Music Downloading's New Deal

Free file-sharing services are considering ad-supported business models—but first, they need to win over music label foes

by Catherine Holahan

The threat of recording industry lawsuits has certainly given pause to peer-to-peer music file-sharing services. Few have dared show their servers on U.S. soil since the Supreme Court in 2005 ruled Grokster and Morpheus could be sued, declaring open season on companies that enable users to swap copyrighted files. On Oct. 30, even News Corp.'s (NWS) MySpace—a social-networking site known for allowing all manner of freedoms—cracked down on the use of copyrighted music, licensing technology from Gracenote that allows the site to review and block songs uploaded to the site.

But the practice of what the recording industry considers illegal music downloading is alive and thriving, thanks to lax copyright protections abroad and the experience of a generation that grew up swapping songs over superfast Internet connections. And lately it's finding a new lifeline: a business model."

This year, 300 million to 500 million files were pirated each day, according to Artistdirect, a New York company that tracks illegal downloads through its MediaDefender service, and in some cases, attempts to block them. "The user base has been chased around the Internet because the companies keep getting shut down…but this is a really stubborn, persistent phenomenon," says Eric Garland, CEO of BigChampagne, an online media measurement firm.

International Lawbreakers

Many of the new sites have cropped up in countries such as Russia and in parts of Asia, where digital copyright laws are not as clear or strictly enforced as in the U.S. The recording industry is trying to fight the overseas sites by adopting the same legal tactics that worked in the U.S. The Federation of the Phonographic Industry, a lobby group representing Eaton Vance Michigan Municipal Income Trust (EMI) and Warner Music Group (WMG), has threatened to sue the operators of Russian site Allofmp3.com, for allegedly violating copyright laws.

The site owners, however, are undeterred by the specter of litigation. Even an October announcement by U.S. officials that Allofmp3's actions could cost Russia entry into the World Trade Organization hasn't shut down the service, which charges 15 cents to 30 cents per song, compared with 99 cents a song from Apple Computer's (AAPL) iTunes Music Store.

So why can't the recording industry stop the illegal music downloading? Part of the problem has to do with culture. For a generation of music downloaders, file swapping isn't the same as stealing a CD from a store. It is seen as a legitimate social-networking phenomenon and, in some cases, a way to get even with an industry viewed as having gotten fat off of consumers.

Going Legit

However, some so-called pirate sites are voluntarily moving to the side of the Recording Industry Association of America and others in the industry. They are doing this not because of the threat of lawsuits, but because of the promise of money—namely, a share in the billions of advertising dollars moving online. To do that, they need to strike licensing agreements. Erstwhile pirate sites such as Qtrax, owned by Brilliant Technologies, are working with the recording industry to become advertiser-supported networks. The goal is to make money off of the millions who have become accustomed to free music by making users pay for songs with their time (see BusinessWeek.com, 10/9/06, "Free Downloads—After This Message").

Qtrax isn't alone in pursuing ways to let users get free songs in exchange for sitting through advertising and music news. MediaServices, the parent company of Allofmp3, is exploring such a model, according to spokesman Ilya Levitov. "We're still at the phase of alpha testing," says Levitov. "When the product is ready there'll be special software which a person will download, and naturally there will be advertising on the player which will be played on the computer." eDonkey, one of the biggest so-called pirate sites, is also looking into an ad-supported model (see BusinessWeek.com, 10/24/05, "A Hard Ride for eDonkey").