Every entrepreneur dreams of creating a company that becomes a household name. But when Napster was born in a college dorm room at Boston’s Northeastern University, it’s unlikely that 19-year old Shawn Fanning was thinking about planting seeds for corporate success. He was trying to solve his roommate’s problem of locating and indexing downloadable music files. Regardless, the quirky company, named after Fanning’s hairstyle, literally exploded almost overnight.
Napster began in beta form during the summer of 1999. By December 1999 the Peer2Peer (P2P) file sharing program had gathered so much attention that the R.I.A.A. launched legal action. At its height, Napster had 80 million registered users, but its remarkable life span was cut short when it was legally forced to close on July 11, 2001.
Napster was a brilliant service which turned music into the killer app overnight. Unfortunately and importantly, compensation for creators was not included in the program’s business model. This serious omission gave record labels and intellectual property owners every right to object. But did creators choose the best course of action?
Wired.com writer Brad King’s now famous article, The Day The Napster Died (Wired.com; 5/15/02) offers a tech writer’s perspective on the music site less than a year after its closure.
“…The revolutionary software allowed people to use the Internet to do what they had done for years in neighborhoods, schoolyards and concert venues: They swapped music,” King wrote. “Within months of its release, Napster was the Internet’s killer app. Napster and its founder held the promise of everything the new medium of the Internet encompassed: youth, radical change and the free exchange of information. But youthful exuberance would soon give way to reality as the music industry placed a bull’s-eye squarely on Napster.”
How did it work? Each user was required to register with an email and password and then download the Napster software to his or her computer. The software allowed each user to specify which MP3 files were shareable on the user’s machine and access similar shareable files on the machines of all the other users in the P2P network. The result was ingenious. Hard to find bootleg recordings and out of print music suddenly became available making the service a joy for music enthusiasts. What’s more, bandwidth for the downloading was seamlessly shared and contributed by all the Napster users.
The critical nature of “getting it right” during the Napster period cannot be underestimated. Internet habits were just forming, laws were being written for the digital era and consumers were still accustomed to purchasing music. Ten years later we have the advantage of time to show us how badly corporate media’s decisions turned out. Yes, Napster users were stealing the music. Something had to be done. But wasn’t there a better way to handle the situation than using the courts to destroy everything? Let’s look at some of the top level dynamics of the situation.
The Lost List
Napster was not all bad. The music industry had never before been able to aggregate 80 million active music users in one place and reach them via e-mail. Selling music on shelves in brick and mortar stores offered the music industry no direct relationship with its customers. Napster offered musicians, labels and fans the ability to communicate and direct market on a one-to-one basis. This amazing resource should have influenced the industry’s digital plans, but people were only just starting to realize the power of email marketing.
Fanning and his Napster team (perhaps unknowingly) had engineered a high profile threat that the recording industry felt obligated to answer with full force. RIAA lawyers, like angry bees, were sent streaming out of the hive with stingers on full force to litigate and destroy the new music distribution system.
What Else Could They Have Done?
Let’s examine Napster with respect to the discussion about business models in the previous chapter. You’ll recall we looked at a few basic ways to charge for goods and services—pay on the way in or on the way out; pay for exactly what you purchase; or pay for average consumption with “all-you-can-eat” privileges and finally use the power of size to get large numbers to each pay a little. Was one of these ideas right for Napster?
Napster’s password/user name log in provided a perfect tollbooth for a Pay on The Way Into The Store subscription model. For example, if Napster convinced its 80 million (and growing) users to subscribe with all-you-can-eat privileges for $10 per month or $120 a year it would have generated $9.6 billion dollars. Unlimited music for about the cost of buying 8 CDs annually would have represented an excellent consumer value. But was it also a good deal for an industry showing $14.6 billion in 1999 sales? The answer appears to be yes.
Monetizing Napster, would have almost doubled existing net industry revenues. Especially when you consider that digital sales, unlike physical sales, have little or no cost of goods sold associated with them. Napster would also have created an incredible direct marketing conduit to reach its consumers. Any eventual losses in physical sales would have been mitigated by new revenue streams from ancillary items such as tickets, videos and merchandise made possible through email marketing. It’s likely that sales of physical product would erode over time, but the effects on the industry from strong digital monetization, plus new revenue streams fueled by email marketing would have been sustaining.
What Went Wrong?
In hindsight, creating a subscription model for Napster instead of destroying it could have made a significant difference in the shape and size of today’s music industry. Why didn’t it happen?
Although we will probably never know the exact details, it appears the recording industry had fatal misconceptions about the nature of the Internet. For example, they believed they could “lock up the store” and completely control music distribution using digital rights management (DRM) software. But after several high-profile, post-Napster DRM fiascos, and much to its disappointment, the industry finally accepted that securing the Internet store was not possible. Ultimately the idea of using DRM was abandoned completely.
Jim Griffin, Managing Director at OneHouse LLC. and a well known agent for constructive change in media and technology, testified before the Senate Judiciary Committee at the famous Napster hearings in July 2000. He told this writer recently in an interview, “Looking backwards and especially based upon history I doubt you’d get a defense from anyone in the industry saying Napster was handled well. It’s a bit like how you might feel sitting at a poker table when someone with a lot of money enters the room. Your thought should be how to win the money from them, not send them away. The answer with respect to digital should always end with a license. We should license because even if we say “No” it doesn’t mean that any less music is going to get out.”
As Griffin notes, labels miscalculated by thinking that shutting down Napster would eliminate the distribution threat from file sharing and P2P software. Napster’s technology stored data in a central server that made it easy to identify users. Unfortunately, the post-Napster generation of P2P programs protected users by making the swappers invisible and untraceable. A few years after Napster was shuttered, illegal file sharing was more popular than ever. Estimates of the ratio of illegal to legal downloads were as high as 20 to 1. Unfortunately, it was a classic case of turning a bad situation into one that was even worse.
Distribution and Scarcity Controls Pricing
Basic economics dictates that pricing is directly related to the balance between supply (scarcity) and demand. Before Napster, labels maintained complete control over decisions about format, pricing, release schedules and more which gave them the ability to set prices. Introducing new formats such as vinyl, cassette and CD also allowed labels to resell classic music multiple times. It was a brilliant cash cow strategy that had placed billions of dollars in industry pockets creating a $14.6 billion dollar U.S. industry at its peak in 1999. However, the new P2P virtual world threatened to erase that control. The recording industry never graduated Summa cum laude in Internet studies, but they were masters of analog marketing and immediately recognized the threat posed by the new P2P functionality.
CDs were costing about $16 each in 1999. But consumers suddenly realized they could purchase a blank CD for $1 and burn it with digital files shared (illegally) from person-to-person for free. They began asking, “Why are music CDs so expensive?” Napster and the MP3 format were unhinging the very foundation of the music industry economic model.
Labels were in no mood to imagine the ways this new distribution behavior might bring exciting and profitable new opportunities to replace those it destroyed. People were stealing their music and they were mad.
“If we aren’t able to control the quantity and destiny of music,” agrees Griffin, “then it won’t lend itself to a product form and its price will fall to its marginal cost of delivery. Once we learned we had no choice about losing control of music’s quantity and destiny the next step was to think about the new business model that lies ahead.”
“It led me to thinking deeply about how we monetize anarchy or risk,” Griffin continues. “There are many things we can’t control like when we die or if our car has an accident. It seems that creators also undergo risk when they create. Could actuarial models of compensation work for creators and how might we structure those models? I looked back in time to see who has faced similar challenges to what we are facing. When Ronald Reagan first put baseball games on the radio people complained, ‘No one will buy a seat.’ Later when you could watch the game at home on color TV people asked why would you go to the stadium? Too often we cling to the vine that keeps us off the jungle floor without thinking about how to grab the next one to propel us forward. I call these product-to-service transitions, Tarzan Economics. Today, sports teams work hard to get on basic-tier cable because then they get paid even by people that don’t watch the games. If you are on the basic-tier as a football team you are going to get money from every cable household whether they watch the game or not and that actuarial model piles up a lot of money. If you can get a little money from a lot of people under a lot of circumstances, you can pay for the team. John F. Kennedy signed the Sports Marketing Act in 1961 that allows hockey, basketball and football to market together in a way that otherwise would have violated anti-trust laws. I’m also for relieving the creative industries of their anti-trust restrictions.”
Griffin’s actuarial concept embraces the Pay On The Way Into The Store and public goods models by getting everyone to pay a little.
Couldn’t We Get Along Together?
Was Napster about compensating intellectual property owners or a fight to control distribution? Could it have been saved, monetized and made legal? Not everyone agrees. But most everyone acknowledges it proved a monumental wake up call to the fact that the properties of the physical and digital worlds are not identical. Ultimately the label’s haste resulted in a missed opportunity that haunts the music industry to this day.
The Digital Solution by David M. Ross ©2014 BossRoss Media All Rights Reserved