Financial Times
May 21, 2002
The digital divide
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By Paul Abrahams and James Harding
Published: May 20 2002 19:54

Last Updated: May 20 2002 19:54  <<...OLE_Obj...>> 
Hollywood and Silicon Valley are at each other's throats. Both are in a
slump - and each blames the other for its plight.
The Valley's leading technology companies complain that the music and film
industries are holding back the development of online distribution. Because
of their obstructiveness, there is no compelling content on the internet to
drive the adoption of broadband technology and so stimulate demand for their
hardware. As Terry Semel, chairman and chief executive of Yahoo, put it
recently: "Four years ago, we saw the change in [music buying] habits - and
the [recording] industry still hasn't moved."
Content owners point the finger at the technology industry. Electronic
distribution was supposed to fire up sales; instead, it has made copying
easy. The music industry has suffered most but film will soon follow. "Many
people in technology say the killer application is pirated content," said
Michael Eisner, chairman and chief executive of Disney, before a Senate
commerce committee in February. "It's very hard to negotiate with an
industry that thinks its short-term growth is dependent on theft."
In the middle of this battle sits Napster. In the summer of 2000, the
peer-to-peer music company had more than 67m registered users swapping files
free of charge - an internet phenomenon. Last week - until Bertelsmann, the
German media group, stepped in - it was on the brink of bankruptcy.
Bertelsmann has agreed to pay $8m (£5.4m) to see off Napster's creditors.
Shawn Fanning, its founder, and Konrad Hilbers, CEO, are to stay on, having
threatened to walk out. But it is far from certain that Napster will survive
as a business. The online music provider is still being pursued by music
companies seeking compensation. And its transition from a free service to a
subscription model has caused users to desert in droves.
Champions of technology point to Napster's decline to argue that the media
industry is being short-sighted, preferring to curtail online distribution
through the courts rather than find ways of making money from a marketing
and sales opportunity. "There is a danger that the dinosaurs are using
intellectual property to make sure there are no mammals in the future,"
commented Lawrence Lessig, a professor at Stanford Law School.
The technology industry's frustration is palpable. Last year, for the first
time, personal computer sales fell. If music and video were commercially
available on the internet in an easy-to-use format, it would drive broadband
usage and force consumers to upgrade their computers.
But once digital versions of songs and films are available, it becomes
difficult to prevent the intellectual property being replicated. Last year
global recorded music sales fell 5 per cent to $33.7bn, according to the
Inter- national Federation of the Phonographic Industry. In the US, unit
shipments of compact discs dropped 10.3 per cent to 968m. And real sales
fell for the first time since 1991, according to Soundscan, the tracking
group.
The Recording Industry Association of America has no doubt where the blame
lies. "The industry's problems reflect no fall in popularity of recorded
music. Rather, they reflect the fact the commercial value of music is being
widely devalued by mass copying and piracy," says Jay Berman, chairman and
chief executive. The IFPI estimates that piracy cost the industry $4.2bn
last year.
Margins were already tight. Hank Barry, former chief executive of Napster,
has calculated that the industry's current distribution model allows it to
make just 35 cents on each CD sold.
The big five recording companies - Vivendi Universal, Sony, AOL Time Warner,
EMI and Bertelsmann, which together control about 75 per cent of the music
market - are fighting back. Their first response has been to introduce
embedded copy protection in CDs, although the tactic has alienated many
consumers. Bertelsmann's release of Natalie Imbruglia's White Lies failed to
play on some equipment because of copy protection technology. Similarly,
when Sony launched Celine Dion's album A New Day has Come in Europe, it
topped the charts but made computers crash.
A second strategy has been to prevent copying through legislation. In the
US, the industry is lobbying for a bill drafted by Ernest Hollings, a
Democratic senator from South Carolina, that would force makers of all
electronic goods in the US to include copy-protection circuitry. The bill,
not yet introduced, is bitterly opposed by the technology industry.
The recording industry's latest response has been to seek to harness the
internet for itself. Sony and Vivendi Universal have created their own
online, fee-paying music service, called Pressplay. AOL Time Warner,
Bertelsmann and EMI have set up MusicNet. Both have struggled to find the
right business model. According to Mr Semel at Yahoo, who was previously
co-chairman and co-chief executive of Warner Brothers Studios, Pressplay and
MusicNet "have limited amounts of music and they're not offering people what
they want".
One of the biggest problems is that the music companies have failed to
re-create Napster's online music hypermarket. Only a small proportion of the
roster of the participating recording companies is available. And users need
to know which artists record for which labels.
In addition, one of the sites sells only disabled versions of songs that,
more often than not, cannot be "burned" on to a CD or downloaded to a
portable player. The other site permits the files to be listened to for a
short time only, or for as long as the user pays a subscription.
What these efforts prove, according to Steve Jobs, chief executive of Apple,
is that the recording industry has failed to learn the lesson of Napster.
Napster's success owed more to convenience than the fact that the music was
free.
Aram Sinnreich, senior analyst at Jupiter Media Metrix, agrees. "The
internet is the greatest thing that ever happened to the music industry and
they're missing out on cashing in on it. The recording industry destroyed
the one place where all the consumers were. They were ready to pay. All it
needed to do was install the cash till. Now the free online music space is
hopelessly fragmented."
Free delivery is undeniably an attraction, however. Having all but killed
off Napster, the music industry now has to deal with a host of rival
services, such as Morpheus, Kazaa, Grokster and LimeWire. They not only have
technology that is arguably more powerful than Napster's, they also provide
music free. Kazaa claims that 78m versions of its software have already been
downloaded from its website.
Unlike the recording companies, the film industry is not yet suffering from
online piracy. About 1.5bn people went to US cinemas last year, the highest
number since 1959. Ominously, however, a version of the newly released Star
Wars Episode II: Attack of the Clones was available last week on Internet
Relay Chat, a network of global chat networks that enables peer-to-peer
file-sharing.
For the moment, the threat is limited by technological shortcomings. The
online movie format is small, the images are of poor quality and it takes a
long time to download an entire film. But Viant, a market research group,
estimates that 350,000 films are illegally downloaded every day, in a trend
that the Movie Picture Association, the industry trade group, says is a
growing epidemic.
The conflict between Hollywood and Silicon Valley appears intractable. Andy
Grove, chairman of Intel, the chipmaker, has complained that Hollywood keeps
changing its demands, in an effort to stall the development of the
technology. But northern California and the technology industry is far more
important to the US economy than Hollywood. And as Mr Grove warned:
"Technology always wins in the end."

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