MP3.com gets $11 million investment

The investment marks a milestone in the evolution of the MP3 (MPEG 1, Audio Layer 3) format, a popular technology that compresses high-quality sound files so they can be downloaded quickly onto a PC hard drive. Its widespread use online makes it a de facto standard for downloading music, observers say, although to date it has been scorned by many in the mainstream recording industry because it is favored by music pirates and often is used to post unauthorized copies of copyright-protected music online.

Net music download, news, and community site MP3.com is "without question" a good investment for Sequoia, said Forrester Research senior analyst Mark Hardie. "They're funding the prospect of a shift in the music business.

"Right now the white-hot spotlight is on MP3.com," Hardie added. "Everyone is looking to MP3.com to see what is possible."

A Sequoia spokesperson confirmed the investment, but declined further comment. Along with Yahoo and 3Com, the company has funded the likes of Cisco, Apple Computer, and Oracle.

The controversial MP3 format is "at the center of the storm" surrounding what to do about online music distribution, Hardie said. As high-speed broadband Internet access emerges, and as the medium's music community thrives, a shift toward more widespread distribution of music online seems inevitable. The question remains, however, which format ultimately will become the standard.

MP3's popularity with early adopters--especially college students, who traditionally are big music consumers--makes it the favorite so far, but it faces competition from the likes of AT&T Labs' a2b Music and others, such as Liquid Audio.

The latter, for its part, hedged its bets last week with a deal to incorporate Diamond Multimedia's Media Device Manager into its Liquid Music Player during the first half of 1999. Diamond's Rio portable MP3 player earned it a lawsuit from music industry trade group the Recording Industry Association of America (RIAA) last fall. With the technology marriage, Rio users will be able to download and play Liquid's more than 100,000 tracks from major artists after purchasing them.

The RIAA last month announced the Secure Digital Music Initiative, which it said is "a framework to work with the technology community to create a voluntary digital music security specification by next fall" aimed at protecting artists' copyrighted works from being distributed over the Net without any return to the labels or artists. That spec ostensibly could be incorporated into any Net music-delivery technology, though some proponents of MP3 said at the time that doing so would not work well for the format.

MP3.com chief executive Michael Robertson said the funds from Sequoia will go toward further cultivating a staff for the company and "engineering," among other expenses. He noted that among the company's new hires are Doug Reece, who was a reporter with industry bible Billboard magazine, and Brad Biddle, a copyright attorney formerly with Cooley Godward.

"One of the big challenges we have is a big demand from artists" to post their music on the site, Robertson said, noting that roughly 55 artists per day request inclusion.

Robertson's goal is to "make MP3.com the best place in the world for artists to place their music."

Hardie pointed out that the artists on MP3.com are largely unknowns looking to make a name for themselves online. But the Net music distribution model is another story for better-known artists. Although their contracts don't specify online distribution, most well-known artists who have contracts with the "Big Five" record companies--BMG, EMI, Sony Music Entertainment, Universal Music Group, and Warner Bros. Music--are unlikely to sell those rights elsewhere, for fear of hurting the relationship with the record company just to get a foothold in what is still a nascent market overall.

"We're still five years away from a mass market that purchases music online," Hardie predicted. With that in mind, most well-known artists are unlikely to stray from the record companies that have helped make them successful.

However, the emergence of a force in the online distribution space, such as MP3.com, could be a signal to artists that the potential is there for them to make more money from the sale of their music than under the current paradigm, given the lower cost of marketing and selling music via the Net instead of on CD, DVD, or other formats.

Plus, the evolution of online music distribution stands to shake up the industry's current model, in which artists are largely dependent upon record companies to make the initial large-scale investment in distribution and marketing. The Web allows for widespread, targeted marketing via email, for example, which comes with the added benefit of a "faster response rate," Hardie noted. Instead of receiving information via snail main and then having to call to order the music or visit a record store, a user who receives an email message with a link can click through and buy the music on the spot. And marketing via email is vastly less expensive than most real-world methods.

Hardie said that, from the sale of a $15 CD, the proceeds generally are distributed as follows: Roughly $2.50 goes to promotion of the artist and CD; $1 goes to manufacturing the CD itself; $1.50 goes to distribution to the larger retail outlets, such as Tower Records and Blockbuster Music; $6 goes to royalties and record label profit, with about $2 of that $6 going to artist royalties, which are usually shared with producers, managers, and others, and $4 going to the label; $2 goes to the so-called subdistributor, such as Valley Entertainment, which in turn distributes to smaller record stores; and about $2 is left over for the retailers' margins.

With Net distribution, many of those costs are significantly diminished or disappear altogether--potentially leaving more of the bounty for artists, Hardie said. With that in mind, MP3.com is looking to attract artists with promises of more money for their work. Robertson said the company's business model is built on ad sales for the site, as well as sales of an array of music products, including Diamond's Rio player and others, concert tickets, CDs--"anything an artist needs to make their business go."

Another MP3 company, online record company GoodNoise, also is looking to attract artists with the promise of more money for their efforts.

In the end, Hardie noted, the winner will be whatever music consumers demand.

"The industry needs products that represent the [music] experience customers want," he said.