Bertelsmann said it will drop its lawsuit against San Mateo, Calif.-based Napster once the service successfully launches. For now, the company will offer a loan to Napster to create the subscription service.
In addition, Bertelsmann said it will purchase warrants that will give it a minority interest in the start-up. A stake in Napster could provide a lucrative return for Bertelsmann should the start-up go public. And the prospect of equity also could appeal to other record labels looking for a foothold in the company.
Bertelsmann executives invited the other major labels to follow its lead in dealing with Napster.
"There's no question that file-sharing will exist in the future as part of the media and entertainment industry," Bertelsmann chief executive Thomas Middelhoff said at a press conference in New York. "There's no way to deal with this fact (other) than to develop a business model for file-sharing."
Napster chief executive Hank Barry and founder Shawn Fanning promised that the service won't greatly be changed as a result of the deal. They said Napster will continue to offer free promotions but will include a secure membership area where people will have access to a library of music from Bertelsmann and future partners.
"My message to Napster users: If you think Napster is great now, just wait," Fanning said. "We're just getting started."
Fanning and Middelhoff then embraced.
While both sides expressed unbridled optimism over the partnership, they gave few details of how the service will work, saying they want to bring in other labels before announcing specifics.
Executives said the service would work pretty much as Napster already does, making no promises to address some of the weaknesses of the free service.
Content on Napster is provided by and stored on the personal computers of its members, with no central library. The result is that popular songs are widely available, but obscure and unpopular music is frequently difficult or impossible to find.
Executives said they would not guarantee access to the full Bertelsmann catalog because they are relying on individual Napster members to provide and store all of the files.
The file-sharing model puts much of the burden of distributing files on people with fast connections and large libraries of music. Whether those people will happily spend money on a service that turns them into unpaid BMG distributors remains to be seen.
The companies failed to explain how customers would be prevented from making membership-only material downloaded onto their PCs freely available to others.
While the companies were thin on technical details, they did drop hints about the cost for consumers. No price was announced, but Barry used $4.95 as a hypothetical example of a monthly fee that might be charged for the service.
The partnership signifies a giant leap of faith by a traditional record company in embracing one of the most popular, but controversial, services on the Internet. The Big Five labels--Bertelsmann's BMG Entertainment, Warner Music Group, Universal Music Group, Sony Music Entertainment and EMI Recorded Music--are embroiled in a high-profile lawsuit against Napster. The labels allege that Napster promotes the infringement of their copyrighted works, and they are trying to shut down the service.
Tuesday's deal comes as Napster pursues settlement talks with the four remaining major labels.
While the Bertelsmann agreement suggests Napster may be closer to mending fences with its adversaries than had been previously believed, the music-swapping service still faces the threat of a court-ordered closure, which could come any day.
Recording Industry Association of America chief executive Hilary Rosen called the deal promising but emphasized that the lawsuit is aimed at asserting the pre-eminence of copyright holders in setting the terms of any resolution.
"This case has always been about sending a message to the technology and venture capital communities that consumers, creators and innovators will best flourish when copyright interests are respected," Rosen said in a statement. "It has never been about peer-to-peer technology itself, which can be implemented legitimately, as today's announcement confirms. I am glad that Napster has gotten that message and hope that this announcement sends the right signal to others who are operating or intending to operate sites or businesses that facilitate piracy."
Napster's popularity has spread like wildfire. To use the service, people agree to let other Napster members tap into their hard drives to search for songs encoded in the MP3 audio compression format. This open network of MP3s lets Napster users find and download an enormous selection of songs and albums.
The problem is that many of these tracks have been downloaded without the permission of the record industry, which has taken legal action to protect its copyrights. Artists such as Metallica and Dr. Dre have been vocal opponents of Napster, saying the service promotes the theft of their works.
These actions, however, have not tempered a secret admiration for Napster among music industry executives. Some executives have conceded that Napster has been the most successful incarnation of how music can be consumed on the Web because of its ease of use and comprehensive selection.
Online and traditional music executives agree that the only way to compete with Napster while protecting copyrights is to create a subscription service. However, since music consumers do not choose songs based on labels, but by artist, it would take cooperation among all the labels to make such a service effective.
Bertelsmann's willingness to shake hands with the guerrillas of the music industry could be the truce that signals the convergence of the traditional and online music businesses.
"This strategic alliance with Bertelsmann is the right next step for Napster," Napster's Barry said in a statement.