The internet has forced change on many activities, and it has had a particularly revolutionary effec...
The internet has forced change on many activities, and it has had a particularly revolutionary effect on the recording industry.
Always faced with piracy through illegally copied vinyl and cassette tape, record companies now have to face up to the implications of digitalisation of music production and dissemination. Online services such as Napster now enable music lovers around the world to swap their favourite tunes as MP3 files with a few clicks of a mouse.
Established business models face a severe test. The UK's main listed music company, EMI, is floundering near its 52-week low in no small part because of this challenge.
Alex de Groote, analyst with ING Barings, says the broker retains its sell recommendation on EMI because of the outlook for the industry as it faces up to the effects of the internet.
He says: "The internet undermines the basis on which to build a growth scenario for EMI. Piracy is everywhere anyway, but online piracy is compounding that issue. EMI is in a difficult position because it is a vertically integrated company, with a deteriorating operating margin in an industry that is experiencing low growth."
Besides the online piracy issue, EMI is also in the throes of trying to sort out a merger with Germany's biggest music publisher, Bertelsmann. That merger is looking more unlikely by the day. The companies have been talking since late November, yet still have not submitted the necessary documentation to the European Commission.
The Bertelsmann link is important because the German company broke the industry's united front against what until now was its biggest single online threat file-swapping service Napster.
Bertelsmann took a stake in Napster last year despite ongoing litigation by the Recording Industry Association of America (RIAA) of which the German company is a member.
Napster has become the focus of the record industry's ire, leading to highly charged court hearings that may have set benchmark precedents for the handling of all copyrighted digital content.
The decision of a US appeals court recently resulted in Napster being told to block access to all copyrighted songs contained in a list provided by RIAA members.
The company failed to meet the 15 March deadline for implementing filters that would block access by users to all songs named, and the saga looks set to continue.
No firm calculations exist as to how much money the industry has lost to Napster and its clones, but some pointers do exist.
Napster recently held out an olive branch by promising to pay $1bn over five years to the big five record companies in the US market. The offer was rejected.
Elsewhere, the penalties that could be applied by US courts in the Napster case give an idea of the value of copyrighted content. Damages of up to $150,000 per copyrighted song traded through Napster, if applied to the 135,000 songs on the list of material the company must now filter out of its service, would equate to a payment of $20bn to the industry.
Napster does not have such assets at its disposal, although that would not stop a judge in the US from awarding such a gigantic sum in damages.
Merrill Lynch analyst Neil Blackley says the outcome of the battle between Napster and the record industry will depend on whether an agreement can be reached between the two sides.
He says: "It is up to Napster to prove its screening technology works and it is up to the music companies to agree a revenue split that is acceptable. Universal is saying it should be more like 70% content companies and 30% platform, rather than the 60:40 split that Napster has proposed."
But such discussions are already considered academic by many observers. Even members of the European Parliament, which is in the process of adopting new legislation that would give added legal protection to copyrighted digital content, admit there are limits to how well the protection can actually work.
"The internet genie is out of the bottle. We can't stop technology, but we can't let it render copyright dead," said one member.
The US has tighter digital copyright controls already in place. But, as Napster has shown, the law amounts to nothing if people realise it cannot be applied to their actions.
Napster, remember, is the one being sued, not the people using it, who will undoubtedly continue swapping songs with each other as it would be impossible for US courts to deal with a case implicating all 60 million Napster users equivalent to one in five Americans.
In addition, the complaints that drove people towards services such as Napster in the first place are also still very much there. Many consumers have felt for a long time that record companies are ripping them off.
The UK's Office of Fair Trading (OFT) said in February that it would undertake an investigation into CD prices, after it was revealed that UK consumers pay more than consumers in other EU member states. It asked Sony, EMI, AOL Time Warner, Universal, BMG, Virgin and Pinnacle Records for information on their marketing and pricing practices.
If evidence of collusion is found, indicating that the companies kept retailers from sourcing cheaper CDs within the EU, fines equal to a maximum of 10% of their UK turnover during the past three years could be applied.
The European Commission is also pursuing an investigation into CD pricing. It wants to know if the world's five largest record companies colluded with retailers to drive up the prices of CDs in the EU. Bearing in mind that these companies control 90% of the world's music, a negative finding could significantly hurt the industry's case against online music distribution.
A technical barrier
Legal action is not the only recourse for the industry, which is also trying to find technical solutions to piracy. Several copyright management software systems already exist on the market.
Persuading consumers that these are a good idea is a different matter, however, and something hardware manufacturers and content producers discovered during the 1980s when the then new medium of digital audio tape (DAT) was introduced.
Consumers did not take to DAT, which included software that prohibited making more than one digital copy of music already owned.
DVD is facing a similar dilemma. Last year, a 16-year-old Norwegian was arrested after posting in online chat-rooms software that enabled users to copy prerecorded movies from DVD discs onto their computer hard drives.
Most challenging for the music industry may be the development of distributed computing. Napster is a threat that can be challenged because it relies on central servers that are needed to connect users together.
Distributed computing using software such as Gnutella means users can connect directly to each other, bypassing server lists, and effectively becoming untouchable, particularly if the users are located in different jurisdictions.
Ironically, it was funding from AOL that enabled Gnutella to be developed. AOL pulled its funding and closed research on the technology when it realised what it was capable of, but by then it was too late, with copies circulating on the internet.
The internet is not going away, but the record companies might unless they develop business models that can deal with the impacts of the new medium and the pressure from market regulators to offer consumers a fair deal.
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