Song-Swappers Love Napster, But Will Wall Street?

Media stocks are high risk. Internet stocks are higher risk. Companies with pending legal action are ... well, you get the pattern. So what could be more risky than an Internet media company defending itself against multiple high-profile lawsuits?

Napster, a privately held company in San Mateo, Calif., offers a free, eponymous software tool that makes it easy to locate and share music files over the Internet.

Three major lawsuits -- one by a music-industry trade group, two by individual recording artists -- claim the technology abets the theft of copyrighted material. Thus far, the courts have been receptive to that argument. Still, the technology has shown such widespread appeal that it can't be written off. The question is, can it be harnessed for lawful purposes and turned into a profit-making venture? Venture capitalists have been interested enough to put up some seed money, but the road ahead is chockablock with obstacles.

Napster doesn't offer a service previously unavailable. If you know where to look, music files, usually in the MP3 format, can be found tucked in repositories all over the Web. Napster's huge popularity -- and the anger it has engendered among record companies and some artists who think it's robbing them -- comes from how much easier it makes the act of file-sharing, particularly for the less technically sophisticated among us. Using Napster, users can help themselves to music files found on the hard drive of anyone connected to the service.

Trading Tunes or Stealing Songs?

Historically, the industry has been resistant to new technologies; its response to Napster has been typically knee-jerk from a monolith that once claimed "home taping is killing music." The industry is pushing a standard called Secure Digital Music Initiative (SDMI), in which so-called "secure" music files can be sold over the Net, at a price of $3.49 per track. Assuming an average of 15 tracks on a CD, that's $52.35 for a CD over the Net. It's doomed.

On Napster, music files are free. The company has secured $2 million in seed funding from notables like ValiCert CEO Yosi Amram, Joe Kraus, who founded the Excite half of Excite@Home (ATHM Quote) as well as the Angel Investors group. Despite the lawsuits, the promise of Napster-like services is great enough that venture firms Benchmark Capital, Hummer Winblad and Redpoint Ventures have all met with the company.

Not Only Rock-n-Roll, and They Like It

All these companies are interested because Napster is about more than music. Since Napster's locating algorithms are rigorous, it makes sense as a vehicle to share more than just some Santana MP3 file. One developer wrote a now-ubiquitous program called "Wrapster" that lets you "wrap" any kind of file so it looks like an MP3 file and Napster can find it. You could, theoretically, "wrap" the entire Windows 2000 CD-ROM and make it available via Napster in what looks like an MP3 file.

A much easier implementation of the same idea is Gnutella, a similar, next-generation service that suffers less legal liability than Napster because it doesn't maintain its own list of all the music files its users store on their own hard disks. Gnutella was developed by the people at Nullsoft who created Winamp, one of the original MP3 players. Nullsoft is now owned by America Online (AOL Quote), which is merging with Time Warner (TWX Quote), which owns a large body of Warner Brothers music assets. Within hours of its release last March, AOL halted distribution of the program.

That hasn't stopped development of Gnutella, though, which was intended as an open-source collaboration project. Many programmers outside the AOL family have worked to improve Gnutella and make it work on different computer systems. As of May 11, there are roughly 2 million files on the system, and a quick look at what searches are being conducted (you can use the program to see what other people are searching for) suggests that the biggest use of Gnutella is to distribute music files and pornography.

Something for Nothing?

So where's the money? Even the most vocal supporters of Napster and Gnutella get tongue-tied when asked that question, reverting to terms like "long-term marketing effects" and "I have no idea." Napster's business model is a question mark, and Gnutella, like Linux and Apache, is an open-source software project not legally owned by any person or company. Napster- and Gnutella-like simplification can be built into any existing file-sharing program or operating system. Perhaps the technology is more likely to fuel a Web standard, like HTTP or HTML, than a particular company. (And early attempts to build for-profit file-sharing services, like Los Angeles-based Scour, aren't particularly promising.)

However, there are many large companies, from Cisco (CSCO Quote) to Amazon.com (AMZN Quote), that owe their existence and success to the existence of standards like HTML and HTTP. Now that the technology is available, it's up to inspired developers and entrepreneurs to figure out what to do with it. For now, investors will have to sit back and wait to see what breakthrough companies it inspires.