File-Sharing Firms Await Suits’ Outcome

The companies behind Kazaa, Grokster and other file-sharing networks weren’t named in the 261 copyright-infringement lawsuits filed this week by the major record labels, yet their livelihood depends on how the public responds.

Like television networks, the companies whose software makes file sharing possible survive on advertising and other revenue tied to the size of their audience. The labels hope to shrink the audience by making people afraid to share songs, depleting the virtual inventory that makes the networks appealing to millions of music lovers -- and profitable to their operators.

Recording Industry Assn. of America President Cary Sherman has said the labels plan to sue thousands of people, with new claims coming “on a regular basis until people get the message.” Legal experts say it won’t be easy for the labels to have much effect by going to court against individuals, given that more than 60 million people share files online in the United States alone.

In fact, the biggest blow the labels have been able to strike has been in saddling three of the most popular file-sharing companies with large legal fees, by suing Grokster Ltd., StreamCast Networks Inc. and Sharman Networks Ltd. The record companies, which were joined by movie studios in the suits, lost preliminary battles with Grokster and StreamCast but are continuing those fights on appeal. The Sharman case is pending.

The recording industry “just can’t accept the fact that they lost, and they still think that they didn’t lose. So obviously, there’s a certain parallel to the California recall election,” said Grokster President Wayne Rosso. “By attacking users for uploading, they’re trying to attack our network.”

Monday’s lawsuits targeted users of Grokster, Kazaa, IMesh, Gnutella and Blubster. Sharman’s Kazaa is the most popular file-sharing network by far; it attracted a total of 12.6 million people in the U.S. in July, according to Nielsen/NetRatings.

The privately held file-sharing companies don’t release their earnings. Executives at two of the companies estimated that a popular network can generate $100,000 to $300,000 in revenue a month and that Sharman probably collects several million dollars per month. Executives at Sharman declined to comment.

The file-sharing companies’ advertiser-supported business model should be familiar to the media giants suing them. They also are tapping into new sources of revenue, selling advertisement-free versions of their software and taking a percentage of their partners’ sales of products and services.

Unlike broadcasters, file-sharing companies don’t have to pay for the programming that attracts people to their networks. Instead, that programming -- in the form of digital movies, songs, photographs and games -- is supplied by the users themselves. Users also cover the cost of distributing those files, further cutting the networks’ expenses.

Practically every business that advertises online now uses file-sharing networks as well, “everyone from auto insurance to debt to credit cards to mortgages, right across the spectrum,” said Robert Regular of Cydoor Technologies Inc., which sells advertising space on Kazaa and Grokster. The main holdouts are “top tier” brands such as Coca-Cola, he said, adding, “These brands usually do not want to attach themselves or participate in anything until it’s extremely proven.”

Grokster, for example, sells advertisements and sponsorships to online dating companies, loan and credit providers, Internet gambling outlets, videogame suppliers, pharmacies and mobile-phone outlets, among others. Kazaa has a similar lineup of advertisers and sponsors but also attracts such well-known brands as Expedia, an online travel service, and Creative Technology Inc., a Singapore-based supplier of digital gadgets.

“There’s a greater natural acceptance in the advertising community that this is a medium that’s here to stay, and it’s valuable,” said Regular, Cydoor’s vice president of sales and marketing. The court rulings in favor of Grokster and Morpheus “validated what a lot of advertisers knew -- it’s a good medium to advertise on, it’s a safe medium.”

Other businesses prefer a broader presence.

In June, Simmons Lathan Media Group, the production company of rap pioneer Russell Simmons, cut a deal with Kazaa partner Altnet Inc. to distribute music and videos through the network’s service. Visitors to the “Russell Simmons Hip Hop Channel” can download short films, video interviews and other material for 99 cents a file.

Simmons Lathan declined to say how much it pays Kazaa for hosting the channel nor how much of the 99 cents it hands over per download. However, sources at the company said that traffic on the new venture has been strong and steady.

MatchNet, a Los Angeles-based online dating network, created an area on Kazaa where users can meet friends and pick up dating tips.

“We approached Kazaa about doing this,” said Joe Shapira, chairman and chief executive of MatchNet. “If you look at the traffic numbers, Kazaa is as big as Yahoo, MSN and AOL in terms of users. It’s the last major frontier that was uncharted.”

Though Shapira declined to discuss financial details of the multiyear deal, he said that MatchNet pays Sharman Networks for each ad on the service as well as a fee for each person who uses the channel.

Grokster’s Rosso said another lucrative revenue source has been charging other companies fees to have their software bundled with Grokster’s. Even though the fees are small, the tactic can generate a significant amount of money because hundreds of thousands of people download the Grokster bundle every month.

Grokster and Sharman Networks, which distributes Kazaa, don’t charge for their basic software, but they offer an advertising-free version that costs $20 to $30 a year. Both also have teamed up with companies that sell software, games and other products to their users, and they collect a percentage of the proceeds.

To IMesh Israel Ltd. CEO Elan Oren, the ideal would be to have the music industry supply songs to file sharers for a reasonable fee.

“I don’t think that all, or even most, IMesh users were born copyright infringers,” Oren said. “If users are faced with a choice, with a reasonable price, we’ll get more and more of them to buy the original tracks and not try to infringe copyrights.”

The major labels have insisted, however, that IMesh stop the unauthorized copying before they provide songs that users can share legitimately. And shutting down the current network doesn’t make any sense, Oren said, because it would drive users away to other, free networks.