• Agreement Is a First Step for Licensing Online Music
• Music services still face bumpy road

Agreement Is a First Step for Licensing Online Music

In a hard-fought deal that paves the way for the introduction of new Internet music services, the major recording companies said today that they had licensed digital distribution rights from songwriters and music publishers.

But while the deal, which heads off a potentially nasty legal standoff, permits the recording companies to sell music over the Internet, the sides have still to determine royalties to be paid. In the interim, the labels will pay a $1 million initial licensing fee to songwriters and publishers, a down payment on an effort to create copyright-friendly alternatives to the explosive popularity of free online music exchanges.

Edward P. Murphy, chief executive and president of the National Music Publishers Association, which represents tens of thousands of songwriters and publishers, said the royalty-rate negotiations had lasted up to 24 months, and it became clear to the two sides that they had to act.

"We all know there were pirated systems out there, and there was no legitimate service" that offered an alternative, Mr. Murphy said.

The development comes amid a flurry of legal and business developments as the major recording companies continue to fight free music exchange, and as they prepare to begin fee-based systems.

The industry plans to start two online services this year. Sony and Universal have formed Pressplay, and Warner, EMI and the BMG unit of Bertelsmann are backing MusicNet with RealNetworks.

On Monday, MusicNet distributed a test version of its service to a few hundred analysts and journalists, ostensibly paving the way for the service's introduction in the next 60 days.

Napster, the once-popular free online music service, reached its own agreement with the publishers last month. The service has been offline since a court order was issued against it in July, but company officials have vowed to return.

But even as MusicNet, Pressplay and Napster get ready, the popularity of free exchanges is growing.

Jupiter Media Metrix, which measures Internet traffic, plans to release a study this week showing the total number of users at a number of the popular free services rose 492 percent from March to August.

Recent big gains were made by the Morpheus service, with a rise of 186 percent in its user base just from June to August, and Kazaa, which had a 157 percent rise in those three months, Jupiter said. Last week, the major recording companies sued both services, accusing them of contributing to the infringement of hundreds of thousands of works.

Mark Mooradian, a Jupiter analyst, said, "File sharing is once again on the rapid rise." But he said the activity at all sites combined was still less than the peak on Napster.

Mr. Mooradian said the deal struck among publishers, songwriters and the recording companies amounted to "basically a truce."

Indeed, the deal underscores business and licensing complexities introduced by the digital medium.

Presently, songwriters and music publishers split a royalty from the manufacture and distribution of each song. The amount they share is typically 5 cents to 7.55 cents, said Mr. Murphy, the executive of the publishers association.

But the songwriters and publishers have been clear about wanting a greater share of the revenue in the digital world. With manufacturing playing less a role in songs to be sold on the Internet, and thus creating fewer costs for recording companies, "we hope to get a larger portion of the pie," Mr. Murphy said.

But people close to the talks said that the amounts songwriters and publishers were seeking were far greater than what the recording companies felt they should pay. Moreover, both sides realized they faced a larger issue: there were so many unanswered questions about how Internet music services would be structured and how popular they would be that it became impossible to determine a fair royalty rate.

For instance, one basic question was how royalties should differ from a song streamed on a one-time basis, versus one sold to be kept on a hard drive, versus one that could be copied to portable devices.

"It was hard to set a rate in a vacuum," said Cary Sherman, general counsel of the Recording Industry Association of America.

Under the deal, the recording labels will pay $1 million to publishers over the next two years, a figure Mr. Murphy called "a pittance." During that time, the sides will continue to negotiate. After two years, the sides have agreed to go to arbitration, with the labels paying $750,000 a year to songwriters and publishers until a rate is fixed.

Music services still face bumpy road

Tuesday's deal between the major record labels and music publishers removed a significant speed bump delaying the arrival of online music subscription services, but it didn't end the rough ride.

 Putting to rest months of uncertainty over the future of new subscription services on the Internet, the National Music Publishers Association (NMPA), its Harry Fox licensing agency and the Recording Industry Association of America said they have reached a "breakthrough agreement" on licensing terms. Under the agreement, Harry Fox will issue licenses for subscription services that offer on-demand streaming and limited downloads, the RIAA said. Labels agreed to pay $1 million to publishers over two years and work out the details of a business deal later.

The immediate effect of the cease-fire is two major label-backed music subscription services, MusicNet and Pressplay, will be allowed to launch as planned by the end of this year.

The agreement does not mean an end to future legal wranglings over these types of services, however, nor does it address deeper questions about the viability of paid online music services. Consumer demand remains a key wild card, for example, particularly since early versions of MusicNet and Pressplay will not likely offer music from all of the labels or the ability to make endless copies for portable MP3 players and homemade CD collections. Those problems are not an issue for the many free, underground alternatives already up and running.

The Byzantine system of interlocking and contested rules governing the music industry all but guarantees that the high-profile services will be dogged by legal questions well into the future, music industry insiders say. Those could come from the same publishers with which the labels Tuesday made common cause, some analysts predict.

"It's not even really a deal; it's $1 million to forestall litigation until after the (subscription services) launch," Jupiter Research analyst Aram Sinnreich said. "There's a lot of unanswered questions about what role the publishers will play in the digital music world."

The publishers' deal follows a similar relationship struck with file-swapping service Napster late last month. That company, which also was seeking to settle a lawsuit, agreed to pay publishers $10 million as an advance on licensing fees, or ten times what all the labels together will pay up front.

The disconnect between those two licensing models is likely to cause some additional tension down the road, some analysts have said.

In addition, other groups including artists and separate songwriters' organizations might step in to take a piece of the profits once any of these services is running, analysts noted. All of these outstanding issues, including the questions about consumers' appetite for paid services, will keep authorized subscription music plans on shaky ground for years.

Nearing market, in pieces
Whatever concerns remain, the major-label backed subscription services appear to be headed for consumer fingertips within two months. MusicNet, backed by RealNetworks, AOL Time Warner, Bertelsmann and the EMI Group, is already distributing its technology through America Online and RealNetworks, the latter of which has said it will start offering the service by the end of November.

Pressplay, backed by Sony and Vivendi Universal, is also slated to launch later this year. Its service will be carried on Yahoo and MSN. That coalition recently added the rights to distribute EMI's catalog of music, but like MusicNet, will lack access to about 40 percent of major label music.

According to recent research from Jupiter, Napster and its song-swapping rivals may have fertilized the market for these subscription plans. Jupiter pollsters found that 80 percent of hard-core song-swappers--those who had used Napster or another service for more than a year--said they would be willing to subscribe to an authorized service at $9.95 a month.

That will require a few components that none of the label-backed services will immediately offer, however. For example, digital music consumers increasingly want the ability to listen to songs on MP3 players or other computers and to burn CDs, neither of which will be available through the subscription services.

"The importance of that grows every day, as consumers bring home more MP3 players or CD recordable drives," noted P.J. McNealy, an analyst with GartnerG2, a division of research firm Gartner.

Analysts also say it's critical that MusicNet and Pressplay gain access to each other's music. The average music consumer pays just $100 a year for music and will be loath to spend $20 a month for access to two services--especially as long as free underground song-swapping services remain, analysts say.

Waiting in the wings: More trouble
Should the subscription plans actually start making money, there will likely be a few more speed bumps in the way.

Many different people can hold rights to make money from any given recorded song, including the artists, the songwriter, the publisher and the record label. These rights change depending on how the song is used; publishers collect money through the American Society of Publishers and Composers (ASCAP) and Broadcast Music Inc. (BMI) when a song is played on the radio, for example, but not when a song is sold as part of a CD.

ASCAP and BMI have so far been quiet about whether they have rights to collect revenues resulting from the subscription services, as they do from some Webcasting services. But legal analysts say there is an argument for these groups to be involved.

Nor does the NMPA represent all publishers. According to NMPA chief Ed Murphy, his organization and its Harry Fox agency represent about 90 percent of songs published in the United States. If the subscription services want access to the rest of the music, they must make deals with independent publishers.

Artists, too, may well have financial or legal claims against the record labels. Many artists' contracts do not explicitly give digital distribution or subscription rights to the labels, and attorneys say that artists' managers could sue for additional royalties if the digital plans turn out to be profitable.

Moreover, some artist contracts bar "coupling," or releasing their songs in conjunction with other artists, as on a compilation disc. Some artists' lawyers say that the subscription services amount to little more than a giant compilation, which break these "coupling" rules.

"There's always a question of whether some court is going to say that digital rights weren't included in some" contracts, said Ken Freundlich, a Los Angeles entertainment attorney. "A few courts have made it seem like they won't bend on digital rights."