LOS ANGELES -- In his spacious corner office overlooking the rolling hills of the San Fernando Valley,

Universal Music

e-commerce head Lawrence Kenswil looks a lot more comfortable than he did during his speech at the

MP3 Summit

. A day before, the cocky East Coast-educated exec with a Georgetown law degree presented the record industry's point of view to a crowd stuffed with downloadable music fanatics.

Given the enmity between the MP3 crowd and the record labels that control the music industry, Kenswil's speech was like

Latrell Sprewell

addressing an assembly of basketball coaches on the latest techniques in anger management. Though glib, Kenswil defused most of the tension in a speech brimming with irony.

"If you believe what you read, then music executives spend mornings screwing the artists and afternoons gouging the consumer," joked Kenswil, a music industry veteran who has been with Universal for more than 15 years.

Kenswil needs a sense of humor to steer his company through the turbulent waters of the new economy, where many believe slow-moving giant labels could be sunk by energetic start-ups. Record labels fear that if they push unsecured digital music, they'll lose their long-held grip on distribution and relinquish control over their vast music libraries. Yet if they embrace the new technology, the odds for success weigh in their favor.

Of the top five record companies, Universal's Internet strategy has been the most aggressive. In April, it announced a joint venture with

Bertelsmann

to promote and sell CDs and cassettes through www.getmusic.com. That week, parent company

Seagram's

(VO) - Get Report

stock soared 19%.

In May, Universal said it would sell and distribute downloadable music over the Net by year's end, beating

Sony Music

by a week as the first major label to unveil plans for digital downloading. And this week, Universal announced an initiative to integrate and promote the company's music with the

RioPort.com

Web site and a host of portable music players, including

Diamond Multimedia's

(DIMD)

SDMI-compliant Rio portable player.

Making Digital Music Sing
What two factors would most influence your decision
to buy songs or albums in digital format?

Source: Jupiter/NFO Consumer Survey, May 1999, N=2,023.

The major labels enjoy several built-in advantages that Internet upstarts will find difficult to overcome. Together, Universal, Sony Music,

BMG Entertainment

,

EMI

and

Warner Music Group

-- the big five -- sell 85% of the music in the U.S. They control the vast bulk of content, the big names and the deepest pockets of marketing funds.

"Six artists don't make a record store," says Forrester Research analyst Mark Hardie, dissing the Internet record label and portal

MP3.com

(MPPP)

. "The record companies are not being chopped down at the knees because of the Internet."

The industry's other big advantage, and perhaps its best-kept secret, is the catalog, or the stacks of recordings each company owns. Jay Samit, senior vice president of EMI, says the 40% to 60% of each year's record sales are back-catalog purchases. The hit-making business is a rough one, say record execs, but the catalog makes those cold years feel a bit warmer.

Last December, Universal became the industry's top dog when parent company Seagram bought Dutch music giant

Polygram

for $10.4 billion in cash and stock. Based on 1997 figures, the combined company owns 23% of the international market and 25% of the U.S. market.

"Seagram made a $10 billion bet on the music business," says Kenswil. "The bet is the business is going to greatly expand."

'Six artists don't make a record store,' says Forrester Research analyst Mark Hardie. 'The record companies are not being chopped down at the knees because of the Internet.'

Thanks to the Polygram purchase, music sales brought Seagram $1.26 billion in first-quarter sales, or 39% of its total revenue. That's up from 16% the same quarter in 1998. Given that weight, if the record industry manages to complete a successful transition to the new world of digital distribution, Universal stands to benefit the most.

Slow at First, but Catching Up

Despite its slow start and some challenges that lie ahead, the recording industry finally seems to be moving in the right direction. The most obvious sign of this turnaround is the completion of the

Secure Digital Music Initiative

framework. The SDMI standards are designed to prevent piracy and protect music copyrights in online music sales.

For its part, Universal has forged two key partnerships: One with

InterTrust

, which makes software that protects the copyrights of electronic content; and another called

Electronic Media Distribution

with

AT&T

(T) - Get Report

, BMG and

Matsushita

(MC) - Get Report

. The goal of EMD is to create a secure and scaleable network to support the distribution of digital music.

Universal is also laying the groundwork for its own digital distribution. Kenswil's 20-person team, which should swell to 40 people by the end of the year, is working on a project to encode the company's gargantuan catalog of music into digital format.

Of course, the biggest risk is that the industry's attempt to create a secure format will blow up in its face. The first test of SDMI will be to see if anyone can come up with a viable product by the holiday season, a deadline the industry has set. The second test will be if consumers actually use it.

Failure wouldn't mean the death of the big five, but a reduction in its clout and perhaps an end to its oligopoly. If customers feel alienated by the industry's strong-arm tactics, the MP3 movement could coalesce into an unstoppable consumer force outside the major labels' domain. For now, the big five -- and especially Universal -- still have the chance to extend their domination into the online music market.

Meanwhile, some feel that rather than focusing on the risks of digital distribution, the record labels would be better served finding ways to make the Web and MP3 work in their favor.

One new idea that was driven home at

Jupiter Communications'

fourth annual

Plug.In

conference in New York this week was that the record labels need to vastly improve their direct marketing skills by taking advantage of the reams of consumer data they gather online. Beyond boosting music sales, that data will also be sellable to concert promoters and merchandisers.

"Their job is to figure out what exactly is the best way to deliver music online," says Lucas Graves, an analyst with Jupiter who urges the labels to utilize MP3 for promotional purposes. "If the record labels want to keep anything like the role they've kept in offline distribution, they have to be in front of this revolution."