Music Giants Miss a Beat on the Web

Next month, after two years of planning, the world’s biggest record company will unveil its answer to Internet piracy.

Seagram’s Universal Music Group will start selling digital downloads on the Web, hoping against reason that fans will cough up $2 each for songs they still can easily download elsewhere for free.

It’s a Hail Mary shot that few executives believe will work.

Universal’s “bulletproof” technology is too unwieldy and too expensive, costing more to operate than fans want to pay for the music itself. But worst of all, it’s really not bulletproof. Sources inside the company say the encryption code is likely to be hacked and rendered obsolete before the corporation ever makes a penny on its investment.

Still, all the music companies have similar plans.

This is just the latest blunder by the music industry, which has managed to miss every major development on the Internet. And Seagram isn’t the only laughingstock online. EMI, Time Warner, Sony and Bertelsmann also are flailing in cyberspace.

So far, the music giants have been unable to come up with any practical alternative to innovative file-swapping technologies such as Napster. Instead, the companies have pursued a piecemeal legal strategy, trying to sue the electronic bandits out of existence.

So it’s no surprise that chaos is crippling the $40-billion music business as the five biggest record conglomerates find themselves torn between the old world establishment and the Internet unknown.

After years of infighting, turf battles and just plain dithering, they now have only a brief window of opportunity to move their industry out of the record store and into cyberspace.

They could easily lose the whole game by destroying the value of intellectual property in the process.

Copyright industries have been the leading agent of U.S. economic growth over the last 20 years, currently accounting for $68 billion in annual foreign sales, the nation’s biggest export. The music industry already stands to lose nearly $1 billion to Internet theft by 2002, analysts at Sanford C. Bernstein say.

The top managers in the recording industry were late to grasp the crisis.

It took his 11-year-old son to alert Martin Bandier, group executive at EMI, the world’s largest music publishing company. Bandier was challenged one evening to “Name your favorite song, Dad.” After a few keystrokes, the requested tune came pouring out of two tiny computer speakers.

“I almost passed out,” recalls Bandier, watching his son cue up composition after composition. Bandier knew kids were downloading free music from the Internet, one song at a time. But now the entire Motown catalog--a collection of 1960s hits worth $20 million annually for EMI--was stored in the family’s personal computer, all accomplished with Napster in one afternoon.

“It’s time to put up or shut up,” says Jimmy Iovine, a veteran record producer who now runs Seagram’s Interscope and Farmclub.com divisions. “The industry needs to move right now.”

The stakes have never been higher. Several global giants are earning billions of dollars from manufacturing, distributing and selling music, films, books and other forms of intellectual property. As the Internet becomes an easy distribution system, these firms are championing the Web as the next frontier full of hundreds of millions of untapped customers.

That’s the sales pitch behind the recent multibillion-dollar mergers of Time Warner with America Online and Seagram with Vivendi. Online distribution will allow them to charge less and make more money, boosting profits exponentially by cutting out the retail middleman and dramatically expanding the consumer base.

Vivendi envisions a world where fans will buy music from a menu of music subscription services, downloading songs on portable digital devices anywhere on the planet. Under that scenario, consumers will be able to download music on a cellular phone in the car, transmit to a hotel laptop and then zap it back to a TV set-top box in the living room of their home.

“We’re talking about a future with unlimited options where music will become a service,” Vivendi Chairman Jean-Marie Messier says. “Would you like to preview the latest song by Shania Twain before it goes to radio? Or download the whole CD? Maybe you would prefer unlimited access to the entire library of New Orleans jazz music. What we will offer is an a la carte menu. In the end, you, the consumer, will decide exactly how much you want to pay--not us.”

Like Messier, most music executives are relentlessly upbeat about the industry’s prospects online, forecasting a booming future with boundless new revenue streams.

Yet, these same executives were painfully slow to grasp the power of this new medium. And so far, they have failed to make it work for them instead of against them.

Migrating to the wireless and broad-band universe will be much more difficult than anyone would like to admit. It will force companies to test uncertain economic models, shut down current manufacturing and distribution operations and, of course, fire thousands of employees.

And while cheap online prices cannibalize compact disc sales, the industry somehow will have to find a way to keep the music stores and the rest of today’s brick and mortar distribution system up and running until they go completely digital.

Retooling music-making to that new reality will reduce profits from a few dollars per unit to a few cents. Now, music is sold in albums of songs. But the Internet is a hit singles medium.

And that’s assuming everything goes right. What if it doesn’t?

There is no proof that the music industry will ever come up with a way to securely and conveniently deliver music online and entice people to pay for it. By underestimating the allure of the Internet, companies already may have lost an entire generation of fans who have grown up thinking music is free.

The industry has taken its case to court, spending most of its energy on lawsuits battling Napster, MP3.com and other purported digital pirates. The flaw in that strategy is obvious to many music executives who privately acknowledge that there is no practical way to enforce any anti-theft rulings they may win.

In fact, only one individual has ever been prosecuted for online music theft--and he was not forced to pay a penny or spend a single day in jail.

For every site they shut down, a dozen new copy-and-swap technologies--such as Freenet, Gnutella, Gnarly! Wrapster and !Mesh--pop up.

“The reality is that the next big thing already is being developed somewhere by some 17-year-old high school student completely off everybody’s radar,” Napster Chief Executive Officer Hank Barry says. “Technology will continue to evolve.”

The industry’s initial Band-Aid--secure online single sales by Seagram and others--appears doomed.

Pirates hardly need to worry about cracking these “bulletproof” technologies as long as companies keep selling compact discs, whose digital contents can be “ripped” and converted to computer files. Indeed, the bulk of the history of recorded music already is floating around in cyberspace, free for the taking.

“We have a very serious situation on our hands here,” says Hilary Rosen, chief executive of the Recording Industry Assn. of America, the trade group that represents the nation’s biggest record companies.

Before now, the music industry has acted as the beat cop in its war on piracy. After it investigates a crime, the feds stroll in to bust the perpetrators. That’s when it was chasing down counterfeiters manufacturing CDs in giant warehouses.

In cyberspace, pirate sites come and go in days.

“The feds need to step up to the plate and deal with it,” Rosen says. “They need to change the way they investigate and prosecute violators of copyright law on the Internet. And they need to move fast.”

If the government does not soon get serious about enforcing copyright laws and prosecuting online piracy, the impact on the U.S. economy could be devastating.

It’s not just music. Internet users also can swap video and data files, portending even bigger piracy problems ahead for copyright holders of films, TV shows and books.

“Let me tell you what else is in trouble here: the Internet,” Seagram head Edgar Bronfman Jr. says. “In the end, the Internet itself will not be able to survive if it becomes a haven for illegal activity. Copyrights must be protected online.”

And things are likely to get worse before they get better.

“This is a very profound moment historically,” Time Warner President Richard Parsons says. “This isn’t just about a bunch of kids stealing music. It’s about an assault on everything that constitutes the cultural expression of our society. If we fail to protect and preserve our intellectual property system, the culture will atrophy. And corporations won’t be the only ones hurt. Artists will have no incentive to create. Worst-case scenario: The country will end up in a sort of cultural Dark Ages.”

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Times staff writer Greg Miller contributed to this story.

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Internet Music Sales Growth

While other music sales in the U.S. are expected to grow 30% by 2004, Internet sales are projected to grow more than twice as fast. They will account for 18% of total sales by then.

Sales and projected sales, in billions:

2004 (estimate): $15.6 billion in retail sales,

$3.4 billion in Internet sales.

Total: $19 billion

Source: Wilkofsky Gruen Associates

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NOT SOUND TIMING

An industry veteran says record firms have been foolishly slow to embrace the Web. C1