Digital Music Pt. III

The mp3 encoder/decoder was reverse-engineered and released as a freeware. Two young entrepreneurs saw a chance to help move music forward to a digital market, but life had other plans. 

Enjoy this post, the last of a series in which we explored the history of digital music. 

Napster

1999, just two years after the incident that freed mp3 encryption as freeware, Shawn Fanning, 19, was frustrated with the difficulties of browsing for music on the Internet, which consisted in using a regular search engine to look for whatever song you were looking for. 

Shawn then got an idea to build a software based on the peer-to-peer protocol, which would consolidate the browsing and downloading  of the users' music files collections using a centralized server. 

In plain English, this means that people would be able to browse each other's hard drives, which was ludicrous. You see, in 1999, hard drives were perceived as private assets. ditto for broadband. 

Fanning's nickname as a kid was Napster, something to do with his haircut. This was also his Internet Relay Chat (IRC) nickname, and it was also the name he chose for his application. 

Fanning logged into an invite-only room within IRC, w00w00, where he interacted with wold-class elite hackers like <Mars> and <Nocarrier>, with whom he bounced ideas on the software (interestingly refusing to share the code, which was unusual). They took the refusal to see the code as a fun challenge and helped out. In the same room he met <Man0war>, Sean Parker, whom he quickly befriended, and invited to become a part of Napster, along with <Mars> and <Nocarrier> who also eventually joined the company. 

Fanning spent around six months coding and the first version of the application was shared with a dozen or so friends, and uploaded to the Internet to allow downloading. 

Pretty quickly thousands were using it on a regular basis. A promising start. John Fanning, Shawn's uncle, offers assistance with the business end of thing for a 70/30 split... 70% for the uncle. Classy...

You’re saying that people are gonna download a client, put a client on their computers, and they’re going to allow stuff on their hard drives to be shared [...] We’re gonna like, download stuff from each other. I was like, 'nobody’s gonna open up their hard drive like that, nobody is going to allow their bandwidth to be used. No one is going to share an MP3.' That was my quote. And… Boy, was I wrong...”

​- Aly Aydar / <mars>
Senior Director of Technology, Napster

Moneys and lawsuits

Like any enterprise, money was a concern. Fanning thought "if you build it, they will come," although no one seemed to know who "they" were, or how "they" would come. They needed a business plan for potential investors. 

The first official business plan was to get 10 million users and eventually sell them concert tickets and music merchandise. This plan got them their first $250,000 usd for 1.25 million shares. 

By fall 1999 Napster had 150K users registered, multiplying at an unprecedented rate, sharing millions of files. New investors joined in at this point, bringing an additional 2 million usd of new funds. at this point they hired a CEO, software engineers, installed hundreds of servers handling the traffic, and rented offices in silicon Valley.

In December 1999, the Recording Industry Association of America (RIAA) files a lawsuit against Napster, citing infringement of music copyrights. 

But no one panicked. 

Parker and Fanning actually saw the whole thing as a "negotiation tactic" to get the best possible deal from Napster when the time for such a deal came, because it's their product, after all, so they should be the most interested party, and they stood to gain BIG once this thing got monetized somehow. And it's not like the Napster kids were oblivious to copyright, they just naively thought they were in the clear because there were no copyrighted files in their servers, as all files were downloaded directly from users' hard drives. The “Safe harbor” provision in the Digital Millenium Copyright act would protect them, as the service provider, from the action of their users, or so they thought. 

Of course, thanks to the lawsuit was that Napster and Fanning achieved unexpected stardom. 

Shawn Fanning

The public opinion was divided, which of course made for even better media pieces. Bottom line: Students loved it, some artists defended it publicly (Limp Bizkit, Chuck D, Courtney Love), some artists were publicly against it (Eminem, Dr. Dre, Metallica).

By the mid-2000 the user base was around 20 million, and tens of millions of dollars poured in. As a precondition for all those millions invested, Napster had to hire a lawyer as the new CEO, the fight was not going away, they needed a strong lawyer. 

Then it hit the fan. A single sentence in one internal e-mail became the star witness in the case against Napster

[...] since they are exchanging pirated music."

- Sean Parker, in an internal e-mail at Napster

This was evidence that management knew all along that Napster is a platform for illegal downloading.

Late in July 2000 the trial started. Both sides presented their case to the judge, she went to her chambers, and 30 minutes later she came back to the courtroom and declared she was ready to rule. 

Both sides froze. 

She was ready to rule on such a complex groundbreaking case after 30 minutes of thought without questions, clarifications or additional documents?

She ruled against Napster. Napster appealed, the court of appeals granted the request for a new trial. In the meantime, the user base kept growing and files kept on being shared by the millions. Napster was actively looking for investors at this stage, to help with the lawsuit and to keep the lights on and operations going. 

In the Fall of 2000, 3 months after the trial began, Bertelsmann, the owner of the BMG record company gave Napster 60 million usd for a major stake in the company, and became a Napster champion, this in spite of their own record company being part of the lawsuit against Napster. BMG’s CEO, the head of Bertlesmanns record company, demonstratively resigned right away, followed by the chairman of the board, but Bertlessmann, the company, stood by its decision of backing Napster. The head of Bertlesmann, Thomas Middlehoff, saw value and potential in Napster as a sales tool (30M users at this time)

In early 2001 the appeals court decision came, the judges ruled against Napster again. At this stage Napster's lawyers went to the US Congress and found a receptive advocate for their cause in the Chairman of the Senate Judiciary Committee, a republican senator at the time, and someone of considerable influence and power, who actively pushed their cause at the highest level. 

Let's just pause a second to acknowledge that what started as a 19 year-old in a chatroom with a funny nickname talking to his friends went through tens of millions of users around the world, to international conglomerates, to a cover of Time magazine, and now was at the epicenter of the political power in the US. All within two years. 

While the Republican Chairman of the Senate Judiciary Committee was trying to aid Napster on the hill, one of the Republican senators leaves the republican party, and the senate majority changes from the Republicans to the Democrats. The republican chairman of the senate judiciary committee loses his position on the Committee, and Napster loses the support on the hill. You can’t make this stuff up. 

Napster hangs on looking for new revenue channels, Bertlesmann spends an additional 30M on them, everyone on the team works feverishly to change tracks, but then in the summer of 2001 Thomas Middlehoff, head of Bertlesmann,  is fired by the Bertlesmann’s owners, and Napster's lifeline was cut. In May 2002 Napster files for bankruptcy. They had 55 million users at their peak.

Fun fact: The only revenue Napster made came from t-shirt sales, an effort Chris Phenner drove, and is happy to remind anyone willing to listen. 

Sean: I brought down the record companies with Napster, and Case'll suffer for their sins too.
Eduardo: Sorry, you didn't bring down the record companies. They won.
Sean: In court.
Eduardo: Yeah.
Sean: You wanna buy a Tower Records, Eduardo?

​- The social network, 2010

It may seem like a win for the labels, but at most it was a Phyrric victory. Soon after the court's decision, services like Gnutella, Morpheus, Kazaa, AudioGalaxy, LimeWire, and Grokster surfaced to replace the gap left by Napster.

The music industry was slow to see the online market as the inevitable future and to embrace it as such. After the lawsuit was won, their solution to illegal online downloading was to keep the old business model. Business as usual. Aside from a couple of initiatives, they didn't even try to offer an appropriate alternative. Why? Two main reasons:

• People who did understand the new online mentality were in lower echelons in the corporate ladder than those with decision-making power who were all about the old school. 
• There were five major record labels, which means five cultures, egos, strategies, and visions that required negotiation and synchronization. IMPOSSIBLE. 

The initiatives: 

1998 - Secure Digital Music Initiative

• Proposed a music file encryption system to secure all music from pirates. 
• Proposed online shops to sell said files. 
• They would design a portable player that everyone would want, on which those files would be listened.

Wishful thinking. After meeting after meeting in hotels all over the world, for years, egos were impossible to negotiate as each label had their particular wants and needs. 

In 2002, SDMI disbands. 

Let's try again, now with a cooler name. That should do it.

Digital Music X (DMX) 

• This time they constrained the group size: Warner, Universal, Sony, Phillips, and Apple. 
• The Advanced Audio Coding (AAC) should do the trick. 
• But Sony had their own encoding: ATRAC. 
• Talks stalled. Again. 

One year later, DMX was dead too. 

By early 2002 Apple had already released iTunes software for management of the digital music files and their first iPod. They were ready for business. 

First generation iPod. Source: CNet

The final piece of the puzzle was getting licensed music from the record labels, without the licenses, it would be just another little software, another portable digital music player.

So Steve Jobs called the label executives and sold them: 

• Songs would be encoded using AAC protected through the Apple FairPlay system. 
• Files will only be playable on iPods and computers.
• Up to 3 computers, unlimited iPods
• Warner, Universal, BMG, and EMI were in. 

​Sony held out, and obviously, they were also an electronics company, and they conquered the market with their own portable music players (the walkman and the discman). Steve Jobs called them back shortly before unveiling the store, and basically told them "this is happening, with or without you". Sony couldn't afford to be the only major label not on this thing. They finally relented and agreed. 

In April 2003 the iTunes Store went live. 

Now, why did the majors relent to Apple? A few reasons: 

• Apple had a 5% market share, how badly could they possibly screw up with a 5% share?
• Apple made it known that they had an 80-100 million usd budget for marketing per year. Any label would want to ride this train. 
• Surely, Microsoft would react and come up with their own platform quickly and compete with Apple, so labels would profit from the competition. 
• And, to be honest, they were probably starstruck with Steve Jobs' genius, success, capability, power, and charisma. The labels were dealing with each other, peers, competitors, and colleagues. Steve Jobs was already a legend at this point. 
• Napster had countersued the labels, charging that they had an agreement among themselves not to sell content to Napster's digital platform. The labels needed cover, an experiment with a 5% market share owner seemed safe enough. 

A few years later, the labels themselves insisted Apple drop the FairPlay system protection, and thus iTunes files became compatible with other digital music players. 

Thank you

Thanks for checking out this series of blog posts, the history was rather interesting, to say the least. Thanks to digital music, no one physical format ties songs to it, and music is free once again. We need to address this issue, as the income that artists are generating from the king of today's music formats, streaming, is sub-par to any other format before. Fights will still need to be fought, but music will surely keep on playing. 

Let us know your thoughts and ideas in the comments, and let's all keep the music playing. 

Author

Luis Garza is a professional project manager, and the head of strategic planning at Estratagema Records.