Music for the Masses

The MP3 saga grows increasingly fascinating as it unfolds its intricate array of plots and counter-plots. A work in progress, its finale is still shrouded in the mists of the future.

How has a seemingly innocuous Internet compression standard for digital music combined with the anti-corporate, populist values of youth culture to create the many-headed hydra that now threatens the massive music industry? Napster Inc., MP3.com Inc., Diamond Rio -- as the music moguls slap one lawsuit after another on existing players to stamp out the blight, new players spring up overnight to replace them. For their efforts, the moguls have been rewarded with a consumer backlash from their most lucrative customers. A demographic cohort that is a primary marketing target for many big corporations is, ironically, becoming expert in the art of counter-manipulation, thanks to peer-to-peer technology.

What attitudes and values does the MP3 saga reveal about tomorrow's tech-savvy consumers? How do they threaten the foundations of the music industry's business model? How to make head or tail of this complex brew of digital standards, intellectual property rights and consumer rebellion?

Let's begin at the beginning. MP3 is a process developed in 1991 that compresses digital audio content by a factor of 12, yet retains reasonable sound quality -- a typical 30MB song is reduced to a manageable 2.5MB. In the mid-1990s, the explosion of Internet usage, fatter broadband pipes and increased PC storage capacity made MP3 a viable digital vehicle for sharing music. MP3 is an open format -- it has no security or tracking mechanisms. Physical CDs are easily ripped, or transferred, to the MP3 file format.

These appealing features caught the attention of tech-savvy young people, who typically have little money, lots of time, an enormous passion for music and a belief that all on-line media is free based on their experience with the Internet. Ripping CDs, posting, sharing and downloading MP3 files from Internet Web sites quickly became commonplace on university campuses. About 13 million people downloaded music from the Internet without paying, according to the Pew Internet Project tracking agency.

These unappealing features caught the attention of the litigious music industry. It threatened legal action against universities that permitted MP3 downloading on their networks and became involved in a series of high-profile lawsuits with the bigger dot-com players: Diamond Rio for its MP3-compatible playback device; MP3.com for its MyMP3 radio/storage locker service; and the notorious Napster for its radical MP3 file-sharing technology.

Not surprisingly, these tactics have alienated a large number of militant kids, resulting in a defiant backlash. Consumers retort: the record industry makes it difficult to get exposure to a wider range of music and makes it risky to purchase a CD. They have to pay about $20 for a CD, a leap of faith since they've only heard a small part of the music beforehand. They may be dissatisfied with the full recording after the purchase, winding up feeling ripped off by a process that doesn't enable convenient sampling beforehand.

These complaints have merit -- in an ironic twist, the five top labels were themselves hit with a lawsuit by the U.S. Federal Trade Commission over antitrust charges that were settled in May. The FTC charge: collaborating to keep CD prices about $5 higher than they could be, defrauding fans of $480 million over the past four years.

But kids now have the means to rebel. Napster and its nuclear peer-to-peer (P2P) technology have changed the power dynamic between content producer and consumer. Instead of placing MP3s in a central Web site repository, Napster's freeware allows registered users to search other users' hard drives for a desired MP3 song/file; when found, a copy can be zapped from one PC to another via the Internet in a few minutes. This plays well with the populist and anti-corporate values of young people, as it gives users the sense of exchanging information without any central mediating entity. In less than a year, Napster has attracted more than 20 million users.

Napster's legal defence is it doesn't directly control the files that are exchanged by users via its service, so file swapping amounts to non-commercial sharing of music among individuals. This definition puts the company in a catch-22: Napster can't make money because it's not in control of the content. In its current state, Napster is clearly an unsustainable business model. It has no way of generating income. It charges people nothing for use. It charges nothing for artists to post songs on it. It has no process to meter use.

But whether Napster survives its legal battle is irrelevant. The genie is out of the bottle. Next-generation P2P software that dispenses entirely with user listings is already available. Napster is an easy target, as it keeps central listings of users and their corresponding directories to fulfil search requests. This information can be used to shut off individual users or shut the service itself down. It's less clear how the industry will deal with users of advanced P2P software such as Gnutella.

Unlike Napster, Gnutella operates in true P2P fashion, relaying directory information among all its users. It also differs significantly in that it lets users share not only MP3s, but any type of file, including video, text and photo. Gnutella isn't even a company, merely a maverick open-source software program. Thirty variants of Gnutella have already been developed. With Gnutella and its ilk, there is no company to sue, and no mechanism for tracking user-pirates.

Litigious record labels are acquiring a reputation for behaving like bad-tempered dinosaurs, roaring futilely as the meteors hit. The industry has been slow and disorganized, unable to agree on a uniform approach. Attempts to develop controllable MP3 formats that are acceptable to users have met with little success. When the labels have ventured on-line, they've posted songs to a central Web site. Pickings are slim thus far, and the downloading process is slow and inconvenient. To be fair, record companies have to wrestle with the complexities involved in generating revenue from on-line music, unlike the dot-commie approach to date -- letting people get free music eliminates billing issues, and ignoring copyrights helps keep the technology simple.

Industry observers agree the subscription model is the most viable business model for satisfying consumers and tapping into the Internet's clearly enormous potential. There is a generation of kids who are learning today that the underlying value of a song is zero. If they are to pay for digital files, they will want more than just a few good songs. Instead, digital music needs to move toward a more attractive suite of offerings that music lovers want -- sampling, flexible pricing, convenient format, lyrics, pictures, concert listings and the like.

Moreover, security against download dangers will also inspire users to pay up, as P2P opens up PCs to viruses and other nasties. "All you need is one virus to kill your hard drive for you to say 'Hey, this free stuff isn't free,'" says Paul Vidich, executive vice-president of Warner Music.

But swift action is needed to rein consumers in. "Basically, if you're not addressing the issue now, you're giving piracy more of a chance to become entrenched. So if you're not offering a legitimate MP3 alternative, or MP3s legitimately, you're kind of missing the boat," says Lars Murray of Rykodisc.

Larry Leung and Rosie Lombardi are consultants with PricewaterhouseCoopers's Global Risk Management Solutions group. Based in Toronto, they can be contacted via e-mail at larry.leung@ca.pwcglobal.com and rosie.lombardi@ca.pwcglobal.com.

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