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Bertelsmann, the German media and publishing giant, broke ranks Tuesday with the major record labels by announcing a strategic alliance with Napster, the song-sharing company it had been suing. Together, the two companies will develop the file-swapping service’s commercial potential. “Napster has pointed the way for a new direction for music distribution, and we believe it will form the basis of important and exciting new business models for the future of the music industry,” said Bertelsmann CEO Thomas Middlehoff in a statement. Under the terms of the agreement, Bertelsmann will assist Napster in developing a membership-based service that compensates artists, record labels and publishers each time a song is traded. As soon as Napster implements the service, Bertelsmann’s music division, BMG, will withdraw its lawsuit and make its catalog available. Bertelsmann’s catalog includes the BMG, Arista and RCA imprints, representing artists such as Whitney Houston, Elvis Presley and Carlos Santana. Bertelsmann will also provide a loan to Napster to develop the service, which would probably take the form of a monthly subscription. The loan could later be converted to Napster shares. Bertelsmann officials would not disclose the amount of the loan, or what percentage of Napster it represents. The deal is not exclusive — far from it. In fact, Bertelsmann today also appealed to the other major labels currently suing Napster — Warner Music Group, EMI, Sony and Universal — to join the effort to develop the Napster network. Bertelsmann’s announcement took the recording industry by surprise. The Recording Industry Association of America, the powerful trade group that represents the major labels, is usually ready with a press release, but today no one there was immediately available to comment. The Napster deal is the work of Andreas Schmidt, president and CEO of Bertelsmann eCommerce Group and former head of AOL Europe. His first purchases for Bertelsmann were CDnow and Barnesandnoble.com. The group operates Bertelsmann’s premier e-commerce site, BOL.com. “We are looking to take a positive and forward-looking approach with a membership-based service that complements other forms of music distribution,” Schmidt said. The Bertelsmann deal notwithstanding, Napster’s fate still lies in the hands of a panel of three federal judges in California. The panel is considering an appeal of a judge’s ruling in July. If the panel finds that the recording industry is likely to prevail in trial, it could shut down the service until the case is heard in court sometime early next year. This would diminish the value of the company, which depends largely on the number of people participating in the file-sharing community. It could also drive Napster users to file-sharing services that have no corporate backing, such as Freenet and Gnutella. In October Media Metrix declared Napster the fastest-adopted piece of software in the history of computing. In just over a year of operation, Napster has amassed a file-sharing community with 38 million registered accounts. Media Metrix found the application on almost 10 percent of American computers connected to the Internet. The research firm NetRatings found Napster on slightly more than 6 percent of Internet-connected computers in the U.K. and Germany. Copyright � 2000 The Industry Standard

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