Napster wounds the giant

Music industry still hasn't recovered since the upstart file-sharing service fired first salvo of digital era in 1999

Excerpt from Appetite for Self-Destruction

Published January 2, 2009 at 3 p.m.

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Photo by John G. Mabanglo / Afp/Gettyimages File/2001

Napster attorney David Boies, right, spoke to the media after a federal court hearing in 2001; the file-sharing company's co-founder, Shawn Fanning, stands behind Boies.

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When Shawn Fanning was born, on Nov. 22, 1980, he lived with his single mother, Coleen, and a rotating cast of her eight brothers and sisters and their families in working-class Rockland, Mass. "Money was always a pretty big issue," Shawn later told Business Week in a Napster cover story. "There was a lot of tension around that."

Shawn was shy, but smart and focused. He played tennis, basketball, and baseball. And he had an uncle who recognized his talents and became a sort of older-brother-and- mentor figure. John Fanning bought him lavish gifts, like an Apple Macintosh in 1996, Shawn's first computer.

"He set me up with Internet access. I was pretty much on the Internet right away," Shawn says, in his polite, no-nonsense, borderline self-deprecating way. "I think the first time I used it was to play chess. I was amazed by it. Completely sucked in like everybody."

Uncle John was a self-made man who had a vocational high school diploma and had tried and failed at two businesses, including Chess.net, run by low-paid Carnegie Mellon students. But as Joseph Menn recounts in his definitive Napster biography, All the Rave, John Fanning had a talent for staving off debt, ignoring creditors, and fighting back in court. Even during his worst periods, he had no problem buying expensive suits and cars for his nephew.

Shawn interned for Chess.net in summer 1997, sleeping on a living room couch in a house rented by the firm's six employees. "We set up a little computer for him in the living room - I think it was something we made with spare parts - and taught him to program. He was 15 years old," recalls Ali Aydar, a Chess.net employee. "You give him one or two little things and he sort of goes with it from there."

Shawn threw himself into hacker Internet Relay Chats like w00w00, learning about MP3s, and amassing his own digital music collection. "I remember having a technical discussion about MP3s online - people explaining compression ratios," Shawn says. "It gained some popularity. I heard quite a bit on IRC."

Looking for a way to trade MP3s that was faster than web search engines, Shawn was in his dorm room at Northeastern University when he conceived the idea for Napster. He was inspired by the easy-to-use format of IRC, in which users' names appeared on the screen when they were logged on, and vanished when they weren't. His plan was to set up a central server, where users would connect, see their log-on names, and view the titles of MP3s they were storing in folders on their hard drives.

The trick was that the central server contained only information on user names and MP3 text information. The actual file sharing took place between individual users' computers. Shawn named his invention after his IRC nickname: Napster. This was a haircut he had as a kid.

"I was living in downtown Chicago, working as a banker," Ali Aydar recalls, "and Shawn popped up on my (Instant Message). He started telling me about this software application he was writing and how it was about sharing music and how it was going to work and all this other stuff. I said, 'Stop wasting your time. No one's ever going to share an MP3.' I encouraged him to concentrate on school. Obviously, he didn't listen to me."

Napster begins

Uncle John incorporated Napster Inc. He took 70 percent of the business, giving Shawn 30 percent, despite Shawn's reluctance. That was a slightly better deal than most unknown musicians received when they signed to a major record label, but it was extremely bad business for 18-year-old Shawn. He agonized over it for years afterward, but always made the decision not to fight his uncle.

Shawn gave the first version of Napster to about 30 friends, mostly hacker types he'd met in the chat rooms, in June 1999. Soon, almost 15,000 people had downloaded Napster from the Internet.

After landing $250,000 from the company's first investor, Shawn Fanning and his young friend and partner Sean Parker moved to Silicon Valley. They found an $1,800-a- month San Mateo apartment with a 6-foot wide-screen television. Napster moved to the top floor of an old bank building in San Mateo. At one point, former Warner Music high-tech executive Ted Cohen showed up to interview as the next CEO. He walked into the office to find a young man sleeping on the floor with his head on a motorcycle helmet. Cohen woke him up, introduced himself, and asked for Eileen Richardson, the company's standing CEO.

"Oh, I'm sure they'll be out soon," said the kid, and went back to sleep. That was Shawn Fanning.

It became fairly clear fairly quickly that Napster had no central business plan - other than the obvious, which amounted to "generate a huge user base by allowing fans to trade copyrighted music." The company's top executives disagreed on strategy. Some wanted to charge a monthly subscription fee, like the phone company. Others wanted to sell merchandise.

"John Fanning was completely thinking a different thing: 'We will take down the music industry and give away free stuff,' " Richardson recalls.

Frank Creighton, head of the Recording Industry Association of America's antipiracy division, was the first to discover Napster.com online. He showed it to Hilary Rosen, chairwoman of trade association for the top record labels. "Oh my God," she responded. It was as if vandals had broken the locks on all the record stores and were looting merchandise in bulk. Creighton sent an e-mail to the registered user for the Napster Web site.

"We're happy to talk with you," responded two names Creighton had never heard of - Shawn Fanning and John Fanning. "We're glad you find our technology interesting and we want to figure out internally who are the right people to sit down with you."

Creighton received two more responses over the next few weeks, then nothing. He called again. And again. Finally, Richardson returned his call. When he mentioned his concerns about copyright infringement, she said she'd talk to others within the company and get back to him. He flew to California for business and tried to reach Richardson between meetings.

He called several times. No response. That made him angry. A week later, she called back. This time, Richardson knew much more about the legal issues. She suggested Napster was totally legal, given the U.S. Supreme Court's groundbreaking 1984 decision legalizing Sony's Betamax for home-taping TV shows. She refused to shut down Napster per his request. Rosen got the message. On Oct. 27, 1999, Rosen instructed the RIAA lawyers to draft a complaint.

Richardson recalls her two phone conversations with Creighton. For the first, he was cordial. For the second, she says, "The whole tone changed. It was like, 'Listen, you come talk to us, but I'm telling you right now, you really need to think about shutting things down before we talk.' Then the next conversation was with Hilary." The phone conversation between the two women blew up into an argument.

The legal war begins

When the RIAA filed its copyright-infringement lawsuit on Dec. 6, 1999, in U.S. District Court in San Francisco, it surprised no one at Napster. Few of the company's employees thought Napster could possibly lose. During Ted Cohen's job interview, he noticed white boards all over a Napster conference room. On one was scrawled the phrase: "How to Talk to the Press."

Underneath, it said, "If they call to say, 'Don't you know this is illegal?,' say, 'We didn't know it was illegal - we think it's fair use.' " "It was all deflection points," recalls Cohen, who turned down the Napster job and later went to work as EMI Music's top high-tech executive.

The lawsuit generated stratospheric publicity. Within a few months, the Los Angeles Times and The New York Times slotted Napster on the front page, and MTV crews showed up to interview Shawn Fanning and Parker. The number of total system users grew from 50,000 when the RIAA filed suit to 150,000 by the end of the same month. Shawn Fanning, in his baseball cap, T-shirt, jeans, and blank, aw-shucks expression, was suddenly a rock star, though he didn't think so.

"Rock stars and people that play music seriously - they know when they're successful, there's a certain fame associated with that," he says. "When you're writing software, it's the last thing you expected. Long coding sessions don't go well with camera interviews, even back to back."

Napster's supporters, many of them college students, were driven by rebellion. They latched onto Fanning as a David-vs.-Goliath type who invented the coolest slingshot ever.

"It just grew and grew. Shawn becomes a cultural phenomenon. Presidential candidates are asked about it in debates," Hilary Rosen says. "The intensity with which the industry was under siege was huge."

Mark Ghuneim, Sony Music's senior vice president of online and emerging technology, spent the 2001 Super Bowl halftime show studying Napster and noticing a massive surge in tracks by performers Aerosmith, Britney Spears, and the Backstreet Boys. The next day, he walked into work to see about reissuing singles to take advantage of the popularity spike. It turned out to be impossible. Labels didn't put out singles anymore. And they couldn't make any new product available in fewer than 12 to 14 days. That would have been too late.

With or without major labels, several artists figured out how to harness the power of Napster on their own: In 2000, Radiohead promoted its album Kid A by secretly releasing tracks to the service, winding up with its first-ever No. 1 album. Dispatch, a young reggae-rock band, flooded Napster with free recordings and, over time, grew its audience to the point that the band would sell out multiple nights at Madison Square Garden in early 2007.

"We were saying, 'It's a new form of radio where people can get music out there, and it doesn't have to have too many strings attached to it," recalls Pete Heimbold, the band's bassist. "What we found was it really didn't deter kids from coming to shows and buying CDs. In fact, I think it had the opposite effect - people heard songs off Napster and had a lot of merchandise and CDs."

"I hit a point where I was convinced that there was no next big thing in the music business except technology. It wasn't going to be a sound or a dropped D chord or a new way of looking or a style - it was going to be technology," adds Liz Brooks, a longtime Virgin and Sony talent scout who quit the business to be Napster's vice president of marketing. "Napster was like this cult piece of software - a lot of people in a certain age group were aware of it, and yet nobody else was aware of it."

The record industry did its best to turn back the David-vs.-Goliath aspect of the story. Dr. Dre sued. So did Metallica, in April 2000, and drummer Lars Ulrich gave heartfelt interviews saying the metal band deserved to get paid for its music. Metallica had a point, but it grossly underestimated its own fans' newfound loyalties to Napster. Suddenly, Metallica, which had made a career of liberally allowing fans to tape its concerts, was Enemy No. 1 of the People.

"Napster spun it cleverly, like 'Metallica is suing their fans,' " recalls Joel Amsterdam, then the band's publicist for Elektra Records. "That was unfortunate. [The band members] certainly hated that part of it."

In September 2000, Shawn Fanning introduced Britney Spears at MTV's Video Music Awards; he wore a Metallica T-shirt and joked to VJ Carson Daly about somebody sharing it with him. In October, he hit the cover of Time in his trademark bowl-cup headphones. Eileen Richardson was constantly on the phone, talking to the likes of Fred Durst of Limp Bizkit, Chuck D. of Public Enemy, and Mike D. of the Beastie Boys, trying to make deals.

Guy Oseary, who ran Madonna's label, Maverick, invited Richardson to the Material Girl's office in Los Angeles. As a pregnant Madonna lounged in the background, Oseary discussed a Maverick investment of $1 million. But no major artist ended up investing. "The RIAA went on the huge tour to everyone and opened up their laptops and said, 'Watch this' and 'This will be the end of you,' " Richardson says.

After Napster landed a new, $65 million round of venture capital from Hummer Winblad, the company replaced Richardson with corporate lawyer Hank Barry, who immediately tackled the RIAA lawsuit. "We felt (Napster) had a pretty good case," Barry says. "When I took this to my partners, we said, 'Look, (Napster) could lose and we could lose all our money. Or they could win and it could be a chance for the first spectacular social networking company.' "

But if the RIAA lawyers could prove Napster knew its users were pirating copyrighted music, they could convince the judge that Napster was hardly an innocent middleman like a VCR manufacturer in the U.S. Supreme Court's landmark 1984 Sony Betamax decision. Napster employees were generally careful not to acknowledge its users pirated music - even though surveys showed almost every song shared over the system was copyrighted. But when the RIAA attorneys asked for internal Napster documents during a phase of the lawyers' investigation known as the discovery process, they came across an internal e-mail from Sean Parker to Shawn Fanning that specifically acknowledged "exchanging pirated music." They deposed Parker. He squirmed. And the case was all but over.

On July 26, 2000, U.S. District Judge Marilyn Hall Patel began the trial in a San Francisco courtroom packed with hundreds of journalists and Napster supporters and opponents. After both sides finished their arguments over a period of days, Patel left the bench for a half-hour. When she came back, she announced that she'd decided in favor of the recording industry.

Napster had to remove all copyrighted material from its service, essentially shutting down the whole thing, within two days.

The final straw

All the way up to Patel's decision, Hank Barry was aggressively using all his wheeling-and-dealing skills. His first call was to Edgar Bronfman Jr., who was, at least in public, one of Napster's strongest opponents.

Bronfman, chief executive officer of the Seagram Co., which had purchased Universal Music a few years earlier, had given a speech earlier that year likening Napster to "both slavery and Soviet communism," according to The Atlantic. But Bronfman also saw that the labels could make a lot of money if they had direct access to Napster's 22 million users - in addition to selling them music over the Internet, they could also figure out what type of music they liked and target them with marketing pitches and sales. He agreed to meet with Barry. Sony Corp. co-CEO Nobuyuki Idei, too, was willing to talk, even though he said in later interviews that Japanese law prohibited a service like Napster. So was Thomas Middelhoff, head of Bertelsmann, which owned BMG Entertainment.

"I very much wanted to make a deal with Napster. I thought it made sense for the industry," Bronfman recalls.

The discussions peaked on July 15, 2000, when Napster's Barry and Hummer met privately with record executives in Sun Valley, Idaho. Bronfman invited some of his colleagues - Idei, Middelhoff, head of Sony U.S. Howard Stringer, and several aides - to the meeting at investment banker Herb Allen's annual conference of media power brokers. Middelhoff walked in and noticed immediately that none of the label executives, not even Bronfman, were sitting on the same side of the long table as Napster. He made a joke of squeezing himself into the remaining chair, between Hummer and Barry. After a few awkward seconds, Barry recalls, Bronfman then said, "Thomas, your seat's over here," and Middelhoff dutifully moved to the other side of the table.

By that time, label and Napster executives were even farther apart than they'd started out. As Bronfman recalls, Barry wanted something like a 5 0/50 split of Napster's future equity, while the record industry wanted more than 90 percent. Although Bronfman recalls a friendly, cordial relationship with the Napster people, particularly Barry, Middelhoff says he could tell from the minute he walked into the Sun Valley meeting that the Napster people and the label people didn't really like each other. Bronfman did almost all the talking. Hummer and Barry made their points. After 10 minutes, it was over.

"This was an unbelievably brief meeting," Middelhoff says. "John Hummer and Hank Barry were not ready to move any of their positions. Neither was Edgar Bronfman."

Days after Bronfman spoke with Hummer for the last time, Judge Patel's injunction came in. The deal with the labels was dead. To an extent, the opposition from executives at the major labels was understandable. Napster was enabling and encouraging theft. But label chiefs were so bogged down in the file-sharing battleground that they refused to act on the digital future of the business. Many figured they would simply win in the courts and the CD-selling business would go back to normal.

As a result, they wasted almost three critical years before agreeing to a functional, legal song-download service. In part, executives felt they couldn't plunge into a deal with Napster because of their contracts with thousands of artists, song publishers, and retail stores.

"It was not what the perception is - it was not ignorance. It was not being caught and bit on the a-- by something that was coming. It wasn't any sort of arrogance of maintaining the old way and preventing new things from happening," says Al Smith, a Sony Music VP who became legendary to tech executives as a champion stonewaller during the early days of the MP3 format. "It's that the whole nature of the copyright business creates issues that are impossible to overcome."

Difficult? Yes. But impossible? When CDs took off in the early 1980s, forever altering labels' contracts with artists, publishers, and retailers, executives had no problem forcing their clients into new deals.

And, of course, labels would later jump into a new service with Apple Computer that overcame the very same hurdles. Had the labels made a deal with Napster, they would have found several immediate advantages: a built-in user base of 26.4 million people, as of February, 2001, according to Jupiter Media Metrix, most of whom were loyal and passionate about both music and the service itself; an efficient way of communicating with their customers, discerning their musical tastes, and aiming pitches for new albums and singles; and the flexibility to set prices at a number of levels, with models ranging from pay-by-the-song to monthly subscriptions. For many users, free was not even the best part of the service. They used Napster to get music whenever they wanted, and could burn it to homemade CDs, play it on their computers, or transfer it to devices like the Rio or, eventually, the iPod.

"I feel very strongly about that moment in time, and the labels clearly blew it," says Jeff Kwatinetz, who was until recently chief executive officer of the Firm, a Los Angeles management company that represents Korn and Jane's Addiction.

"Something like 30 million-plus music fans were in one spot online. At the time, the idea of all the music you would want for $15 a month was an appealing thing and studies showed most users would've paid it. On top of that, if the site was marketed, in addition to the viral buzz, it goes to 50 to 60 to 70 million users. It's in the billions and billions of dollars that (labels) left on the table by suing Napster."

Hilary Rosen saw the same thing. At the time, she was infamous among Napster supporters for absolutely refusing to budge from her file-sharing-equals-theft position. In private, however, she argued strenuously for a deal.

"Hilary, just stop it," Universal Music's CEO and veteran record man Doug Morris told her. "We have something internally that will solve it all." He was referring to Pressplay, a clunky, poorly reviewed online music store created by Sony and Universal that cost $14.95 a month for a limit of 50 songs. The other "official" service, MusicNet, was planning to use content from EMI, Warner, and BMG, but it never got off the ground despite intense, hard-sell content-licensing meetings between its parent company, RealNetworks, and label executives such as Al Smith of Sony Music.

Today, Rosen, now the political director for the Huffington Post and a familiar Democratic face on CNN, finds the labels' Napster-era foot- dragging a tragedy. "I say this with the most affection possible: (Label executives) had all the wrong reactions. I thought this was a revolution and we should ride the wave," she says. "But they just did not see a business model that was anything but cannibalizing in the worst sense. They needed to jump off a cliff, and they just couldn't."

A new musical world

For veteran artists, the newfound independence (digital music provided) from major record labels means a shocking, liberating new world. They began their careers when labels had just about every bit of leverage possible in the star-making process.

An artist who wanted to make a record needed studio time - and that cost money, which meant a sizable loan from a label. An artist who wanted to get a single onto a radio playlist needed connections - and that usually meant a label executive who had the money to hire an independent promoter. An artist who wanted to sell millions of copies of a record needed a big-time distributor with the clout to push CDs into big stores like Best Buy or Target - and that meant one of the major label's own subsidiaries.

Today, an artist can make a record cheaply, and professionally, using software like Pro Tools. An artist can forgo the radio, building buzz and exposure online via do-it- yourself Web sites like MySpace, viral videos on YouTube, or any number of social networking services from Facebook to Garageband.com. As for distribution, who needs crates, trucks, warehouses, stores, or even the discs themselves? Artists can follow Radiohead's example and simply distribute the music essentially free online.

And that's exactly why major labels are failing in the digital age. For decades, they relied on long-term artist-development plans, breaking stars such as Bruce Springsteen and U2 over a period of four or five records, betting their investments would pay off with huge hit albums.

But that process has become a luxury in today's record business. Signing an unknown act like R.E.M. or TV on the Radio and waiting years for it to manufacture a hit is simply unprofitable. In late 2007, major labels started letting go the executives who were experts at exactly that. Mark Williams, longtime A&R man for Interscope, who helped Gwen Stefani transform from No Doubt punk rock frontwoman to glamorous solo diva in 2004, allowed his contract to expire and left the label three years later.

A few days before he left Interscope, just before Christmas 2007, Williams was reflective. "If I could just make records and work with artists, I'd do it forever. But it just doesn't work that way," he says. "There's always pressure. 'Is this the best it can get?' 'Will people like it?' 'It's not there yet.' 'Can we spend more money?' The overall focus (at major labels) is one of desperation to have hits. When the climate is one of desperation, it tends to not work so well.

"People at the majors for some time have been looking for an answer. The obvious answer is 'there is no answer.' Big labels are going to become smaller and smaller," Williams continues. "It's going to be like in the '50s and '60s, when you had hundreds and hundreds of small labels. It's going to be a lot of trial and error. I laugh when people say, 'We're going to try to fix it.' They can try, but there's no real answer.

"It's over. It's just done."

Hear more

Steve Knopper will speak about Appetite for Self-Destruction and sign books next week:

* Tuesday: 7:30 p.m., Tattered Cover Book Store, 2526 East Colfax Ave.

* Thursday: 7:30 p.m., Boulder Bookstore, 1107 Pearl St., Boulder

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