Napster Ally Middelhoff Questions Motives of Rivals

Bertelsmann Chairman Thomas Middelhoff is not one to run with the pack.

The German executive recently broke ranks with the Big Five music giants to join forces with industry archenemy Napster. Middelhoff’s decision stunned not only his partners in the Recording Industry Assn. of America, but also his own music management team--a number of whom got the boot soon after in a sudden restructuring.

Middelhoff has been knee-deep in negotiations for the last two months trying to close a merger with British music behemoth EMI Group and to convince his counterparts at Sony, Vivendi and AOL Time Warner to keep Napster up and running until July 1--the day he predicts a legal version of the file-sharing service will be ready to be launched.

With the clock ticking on a court ruling to shut down Napster, Middelhoff questioned the motives of his competitors and spoke candidly about the problems facing his own music division.

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Question: Music conglomerates say they want to banish Napster because they are concerned about protecting the intellectual copyrights of artists. Not everybody believes their motives are so altruistic. Do you think killing Napster is more about protecting the Big Five’s lock on music distribution?

Answer: It’s no longer a question of protecting intellectual property rights. The court has already ruled that Napster can’t go on the way it has. A new legal Napster is about to be launched. So now it’s purely a question of who will have the power, who will control the new distribution channel. And it seems to me that the music majors are saying, “We must control it. We controlled it in the past and we must control it in the future.” The problem is they are not thinking about what the consumer wants.

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Q: Napster users aren’t consumers. They get their music free.

A: Up until this point in history, record companies have always had the power to set the standard for distribution. They invent the format and consumers are expected to use whatever delivery system the companies dictate. LPs. Cassettes. CDs. But Napster and the Internet changed all that. What music companies fail to accept is that kids don’t just like Napster because it’s free. They like it because it’s easy to use. My fear is that if they shut Napster down before we’re able to implement the legitimate version, 70 million music fans who use it may be lost to the industry forever. Why take that chance? All we’re talking about here is three months. Why not let it stay open?

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Q: So Napster has developed a technology that will allow them to launch a legitimate file-sharing service by July 1 that will compensate artists and record companies?

A: Yes.

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Q: You’ve seen the technology yourself?

A: Yes.

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Q: And if on July 1 the new Napster doesn’t work, what would you suggest be done then?

A: Then it should be closed. That’s how confident I am that it will work. That’s why we should keep it up and running until they can make the transition. Why shut it down and burden consumers testing a bunch of other systems that are more difficult to use? They’ve already found a service they love: Napster. And they are willing to pay a reasonable fee to use it. Our market research indicates that Napster could create significant additional revenue streams for artists and songwriters, labels and publishers, for the entire music industry. The potential for this new revenue stream should not be underestimated. You know, no one in America talks any more about why MTV earns all the money from our music videos or why radio makes all the money from playing our singles. Labels don’t get anything. Artists don’t get anything. The industry lost out completely on those revenue streams. But now, a new opportunity has been presented with Napster.

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Q: Napster angered the industry when it staged a news conference and announced it was willing to pay $200 million per year to the industry without even consulting the labels beforehand. Why should labels accept a cap payment from Napster?

A: This was simply a principle offer from Napster, saying, “How about this? How about this possibility for a business model?” A launching point to discuss new revenue streams and profits. It was an invitation for a discussion. The problem is that neither side trusts the other. There’s been bad blood for so long between Napster and the record labels that it’s hard to get them into the same room to talk it out. The industry’s reaction to the announcement was negative. At least now though, everyone is finally sitting down together and trying to find a solution.

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Q: How do you plan to persuade artists and publishers to accept a deal that won’t pay them royalties on a per-reproduction basis?

A: Based on our studies, file sharing does not cannibalize CD sales. Our research indicates that Napster users are heavy music buyers. In fact, we believe they may be some of our most important customers. Artists need to understand that Napster will plug them into a giant community where fans interact and communicate exclusively about music. We’re not talking about a mature business here either. Right now, Napster is still just a baby. If it grows, the revenue potential will be enormous.

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Q: There has been much speculation about recent meetings between you and Vivendi chief Jean-Marie Messier, Sony chief Noboyuki Idei and AOL chief Steve Case. Competitors at their level must be mulling over some of the same questions as you, particularly the issue of balancing a company’s intellectual property concerns with e-commerce goals.

A: Well, I can’t confirm officially any specific meeting, but I may say that the way I’m thinking at Bertelsmann is principally the same as how my peers are thinking at other companies. They would’ve preferred that we not make a move until after the final court decision came in. But I think it’s clear that if Napster is allowed to grow into a legitimate service, then practically every software company will step up to negotiate deals with them. In terms of digital management, it would clearly be of interest for companies like Microsoft and Sony. I can imagine a day when the Napster brand could find its way onto game devices like the PlayStation.

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Q: Let’s talk about Bertelsmann’s music division. You negotiated the Napster deal behind the back of your music chief and then restructured your entire record division.

A: It’s my conviction that digitization and file sharing will change the entire music industry value chain. My thinking is that more than ever, a record label should focus primarily on signing and developing talent and marketing their music. In the future, corporations must establish direct access to consumers through multi-channel online and offline distribution strategies. Some of that distribution may be owned by the industry, but I don’t believe the industry can control every channel any more. The industry must determine what the music fan really wants in the future. And to me, it’s clear that [Napster founder] Shawn Fanning figured out something the industry overlooked. I believe that file sharing is going to change the way music is created and marketed in the future.

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Q: Bertelsmann has gone through much turmoil on the management level in your BMG record sector. Your former music chief Strauss Zelnick tangled with executives such as Clive Davis, Clive Calder and Rudi Gassner. Could you explain what led your decision to replace Zelnick?

A: I wouldn’t like to comment now about what happened in the past.

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Q: The management shake-up ended up costing Bertelsmann quite a bit of money. We reported before that BMG had been expected to fall nearly $100 million short of its projected profit goals this year. Now I hear it’s even worse than that.

A: Well, it’s a question of whether you’re speaking about ongoing business or about budgets. If you take into account one-time items, then you might be right. But when you say, OK, these are one-time items and we report on an ongoing business base, it’s under $100 million.

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Q: What I’m trying to point out here is that there seem to have been other problems beyond the management shake-ups in your music division, problems with profitability.

A: True. Bertelsmann has been unhappy for years with the profitability of BMG. We have always said that relative to others, the profitability at BMG is not good enough, and we should increase it. And that is exactly what we are trying to do right now.