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With an intriguing combination of carrot and stick -- and a big hug -- German media-and-music giant Bertelsmann offered a tasty morsel to rogue file-sharing company Napster on All Hallows Eve.
The hug came from prim and proper Bertelsmann CEO and Chairman Thomas Middelhoff, who embraced Napster founder and geek icon Shawn Fanning on the podium of the ritzy Essex House hotel in Midtown Manhattan during a press conference (see accompanying story, "Bertelsmann's Middelhoff: 'Somebody Has to Take the Lead'"). The carrot and stick came in an odd deal that could have Napster using Bertelsmann's money in a legal defense against a lawsuit by Bertelsmann Music Group (BMG), the recording-label subsidiary of Bertelsmann.
In the agreement, attributed largely to Napster CEO Hank Barry and Bertelsmann e-commerce chief Andreas Schmidt, the German company made a convertible $50 million loan redeemable for a minority equity stake in Napster. Bertelsmann also offered its full catalog of music -- the world's fourth-largest -- for use on Napster.
The catch: That catalog will be forthcoming only if Napster can figure out a secure way to distribute and charge for copyrighted files. At the press conference, Barry and Schmidt suggested some type of affordable monthly subscription model and creating a two-tier system that splits Napster between free and copyrighted content.
LEGAL HURDLES. Clearly, the deal solves Napter's short-term funding crisis. The startup had been running largely on proceeds from a $15 million investment by San Francisco venture-capital firm Hummer Winblad, but that cash had begun to dry up under legal bills and other operational costs. The deal might also put pressure on the other four big labels -- Sony Music Entertainment, EMI, Warner Music, and Seagrams' subsidiary Universal Music Group -- to sign with Fanning and Barry.
And the accord adds heft to what had been flimsy business prospects for Napster, which claims to have 37 million users but no revenue to speak of. "I think that BMG foresees a tremendous financial future for Napster. Otherwise, BMG doesn't need to loan any money to anybody unless they see some profit down the line," says Leonard Rubin, an entertainment attorney at the Chicago firm of Gordon & Glickson.
But Rubin and other legal experts say Barry's deal with Bertelsmann appears to undercut a key Napster legal assertion: that it can't identify copyrighted material flowing through its file-sharing system. And thus far, the plaintiffs, including BMG, have shown no indications of caving.
They might not have to if U.S. District Judge Marilyn Hall Patel rules against Napster, as most legal observers believe she will. On July 26, Patel ordered Napster to shut down, but her order was quickly stayed by a three-judge federal appeals panel. "Even if BMG did withdraw today from the lawsuit, it wouldn't affect the decision of the U.S. Ninth Circuit Court. Other plaintiffs are left in the lawsuit. It's anybody's guess whether the other plaintiffs will make their own deal with Napster," says Jonathan Potter, executive director of the online music trade group Digital Media Assn.
SENDING A MESSAGE. The deal certainly gives some indication that Napster's e-commerce potential has become too strong a lure for record companies to avoid. Potter notes that Schmidt and Bertelsmann's e-commerce wing are making the Napster investment -- not the BMG music unit. That seems to hint at a developing schism, at least inside Bertelsmann, where the more conservative voices in the record-label wing have been shouted down.
The move wasn't much of a surprise to industry insiders. Napster head Barry has been meeting with the big-label chiefs for some time now. But music industry sources say Barry has been trying to sell stakes in Napster at nose-bleed levels that have further enraged music execs already infuriated by what they see as Napster's blatant theft of their material.
With Napster no longer running on fumes, thanks to Bertelsmann's bread, Barry now has a real chance to develop a business model. And with Middelhoff as a broker and ally, Napster stands a far better chance of striking content deals with other major labels. "I think it sends the message to the other record companies that they should make a deal because they can also profit from this. There will be enough money for everyone," says Rubin.
But that may not prevent more clones from sprouting, even though Napster enjoys a massive branding head start. Less clear is what the deal means for smaller artists and for consumers. Rubin thinks the shift from CDs to completely digital distribution of music means prices should drop. As part of the deal, Napster and BMG hope to improve the quality of MP3s available on the system, addressing a major gripe of serious music lovers. And by opening dormant catalogs of music that might appeal to small audiences but be uneconomical to produce and distribute to record stores, the deal definitely could benefit both consumers and artists.
ONLINE SIBERIA. However, if the big labels gain control of Napster, then this vaunted Internet distribution engine might end up as yet another pawn of the music Establishment. At the very least, the deal serves as an insult to all the online music companies that played by the rules and signed early deals with the labels -- but received far less in return.
In the end, a big-music-dominated Napster might marginalize independent artists yet again, this time in the untrafficked corners of the service or in cold confines of the Net far from the hordes of Napster users. Rubin, for one, expects this to be the deal's result. "It's not a victory for the artists at all," he says. "BMG will still decide what artists will go on its label and what artists do not."
The ultimate challenge for Napster may not be just survival, but figuring out how to survive without selling its soul.
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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