October 19, 2001 4:00 AM PDT

Music industry's plans spark concern

A few months ago the big record labels finally seemed to have tamed their biggest Internet foes, from Napster to MP3.com. But a threat potentially greater than California start-ups lurks on the other side of the country.

The U.S. Department of Justice is growing suspicious of the labels' increasing power, and antitrust investigators are beginning to invite start-ups to closed-door discussions in Washington, D.C., to determine whether the labels are violating antitrust laws.

"We weren't surprised," said one Internet music executive who received an invitation to a private meeting with the DOJ. "Whether or not this pattern of behavior we've seen from record labels does or does not constitute antitrust, it's certainly (a concern) to us. I wasn't surprised it was (a concern) to others as well."

After years of tension between record labels and frustrated digital music companies, antitrust authorities jumped into the debate last week. The DOJ sent civil investigative demands to several parties as part of a preliminary antitrust investigation--a probe that could derail the recording industry's precarious foothold in online music distribution.

The stakes could hardly be higher.

"Ultimately it will determine whether the online music industry is a $1 billion or a $10 billion market," Jupiter Research's Aram Sinnreich said of the investigation.

Several state attorneys general are also closely watching the labels' online ventures for signs of anti-competitive behavior. They could eventually file their own lawsuit against the record labels--or a class-action suit on behalf of consumers.

"We're certainly aware of it and are monitoring the situation carefully," said Liz Leeds, Florida assistant attorney general. Florida is one of 42 states pursuing an antitrust suit against the labels based on alleged price fixing for CDs at retail outlets. Leeds said she'd gladly take that battle to online distributors if appropriate.

"We take on anything. We're not afraid of anybody," she said.

Concerns largely appear to hinge on MusicNet and Pressplay, joint ventures between the five major record labels to distribute music online.

MusicNet, owned by RealNetworks, AOL Time Warner, Bertelsmann and EMI Group, is slated to start offering music through RealNetworks by the end of November. Pressplay, a joint venture between Sony and Vivendi Universal, is supposed to appear on Yahoo, the Microsoft Network and MP3.com by the end of the year.

DOJ spokeswoman Gina Talamona declined to provide details about the

Feeling the heat
Legal scrutiny has followed the record companies for as long as they've planned their online ventures.

May 2000
The Federal Trade Commission settles with the labels on the retail CD price-fixing issue. The labels do not admit fault.

Sony and Universal announce plans to create a subscription-based service.

August 2000
A coalition of 28 states files an antitrust suit, alleging the major labels conspired to prop up CD prices.

January 2001
European Union antitrust officials open their own retail CD price-fixing probe.

April 2001
RealNetworks, AOL Time Warner, EMI Recorded Music and Bertelsmann form MusicNet.

June 2001
Sony and Vivendi Universal christen their subscription service "Pressplay."

A European Union antitrust official says his agency will scrutinize MusicNet and Pressplay.

Napster strikes a deal to license MusicNet music.

August 2001
Word of the Justice Department investigation of record labels leaks to the press.

October 2001
The DOJ sends "civil investigative demands" to online companies, trade groups and labels, asking for detailed information about label dealings.

agency's investigation. But she confirmed that the DOJ is monitoring "potential anti-competitive practices and competitive effects of certain joint ventures in the online music industry."

A status quo shaken
The recording industry has never been popular--nor has it striven for popular appeal. Instead of spending billions of dollars on advertising and marketing, as consumer companies such as Coca-Cola and Ford Motor have, record labels have maintained a discreet distance from their actual products: Consumers buy "Radiohead" rather than "Capitol Records' Radiohead" albums.

Instead of grabbing market share and revenue through brand recognition, they control the industry through copyright laws. The laws give each company a government-granted monopoly over its own artists' content. Five conglomerates--Sony, EMI Group, AOL Time Warner, Bertelsmann and Vivendi Universal--hold close to 85 percent of the United States music market. These companies have used their market dominance to wield deep influence over prices, technology decisions and the process of distribution to retail stores.

Their control slipped in the mid-1990s, when music fans started creating MP3 files from ordinary CDs to post online. Control slipped further away in 1999, when Napster and other file-swapping services hugely expanded the amount of free music that was available at the click of a mouse.

Even before Napster's rise, the record labels were besieged with requests from start-up companies looking for rights to legally distribute music online. MP3.com, EMusic, Listen.com and a host of smaller start-ups believed they could revolutionize the music business.

Some, including Napster and MP3.com, launched services before getting the industry's support. The labels took them to court, arguing that they were violating copyright law--and for the most part, the labels have won. But even those companies attempting to play strictly by the rules found it next to impossible to get licenses, convincing many entrepreneurs that the labels were colluding against them.

One former digital music executive, relating a conversation in mid-1999, says he was told flat out by a high-ranking label representative, "We meet with all five of (the labels) once a week." The labels wouldn't "break ranks" on licensing music to start-ups, the music label executive reportedly said.

Record executives tell a different story--a classic case of the Old Economy butting heads with the New Economy.

Start-ups knew little about the music business and had no way to protect music against piracy, label executives complained. Most importantly, the start-ups wanted to give away music and were unwilling to pay for it.

"We were in (the) business of trying to give licenses, but there was no one to give them to who would write a check," one record company executive said.

Last one standing is a monopolist?
As the start-ups folded, the record labels prepared to launch their own start-ups to feed consumers digital music. MusicNet and Pressplay differ slightly, but each will be a subscription service offering downloaded and some on-demand streamed music.

MusicNet will let its retail partners--America Online, RealNetworks and perhaps Napster--decide how much they want to charge for subscriptions. Pressplay casts itself more strictly as a retailer, imposing strict rules about what MSN, Yahoo and others can charge consumers.

Many digital music executives are unwilling to criticize the labels' practices openly for fear of endangering ongoing negotiations. But skepticism of the joint ventures abounds.

"When The Beatles sang, 'I Wanna Hold Your Hand,' I don't think they meant it as a business model for the record industry," said Bob Kohn, chief executive of Laugh.com and former chairman of music download site EMusic, which was recently acquired by Vivendi Universal.

The labels insist that their joint ventures will not violate antitrust laws when they debut later this year.

"We are confident that, once it has gathered the relevant facts, the Department (of Justice) will conclude that our actions have been fully compliant with all applicable laws," Recording Industry Association of America spokeswoman Amy Weiss said in a statement this week. "Indeed, the steps we have taken to facilitate the legitimate online marketplace have been pro-competitive and beneficial to consumers."

One high-placed source close to one of the initiatives was frank in descriptions of the labels' calculations in forming the joint ventures. The music companies believed they had pushed right to the edge of collusion or antitrust concerns but had not crossed the line, the source said, declining to be quoted directly.

Copyright experts say the joint ventures cannot be exclusive and pass DOJ inspection. For instance, if a company wants music from AOL Time Warner, it must be able to license it directly from Warner Music Group as well as MusicNet.

Appointment with "the janitor in chief"
In theory, the labels have said they will give music rights outside of the joint ventures, recording industry critics say. But the number of broad licenses approved for services competing against MusicNet or Pressplay can be counted on one hand, they complain.

They also complain that the labels have dragged their feet for months or even years when start-ups have asked about getting licenses.

"The janitor has to talk to you for a long time before he sets up a meeting with the janitor in chief," one embittered Net executive said. "It's an extraordinarily protracted process."

Start-up executives also suspect collusion. They say contract terms offered are remarkably similar among the major labels: Almost all demand 7 cents per song for a download that is locked to a computer and expires after 30 days, for example.

"You maintain the polite fiction that you're sitting down with an independent company that in no way colludes with its competitors," the Net executive said. "I suppose you could flip a coin 500 times and have it come up the same way. And five independent companies could suggest the same contract terms."

The most tangible story comes from Napster, which is fighting a copyright lawsuit filed by the record companies. That company said MusicNet agreed to give it licenses to music but that the joint venture imposed a condition barring independent deals with Pressplay or other major labels individually.

"The major labels have employed a series of tactics to forestall or undermine competition in the digital music marketplace," said Napster General Counsel Jonathan Schwartz. "Their joint ventures are just the most recent."

It's unclear whether the start-ups are merely carping about their bigger rivals or whether they're uncovering violations of antitrust laws. But they're not the only ones suspicious about Pressplay, MusicNet and potentially anticompetitive behavior among record labels.

"I'm really confused as to why the (record labels) came upon this way of getting together in a joint venture," federal Judge Marilyn Hall Patel said last week while discussing Napster's ongoing copyright lawsuit. "Even if it passes antitrust analysis, it looks bad, sounds bad, smells bad."

 

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