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Rocky financial road awaits file swappers

Droves of Napster clones are busy creating file-swapping services under the nose of the entertainment industry--but such ventures promise mostly high risks and little pay.

Droves of Napster clones are proving that it's still cheap and easy to create file-swapping services under the nose of the entertainment industry--but such ventures promise mostly high risks and little pay for the people behind them.

Even as the U.S. courts have effectively shut down file-trading giant Napster, numerous would-be replacements have taken root. Most hope to avoid legal entanglements and eventually profit on the immense popularity of services that offer free access to popular music, videos and other files.

Like the evanescent "eyeballs" that lured venture capitalists to sink billions into failed dot-coms, the staggering number of consumers signing up for file-swapping services has been a siren's call to developers. Already, millions of people have migrated to start-ups such as MusicCity, Audiogalaxy and Aimster.

But popularity also brings financial pressures, and file-swapping companies are increasingly resorting to creative ways to make money through advertising, subscriptions and other fees.

Still, the reality so far is that these start-ups have demonstrated little economic potential. Although file-swapping technology poses a potent threat to the entertainment establishment, analysts say the companies developing and marketing it face enormous obstacles if they ever hope to break out of subsistence-level operations.

"It's not too hard to see them squeaking by or maybe doing a little better," said Kelly Truelove, an independent industry analyst who closely follows the peer-to-peer market. "It's hard to see them being hugely profitable."

The current lot of file-swapping companies is in sharp contrast to the shattered ambitions of pioneers such as Napster and Scour, which in their brief heydays saw themselves as torpedoes aimed at the entire promotional and distribution systems of the entertainment industry.

Scour was backed by Hollywood power broker Michael Ovitz, and Napster is now allied with media giant Bertelsmann.

The new wave of companies, by contrast, is keeping a low profile even as they gain hundreds of thousands of daily visitors. Executives from the two most successful companies, MusicCity and Audiogalaxy, did not return repeated phone calls for this report.

Don't need much
Driving the outbreak of Napster wannabes is the spread of peer-to-peer technology, which allows PCs to be linked together without the need for central servers to direct data.

Peer-to-peer networks are considered a hedge against litigation, since a developer would not be required to list copyrighted files or otherwise directly assist in the trade of unauthorized works. The theory has yet to be tested in court.

In addition, peer-to-peer services are almost by definition cheaper to operate than their Web counterparts. If anything, this has been the saving grace of companies that still operate.

Attracting attention
CNET Download.com hosts most of the popular file-swapping applications. A look at its statistics gives some idea of each program's popularity:
Software Title Total downloads Downloads for week of Sept. 9
Audiogalaxy Satellite 24,303,000 891,993
MusicCity Morpheus 18,046,000 1,539,000
iMesh 16,453,000 345,500
Kazaa Media Desktop 11,715,000 871,538
BearShare 8,080,000 229,443
LimeWire 5,552,827 180,502
SwapNut 602,264 237,561

Source: CNET Download.com

In addition to labor costs, Web companies in the business of distributing content have to pay for bandwidth for transmitting files and for the server space that stores files online. If they want to be fast, or able to serve a large number of people at once, most big Web companies also use an expensive content-distribution service such as Akamai Technologies to help speed content.

These costs are all but gone for peer-to-peer companies. Files being distributed across networks such as those maintained by Audiogalaxy or MusicCity are stored on individual personal computers. As was the case for Napster, the bandwidth used to transfer files between computers comes from the people and Internet service providers on each side of the connection, not from the file-swapping company itself.

In the case of MusicCity, Kazaa, and all of the Gnutella-based companies such as LimeWire or BearShare, there is not even a central server that makes connections between personal computers on the network. This role is played by tens or hundreds of thousands of ordinary computers that are deputized on the fly to play temporary roles as network traffic cops, unbeknownst to their owners.

This means the costs for a file-swapping company of this sort is very low. Some software has to be developed. Some actual people have to take care of relationships with advertisers or companies such as CNET Download.com, which serves as one popular distribution point for the software and is part of CNET Networks, publisher of News.com. Some hardware and Web connections have to be maintained, depending on the architecture of the service.

Take Johnny Deep, the founder of Aimster. Deep runs most of his company with the help of his daughter Aimee, the company's reputed namesake, from his upstate New York home.

Aimster was one of the first popular file-swapping programs to emerge after Napster's meteoric success, and it retains one of the highest profiles. Aside from Napster itself, it's the only site still operating to have drawn enough of the ire of the music industry to prompt a pending lawsuit.

As yet, Deep doesn't have actual revenue. He's posted an appeal on his site for voluntary contributions, and he says this is close to taking him to a break-even point. Like others in the business, his costs are minimal, he says. Every time the audience goes up by another 50,000 people, he adds a stripped-down $300 PC to serve as a message router and the system remains stable.

"Most of our expenses are legal," he says. "I'm not sure what we're going to do about that."

The two most popular companies in the business are now Audiogalaxy and MusicCity, with its Morpheus software. Each has stepped up efforts to make money in recent weeks, however. Audiogalaxy has added a $2.95-per-month subscription option that it says will provide faster page loading and more stable service. Like Kazaa and BearShare, the company has also long bundled third-party "adware" with its download, which installs advertising software on a consumer's PC.

MusicCity has added progressively more advertising in the past few months, with pop-up windows and banner ads becoming a regular part of the software program. Executives have previously spoken of a new version of the service under development that would add more Internet communications services to the software as a possible source of revenue.

Several companies, including iMesh and Kazaa, bundle advertising software that adds links to ordinary Web pages, much like "smart tags," which Microsoft developed but removed from its upcoming XP operating system after some controversy. Installing this software will underline regular words on pages and link to a company that has bought that keyword--online real-estate agent service HomeGain.com for the words "home buying," for example.

According to eZula, one of the companies that provide this technology, an advertiser can pay up to 30 cents to $1 when a consumer visits its site through such a link; a peer-to-peer network that distributed the software can get 20 percent to 50 percent of this revenue.

Fame may not bring fortune
Although consumers continue to flock to peer-to-peer services, it's unclear whether large numbers will ever translate into large profits.

MusicCity and Audiogalaxy, in particular, have continued to grow rapidly. According to Download.com, which keeps statistics on numbers of files distributed, MusicCity's Morpheus has been downloaded more than 18 million times, with more than 1.5 million downloaded in the week ended Sept. 16 alone. Actual traffic on the network, which also includes people who have downloaded the Kazaa software, appears to have leveled off around 600,000 simultaneous users a day, a level it has flirted with for the last month or so.

With this level of reach, industry veterans say the services could be invaluable promotional tools for artists--a source of revenue that could quickly outstrip the anemic Web-style advertising. But even those companies that haven't yet been sued remain effectively blacklisted by major media companies, making it difficult for them to make the jump to mainstream radio or MTV-like promotional vehicles.

"That's a delicate transition," said Travis Kalanick, founder of former peer-to-peer giant Scour and current CEO of content-distribution start-up Red Swoosh. And whatever the technological cost savings, legal expenses must certainly loom on the horizon for anyone in this business, he warned.

"It doesn't matter how legal you think you are," said Kalanick, whose first company was put out of business by a lawsuit led by movie studios and recording companies. "You are going to get hammered if your intent is to distribute (potentially) infringing content."