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What was striking about this deal is how improbable it was. It came out of nowhere. It brought together two fierce enemies, one of whom was suing to put the other out of business. It pulled the trendy partner from the brink of collapse while it put the stodgy one in the vanguard of its industry. When German media-titan Bertelsmann, which owns recording company BMG, announced a pact with renegade music-swapping service Napster last week, it promised to address many of the recording industry’s most pressing concerns about digital distribution. Its vision of a secure, fee-based online service would simultaneously respect copyright owners, ensure payment of royalties and preserve Napster’s appealing swap-all-you-like environment. The alliance rips apart old tribal loyalties. It represents a concession on the parts of both Napster and BMG that they need each other. “There is no question that file sharing will exist in the future as a part of the media and entertainment industries,” said Bertelsmann CEO Thomas Middelhoff when announcing the deal. But his strategy risks alienating Napster’s zealous fans, many of whom immediately branded the site a sellout. The new Napster, if it can really be created, could serve as a blueprint for the future of online music. Indeed, a day after the Napster news broke, Listen.com, an industry-supported music service, offered to buy parts of Scour, another peer-to-peer service the labels were trying to shutter. The Napster-Bertelsmann partnership, dubbed a “strategic alliance,” is an elegant piece of dealmaking. Napster is taking a loan — estimated to be more than $50 million — from Bertelsmann’s new eCommerce Group, giving the Redwood City, Calif.-based startup a needed infusion of cash. The Napster service will use the money to develop technology that monitors and tracks how many times a song is downloaded from one user’s computer to another’s. Once that’s in place, BMG has promised to withdraw from the copyright lawsuit it and the four other major labels filed against Napster. It also has the option of taking an equity stake in the company. Both of the privately held companies were vague on the financial details. “We don’t have to disclose,” says Andreas Schmidt, the CEO and president of BeCG. “And we are not going to disclose.” However the deal works, Bertelsmann looks as if it can’t lose. If Napster and Bertelsmann succeed — a big “if” given a pending lawsuit against Napster that BMG is still participating in, as well as technological challenges Napster has previously said can’t be overcome — the new service will turn up the heat on the other record labels. The recording industry has long coveted Napster’s user base (38 million people have downloaded the Napster software) even as it denounced Shawn Fanning’s creation as a virtual pirate. Now Napster has the backing of one of the industry’s own. While the lawsuit won’t go away, the labels may now have more incentive to find a way to do business with Napster. Napster’s arrangement with Bertelsmann isn’t meant to be exclusive. “The plan involves bringing other people in,” says Napster CEO Hank Barry. “What we’re looking for is industry support.” Whether they’ll get it is an open question. The other four major labels say they’ve spoken with Napster, though none has felt compelled to cut a deal. BMG’s move signals the start of a thaw. “Had they done this six or 12 months ago,” says Hilary Rosen, president of the Recording Industry Association of America, “the online music space would look very different now.” EMI has already signaled its willingness to talk to Napster. “If the phone rings,” says EMI senior VP of new media Jay Samit about Napster, “I take the call.” And soon after the deal was announced, Sony issued a statement saluting Napster’s new collegiality. Universal and Warner, each of which issued dovish — but unyielding — statements about the alliance, may prove the hardest to pull into any industry-wide effort. The two already have their own digital distribution projects under way and so have the least to gain by joining hands with Napster. Universal has proved the most litigious of the lot. In an earlier spat with MP3.com, a popular download site, it successfully sued while other labels settled. It also has the most advanced and diverse digital strategy; Universal offers downloads and music videos via broadband, and is beta-testing a stream-all-you-want subscription service that offers its entire catalog. Warner isn’t quite as advanced. But it’s on the verge of marrying into the ultimate digital platform: America Online. Robert Pittman, AOL’s president, has stated his intention to add a subscription service to AOL’s array of offerings, and Warner sources have acknowledged they’ll be part of it. AOL Time Warner might well figure it has little to gain in joining forces with the new Napster. AOL, after all, already claims 25 million users — and that’s before they’ve even introduced a downloadable music service. Still, reinventing the wheel makes little sense, something everyone acknowledges. “It’s not like we’re uninterested,” concedes a source at one major label. “It’s that to date, they haven’t brought anything palatable to the table.” The newly conceived Napster will require a complete technological metamorphosis. That’s something even Napster’s Barry says he isn’t certain can be done — although his public statements to that effect are probably an attempt to manage expectations. Few details are known, but Napster will probably have to build security features into every song, lay in a reliable tracking system and replace all existing versions of its software wholesale. So far, the company has been silent on how it plans to achieve those goals. “Napster really has their work cut out for them, as does BMG,” says Ian Clarke, creator of Freenet, a competing free-music program on the Internet. Napster and BMG are also tight-lipped on the revenue model for the future service. Barry has in the past floated the idea of a $4.95-per-month subscription model that would allow users to download all the music they want. But some say the company’s all-you-can-eat model will be hard to pull off in a secure world. Coding a music file so it will play on one machine and not another is no small feat, notes Andrea Fleming, vice president of corporate marketing at Liquid Audio, a firm developing secure music-delivery technologies that has done research for Napster. To tackle the tracking challenge — a necessity for figuring royalties — Napster has hinted it may use a statistical sampling method of the sort radio stations have used for years. But building such a feature into Napster won’t be easy. Ranjit Singh, president and COO of ContentGuard, a company developing software that prevents the unauthorized use of content on the Net, estimates the project could take up to a year to implement and cost tens of millions of dollars. No matter what system Napster adopts, the company almost certainly will make existing versions of its software unusable so that unauthorized transfers can no longer take place via its network. In requiring its users to upgrade, Napster risks eroding what is indisputably its core asset: its user base. Who, after all, wants to start reloading software? What users will really hate, though, is that they’ll have to start paying for what they’ve long gotten for free. “When something has been free and you start talking about pay, it’s a difficult conversation,” says Barry. “But it’s not impossible: Look at cable TV.” If Napster has any prayer of holding on to its user base, it’ll have to beef up its offerings. “You need to provide substantial benefit to get consumers to pay for anything,” says David Pakman, senior VP of business development at MyPlay, an online music storage service. “That is magnified on the Internet, where the lion’s share of services are free.” Connectivity might be a prime target for overhaul. Using Napster can be a frustrating experience. Songs stop downloading for no apparent reason, and logging on to the system during peak hours can be next to impossible. Since Napster is free, consumers are willing to put up with inconveniences; but when they’re paying for the service, they’re not likely to be so forgiving. Napster might also need to consider expanding beyond music files. One approach could be to add features — cover art, band histories and discographies — which would enhance the overall experience. A new, industry-sanctioned Napster might also stage events, like chats with recording artists, that could transform it into an online MTV, another wildly popular product the recording industry allowed to slip away. Still, those are technicalities for the principals behind the deal. Napster, which the recording industry was prepared to sue into oblivion, now has cash and cachet. And Bertelsmann, which saw its European Net dreams implode when erstwhile partner AOL announced its merger with competitor Time Warner, has made a splashy move that could compensate for a raft of virtual disappointments. The new alliance raises as many questions as Napster created controversies, but it shifts the momentum back to the upstart. Now Napster needs to show it can make friends as quickly as it made enemies. Related Articles from The Industry Standard: Napster Won’t Remain the Same Copyright � 2000 The Industry Standard

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