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The Best Things in Life Are (Legally) Free
by Shahnaz Mahmud, Managing Intellectual Property
November 2006
After years of high profile but unpopular lawsuits targeting illegal downloaders, music companies are showing signs of wanting to get off the litigation track and rethinking how they make money from their precious intellectual property. Some are even offering up their closely protected assets for free under new digital business models. Shahnaz Mahmud examines how a downloading website is persuading major record labels to sign up
"You must not go on to the internet." These ominous words were a part of a memo sent to Polygram Entertainment employees in 1995, warning that staff caught using it risked being fired. Bob Frank, president of Koch Records and former general manager and senior vice president at Polygram for North America, laughs as he pulls the memo from a stack of papers that takes up a corner of his desk. The self-professed document hoarder says: "I'm so glad I saved it. I'm going to frame it."
The memo reveals much of the fear about the internet that existed just 11 years ago. But record labels have come a long way since 1995. Koch Records is the latest to sign an agreement, inked in September, with a new digital download business called Spiral Frog. Spiral Frog's business model is unusual for the music industry in that it is completely supported by adverts, allowing consumers to legally download music on the internet for free. It is set to launch in December in the US and Canada. Under the multi-year agreement, Spiral Frog pays Koch Records an undisclosed sum in return for access to its extensive catalogue of music, including works from artists as diverse as Jeffrey Osborne, Ringo Starr, Bone Thugs & Harmony, The Alchemist, Charlie Daniels and Public Enemy, in addition to well-known children's works from Barney, Bob the Builder and Pokemon.
Many may regard Koch Records, one of the US's biggest independent music labels, as a likely candidate for such a deal given its independent nature. But the agreement came within weeks of an announcement from America's biggest music company, Universal Music Group, that it, too, was signing on Spiral Frog's dotted line in a deal that sees Universal share the internet company's advertising revenue. One week later, EMI Music Publishing, the world's largest music publisher, signed a deal which will see its catalogue of music available on Spiral Frog's site.
Although it was not announced at the time, BMI, an American performing rights organization representing more than 300,000 songwriters, composers and music publishers, says that it was the first to sign with Spiral Frog two years ago when it was working under the name of Music Loads. The Harry Fox Agency (HFA), the largest US agency that collects and distributes licence fees on behalf of music publishers, is also in discussions with Spiral Frog, says Michael Simon, the agency's general counsel and chief strategic officer.
But it is the decision of big players such as EMI and Universal to team up with Spiral Frog and its innovative business strategy that is shaking up the music industry.
Quinn Heraty, founder of Heraty Law, commends the companies for taking a step in the right direction, even if it has taken them a long time to do so. In 2003, the Record Industry Association of America (RIAA), which is dominated by big record labels, began to file a series of lawsuits against individuals alleged to be downloading illegally. Heraty says that the legal action was a defensive move at best and at worst a huge mess. "Individuals were being dragged into litigation for things they didn't understand and told they had to pay $3,000. Even the judges in these cases criticized these guys," she says. The lawsuits did little to endear the music industry to its target audience, and arguably failed to deter committed illegal downloaders.
The RIAA disputes any suggestion that its lawsuits have been ineffective. A spokesperson for the organization said: "Although a significant online problem clearly persists, particularly on college campuses and with hardcore frequent peer-to-peer users, absent action by the industry, the illegal downloading world would be exponentially worse." But the RIAA also says that the best way to beat piracy is to offer fans a compelling legal alternative. "Giving [these] legal online services a chance to flourish is a driving factor in almost everything we do," said the spokesperson.
The Electronic Frontier Foundation echoes the argument: "If you can't beat 'em, then join 'em," says Jason Schultz, a staff attorney at the consumer digital rights lobby group. Schultz says that demand for instant access to entertainment means that companies wanting to compete must be a part of this movement. Joining with Spiral Frog allows music companies to make money from advertising, he adds, and the deals are a sign that the industry as a whole is opening up to new opportunities. But more than anything else, the agreements are borne out of necessity.
Intriguing proposition
So, what is Spiral Frog exactly? Robert Goodale, chief strategic officer, explains the company's choice of name: "We wanted to come up with something that's intriguing and that captures the uniqueness of what we're doing in the marketplace." Goodale is referring to the distinctiveness of its advertising-based model. Although the concept itself is not new many websites rely on advertising revenues to make their money applying it to the IP-rich music industry is.
From Goodale's perspective, the modern music business has twice been present at the birth of a new medium. The first was when technology made it possible to listen to songs at home or on the radio, rather than only at live performances. The second was when music videos and MTV burst into modern culture. In both cases, says Goodale, the record companies were there, but did not generate real revenue themselves. "They became a cost centre and a marketing source a sad bystander," he says. Now the question is whether they will take a more central role?
Koch Records' Frank says that companies need to be ready. "As entrepreneurs, we have to pay attention to the marketplace. Things can turn on a dime and we have to be prepared. We have to be aware of the best opportunities out there or they will pass us by."
Goodale says that the time has arrived for the advert-supported model. Investors clearly have faith in the advertising revenue model: video-clip sharing website YouTube, another ad-based initiative, was snapped-up by Google in a $1.65 billion stock-for-stock deal in October, despite the fact that the site only officially launched in February 2005.
YouTube has also struck up a content and advertising deal with CBS, further demonstrating the growing interest in revenue sharing models. Clayton Moran, a stock analyst covering media and communications at the Stanford Group, says that the way music companies are using the internet is evolving. "The biggest question for content-rich companies is whether they will choose the ad-supported model or the pay-per-use one. Are both worth trying? The answer is yes. Which model is more efficient? That remains to be seen."
Koch Records' Frank stresses that the bulk of his record company's revenues still come from selling its physical product. Around 10% of its business is generated through revenue sharing models. "That figure may be higher for one of the larger labels: it could even be as high as 20%, but not for us," he says. The HFA's Simon agrees. "In New York it's easy to walk down the street and buy a bootleg CD for five dollars. But, the reality is that in the rest of America there are people that go to their local Wal-Mart and buy a CD every week." Nevertheless, Frank says the music industry is showing interest in new models. "Anything that is a potential revenue stream, we'll look into it. It's about multiple revenue streams. Digital allows music to be ubiquitous. Music is limited in the physical space," he says.
In search of the dream demographic
Spiral Frog makes it clear that the music it offers for free downloading cannot be burned on to a CD. The hope is, says Goodale, that those who are actually using the service will come back to the site and spend more time on it. The one thing Spiral Frog asks, adds Goodale, is that while users are downloading music, they view related adverts or news items. But he denies that users are forced to sit through 90-second commercials before they can access the music. "You'd have to be out of your mind to think that we'd do something like that," he says. "It's not as intrusive as others may think it is."
But Koch Records' Frank acknowledges that the advertising model raises challenges. The free music downloads are enticing, but the key, he says, is to have adverts that correspond to the target demographics. Spiral Frog says its main target audience is aged between 13 and 34. "This is the most coveted demographic," says Goodale. Frank believes that if the adverts promote movie trailers or the entertainment industry at large, the success rate will probably be higher. Goodale says that users are asked to provide demographic information from which Spiral Frog can determine which adverts are most appropriate. It comes as no surprise that the 13 to 34 age group contains the greatest numbers of individuals using pirated music sites. By joining forces with a company such as Spiral Frog, the big record labels hope to lure illegal downloaders to a legal website.
Goodale says that one of the big problems with pirated sites is the consistency and the quality of the content. "Sometimes you don't even know how long a download will take," he says. This inconsistency of experience creates a compelling argument for Spiral Frog, according to Goodale. "We have a real business we're not caught up in litigation."
And he points out that while users won't be able to burn the downloads, the site will try and offer alternatives. "We will give Spiral Frog users the choice to buy what they're downloading. There's a price button." He underscores the issue is one of control. "Users can control what they want to listen to and when they want to listen to it. But, when we allow for free music burns, then the issue of control gets lost," he says.
Frank concedes that it is unlikely that many users will be converted into paying customers. But he argues that eventually, pirated music sites will be less accessible to users. In addition to legal actions aimed at peer-to-peer networks such as Napster and Kazaa, IP owners are trying to beat the pirates by developing technological measures to block their ability to reproduce copyright material. Koch Records, for example, has signed up with organizations such as Snocap that create so-called music dummies designed to stop people from copying songs. It works like this: copyright holders register with the Snocap system, which then gives them a string of code that they incorporate into a peer-to-peer website. When someone wants to download one of their songs, the copyright owner gets to set the price and the terms and conditions for using the music. Snocap was founded by Shawn Fanning, creator of Napster and one of the music industry's earliest online b๊te noire.
The free music danger
Although major record labels are trying to catch up with their customers by signing a deal with an internet site that offers downloads for free, entertainment lawyer J Scott Rudsenske says that changing the business model does not always change the mindset of the people who download music. "The record companies may now be making some money, but consumers are still getting the music for free." Steve Gordon, an entertainment lawyer, consultant and author of The Future of the Music Business, argues that the advertising model epitomized by Spiral Frog does not involve music companies giving their IP away for free. Instead, he says, they are using downloads as a marketing tool. But this may still have implications for the music industry in the future: if music is offered without cost, does it lose its value? Rudsenske says music is being diminished by record labels allowing free downloads. "The music then becomes a value-added to the advertisement."
Koch Records' Frank says that consumers simply connect differently to music in the digital era, regardless of how much they paid for their songs. "Kids today don't have the same attachment to music that we did [because they have grown up with the digital medium]. They don't pick up an album and try to learn the words on the record sleeve. It's an entire experience. That's gone. So our challenge is to keep the emotion alive with music consumers of all ages."
Another problem is that hackers may try to beat the music companies. Although Spiral Frog will want to keep tight hold of its content, clever programmers will doubtless try and detach the adverts from the music, challenging the model's advert-revenue rationale. "This obviously would be a violation of Spiral Frog's terms of service, but the risk exists, and once a song is posted on third party sites it can be very difficult to stop the damage," says Jim Davis, an IP lawyer at Arent Fox. "I assume Spiral Frog is taking steps to address this situation and programmers have developed technology to prevent downloaded content from being shared with other computers, so that may be how Spiral Frog intends to ensure that users visit its site to hear and download the music, but I have a feeling hackers and infringers are devising ways to overcome such restrictions." Goodale notes Spiral Frog is using Microsoft's Janus DRM to help prevent infringement but Davis says the companies will need to monitor the internet and ensure songs from Spiral Frog are not available elsewhere for download. Bobby Ghajar, an IP partner in the Los Angeles office of Howrey, says that music companies will be confident that they can police their IP assets because they would have been extremely careful in the agreements they signed with Spiral Frog. "They would not risk what they own," he says.
A model for the future?
Richard Conlon, head of new media and strategic development at performing rights organization BMI, says that the benefit of aligning with a new media business model such as Spiral Frog is its potential for growth. "New media may not necessarily supersede the physical product going forward, but it's obvious that this is the area [with the potential] for the greatest growth," he says. But he adds that it is critical that everyone who is involved in revenue-sharing models, including the music labels, publishers and songwriters, must avoid becoming too greedy. "There has to be a sustainable model and if everyone wants 100%, it won't work."
Gordon says that in a post-Napster world many more powerful peer-to-peer players have developed and people are downloading free music more than ever.
Goodale says Spiral Frog is trying to strike the right balance between the music business and consumers. He says record labels get money for the use of the intellectual property in their music, while consumers get the free internet downloads to which they have grown accustomed. If the model is successful, Spiral Frog will achieve the best of both worlds. It is already laying plans to launch into the UK next year and Europe soon after. When asked if he thinks the Spiral Frog model will work, Goodale says he is confident that it stands a good chance. Gordon backs him: "The music industry has finally determined that the digital world is its future." Perhaps that's the sentiment that should get circulated in the latest memo at Polygram.
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