BMG’s Owner, Napster in Surprise Online Deal

One of the world’s top media conglomerates stunned the music industry Tuesday by joining forces with Napster Inc., the free online file-swapping service that record companies have been trying desperately to kill.

Bertelsmann--parent of one of the top five music companies, BMG Entertainment--said Tuesday it will help finance Napster’s transformation into a paid service that compensates artists, labels and songwriters for their works. The companies also pledged to bring the rest of the recording industry into the system.

If the alliance works, it could defuse the music industry’s attacks on Napster as a rogue pirate. Instead, Napster, which has already captivated the attention of millions of music fans, would become the standard for the legal distribution of music online.

Although the alliance appears to be a major victory for Napster, it doesn’t solve many of the upstart company’s problems. Most important, it does not stop industry lawsuits that are threatening to shutter the service. Industry observers also say there’s no technology available to fulfill the promises made by Napster and Bertelsmann. Even if Napster develops the technology, such a service won’t succeed without the support of the rest of the industry.

Beyond that, Napster will have to persuade its legion of users to pay for a service they have enjoyed for free. Napster Chief Executive Hank Barry said the fee must still be determined, adding that $4.95 a month is possible. He has previously estimated that up to 90% of Napster’s users would disappear if they had to pay for the service.

For now, BMG isn’t dropping out of the industry’s lawsuit against Napster. That fight will go on until the proposed system is running and compensating all copyright holders, said BMG chief Strauss Zelnick.

A federal judge issued a preliminary injunction against Napster in July for violating music labels’ and music publishers’ copyrights, but the injunction has been on hold while the U.S. 9th Circuit Court of Appeals reviews the case.

Bertelsmann’s competitors were baffled by the timing of the announcement, given the fast-approaching ruling from the appeals panel. On the surface, it appears to be a brilliant ploy by Napster to keep the company up and running--with a sizable cash infusion.

Legal experts think Bertelsmann’s plan to join forces with Napster probably will undermine the industry’s allegation that Napster has caused it irreparable harm. It also throws dirt on the allegation that there is no legitimate use for Napster.

They say the appellate court probably will reject the industry’s request for an injunction and allow the case to go to trial. The announcement could, however, backfire against Napster once the case goes before a jury.

Until now, Napster has never acknowledged that its service could be used as a vehicle to monitor transactions or pay artists and labels. In fact, Napster has often asserted the opposite, contending that Napster’s technology is only a conduit for file-swapping and that the firm is not responsible for what files fans swap and bears no responsibility in compensating artists or labels.

“Now, it appears Napster has accepted the fundamental importance of protecting the creators of the content,” said Jay Berman, chairman of the IFPI, a trade group representing the international recording industry in 70 countries. “That recognition should have occurred at the outset and saved a great deal of time, effort and resources that have gone into the litigation.”

Though Napster has a powerful new ally, it doesn’t have the technology yet to pull off the feat it proposes. In fact, the company has argued in court that it’s simply not possible to track and control what users do with the music files on their computers, at least not in the Napster system.

Even if the company finds a technological solution, industry insiders say the service won’t succeed without the support of all the major labels. And Napster has been unable to cut deals with the rest of the labels, despite more than six months of talks.

As part of the agreement announced Tuesday, Bertelsmann received rights to a stake in the privately held Napster, which is based in Redwood City, Calif. The amount was undisclosed, but sources pegged it at nearly 60% of the company.

Bertelsmann plans to offer equal shares to competitors, but it is unclear whether such a plan would raise the ire of antitrust regulators. The new version of Napster could accelerate the Internet-fueled shift in the way music fans acquire songs, giving consumers more options for how and what to buy. Napster says it has attracted 38 million registered users in part because it’s giving consumers access to a vast array of songs--something the major labels haven’t come close to doing.

Instead, the labels have been inching forward onto the Internet, making a small percentage of their songs available online in ways that are much more challenging to use than Napster. In the latest example, Warner Music is set to announce today that it will be making 100 of its songs available for downloading through the Internet.

Those songs will not be in a format that buyers can trade, however. By contrast, the new version of Napster, like the current version, will be built on popular, unencrypted formats that can be swapped, CEO Barry said.

The new service will “look like Napster looks now,” he said, adding that there would be a free service for “promotional” purposes, as well as a new membership-based service. The heart of the service, he said, will be users copying files from each other’s computers, as they do today.

“We have two core values. One is that we’re going to preserve the user experience of Napster. Number two is, we’re going to compensate artists and songwriters,” Barry said.

The leap of faith for Bertelsmann is that the new service won’t cut the bottom out of its CD business, which makes up about 21% of the current U.S. album sales from January to April of this year, according to Soundscan. A new survey released Tuesday by PC Data, an Internet research firm, found that Napster users purchased less music online than non-Napster users, with the biggest decreases seen in artists that appeal to young audiences.

Other surveys have found that Napster use leads to more CD buying. The music industry as a whole has enjoyed strong sales even as Napster’s ranks have skyrocketed.

Bertelsmann officials said they’re not worried about CD sales. Instead, they said, they were eager to tap into the community of music fans that Napster had attracted--provided they were compensated for their works.

“Somebody had to move on this, and we decided to take the lead,” said Bertelsmann Chairman Thomas Middelhoff. “I believe that the rest of the industry will eventually come along.”

As part of the membership service, Bertelsmann will make available high-quality versions of all the songs in its catalog. But one lingering problem for Napster is how to deal with the song files that users record off their CDs, including the millions of files already being traded on the system for free.

High-level music executives at Seagram, Sony, EMI and Time Warner privately said they had not been consulted about Bertelsmann’s deal with Napster, which they say is still violating copyrights.

Competitors weren’t the only ones blind-sided by Tuesday’s announcement. The deal follows months of behind-the-scenes wrangling inside of Bertelsmann and was initially opposed by executives at the German conglomerate’s own music group, including BMG’s Zelnick.

Sources on both sides of the talks say the pact was conceived by Middelhoff and Andreas Schmidt, chief of Bertelsmann’s ECommerce group, in September. Middelhoff and Schmidt entered into secret discussions with Napster chief Barry, trying to come to an out-of-court settlement to resolve their lawsuit against the online file-sharing service.

Middelhoff informed Zelnick that he intended to settle the suit just days before the industry squared off in court against Napster for oral arguments Oct. 2. The settlement proposal caved in after Zelnick objected and convinced Middelhoff to withdraw the offer at the eleventh hour.

The discussions, however, resumed within days following the hearing. This time around, Middelhoff included Zelnick and BMG digital head Kevin Conroy in the negotiations. The proposal, which was finalized late Monday night, hinges on Napster developing a legitimate business model, under which artists and songwriters and labels would be paid royalties. BMG has promised to withdraw its lawsuit against Napster when it can implement such a plan and convince at least two other major conglomerates to sign on.

On Tuesday, representatives for Bertelsmann’s competitors said they were supportive of initiatives that allow legal file-sharing that respects the rights of artists, record companies and other rights owners. But it’s unlikely that any of those conglomerates will join Bertelsmann any time soon.

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A special Times report with articles about the growth of music sharing on the Internet is at https://www.latimes.com/musicweb