State of the art: A medium reborn

By John Borland, Evan Hansen and Mike Yamamoto
May 28, 2003, 4:00 AM PT

David Goldberg took out a magazine ad this month with a bold promise to make a star out of a little-known singer from Virginia named Jason Mraz.

But Goldberg isn't a record label executive or a Hollywood agent--he's the head of Yahoo's music division. Using online ads, exclusive live videos, and continuous play on the Web portal's radio stations, the campaign is a shot across the bow of the music industry to show that Yahoo can become a hit-making machine to even rival radio giants such as Clear Channel.

"In two years, no, we're not going to match Clear Channel--five years possibly, though that's still a stretch. But we'll be up there," Goldberg said. "At the rate we're growing, we will start to surpass most radio chains in a year."

Yahoo's confidence is just one sign of digital music's long-awaited surge into the mainstream. Years of paralyzing litigation, industry intransigence and failed strategies are finally giving way to promising efforts backed by major labels and artists--most notably Apple Computer's new iTunes Music Store.

Other services have quietly established themselves with mass audiences, too. AOL subscribers tap close to 3 million songs or music video streams a day, as well as listen to hundreds of millions of Net radio streams. On a smaller but growing scale, digital music is being distributed in hundreds of places on the Web, from artists' own sites to retail outlets like BestBuy.com.

If this trajectory stays true, the result could be the redefinition of music that Net visionaries have promised for years. Just as vinyl albums dictated song counts and radio gave rise to one-hit wonders, digital distribution may ultimately help revolutionize the way music is produced, packaged and even created.

Such changes carry broad ramifications for major industries from software to entertainment. Some believe that technology companies such as Apple, Microsoft or Yahoo will challenge broadcast media and the record labels in influence--a prospect that haunts music executives and one of the reasons for their early opposition to digital distribution.

"In the history of consolidation of the record industry, maybe it will be the technology companies that go after the media companies," said Jeff Cavins, chief executive of music encoding service Loudeye. "We saw that with AOL Time Warner. Sony purchased Columbia in 1987. Perhaps it will play out the same way here."

Even if that risk is real, many in the music industry are banking on downloads and other digital services to help rescue a business that has seen a precipitous drop in the sale of albums in recent years. The industry has in part blamed that decline on the huge number of songs downloaded through file-swapping services, but many executives speak candidly about online distribution as the key to a much larger resurgence in profits.

"We all have to recognize that industry is going to get smaller before it gets larger," one senior label executive said. "The game is to take the significant expansion in overall consumption and find a way to win it back...As the industry seeks those new paradigms, it's going to have to do it in a context where it is going to shrink for a while."

How long is anyone's guess. The bitter and protracted fight against free file-swapping services such as Kazaa and Morpheus has led to a backlash against the labels, particularly among young people, and music labels are hoping to rehabilitate the idea of paying for music for the next generation.

"Music is the most important thing in a teenager's life," said Strauss Zelnick, former chief executive of BMG Entertainment. "It defines our society."

A representative of both sides
In Apple CEO Steve Jobs, the record labels have found the perfect personality to establish them firmly in the digital era. Jobs has long been a hero for iconoclastic youths and other rebels with or without a cause. Moreover, no one straddles the entertainment and technology worlds as Jobs does, giving him credibility in two realms historically at odds.

But Jobs is far more than a charismatic front man. He has a unique ability to identify trends and understand what the everyday consumer wants, whether it's designing a tangerine-hued iMac or producing the latest blockbuster from Pixar Animation, the digital studio he founded.

"The first thing Apple did was understand what consumers wanted and then give it to them. The behavior Jobs saw online in the way people bought music is that they want to own something, not rent it," said Paul Vidich, executive vice president of Warner Music. "They want to do it in a way that is absolutely simple to do. Plug and play."

Vidich witnessed Jobs incubate the concept of the iTunes Music Store in the earliest stages. After an initial conference call in March 2002, Vidich and Warner Music CEO Roger Ames flew from their Manhattan offices at Rockefeller Plaza to Apple's headquarters in Cupertino, Calif., to advise Jobs about what it would take for the major record labels to back a new downloadable music service.

For the next three or four months, Warner and Apple executives and engineers worked on encryption systems, usage rules and countless other sticking points that had hampered previous music services. The two camps approached the exercise from opposing perspectives.

Jobs initially wanted to sell music that had no restrictions at all, with songs that could be played and used as easily as free files downloaded from Kazaa using standard MP3 technology. Warner executives said no, but they eventually compromised on a set of rules that had fewer limitations than those granted for any previous store they sanctioned.

Once the details were worked out, Jobs did what he does best: He went on tour.

"He did it personally, in a very smart way. He personally showed this to lots of people, from its early incarnation with early prototypes," said another music executive familiar with Apple's strategy. "He flew around the country, went to heads of companies. It was always Steve for two hours showing that he loved music. It inspired confidence."

Perhaps most importantly, label executives say, Jobs guaranteed that he would apply Apple's full marketing weight, as well as his personal credibility, behind the store. No technology figure of his stature had ever made that kind of vow before, and it worked wonders.

At the celebrated unveiling of the iTunes service, Jobs showed videotaped testimonials from high-profile artists such as U2's Bono and Sheryl Crow. Portraying the store as nothing less than a reinvention of the music business, he said Apple has an advantage over rivals because it controls the computer hardware, the jukebox software and the iPod portable player.

"We don't know of any other company that has these assets," Jobs said. "Only Apple could do this."

Apple's success is unlikely to be singular, however. Everyone in the record industry expects many more companies, from music retailers such as Tower Records to existing services like MusicMatch, to follow suit.

"Have you ever seen penguins? They wait for the first one to go in the water. Then if he comes back up they know there are no sharks about, and the rest follow," said Robbie Vann-Adibé, chief executive of Ecast, which makes technology for secure downloads. "A lot of these guys were waiting to see who would go first to move this market."

Of course, not everyone agrees with everything Jobs has to say, such as his assertion that monthly subscription services don't work. If a consumer bought all music at 99 cents per song, some point out, it would cost $7,500 to fill a 30-gigabyte iPod. A subscription service could conceivably allow a music listener to fill it completely with different songs each month, for just $10 a month.

Buying single songs online is familiar to people raised on today's record stores, but digital networks will allow far more variety for young people unburdened by the shopping habits of previous generations. The options will mean that different kinds of listeners will buy their music in different ways, just as they do with film and other forms of entertainment.

"A period of education first"
"Think about movies, where you have HBO, rented videotapes and movie theaters," said Dan Hart, CEO of Echo, a digital music technology venture created jointly by retailers such as Tower Records, Best Buy and Virgin Entertainment. "In each case, technology made a new model possible, but there was a period of education first. People say that buying and owning music is all people understand. But over time, people are smart--they get what HBO means."

The entire music experience could be markedly different in a world where consumers can buy songs individually or listen to hundreds of thousands of them at any time in a subscription. Portable players, CD burners and home networks have already begun changing music consumption in radical ways.

"It's very cool. It makes it very easy to spend money on music," said Bart Wise, an attorney and amateur musician who lives in San Francisco who tried Apple's service recently. "I spent $20 to get 20 songs I wanted, instead of $200 I would have had to pay to buy the albums."

In addition, the influence of Clear Channel and other radio chains could be diminished if tomorrow's hits are determined by tens of millions of people listening to Internet radio streams. Yahoo decided to focus its music initiative on Jason Mraz only after its Net radio listeners began giving high ratings to the relatively obscure artist.

The role of record labels as marketing behemoths will likely continue, but the availability of seemingly infinite online catalogs could help shift consumers toward independent labels and a wider range of artists than whatever music is stocked on record store shelves. The album as currently packaged may give way to constant streams of songs released by artists to online services or even directly to fans who pay for subscriptions to their favorite bands.

"The main thing is the beginning of a trend to pure digital music as opposed to the thing that holds it, like a CD platter. Digital music is a file that can be moved around, from a hard drive to a handheld device or a stereo," Ecast's Vann-Adibé said. "We're heading down the path of devices going to home stereo systems that are the equivalent of Windows on the PC, devices like TiVo that use TV as the monitor."

This type of sea change can influence other mass media as well--which is why all of Hollywood is closely monitoring these developments. The movie studios have always looked to the music industry as a signpost on piracy and other issues for its own multibillion-dollar business, whose revenues far surpass those of the record labels.

Historically, the movie studios have been even more wary of technology than their counterparts in the music industry. They spent years in court trying to block the spread of home video players like Sony's Betamax, only to find later that losing this battle helped drive a huge new business in home video rentals.

"Content companies have put themselves through a lot of unnecessary pain. If these commercial solutions work, they will prove very much what happened in the Betamax case: that on the other side of lawsuits is a thriving industry," said Kevin Bermeister, chief executive of Altnet, a distribution service whose alliance with Kazaa has put it at odds with entertainment companies. Apple's service, he said, is "slowly turning this 50-year-old ship to a different path."

That's exactly what Yahoo's Goldberg is counting on. He doesn't care what path digital entertainment takes, as long as it runs through his company at some point. It may take some time, but he's more than willing to wait.

"The difficulty right now is we're not in cars, we're not in the streets, we're not everywhere in all the parts of the house where people listen to radio," Goldberg said. "At some point we are going to get to those places, and then we become the dominant place where people listen to music."