloaded or streamed will expire after a

certain time period–absolutely a fatal flaw.

What could complicate doing any cross-licensing deals in the

future is that the two services have different business models. MusicNet will

act more like a traditional record business, selling music wholesale and letting

its on-line distributors, such as AOL, set the price to consumers. That’s

similar to the relationship today between music companies and a retailer such as

Tower Records. By contrast, pressplay will have arrangements with its

distributors more like those between airlines and travel agents. Pressplay will

set its price, and its on-line distributors, such as MSN and MP3.com, will take

a commission on sales. Edgar Bronfman Jr, executive vice-chairman of pressplay

partner Vivendi Universal, says he wants to control pricing for fear that AOL

will sell music at deep discounts as a loss leader for its other on-line

businesses.

As they prepare to test those models though, the on-line

services face a head-banging from music composers and publishers who claim the

new ventures will owe them royalties. That demand is especially ironic given the

labels’ recent hounding of Napster over the very same issues. This time

around, the services launched by the labels are being pressured to pay as much

as 7.5 cents per song sold on-line, the same "mechanical royalty" they

pay each time a song is reproduced on a CD or cassette. Last year, the National

Music Publishers Association sued Farmclub.com, a Universal Music site, for

failing to pay for songs. That suit is still pending. "All we are asking

for is the same arrangement for the Internet that exists everywhere else in the

industry," says Chris Amenita, senior vice-president of the American

Society of Composers, Authors & Publishers, which collects a royalty each

time a song is played on the radio or elsewhere.

Much ado?

Without some deal with the music publishers, the labels

likely won’t be able to launch the services, says Cary Sherman, general

counsel of the trade group Recording Industry Association of America (RIAA). One

way out might be for the two sides to agree to have the US Copyright Office set

royalty rates. But no rulemaking is likely to stop the ongoing pressure from

Congress, the Justice Dept., and the European Union. Regulators say there’s

little evidence that the major labels are playing fair. So far, only one small

independent on-line music company, FullAudio, has struck a licensing deal with

big labels–BMG and EMI. Because the industry hasn’t shown more openness to

small players, Representative Chris Cannon introduced legislation August 3

designed to stop major labels from striking "sweetheart deals with each

other." The record industry is calling for some perspective as lawmakers

consider new copyright rules this fall.

For now, record execs would be happy just to get their

services off the ground and start finding customers–a big challenge in itself.

At its height, Napster perhaps had 70 million users, none of whom paid a cent to

download nearly unlimited amounts of music and then swap files with pals.

Several Napster clones still draw music fans. Pressplay and MusicNet figure

consumers will pay something for a quicker service that offers secure downloads

of complete songs, ensuring against the song fragments that plagued Napster. How

many will sign up? Neither company offers projections. But with so many hurdles

yet to cross, it may be a while before customers even know they exist.

By Ronald Grover in Los Angeles and Tom Lowry in New York, with

Arlene

Weintraub in Los Angeles in BusinessWeek. Copyright 2001 by The McGraw-Hill Companies, Inc