Can Napster and Bertelsmann make sweet music together?

It's no surprise, then, that 38 million people have flocked to Napster, the Web site that enables people to rummage one another's hard drives for free music. Neither is it a surprise that major record companies have sued Napster, claiming such sharing violates copyrights and cheats music makers of revenue and royalties.

It was something of a surprise, though, when one of the world's biggest media companies recently announced a 180-degree turn. Bertelsmann said Oct. 31 that it would drop out of the anti-Napster suit and instead team up with the renegade company, contributing an undisclosed sum, thought to be many millions, in exchange for a future ownership share. Napster users who relished their anti-establishment image were startled by the enthusiastic welcome given Bertelsmann by Shawn Fanning, the college dropout who created Napster last year.

Privately owned Napster is looking for a way to become profitable, perhaps by--gasp!--charging fees. Bertelsmann, owner of music company BMG Entertainment, wants a leg up in the online music distribution business as well as direct contact with those 38 million music lovers. Has the revolution been co-opted? Is the Napster "sellout," as some termed it, the end of free online music?

Not quite. Over the next few years, the established music, movie and publishing industries will have less effect on the Napsters of the world than the Napsters will have on them, according to Wharton experts.

"My guess is that the music industry will have to get a lot thinner. It's going to have to squeeze out a lot of the intermediaries in the middle," says Greg Meyers, an adjunct marketing professor at Wharton and strategist for Qwest Interactive, the Internet consulting unit of Qwest Communications International. "The only thing that's sure is that the way it is now is not the way it's going to be."

Today, much of the price of a $16 CD goes for production, distribution, marketing, transportation and other costs, he says. Digital distribution over the Internet is much cheaper, and traditional music companies will have to cut costs and prices to compete.

Napster and similar data-sharing companies have been made possible by the development of fast Internet connections and the shift of music and other information to easily transmitted digital formats. Napster's role is to maintain a vast index of music its users are willing to share and to provide the software for doing it. A person seeking a song or album can log on to Napster through the Internet, find someone who has the tunes, and extract them from that person's computer.

At first glance, it may seem beyond question that Napster is in the business of thwarting copyright laws. But the company says it does not provide music itself, and its Web site cautions people who trade among themselves to obey copyright laws. The record companies insist Napster exists only to help people exchange music without paying the artists and producers. It is thus a knowing, willing enabler of copyright infringement, they contend. A federal court ruling could come any day.

As interesting as the lawsuit may be to aficionados of copyright law, services like Napster's are sure to proliferate regardless of the outcome of the Napster case, Meyers says. Already, Napster has competitors, such as Gnutella and Freenet. Some use encryption technologies that make it impossible to tell who is sharing files with whom, thus making copyright infringement impossible to police.

Not a sure thing
Napster's survival, even if it wins the lawsuit, is hardly certain. The company's strength is its enormous membership list, enabling it to offer a vast selection of music. But patrons of Internet businesses are notoriously fickle. With just a few clicks, one can switch to a competitor. "As long as there's a free alternative, why would anyone pay?" asks Meyers, pointing to Napster's central dilemma.

To flourish, Napster has to generate revenue and, eventually, profit. Currently, much of the money it has raised privately is going to legal fees. But people may flee Napster if it charges large fees. Small fees--say only a few cents per song--might not drive people away, especially if authorized downloads are of better quality than pirated ones. And some people undoubtedly feel that artists should be paid for their work.

But it's not cost-effective to use credit cards to collect tiny fees, Meyers says. Perhaps Napster will aggregate small fees into lump sums--$20 for 100 downloads, for example. The company says it hasn't decided how to proceed but will continue to offer some free material, though a monthly membership fee is likely.

Bertelsmann and Napster need to do more than just mollify music seekers who like the free format. They also have to find a way to compete with people eager to provide music for free.

Sheen S. Levine, a Wharton lecturer and doctoral candidate who studies the behavior of Internet users, notes that Napster thrives because people allow access to their hard drives to complete strangers. The person who provides music to others gets no pay and doesn't even demand a promise that the other person will reciprocate. The Napster music provider does not sell, or even trade. The music is a gift.

"It's not a phenomenon that we see anywhere else but on the Internet," Levine says. "This culture of sharing over the Internet is something that dates back to its early days. Today, most of the stuff that you have online is free."

Levine has studied people who use Napster and other sites and believes they have a variety of motives. People who write software and then offer it for free may simply find satisfaction in creating something others want. Others get a kind of anti-establishment kick out of defying standard business conventions. In addition, "we may not be as opportunistic as we think we are," Levine says. "People do things to benefit society."

But if millions of people are willing to pay good money to buy CDs, then load them onto hard drives and offer the material to others for free, traditional music sellers are in trouble. Indeed, Napster is too. "Napster was not born as a business idea; Napster was born as part of this movement toward sharing," Levine says. "How they are going to make money off that nobody knows...I don't see how they are going to charge money and keep their users."

Making the concept work
The music, entertainment and publishing industries are ideally suited to e-commerce, since their products can actually be delivered online, not just ordered. But how can for-profit businesses thrive in a sea teeming with pirates?

Years ago these industries worried they'd be put out of business by tape recorders, VCRs and Xerox machines. That didn't happen, but those technologies were cumbersome, and copies often weren't as good as the originals. However, digital transfers from CD to hard drive to handheld MP3 player can yield perfect duplicates.

Music and other information producers are working on digital watermarks, encryption and other methods to block unauthorized copying. But in the Spy vs. Spy software wars, hackers have a long history of quickly toppling such defenses.

Meyers suggests music companies will adapt by earning less from music sales and more from peripheral products and services. In a similar way, software makers in the '80s dropped efforts to block copying. They realized that many users--especially businesses--would pay to be sure of obeying the law, to get documentation, upgrades and the registration they needed for technical support, for which many software companies now charge.

Record companies may draw people to Web sites that require registration and track music acquisitions, producing valuable customer lists that can be sold, Meyers says. They may find they can attract paying customers by offering free samples, then selling individual songs instead of whole albums, making music purchases more cost-effective.

And record companies probably will offer new services, such as guarantees of download quality and notifications of new releases by a customer's favorite artists or others like them. They also may forge profitable links with makers of music hardware such as MP3 players, Meyers adds.

As Web-based music, movies, books and other publications become more prevalent, media companies will have less of a gate-keeping role, he says. When production, distribution and marketing costs fall to nearly nothing, just about any performer will be able to get work to market. "I can record a song in my shower and put it up on Napster for free," Meyers says.

Music lovers, then, will have more choice. But faced with a blizzard of unknown material, they may want media companies to help them find work to their liking. Maybe they'll be willing to pay for the help.

 
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