MP3 and More: Understanding the Digital-Content Revolution

Regular readers know that I have a continuing interest in the digital music wars, both as a frequent listener and as a musician myself. But the battles that have broken out over an anticopying technical scheme, over actions by the Web site MP3.com (MPPP), and over the propriety of new ventures such as Napster and Gnutella, have shifted the arguments from ripping off only music to ripping off nearly everything, from tunes to television to Hollywood's biggest and most successful movies.

I don't know where this will end -- though I have an inkling, keep reading -- but these are serious issues for many investors, because they go to the security and economic viability of many kinds of digital "content," and to the survival of the companies which sell that content.

You may laugh, for example, at Metallica's efforts to shut down Napster ... but if you're a Disney (DIS) holder, will you find it so funny when the latest Disney movies pop up as free downloads on the Net?

I have a huge stack of emails from TSC members asking for an explanation of how these services work, and why the threat to so many kinds of intellectual property is so immediate. Within space limitations, here's a quick run-down, with MP3.com today, and Napster, Gnutella and some conclusions tomorrow.

This gets a bit sticky -- it's a tangled tale -- but it's worth following if you're interested in the distribution of digital content. And hey ... if you've been feeling awfully out of it as your kids go on about Napster and Gnutella, here's your chance to catch up with them!

Let's start with MP3, both the format and the business.

MP3 is the digital file format of choice for most digital music today. It's a subset of the larger digital standard for digital movies, the "audio layer" of the MPEG spec. MP3 tools are widespread on the Net; they make it easy to convert any standard recorded-music format -- LPs, CDs and cassettes -- to a compact, high-quality digital form. The resulting files can then be easily transferred to others -- over the Web, as email attachments, or by copying them to a CD-R disc.

Playing-back an .MP3 file is even easier, using commercial products (usually also available in a fully featured free version), such as RealNetworks' (RNWK) RealPlayer. They sound good -- about FM radio quality in their most common form, but as good as CDs when saved at a higher bit rate during conversion.

Most importantly, since these are digital, not analog copies, additional copies will sound exactly like the first one. It's not like the old cassette-tape copies you used to make, where noise and especially tape hiss increased with every round of copying.

A second successful digital-audio storage and playback format is Microsoft's (MSFT) Windows Media Player. It's included with every copy of Windows 98 and Windows 2000 -- and also available for free as a download from Microsoft's Web site. WMP is now available in beta for its new version 4. Windows Media Player isn't nearly so widely used as MP3 -- yet -- but it sounds great, and saves a typical song in about half the space required for comparable MP3 files. That not only saves space on your computer's hard disk; it also means you can download a file, or send it to another person, in about half the time.

Windows Media Player files aren't important yet, but they soon will be.

The Web site called MP3.com was begun in 1996 as a distribution channel for .MP3 music files. By spotlighting the work of unknown musicians -- through free downloads of their work, files eagerly provided by the artists -- MP3.com built up a huge following. It has also occasionally been used for promotions by name-brand music acts, such as Alanis Morissette, Tori Amos, the Beastie Boys, Billy Idol, Tina Turner, Peter Townshend, Dionne Warwick, George Clinton and others, for limited free release of their new recordings.

Last July, MP3.com went public, pricing at $28, closing the first day at 63.31, after briefly touching 105. Since then, excepting only a brief November rally, MP3.com's share price has been in steady decline.

The five major record labels -- "the Big Five," including Sony (SNY), the Warner Music division of Time-Warner (TWX), EMI Group, Seagram's (VO) Universal unit and BMG Entertainment -- are not fond of MP3.com, for they see it as a threat to their continuing control of and profits from recorded music. When MP3.com was distributing only songs from people you've never heard of, who eagerly provided the .MP3 files to get publicity, the labels weren't much worried.

Then, several months ago, MP3.com rolled out two new services which drove the majors absolutely nuts. Neither relies on downloads which you can then play back endlessly, but on listening "live" to "streaming" media.

One of the new services, Beam-It, allows MP3.com users access to copyrighted music from big stars. To use Beam-It, you put a CD you (presumably) legitimately own in your PC's CD-ROM drive, then log on and ask to "beam" that CD to MP3.com's my.mp3.com site. No actual file transfers take place; MP3.com simply examines that CD in your CD-ROM drive to determine that it's a legal, original disc, then gives you access to that album online, assuming it's among the 80,000 CDs it has purchased and digitized for the Beam-It service.

You don't need to download those files to listen to them -- after all, you already have the CD itself -- but now you can listen to that music anywhere you can find a Net connection, through such popular streaming-media playback programs as RealPlayer. No long waits for downloads; just click and listen. Presto: anytime, anywhere access to your favorite music.

MP3.com's second new service allows you to buy a big act's CD from them, and start listening to the tunes on that CD immediately, rather than waiting for the CD to arrive. Since MP3.com knows you've bought the album, it felt safe allowing you to listen to the music.

Nope, said the court. In a suit against MP3.com filed by the Recording Industry Association of America earlier this year, U.S. District Judge Jed Rakoff ruled the Beam-It service violates copyright law, and enjoined MP3.com from continuing it. The company has shut down the service, though on May 8 it announced a licensing contract with BMI, the broadcast-music licensing agency, which would allow it to "broadcast" music over its Web site, with BMI collecting and distributing royalties to songwriters and artists.

The BMI deal kicked MP3.com shares up that day almost a third, to close at 13.63. More recently, MP3.com has been trading down a little, around 11.

The judge's ruling isn't necessarily fatal for MP3.com -- the BMI play, essentially claiming that what MP3.com is doing is the same as a radio station's broadcasts, shows that -- but it does suggest that digital-content sites are going to be held to a tighter standard on copyright than many had believed. That's good news, if only for a short while, for the content distributors, but in the end just makes this copyright battle messier and more deceptive.

I think what MP3.com was doing probably met the test of copyright law, since it made a good-faith effort and more to make sure users of Beam-It and my.mp3.com were legitimate owners of the CDs they "beamed."

But the advent of two logical successors to MP3.com -- Napster and Gnutella -- illustrate how serious and widespread this content protection problem has become. More on those tomorrow.

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In the discussion this weekend on "TheStreet.com" on the Fox News Channel of my forecast that the WorldCom (WCOM)-Sprint (FON) merger will go through -- present grumblings from the Department of Justice, the Federal Communications Commission and the European Union not withstanding -- I misspoke on a critical point.

I said that I thought WorldCom could be up to around 50 this summer. What I meant to say was that I think WorldCom can be up around 50, or even higher, this fall ... after the approvals for the merger are all lined up.

Sorry.

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