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Napster's learning curve

Former Napster exec Don Dodge says lessons from the company's flame-out speak volumes to would-be entrepreneurs.

Shawn Fanning created Napster in his dorm room at Northeastern. It was the fastest-growing application in the history of the Internet. We changed the world but failed to achieve business success. Here is a glimpse into that story.

Napster started out as a free download tool for college students. Later the goal was to make it a real business in partnership with the record labels. At first Napster was too small and unknown to get a meeting with the major labels. That changed fast. In less than four months Napster went from being an unknown underground technology to the biggest threat the record labels had ever seen.

Napster wanted to be the online distribution channel for the record labels, much like iTunes and the new Napster is today.

Napster's promise was simple: It could target niche music markets and easily find the 400,000 people who loved a particular brand of new age techno or Irish folk music. More artists could make more money, and the record labels could avoid much of the manufacturing, promotion, and sales channel expenses. Digital downloads could be much more profitable than CDs.

We had a plan. We just didn't get a chance to make it work.

Things looked promising. Hummer Winblad made a first-round investment in Napster and installed Hank Barry as CEO. Hank hired several music industry veterans to prepare Napster for a real business relationship with the labels. We had a plan. We just didn't get a chance to make it work.

Later, Bertelsmann Music Group CEO Thomas Middlehoff made a significant investment in Napster. Middlehoff made billions for BMG in a joint venture deal with America Online to establish AOL Europe. He thought that Napster would be the next big thing and that he could broker business deals with the other record labels. Things were looking good.

Then the Recording Industry Association of America (RIAA) sued Napster on behalf of the major record labels. Napster hired David Boies, one of the best trial lawyers in the country. We lost the case in the first round, but won a stay that allowed us to continue operating until an appeal was heard.

We made one last effort to convince the labels that they should do a deal with us. A little-known underground product called Gnutella had just surfaced. It was a P2P file-sharing program that required no central server and no company to operate it. If the labels didn't do a deal with us, and instead put us out of business, then Gnutella and its derivatives would become unstoppable. If we worked together now we could convert the market to a paid-subscription model. If we didn't do a deal, chaos would ensue. The labels didn't believe us and didn't really understand what this Gnutella threat was.

Big mistakes
The RIAA succeeded in shutting down Napster, but lost billions in potential revenue over the next several years to Gnutella, Grokster, Morpheus, Kazaa and others.

We made several big mistakes. We were conflicted about who we were and what we wanted to do. We embraced the bad boy rebel image that our users enjoyed, but we knew that we had to make peace with the labels to have a viable business.

We were naive about what the labels would or could agree to. It was not reasonable to expect that we could challenge their fundamental business model, and then agree to work together as partners. It is now clear that they couldn't have made a deal with Napster even if they wanted to. Their existing contracts with the artists had no royalty provisions for digital distribution of individual songs. The payments to artists were all based on CD sales through the normal retail channels. It took them several years to rewrite their contracts with artists to get to the point where today you can buy a single song via digital download.

What lessons can be learned from this experience?

• Never get too far ahead of the market. Creating new markets, business models, and value propositions is very risky and takes lots of time and money.

• Understand who your customer is, what problems you need to solve, and how much they are willing to pay for it.

• Never start a business focused on solving a big company's problem. They don't know they have a problem...and they are probably right.

• Test your assumptions. Interview your potential customers. Understand their top 10 problems. Don't try to convince them that you have a solution to a problem they don't know they have.

•  Marketing and image matter. Provocative challenges make good headlines but don't make good business.

Napster changed the world. Millions of people rediscovered their love of music through Napster and created a whole new way to enjoy it. We made mistakes, but we learned valuable business lessons. The business lesson of the Internet is that you can attract a much larger audience--and generate more revenue--with a "try it for free and buy it if you like it" approach. Five years later, the music industry is still struggling with how to capitalize on the Internet business model.