Music and The Internet

INTERNET
EUROPE
9 November 2000
EUROPEAN INTERNET
Heidi Fitzpatrick
44 20 7260 2964
hfitzpat@lehman.com
Music And The Internet:

A Celestial Jukebox
Andrew Hogley
44 20 7260 1499
ahogley@lehman.com
q
q
q
Pub Codes: 01/06/36/43
Get ready to be dazzled, because it is definitely show time in the music

industry. The emerging digital formats and new distribution channels, catalysed
by the arrival of broadband access, will fuel new growth in the industry.
The next two years are going to see rapid changes as the industry experiments
with new technologies and consumer applications. However, the 38m Napster
users indicate that consumers have already chosen their favoured format. We
believe that the internet will be a net positive across the value chain.
Although near-term revenues from digital downloads will be marginal, new
business models in music distribution will capture the shift in value from the
retailers to the content owners. Copyright exploitation will be one of the most
attractive growth areas in the new digital era, in our view.
Contents
1)
Executive Summary ............................................................................................................ 6
2)
Overview of the music industry.......................................................................................... 9

Recorded music is a $40bn global market
Consumer buying behaviour is changing in the digital age
Diversified tastes, increasing volume output, stagnating growth = decreasing returns
Digital downloads are changing the way people consume music
The role of independents is becoming more prominent
Complex value chain
3)
Evolution of the online music market .............................................................................. 27

Physical distribution on the internet
Digital distribution on the internet
4)
Drivers behind digital music take-up ............................................................................... 44

Broadband take-up
Availability of playback devices, wireless connectivity
Availability of content
5)
How the internet will impact music: opportunities ......................................................... 56

Multiple routes to market, every party benefits
Digital distribution as a marketing tool
Music on demand: new consumer applications
New pricing models: Multiple, different revenue streams
6)
How the internet will impact music: threats .................................................................... 79

Piracy and copyright confusion are holding back the industry
Should music be free or could music be free?
7)
The European landscape .................................................................................................. 90
8)
Conclusion......................................................................................................................... 92
9)
Company profiles:
q
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Peoplesound ....................................................................................................................... 95
Clickmusic........................................................................................................................... 98
Netbeat ............................................................................................................................... 99
Vitaminic ........................................................................................................................... 101
Freetax AS ........................................................................................................................ 104
BeSonic............................................................................................................................. 105
ICrunch ............................................................................................................................. 107
Mode Intl ........................................................................................................................... 110
Popwire ............................................................................................................................. 112
Worldpop........................................................................................................................... 114
q
q
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Tornado Group Plc ............................................................................................................ 116

Poptones ........................................................................................................................... 118
Playlouder.com ................................................................................................................. 119
MP3eu.net......................................................................................................................... 121
10) Appendix .......................................................................................................................... 123
Technology made simple: How it works
Table of Figures
Figure 1: Global music sales growth, 1984-1999
10
Figure 2: Global Recorded Music Sales, 1983-1999 ($bn)
10
Figure 3: Share of global music sales, 1999
11
Figure 4: World CD and LP Unit Sales 1983-1999 (millions)
11
Figure 5: Album sales of selected artists (m)
13
Figure 6: Bon Jovi album sales (unit m)
13
Figure 7: Number of albums launched in the UK all formats (1990-1999)
14
Figure 8: Share of Top 200 Albums (US,%), 1998-1997
15
Figure 9: % Of Music Sales in Domestic Repertoire
16
Figure 10: Average repertoire origin
17
Figure 11: Music Company Operating Margins, 1993-1999
18
Figure 12: Reasons for Downloading Music
20
Figure 13: The Music Industry Value Chain
22
Figure 14: Revenue Distribution of A CD
25
Figure 15: Total Western European Online Penetration (% of population)
27
Figure 16: US online music share of total music retail
28
Figure 17: % Of total retail sales sold online in 2005 (Europe)
29
Figure 18: Average Online price of music by Madonna in various
30
European countries ( e)
Figure 19: European Online music sales, 1999-2003E (e m)
30
Figure 20: US Online music sales Digital downloads and online CD sales ($ m) 33
Figure 21: US Online Music Market ($m)
34
Figure 22: Estimated European Download Sales, 1999-2005E (em)
35
Figure 23: The effects that people who have downloaded music think
36
downloading will have on their CD purchasing behaviour

Figure 24: Where 13-25 get their MP3s (US)
38
Figure 25: Music Sales by Age Group, 1998
39
Figure 26: Share of Total European Music Sales for Offline, Online Retail and
42
Digital Downloads
Figure 27: UK Music, Video and DVD retail market shares
43
Figure 28: Obstacles for digital distribution take-up
47
Figure 29: Broadband Access Connections in Western Europe, 1999-2004E
44
Figure 30: Broadband households as a % of all households, Western Europe
48
Figure 31: Mobile Handsets
50
Figure 32: Evolution of music content online
54
Figure 33: MODE system
61
Figure 34: Programme schedule of Storm, a major UK internet radio station
65
Figure 35: Digital music value chain
66
Figure 36: CDNow: digital downloads available for sampling music before
purchase
68
Figure 37: Everad advertising during download
74
Figure 38: Three ways to micropay by mobile phones
76
Figure 39: How Napster Works
80
3
Table of Figures
continued
Figure 40: Gnutella user session
81
82
Figure 42: Levels of domestic piracy, 1999 (units)
86
Figure 43: What compels you to visit a web site?
88
Figure 44: Peoplesound.com web site
97
97
Figure 46: Clickmusic front page
98
Figure 47: NetBeat web site
100
Figure: 48: Songs delivered per month (000)
103
Figure 49: Vitaminic UK web site
103
Figure 50: Besonic web site
106
Figure 51: iCrunch web site
109
109
Figure 53: Popwire web site
113
Figure 54: Worldpop web site
115
Figure 55: From Poptones web site
118
Figure 56: Playlouder.com web site
120
Figure 57: MP3.de front page
122
Figure 58: MP3.fr front page
122
Figure 59: Sound Quality in Audio Compression
124
Figure 60: Winamp interface
127
Figure 61: Skins and visualisations for Windows Media Player 7
128
Figure 62: Number of players downloaded since release

(end of September 2000, 000)
129
Table of Figures
continued
Table 1: Major domestic artists outside North America
16
Table 2: European Recorded Music Market Statistics (1999)
19
Table 3: Combined majors vs combined indies global market share (%)
21
Table 4: Record label market shares by region and globally, 1999
21
Table 5: Music Industry Value Chain: Examples and Participants
24
Table 6: How a band spends a $1m advance received with record deal
26
Table 7: European Wireless Penetration Data
31
Table 8: UK Media Metrix survey, entertainment category, September 2000
37
Table 9: Napster use among US college students
39
Table 10: US Media Metrix August Survey, 60 top online media sites
40
Table 11: Estimated European music sales through traditional retail, online
42
retail and digital downloads (em)

Table 12: MP3.com Top 15 Downloads (7 November 2000)
52
Table 13: Vitaminic.co.uk Top 10 Downloads (7 November 2000)
52
Table 14: Impact of the internet in various points of the music industry
56
value chain
Table 15: Major Players in DRM Base Technologies
63
Table 16: Major Clearinghouses
63
Table 17: Examples of download pricing
71
Executive
Summary
Digital media will be one of the biggest beneficiaries of the

internet revolution
With the internet, music can be distributed and consumed in a digital format.
While still experimental in technology and applications, digital downloads and
streaming are already the formats of choice for a large consumer group. In
addition, the arrival of digitally delivered music is coinciding with other transition
drivers within the music industry. Consumers are not buying music the way they
used to, tastes have proliferated and the industry is launching an increasing number
of products to match this. There is an abundance of music available, waiting to be
channelled to the consumers.
The term MP3 is a compression format, and it competes with other formats such
as Windows Media Audio and RealAudio. Compression involves encoding a
music file (essentially eliminating inaudible sounds and thus reducing the file size)
and decoding it again during playback. Although MP3 is the most popular format
currently in the market, the music industry has not embraced it because of its lack
of security. CDs can be ripped into MP3 files and thus distributed illegally on
the internet. We believe streaming instead of downloads will initially drive
growth, as streaming enables the content owner to retain control of the file.
Recorded music industry is a $40bn global market, which has been facing
stagnant growth over the past few years, as the growth in the 1980s and early
1990s resulting from the CD replacement effect has worn off. The European
music market is the second largest in the world with higher than average album
sales per capita. Growth in Europe was flat in 1999 after 3% in 1998 (in value
terms). Domestic repertoire is growing in importance, with on average 42% of
European music sales being generated by local artists. The industry is essentially
an oligopoly, with over 75% of sales being supplied by the five major record
labels; Universal, Warner Music, EMI, BMG and Sony Music.
Music distribution on the internet has already started in physical format. Ecommerce in Europe is expected to grow over 100% annually for the next three
years, according to Forrester Research. Online music retail is still a nascent
market where key players have launched only recently, but Forrester Research
expects online music sales to capture almost 20% of total music retail by 2005. As
only 1.3% of music sales were online in 1999, there is still a lot of growth ahead.
Note that CDs are one of the easiest products to merchandise online, and they are
also easy to pick, pack and ship. Some online sales will be captured by wireless
channels as internet-enabled handsets proliferate, however actual revenues from mcommerce will initially be small.
A growing consumer group is abandoning CDs altogether and consuming

music in a digital format. Revenues from this channels are tiny: in 1999, US
digital download revenues were a mere $1m, leading us to believe that in Europe
they were practically non-existent. US digital download revenues are estimated to
be a $1.1bn market by 2003, according to Forrester Research, and if we assume
that Europe is 24 months behind US in take-up, we can extrapolate that European
digital download revenues could reach EQE\
We think that current revenue figures available on downloaded music do not

accurately reflect the consumer take-up. Looking at other usage metrics, it
appears that there is already a huge active user base consuming music via digital
downloads they are just not paying for them. Napster, the file sharing service,
has in under a year attracted over 38m users, and this compares with Amazon with
Digital downloads are

experimental, but they
are already popular
There are several

compression formats
available in addition to
MP3
Music industry growth

has stalled
Online sales of CDs

should be 20% of total
retail in 2005
We expect European
download revenues of
EQLQ
Huge user base but it is

not paying
25m customers built over five years. Napster is already featuring among top 50
domain names in the US Media Metrix surveys. In the UK, Peoplesound.com is
the 5th largest site in the Entertainment category in the September Media Metrix
survey, surpassing such well-known media destinations as www.disney.co.uk and
channel5.co.uk. Although it is a concern that a large user base is getting
accustomed to receiving music for free, we believe that this use is still
experimental, and that with improving sound quality and service applying charges
will be easier.
We think that broadband take-up will be the single most important driver for
growth in digital music. Slow download speeds on narrowband connections
cannot fully utilise the benefits of this format. In addition, we believe that
availability and declining prices of playback devices will also spur growth in the
format.
So far most of the content available for legitimate downloads is generated by

lesser-known and/or unsigned artists. Because of the unsolved copyright issues
and uncertainty over format security, the majors have so far been reluctant to make
their content available for downloads. So far they have been experimenting with
limited catalogues in limited distribution.
Piracy is a valid fear for the music industry. One of the biggest headaches for
the industry has been the file-sharing applications such as Napster. However, we
do not believe that disabling Napster is going to win the war for the music industry.
First, their popularity means that new applications will keep emerging, second, the
client-to-client services such as Gnutella (allowing anonymity) represent a far
bigger threat than Napster does. Furthermore, as Napster the programme has been
the most successful viral marketing concept in the history of the internet, the record
industry might eventually find a way of exploiting this so that the copyright holders
get paid. However, piracy will never be completely eliminated (currently piracy
levels are 10-20%).
Complex value chain
The music industry food chain is extremely complex, consisting of several

different business models in which revenues are obtained. With the arrival of the
internet, this value chain is going to change. There will be new routes to market
for the music, and more efficiencies to be obtained for every party in the chain.
There will be opportunities for disintermediation, as well as some reintermediation. Artists can connect directly with their fans, and record labels can
sell their artists themselves. New business models will emerge, in particular in
music distribution, where companies providing digital fulfilment and DRM
(Digital Rights Management) services are already lining up. We believe that
eventually there will be a shift in value from the distributors to the copyright
holders.
New routes to market

for music
The key question is how will consumers acquire and consume music? We
believe aggregators will be increasingly important, and that existing online and
offline retailers with their customer relationships will be playing a major role in the
short term (after all, this is essentially a format change). There will be several new
ways for music to reach consumers, whether it is through a portal, through an etailer, through the artist site or another gateway. Music will be available on
demand. Record companies will have to become increasingly like aggregators,
channelling music to consumers according to their preferences.
Broadband will be the

key driver
Very little mainstream

content
Disabling Napster wont

eliminate piracy
New pricing models
Digital delivery of music will bring about new revenue models for the
companies in the front end of the value chain. Music can be sold on a perdownload basis, or on a subscription basis. Music files can also be rented, or
music can be given out for free with revenues coming from advertising.
Essentially, music will start to resemble a service rather than a product, and this
will result in a change in consumer mindset: music does not have to be owned,
instead it can be acquired only when needed.
Demand for content will

accelerate
We believe that as the number of digital channels on various platforms

explodes, demand for music content is likely to reach new heights. Content
exploitation will therefore become a very attractive growth area, with music
publishing revenues enjoying the benefits. We also believe that this format shift
will be a fundamental net positive for the music industry, accelerating growth
through both increased demand and wider distribution in various platforms.
In Europe, the early stage of industry development is reflected by the

diversity of business models currently on the market. What the winning model
will be is still unclear, however for the near future revenues from download retail
are likely to remain marginal. We would pick Peoplesound.com, NetBeat and
Icrunch as the most interesting start-ups in this scene. One of the largest pure
plays, Vitaminic, completed an IPO on the Nuovo Mercato in October, valuing the
company at P.
Share Of Total European Music Sales For Offline, Online Retail And Digital Downloads
100%
1%
1%
3%
6%
9%
90%
2%
13%
3%
5%
7%
16%
80%
19%
21%
9%
23%
70%
11%
24%
14%
26%
27%
60%
50%
18%
99%
97%
94%
40%
89%
82%
77%
71%
30%
65%
60%
53%
46%
20%
38%
10%
0%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
OfflineIFPI,
Online
CDsBrothers
Downloads
Source: Forrester Research,
Lehman
Research
Source: Lehman Brothers Research, Forrester Research, IFPI
Digital Music Is
Hot
Industry at an
inflection point
Overview of the music industry

We believe digital media will be one of the biggest winners of the internet
revolution. Unlike other e-volving industries, music industry is already digital:
Practically all forms of media content (books, newspapers, film, music) can be
transferred into a digital format ready for networked transmission, in which case the
need to distribute a physical object (book, CD or a video) is eliminated - at least in
theory. In practice consumer preferences dictate which distribution channels will
prevail. However, what digital distribution means for these industries is transforming
business models with new efficiencies in production and supply chain, in addition for
consumers it means new ways of acquiring and consuming media. Although media
content has already been converting into digital format for some time, only the arrival
of the internet has allowed for these new business models to emerge. We are therefore
in the beginning of a radical shift in how this industry operates.
Recorded music is a $40bn global industry, which has over time experienced several
changes in distribution and format, starting from the radio in the beginning of the
century to Minidisks which came to the market three years ago. However, the internet
and digital technology are likely to bring about a profound paradigm shift. This will be
experienced not only in the way music is distributed and the format in which it is
distributed, but also in the way it is produced and consumed. The industry is currently
in the inflection point, in the very early stages of migration, with considerable
instability and extreme viewpoints. Visibility of how the sector is going to settle is low.
Recorded music is a $40bn global market

The music industry has always benefited from the arrival of new delivery formats.
Cassette, Vinyl LP and CD have all spurred additional growth in this market, as each
new format has been able to offer better sound quality and convenience, in addition
consumers have not just carried on by buying new releases but also replaced their
collection held in the old format (this was particularly visible at the end of 1980s
beginning of 1990s when CDs took over vinyl). These extra sales generally offset
increase in the percentage lost to piracy. Although both audio cassette and CD caused
concerns for piracy, both formats ended up being a major boost for the global music
industry. We think digital music can turn out to be a similar uplift, rather than the
threat envisaged by the music industry.
Global music market
is growing at 3.4% pa
The worldwide recorded music represents a $38.5bn global market (as of 1999),
and has been growing at a rate of 3.4% pa since 1991 in value terms. Between 1985
and 1991 the industry was growing at over 15% pa in value terms, whereas over the
past two years the growth has dropped to under 1% pa although as this data is not
inflation-adjusted, so real growth in 1997-1999 has dropped to negative. Of this
$38.5bn Europe represents around $14.6bn ( EQ DFFRXQWLQJ IRU RI JOREDO
recorded music sales. The North American market is slightly larger with 39% of world
record sales, and Japan is the third largest, with 17% of world record sales. Ten largest
music markets in the world generate 83% of the worlds record sales (according to
IFPIs 1999 statistics). However, the reported sales figures represent only a proportion
of total music consumption: a vast amount of music is consumed for free, either in the
form of radio or TV broadcasts, or indirectly in films, TV programmes, advertising,
videos or other products that use audio content.
Global music sales

growth has stagnated
Figure 1: Global music sales growth, 1984-1999

2 5 .0 %
2 0 .0 %
1 5 .0 %
1 0 .0 %
5 .0 %
0 .0 %
1998
1996
1994
1992
1990
1988
1986
1984
- 5 .0 %
- 1 0 .0 %
Source: IFPI
Figure 2: Global Recorded Music Sales, 1983-1999 ($bn)

40.0
36.1
35.0
29.0
30.0
39.6 39.9 38.0 38.2 38.5
30.9
27.1
24.1
25.0
20.3
21.6
17.0
20.0
15.0 12.0 12.0 12.3
14.0
10.0
5.0
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
0.0
Source: IFPI
10 Largest Music Markets

(1999)
Retail value
% of
($ m)
World Sales
USA
14,251
37%
Japan
6,437
17%
UK
2,909
8%
Germany
2,833
7%
France
1,983
5%
Canada
884
2%
Brazil
668
2%
Australia
656
2%
Spain
640
2%
Mexico
636
2%
Total
31,897
83%
Source: IFPI
Europeans are heavy users but growth has stalled. Interestingly, per capita album
sales in Western Europe, at 2.7 albums pa per person are more than three times the
global average, with the British population each buying on average 4.1 albums per year
(highest in the world). Seven European countries feature in the top 10 in terms of per
capita album sales. As a comparison, the North American per capita album sales are
3.7 albums pa, or $47 in value terms. The European music market has seen flat to
negative unit growth for the past two years, and in value terms the market was flat in
1999 after growing by 3% in 1998. A few countries in Europe are still growing fairly
steadily, notably the Nordic region and certain Eastern European countries. The weak
growth in 1999 in most Western European countries can partly be attributed to
relatively few big-selling releases coming to the market that year compared to 1998. In
1998 the market bought the Titanic soundtrack album as well as new albums from
Celine Dion, Madonna and Robbie Williams.
10
Most of the music market growth in mid-late 1990s can be accounted for the new
format replacement effect, as consumers replaced their album collection with CDs.
In the words of one record label executive: the music industry was growing by selling
consumers what they already owned but this time in a different format and charging
more for it. CDs overtook other formats (LPs, singles and cassettes combined) in terms
of units sold in 1994, although CD players had been in the market since 1983. This
demonstrates how slow the consumer adoption of new formats can be, and in the case
of CDs it was driven both by CD player take-up (as prices came down) and availability
of content in the new format. We think digital music will go through a similar
evolutionary path, as it is in fact another format for delivering and consuming music. It
is worth noting that despite digital delivery being around for two years now, worldwide CD sales are still growing at 2.8% pa in unit terms.
Figure 3: Share of global music sales, 1999
Latin
Australasia
America Asia
2.0%
4.9% 3.4%
Japan
16.7%
North
America
39.4%
Africa
0.5%
Middle East
0.9%
Europe
32.2%
Source: IFPI
Figure 4: World CD and LP Unit Sales, 1993-1999 (millions)

2,500
CD
LP
2,000
1,500
1,000
500
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
Source: IFPI
Despite industry growing annually in value terms, global volume growth (all
formats) has been flat (-0.4% in 1999 and 3.8bn units). The CD replacement effect
has worn off (CDs now account for 65% of all units sold worldwide), in addition
reduced consumer demand in some of the emerging economies have had a negative
11
impact in volumes. Minidisc is emerging fast, and IFPI reported over one million units
sold in 1999, with UK taking the largest share of this format (50% of all units sold in
1999). Cassettes still dominate in many developing markets, although overall global
unit growth was down 7% in 1999.
Consumer buying behaviour is changing in the digital age

Traditionally music has
been about mass-market
stars
Music is increasingly
consumed indirectly
The technological change following the digitisation of music is being combined by

changes in customer usage patterns. The 21st century music consumer relates to
recorded music differently from the consumer in the 1970s, 1980s and 1990s. These
decades launched a series of huge mass-market stars, who received a global following
and sold a large proportion of their respective labels total annual publishing quota.
Music used to be a more essential part of a lifestyle than it is today, defining the
existence of Mods, Beatniks, Punks, New Romantics, Rockers and other youth culture
groups. People in the heavy user age group, 16-40 year olds, often identified
themselves as being a fan of a certain mass-market artist, and owning an album
collection used to be part of a persons identity. Consequently, as tendency was
towards mass-market artists, tastes were more unified than they are today. Young
people (the heavy music users) used to listen to the same artist at the same time.
Consumers today in the heavy-user age group are seeking new ways to define
themselves, with music taking a back seat or becoming only one of the ways identities
are formed (internet, video games, dance parties or extreme sports gaining in
importance). Curiously, this is taking place at the same time as use of music is
increasing. But the growth of music usage is becoming increasingly indirect, from
owning an album collection to conscious and sub-conscious consuming of music in
films, television, advertising, shops, radio channels, and other occasions. Music is also
merging with brands and getting closer to consumer experiences on several levels and
occasions. For example, Stings new single in the Jaguar advertisement worked to
promote both the car and the artists. During the Sydney Olympics, Nike launched an
internet radio station called Radio Free Sydney, where dance music played by DJs was
streamed live around the clock. This was part of Nikes overall marketing strategy to
bring product relevant content to customers, and a good example of how music content
is becoming increasingly important for brands wishing to connect with their consumers.
This has implications for content owners and their revenue models, with a subtle shift
from revenues from direct sales to revenues from exploitation of content rights, in the
form of publishing and licensing contracts. Therefore, we believe that the content
exploitation will grow substantially as distribution channels proliferate.
Stars often fail to

generate repeat hits
A potential indicator of mass-market stars fading appeal is their ability to

generate repeat hits. Several artists who have gone to score jackpots with their debut
albums have seen their subsequent album sales dwindle. Many artists have become
one-hit wonders with only a handful of stars being able to score top hits year after
year. Consumer loyalty is eroding fast. Figure 5 below shows a selection of artists and
unit sales of their debut and subsequent albums: most of us can remember Alanis
Morissette and her huge success in the early 1990s.
12
Figure 5: Album sales of selected artists (m)

Debut album
16
2nd
3rd
4th
14
12
10
8
6
4
2
0
Hootie &
The
Blowfish
Boyz II Men
TLC
Pearl Jam Cranberries
Alanis
Sheryl Crow Melissa
Morissette
Etheridge
Source: Billboard, Peoplesound.com
Of course, there is also evidence of a contrary trend, especially with artists in

alternative and alternative mainstream genres. Artists that have a very targeted audience
can have stable sales for each released album, however these artists are unlikely to sell
in the 10m+ range (units) that well-promoted pop/rock artists frequently do.
Established artists tend to have varied levels of success in subsequent releases, for
example Bon Jovi in Figure 6 below.
Figure 6: Bon Jovi album sales (units m)

15.2
16.0
14.0
10.3
12.0
10.0
7.0
6.4
8.0
5.6
6.0
4.0
2.0
0.0
Album 1
Album 2
Album 3
Album 4
Album 5
Source: Vivendi Universal
Consumer tastes have

diversified
Consumer segments are becoming increasingly fragmented. Although previously a

small number of world-wide stars could cater for large groups of consumers, customer
tastes have since diversified and as a result, the record industry is launching an
increasing number of artists to satisfy this diversity. However, for consumers, this
growing array of choice means that it has become more difficult to go to a record store
and pick an album. As a result, people increasingly purchase music based on mood or
certain style. An indication of the growing complexity for consumers is the huge
13
growth in compilation albums, which now serve as navigators offering vital guidance.
Often these compilations are also being marketed to represent a certain style: for
example, the widely popular Caf Del Mar albums featured mostly lesser-known
artists, but were significant in depicting a certain mood. Consumers are also becoming
more willing to buy albums of unknown artists on the back of one hit song, which is a
lucrative trend for content owners.
More genres cover the
diversity of preferences
The industry is
launching an increasing
number of albums
The proliferation of music genres has been one of the phenomena of the past 10
years; for example in the dance music category we now find artists in such sub-genres
as Ambient, Breakbeat, Big Beat, Trance, Goa, House, Deep House, Trip-Hop, Jungle,
Garage or UK Garage. Similar diversity is found in other broad genres such as rock,
R&B and Country (with interesting offerings such as Neo Folk and Modern Country).
There are now over 200 different recognised genres available for consumers. Dance
music, which emerged at the end of 1980s, is now one of the fastest growing genres
where new stars are being discovered almost on a daily basis. Again, music tastes have
expanded and new genres continue to emerge in order to satisfy this.
Given the wide differences in consumer tastes, it is not surprising that the number
of albums launched in the industry has accelerated: Figure 7 below shows the
number of albums launched in the UK between 1990 and 1999. In the UK alone, almost
20,000 new albums were released in 1999, compared to 5,500 in 1989. In the US,
38,900 new albums were released in 1999. This is a significant increase in supply in a
market that is becoming increasingly fragmented. The expanding number of releases
means that there are more artists chasing the market. And, partly because more artists
are now taking a share of the $40bn global market, which is only growing at around 3%
annually, fewer artists can command truly significant sales. It is telling that whereas in
1990, 20 best selling albums took in 22% of total global music sales, in 1999 it was
17%. Furthermore, typically less than 3% of all released albums sell more than 50,000
copies, and a large number of new releases sell only a few thousand copies. Moreover,
if a record label is lucky enough to launch an artist that can produce a hit album, it is
not certain that the same artist can continue producing hits, as we demonstrated in
Figure 5. The industry carries an enormous back catalogue representing various artists
that sold well in their time but continue to exist only in discounted compilations or in
music clubs.
Figure 7: Number of albums launched in the UK all formats (1990-1999)

19,900
21,000
18,386
17,597
19,000
17,000
15,393
15,000
13,551
11,988
13,000 11,021
10,141
11,000
11,654
10,716
9,000
7,000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
5,000
Source: BPI
14
Figure 8: Share of Top 200 Albums (US, %), 1988-1997
100%
90%
21
80%
7
36
70%
14
26
7
33
10
27
11
16
27
28.5
75
60
63
65
57
20%
32
49
54.5
1996
60
23.5
1995
57
24
24
60%
50%
40%
30%
22.5 22
44
10%
1997
1994
Debut Albums
1993
1992
1991
Established Artists
1990
1989
1988
0%
Compilations/Soundtracks
Source: IDC
On average, 5% of
artists deliver a return
Domestic repertoire is catching up. In addition, the growing popularity of domestic

repertoire has resulted in an increasingly fragmented industry where tastes are scattered
not only by musical genres, but also by countries. Overall globally the importance of
domestic repertoire has increased steadily, and nearly 65% of all music sales are now of
domestic origin, compared to 58% in 1991. Although the stars generating highest sales
on a global basis tend to be North American or British, it is typically the local artists
that are market leaders in their home countries. In addition, these artists are often
outside the mainstream rock/pop genres. In Italy, italian rock is a genre of its own and
enjoys tremendous popularity, whereas in France chansons are still enjoyed by the
population across various age groups.
Domestic repertoire generates a majority of music sales in most markets.
International repertoire typically has a higher market share in certain European
countries such as Denmark, Norway and Ireland, as well as in the Eastern European
countries. Asia, Latin America and the Middle East all listen to local artists. Over
90% of US music sales consist of domestic repertoire. The large Continental markets
Germany, France, Spain and Italy report around half of their music sales going to
domestic artists. In Europe the share of domestic repertoire is slightly below global
average, but nevertheless it has been increasing: In 1999 42% of all recorded music
sales in Europe were domestic, compared to 36% in 1991. At the same time both
international and classical repertoire have decreased their share.
This supports the view that the music industry is not dominated by a few mass-market
stars, but album sales are generated by a vast variety of domestic and international artist
in a plethora of music genres. See Figure 10 for an illustration of how the share of
international artists has decreased in global music sales.
15
Figure 9: % Of Music Sales In Domestic Repertoire

US
91%
Thailand
82%
Turkey
79%
78%
Japan
73%
Brazil
61%
Argentina
57%
Mexico
48%
UK
44%
France
43%
Germany
42%
Spain
39%
South Korea
Netherlands
27%
Sweden
25%
South Africa
24%
Australia
20%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Source: IFPI
Table 1: Major domestic artists outside North America

Country
Artist
Sweden
Abba
Denmark
Aqua
Germany
Rammstein
Italy
Andrea Bocelli
UK
U2
France
Johnny Halliday
Spain
Rosana
Puerto Rico
Jose Feliciano
Hong Kong
Jacky Cheung
Brazil
Sandy & Junior
Source: Vivendi Universal
Domestic repertoire is
growing
This means that content ownership, artist acquisition and development as well as
content exploitation is very much a local business, requiring local presence and
expertise. In addition to consumer tastes, their access to music relies on very local
distribution channels, as both retailers and media rarely cross national borders.
Although local acts can provide a good source of growth for the majors, it is a doubleedged sword: music companies cannot offset promotion and development costs against
a bigger market, as sales potential is limited.
16
Figure 10: Average repertoire origin

100%
6.1
5.8
5.2
5.3
4.9
4.8
4.5
5.5
80%
35.5
34.3
32.4
32.0
32.7
32.6
32.1
29.9
58.4
59.9
62.4
62.6
62.4
62.6
63.3
64.6
1991
1992
1993
1994
1995
1997
1998
60%
40%
20%
0%
Domestic
International
1996
Classical
Source: IFPI
Diversified tastes, increasing volumes, stagnating growth =

decreasing returns
Music is more diversified than ever. Consumers music tastes have expanded
covering a multitude of genres and dispersing across geographies, and mass market
stars are not able to pull crowds as well as they used to. In order to cover all the tastes
of music, the industry is launching more new artists and more albums. However, this is
taking place in a market that is seeing stagnating growth both on volume and value
terms in other words the industry is pushing more product into a contracting market.
As a result, the music industry is facing diminishing returns on their artist investments.
Only 5-10% of signed

artists return a profit
However, this is happening in an industry where success rate was not too
impressive to start with. On average, 5-10% of all signed artists return a profit for the
record label, meaning producing sufficient sales to cover investment such as advances
on royalties, production and promotional costs, and even this ratio has been
continuously eroding. What this means is of 100 artists (and we believe that this figure
works when looking at album launches as well) launched by a record label, typically
around 5 will become very big sellers, covering the losses stemming from investments
in the other 90-95. And in the music industry, investments in album launches are
escalating, requiring significant promotional effort such as music videos and radio
campaigns. Many albums with considerable production and promotion investments
have bombed, selling only a handful of copies. As a result, the record industry writes
off several billion dollars each year in unrecoverable A&R investment. This also
highlights how the success of an artist is very much down to luck A&R executives
positive opinion does not always guarantee sales. The signing decisions typically are
not based on any analytical process but more on gut feel.
This environment of increasing product launches and diversified tastes together with
traditionally poor success rate on artist investments and stagnating music sales can only
result in one thing: Music companies are witnessing declining operating margins.
17
Figure 11: Music Company Operating Margins, 1993-1999

21.0%
19.0%
17.0%
15.0%
13.0%
11.0%
9.0%
7.0%
1993
1994
Sony Music
1995
1996
Warner Music
1997
1998
1999
EMI Music
Source: Company reports, Lehman Brothers Research
Music industry market

shares
Universal
23%
Others
23%
BMG
12%
Warner
13%
Sony Music
15%
EMI
14%
Source: BPI
Fragmented market creates

challenges for retailers
Local media, collection

societies and legislations
The recorded music industry is dominated by five big record labels the five
majors. These are Universal, BMG (Bertelsmann Music Group), EMI, Sony Music,
and Warner Music. The five majors cover approximately 75-80% of the global music
sales, with the rest being supplied by hundreds of independent record labels. Each
major label owns dozens of smaller labels, which typically specialise in a certain music
genre. Universal is the largest of the five majors, with approximately 23% market
share. The majors dominance has long been a sore point for many professionals in the
music industry, which is why the independent sector continues to gain prominence in
particular with some of the non-mainstream genres. The discarded merger between
EMI and Time Warner was designed to create a music industry superpower with the
largest market share. Market commentators have flagged other possible partners for
EMI, indicating that consolidation is becoming a feature in the music industry as well.
For online retailers, this market structure represents some considerable
challenges. Not only are there large national differences in terms of online penetration
(with Scandinavia leading and Southern Europe lagging behind), there are also large
national differences in terms of what consumers are buying. As the internet is still a
minority channel, any online retailer would have to have a presence in several countries
in order to build scale. However, only a proportion of the catalogue is transferable
across borders, and any e-tailer wishing to trade on a pan-European scale would have to
manage several domestic catalogues and several supplier relationships.
In addition, not only does the music bought by consumers differ considerably
between the various countries, music industry structures are also local, which
complicates artist development and promotion. Each country has its own copyright
legislation and royalty collection society, and distribution is done on a local rather than
pan-European basis. Promotion cannot be pan-European since each country has its
own national media, which does not cross borders. Retail chains are also local with
different channel market shares (for example, direct sales through record clubs are
popular in some countries e.g. Finland). We believe that this complexity and
fragmentation, which runs throughout the value chain, has been the single biggest factor
deterring US operators from entering into Europe. The few that have crossed the
Atlantic have in most cases had considerable challenges.
18
Table 2: European Recorded Music Market Statistics (1999)

Company
Austria
Belgium
Denmark
Finland
France
Germany
Greece
Iceland
Ireland
Italy
Netherlands
Norway
Portugal
Spain
Sweden
Switzerland
UK
Retail
Value
(USD m)
322.9
342.3
263.9
128.6
1,983.4
2,832.5
98.8
17.8
113.3
607.3
522.1
260.9
176.8
639.5
356.6
277.1
2,908.9
Growth (99-98)
Units
USD
-6%
-1%
2%
-8%
-4%
0%
-15%
13%
2%
1%
-3%
-3%
-9%
0%
1%
-5%
-5%
-7%
-7%
-1%
-8%
-8%
-6%
-18%
4%
0%
-1%
-4%
-6%
-5%
-6%
0%
-11%
2%
Local
-3%
-3%
3%
-4%
-4%
-2%
-15%
6%
5%
4%
-3%
-2%
-1%
-2%
4%
-8%
4%
Per
Capita
album sales
2.6
2.5
3.3
2.3
2.3
2.9
0.8
2.6
2.1
1.0
2.4
3.6
1.7
1.6
2.9
3.5
4.1
% of
repertoire
domestic
15%
20%
35%
42%
44%
43%
59%
45%
16%
51%
27%
19%
31%
42%
25%
8%
48%
Source: IFPI
Digital downloads are changing the way people consume

music
New ways of buying and
consuming music
In addition to what people are buying, how they are buying it is also experiencing a
profound change, brought about by the arrival of internet and digital formats. We will
be analysing the digital formats and how large this market really is further in the report,
however the following statistics show that digital distribution of music is already
reality, and it is changing the industry.
Over 70% of US college students have downloaded music using Napster, the
software that allows users swap audio files from each others servers.
MP3 was the most popular search term in US search engines in June 2000
While no doubt still being experimental in usage and technology, digital distribution is
already a very important music format for a certain customer group. We believe that
this is the same customer group who were the first adopters of the internet in the early
to mid-1990s, and this will be followed by a more mainstream consumer.
A more convenient
format
Why would consumers favour digital distribution over physical format? In

addition to the convenience factor, downloading music offers instant gratification,
something which buying CDs over the internet cannot do, as you have to wait for days
before you receive your product. Digital downloads also offer an important navigation
tool as the choice in music has exploded: customers can sample music prior to
purchasing by downloading audio files, which is something that is extremely difficult to
do offline. This will prove to be an important factor in guiding music purchases, and
may result in content owners having to repackage music. Curiously, music companies
have been able to sell full CDs on the back of a few popular tracks, meaning that of the
12 tracks on a regular CD only 1 or 2 are hits or at least tracks preferred by the
customer, and the reason why the CD is purchased. From a customers viewpoint, the
remaining 9-10 practically act as space fillers. Although this is intended to be
19
eliminated by the so-called coupling clause, the storage capacity in a CD means that
more tracks can be included in an album. For customers purchasing digital downloads
on a per track basis means that there is no need to buy the whole CD in order to get the
favoured track. Digital delivery allows customers to download only those tracks that
they wish to purchase.
A more customer-friendly
format
Convenient storage
In addition, for many customers record stores are inhospitable outlets,

especially if the customer does not know what s/he wants. Merchandising is often
confusing and customers sometimes find the staff too intimidating to ask for help. This
is probably one reason why back catalogues tend to sell better in online CD stores: the
convenient search and navigation facilities are something that do not exist in bricks &
mortar stores. Some teenagers report being watched constantly with suspicion by the
store staff, and thus find downloading songs from the internet a more hassle-free
experience.
Digital downloads are a more convenient way of storing and listening to music.
Audio files can be stored in a playback device, and there is no longer a need to travel
with several CDs. Customers are able to build personal mobile jukeboxes without
having to own and carry a sizeable album collection. This will obviously create an
entirely new way for customers to hold and own music: as digital files cannot be stored
on shelves alongside traditional CDs and albums, the size of a persons displayed
album collection will no longer reflect the extent of the collection. Music does not
have to be owned and held. If music files can be downloaded whenever a consumer
chooses to listen to them, music can be consumed on a need-to-use basis.
Figure 12: Reasons For Downloading Music
Availability of hard-to-find music/genres
Convenience
Free music, pirated
Free/cheap music, legal
Curiosity
"Loves Music"
Other
0%
5%
10%
15%
20%
25%
Source: IDC
The role of independent labels is becoming more prominent

Over 3,500 independent
labels in Europe
Although a majority of the worlds recorded music revenues goes to the five major
labels (Universal, Sony Music, Warner Music, BMG and EMI), around 23% of the
revenues are owned by hundreds of independent record labels. There are over 400
independent labels in the UK alone, and over 3,500 in Europe. Although most of these
are either focused on a particular genre, small with few resources to develop and
promote the artists or unable to attract marketable artists, some independent labels have
grown into formidable players in the European music scene.
20
Several successful artists have chosen to eschew the majors as it is felt that they are too
commercial and instil too much control on their portfolio of artists. The attraction in
going with an independent label is often more creative freedom, in addition the majors
tend to be more wary of signing music that does not appeal to the mass market. As the
majors are all quoted companies (with the exception of BMG) with strict financial
performance targets, artists are usually required to produce chart success immediately.
However, most bands and artists do not develop that quickly, instead they require often
two, three or four records before they see a lift-off (The Verve is a typical example).
Indies will grow in significance
Indies have 50% of the

copyrights, but only 20% of
revenues
Whereas a few years ago very few independent artists were able to launch themselves
into the charts, over the past few years some of the most popular artists have started to
come through the independent labels. Good examples are Oasis (Creation Records)
and Prodigy (Beggars Banquet). As the consumer tastes become more fragmented and
as the music consumer is increasingly looking for individual tastes and styles at the
expense of mass-market artists, we believe that independent labels will grow in
significance in the European music scene.
The independent music scene is populated by thousands of artists. In Europe around
50% of the copyrights belong to independent labels, however it is probably a reflection
of the type of artists going through the independent labels that only 19% of revenues
are collected by the independents although this figure varies depending on sources.
In addition, because the majors have greater access to world-wide distribution, they are
able to market their artists more effectively than the independents. The indies share of
revenues tends to be even weaker in Europe, whereas in Latin America and Asia it is
more prominent, because of the smaller presence by the majors. Worldwide, the
combined share of all independent labels has declined over the past 10 years, which
reflect the challenges resulting from smaller distribution capabilities. Globally the
indies capture around 23-24% of all record sales, which has been declining since 1988,
when they represented over 30% of the market. Some decline in indies' market share
can be accounted for majors acquiring smaller independent labels.
Table 3: Combined majors vs. combined indies global market share (%)
1988
Combined majors 69.8
Combined indies 30.2
Source: IFPI, MBI
1990
73.6
26.4
1994
73.8
26.2
1995
72.1
27.9
1996
72.8
27.2
1997
74.5
25.5
1998
75.9
24.1
1999
76.0
24.0
Table 4: Record label market shares by region and globally, 1999

BMG
EMI
Sony
Europe
11%
17%
18%
Latin America
15%
11%
18%
North America
12%
9%
18%
SE Asia (ex Japan) 6%
8%
11%
Global
11%
14%
18%
Source: SoundScan, IFPI, Lehman Brothers Research
Universal
Warner
Indies
25%
22%
25%
17%
22%
12%
10%
16%
6%
13%
19%
25%
21%
53%
23%
Complex value chain

Revenues are split in several
ways
The music industry operates in a complex value chain consisting of several

different business models in which revenues are obtained. The $40bn annual
revenues are split in several ways with many involved parties taking a cut during the
process. Although the most significant revenue streams come from the retail
distribution of music in various formats, both the record industry and the music
21
Technology allows for more

flexibility.
publishing industry receive revenues from a wealth of other forms. This ranges from
the obvious such as the broadcast industries, live performance, films and any music
heard on public places to the less obvious such as use on corporate presentations or
video games. These uses will continue in the digital age. However, internet and digital
technologies will not only restructure the value chain, entering into every link with
either value adding or destroying results, but also expand the range of use as the new
platforms offer new distribution opportunities. As a result, we expect to see new
business models emerging as the reliance of core revenue generators such as retail sales
and broadcasting decreases. With the arrival of Napster and other file sharing
technologies as hugely popular consumer platforms, the industry is facing tremendous
changes. There are an incredible number of moving parts, which have to be rearranged.
Figure 13: The Music Industry Value Chain
Retailer
Composer
Artist
Publisher
Record
Label
Manufacturer
Con sumer
Distributor
Radio
Station
Source: Lehman Brothers Research
Below we will provide a brief overview of each partys role in the music industry food
chain.
Composer/Songwriter
The songwriter is the original author of the music. Sometimes the artist or a band also
acts as a songwriter, but it can be done by a separate company or individual, via various
channels. The composer receives a share of the royalties.
Artists create and

perform music
Publishers are the

custodians of music
Artist
The artist or a band is the most visible part of the value chain. Creating and performing
music is their livelihood, and they want to get paid for it, whether we are talking about
a struggling unknown band or a platinum-selling superstar. Traditionally the only way
of getting music to the market and earning revenues from the creative process has been
to get signed with a record label. The artist receives share of revenues from record
sales, as well as fees from record labels.
Publisher
Publishers administer the copyright and look after the collection of royalties for the
composers. They are essentially custodians of the songs, and represent the copyright
holder and licence the musical compositions for artists to use in records, movies,
television programs, films, restaurants, radio, advertising and many other uses. The
copyright of a song can refer to either the lyrics and the composition, or the actual
recording, and whereas specialised publishers often own the rights to the lyrics and
songs, record labels often acquire rights for the actual recording. For example, if an
artist wants to record a cover version of an old song, the songs publisher would grant
the licence to the song from the catalogue. Each time the song was played on the radio
or each CD sold, the publisher would collect royalties, of which it would keep a portion
and pass the remaining share to the artist.
22
This is an extremely lucrative business with very high margins and repetitive revenue
streams. Music publishing is also one of the fastest growing revenue streams in the
industry. For example, last year Vivendi Universal collected nearly $1m in publishing
royalties of one song alone; I Will Survive. Publishing revenues come in three forms:
Major labels are

vertically integrated
Mechanical royalties this refers to royalties being generated by record sales, so

each time a record is sold the publisher gets paid.
Performance royalties royalties generated from songs played live on stage or in a

public place, however also from songs broadcast on radio, television, in a cinema
or over the internet
Synchronisation royalties this is the fastest growing publishing revenue stream. It

involves marrying the song (words and music) with visuals, such as in television
programmes, advertising, film or videos.
Record label
Record labels are powerful players in the music industry. The five majors, EMI,
BMG, Warner Music, Universal Music Group and Sony Music control around 85% of
the global recorded music market. Each of these labels also holds a number of minor
labels which specialise in a particular genre or artist type. The major labels tend to be
vertically integrated, all the way from songwriting to music publishing to distribution,
therefore holding considerable power over what music is recorded and where it is
distributed. The remaining 15% of the world music industry is covered by a large
number of so-called independent labels, which vary in size and can represent only a
handful of artists.
The record labels play a major role in taking artists to the market. One of the key
function is the discovery of new artists through A&R process, which provides a type of
quality control for the consumers. The talent scouts employed by the record labels
search the world for unsigned artists, hoping to find the next platinum-selling superstar.
The time and money invested in this process is substantial.
Advances on future
royalties
Once a promising artist has been identified, the record label typically provides the artist
with an advance on future royalties, designed to cover the cost of living expenses,
production, travel, promotion and salaries. This in a way is an underwriting fee as the
record label assumes the risk of the artist never being successful. In fact, the success
rate of launching new artists has radically decreased, and now around 5% of all new
signings make a return on the investment.
Record labels also provide producers and resources for the actual recording and
production of the album. The labels bear the costs of recording studio fees, studio
musicians, sound engineers and producers. In addition, large record labels have
vertically integrated printing (the actual manufacturing of the CDs or albums) and
distribution. Large labels usually have distribution centres that act as wholesalers,
often working with the retailers on promotions and merchandising.
Manufacturer
Majors and other large labels usually own manufacturing facilities, such as
Bertelsmanns Sonopress. Most smaller or independent labels that are not vertically
integrated have to outsource printing and manufacturing the CDs and albums (often to
the companies owned by the majors). This involves pressing the albums and CDs as
well as producing the packaging and artwork for the covers.
23
Distributors get the CDs

to the stores
Various retail channels
Distributor
The distributors get the CDs physically from the manufacturers or record companies to
the retailers. They own and operate the warehouses, drive the trucks and deliver the
CDs to the stores. Major labels have their own distribution networks, or they use
independent, third-party distributors. Again, smaller or independent labels that are not
vertically integrated typically outsource distribution to third parties, who as wholesalers
work with the retail chains and other sales channels to ensure the music reaches the
consumers.
Retailer
This is the last stage in the music value chain. The music reaches the consumers
through various channels, whether it is a large-scale record store such as Virgin
Megastore, a supermarket, a music club, or a specialist music shop on the high street.
Radio station
Radio stations often receive new music through promotions run by the record labels, as
playtime in top radio programs are one of the most important ways of promoting new
artists and music. Radio stations now play a very big role in the music industry value
chain, and their revenues come from advertising,
Table 5: Music Industry Value Chain: Examples of Participants

Songwriters
Artists
Randy Newman
Madonna
Holland, Dozier &
Holland
The Beatles
Larry Bastian
Oasis
Don McLean
Elton John
Paul McCartney
Moby
Elton John
Bjorn Ulvaeus & Benny Anderson
Publishers
Labels
Manufacturers Distributors
EMI Music Publishing

Sony Music Licencing
MPL Communications
Warner/Chappell
EMI
RPM
BMG
Warner Music
UMG
Sony Music
Beggars Banquet
Instant Karma
Valley Media
Retailers
Radio St.
HMV
Our Price
Virgin
Amazon
BOL
Radio 1
Classic FM
Capital Radio
Kiss FM
Music industry lives from royalty payments

The music industry food chain is traditionally complex. The $40bn annual global
sales need to feed several parties, and as a result the average price that the consumer
pays for a CD is split many ways.
Artist gets less than 10%
of the record sales
A typical contract gives the artist or band a royalty equivalent of around 1 for
each CD priced at around 13. The remaining 12 is shared by other parts of the
food chain. One of the fastest growing revenue streams is publishing royalties, which
refers to exploitation of copyright. The songwriter and the songwriters publisher get a
royalty payment roughly equivalent to what the artist receives, but typically 5-8%. The
retailer and wholesaler each take a typical margin, and the remainder goes to printing,
packaging and promotion. The figure below illustrates the revenue distribution in a
typical CD.
24
Figure 14: Revenue Distribution Of A CD
Retailer
15%
Publisher/
Composer
8%
Artist
8%
Print/press
15%
Distribution
15%
Label
39%
Source: IDC
Record labels take on risk
Distribution is expensive
Although it seems that record labels rake in a lions share of the artists creative work,
it must be remembered that the label also assumes the risk of that particular investment
failing, if that particular artists music does not sell. The label also bears all the costs of
promoting the artists, including producing the music videos and any advertising as well
as all promotional effort to get the songs played on the radio. The label also invests in
potential tours, which can involve sending hundreds of people on the road for extended
periods of time. In addition, the production process is extremely costly involving often
sophisticated sound engineering technologies, the costs of which are born by the record
label.
A large share of the revenues are also spent in the distribution process, which in
IDCs example takes up 15% of the price of the CD. This is understandable given that
the process is very capital intensive, involving moving pallets of CDs from the
manufacturing plant on trucks to various retailers, or to wholesalers who distribute
them onwards to record stores. In addition, both wholesalers and retailers retain a piece
of the pie in their margins. Outside of the distribution value chain there are also several
parties that are involved, all of which need to get paid: these are the artists managers,
lawyers, and other staff, as well as the government in the form of taxes.
CD manufacturing, or the printing and pressing of CDs, can be undertaken by
various independent companies operating in this sector. A going rate for printing is
around 65p ( SHUDEDVLFTXDOLW\&'ZLWKVRPHYROXPHVDFFRXQWHGIRULQDGGLWLRQ
to this there are charges for the manufacturing of plastic covers, and printing the cover
graphics.
Within the music industry value chain, the fiercest opponents towards digital
distribution have been the record labels, and in general the fiercest supporters have
been both the consumers and the artists. This is not surprising if we look at which party
has most to lose. Courtney Love, singer of the rock band Hole, presented the following
calculation of how an advance of $1m for a four-member band is split and what the
artist is left with:
25
Table 6: How a band spends a $1m advance received with a record deal
$1,000,000
($500,000)
($100,000)
($25,000)
($25,000)
$350,000
($170,000)
$180,000
$45,000
Record labels advance

Cost of recording an album: production, promotion, distribution
Managers commission
Lawyers fee
Business managers fee
Profit
Taxes
Net profit
Net profit per person, divided by four band members
Source: Courtney Love
Industry in transition
The music industry is ripe
for transformation
Music industry is a challenging industry, with its lack of visibility on revenues in

new launches, and the difficulties in monetising creative work. However, even with
the challenges we highlighted above, or conversely because of these challenges, we
believe that the music industry is ripe for a significant paradigm shift which will come
to impact the entire value chain. This will be driven both by changing consume profiles
and new technologies. Digital distribution and consumption of music is here to stay,
and the internet is bringing about new efficiencies and new formats, and new ways of
distributing and consuming music. As a result, there will be several ways in which the
industry is likely to benefit. However, as in any step change, old business models will
either have to adapt or face the music. New business models will emerge, and some of
these will grow to become formidable businesses.
Key Thoughts:
Recorded music is a $40bn global industry, which is dominated by five major record labels: Universal,
Warner Music, Sony Music, BMG and EMI.
Growth has stalled after the CD replacement effect in the late 80s. Average annual growth in value
terms has been around 3% since 1991 with flat volumes. However, new formats have traditionally
resulted in accelerating growth in the music industry.
Choice for consumers has exploded, which makes choosing music more difficult.
Domestic repertoire generates a majority of music sales in most markets, and its share is increasing.
Music industry is launching an increasing number of new artists and albums. As this is happening in
an environment of stagnant growth, margins have been declining.
The share of independent lables has been decreasing over time, however we believe that their role
will grow in importance.
New digital formats are growing in popularity, and their appeal to consumer is convenience and
versatility. In addition, free music, although mostly illegal, has been spurring growth in digital formats.
The music industry has a complex value chain and revenues are split several ways.
26
Evolution Of The
Online Music
Market
Total European B2C
spending forecasts ( P
200,000
Music distributions migration to internet has already started in physical format.

Along with the rise of e-commerce, companies such as CDNow started retailing CDs
online, and in just a few years internet as a retail channel has emerged as a clear
challenger for the traditional retail formats. The attractions for consumers are
numerous: convenience, better range, a more personalised shopping experience, better
access to information and lower prices are some of the reasons why people shop online.
183,292
180,000
160,000
140,000
122,561
120,000
100,000
74,849
80,000
60,000
40,152
40,000
20,000
Physical Distribution On The Internet
19,185
2,874 8,543
0
1999
Despite the recent market turmoil and some commentary predicting the doom of
e-commerce, growth in online spending is going to be substantial. Internet
penetration in Europe is increasing rapidly, driven by cheaper access (many ISPs are
now offering access without subscription OR call charges) and internet-enabled
handheld devices. IDC is estimating that half of the European population will be online
by 2002. In 2004, the organisation predicts that there will be nearly a quarter of a
billion online users in Europe. This will represent serious critical mass and make
internet a viable contender to traditional retail channels.
2000E 2001E 2002E 2003E 2004E 2005E
Source: Forrester Research
Figure 15: Total Western European Online Penetration (% of population)

100.0%
90.0%
242m Web users in

Europe by 2004
80.0%
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
1998
1999
2000
2001
2002
2003
2004
Source: IDC
In Europe, Christmas 2000

will be the first e-holiday
European B2C spending will

be e75bn in 2003
Moreover, these online surfers are also increasingly turning to online buyers. As
there is typically a time lag from first getting connected to the internet to actually
transacting online, we believe that the 2000 holiday season will see a huge pool of new
online users making their first purchases. People are also becoming more confident
about online security, and whereas credit card fraud was the biggest factor deterring
people from making purchases online, it has now taken a back seat. Reasons for not
buying are increasingly site-specific, relating to download speeds, lack of availability
and, just like in offline world, customers not finding anything to buy from the range
available.
Forrester Research is forecasting total European business-to-consumer (B2C)
online spending of bn by 2003, from bn last year. This would equal over
124% CAGR from 1997 to 2003. One can be cynical about these forecasts, but US
forecasts made a couple of years back about online spending growth proved to be
hugely understated. In 1996, Forrester Research forecast 1999 full year online sales to
reach $4bn, and the actual sales in fourth quarter 1999 alone were $7bn. We believe
27
that the actual growth will surprise us on the upside. Therefore, despite the wellpublicised failures in the e-tail sector, we should not forget that this channel is taking
market share extremely fast, and increasingly becoming consumers preferred way to
shop for products and services.
In the US, online music sales
are around 3% of total music
retail
Online music retail is still a nascent market, where key players have launched their
operations fairly recently. CDNow launched in 1996, whereas Amazon launched its
music sales in June 1998. However, this is a market that will experience a rapid
migration to the internet: US forecasts expect online music sales to capture 11% of total
music market by 2003 (according to Jupiter), and we have no reason to believe Europe
should not be able to replicate this. Music and home entertainment products are ideally
suited to the net, and not surprisingly enjoy high consumer acceptance. Music is a very
information-intensive purchase category, requiring a modicum of pre-purchase
research. In addition, the merchandise does not require a hands-on shopping
experience (for example, it does not require trying on before purchase). For
information-intensive categories, the internet offers superior browsing capabilities with
search functionality and better product information, as content can include various
types of editorial material, such as reviews and news articles.
Figure 16: US online music share of total music retail
11.0%
12%
9.2%
10%
8%
5.4%
6%
3.3%
4%
2%
0.3%
1.0%
2003E
2002E
2001E
2000E
1999
1998
1997
0%
2.0%
Source: Jupiter Communications
Music has a streamlined

supply chain
For e-tailers, music has been one of the easiest categories to merchandise in the
early days of e-commerce. Music as a category has the advantage of a streamlined
supply chain, where established distributors and wholesalers maintain databases based
on identifies similar to ISBN numbers. These can be uploaded into the back-end
system. The e-tailer can outsource a large proportion of the inventory, and although it is
possible to merchandise hundreds of thousands of CDs on the site, only a fraction of
these are typically in the warehouse. As distributors and wholesalers normally maintain
inventory on the catalogues they sell, any non-stock items can be sourced from the
distributors with a fairly quick turnaround. Inventory costs can be kept low by ensuring
availability of fast-selling chart albums and leaving back-catalogue to the distributors.
Online merchandising is simplified by not having to tackle challenges in product
presentation, in a way that, say, apparel or furniture do. At a bare minimum, online
music retailers can feature a CD cover and a track list and with a basic database
application be up and running. Customers do not have to see or feel the CD before
purchase, as they usually have the necessary information already (have already heard
the album or know the artist).
28
Easy to ship
Media products are

among the earliest
categories to migrate
online. Almost one fifth
of European music
sales should be online
in 2005.
Furthermore, music is one of the easiest categories to ship, pick and pack. Being
small and light, delivery costs (which are typically charged per kilo by the fulfilment
companies) can be kept low. CDs can also be posted through a regular mailbox, thus
avoiding one of the biggest problems in fulfilment; customer not being at home to
receive the parcel. Therefore, we are not surprised to see music and other media
products being the most advanced category in terms of migration online. According to
Forrester Research, nearly one fifth of all media products will be sold online in five
years time, compared to 7% for the entire European retail sales, and 4-7% for more
challenging categories such as grocery, apparel and furniture.
Figure 17: % Of Total Retail Sales Sold Online In 2005 (Europe)
Electronics
18%
Media
18%
14%
Miscellaneous
12%
Flowers
11%
Event Tickets
9%
Leisure travel
Health and beauty
7%
Recreation
7%
Apparel
7%
6%
Housewares
5%
Autos
Average: 7%
4%
Groceries
0%
5%
10%
15%
20%

Media includes books, music, video and software. Recreation includes toys, DIY and sports
equipment. Housewares includes appliances and furniture.
Pricing differences
are an advantage
European online
music sales will be
e2.9bn in 2005
Although European e-tail carries several challenges resulting from having to execute in
a fragmented market, in music category, the fragmentation of the market produces
opportunities that the US e-tailers dont have. These are found in pricing, which despite
the arrival of the Euro, is far from harmonised across borders. An e-tailer operating a
centralised fulfilment system should be able to source CDs from the lowest price
distributor, and retrieve different product margins depending on country. CDs tend to
be priced higher than average in UK and Finland and lower than average in
Netherlands, Germany and Austria. See Figure 18 for an illustration of European price
differences.
Forrester is estimating that European online music sales will reach EQ LQ
2005, from PLQNote that Forrester Research is only expecting a 15% yearon-year growth in 2005, which is probably conservative. Comparing the 1999 data to
IFPI European statistics, this indicates that 1.3% of European music sales were online
in 1999. We still have a long way to go. Although we can always be sceptical towards
these market research forecasts, however it is worth noting that in 1998, Jupiter
Communications was forecasting $200m in US online CD sales for 1999, and the actual
figure turned out to be $900m.
29
US in 18-24 months
ahead
The US market is maturer, and migration to the internet is around 18-24 months
ahead of Europe, although Europe is catching up very fast.
Jupiter
Communications estimated that over 2% of US music sales were online in 1999, again
representing a huge opportunity. We believe that the growth in online music will be
driven by existing sales migrating online, and this will have an increasing impact in the
existing online players. Recognising this, most bricks-and-mortar retailers now have
online offerings, which they have been executing with various success. Pure-plays such
as Amazon and CDNow have been able to steal a lions share of online music sales in
the US, however in Europe we believe offline retailers will play a bigger role, simply
because in Europe they were more prepared for the channel migration than the US
retailers were.
Figure 18: Average online price of Music by Madonna in various European
countries (
18.00
15.17
15.96
16.46
17.12
16.00
14.00
11.22
12.00
10.00
8.00
6.00
4.00
2.00
0.00
Germany
Sweden
Spain
France
UK
Source: BOL, Amazon, various e-tailers
Figure 19: European Online Music Sales, 1999 2003E ( P
European online music

sales should reach EQ
in 2003
2,898
3,000
2,512
2,500
1,958
2,000
1,273
1,500
1,000
500
677
313
139
0
1999
2000E 2001E 2002E 2003E 2004E 2005E
30
Wireless internet will capture a share of online sales

In addition to wireline internet, wireless internet and m-commerce has emerged,
driven by convergence of communication and digital technologies. Growth in
mobile subscribers in Europe continues to exceed forecasts. Mobile commerce will in
some ways act as an extension of internet usage as it stands today, but also create a
revolution in terms of how online services will be used. Numerous estimates put the
number of internet-enabled handsets at 500m by 2003, providing a large and vibrant
market for new mobile applications and services. Although it is still early days and
barriers to adoption remain (for example, the demise of the WAP standard is already
under discussion), consumers are already using their mobiles and PDAs to play games,
send e-mails, buy travel tickets and surf for information. With internet anywhere,
services can follow the user and not be bound to when a PC is available (typically
certain times of the day).
Growth in mobile
subscribers is fast
Europe is leading the way in the development of this space. Industry analysts
estimate that Europe is 18-24 months ahead of North America in the adoption of
mobile commerce. This is not surprising, given that mobile penetration rates in Europe
are considerably higher than in North America. In countries such as Finland, wireless
has actually exceeded wireline penetration this year. One of the factors that has driven
this is the consistency of European standards (GSM) across a large population. In the
US, the opposite is true, and a hodge-podge of mobile standards has stymied mobile
adoption.
Europe is ahead of US
So far online retailers have been using m-commerce mainly to generate headlines,
since actual revenues from this channel are still minimal. M-commerce revenues for
the entire B2C sector should not exceed P XQWLO DQG HYHQ LQ
forecasters look for B2C revenues of PJHQHUDWHGE\WKLVFKDQQHO$OWKRXJKWKHVH
amounts seem minuscule, we must remember that m-commerce is likely to be
concentrated around a few key categories, at least in the early years of deployment.
Purchases that are time-critical, that do not require configuration, and do not depend on
touch & feel are likely to be the first ones to utilise this new channel. The best fitting
channels are likely to be travel, event tickets and flowers, however these will not
capture a major share of European e-commerce. Early m-commerce market has mostly
been about small transactions, which are often impulse buys (impulse purchasing will
be a big feature in this channel), such as cinema tickets.
m-commerce revenues
will be small
Table 7: European Wireless Penetration Data

Austria
Belgium
Denmark
Finland
France
Germany
Greece
Italy
Netherlands
Norway
Portugal
Spain
Sweden
Switzerland
UK
AVERAGE
1998
27%
18%
36%
58%
19%
17%
18%
35%
22%
47%
31%
18%
51%
22%
22%
29%
1999
49%
32%
52%
67%
36%
29%
37%
52%
44%
62%
48%
38%
58%
43%
41%
46%
2000
61%
43%
62%
74%
46%
40%
45%
66%
56%
71%
56%
51%
69%
55%
53%
57%
2001
69%
51%
69%
80%
57%
50%
54%
73%
65%
77%
63%
59%
74%
63%
62%
64%
2002
75%
58%
73%
85%
65%
58%
60%
78%
71%
82%
69%
65%
79%
69%
69%
70%
2003
79%
64%
76%
89%
71%
65%
65%
82%
75%
85%
75%
70%
82%
74%
74%
75%
2004
82%
70%
79%
92%
77%
71%
69%
85%
79%
87%
79%
74%
85%
78%
78%
79%
2005
84%
75%
81%
94%
81%
76%
73%
88%
81%
89%
82%
78%
87%
81%
82%
82%
2006
86%
79%
83%
95%
84%
81%
77%
90%
83%
91%
85%
81%
89%
84%
85%
85%
2007
88%
82%
85%
96%
87%
85%
80%
92%
85%
92%
87%
84%
91%
86%
87%
87%
2008
90%
85%
87%
97%
90%
88%
82%
94%
87%
93%
88%
86%
93%
88%
89%
89%
2009
92%
87%
89%
98%
92%
91%
85%
95%
89%
94%
89%
88%
95%
90%
91%
91%
2010
94%
89%
91%
99%
94%
93%
87%
96%
90%
95%
90%
90%
96%
92%
92%
92%
31
Key Thoughts:
Despite market turmoil, the C in B2C e-commerce is growing: Forrester Research forecasts
EQLQFRQVXPHURQOLQHVSHQGLQJLQ(XURSHLQ.
Internet users are beginning to represent critical mass. IDC estimates that half of the European
population will be online in 2002.
Online music is still a nascent market. In the US the internet is currently estimated to capture just
over 3% of total music sales.
CDs are an ideal product for online merchandising.

In the European music category, over PVKRXOGEHVROGRQOLQHLQ
Almost 20% of European music sales should be online in 2005, according to Forrester Research.
32
Digital Distribution On The Internet

Digital distribution
visibility still poor
US: Only $1m in paid

downloads in 1999
While majority of the population is still getting accustomed to migrating their shopping
online, a growing consumer group is abandoning physical music altogether and
acquiring and consuming music in digital format. We have already seen the massive
user groups attracted to file sharing applications such as Napster. However, revenues
from digitally distributed music are only now beginning to emerge. We acknowledge
the difficulty in estimating the market growth with any degree of accuracy because as
with any new format and technology, visibility is very poor, especially when revenues
are still some five years from representing any meaningful scale. Several research
institutions have published their own estimates, which we can use as the first
benchmark in determining the role of digital distribution in this category.
In 1999, Americans spent a mere $1m in paid digital downloads, a drop in the
ocean compared to the total US music sales of $14.3bn. Of total online music sales,
this would represent 0.1%. Most of this spending was concentrated among 3-4 leading
players in the industry, such as MP3.com and Emusic (Emusic reported $675,000 in
revenues for the 1999 calendar year, but most of this was from advertising). Download
sales are therefore still very marginal, although Forrester Research expects digital
downloads to start catching up with CD sales from 2003 onwards. Forrester Research
expects digital downloads to be a $1.1bn market in the US in 2003, compared to
$6.7bn in online CD sales.
Figure 20: US Online Music Sales Digital Downloads and Online CD Sales
($m)
6,695
$7,000
$6,000
$5,000
4,033
$4,000
2,488
$3,000
$2,000
$1,000
1,345
890
1
10
1,101
284
552
2001E
2002E
$0
1999
2000E
Digital Downloads
2003E
Online CD sales
Subscription revenues
should overtake download
revenues
Online subscriptions are estimated to be the killer application Recent estimates

from Jupiter suggest that in the US, digitally distributed music revenues should come to
around $1.5bn by 2005. Jupiter also assigns estimates for revenues generated by digital
subscriptions, which they see as overtaking downloads as the channels primary
revenue model. In Jupiters forecasts, revenues from internet music subscriptions
should be close to $1bn pa, compared to just over $500m generated by digital
downloads. The growth in subscription revenues is likely to follow closely on the heels
of broadband access growth, and streaming is probably going to be the primary
distribution technology in this business model. In this study, online sales of physical
products would still be over double the sales from digital downloads in 2005.
33
Figure 21: US Online Music Market ($m)

$6,000
Total US Online music spending
Physical Products
Downloads
Digital Subscriptions
5,364
$5,000
4,219
3,853
$4,000
3,299
3,180
$3,000
2,713
2,260
2,109
$2,000
1,4701,431
980
845 836
$1,000
387 387
$0
1999
2000
34 5
2001
88 63
2002
278
189
2003
581
339
2004
531
2005
Source: Jupiter Communications
The European market

could be e0.6bn in 2005
As for Europe, no reliable forecasts exist, however if we extrapolate the US digital

music take-up and assume that Europe is a year behind US in this development, we can
estimate that European paid download sales would be 6bn in 2005 (using Forrester
Researchs estimates for online music sales). This data would show that substantial
sales from digital downloads are still some two years away, and that we are currently in
a stage similar to where e-tail in general was in around 1997. Although at the moment
Europe is probably some 24 months behind us in terms of digital music take-up, we
think that Europe will close the gap in 2002-2003, so our post-2003 estimates could be
conservative. First download revenues should be recorded this year, and in 2001 a total
of PVKRXOGEHVROGLQGLJLWDOGRZQORDGVLQ(XURSH
Extrapolating Jupiter Communications forecasts give us somewhat more optimistic
revenue forecasts. European revenues from digitally distributed music could be P
in 2000. In any case, as the European music market is roughly the same size as US (US
music market takes up 37% of total world sales compared to 34% for Europe), digitally
distributed music should eventually reach same levels of revenues in the two markets.
UK, France, Germany

and Benelux will be
largest markets
We think most of these early download revenues will be concentrated in the four
key European music markets, UK, France, Germany and Benelux. We expect UK
to lead the way in digital download take-up, because of the countrys leadership
position in international music and because of UKs high music consumption (4.1
albums per capita is the highest of the world). In addition, we expect Scandinavia to
play a role in the first phase in Europe, because of the regions large pool of
technology-savvy consumers.
Also, the speed of take-up will also be driven by the fact that there is a strong
correlation between the demographic profile of a heavy user music consumer, and the
early adopters of new technology. 15-25 year olds are the largest music consumer
group in the world, with a heavy appetite for new artists and new music experiences.
This consumer group has also been the first one to get logged onto the internet, and
they are also likely to spend significant amount of time online.
34
Internet users and

heavy music users are a
perfect match
In addition, because music files eat a lot of bandwidth, the consumer group most likely
to be able to use them in a recreational context are students linked with high-speed
connections provided by their universities. As most downloaded music currently on the
net is free, it is not surprising that college students have been the first consumer group
to embrace this new format.
Figure 22: Estimated European Download Sales, 1999-2005E ( P
637.6
700.0
600.0
413.1
500.0
400.0
268.0
300.0
145.3
200.0
100.0
0.4
5.0
2005E
2004E
2003E
2002E
2001E
2000E
1999
0.0
0.0
Source: Forrester Research, Lehman Brothers Research
Huge volumes are

downloaded, but they are
not paid for
10% of US adults download

music
70% of US college students

use Napster at least once a
month
Are pirated downloads

replacing CD sales?
The revenues derived from downloading are still marginal. However, if we analyse
sales together with other usage metrics, we find that there already exists a huge active
community of people who consume music via digital downloads they are just not
paying for them. So far digital downloads have primarily been free of charge, either
because they are illegal copies, or because they are being used as promotions tools by
music companies or e-tailers.
Download take-up is already substantial however it is not paid for
We think that the current revenue figures available on downloaded music on the
internet are far from accurate in describing the size of the consumer group
involved in using music this way. Because most of the digital music currently being
downloaded is free, looking at revenues alone does not reflect the popularity of this
format accurately. In a recent survey conducted by IDC, over 40% of households in the
US had downloaded music from the internet, but of these only half had paid for them.
This would suggest an audience of 50 million people in the US alone. A survey by
Angus Reid Group found that 10% of America adults currently download music from
the internet (survey was based on 750 online users).
A survey by Webnoize found that over 70% of American college students use Napster
at least once a month and 57% use it weekly. Interestingly, most students listen to files
through Napster without saving them, indicating that there is already a consumer group
coming up the curve that is getting accustomed to music as a service and not something
that you have to physically own. This is a vital shift in consumer habits that is going to
drive the growth in many new pricing models currently being deployed in this channel.
The question now stands whether music downloaded free of charge (in other
words, pirated digital files) is being used to replace CD consumption and
legitimate music purchases. Data available is still very sketchy. However, the
shockwaves that Napster has sent throughout the music industry seem to have some
35
ground, since the digital rights management group Reciprocal found that record stores
within five miles of 3,000 college campuses in the US showed a 4% drop in sales in
just over two years. During the same period, the US record industry as a whole
enjoyed annual growth of 8%. A note of caution the study was paid for by
Reciprocal, who has a deep interest in legitimate download sales, not file sharing.
Top 50 European domains,

August 2000
Unique Digital
Visitors Media
(000) Reach
%
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
YAHOO.COM
MSN.COM
T-ONLINE.DE
LYCOS.COM
ALTAVISTA.COM
AOL.COM
LYCOS.DE
MSN.CO.UK
YAHOO.DE
YAHOO.CO.UK
BIGBROTHER.COM
NETSCAPE.COM
DEMON.NET
WEB.DE
FREENET.DE
XOOM.COM
BBC.CO.UK
YAHOO.FR
ABOUT.COM
CHANNEL4.COM
VIRGIN.NET
GO.COM
MSN.DE
EXCITE.CO.UK
LYCOS.CO.UK
EXCITE.COM
WINDOWSMEDIA.COM
FIREBALL.DE
VOILA.FR
RTL.DE
AOL.DE
UKPLUS.CO.UK
LINEONE.NET
AOL.CO.UK
NAPSTER.COM
MOORHUHN.BILD.DE
NETBROADCASTER.CO
NETSCAPE.DE
GO2NET.COM
COMPUSERVE.COM
MP3.COM
AOL.FR
MSN.FR
SUPANET.COM
PEOPLESOUND.COM
NOMADE.FR
THEGLOBE.COM
BANANALOTTO.FR
SPEEDYCLICK.COM
STERN.DE
Source: Media Metrix
8,021
7,111
4,339
3,267
3,207
2,874
2,676
2,658
2,406
2,339
1,936
1,850
1,770
1,758
1,641
1,541
1,539
1,500
1,334
1,328
1,325
1,269
1,235
1,208
1,156
1,141
1,101
1,099
1,019
1,002
954
882
867
806
748
744
741
721
641
638
579
567
547
524
522
509
484
473
453
448
33.0
29.2
17.8
13.4
13.2
11.8
11.0
10.9
9.9
9.6
8.0
7.6
7.3
7.2
6.7
6.3
6.3
6.2
5.5
5.5
5.4
5.2
5.1
5.0
4.8
4.7
4.5
4.5
4.2
4.1
3.9
3.6
3.6
3.3
3.1
3.1
3.0
3.0
2.6
2.6
2.4
2.3
2.3
2.2
2.1
2.1
2.0
1.9
1.9
1.8
On the other hand, some sources cite that using digital downloads is more likely to
increase music sales in traditional formats: digital download users tend to listen to
tracks on the internet first and then go and purchase the CD. For example, a study by
Jupiter Communications found that people who use Napster are 45% more likely to
have increased their music buying than non-users. Similarly a study by Angus Reid
Group found that 64% of people downloading music will not by any more or any less
music than what they already do. In the same study, 22% of downloaders said that they
will buy more music as a result of being able to download it from the internet
compared to 12% saying that they are likely to buy less.
Figure 23: The effects that people who have downloaded music think
downloading will have on their CD purchasing behaviour
Will buy less

12%
Dont know
2%
Will buy more

22%
No effect
64%
Source: Angus Reid Group, July 2000
This indicates that by making digital downloads available, consumers are more
likely to purchase music they would not have otherwise been tempted to sample.
The jury is still out on whether free downloads will in the end be detrimental to the
music industry. Our view is that they will do the opposite not only will they enable
diverse exploitation of music content in a multitude of platforms, but they are likely to
stimulate demand by promoting music more intensively. In addition, free music can
already be obtained with the physical format- by copying cassette tapes, however this
has not had a destructive impact on the music industrys growth
Magex, the digital rights management company estimates that more than 3 million
copyright infringing files are downloaded every day. In their research they estimate
that more than 4.2m internet users in the US own 91m pirated music files. Another
study estimated that in 1999 there were one billion illegal downloads of copyrighted
music. The music industry could lose $10bn by 2003 to pirated music being
downloaded from the estimated 500 websites that currently offer illegal MP3 files,
according to Magex. We think this amount is probably vastly overestimated, in
addition this type of scaremongering tends to come from the companies who are most
likely to benefit from piracy fears, namely digital rights management (DRM)
companies and providers of secure digital distribution services. We are not contesting
their estimate on user numbers, however we would like to note that in 1999 when
36
supposedly over a billion files were downloaded free and illegally from the internet, US
music sales grew by 8% on value terms and 5% in units.
Looking at Media Metrix traffic statistics, MP3.com was ranked no 27 in the
Entertainment category in the US in August with 3,229,000 unique visitors. This
puts it ahead of MTV.com which had 2,988,000 unique visitors and immediately
behind Broadcast.com, Uproar.com and Macromedia. In August MP3.com reported an
average of 167,000 unique visitors a day, and a total of 38m listens (songs delivered
online: played or saved) during the month of August. This traffic already represents
significant critical mass considering that the available songs posted on site are those of
lesser-known artists.
Napster has over 38m
members
Napster has achieved an unprecedented growth in user numbers. In just over 12

months, the company started by Shaun Fanning in his university dorm room has
attracted over 38 million members. This exceeds the customer base of Amazon (25m),
which the company has built over five years. Napster in the US is visited by on average
80,000 web users per day, according to Media Metrix, and it first arrived in the coveted
top 50 list at 47th position in July. This represents the fastest growth generated by viral
marketing in the history of the World Wide Web, and a fastest growing site in the
history of Media Metrix audience measurement service. The site is used monthly by
6% of the US online population, an unprecedented scale for what is still viewed very
much as a counter-culture service.
Table 8: UK Media Metrix survey, entertainment category, August 2000
Rank
Site
1
2
3
4
5
6
7
8
9
10
Virgin.net
Bigbrother.com
Channel4.com
Windowsmedia.com
Peoplesound.com
WWF.com
Bananalotto.co.uk
Channel5.com
Netbroadcaster.com
IWIN.com
14
15
Mp3.com
Napster
Unique Visitors
(000)
1120
1055
735
450
404
261
242
237
229
221
Reach
%
10.3
9.7
6.7
4.1
3.7
2.4
2.2
2.2
2.1
2.0
177
167
1.6
1.5
Avg Minutes
Per Month
10.6
17.5
4.6
3.6
2.0
15.1
53.3
9.4
0.8
1.5
5.9
-
In Europe, online music

sites rank high in traffic
surveys
In Europe, it is still early days and very few home-grown sites feature in the
audience surveys. However, we think it is significant that in the Entertainment
category, three of the top 10 sites were online music sites (note that we have
categorised Napster in Entertainment although Media Metrix categorises it in Services).
Home-grown talent is beating the US sites: Peoplesound.com was the 5th most popular
site in the Entertainment category in the UK in September with 404,000 unique visitors,
driven by successful marketing (Note that in April Peoplesound.com ranked 8th).
MP3.com was number 9 in this category with 231,000 unique visitors. Peoplesound
was ranked no 47 overall in the UK survey of online properties, topping such online
brands as Scoot, LetsBuyIt.com, eBookers or Looksmart. Note that we attach a health
warning into the European Media Metrix statistics. The survey still excludes office
usage from its audience measurement, therefore understating traffic across the board, in
addition the European sample sizes are still very small which increases the margin for
error even more. However, we think even these audience statistics indicate that the
early European consumer base is already flocking to digital download sites, and is
clearly beginning to sample this new format.
37
Consumers opt for free

download
Huge user base already exists

The user numbers extracted from Media Metrix audience studies and available
market research indicate that there is a large group of people who are getting
accustomed to receiving music free of charge. Some are questioning whether digital
downloads will ever create viable business opportunities as consumers dont seem to be
willing to pay for them. From a consumers standpoint, if the same track is available
free on Napster or one of the many sites hosting digital downloads, most are probably
going to opt for the free version. Another indication of consumers preferences is that
Napster, which is free of charge, has practically taken ownership of the digital
download sector amongst the 13-25 age bracket: 70% of people in this age group get
their MP3 downloads from the service, compared to 12% from MP3.com. As only
$1m of revenues was generated by paid downloads in 1999, this enormous file traffic is
almost entirely free of charge.
Figure 24: Where 13-25 get their MP3s (US)
MP3.com
12%
Other
18%
Napster
70%
Source: Element, June 2000
Young music consumers

are driving new formats
People in the 10-35 year demographic group are the biggest consumers of music.
60% of all music sales go to people aged under 35, and 25% of total music sales go to
the 10-19 age group. This young and very wired consumer group is therefore driving
new formats. We think the propensity towards free downloads is closely linked with
the fact that college students and other young people are still the largest user group for
digital downloads. This group tends to have very little respect for proprietary rights,
but similarly to software piracy, as people move up the income curve and into older age
brackets, the resistance towards paying for intellectual property decreases. Young
people are the early adopters in this new delivery method, unlike CD, which was first
adopted by high-income audiophiles because of the expensive hardware required. As
the format becomes more widespread amongst a wider demographic base, we think
consumers will get accustomed to treating downloads like regular CDs bought from a
store and pay for them. In a June 2000 survey of US college students, 74.4% of those
who use Napster daily would be willing to pay $15 a month for the service, and almost
half of those who use it only once a month would be willing to pay the charge. In
addition, the fact that many young people are unable to obtain credit cards has probably
played a part in the resistance towards paying for digital downloads.
38
Figure 25: Music Sales By Age Group, 1998
45+ years
18%
<10 years
1%
35-44 years
21%
10-19 years
25%
20-34 years
35%
Source: RIAA
Table 9: Napster use among US college students

% of college students % willing to pay $15 a
month for Napster
Never Heard of Napster
Aware of Napster, but never use it
Use Napster monthly
Use Napster weekly
Use Napster Daily
Source: Webnoize Research
Free downloaders will

convert into paying
customers
16.2%
11.1%
16.0%
37.6%
19.2%
0%
0%
42.2%
58.7%
74.4%
Most digital distributors and music download sites seem to share the view that
although consumers are not yet paying for downloads, what is more important is
that they are downloading. The business models in this early stage of digitalisation
seem to be about getting people accustomed to use the technology by giving away free
music, and then converting users into paying customers at a later point. Several digital
e-tailers therefore use free downloads as a promotional tool, while deriving revenues
from other sources such as advertising and CD sales. The digital format is still very
much experimental, and consumers are using the free downloads as a means to test its
usability and quality of service. Once consumers are convinced that digital downloads
work, they should be more comfortable with paying for the service. We believe that as
the format moves from being an underground community offering mainly popularised
by college students and heavy internet surfers, new business models with stronger
revenue streams can flourish, and some of these will probably achieve success in a
same way that online CD retail has.
39
Table 10: US Media Metrix August Survey, 60 top online media sites
Rank
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
Site
yahoo.com
msn.com
aol.com
microsoft.com
lycos.com*
go.com
netscape.com
excite*
real.com
about.com
iwon.com
msnbc.com
snap.com
passthison.com
infospace.com
speedyclick.com
weather.com
cnn.com
disney online
xoom.com
windowsmedia.com
espn*
freelotto.com
webstakes.com
juno.com
luckysurf.com
iwin.com
shockwave.com
sportsline.com sites
cbs.com sites*
gator.com
sony online
warner bros.
prizecentral
eonline.com
uproar.com
cdnow.com
webshots.com
justsaywow.com
napster.com
compuserve.com
macromedia.com
go2net.com
time.com
ticketmaster
ourhouse.com
nytimes.com
abc*
broadcast.com inc.
adobe.com
grouplotto.com
abc news
gamesville
mp3.com
citysearch*
pogo.com
discovery.com
netbroadcaster.com
usatoday.com
mtv.com
Unique
Visitors
(000)
49,300
41,643
35,155
30,080
27,612
21,094
18,355
15,654
13,727
12,242
10,078
9,955
9,320
9,106
8,958
7,918
7,590
7,253
7,107
6,882
6,447
6,269
6,174
6,064
5,668
5,561
5,458
5,409
5,361
5,335
5,258
5,227
5,203
5,005
4,930
4,880
4,431
4,243
4,215
4,098
4,033
4,015
3,907
3,808
3,661
3,628
3,553
3,536
3,348
3,329
3,312
3,300
3,237
3,229
3,135
3,134
3,108
3,096
3,028
2,988
Reach
%
64.0%
54.1%
45.6%
39.1%
35.9%
27.4%
23.8%
20.3%
17.8%
15.9%
13.1%
12.9%
12.1%
11.8%
11.6%
10.3%
9.9%
9.4%
9.2%
8.9%
8.4%
8.1%
8.0%
7.9%
7.4%
7.2%
7.1%
7.0%
7.0%
6.9%
6.8%
6.8%
6.8%
6.5%
6.4%
6.3%
5.8%
5.5%
5.5%
5.3%
5.2%
5.2%
5.1%
4.9%
4.8%
4.7%
4.6%
4.6%
4.3%
4.3%
4.3%
4.3%
4.2%
4.2%
4.1%
4.1%
4.0%
4.0%
3.9%
3.9%
Avg
Daily
Visitors
10,814
9,941
5,103
2,620
2,761
2,586
3,553
2,777
930
711
2,926
1,060
1,082
499
462
792
759
842
413
400
354
1,051
1,056
822
1,170
1,058
634
332
553
327
390
303
235
597
302
362
257
534
422
264
976
155
214
184
177
187
435
240
...
140
299
298
345
167
162
485
150
210
313
173
Avg
Min./
Month
94.4
76.1
23.3
10.5
16.7
32.0
34.9
62.6
6.7
9.8
111.6
22.6
21.5
4.4
8.4
5.1
10.8
25.7
12.7
7.3
5.1
51.0
31.6
23.9
47.8
10.3
47.4
20.5
26.0
10.5
7.5
14.2
6.6
56.4
7.5
32.2
12.0
20.0
6.5
7.0
85.2
3.1
1.5
3.0
9.5
3.6
25.9
11.9
6.3
4.2
11.0
18.7
57.9
9.5
6.6
299.7
6.7
1.5
18.0
9.5
40
Unreliable sound quality
Free downloads risk

spreading computer viruses
In addition, current service quality in digital downloads is still very elementary.

Because of lack of bandwidth (broadband access still capturing only a minor share),
downloading music is a tedious exercise which is mostly neither quick nor convenient.
Compression techniques are still experimental which result in variable sound quality,
and a listening experience that can rival CDs is still limited to those with top-range
equipment and fat pipe access. Digital downloads can not fully replace CD players at
home yet in delivering high quality entertainment, since most users listen to downloads
either on the PC using software players or with portable MP3 players. Integrated home
entertainment systems (for example, with playlists being programmed on PCs and
played through the speakers during a dinner party) are still very rare. Therefore, it is
not surprising that consumer do not want to pay for this. Once the service improves to
a level that makes downloads a viable alternative to CDs, applying charges will
certainly be easier.
Another factor likely to support the distribution of legitimate digital downloads is
file security. By downloading free music files from an unknown source using Napster
or other file sharing applications, the user has no way of knowing what s/he is
downloading. Computer viruses can travel this way to unsuspecting users, and given
the damage caused by well-known bugs such as Melissa and the I Love You virus,
this is a cause for concern. There is a risk of file-sharing applications such as Napster
(which rely on users implicitly trusting each other) becoming overrun by bombs, or
intentionally misnamed files, and viruses. In this case we would expect that people are
willing to pay for a centrally maintained, trustworthy network.
Moreover, because it is the young consumers that are also heavy internet users
who are the first ones to adopt digital downloads, certain genres are likely to
succeed before others. Already the charts for online CD sales look different from
overall music charts (for example, see charts available on Billboard), and this is why
we believe that for example dance music is the first one to migrate onto digital format.
One of the European pioneers in digital music retail, Icrunch, is specialised on this
genre.
Flat music sales in bricksand-mortar channels
Digital downloads will eat

into retail sales
Bricks-and-mortar retailers under threat

If we look at both online retail and digital download take-up in Europe, an
interesting picture emerges which should raise some thoughts within the bricksand-mortar retail sector. Remember that European music sales have been flat to
negative over the past few years. In 1999 European music sales were flat in value
terms and fell 3% in unit terms, clearly deteriorating from 1998 when unit growth was
flat and growth in sales value was 2.6%. Almost the entire industry sales still go
through bricks-and-mortar retailers. Depending on a national market, direct sales
through music clubs take 2-3% in value terms, although this is normally higher in
volume terms because of the discounts offered typically in this channel. Online sales
were still around 1% in 1999.
With the online channel emerging fast, and change in format from CDs to digital
becoming more evident, the sales in this new channel can only come from existing
retail sales, given that the total market growth is flat. In graph 26 below we have
estimated ten-year growth forecasts for the total European music sales, online CD sales
and digital downloads. We assume an average annual growth of 2.3% for European
music sales, and use Forrester Researchs estimates for total European online music
sales (Forrester Research expects these to be EQLQ:HHVWLPDWH(XURSHDQ
digital download revenues by using available US take-up estimates and assuming that
the European market is one year behind US. From 2005 onwards, we assume 15%
annual growth for online sales, and assume that digital downloads take an increasing
share of total online music sales, from 20% in 2005 to 40% in 2010.
41
Only 38% of music sales

will be in bricks-and-morte
As a result, we expect 38% of total music sales to be in bricks-and-mortar

retailers in 2010, whereas 27% will be CD sales online and 18% will be in digital
downloads. This means that offline retailers will see their sales fall from EQ LQ
1999 to EQ LQ OLWHUDOO\ KDOYLQJ LQ YDOXH LQ WHQ \HDUV Realistic? Given the
speed with which online retail has been taking share in this category in the US, we think
this scenario is possible. For traditional retailers, its either sink or swim: either they
start developing their online offerings now in order to stay with their customers as they
migrate online, or they will face rapidly declining margins over the next ten years.
Figure 26: Share Of Total European Music Sales For Offline, Online Retail And Digital Downloads
100%
1%
1%
3%
6%
9%
90%
2%
13%
3%
5%
7%
16%
80%
19%
21%
9%
11%
23%
24%
70%
14%
26%
27%
60%
50%
18%
99%
97%
94%
40%
89%
82%
77%
71%
30%
65%
60%
53%
46%
20%
38%
10%
0%
1999
2000
2001
2002
2003
Offline
2004
2005
Online CDs
2006
2007
2008
2009
2010
Downloads
Source: Lehman Brothers Research, Forrester Research, IFPI
Table 11: Estimated European music sales through traditional retail, online
retail and digital downloads ( P
Offline
Online Retail
Downloads
1999
11,505
139
0
2000
11,584
313
0
2001
11,473
672
5
2002
11,001
1,128
145
2003
10,462
1,690
268
2004
10,039
2,099
413
2005
9,470
2,512
638
2006
8,833
2,835
945
2007
8,301
3,130
1,217
2008
7,581
3,399
1,600
2009
6,740
3,737
2,012
2010
5,574
3,967
2,644
Source: Forrester Research, IFPI, Lehman Brothers Estimates
Total
11,644
11,897
12,150
12,274
12,420
12,551
12,620
12,613
12,648
12,580
12,489
12,185
42
Biggest losers will be the

large music retailers
In the UK, the largest European music market, we see the biggest losers being the
large music retailers. Woolworths, the general merchandise chain owned by
Kingfisher and now undergoing a demerger, is the UK market leader with around 14%
market share. HMV is second with 12% share , with Virgin at third place (11% share).
A large share of UK music sales goes through the supermarkets, who have been
channelling a lot of effort in developing their non-food offer. Asda has around 4%
market share in UK music retail, whereas Tesco has 3%. In general, music retail is a
very fragmented market with sales going through a variety of outlets from petrol station
forecourts to department stores to specialist stores.
Figure 27: UK Music, Video and DVD retail market shares
33.9%
Others
13.7%
Woolworths
12.0%
HMV
11.1%
Virgin
Our Price
6.4%
WH Smith
6.0%
4.2%
Britannia
Asda
Tesco
MVC
3.9%
3.0%
2.6%
J Sainsbury
1.6%
Tower Records
1.6%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
Source: Verdict
Key Thoughts:
Download revenues were a mere $1m in the US in 1999.

Forrester Research expects digital downloads to be a $1.1bn market in the US in 2003.
Very few forecasts exist for Europe, however if we extrapolate from the available US forecasts
we can estimate that European paid download sales could be - bn in 2005.
Although revenues are still marginal, other usage metrics reveal that download take-up is
already substantial. However, it is not being paid for.
Napster has grown to a user base of over 38 million in just 12 months, and is ranked among the
top 50 US online domains in the Media Metrix survey.
We think that as the user base matures and becomes more mainstream and as the service
quality improves, consumers will be more willing to pay for legitimate downloads.
Migration to digital format will put existing bricks and mortar retailers under threat.
43
Drivers Behind
Digital Music
Take-Up
Broadband will be the single most important driver in digital

music take-up
We think that adoption of digital distribution is imperative for the music industry.
However, there are numerous obstacles in place, which must be overcome in order to
clear the way for widespread consumer adoption. These are found both in the
technology deployment and customer acceptance, as always with new formats and
business models. We believe that despite consumer receptiveness towards downloads
is clear and increasing, the speed of adoption will depend on three issues: broadband
take-up, availability of content and both format and player technology development and
pricing.
Figure 28: Obstacles for digital distribution take-up
Industry
Consumer
Bandwidth
Compression quality
Playback devices
Bandwidth
Portable storage
Compression quality
Indie label acceptance

Retail channel conflict
PC and mobile as
entertainment device
Piracy
New pricing models

New consumption
occasions
Acceptance
Major label acceptance
Technology
Format security
Broadband take-up
Download speeds for a
typical 3-4 minute track
in MP3 format
28K Modem
56K Modem
ISDN
ADSL
30 mins
8-10 mins
4-5 mins
30 seconds
Source: Lehman Brothers

Research
Internet as a medium is still a fairly low-grade communication device with

cumbersome navigation and painfully slow downloads. The benefits of digital media
can only be fully utilised on high-speed connections. Not surprisingly, at a recent IDC
survey slow download speed was one of the key reasons not to pay for downloaded
music. This is understandable when a single track can take over 30 minutes to
download over a 28K dial-up connection, with a faster 56K modem still taking 10
minutes per track. With these download speeds it would often be easier to walk to a
shop to buy the CD! Downloading entire albums with a dial-up connection is usually
out of the question, as it would take several hours (this is why the digital download
market is still predominantly singles-based). However, the adoption of broadband
access will revolutionise the internet in many ways and its greatest impact will be in the
entertainment and media industry, in our view. This new medium will provide a whole
new internet experience.
"Broadband" describes emerging network technologies and architectures, which
enable the high-speed transmission of information - regardless of whether it is data,
voice, or video - over long distances to users in widespread geographical areas. This
44
high-speed transport of information is accomplished using high-frequency transmission

carrier signals over fibre or copper cable, or through the airwaves. High speed is
loosely defined as speeds greater than T1/E1 speeds - with more emphasis placed on
information content capability (ie, data, voice, and video are all possible and practical)
than on actual bandwidth. The connection speed will be multiple times faster than the
current dial-up modems: 2MBs or more compared to 56kbps for a typical dial-up.
Broadband as % of all
internet connections
(Western Europe)
30.0%
25.4%
25.0%
18.0%
20.0%
15.0%
11.8%
10.0%
5.0%
The main attraction is that internet connections will be running at anything up to

100 times faster than current dial-up modem speeds, which means that whole lot
more information can be sent down the wires. Also a key advantage is instant
availability, an internet service that is always on without the need to wait for the
connection to dial up. Typically the user will be charged for the service (a monthly fee)
regardless of how much time s/he spends online. This opens the possibilities of
multiple access points throughout the house, as internet becomes as ubiquitous as the
television. The always-on facility means that internet and telephone can be used
simultaneously without web surfers clogging the phone lines.
6.3%
0.9%
2.6%
0.0%
1999 2000 2001 2002 2003 2004
Source: IDC
Broadband architectures can be broken into two categories: 1) Switched

Architectures, where information can be delivered to multiple users through a multiple
connections, and 2) Broadcast Architectures, where information can be delivered to
multiple users using a shared connection.
The key broadband technologies in these categories are:
Several available
broadband
technologies
Switched architectures:
1) Fibre
2) WLL
3) ISDN
4) DSL
Broadcast architectures:
1) Cable
2) Satellite
Fibre The main switched architectures are Fixed Wireless Access (FWA) using Local
Channel Multipoint Distribution Service (LMDS) and fibre-based architectures. Fibrebased architectures have the benefit of almost infinite capacity, which make it the
ultimate broadband solution. However, fibre is expensive to deploy approximately
80% of the costs of deploying fibre in the local loop are related to digging/construction
and therefore are not likely to fall.
There are many different architectures that use fibre to a serving area. The general
name for these types of architectures is Optical Subscriber Network (OSN). These
networks differ mainly with regard to how far the fibre extends to the customer
premise. Some of these OSNs are listed below:
FITL: Fibre in the Loop (eg, any architecture where fibre is used in the local loop).
FTTC: Fibre to the Curb.
FTTH, FTTB, or FTTO: Fibre to the Home, Fibre to the Building, or Fibre to the
Office. FTTH is providing direct fibre connection to the residence allowing data
transmission speeds of several hundreds MB/s or higher.
FTTZ: Fibre to the Zone.

45
DSL uses existing

telephone lines
DSL could bring

broadband to mass market
DSL applications will speed broadband take-up in Europe, in our view. DSL uses
existing telephone lines with no last-mile issues present in cable access, as broadband
services can be carried over existing copper twisted-pair infrastructure along with
traditional telephone service. There are several flavours of DSL, all with different
capabilities and configurations. The main difference between the varieties is the ability
to transfer data at the same speed in both directions (asymmetric vs. symmetric). For
residential customers, asymmetric services (ADSL) are likely to be more suitable
because internet is more used for downloading data rather than uploading data.
Maximum data speeds for ADSL are around 2Mbits/s, although trials have shown that
ADSL can support bandwidth of 4-6Mbits/s. The early ADSL services have been
limited to 500kbps (for example, BT Openworld), which already offers faster audio
applications but do not have the capacity yet to deliver TV over the internet.
We think DSL technology will be the application that will bring high-speed internet
access to mass residential market. So far the European telcos have been slow to
implement DSL services, fearing cannibalisation of existing leased line and ISDN
revenues, however the unbundling of the local loop will bring new entrants to the
market and force telcos to implement widespread rollout of these services. Although
DSL has less capacity than cable, it will be the most viable option for most consumers
and small businesses.
FWA (Fixed Wireless Access) involves broadcasting at radio frequencies to receivers
that are within Line of Sight (LoS) or sometimes Near Line of Sight (NLoS). The
advantages of this technology are the speed and low cost for operators to roll out
infrastructure.
Cable and satellite are examples of one-way broadcast architectures that are being
developed to allow for two-way communications.
50% of European households

have cable
Cable is a viable access architecture in Europe, given that almost 50% of European
households have access to cable. Cable internet access requires upgrading existing
cable networks to allow two-way transmission, which involves digging up the roads and
installing two-way amplifiers. However, one characteristic of broadcast architectures
(including cable modems) is that there is a finite amount of bandwidth that is shared by
all users, which can lead to problems of contention as service levels fall in periods of
high demand. Because the network is shared, no-one has a dedicated connection.
Security is also difficult to implement adequately in these architectures, which would
impact business take-up. In the residential areas, however, cable modems should take a
reasonable share of European broadband access. In the US cable broadband access is
at the heart of high-speed internet services, this was also one of the drivers behind AOL
and Time Warner merger.
Satellite is at present used to provide one-way high-bandwidth transmission (e.g.
television broadcast). Provision of two-way transmission for residential customers
would be more problematic because of return path economics. The best prospects for
satellite high-speed internet access would be for remote residential locations where it is
uneconomical for service providers to deploy other technologies. Like cable, the
disadvantage is that transmission capacity is shared between multiple users.
18-22% of all Western European internet connections will be on
broadband by 2003
2.8% of US home
internet users are
broadband
Broadband is arriving fast. In the US, 2.8% of home internet users are currently on
high-speed connections (approximately 2.8m users). In Europe, broadband internet has
been resembling a type of mythical hero, of which everyone talks about but no-one has
46
By 2003 18% of
European internet
connections will be
broadband
ever seen. So far broadband has been unavailable and/or unaffordable for the
Europeans, partly because of slow rollout on behalf of the telco incumbents. IDC
estimated that at the end of 1999, there were 344,000 residential broadband
connections in Western Europe. However, broadband connections are set to skyrocket:
By 2003, DSL, cable and FWA (Fixed Wireless Access) connections will top 27m in
Western Europe, making up 18% of all internet connections, according to IDC.
Forrester Researchs forecasts are more optimistic, estimating that in 2003 22% of all
internet connections will be high-speed, with 12.5m households in Europe connected.
IDC, on the other hand, forecasts that in 2003 there will be 27.2 million users
(households and businesses) accessing internet via fat pipes, providing critical mass
which should accelerate the development of broadband content and open up the
avenues for streaming media among others. The growth will come both from existing
internet users graduating from dial-up connections, and new users that go straight to
broadband. IDC expects DSL connections to overtake cable as the dominant access
service in 2001.
Figure 29: Broadband Access Connections In Western Europe, 1999-2004E
50,000,000
45,000,000
40,000,000
35,000,000
30,000,000
25,000,000
20,000,000
15,000,000
10,000,000
5,000,000
0
1999
Source: IDC
Source: IDC
Scandinavia is set to lead
2000
2001
DSL
2002
Cable
2003
2004
FWA
In Europe, Scandinavia is set to lead the continents transfer to fat pipe access.
Sweden, Denmark and Finland are forecast to have 30-40% of all households on
broadband in 2005, according to Forrester Research, and half of all online households.
This penetration should match the US.
47
Figure 30: Broadband households as a % of all households, Western Europe

18.0%
18.0%
16.0%
12.2%
14.0%
12.0%
10.0%
7.9%
8.0%
4.9%
6.0%
4.0%
2.0%
2.1%
0.0%
0.2%
0.6%
0.0%
1998
1999
2000
2001
2002
2003
2004
2005
With broadband the game

starts all over again
Rich media will become

part of everyday internet
use.
Download speed will

improve
Broadband customer
spends longer online
Broadband offers an interesting aspect to World Wide Web. We think that when
web becomes universally a high-bandwidth medium, the game starts all over again, as it
is an entirely new medium and a new service platform. Not only will people use it in a
way that to a large extent is not yet possible, it opens up the avenues for next generation
of entertainment and retail services, where success and failure will have new
determinants. Almost the entire World Wide Web as it stands today has been designed
for dial-up connections and with their speed limits in mind, including the most popular
sites such as Yahoo! and Amazon.
The 21st century internet will be a broadband world. Bandwidth-hungry
applications such as streaming media, video-on-demand, video commercials, and
webcasting can finally become part of everyday internet use. Videoconferencing via
internet will become applicable using webcams. Sophisticated multi-player games
involving audio, video and other multimedia can be introduced to computer games
fanatics worldwide. Shoppers can view 360-degree images of goods (for example cars
or houses). For retail and entertainment companies broadband will enable the shop
fronts to have more dynamic content and more functionality, as bandwidth is no longer
an issue. CD-quality audio sounds can be introduced to accompany shopping sites.
And, music can be downloaded in a few seconds rather than the 10-30min per track on
a dial-up modem.
In addition to download speeds, sound quality will improve in the broadband
world. The more an audio file is compressed, the worse the sound quality. However,
with smaller compression that would improve the sound quality, file size is larger and
download speed is vastly reduced. As with high-speed connections file size is not an
issue, therefore the applications can focus on delivering high quality sound to users.
Research has also shown that a broadband customer will stay online four times as
long as a narrowband customer, and spend nearly three times as much on ecommerce. Part of this is surely because the first broadband users tend to be more
internet-savvy and also fall into the high-income demographic bracket, however the
impact for online business models will be significant. Chello, the pan-European
broadband service provider, says that a broadband customer spends on average 52
hours per month online, compared to 15 hours per month spent by a narrowband user.
48
This will have positive knock-on effects for a majority of online business models,
especially advertising: as there will be more page views and more minutes spent on site,
internet will start to close the gap between traditional media as a viable advertising
vehicle. Online advertising revenues are set to experience a step-change in growth. In
addition, as online shopping can be made more enticing and entertaining with new
visual applications, online retail models (whether the delivery is in a digital or physical
format) will find new support. Furthermore, e-commerce activities and revenues will
be boosted if customers can spend more time browsing. In addition, because of rich
multimedia capability, a premium shopping experience will become an alternative and
internet does not have to be a discount channel.
Availability and
connectivity
Portable MP3 players
increase usage
Diamond Rio500 MP3

Player
Source: Lehman
Brothers Research
Mobile phones will

become playback devices
price
of
playback
devices,
wireless
The arrival of portable playback devices made digital downloads a viable

alternative format to CDs, vinyls and cassettes. With software players the usability
is limited to the vicinity of a PC, however since the launch of Diamond Multimedias
Rio in 1997, is has been possible to store MP3 files on a portable player and listen to
them with headphones, just like a regular Sony Walkman. Unlike cassette or CD
players, MP3 players have no internal moving parts, therefore the music does not skip
or change pitch if the device is moved.
When Rio debuted, the hardware players were priced at around $300 (200) with
32MBs of storage. Currently portable MP3 players are priced at around 150-200
($240-$310), depending on memory capacity. Diamond Rio500 player with 64MBs of
memory space is priced at around 250 ($380), whereas the downscaled version
Diamond Rio300 is priced at around 130 ($200), containing 32MBs of memory space,
equivalent of around 30 minutes of music. This is obviously not very practical, since
most CDs are around 60 minutes long. Therefore the added memory required to
upgrade the inexpensive version into a more user-friendly device is going to add to the
cost of acquiring a portable player. Once the user has listened to the preloaded songs,
s/he will have to return to the PC and load the player with new music. Another factor is
the sound quality: a true CD sound quality demands 256kbps or better, whereas MP3
encodes at 128kbps. A higher encoding rate (which is adjustable with the format)
translates into a larger file, which occupies more space on a portable player. With
continuously developing format technology, more sophisticated codec systems should
emerge, allowing for more convenient portability of digital music.
In comparison, portable CD players are priced generally between 20-80 ($30-125),
and you can get a reasonably good player with just 50 ($78). We think that until the
prices of portable playback devices come down to level with personal CD players, the
migration to digital delivery will be held back.
With the emergence of wireless internet and more specifically wireless broadband,
mobile phones should eventually take on the role of a digital music playback
device. Streaming audio to a handheld device (mobile phone or a PDA) is a viable
concept, which should further increase digital music take-up, as users will no longer be
PC-bound in order to utilise streaming services. In addition, with the race to build
mobile content for the new wireless world, digital music should become increasingly
valuable for network operators and mobile portals.
49
PDAS will become

playback devices
With the increasing growth in wireless take-up, we expect to see a range of

developments in audio products. Handsprings Visor hand-held product range, for
example, has expansion slots that enable users to plug in MP3 players and listen to
downloaded music files. Sony has recently announced that it will licence the Palm
operating system. The company is planning to develop a new line of hand-held
products, which is expected to include mobile wireless audio consumer electronic
products. Microsoft has made its Windows Media Player available for download to
handheld computers. Palm already enables wireless downloads from the internet.
Samsung has recently launched a mobile phone with a MP3 player built in, and we
expect other handset manufacturers to follow suit.
Figure 31: Mobile Handsets
Nokia 9000 Communicator

Nokia 7110
Motorola P7389
Ericsson R380
Ericsson MC218
Source: Nokia, Ericsson and Motorola
The Scandinavia
wireless penetration
exceeds wireline
3G will offer near

broadband data
speeds
We think that Europe being the global leader in the adoption and development of
m-commerce, European wireless digital music services have a lucrative launch
pad compared to US operators. Mobile handset prices are constantly declining, and
in markets such as the UK, can be purchased with as little as $20-$30. Consumers
across Europe have already become accustomed to using mobile phones, with wireless
penetration in some countries (Finland, Sweden), exceeding the penetration rates of
wireline connections. Children and teenagers already represent a large user base, and
these consumers have also been one of the first customer groups to embrace mobile
data services, with SMS being a communication method of choice among the European
teenagers. Therefore, the demographics of mobile internet users present a good fit with
the average music buyer; young people and teenagers being avid users of mobiles and
also the presenting the largest group of music buyers.
Current connectivity is lacking the capacity that would allow for a seamless user
experience, as networks are still too slow to support anything but the simplest and
smallest audio files. However, with 3G licences being under furious bidding,
infrastructure is being laid to allow for more sophisticated wireless streaming
applications. 3G offers enhanced data speeds relative to the current standards, but the
initial data speed capability is still going to be restricted to max. 384kbps in dense,
urban areas and 128kbps in a rural environment. It is expected that GPRS (General
Packet Radio Service) infrastructure will be implemented into the current GSM
networks throughout 2000 with the first trials being carried out in summer 2000. This
enables the network operators to launch commercial GPRS services in 2001. Only by
2002 it is expected that GPRS is routinely incorporated into GSM mobile phones and
50
reaches critical mass in terms of usage. Full-on mobile broadband is promised within
two years through UMTS (Universal Mobile Telecommunications System)
(Please refer to report dated 12th June 2000 by Mairi Johnson and Brian Skiba,
Lehman Brothers Technology Research, titled Moving In Mobile Media Mode)
Majority of legal
downloads are from
unknown artists
Many download sites are a

platform for unsigned
artists
No quality controls has

resulted in huge volumes
The reason why digital downloads have only taken 0.1% of total online music sales in
the US (in Europe we expect download sales to have been practically non-existent last
year) is partly because of lack of bandwidth and resulting inconvenience, but also
because of lack of mainstream content available online. The digital download sellers
(MP3.com, Emusic, Vitaminic, Peoplesound.com) contain thousands and thousands of
tracks, however a majority of these are from lesser-known artists. Many of the new
entrants in this sector have focused their business models around providing a platform
for unsigned artists to feature and distribute their music. For artists without a record
label contract, posting tracks on a download site is the only way to get his/her work
published and distributed to a wider audience. As a result, a large number of available
digital download sites tend to consist of marginal artists without any big-selling mass
market stars.
Similar offering can be found in the large recently European sites. Amongst the
top 10 downloads listed on Vitaminic.co.uk, we could not find any mainstream artists
or tracks. These business models fill two functions: first, they allow consumers to find
new music that perhaps would not get published, since these artists are not represented
by any record labels. Second, they provide services for record labels A&R function,
allowing them to screen new artists and potentially discover the next star. For aspiring
musicians, the offer is extremely compelling. By posting their work on sites such as
Peoplesound.com, Vitaminic or MP3.com, artists can get access to a large global
audience, (mostly) free of charge. Most sites offer revenue-sharing agreements
whereby any revenues from sold downloads will be shared with the artist, therefore
offering the artists a viable opportunity to be rewarded from his/her work.
However, as publishing and distributing music in the form of digital downloads on
websites carries minimal costs, the sheer volume has grown exponentially.
Although most of the sites claim to have systematic quality controls in place in the form
of a professional A&R network, the sites that aim for volumes ultimately will have to
sacrifice quality. For consumers, having to plough through thousands of artists whose
talents sometimes are not far away from next door neighbour singing in the shower, the
value proposition becomes less compelling. So far digital downloads have appealed to
a consumer group that is passionate about music and enjoys searching for new artists
(similarly to attending clubs and bars where new bands perform). We think digital
downloads will not be able to attract the masses (and therefore pull significant
revenues) until mainstream content is available in this format.
As an example, we pooled the Top 15 chart from MP3.com on 7th November.
MP3.com together with Peoplesound.com and Vitaminic operate vaguely similar
business models, listing unsigned or emerging artists. The 15 best sellers could
hardly be called big-selling artists. In addition, best-seller lists on download sites often
get highest traffic simply because they provide navigation tools for the confusing array
of choices, therefore these are the ones people tend to download, which gets the tracks
to stay on the list even longer.
51
Table 12: MP3.com Top 15 Downloads (7 November 2000)

Rank Artist
Genre
Title
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Pop
Pop
Rave/Old Skool
Goa
Pop
Intelligent Techno
Progressive Trance
Melodic Trance
Progressive Trance
Deep House
Film Music
Seasonal/Holiday
Progressive Trance
Smooth Jazz
Club
Cowboy Junkies
Cowboy Junkies
303infinity
ASTRAL PROJECTION
Cowboy Junkies
DarkUFO
t r a n c e [] c o n t r o l
PPK
[SuPERGRooVerecords]
Art Sulit Pipe Organ Works
Halloween
Cedric Simon
DJ Turbo
Misguided Angel
Crescent Moon
Winter Rain
MAHADEVA
A Few Simple Words
Crash Landing
Deep Vibrations
Resurection (space club mix)
Phazed Reality
IBIZA SUN
Dracula Theme
Halloween Screams
Love and Desire
Velvet
DJ Turbos Dance Megamix
Source: MP3.com
Table 13: Vitaminic.co.uk Top 10 Downloads (7 November 2000)

Rank
Title
Genre
1
2
3
4
5
6
7
8
9
10
Moonlight City
80ies/Wave
Love - Bajottis House Dancefloor-Pop
Gifts
80ies/Wave
Burning for you
Trance
Football Is Life
Pop
Brotherhood
Heavy Metal
Mushmellow Dream_01Pop
Your mind (radio edit) Techno
Flashpoint
Heavy Metal
Coz - swashing cut
Dance
Artist
Skylin
Nicole Key
Skylin
Jono
FC Allstars
Headup
Debaser
DJ 16V
Headup
Gumbo
Source: Vitaminic.co.uk
Indies see downloads as

a distribution
opportunity
Indies have been the first sector to put their content online. In addition to listing
unsigned artists, the second early business model in digital music is providing digital
distribution services for and selling digital downloads from the vast number of
independent record labels. These labels have been faster to embrace the new format,
primarily because they have less at stake but also because being smaller, more receptive
to new ideas and potentially more creative, they have been viewing digital music less as
a threat but more as an opportunity. In addition, indies tend to view digital formats as a
distribution platform: artists signed with the majors have distribution taken care of, as
all the majors own and operate their own distribution operations (literally own
warehouses and trucks which ensure that the CDs get to the retailers shelves).
However, the independent labels usually do not have these capabilities, which means
that the labels have to buy third party services either from the majors or from other
distribution service providers. Digital distribution is an inexpensive way to get their
music to the consumers, which is why some of the most successful early businesses in
Europe have been focusing on distributing the music of independent labels. NetBeat
and iCrunch are the two most prominent names in Europe with this model. Although a
lot of the music signed by the indies tends to be alternative or cover marginal genres,
some extremely popular artists have been launched through independent labels: Oasis,
Prodigy and Moby are good examples.
52
Selling content is this

industrys livelihood
Because of copyright
issues, majors are staying
put
Testing the waters with

small experiments
Piracy is still rampant
Singles could go online

first
Out Of Print (1999)
A-List (2000)
Back Catalog
Rollout Schedule
B-List (1999)
Back Catalog
(Compilation-Grade)
New Releases (2002)
Source: Jupiter
Communications 1998
Major record labels are guarding their content

The entertainment industry is built around developing, promoting and
distributing content. The entire industry generates revenues from selling and
distributing content. It is their livelihood. It is therefore understandable that music
companies want to maintain control over their content and minimise unauthorised use.
However, since a majority of the worlds most popular artists are represented by one of
the five major record labels, it is essential for the take-up of digital music to get the
acceptance from these industry giants. But so far the majors have been fiercely
protective of their content, and slow to make any moves when it comes to distributing
their content in the form of digital downloads. Because copyright issues have not yet
been resolved in the most popular download formats, major record labels have so far
been reluctant to make moves in this format. The mainstream content currently
available on the internet is mostly illegal, and there are hundreds of web sites from
which to download ripped CD tracks.
The majors have begun to dip their toes slowly into the world of digital downloads
by making small announcements and limited experiments. Warner announced in
September that it will offer digital downloads of its catalogue of artists, working
together with RealNetworks and selling them on Walmart.com and Amazon.com.
Bertelsmann has put a small selection of its catalogue for sale in digital downloads
through selected sites (initially Lycos).
However, this together with similar
announcements from EMI and Universal are still experimental and restricted to certain
sites in exclusive agreements. We are still far away from moving to widespread online
distribution of mainstream content. The record labels are still struggling to find a way
of moving to digital distribution that will preserve their earnings.
Therefore it is not surprising to see the digital download companies generating only
marginal e-commerce revenues to date. The industry has been marred with litigation,
as the record labels have remained distrustful of this new format. Piracy is still
rampant, and as long as the major labels refrain from releasing their catalogues in
digital downloads, this format will remain marginal.
Major labels will start with singles and back catalogue first. The graph on the left
illustrates a potential rollout schedule for converting major record label-owned content
into digital format and making it available in a commercial model. Forrester Research
estimates that the next two years will see downloads being used as a promotional tool
only, but as secure platforms emerge, the majors will put their content available in mid2002. We expect singles to be first product to move online, since singles are already
used to a large extent as a promotional tool, to entice consumers to buy the full album.
The possibility of making downloaded tracks to time out, or deactivate after a
designated time, should encourage majors to release more music in promotions before a
full-scale commercial deployment becomes reality. We think that digital downloads or
streams will not be able to fully replace CDs until internet connectivity expands from
PCs to match the accessibility and portability of CD or cassette players. As long as
listening to downloaded music is limited to PCs at home (even if these can be
connected to the speakers), consumers are likely to buy CDs for listening in the car, in
the office, or other rooms in the house. During this period digital downloads will serve
as a superb promotional tool, in the same ways as radio but with more personalisation,
more interactivity with the user and more choice for consumers.
53
Figure 32: Evolution of music content online
1999 Pirate Era

Pirate content explodes as net users rip CDs into
audio files
MP3 format becomes popular
2000
Downloads from unsigned artists

File sharing widely adopted
Choice in playback devices expands
Major labels experimenting with download solutions
2001 Promotion Era

Price of playback devices drops
More music from indie labels available for sale
Samples widely used on music e-tail sites
2002
Secure platform will be developed by music industry

Mainstream content available for sale or subscription
Broadband take-up accelerates
Net destinations will feature digital audio as standard
2003 Commerce Era

Playback devices become commonplace (like
Walkmans)
Download sales start catching up with online CD sales
Broadband widely available
2004
Virtual record labels, online promotions, Web music

communities
US download sales exceed $1.1bn in 2003
Source: Forrester Research, Lehman Brothers Research
Back catalogue will go

online first
Radio and TV were

also seen as a threat at
first!
In addition, we believe that the majors will start testing the digital waters by
making their back catalogue available online first (this means old releases). As
most of the back-catalogue albums or out-of-print albums tend to sit at the bottom of
the warehouse anyway without generating much sales, revenue loss in the event of
piracy would still be negligible. Jupiter Communication was forecasting in 1998 that
compilation-grade back catalogue (old releases from obscure artists) would come
online in 1999 latest, with the better quality A-List back-catalogue being made
available this year. In reality, this is not taking place as fast as originally predicted,
however the rollout is likely to follow this sequence.
It is interesting how the music industrys fears are not unique: Radio was once
feared by the music industry, as it was thought that music on radio would mean the end
of record sales. In a similar way, Hollywood believed TV would kill the movie industry
by emptying the cinemas. We all know what actually happened - radio became the
music industrys staple promotional medium, and the movie industry discovered the
secret of eternal life for its back catalogue. New media usually do not replace old
media, instead they complement them. Like with the arrival of all new channels, the
industry will eventually come to embrace them.
54
Key Thoughts:
The key drivers that will determine the growth rate of digital music take up are 1) broadband takeup 2) availability and price of playback devices and 3) availability of mainstream content.
On broadband, download speeds are significantly faster with a better sound quality.
For online businesses, broadband will have several positive implications. Front-ends can include
bandwidth-hungry applications. Also, broadband user spends nearly four times as long online sas
a narrowband customer.
With the increasing growth in wireless take-up, we expect to see a range of developments in audio
products embedded in mobile phones or PDAs.
Most of the content available for download is currently from lesser-known artists. So far the majors
have held back from making their content available online because of piracy fears.
We think that the majors will start testing the waters with small online catalogues this year.
55
How The Internet

Will Impact Music:
Opportunities
New value chain
New routes to market
Multiple Routes To Market, Every Party Benefits

With the arrival of the internet, the music industry value chain is set to change.
The record industry needs to work out a digital value chain that can accommodate
artists, hardware makers, compression technologies, portals and retailers. However,
rather than replace the traditional physical value chain entirely, we think that the
internet will be a facilitator, supplementing the existing system without making it
disappear. As a result, there will be more choice for consumers and businesses in the
value chain, and a more efficient distribution system. Some links in the chain will find
their role changing diminishing or disappearing entirely as a result of digital delivery.
What will be one of the most profound changes for the industry is that with the
new channels, there will be new and different routes to market for the music. In
this way, music will start to resemble a product that is marketed in a similar way to,
say, a soft drink brand, which has a multitude of ways to reaching consumers depending
on occasion, type of consumer and type of channel. In our soft drink example, the
product is sold from vending machines at workplace, sold from kiosks at a football
stadium, sold in cooler cabinets in a supermarket, sold in cups at a fast food outlet, plus
a dozen other ways and locations.
Table 14: Impact of the internet in various points of the music industry value
chain
Artist:
New ways of getting music out to the market
Unsigned artists will have an opportunity to market their music
Opportunity to connect directly with the fans
Record Label:
More efficient A&R process
More efficient marketing process
More efficient distribution process
More efficient use of back catalogue
Ability to connect with music fans direct
Distribution:
Capital outlay is dramatically reduced
Wider distribution opportunities
Retail:
New opportunities to direct consumers to music
New opportunities to merchandise a wider selection
Higher margins when inventory and shipping costs are eliminated
Customer:
New ways of buying music: per track, subscription, rental
More and different music is made available (new bands, back catalogue)
Free music
New occasions for consuming music (to mobiles, to PDAs, Jukeboxes, download
kiosks)
No more need to buy a full CD for one track
More sources for music (e-tailers, portals, fan sites)
56
Artist can
disintermediate record
labels
Artists
In the digital food chain, songwriters will still be composing music, and artists will
still be performing. For the artists, however, there will be more options in how they
can access the market. For example the artist can make his/her music available to the
public online, rather than going through the record label, distributor and a retailer. An
artist can record the music, compress it into a digital format, and distribute it either on
his/her own web site, or through a digital download site. The artist can either rip the
music him/herself or use a digital distribution company for secure downloads. Finally,
the artist can bypass the middleman in concert ticket sales (agencies often take as much
as $20 per ticket sold), and bands such as Pearl Jam are selling concert tickets through
their own web site.
This is already taking place: Public Enemy and Beastie Boys are two bands that have
put limited releases available on their web sites only. Offspring and Smashing
Pumpkins have also released music exclusively online. The Smashing Pumpkins latest
and last album, Machina II:The Friends And Enemies Of Modern Music, appeared on
the internet in September 2000. Initially the band distributed it to friends and fans,
asking them to distribute it onwards as widely as possible. Soon after, the tracks
appeared on a fan site and on Napster. Although this was largely a snub against the
bands label Virgin, Smashing Pumpkins also claims that this is a better way to reach
their fans. In theory, the internet offers the first real possibility for the artist to have a
greater participation in the industrys revenues and profits they help to create.
Labels are against

artists selling direct
Offspring has not had it quite so easy, as the bands label Columbia is against the
bands plan to distribute its new album on the net. Courtney Loves band Hole is
currently fighting its label regarding Holes plans to distribute on the internet. We
think that we are still some way from artists receiving the 50/50 split, at least this
should only be possible by cutting out several middlemen and moving to independent
production and distribution. It is in the record labels interest to control as big a part of
the entire value chain as possible.
We also believe that as music migrates onto the digital platform, the way it is
produced can finally begin to follow the needs of the consumer. Bands and artists
no longer have to try to find a sufficient number of songs to fill a 70-minute CD as
songs can be sold individually or in cycles of various lengths. Instead, the artist can
determine at what rate new music should be released to fans and in what amount.
Unsigned artists can

get their music heard
Breaking new artists

online will be tricky at
first
As a result of the internet, more artists can get their music heard. Many of the
early business models in digital music distribution have been about providing unsigned
artists a platform on which to showcase and distribute their music (such as Vitaminic,
MP3.com and Peoplesound). Because space on the internet is unlimited and costs of
distribution minimal (if regular MP3 compression is used), practically any aspiring rock
star can be featured in one or many of the download sites available. Whereas in the
offline world the artist discovery depends on getting the songs available to a particular
A&R person, on the internet it is the listeners, the users, who can directly judge the
quality of the artists music. More artists should get a chance to be discovered by a
major label, as the download sites for unsigned artists provide record labels a good
database from which to search potential new signings.
So far the internet has not proven to be an automatic launching pad for any
aspiring rock star. We believe that new artists still need help of a professional artist
development team and that it is very difficult to break new artists on the internet alone.
However, it is the mid-size artists (fan bases of around 300,000-500,000) that should
find internet a powerful platform to increase their following and gain more exposure.
57
Record labels can by

pass retailers
Labels can market to

the fans directly
A&R function will

become more efficient
Record labels
The internet can in theory remove the middleman (distributor and/or retailer)
and enable the record labels and/or artists to distribute their content directly to
consumers. Digital distribution of music should in theory result in some form of
disintermediation and compression of the supply chain, although so far the record
labels efforts to sell direct to consumers have been rather fruitless, since they are not
consumer brands (rather, their artists are). We believe that the record labels are likely
to start taking more decisive steps towards distribution and retail, driven by the
marketing opportunities brought about by the internet. Initially these will be first
limited to promotional downloads (for example on the labels web sites or artists
official web sites). So far record labels have not tried to retail to their customers
directly, and brands have been created out of their artists, not the labels.
Even if the labels are hesitant to take on distributors and retailers (because of
potential channel conflict), internet and the digital formats will present them with
opportunities to connect with their customers in an entirely new way. They can
deliver high-quality music samples with packaging, allow for interaction with the
performer (via a chat or another method), provide advance word on tour dates and
make the artists more available to the fans. These concepts will present a lot of new
opportunities for industry which is notorious for its lack of understanding of and efforts
in consumer marketing: it is telling that most music consumers do not even know when
their favourite artists releases a new album. Marketing for record labels has so far been
limited to a few outdoor posters next to subway stations.
The A&R process will stay, but it can be facilitated by the internet. Although
internet creates an abundant world of unlimited music, resulting from thousands and
thousands of artists being able to distribute their music, we believe that the A&R
process is a vital service to music users and hence is likely to stay in some form.
Without any form of filtering, the average quality of published music would plummet
dramatically, as a result of anyone with a synthesizer being able to publish music.
However, the internet allows for a new, more creative A&R function which should
result in a better success rate. As we discussed earlier, the music industry generally has
around 3% success rate (in other words, 97% of the artists signed up fail to recover the
investments allocated to them), and developing new artists and releasing new albums is
very much based on luck. Before the arrival of the internet, the record industry had no
way of monitoring and mapping consumer demographics in order to decide whether an
artist would succeed and where. Often the record labels would plough millions of
dollars in advertising campaigns that were either ineffective for the albums target
group, or in some cases the album was never going to sell in that particular region in
the first place (in which case advertising investment is money down the drain).
This is an area where Peoplesound.com, the European online music company, is
making significant inroads. By having a site that attracts heavy traffic (twice the size of
Napster in the UK) and music from over 10,000 artists in a variety of genres, the
company is able to provide the music industry with a unique tool with which to analyse
and channel marketing efforts, track consumer responses and predict demand. This is
because internet has the unique ability to capture user data from the clickstream, which
the record labels can use to optimise their A&R and marketing process.
Record labels will take

on new roles in artist
development
Despite some disintermediation by artists reaching fans directly using digital

platforms, we believe that music companies will play an important role in
distributing and promoting music. Their role will move from being simply an A&R
play and an adopter of risk to support, promote and develop artist on multiple channels.
So far there are few success stories in breaking new artists on the internet alone, and
record labels will continue to provide the ever-important services in production and
58
development. Although parties on the industrys fringes claim that good music will
raise to the top automatically, we believe that it will still have to be promoted and
marketed to consumers, and with the choice proliferating even increasingly so.
Most of the distribution

costs can disappear
More music can be

made available
Independents will have

equal access to
distribution
Digital distribution
companies are
emerging
DRM = Digital Rights

Management
Distribution
What the digital value chain will certainly remove is the physical manufacturing
and printing process. As no CDs need to be pressed and no CD covers need to be
manufactured, this cost can be eliminated. In addition, as there are no physical
products to be shipped, the distribution costs can be dramatically reduced. In this
environment of unlimited shelf space, inventory is no longer a cost and the music
industrys perennial problem of returns can be largely eliminated. Based on the current
revenue distribution we highlighted earlier, we think that in the digital world, 25% of
the costs can disappear, resulting in higher margins and returns for the participants in
the music industry value chain. Some new costs will be introduced related to
technology spend, however these are largely fixed and can be absorbed by scale.
More music should also become available in mass distribution. As costs relating to
physical manufacturing and distribution are eliminated, record labels might not have
such a pressing need to either kill artists or avoid signing artists that do not have mass
appeal. In the current value chain with the low success rates, the labels have to extract
enough revenues from the 10% of their successful artists to cover the costs of
investment in the remaining 90% that are never going to turn a profit.
The new flexibility that digital distribution introduces will also create some
challenges to the members of the music industry value chain but also
opportunities. As the internet removes the need for distributors and wholesalers (there
are no CDs to warehouse or ship), these roles will become limited. So far the large
music companies have dominated music distribution by being vertically integrated and
owning distribution companies (literally warehouses and trucks). What digital
distribution is likely to mean is that independent artists have more opportunities to
operate on a level playing field with artists supported by the major labels. Artists
signed by major labels can benefit from the established distribution networks owned or
operated by the labels, whereas independent artists have to use third-party distributors.
Independent artists often lack the resources for a wide distribution and promotions
push, however with digital distribution, logistics costs relating to moving piles of CDs
around on trucks are eliminated.
Physical distributors will be replaced with digital distribution companies. These
will in effect do the same thing as the trucks and warehouses do in the offline world, in
other words ensure the storage and delivery of digital music files. These digital
distributors provide fulfilment and aggregation for the labels, distributing copyrighted
music to other distributors, retailers or media companies. In addition, they provide
digital fulfilment services for the retailers, usually having a proprietary technology
platform that carriers the necessary bandwidth to accommodate the demands of large
customer bases. The platform would normally take care of all payment processing and
database functions as well as provide technical and customer support. Whereas most of
the distribution in the offline music industry is done by the labels in-house distribution
divisions, in the digital world we are seeing a proliferation of independent digital
distribution and fulfilment companies.
As intellectual property rights are at the centre of this industry, secure digital
music delivery will be one of the key functions in the new online value chain.
Digital Rights Management (DRM) will be a new function added to the back-end of the
delivery system. DRM is in effect a piece of software technology that sits on a server or
desktop that encapsulates content and controls and manages it. The technology is
59
embedded in the digital files and dictates how audio is protected and where consumers
have access to it. Companies that manage digital rights on behalf of content owners
(publishers, artists, record labels) are called clearinghouses, and they track all the songs
that are played and make sure everybody gets paid.
Several DRM
technologies available
DRM software can be

embedded in
compression formats
DRM service providers

can become music
aggregators
Approaches and companies in DRM and distribution technology

The landscape for DRM technologies is changing fast. No single format, standard
or approach for secure content and distribution has yet been adopted by the industry as
it makes moves to adopt online digital media. The technology solutions from specialist
DRM companies are ready to operate at a commercial level. Content owners and etailers now face a number of choices as they approach commercial digital distribution
of content. Issues such as preferred format, charges, territory, subsequent control, and
exclusivity of distribution all have to be decided. These issues will differentiate which
of the DRM technologies and service providers establish themselves. It may be some
time before the winners and the favoured approach become clear.
DRM technologies controlling the use of digital media can now be incorporated
into all of the popular music file formats, i.e. ePAC, MP3, Liquid Audio, WMA.
Final users of the media require software applications to use DRM controlled files.
These as discussed earlier could be generic products that can decipher all controlled
formats whoever the supplier, e.g. Winamp or dedicated systems such as the Liquid
Audio player. In addition, DRM enables territorial control of content. DVDs are
already subject to regional coding to allow phased distribution, and such controls can
be built in for music files with DRM and servers can be set to only allow sales to
certain territories, e.g. the US or Scandinavia.
Some European music e-tailers are already trying to tie up exclusive contracts for
the delivery of content. This would force users who want to download a certain
artists music to go through a specific portal or site. But many content owners will not
want to restrict themselves to just one distributor with a limited audience reach and
many sites would be unable to negotiate sufficient range and content to be viable. To
maximize the potential for sales content owners will be keen to see their product on the
maximum number of portals in the same way that in the offline world music is available
in a wide range of retailers. This requires a wholesale approach to DRM with
aggregators for content positioning themselves between the content owners and online
storefronts.
The DRM technology provider in an aggregated model would provide the encryption
and storage facilities to the content providers and the download and transaction
facilities to a range of e-tailers who would incorporate the DRM providers technology
into their site. The DRM solution provider would oversee the delivery of royalties to
the content providers and generate revenue by taking a proportion of sales. E-tailers
would be able to choose their stock from the catalogues of available music and would
not be restricted to negotiated deals with a few artists and small labels. Customers on
purchase of a track are given a permit or key to download the file from the DRM
solution provider.
If content providers choose to select a preferred DRM solution provider and negotiate
directly with a smaller range of online sites another business model evolves. DRM
technology providers can now offer a management approach to the distribution process,
where they offer a tailored solution to the provider and retailers. Realistically this is
probably only suitable for large content owners or for specialist content owners and
suppliers.
60
Content owners can

develop DRM systems
in-house
Furthermore, larger content owners, specifically the major labels may choose to
develop their own proprietary systems for DRM in-house. They will have the
power to force e-tailers who want their content to distribute it in the formats they prefer
in a similar way to how they control distribution of their product in the offline world.
However for all but the largest labels in-house development of DRM technology is not
a viable proposition. Record labels are in the business of finding, grooming and
promoting musical talent, not developing technologies for encryption and online
distribution of their content. If these companies and indeed individual artists want to be
participants in the new media they will have to outsource their technology and
distribution requirements. It is in serving this content that independent DRM solution
providers will be key to the online distribution of digital media.
Most distributors will probably opt to allow customers to download and store files on
their PCs. At current bandwidths the only way to have music of high quality is by
download not streaming. DRM technology means that files are not transferable without
payment of a subsequent fee, thus preventing copying. However there may be other
approaches. Sony has announced a system where customers purchase music but it is
stored in a secure vault from where it can be streamed on demand to the owners PC
or other media device.
MODE and Tornado

Groups are two key
European providers
There are several companies operating in the DRM space in Europe and North
America. Mode and Tornado Group (profiled in detail separately) are both focussed
on the European markets. Mode offers the managed approach to DRM and Tornado
seems to be offering the aggregated solution. As with many technologies the driving
force for standardisation may come from the US market. But the different nature of the
European music market where much of the content is local may require a different
model.
Figure 33: MODE system
Source: Mode.net
There are several DRM solution providers and technology developers in the US and the
major music companies are starting to take steps to publish online. North American
DRM technology providers include:
Reciprocal Inc (http://www.reciprocal.com)
Reciprocal offers outsourcing and maintenance of DRM and e-commerce systems
providing clearinghouse and back-office solutions for music, publishing, film, software,
and entertainment industries. Reciprocals management tools work with DRM
technology from the leading providers, Adobe Systems, IBM, InterTrust Technologies
61
Corporation, Microsoft, Preview Systems, and ContentGuard. Allowing content

providers to select the technology that serves them best. Their platform is a scalable,
digital clearing service with multi-platform support and multi-content compatible.
ContentGuard Inc (http://www.contentguard.com)
ContentGuard, a spin-off from the Xerox Corporation, is a provider of DRM
technologies, products and services for integration into the digital distribution value
chain from content owners to retailers. The ContentGuard system provides content
owners with flexible choices for delivery, distribution and management and services for
capture, creation and aggregation of content, which can be tailored to individual
business models.
InterTrust Technologies Corporation (http://www.intertrust.com)
The business model InterTrust has adopted is to commercialize its DRM technology
software tools by licensing them to partners who provide e-commerce applications and
services to customers. InterTrusts partners, build products around the InterTrust
software and operate digital distribution services. Partners include content providers,
application builders, service providers, and financial and usage clearing houses.
InterTrusts software allows data to be protected with a flexible set of rules controlling
its use, preventing unauthorised copying and distribution. The rules are controlled by
the owner of the content and can be adapted and changed allowing management of
distributed media. The technology has been designed to be adaptable and will operate
over the range of new digital devices as well as PCs.
Microsoft, IBM and Adobe are other competing developers of the core DRM
technologies.
Preview Systems (http://www.previewsystems.com)
Preview Systems develops and markets e-commerce infrastructure solutions for
electronic distribution with a significant focus on the licensing of digital goods.
Preview provides consulting and training services for its Vbox and Ziplock products
rather than outright management of solutions.
The first of the major labels to start to sell its content online is BMG. The content is
limited to a few hundred tracks and albums priced at similar levels to regular CDs but
the range is anticipated to grow to 2500 in the pre-Christmas season. BMG is using a
company called Digital World Services The Bertelsmann Digital Rights
Management Company. DWS is partnered with InterTrust Technologies Corporation
and Reciprocal Inc, therefore it can not strictly be considered an in-house solution to
DRM. DWS uses the packaging and clearinghouse tools of its partners in its solution
for BMG. BMG is currently only selling through the Lycos Portal using DWS. (see the
web site at http://www.dwsco.com/static.htm)
Whether this market becomes a winner takes all with one standard predominating or
different standards develop may not be clear for some time.
62
Table 15: Major Players in DRM Base Technologies

Company
Comment
InterTrust
Technologies
General-purpose DRM platform - licenced to

UMG, MusicMatch, BMG, PwC
partners with related services and applications
Microsoft
IBM
Sony Corp
Intel
Liquid Audio
Partners
embedded DRM solution (Rights Manager) in

EMI, BMG, Warner Music, Sony,
its operating system, to protect content
TVT Record, Liquid Audio
sold/accessed via Windows Media formats
Operates Electronic Music Management System
RealNetworks, Sony, BMG, EMI,
(EMMS) for sale and downloading music.
Warner Music, Liquid Audio,
Includes a clearinghouse function
Universal, Reciprocal
Operates OpenMG, a copyright protection and
InterTrust Technologies, Liquid
DRM technology. Also operates MagicGate
Audio, Preview Systems,
copyright protection system with compliant
RealNetworks, Warner Music
products
Operates Intel Software Integrity System (ISIS),
Preview Systems, Supertracks,
an encryption/protection solution for developers
EMI Recorded Music
of content distribution platforms.
Provides services and software that enable
CDNow, BMG, Virgin JamCast,
companies to digitally deliver music via
Musicmaker.com, MP3.com,
Internet. Proprietary network, also acts as a
Warner/Chappell
distributor for third-party formats.
Source: Billboard, Liquid Audio
Table 16: Major DRM Service Providers

Comments
E-commerce infrastructure solutoin based on
Intels ISIS DRM that enables networks to
Preview Systems
electronically distribute and licence digital
goods
DRM Services, platform-agnostic service,
Reciprocal
clearing transactions for InterTrust, Microsoft
and Sony DRMs
DRM services arm of Bertelsmann, end-to-end
Digital World
DRM solutions based on InterTrust and
Services
Reciprocal platforms
Developed by NatWest, solutions based on the
Magex
InterTrust technology platform
Company
Partners
EMI Music, Musicland,
Supertracks, Sony, Intel
BMG, Warner Music, Sony,
Amplified.com, IBM, Microsoft
InterTrust, Reciprocal, BMG
MusicMatch, Universal,
RioPort.com
DigiHub
DRM arm of PricewaterhouseCoopers, content

and transaction clearinghouse functions on the
InterTrust technology platform
InterTrust Technologies
Supertracks
Digital distribution service company, solutions

based on the Preview Systems platform.
EMI, Musicland, Preview Systems
Source: Billboard, Liquid Audio
Existing online
retailers are likely to
be one of the key
platforms
Retail
Where will customers go for their music? This is the killer question. When the
market matures to a level at which revenues can be extracted from this distribution
channel, we are likely to witness the emergence of a variety of new business models
offering consumers access to music in a digital format. The key platforms are likely to
be existing online retailers, pure-play download retailers, music portals, fan sites or
record label web sites, but also various internet broadcast sites, internet radio stations
or concert sites for music streams either on a subscription or pay-per-view basis. A
63
proportion of music is likely to be consumed free, and the file-sharing applications such
as Napster will continue in one format or another, given that they have the consumers
stamp of approval.
Offline retailers have

the relationships with
the labels
Consumers will look

for aggregators
We believe that existing online and offline music retailers will have an important
part to play in the new digital value chain. First of all, they possess the all-important
relationships with the record labels. Because the retailers and e-tailers still sell a
majority of the worlds music, record labels are likely to be willing to accommodate
them in the transition to digital distribution. Most key music e-tailers are already
offering digital downloads, either as free samples or with a charge applied. We expect
this offering to strengthen to encompass a wider selection, and online distribution will
simply be attached to the business model as an additional channel. In addition, offline
retailers are likely to incorporate digital delivery in the form of download kiosks,
whereby customers can download music files from existing catalogues and either burn
them onto CDs or save on a hardware player. Initially these download kiosks might
prove to be a vital factor in educating consumers towards downloads, in addition they
enable consumers to sample a broadband experience while visiting the stores (this may
have a big influence on tempting narrowband users to adopt broadband).
Aggregators will play an increasingly important role. As digital distribution and
digital formats become more universal, more music will come to the market driven by
lowering barriers to entry for artists and the availability of free downloads.
Independent artists will be able to have a voice in a way they did not before because
distribution challenges are removed. Unsigned artists are already flooding web sites
with their offerings (MP3.com, peoplesound.com, Vitaminic, Musicunsigned are
examples). This combines with the ongoing evolution in consumer tastes away from
mass-market pop stars towards a wider variety of genres and artists, as demonstrated by
the rapidly growing popularity of compilation albums. What this means is that people
will need more help than ever in finding their music since it will be more and more
difficult to pick music when supply will be limitless and readily accessible. This will
be reinforced with the arrival of broadband, as we believe that when pipes expand, they
do not necessarily get filled with quality content.
We think it is nave to believe that consumers will automatically flock to new music
just because it has been put on the internet. As our short experience of the internet
proves, consumers are unlikely to just stumble across web sites, they have to be invited
(with one exception being Napster). This is why portals on the internet are such popular
destinations: They organise the unlimited information on the internet in a way that
makes accessing it simple and easy for the user. In a broadband environment when
streaming and downloading on demand becomes a ubiquitous consumer application,
consumers will need reference points and information in order to be able to utilise the
personalisation opportunities fully.
Aggregators will serve

as vital navigation
tools
In this new environment of abundant music, aggregators and gateways will

provide vital navigation tools for music consumers. This requires a tight
relationship with the customer, and more and better information on personal
preferences. The existing portals with limited customisation features are unlikely to be
able to channel the right music to the right customers at the right time. In the next
chapter we will discuss new consumer applications and new ways to consume music in
the environment of unlimited bandwidth and unlimited choice.
64
Figure 34: Programme schedule of Storm, a major UK internet radio station
Source: www.stormlive.com
Online radio stations will

capture an untapped
market
Several routes to market
Various different value

chains
Online radio stations will also provide consumers with new opportunities to access
music. Internet radio with streamed content can be used outside those occasions where
commercial radio broadcasting has traditionally thrived, typically breakfast and
commuting hours. Ratings typically trail when people reach the offices, however this is
where internet radio will take over. In addition, internet radio also offers a visual
dimension, where listeners can either watch DJs as they are broadcasting, access
schedules or see other images. Online radio stations are also likely to emerge as
attached to retail propositions; for example BOL.com, the books and music e-tailer, has
launched an online radio station where users can listen to music while browsing the
site. Also, online radio can offer practically limitless channels with various targeting.
As a result, there will be several ways for the music to reach consumers. Some
artists will send their music to their fans direct, or they can do it via a download site, or
via a contract with a digital distribution company. Or the record label can send streams
from the official fan site, from the labels own site, or by using an e-tailer which has a
secure distribution platform provided by one of the DRM service providers. A
customer can access music either by logging onto the many music portals, or by visiting
the same CD e-tailers s/he has used for buying CDs. Or, the customer can access music
from other customers by logging on to the various P2P applications.
In essence we are likely to see various different value chains, depending on the type
of music, the type of release or the customer preferences. This is likely to start
introducing more sophisticated marketing disciplines into the music industry, as by
continuing to do what the industry has done before (releasing an increasing number of
new albums and crossing its fingers that some of them will be bought) is likely to result
in declining margins and inefficient capital allocation. New routes to market will result
in music being sold and marketed like a branded product (see our soft drink example on
the previous page!).
65
In Figure 35 we highlight some of the possible value chains that are likely to emerge in
the new digital world. One of the most profound shifts in music consumption will be
the way consumers are able to access and request whatever music they want, how they
want to access and when they want to access it. Consumers will have more choice in
how and when they listen to music, and they can actively search for music in a variety
of ways (for example by subscribing to weekly e-mail with MP3 attachments, by using
an online music search engine such as Musicseek or by logging onto a portal with chart
listings). At the core of the value chain is the distribution platform and DRM software,
which enables the entire deployment of digital music, both for consumers and content
owners.
In summary, we strongly believe that adoption of digital formats and digital
distribution platforms will accelerate growth in the music industry. To date, music
industry has been constrained to existing distribution infrastructures that have not been
able to stimulate demand in the way that connectivity provided by the internet can. In
addition, new opportunities and marketing and promotion will provide an added
catalyst for the sector.
Digital formats will

accelerate growth in
the music industry
Figure 35: Digital music value chain

Software
players
Formats
Hardware
players
Artist delivers directly to fans
Artist delivers directly to an aggregator (e.g MP3.com, online retailer)
Label delivers to e-tailer/portal
Artist
Label
Distribution
platform
Portal links to record label streaming site
Aggregator
Customer
Various routes to
market
Music portal
Portal links to artist site, e-tailer accesses artist site
Retailer
Customer accesses artist website for downloads
E-tailer
Publishers
DRM software
vendors
Live webcast
Clearing
houses
File sharing
Kiosk
Online
jukebox
66
Margin uplift will not be

captured by the retailers
Margin uplift is likely to be captured by content owners, not retailers

In the new digital value chain, it would be natural to assume that margin increase would
be substantial, as physical manufacturing and distribution costs are eliminated or
considerably reduced. Some initial business plans have suggested that gross margins in
digital distribution could nearly double those for online CD retailing. Costs associated
in digital distribution are likely to be the same royalties going to publisher, artist and
record label, as well as credit card fees and server costs. Assuming that digital music
files are retailed at a price that is at least close to physical format (in order to avoid
channel conflict and cannibalising CD sales), we should expect some margin uplift.
However, we believe that the net beneficiaries of these reduced costs will be the
content owners rather than retailers, and that revenue share on files made available for
sale will not result in abnormally high margins for the e-tailers. If anything, prices
should drift down because of the lower unit costs.
Key Thoughts:
With the arrival of the internet, there will be new and several routes to market for music.
Record labels will have new opportunities to promote their content, for example in promotional
downloads or by providing fans new ways to access the artists.
The A&R process can be significantly facilitated by the internet with more creative ways of
discovering new music, such as various websites designed to host unsigned artists.
New companies and business models will emerge in digital distribution and DRM (Digital Rights
Management).
The killer question is; where will consumers go for their downloads? We believe existing offline
and online retailers will have an important part to play in the new digital value chain.
In addition, we believe that aggregators will play an important role on the internet.
67
Digital distribution as a marketing tool
Record industry
traditionally lacks market
discipline
Downloads can be an
effective promotional tool
As revenues from digital downloads are still minimal, the initial opportunities for
both retailers and content owners will be in promotion and marketing. For the
record labels, this is a new view of the world: traditionally the industry has not built
relationships directly with the consumers. Marketing for the record industry has so far
been limited to pushing new releases to radio stations or music television channels, and
ensuring that CDs arrive on the retailers shelves on time. The music industrys contact
with the fans has been limited, and many music fans do not even know when their
favourite artists have a new album out. Internet allows for a myriad of promotion and
marketing models: band web sites can host concert information, artist biographies, chat
rooms, live interviews with the artists and music samples. Artists or record labels can
communicate with the users by e-mails that can include latest news and samples of new
releases. Before the internet, a vast majority of the artists had no idea who their fans
were, so for the first time there is a medium that allows for direct contact with those
who buy the albums.
Digital music files delivered on the internet can also be music samples, which
allows consumers to test drive new music prior to purchase. This is another worry for
the music industry, which has until now relied on selling full-price CDs on the back of
one track; when consumers can hear 30-second samples on a record store web site, they
will be able to make more informed purchases. For example, Boxman, the late CD etailer, was already offering this service on its web site, and CD Now has music samples
of most of the latest releases.
Figure 36 :CDNow: digital downloads available for sampling music before
purchase
Source: CDNow web site
68
Music on demand: New consumer applications

Most people consume music in one way or another, either by buying CDs or
cassettes and building up collections, tuning in the radio or going to concerts or
clubs. Some of us even make our own. The technologies have changed from vinyl,
cassette and CD to Minidisk from longwave to FM with the sound quality if not
musical talent improving accordingly. Over time, with the arrival of Walkman,
Discman and Minidisk players, music has become more portable. In addition, it can be
consumed in car stereos and mobile phones with built in radio. The shelving the vinyl
or the stack of CDs occupies no longer measures a persons musical identity. But
essentially nothing has changed in the way we consume music until now, in that people
still go to a store or access an e-tailer, buy a CD and listen to it by playing it on a CD
player either at home or on a PCs CD drive.
All-you-can-eat music,
on demand
What are the new opportunities available with the new audio technologies in the
digital era? Some of the most profound changes will be in the amount and breadth of
choice and freedom music consumers are likely to see over the next few years. Digital
delivery of music will bring about better ability to take advantage of individual musical
preferences. Napster may be leaving us but streaming, download, rental and
subscription services all loom on the horizon, which are all driving towards the ultimate
consumer experience: unlimited access to music, anywhere, anytime, as-much-as-youcan-eat, regardless of device and playback technology. In summary, music in the
digital era will not be restricted to playing CDs at home or in the car. Because of the
abundance of channels and content, the format change will in fact accelerate
consumption instead of the doomsday scenario publicised by the record companies.
The industry is going to see value added from making music more accessible.
Here are some scenarios to help us think about what is already possible and how music
will be consumed in the near future (in fact, there is a consumer group that is already
consuming music in a way presented in these cases). Digital music need not just be
about transferring the vinyl collection of old onto the hard disk of the PC. We are
talking about new opportunities in entertainment.
Deciding to host the reggae party seemed like a great idea. The food and cocktails
are laid out and you discover only half an hour before your guests arrive that your
younger brother has borrowed your collection of Bob Marley CDs. Not a
problem, connect to the broadband reggae music search site and rent a couple of
Bob Marley albums for the night. You plug them through the hi-fi system by
hooking up the portable digital player to the stereo, download the albums from the
reggae site and play through the speakers throughout your reggae party.
A music journalist is on the way to meet a new band that he has heard of through a
friend of a friend. Not knowing anything about them and not having heard the
single that they are hoping will get them signed he needs some information. The
journalist connects to one of the new artist showcase sites and downloads their
latest songs and profile to his laptop. Alternatively, the journalist could download
their songs to his Palm V PDA together with band member biographies, song lyrics
and contact details.
What were the lyrics to Yellow Submarine? Your software player will download
them for you as you listen to the track on your PC and will even bring up the cover
art if you want.
69
q
q
Example of a track
downloading
You can have your own personal streamed online music station, tailored to your
preferences for genre, artist, style and paid for by monthly subscription. The
subscription will allow you to access the site and stream your favourite music, be it
UK Garage, Motown or 70s Disco. You can have a multitude of profiles which
you set up according to various preferences: different music for entertaining
clients, cleaning the house or wooing a new love interest, all streamed through the
speakers in your house, car or office at your request (since you can access the web
site either from the PC, from your mobile/PDA or from iDTV). Moreover, the
music could also be paid for by watching adverts tailored to your interests and
lifestyle.
Unable to travel down to Verona to the annual opera festival, you order the live
webcast of La Traviata streamed to your ADSL-connected PC. Having paid the
per-view charge, you enjoy live opera in the comfort of your own home.
You are away on holiday and your 12-year old daughter cant get to the shops for
the new release by the latest boy band that she just cant live without. Connect up
your portable MP3 player to the G3 phone and download it for her from one of the
e-tail sites. She can then listen to the album by plugging the headphones into the
MP3 player.
You can build a playlist from all the songs in your digital collection, picking out
your favourite tracks and leaving out all the unbearable ones. This you can then
play by accessing the appropriate area on the music site, either from PC,
mobile/PDA or TV. In the not-so-distant future, your hi-fi is likely to have an inbuilt internet connection, which means that you only need one appliance to access
your playlists.
Last night you heard a band playing in your local pub and you think they are the
next Rolling Stones. But refreshing the ears might be a good idea before rushing
to the shops to buy the CD (you still like your CD collection and have no intention
to stop using them). You can stream samples of their tracks onto your PC and reevaluate their talent in the cold light of day. Then you splash out the cash on their
new album, having convinced yourself that you have indeed discovered the next
Rolling Stones.
Your dad has been going on about music from the good old days again. You
would like to get a copy of some of The Supremes greatest hits for his birthday.
No more hunting through old record collections at car boot sales for those obscure
tracks on some scratched vinyl. Their back catalogue is available online in remastered digital stereo you download it for him sounding even better than it did
the first time around. Because your father still cannot quite master the multifunctional appliances, neither can he quite navigate his way through the online
jukebox sites, you burn the tracks for him on a CD.
Why do they always fill half of the album with tracks youve never heard played on
the radio and would never want to own? With a download you can be more
selective and only pay for the music you want to listen to again and again
effectively building a personal CD.
70
New pricing models: Multiple, different revenue streams

How are the new
formats going to be
priced?
Digital delivery of music will bring about new revenue models for the companies
in the front end of the value chain. As the user base begins to move from free
download to paid service, the question is how the service/products should be priced.
Downloadable music cannot be sold the same way music has traditionally been sold.
New pricing models will emerge at the same time as digitally delivered music becomes
mainstream. Below you will find a selection of revenue models, which have been
emerging at this early stage of channel development. There is no way of predicting
which one will emerge as the winner, in addition we are likely to see all of these models
co-existing in some form or another. In addition, new revenue models will almost
certainly emerge.
The price-per-download model
The key question facing the industry is how to price music when it is no longer sold in
the form of CDs, cassettes or vinyl albums. Because the price of the CD consists of
costs absorbed in the manufacturing and distribution process, customers may find it
harder to accept a price for downloads that is equal to CDs, as digital downloads do not
carry these costs.
Pricing strategies still

experimental
So far downloads have been charged in an experimental fashion, and any

standard price points are yet to be formed. Icrunch is selling downloads for 99p per
track ( DSSUR[LPDWHO\ DW D VDPH SULFH DV 1HW%HDW DW SHU WUDFN ,Q WKH 86
companies have been pricing them at around 99c-$1 per track. BMG, one of the
majors, has recently started to put some of its catalogue available for downloads, which
it is retailing through Lycos in the US. BMG is pricing its singles at $3.49 and albums
at $13.98, the same or higher than high street prices. Considering that a customer can
go and buy a CD at a same price and rip it into an MP3 file, we believe this is more of
an experiment than a vital new channel push for BMG.
Table 17: Examples of download pricing
Site
Title
Artist
Product
Price
NetBeat
Icrunch
Icrunch
CDNow
CDNow
Emusic
Lycos
Lycos
Living Room
Before I Was So Rudely Interrupted
Beyond Sunrise
Shelter
I Feel Good
Mouth (The Stingray Mix)
Christina Aguilera
Love of My Life
Paris Combo
Dave Clark
Belle & Sebastian
Sarah McLachlan
James Brown
Bush
Christina Aguilera
Santana
Track
2-track
Track
Track
Track
Track
Album
Single

1.98
0.99
$2.49
$0.99
$0.99
$13.98
$3.49
Source: company websites, Lehman Brothers Research
Lower download
prices can result in
channel conflict
However, it is probably unrealistic to assume that downloads will be immediately

priced considerably lower than other formats, simply because of the channel
conflict that this is likely to fuel among retailers. So far feedback from the record
companies is that download prices will be kept at the same level as CDs, however
although this is their aim, it is doubtful how successfully this will be. Also what is
worrying the music industry is the customers ability to purchase downloads on a pertrack basis. As a majority of CDs have 1-3 tracks that drive the sales with the remaining
9-10 acting as fillers, customers in effect have been paying a full CD price for the 2-3
tracks that they will eventually listen. Therefore, as digital downloads enable them to
purchase only those tracks that they like, the music industry can no longer push filler
tracks.
71
Once paid for, files

can be copied and
re-distributed
Security software is
needed
Tiered pricing is
one option
In pay-per-download, a customer uses his/her credit card to buy albums and individual
tracks to be downloaded onto his/her hard drive (although ISPs/cable companies will
increasingly start offering their customers the opportunity to pay for products by adding
charges to the monthly service bill). The customer then owns these files and can play
them as often as s/he wants. This is the traditional way of paying for music, but the
problem is that once the file is in the customers possession, it can be freely distributed
if it is not secured. Several companies provide file securing services that prevent the
customer from sending the file onwards, and these are likely to become commonplace
for digital retailers and music companies.
A secure file is locked so that if a user sends it to friends and they try to play it, they are
prompted to enter a credit card number and pay to unlock the song, or enter a security
key which is specific to the original purchaser of the song. Windows Media Audio
format has this payment prompt embedded in the format, thus enabling a secure viral
spread of music which is paid for every time the file is reused.
One option is to price downloads in a tiered fashion, similar to the way movies are
sold. To watch a newly released movie in a theatre, a customer needs to pay a premium
price. It will be cheaper to wait a few months for the movie to be released on video,
and cheaper still to wait for another couple of months for it to be released on pay-perview cable TV. Finally, a customer can eventually watch the movie for free on TV,
albeit several months after it was originally released. Currently music buyers have only
two options: either pay the full price or hope to hear it on the radio for free. With new
customer channels, retailers or/and content owners could start pricing music like
movies: new releases would cost more and price would be tiered down depending on
how timely the music is. Currently retailers apply discounts to back catalogue items
but these are normally done in order to clear inventory that no-one wanted to buy in the
first place. Moreover, tiered pricing could be applied to different customer groups:
students, for example. Different prices are easier to apply in a digital world because
internet allows for better targeting of customers (right price for the right customers).
Or, the content owner or retailer could choose to set a lower price point for new artists
in order to help them break into the consumer realm. In the
It is probably nave to expect digital download sales to generate anything beyond
experimental revenues in Europe for the time being. As we discussed earlier, we
dont believe online music companies can charge for downloads unless the music and
artist is known to the audience. Music from unsigned and emerging artists is likely to
remain free for the time being, and treated as a loss leader to attract crowds.
Pay-as-you-go needs
one single standard
Rental model can be

applied to music as well
as films
The Pay-per-view or Pay-per-chunk model

This model could work in a similar way to pay-as-you-go telephone cards. The
customer pays a deposit for a third party in exchange for credits redeemable against
music downloads. These could be usable at a variety of digital music retailers, instead
of just one site. This way a customer does not have to deal with per-song
micropayments, instead s/he could buy a lump of music with one single payment. The
challenge in this model would be in achieving a single standard, since consumers would
not be willing to buy several cards from a variety of providers.
The rental model
An application which is currently deployed in the film industry is the rental model.
This has a good fit with the type of content, as consumers rarely seek to watch a movie
more than once. It is therefore natural that consumers should be able to go and rent the
movie they want to see for a day or two. With digital delivery channels, we think this
can be applied to music as well. The usability comes more evident when we consider
72
Files would have

to deactivate after
the rental period
We see attractive
opportunities with
the subscription
model
the purchase occasions for music: several times music is purchased in order to be
played in a specific occasion, such as a party. We expect that soon consumers are able
to rent albums or individual songs for a pre-defined period of time (24 hours, 48 hours).
The consumer would pay for the rental, and receive the download, which would have
timed encryption software causing the file to time out, in other words rendering the
file unusable after the rental period has expired. This model would be especially
applicable for the vast back catalogue that is currently sitting in distributors or
wholesalers warehouses and not put to use.
The subscription model
A revenue model increasing in popularity is the subscription model. This is already
being implemented in the US by companies such as Emusic. The customer pays a
monthly fee (say $15, Emusic in the US charges from $9.99 per month for a years
subscription, Universal has mentioned PRQWK DQG JHWV XQOLPLWHG DFFHVV WR D
library of MP3 files. This revenue model is by no means a new one: cable and satellite
TV broadcasting has been operating on a subscription basis for a long time. This is
also how internet music subscriptions are likely to work with multiple channels
dedicated to a specific genre, style or service (such as charts), except that with
downloading the music is delivered on demand instead of broadcast. Secure
subscriptions will need a DRM technology embedded in the files so that they can be
locked and cannot be copied and sent onwards.
With streaming the subscription model will be more secure for the content
owners, as the music files will not change hands. The popularity of streaming versus
downloading is also a question of market maturity, as consumers will have to adopt an
entirely new way of owning and consuming music: streaming music means that the
consumer cannot own the music, instead it is a service just like a television broadcast.
But unlike videotaping television programmes, streamed files cannot be copied, at least
with currently available technologies.
Subscription models in music will start to proliferate once streaming becomes a
mainstream way of consuming music. Streaming audio is almost entirely a
broadband application, as the music quality in dial-up connections is usually
substandard. Better security by nature of the format means that content providers are
more comfortable in implementing subscription services.
The advertising
model is already in
use in TV and radio
The advertising model

Internet will also allow for music to be broadcast across the connection in a oneto-many fashion similar to radio and TV broadcasts. One of the reasons consumers
are willing to pay 12 for a CD is that they can listen to it whenever you want, as many
times as you want. With radio, they don't pay a penny but they don't have any choice of
when their favourite song plays. The media model has been restricted to radio as
internet as a medium has not been able to support advertising revenues because of lack
of penetration. However, with broadband this is set to change, as people begin to
spend more time online and as internet is able to produce a much richer user
experience.
One of the key debates surrounding the digital download scene has been whether music
should or could be given out for free, after all radio stations operate this model. We
believe that media model will be find successful applications. These business models
focus on drawing crowds and monetising eyeballs, generating revenues by selling these
eyeballs to advertisers. We are big believers on online media, once internet penetration
allows this medium to capture a larger piece of the advertising pie. At the moment
opportunities for media models are limited because of the underdeveloped channel, but
that doesnt mean that large players wont emerge. The media model is a scale
73
business where there will be room for a few limited operators. After the initial
proliferation of sites (in the UK alone there are several online music sites relying on
advertising revenues alone) there is likely to be consolidation.
Back catalogues could
be distributed free of
charge
One opportunity is to make back catalogues or selected promotional tracks

available free of charge and use these to pull in crowds. Advertising can be in the
form of banner ads or sponsorship, or the company can deploy one of the more
innovative advertising concepts such as Everad: This is a technology which wraps
advertising into a download, so that as the song is downloading the window produces
an ad. Note that the early business models in digital music distribution have been
generating revenues this way, since paid downloads are not sufficient to support a
business. Vitaminic, one of the largest European download sites, has 97% of its
revenues coming from advertising, and most companies in this space derive at least
some of their revenues this way. For advertisers music download sites present a
returning audience with attractive demographics: young, technology-savvy with high
percentage of spending power going to entertainment and leisure.
Figure 37: Everad advertising during download
Source: Peoplesound.com
Find a way to build

payment system into
Napster
The file share model

Although Napsters future hangs in the balance and in the hands of US appeals courts,
the explosive growth of its user base (38 million in just 12 months) has shown the
industry that file sharing is indeed how consumers want to access and consume music.
However, Napsters philosophy has been to allow users swap music files for free. We
believe that should there be a way to build a Napster-like application but with a system
for extracting payments from the transactions, it could become one of the new killer
applications in the digital distribution of music. We are talking about a cross between
eBay and Napster and a model that relies on a fully-functioning and ubiquitous
micropayment system being deployed. A US start-up called Mojo Nation has taken the
first steps towards this model, however payments are voluntary and based on digital
web currency instead of real money.
74
Revenues can also

come from providing
services
Music industry service provider model

Several companies in the early online music market have been set up to offer a variety
of services for the music industry, whether these are artists or record labels. The most
widespread business model so far is promotion and distribution platform for unsigned
artists. This is the model followed by MP3.com, Peoplesound.com, Vitaminic,
BeSonic, musicunsigned and various other new entrants. By collecting a large
catalogue of artists and songs on the site, traffic should follow, which results in a large
community of music fans. Companies can then help record labels promote their artists
to this community, or test market potential new acts, or collect consumer feedback or
other market research data. In this case revenues would be in the form of project fees.
So far most sites allow artists to upload their music for free, and service charges from
artists have so far been difficult to extract. Similarly there is little evidence of these
sites being able to earn rewards should one of the artists actually be discovered by a
record label. Many sites play down this aspect of their model, which we find curious.
After all, if the sites offer a platform for unsigned artists to promote their music, an
important party for which to promote music is the record labels in the hope of being
discovered, which would lead to attractive advances on future royalties on produced
music. In fact, these types of success stories are still very rare, reflecting the
difficulties in breaking new artists on the internet alone.
Other considerations for pricing models

Owning music will no
longer be necessary
Music will be priced like a service, not a product

As we move from paying per product downloaded towards the subscription model,
music changes its form. It is increasingly becoming a service, and treated and priced as
such, rather than a product that is manufactured and pushed by its manufacturers, the
record labels. This will result in diverse routes to market, and diverse ways of charging
for the service. However, the main challenge in these new business models is how to
wean customers, who are used to purchasing and owning music, off the idea that
ownership is necessary. As music begins to be a perishable and bought as it is
consumed, it allows companies to channel content based on different variables such as
occasion or impulse.
This change will not happen overnight, as many people who download illegal music
from the internet are often tempted to by the CD itself (thus it could be argued that
making music available on the net could in the short term accelerate CD sales). Many
people still prefer owning a CD collection, however the current generation of college
students and Napster devotees are embracing the new digital format, and they are also
likely to be most receptive for new pricing models.
Micropayments are very

low value transactions
Online music revenues will be accelerated by the emergence of new

micropayment systems
One reason why digital downloads have not generated revenues for the music
industry is their challenging pricing model. The fact that most digital downloads at
the moment are sold as singles (one track) rather than albums results in purchases
consisting of several micropayments. Micropayments are loosely defined as any
transaction under $5 (3) and as low as a few pennies. Because of costs and
complexities inherent in traditional credit card transactions, online merchants have
dismissed selling very low-priced goods as unprofitable. For example, companies
installing and operating online transaction engines such as Cybersource which process
payments, conduct credit card verification checks and process VAT and tax charges
typically take around $0.5 per transaction. If a digital music merchant prices tracks at
75
These are very costly to

process
Some heavy music

consumers do not have
credit cards
$1, the transaction charges eat most of the revenues. In addition, the merchants bank
charges anything between 2% and 4% of the transaction value, and the lower the value
the higher the commission. There is also often a flat fee to use the banks phone line.
In addition to a lack of credit card enabled digital download sites, some of the
heaviest downloaders probably do not even own a credit card. This is because
digital downloads are still the domain of young people or students. What this means is
that in many situations, even if users would like to pay for downloads, they cant,
because no payment mechanism exists. So, while fighting against free downloads, the
music industry is also forcing people to steal them. We are sure that some Napster
users would be happy to pay per download if there was a simple, easy and efficient way
to do that.
Figure 38: Three ways to mircropay by mobile phone
Operator pays merchant
Operator
Operator
bills user
Phone
User phones
order
Merchant
Details go to operator
Operator
User downloads
e-cash to phone
purse
User pays
merchant
directly
Phone
Merchant
Operator pays merchant
Operator
User buys
pre-pay card
Phone
User pays
merchant
Merchant
Operator debits prepay card
Details go to operator
76
Micropayment systems
already exist
Too many competing

standards
Micropayment systems have been in evolution for some time. Throughout the
1990s consumers have been introduced to smart cards, digital wallets or other types of
e-money. These next generation micropayment services rely on simplicity and often
incorporate purchases to the monthly ISP, telephone or mobile bill. In Finland mobile
phone users can already buy soft drinks from vending machines by calling a number on
the machine, and the charge appears on their monthly mobile phone bill. Mobile
phones are becoming electronic wallets, because the chip embedded in a credit card is
very much like the SIM card in a mobile phone. The method of processing payments
through mobile phones varies. It could be through link-ups between operators and
banks, or by downloading money to an electronic purse in a pay-as-you-go fashion.
However, despite the obvious advantages for both customers and merchants, the
deployment of these services has been very slow. This is because of current
proliferation of different standards and systems. There are simply too many disparate
micropayment services for too few customers. Merchants are unlikely to support
several competing systems, in addition as development work in this area is moving fast,
there is a risk of implementing a system that will be overtaken by another leader.
In addition, consumer demand for micropayment services is still very weak. It
seems that online consumers are gravitating more towards paying a charge at once for
an all-you-can-eat model (such as subscription), rather than deal with several small
payments. Unless a site operates an Amazon-style 1-Click system, keying in user data
every time a track is purchased is extremely time consuming.
Key Thoughts:
Digital delivery of music will bring about new revenue models for the companies in the front end of
the value chain.
The price-per-download model raises a question of how much to charge per download. Currently
available files are priced between $0.99 and $3.49.
The rental model would allow customers to rent music files for a certain period, with the files
deactivating at expiry.
The subscription model will follow from improved streaming applications, and this will arrive
together with broadband.
The advertising model is already deployed in radio broadcasts, but new services could give music
out for free and generate revenues by monetising the crowds.
In the digital world, music will be priced like a service rather than a product. Music will no longer
have to be owned (in the form of a CD collection), since it will be available on demand.
A micropayment system should facilitate the purchasing of digital downloads.
77
Demand for content will explode

Music can be channeled
through various outlets
New digital platforms

mean more music content
is needed
Music publishing
revenues should see
attractive growth
Publishing has
recurring revenues
Earlier we discussed how digital delivery will result in multiple routes to market. As
music distribution is not confined to physical capacity requirements, music can be
channelled through a variety of outlets to a diverse group of consumers. Multiple
digital platforms such as iDTV, mobile phones, PDAs, broadband internet, narrowband
internet and internet radio stations create whole new opportunities in addition to
traditional broadcast radio and TV.
With the explosion in the number of digital channels on various platforms,
demand for music content is likely to reach new heights. Wireless and wired
portals, online radio stations, and many other operators need music in order to provide
their users with a richer entertainment or shopping experience. Attractive content
creates traffic, which is the backbone for many business models in online media and
retail. Furthermore, as richer visuals become possible along with broadband take-up,
online advertisers are likely to start moving away from banner ads to TV-style
advertising involving video and audio clips. For this they need music content.
Therefore, in this new multi-platform world of digital media, content exploitation will
become one of the most attractive growth areas. This will complement revenues
generated by traditional retail.
This will mean new revenue streams for music publishers. As the publisher owns
the right to licence the artists music to third parties, the publisher earns royalty fees in
the process. This means that if, say, a wireless portal wants to offer its customers
streamed music and uses a catalogue provided by a publisher, the publisher is paid
every time the portals customer samples a song. Similarly, if an advertiser wants to
use a particular track in a television or radio ad, the publisher would receive a payment
every time the advert is shown. As there are several new ways that music can be
packaged and used, from background music in an e-tailers shop front to a radio
broadcast on an entertainment portal, companies that can monetise this demand will
capture a lions share of the growth. We see music publishing as one of the most
attractive industry sectors in the new digital era.
Typically the publisher pays to acquire the rights for the works of a certain artist,
however once these are acquired, revenue streams carry no additional costs and can
extend several years. Therefore, acquiring publishing rights is a result of a similar
artist vetting and assessment as the record labels A&R process, however the cost
outlay is smaller. Often the record label also owns the publishing rights, and the majors
are the dominant operators in this field, however there are several independent
publishers with smaller market shares.
Key Thoughts:
With the explosion in the number of digital channels and platforms, demand for music content is
likely to reach new heights.
Music publishing will benefit, and we see this as one of the most attractive industry sectors in the
new digital era.
A&R process also applies in music publishing, and rights acquisition is an investment in future
revenue streams.
78
How The Internet

Will Impact Music:
Threats
1992
MPEG1-Layer
3 (MP3 is
developed)
1998
MP3.com
launches
RIAA tries to prevent a
student in Arizona
State University from
posting music online
RIAA seeks injunction

against Diamond
Multimedias Rio
player
RIAA contacts artists

asking their support in
the fight against MP3
1999
Sony develops
Magicgate, a copy
protection method
IBM, Matsushita
and Intel develop a
digital watermark
Napster is founded
AOL buys Nullsoft +
Spinner
IBM and the five

majors test downloads
on high-speed cable
links
SDMI launches
Real Networks
Jukebox debuts,
allowing consumers to
create digital playlists
MP3.com IPO
Sony Memorystick
Walkman
RIAA sues Napster
2000
RIAA sues
MP3.com
MP3.com loses case
against My.MP3.com
MP3.com settles with
BMG and Warner Music
Napster trial begins
AOL merges with Time

Warner, owner of
Warner Music
First artist sues Napster
(Dr. Dre)
Napster ordered to
stand trial, receives
$15m funding from
Hummber Winblad
Piracy and copyright confusion is holding back the industry

Music industry is unique in the economy, as its product, music, is a result of a
creative process where the only way for the owner of the content to monetise this
creative process is by means of copyright. Copyright is how a person or a business
makes a living from creativity. Copyright provides that the rights holders determine
whether and how copying, distributing, broadcasting and other uses of their works take
place. This gives the incentive to create music, and entrepreneurs the economic reasons
to invest in them. Copyright also ensures that all parties that have had a part in creating
the music are rewarded for their work. In other words, the music industry needs to
enforce copyright so that, professionals get paid fairly for their contributions. If artists
and other music professionals do not get paid, it questions the viability of the entire
industry. Therefore, piracy is an ongoing threat for a livelihood of thousands of
professionals.
Piracy means a deliberate infringement of copyright on a commercial scale. It
refers to unauthorised copying and dissemination of copyrighted work. There has
always been piracy in the music industry, and IFPI estimates that sales of unauthorised
music amount to $4.5bn annually, worldwide. In other words, piracy level worldwide
is around 15-20%, or more in markets where copyright legislation is weak. Piracy has
existed even before MP3s, since both audio cassettes and CDs are formats on which
content can be duplicated. So far music industry has resigned to accept that a certain
level of piracy will continue to exist in the industry.
However, the music industry saw digital downloads as a new, more serious threat
than illegally copied CDs or audio cassettes. Since the launch of MP3.com in
February 1998, the music industry has been fighting against digital downloads, using
law as their first line of defence. First RIAA tried to stop the launch of the portable Rio
MP3 player, and the campaign has culminated in the high-profile lawsuit against
Napster, the controversial file swapping service. The entire industry is watching this
court case as it is seen as defining the near-term future of digital music.
File sharing applications are spreading like wildfire
One of the biggest headaches for the music industry have been the so-called file
sharing communities, or peer-to-peer networks, which have allowed members to
search for MP3 files from each others drives during online sessions. Thousands and
thousands of illegally copied digital downloads have been distributed to the 22m
Napster users worldwide. Below is a description of the most popular file-sharing
services distributing MP3s.
Napster
Napster was founded by a 19-year old college dropout Shaun Fanning in May 1999,
who wrote the software programme carrying his childhood nickname. Napster went live
in September 1999 and since then it has raised $15 million in venture funding. It has
become the most widely adopted file sharing community, partly because of its
simplicity: as the system does not use slow e-mail programmes, files can be transferred
in a matter of seconds. Users need only to download a software application from the
Napster web site to access thousands of MP3 music files from other Napster users hard
drives, and these MP3 libraries are shared freely. Users register with the central
Napster server, which records the IP (Internet Protocol) address of their computers and
the names of the local folders where shared music is stored. The content of these
folders is catalogued in the central Napster database, which other members can search
when they're looking for a particular artist or track. If a user finds a desired file on a
computer currently connected to the network, Napster transfers the file.
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The recording industry has been outraged by the system, mainly because in only 12
months it has spread through viral marketing like wildfire, with over 22m users
worldwide. This equals the global customer base of Amazon.com, which was built
over five years. At the time of its launch, swapping MP3 files was very much a gray
area. The Digital Millenium Copyright Act, which was passed in the US in 1998
allowed search engines to link to MP3 files unless otherwise notified, therefore Napster
as a search engine of sorts could have been classified as not infringing copyright law.
Napster also suggests that because none of the copyrighted files are stored (although
they are catalogued there during a user session) on the companys servers, it is not
liable even though its users are. However, the question is whether the software itself
will make Napster liable for infringement. RIAA claimed that Napster facilitates piracy,
slapped the company with a lawsuit, and a federal judge has ruled in favour of the
recording industry by ordering Napster to shut down. Napster is appealing, at the time
of print the site was still up and running thanks to a temporary reprieve.
Figure 39: How Napster Works
Gnutella
Gnutella is an open-source variation of Napster, which was originally created by
programmers inside Nullsoft, which AOL acquired without knowledge of the
programme in development. The user needs to download the programme, after which
s/he can connect to one person on the network by entering their IP address. The
programme connects this computer at the IP address specified to a handful of other
computers, allowing the user to search for music files, and these computers again
connect to another handful of computers, creating a chain of members which can
become enormous in one user session. The program finds (anonymously) the data and
returns a copy without indicating the file's source. Computers belonging to the Gnutella
network act as both clients and servers, able to accept searches from other clients but
also able to pass on those searches to other clients if the requested files aren't available
locally.
The networks the sessions create require no central servers and are not owned or
controlled by any company or individual. As a result, Gnutella is very difficult for
opponents to shut down, because users cannot be identified. Gnutella's other major
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difference compared to Napster is that it can search for any variety of media file, not
just those with the ".mp3" extension. That includes text files, HTML, PDF,
RocketEditions, and any other format used to store electronic books.
FreeNet (The Free Network Project)
A peer-to-peer network similar to Napster, FreeNet calls itself a "near-perfect anarchy."
The network is decentralised, unlike Napster, which is controlled by a central network.
Because FreeNet is not controlled by any individual or company, the information
distributed on it is virtually censor-free and cannot be removed from the system.
Participants must install and configure FreeNets Java server and client software on
their computers to contribute to the network. This system works very differently from
Gnutella and is designed to be even more anonymous and censorship-resistant. In fact,
the harder someone tries to eliminate a document from the Freenet network, the more
copies of the document the network creates and caches.
FreeNet was developed in June 1999 by student Ian Clarke as part of his final-year
project for his degree in artificial intelligence and computer science at Edinburgh
University, Scotland. The system was originally formed to promote free speech on the
Internet, but it has evolved into a popular network for sharing all types of copyrighted
information including digital music.
Source: Gnutella.wego.com
81
Source: Gnutella.wego.com
Macster
Macster is a Napster-like program for Mac users. Created by Blackhole Media, the site
enables users to download MP3 files. Users can listen to the downloaded songs only if
they have a Mac-compatible player.
Gnutella and other

anonymous P2P
networks are the real
threat
Unrelated songs are

appearing on Napster
Disabling Napster is not going to win the war for the record industry
For the record industry, these P2P (peer-to-peer) services allowing anonymity
(Gnutella and FreeNet being the largest) are a far bigger threat looming on the
internet than Napster could ever become. Napster is not a peer-to-peer network in
its pure definition, as users access files through a central database. Gnutella, FreeNet
and others (such as Flycode, Angry Coffee, Flatplanet and Sightsound.com) are the real
problem. Therefore, closing down Napster could actually backfire against the majors:
the 22 million users that have been flocking to Napster to retrieve free digital
downloads could possibly move to use the decentralised file-sharing systems Gnutella
and FreeNet. Gnutellas rapid growth in August could be attributable to this migration.
On these networks it is impossible to trace music files and track copyright. Although
both these file-sharing systems are still in elementary stage of development, with lots of
bugs and a very complex user interface, they have been growing their user base at an
accelerating speed.
In addition, a worst case scenario for the record industry is to see yet unreleased
songs appearing on P2P platforms. This happened with Madonnas new single
Music, where an unfinished version appeared on Napster months before it was
officially released. Similarly yet to be released albums from Wallflowers and
Smashing Pumpkins went into circulation on Napster long before they were due to be
officially released. As a large role of the record labels is to promote their artists and
ensure publicity for new releases (which are usually well-guarded secrets), the deflating
effects of new releases reaching consumers pre-maturely is obvious. On the other hand,
82
these could fuel consumer interest prior to the new release coming to the market
however the main point is that the content owner in this case is not in control of how,
where and when the music is promoted.
Napster is almost antiestablishment
Napster bought file

sharing to the mass
market
Napster is a very
convenient way of
getting free music
The popularity of these P2P applications is partly based on the almost counterculture, semi-anarchistic status they have achieved. They also play on the original
internet traditions with an appeal of an underground community. Although Napsters
user base is extremely broad (7-70 year olds), the more anarchic P2P applications
have a cult-like following amongst the hacker community. When court ruling to close
down Napster was aired, several web sites were defaced by hackers with pro-Napster
messages. The fact that these sites have grown by strong viral effects only with no
official corporate marketing behind them demonstrates how strong the acceptance is.
Napster has created a tremendous momentum for digital music, and we believe that
eventually this will prove to be a good thing, despite frightening the record labels. We
think Napsters popularity demonstrates that consumers are looking for an alternative
distribution channel, an alternative way of sourcing and consuming music.
In addition, Napster has also proven to be one of the biggest innovations the
internet has ever produced. File sharing is fast becoming ubiquitous, thanks to
Napster. Some observers have rightly noted that Napster is not about music: it is a
demonstration on what ultimate networking means. The technology has seen its first
application, but its followers could render online marketplaces such as QXL and eBay
meaningless, as these companies rely on their ability to charge fees for connecting
internet users with one another. Although music files are the primary products
exchanged on these platforms at the moment, users could list items they want to sell,
drop them into a file-sharing upload directory where buyers can browse the offerings
directly.
We believe that a majority of Napster & Gnutella users are aware that there is a
copyright infringement issue (after all, with all the publicity the Napster court cases
have received, it is hard not to!). However these viral distribution platforms have
received huge consumer acceptance, and consumers have demonstrated that file sharing
is something that they want to use. In the case of Napster, it is simple, quick and
convenient, and most importantly it provides access to a vast database of music,
something which no existing aggregator is able to do. As these services have already
attracted such a huge user base, disabling them will be extremely difficult. Even if
Napster was shut down, Gnutella, FreeNet and similar applications would still continue
to exist, and new Napsters would no doubt keep appearing (after all, the software was
not overly complex to write). Even if it were possible to disable the services, it would
be close to impossible to disable the technology. With the speed of development as it
is today, legal authorities are likely to stay one step behind emerging technologies.
To support this view, we discovered that a survey released by PC Data Online found
that 25% of Internet users - even those who had never used Napster themselves - plan
to continue to use free-exchange services, even if the courts do determine that they
comprise a form of piracy. Among Napster users, the figure was 60%.
Some Artists are for,

some against
Artists are divided when it comes to downloads and Napster. In an extreme case,
Metallica (the heavy metal band) sued Napster for copyright infringement, in addition
several artists such as The Corrs have voiced their support for RIAA over the copyright
law suit. However, other such as Public Enemy, Offspring have said that they view
Napster as a formidable promotions and distribution platform, and that people should
be given access to music if they so wish.
83
Record industry is
fighting Napster in court
Average piracy in the

music industry is 20%
Current estimated
pressing capacity all
formats
Taiwan
Hong Kong
China
Singapore
Macau
Malaysia
Czech Republic
Russia
Israel
Ukraine
Current estimated
capacity (units m)
3,900
2,800
680
490
340
280
90
90
90
70
Source: IFPI
In Europe, different
national legislations are
a problem
SDMI is not the

solution
Record industry is digging its heels

In addition to fighting Napster, the record industry has attacked MP3.com, the
digital download site. MP3.com (which is one of the popular digital music
destinations on the web today) had to settle a court case with Warner Music, Sony
Music, BMG and EMI regarding the controversial my.mp3.com, where users could
store their MP3 files in a library on MP3.com and access it from any computer. The
database grew to over 80,000, which was then declared to be infringing copyright. The
settlement was estimated to be $20m per record label. Universal refused to settle with
MP3.com, instead was awarded the case with MP3.com having to pay $118m in
damages, which will seriously threaten its viability as a business. Although this and the
Napster case will set precedents in terms of copyrighted music on the internet, the
consensus is that the record industry is acting out of panic and desperation and using
law as the first line of defence.
but piracy has existed long before the internet
The reaction seems out of context in particular when we consider the existing level
of piracy in the music industry. Since music has been recorded, there has been
piracy. In the industrialised countries in Western Europe and North America, piracy is
generally under 10% of existing industry sales, however it can be over 50% in some
Eastern European, Latin Asian countries, and typically 10-25% in countries such as
Singapore, South Korea, Argentina or Chile. This will exist with any format that can
be recorded on, which is the case with both cassettes and CDs.
IFPI estimates that total sales of pressed pirate music CDs topped 500m units in 1999,
compared to 2.36bn units sold through legitimate retail. This constitutes a worldwide
CD piracy level of over 20%. Growth in optical disc manufacturing continues to grow
at a rate that is exceeding legitimate demand, which has kept cost of producing pirate
music low. World manufacturing capacity of all disc formats rose to 23bn units in
1999, with the number of known CD plants increasing by 75 in 1999, to 660
worldwide.
South East Asia remains a huge source of pirate CD production, whereas in
Europe Ukraine poses the greatest threat to legitimate markets. In Europe Italy
and Greece have the highest piracy rates, and Finland has been affected by pirate
product entering from Estonia (piracy in Finland has now risen to over 10% of the
market). Governments and music industry associations have been campaigning against
piracy for some time now, with a zero tolerance approach enforced by seizures and
raids in CD manufacturing plants. The arrival of the internet, however, has brought
about a new kind of enemy in that the offenders have been more difficult to track down.
Although Forrester Research puts the number of illegal downloads of music files at
more than 1bn in 1999, internet piracy is a gray area. Most downloads have been made
for personal use only and are the online equivalent of taping your favourite CD and
giving the tape to a friend. Since very few have been profiting from illegal downloads,
it is hard to draw the line to what constitutes as piracy.
The issue of what is fair use or private copying has been in the centre of the
controversy. In Europe, the fragmentation of the market complicates matters. The
European Union is moving towards adoption of the Copyright Directive, which should
provide the legal framework that the music industry needs in the digital environment.
The directive is set for its second reading in the European Parliament, probably in early
2001, after which it is likely to be adopted by the 15 EU governments.
The music industrys attempts to manage the ongoing migration to digital format and
find a solution for online piracy have centered around SDMI, the Secure Digital Music
Initiative. SDMI is a coalition of over 160 companies ranging from consumer
84
electronics businesses, ISPs and security technology companies to record labels, and it
was formed to cultivate new technologies designed to find a way of delivering
copyrighted music on the internet securely. So far SDMI has created a set of open
standards (portable device specifications) which can be used by anyone involved in
creating or distributing music digitally. SDMI has also come up with digital music
guidelines for the industry. However, so far the SDMIs success in developing a viable
consumer alternative for the existing formats and standards has been very limited.
Pricay will not disappear
Although in the short term the music industry is using litigation as their first line of
defence, while at the same time attempting to solve the security problems in format
design, piracy will always be a feature. Theft of content cannot, unfortunately, be
completely eliminated.
There will always

be piracy, with or
without the
internet
We think that as long as both physical and digital formats co-exist, there will be
piracy. If music is released on CDs, it can be ripped into an MP3 file with practically
no effort and cost, and distributed online. Only when content owners release music in
secure digital format alone, there would be no CDs from which to rip illegal copies.
Therefore, we believe that it will be some years until online piracy can be completely
eliminated. This begs the question how digital e-tailers can survive on selling
downloads, if it is likely that somewhere the same track is available as an MP3 file
ripped from someones CD.
Key Thoughts:
In the music industry, the product is a result of a creative process, and copyright enables
monetising this process.
Piracy means deliberate infringement of copyright on a commercial scale.

One of the biggest headaches for the music industry have been the file sharing communities.
Napster is the most widely adopted service, partly because of its simplicity and user-friendlyness.
Users download a software application to access MP3 files from other users hard drives.
Gnutella is different from Napster in that there is no central server and users cannot be identified.
We do not think that disabling Napster is going to win the war for the record industry. We see the
peer-to-peer services allowing anonymity as a bigger threat.
Record industry is using litigation as its first line of defence, however piracy has existed long before
the internet. The industry average is 10-20%, and we do not think piracy will ever disappear
completely.
85
Figure 42: Levels of domestic piracy, 1999 (units)

Over 50%
25-50%
10-25%
Less than 10%

Canada
USA
North America
Europe
Bulgaria
CIS
Estonia
Latvia
Lithuania
Romania
Russia
Ukraine
Cyprus
Greece
Poland
Slovenia
Finland
Hungary
Italy
Austria
Belgium
Czech Republic
Denmark
France
Germany
Iceland
Ireland
Netherlands
Norway
Portugal
Slovakia
Spain
Sweden
Switzerland
UK
Asia
China
Pakistan
Hong Kong
India
Malaysia
Thailand
Indonesia
Philippines
Singapore
South Korea
Taiwan
Japan
Bolivia
Central America
Ecuador
Paraguay
Peru
Brazil
Colombia
Mexico
Uruguay
Venezuela
Argentina
Chile
Latin America
Australia
New Zealand
Australasia
Middle East
Africa
Israel
Palestine
Kenya
Nigeria
Egypt
Kuwait
Lebanon
Quatar
Saudi Arabia
Turkey
Bahrain
Oman
UAE
Ghana
South Africa
Zimbabwe
Source: IFPI
86
Should music be free of could music be free?

People want free
music
Could music be
distributed for free?
It can be done on the

radio
Music could be used

to attract crowds
Current use of digital downloads and the roaring popularity of the file-sharing
systems such as Napster has indicated that consumers indeed want free music. As
we discussed earlier, this distribution channel is growing almost entirely free of charge.
In the US only $1m was paid for digital downloads in 1999, despite the surging traffic
in online music sites. The fact that music is not being paid for certainly looks fatal to
the industrys current business model.
The Pro-Napster camp which is usually anti-record labels has thrown in a
challenge, which questions the entire livelihood of this industry. Why do owners of
content have to charge for it? Couldnt music be distributed freely to whoever requests
for it? Couldnt the music industry extract revenues in some other manner? After all,
artist receives only a fraction of the price of the CD, 1 for a typical CD priced at 12,
which would suggest that the losses would hurt all the middlemen in the industry more
than the artists. Some have said that the entire music industry supply chain is thievery
(why pay for the fat guy with a ponytail and a Lexus). Most users find free music
files too good to turn down, and it is hard to persuade them to pay for the same
downloads they can get for free (easily) from Napster. Yes, most users probably know
it is illegal but they do it anyway.
After all, free music has been available for consumers for years; on the radio. The
broadcast model is based on drawing crowds, and monetising the content by means of
advertising and sponsorship. Similarly on TV, the broadcast model lets viewers watch
Friends for free but in reality it is paid through advertising and sponsorship. In a way
the broadcast model allows for a much tighter connection with the customer: by having
to summon music from a particular source, the customer will have to return. Whereas
when a consumer buys a CD s/he disconnects immediately and never has to return (the
CD never wears out). Also, the broadcast model has an opportunity to draw very large
audiences.
Similar to the broadcast model, digital downloads could act as a gatekeeper to crowds,
with revenues coming from advertising. In other words, to consumers music feels as if
it is free of charge, but in reality they are paying with their eyeballs, their time and their
attention. A clever system that enables digital e-tailers to monetise free downloads is
Everad, which wraps advertising into downloads (as the file is downloaded, an ad is
shown) and also allows for sharing of these ad revenues with the artist and the
distributor.
Another free music model was the Grateful Dead model, the legendary band which
gave out its music free of charge in several formats, for example by allowing fans to
tape its concerts. The band derived revenues from merchandising and concert tickets
sales alone, and sales of records are only a small part of the total revenue stream.
Grateful Dead has been touring for almost 30 years, demonstrating that for artists this
can be an alternative revenue source.
Therefore, we ask whether the future model in the music industry could shift the value
from the record labels to the individual artist, in a same way that the sports industry is
currently structured. Take Tiger Woods, the gold hero: although he receives prize
money for winning tournaments, majority of his revenues come from the various
sponsorship deals with Nike, American Express and others. Essentially, Tiger Woods
is performing for free, instead the revenue model is sponsorship and merchandising.
87
More efficient
distribution of
catalogue could
mitigate the problem
Copyright owners
need to be paid
File-sharing can
revolutionise how
music is marketed
One reason why free and pirated digital downloads via file-sharing platforms
have proliferated is the enormous selection they offer; it is extremely likely that the
song you want to download is available from some other Napster user. In a way the
music industry is driving this behaviour by failing to distribute its entire catalogue
efficiently: back catalogue sales consist less than 40% of all record sales in high-street
stores. Although Napster has been promoted as a community by the fringes of the
music industry, in our view the community feature in Napster is very limited. What
has attracted users has been the abundance of free music.
The problem with free music is that it is unlikely that advertising and sponsorship
revenues alone would support the music industry in its current form. Sure, while
digital downloads are still representing a marginal share of the industrys revenues their
impact for professionals livelihoods remains small, however as this channel becomes
more dominant, this is going to change. Artists have to be paid, otherwise quality
music will not be produced. We strongly believe that copyright owners need to be
rewarded and musics value should be preserved, simply to protect the quality of the
content and the consumer experience. However, that does not automatically exclude
file-sharing applications such as Napster.
In Napster the programme, the recording industry might have at its disposal the
rudiments of a programme that can deliver precisely what major labels need to
convey via the Net. Secretly, many record industry insiders see file sharing as the holy
grail, the killer application that will revolutionise how music is marketed. File sharing
has enabled music gain exposure in a way that has never been possible before. After
all, we should not forget that word of mouth is still probably the most influential
method of music promotion, even surpassing radio exposure. Chart 43 below
highlights this, detailing results of a recent survey on what compels consumers to visit
web sites. We think Napster the programme should not be made illegal, however in
using the programme music should be paid for.
Figure 43: What compels you to visit a web site?
Word of mouth
Mentioned in magazine/newspaper article
Online ad
Magazine/newspaper ad
TV ad
Radio ad
10
20
30
40
50
60
Source: PC Data
Bertelsmann
Napster alliance
Our views were shared by Bertelsmann, the German media company and parent of
Bertelsmann Music Group, which announced on 31st October that it had signed an
alliance with Napster. The two companies will develop a paid membership service that
will be separate from Napsters free 38m member-strong file swapping service. We
understand that Napsters paying members will be able to purchase songs from
88
Bertelsmanns catalogue, while at the same time swapping files for free in the old
Napster environment. In the deal, Bertelsmann will gain access to Napsters huge user
base as well as access to valuable expertise in P2P technology. We think this is an
important indication that P2P applications will become a major channel in this sector
going forward.
Free Napster
lives
New Napsters will

emerge
Note that the paid membership in the Bertelsmann deal will not replace free
Napster, which means that the copyright case is still hanging over Napsters head, and
that the threat to music industry is still alive. In addition, as the alliance is still in plans
only, we have only a vague idea on how the new service would look like. We think the
deal is very positive for Napster, as it gives the start-up a lifeline in case the court
decide on record companies favour, forcing Napster to close down its service.
We also expect new Napster-like applications to emerge but this time with a charge
structure, whether it is per download, a subscription fee or an advertising model.
However, online ad revenues remain limited, and we are sceptical about long-term
opportunities for distributors relying on ad revenues alone.
One possibility is to attach Napster or a Napster-like system to an ISP, and bill users
monthly with their ISP subscription. This way file sharing will still feel free, while at
the same time providing the content owners with a justified payment for their work.
MP3.com has solved the problem by paying the artists it houses on the site for each
download, however for customers the downloads are free. MP3.com spends around
$1m per month in artist payments, and generates revenues primarily from advertisting.
The quote below by Richard Parsons, President of Time Warner, describes vividly the
view shared by many in the music industry.
This is a very profound moment historically. This isn't just about a bunch of
kids stealing music. It's about an assault on everything that constitutes the
cultural expression of our society. If we fail to protect and preserve our
intellectual property system, the culture will atrophy. And corporations won't
be the only ones hurt. Artists will have no incentive to create. Worst-case
scenario: The country will end up in a sort of cultural Dark Ages.
- Richard Parsons, President, Time Warner -
Key Thoughts:
Napster throws a challenge to the record industry: could music be given out for free with revenues
coming from other sources?
Free music is available on the radio, with the business model based on drawing crowds which then
generate advertising revenues.
We think artists should be paid for their creative work, as advertising revenues will not be able to
sustain the industry, including paying for the production of new music.
However, Napster the programme might turn out to be a formidable marketing tool for the record
industry, should there be a way to apply charges for the service. The alliance with Bertelsmann is a
sign of things to come.
89
The European
Landscape
Europe has a
vibrant start-up
scene
Various different
business models
Winning model
will not emerge
for some time
Diverse business models

The remainder of this report will profile what in our view are the key European
players in online music at present. We have not included the incumbents, the music
companies, which is not to say that these companies are falling behind in the category
evolution. Quite the contrary, and all the major labels are engaged in various online
initiatives and are already using the internet to distribute and promote their content. For
example, BMG has recently put a selected catalogue for sale online through designated
sites, such as Lycos. However, we think that in Europe there is a pool of young startups that currently have a major role in driving the sector. Although still small in scale,
their business models and operations highlight the various revenue opportunities that
are emerging in this sector.
The early stage of development is highlighted by the vast diversity of business
models currently on the market. Some companies have chosen to work with unsigned
artists and derive revenues from advertising or market research fees, some have signed
small or large independent labels and are already retailing downloads. Some prefer to
work on exclusive basis only, whereas others prefer non-exclusivity. Some use music
as a traffic builder and derive transaction revenues from other categories such as
hardware or event tickets. Some have gone out to provide a directory to music files
without actually holding any. Some are resembling content production companies,
packaging and programming their existing music with revenues coming from
syndication. Many companies are moving towards the syndication model, and with a
multi-platform format, highlighting how the proliferation of digital distribution
channels is creating a multitude of opportunities as demand for content is growing.
What the winning model will be is still unclear. We would like to draw comparisons
on the early development of the portal model. Five years ago there were vastly
different business models for what eventually became a portal: Lycos was a search
engine, Yahoo was a directory of web sites, and AOL provided access to the internet.
However, the optimal portal model has since become clearer with all these companies
gradually falling into the same format, and as this evolution took place the concept of a
portal was set. Now, a portal has typically a search engine, some original content,
syndicated content, directory of web sites, an e-mail facility, calendar and address book
facility, channels such as shopping, news and sport. We think that eventually the ideal
online music platform will emerge, although this is likely to be a moving target for
quite some time.
We think that online music companies will fit in three broad categories:
1) Online media music communities such as Vitaminic and MP3.com, where
revenues are generated by advertising.
2) Online retail e-tailers and digital retailers such as iCrunch and NetBeat,
revenues come from sales of music files and/or CDs, or from subscription fees.
3) Content and copyright exploitation holders of copyright or music content,
which is licensed and/or repackaged to third parties. Peoplesound is one of the key
players with this model.
In our view, there are challenges facing each of these business models. Online
media models depend on scale, and we believe that there will be room for only a
handful of large portal-style players with large selections and diverse offerings. Online
retail models, on the other hand, will also depend on volumes and also access to
90
inventory, which for digital downloads/subscriptions will not be very compelling until
secure download formats encourage major labels to put their catalogue for sale online.
Margins in digital delivery will be higher than in physical CD retail, however it is
doubtful whether these will be captured by the e-tailers, or whether prices eventually
will be competed out to represent more normalised margin levels. In addition, we
acknowledge that as long as music files are available for free (albeit pirated) on Napster
and other file-sharing services, it is hard for legitimate retailers to compete by charging
for the same files.
Publishing and
licensing revenues
represent the most
attractive opportunity
Vitaminic is still the

only quoted pure
play
We think that in the near to medium term, we see most attractive opportunities in
content exploitation and syndication. As a result of expanding demand for music
content, publishing revenues driven by exploitation of copyright should be the first
beneficiaries of the migration of music to the internet. In addition, publishing revenue
model is attractively scaleable, without necessarily demanding scale from the business
itself: by securing a portfolio of quality copyrights with multiple usage potential, a
publisher can enjoy steady revenue streams from this content.
Investment opportunities for public sector investors are limited in Europe, since
the only quoted pure-play is Vitaminic (VIT NM, which derives revenues
primarily from advertising. Tornado Group (TDO LN, 1.20), the digital fulfilment
company, trades on AIM, but with a limited market cap and liquidity. The VC sector
has been active in this space, with the largest European pure-plays attracting good
quality backing. At present most of the companies are too early in their business to
contemplate an entry into the public markets, however in 2001 we would expect a
handful of companies to test the market sentiment with public offerings.
Key Thoughts:
The companies in the online music space follow three different business models: the online media
model (Vitaminic, Clickmusic), the online retail model (iCrunch, NetBeat) and the content
exploitation model (Peoplesound).
There are likely to be winners in each of these categories. However, online retailing of music files is
likely to generate only minor revenues for the next few years.
We believe that in the near term, most attractive opportunities are in copyright exploitation as a
result of expanding demand for music content in various digital platforms
In an undeveloped market, visibility of success is very poor and the eventual industry structure is
still undecided.
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Conclusion
Digital Distribution Will Transform Music Industry

The internet and digital technologies have entered into practically every industry,
deconstructing traditional business structures and traditional business strategies.
Amazon has transformed retail, eBay has transformed classified advertising, and
similarly new entrants are challenging the music industry establishment.
Music industry will be one of the biggest beneficiaries of the internet and digital
technologies, in our view. It is an industry with an extremely challenging value chain,
with several inefficiencies and where growth has so far been restricted by the traditional
distribution infrastructure. Music up until now has had limited routes to market and
limited ways of reaching consumers (outside CD and radio). However, the content is
already in a digital format (CDs). In other words, perfect for the internet.
Five major record labels control 80% of the global music market. For them, the
internet so far has presented one of the biggest threats since the arrival of the radio in
the 1930s. Consumers have already voted with their eyeballs and attention, as
demonstrated by the 38m users that Napster has acquired in 12 months, with no
advertising or marketing beyond word of mouth. Napster and the pure peer-to-peer
networks such as Gnutella take disintermediation to the extreme: millions of individuals
around the world connecting to each others PCs, distributing copies of each others
music collections. The record industry is shaking in its foundations and using litigation
as the first line of defence (and even raising the prices of the traditional formats CDs),
as its livelihood is at stake. Artists are discovering that digital technologies enable
them to connect directly with their fans, which means that they no longer need to hand
in a majority of their hard-earned revenues to record company executives. Technology
has created a shift in value from the middlemen to the creative artist.
Furthermore, the pro-Napster camp is declaring that all music should be free and
that record labels should give up their control in order to accelerate growth in the
industry. We believe that by releasing the music industry from its current distribution
constraints will essentially create new growth. As early studies of Napster users have
shown, people listening to music on the internet are in fact buying more (legitimate)
music. This is called the media effect, where each new medium enhances the usage
of existing media. However, we believe that music needs to be paid for, otherwise
there is no way of encouraging new production of quality content.
We believe that the next two years will include rapid changes as the industry
experiments with new technologies and consumer applications. As with e-tail four
years ago, we have very little visibility on which of these will eventually become the
killer application, consumers music platform of choice. We expect that content
owners (artists, record labels) will have to make music available in several different
ways and on several different platforms, whether it is CDs, mobile phones, TVs, PCs or
download kiosks inside record stores. Record labels are testing the digital waters by
making small parts of their catalogue available online in paid downloads, however we
think it will be extremely difficult for them to make these pay, if the users can
download the same song for free from one of the file swapping services. In the short
term, we expect revenues from downloads to be very small, and see more opportunities
in streaming exclusive, online only content, on a subscription basis.
Not only is the optimum consumer platform still unclear, there are currently
several competing formats and distribution platforms. Although MP3 is by far the
most popular format and the format which carries the largest selection of content
available, its lack of security is a headache for the music industry. Only when MP3 had
universally been accepted by consumers as their favourite digital music format, the
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record labels started to work on secure applications such as SDMI. Playing catch-up,
this is happening at the same time as the number of formats is expanding.
However, we think that although the current market has the huge user base mostly
downloading music for free, what is important is that consumers are downloading, and
in this way rapidly adopting this format. Because, for the music industry digital
distribution will eventually be a huge positive catalyst. We believe that digital
distribution will create efficiencies throughout the music value chain, ranging from the
way artists are discovered to the way music is disseminated to consumers. As a
majority of printing and distribution costs are eliminated because there is no need to
move physical products, there will potentially be a positive margin impact from the
migration on this new format. However, we do not believe that it will be the retailers
who will capture this uplift. Unless the existing outlets position themselves to become
the new digital distributors of the future, they are likely to see continuing sales erosion
from declining growth in CD demand.
As more music becomes available in more channels, we believe this will accelerate
demand for content. For music industry, this can only be a positive thing. We believe
that the music companies, as owners of copyrighted content, will eventually come out
as winners. However, their role will have to change, and the way music is marketed
will have to change. Instead of holding on to the belief that artists should do tours in
order to sell more albums, in the digital age albums (and all produced music) will
create revenue streams from promotional opportunities, such as tours or merchandising.
The role of the music company will be more like a navigator and distributor,
channelling music to consumers according to their preferences.
We believe that we have not even seen the start of it. New consumer applications
are being discovered almost on a daily basis, and eventually the copyright litigation will
make way to an abundance of music content being made available on various digital
platforms. The Bertelsmann-Napster alliance is a sign of things to come, likewise the
acquisition of Scour by Listen.com. Get ready to be dazzled its show time!
93
Company Profiles
Peoplesound.com
Clickmusic
Netbeat
Vitaminic
Freetrax AS
Besonic
Icrunch
Mode Intl
Popwire
Worldpop
Tornado Group Plc
Poptones
Playlouder.com
MP3eu.net
94
Peoplesound.com
20 Orange Street
London WC2H 7NN, UK
+44-(0)20-7766 4000
www.peoplesound.com
Founded: July 1999

Number of employees: 120
Key investors:
Sonera
Private company
Europe@web
Ladybird Investments
Management team:
Ernesto Schmitt CEO, co-founder
Martin Turner COO, co-founder
Bruno Heese Vice-President International, co-founder
Paul Levett Vice-President Technical Operations, co-founder
Business model: online distributor, publisher and music service provider

Company description
Peoplesound.com is one of Europes largest new music entertainment sites.
Since launching the first site in November 1999, the company has established fully
localised sites in UK, France, Germany, the Netherlands, Spain and Italy, in effect
covering the largest European music markets.
Peoplesound.com attracts emerging artists and bands across Europe to sign up
to the web site, offering them free hosting and large-scale online distribution for their
work. The company has in its first 10 months of operations signed up 9,000 artists and
uploaded over 27,000 tracks which can be listened to via digital downloads or streams.
However, instead of inviting any aspiring backroom artist to post music on the site,
Peoplesound.com has its own A&R function which implies quality controls to the music.
According to the company, around 30-40% of artists that apply are rejected.
The 9,000 artists and thousands of available tracks attract in turn a tremendous
user base and traffic. With over 700,000 registered users and 1.4m unique visitors
per month, Peoplesound.com is already topping Napster in the online music category
(according to UK Media Metrix numbers). Peoplesound.com helps users find the type
of music they like by offering a simple navigation/recommendation system: you type the
name of an artist/band you like (say, Radiohead), and the search engine finds those
Peoplesound.com artists that are of similar style and sound. This cleverly deals with the
biggest problem facing web sites offering music from unsigned artists: with the
abundance of music and largely unknown artists, it close to impossible for consumers
to know where to find the type of music they are looking for.
As a result of a large artist roster and huge site traffic, Peoplesound.com has a
powerful tool to gather consumer information. From clickstream data captured
when users navigate the site, Peoplesound.com can gather information on musical
preferences and listening habits, cross-referenced with geographic and socio-economic
information. This type of detailed consumer information has never been captured
before: in the offline world, the most retailers could do was report sales per artist per
store. Peoplesound.com is actively monetising this information by selling market
research services to the music industry. By using peoplesound.com data, a record
label can know what works and what doesnt, and allocate capital and resources
accordingly (for example, in deciding whether or not to sign an artist, or whether to
spend money on marketing a certain artist in a certain region). This will help record
labels overcome the 95% failure rate that is typical in the industry. Early results from
this service has been above expectations, according to the company: the ability of
Peoplesound.com to analyse and predict how particular music is received by
consumers has been extremely accurate. Peoplesound.com has executed artist
95
testing or promotions deals with Sony Music UK, BMG Europe, EMI France and Virgin
France, with negotiations underway to provide these services to the other major labels
as well as several independents.
As the company has access to a large pool of emerging talent, Peoplesound.com
has taken up publishing rights for selected artists from its own roster. The
company has established a JV with EMI Music Publishing (the worlds largest
publisher) which will exploit these artists work in both publishing deals as well as
licensing the content to commercial use (for example, in advertisements, films or
television). The revenue stream for Peoplesound.com will be in the form of royalties.
We believe that the company is in an ideal position to pick winners from losers, as the
consumer data captured from the web site allows for more accurate assessment of
potential success. As a result, contrary to the voices from the traditional A&R function,
we think Peolesound.com has access to emerging artists before record labels do. We
think publishing revenues are an attractive opportunity for the company, as they are
scaleable without requiring scale from the company itself, converting into high margin.
In addition to music industry services, Peoplesound.com is monetising its traffic by
selling advertising on the site. These are in the form of banners, sponsorships or
microsites, and can be placed either on the site or in the weekly e-mail the company
sends to its user base.
Finally, Peoplesound.com receives transaction revenues from sales of customburned CDs as well as sales of music hardware, such as MP3 players. The
company does not charge for downloaded music, because it believes that the market is
not in a stage where this would present a substantial revenue opportunity. In addition,
given that Peoplesound.coms artist roster is primarily emerging artists and by nature
unknown to most users, we think it would be difficult for the company to justify a charge
for the downloads for the time being. However, this is not to say that customers would
not want to pay anything at all: as the market develops, we think a revenue stream from
downloads is inevitable.
Where will Peoplesound.com be positioned in the online music landscape? At the
moment, all players in Europe are positioning themselves in anticipation of the arrival of
the record majors. We think Peoplesound.com has the opportunity to go several ways:
it can continue as a platform for emerging, unsigned artists and deepen its portfolio of
copyrighted content, and become a publisher that simply uses the internet and other
digital channels to distribute and acquire the artists. Or, it could continue building its
brand as an online media company and a digital retailer, and increasingly capitalise on
its loyal customer following. This would mean introducing paid downloads, more
transactional revenues and continued growth in advertising revenues. Although we see
biggest opportunities in the arena of music publishing, we find the diversity of revenue
streams attractive. What we think is important is Peoplesound.coms existing
relationships with the record majors.
And, because of its huge traffic,
Peoplesound.com is likely to be one of the sites the labels will want to work with.
Traffic and user growth will be supported in the near future by a number of top
distribution deals with major online media companies. Peoplesound.com is
providing local content for Yahoo UK, Germany, France, Spain, Italy, Norway and
Denmark Yahoos MP3-page. Similar deal is in place with AltaVista. Other significant
online deals are with Microsoft/MSN (Peoplesound.com is a launch partner with the
new ME operating system, heavily branded on Windows boxes, also on msn.co.uk),
Freeserve, AOL, LibertySurf, Wanadoo, MultiMania, Club Internet, Terra, De Telegraaf
and Spray among others.
We think Peoplesound.com represents one of the most interesting plays in the
European online music sector. The company is backed by good quality investors, of
which we would pick Sonera as the one with significant leverage opportunities,
considering the migration to mobile platforms. The business model is still morphing, but
the company is well positioned to ride the first waves of European digital music
revolution. As we highlighted in our analysis, we find the most attractive near-term
opportunities to be in content exploitation and publishing - Peoplesounds strength.
96
97
Clickmusic
99c Talbot Road
London W11 2AT
UK
Tel.: +44 (0)20 7727 7500
www.clickmusic.co.uk
Launched: October 1999

Number of employees: n.a
Key investors:
Alan McGee
Sir Bob Geldof
Matthew Freud
Private company
Management team:
Becky Lancashire Managing Director
Business model: music portal, music search engine
Company description:
Clickmusic is a music portal providing internet users a gateway to online music
content, aiming to help people navigate the estimated five million pages about music
that currently exist on the internet. Launched in October 1999, the site offers several
music-related channels such as music news, information on latest releases, UK charts,
concert listings, shopping and free downloads. There is also a band directory with
artist profiles. Music shopping services are provided by linking to existing e-tailers.
This is a media model with revenues coming from advertising and e-commerce
commissions, the site does not retail any own inventory.
Figure 46: Clickmusic front page
Source: Clickmusic.co.uk
98
NetBeat
Olympic House
317-321 Latimer Road
London, UK
+44-(0)20-8962 9272
www.netbeat.com
Founded: January 1996

Number of employees: 30 full time, 21 freelance
Key investors:
Kappa-IT
Private company
Equinet
Private investors
Management team:
Stephanie Hunt CEO
Renaud Janson Founder/VP Content Acquisition and DRM
Mark Woolley Finance Director
Dominique Delforge CTO
Jennifer Singer VP Marketing
Business model: Distribution site for independent record labels
NetBeat has been one of the European pioneers in digital distribution of music.
Launched in Belgium four years ago as an online CD sales platform for independent
record labels, Netbeat has moved towards digital delivery of their music content whilst
maintaining sales of CDs and vinyl. The companys strategy is currently focused
entirely on developing partnerships with independent labels, which account for 50% of
music copyright ownership in Europe. Note that although there are over 3,500
independent record labels in Europe, sales are fairly concentrated in that top 5% of
these labels generate around 50% of total indie sales. By targeting the largest
independent labels NetBeat is able to go after a sizeable chunk of the entire European
music market. We also believe that in time NetBeat should be able to expand into
servicing the majors, after it has proven its ability to execute in the indie sector.
NetBeat provides independent record labels with a full range of distribution
capabilities for their artists.
One of the companys proprietary services is
NetBeatPro, an extranet facility which allows labels to control information flow by
creating and updating their content directly into the NetBeat system. NetBeat also
manages and administers DRM for the labels. The company is format-agnostic, and is
able to distribute the labels music in any of the main formats; MP3, Liquid Audio,
Windows Media. In addition, because of the companys strong music industry
expertise (CEO Stephanie Hunt is a former BMG executive), NetBeat is also able to
add significant value in artist promotion and development.
NetBeat does not set out to discover new talent, believing that this is best left to
the record labels themselves (this is the main difference between NetBeat and the
Peoplesound model). As evidence of success in breaking new artists solely online is
still limited, NetBeat chooses to work with artists that have passed the labels A&R
quality control. NetBeat works to promote, market and sell new artists using the new
media, the internet being a fantastic channel to reach music fans. This is done for
example via webcasts, chat events with the artists and other ways that give fans
access to the artist, something which has been extremely difficult to do offline.
Currently NetBeat sells 9,000 exclusive and over 70,000 non-exclusive tracks
which are available for downloads, and it has secured sole digital distribution rights
from 21 independent labels. Because of the companys Belgian origins, the early label
roster has been primarily French, with such names as Boucherie, FrancAmour,
99
Osmose and Last Call. The first signed UK label was Seriously Groovy, a deal which
was completed in July 2000 at the time of NetBeats UK launch. The company pays
labels an advance on royalties, however the rights are typically over a 5-year period,
and this payment is seen as an investment in a future market opportunity. The tracks
are priced at RQ WKH VLWH, and NetBeat retains a margin on the selling price
(typically 50%). For customers, NetBeat has a content-rich front end with My Radio (a
24-hour online radio service), artist information, community features (such as
discussion forums) and an extensive catalogue of CDs for sale. The labels NetBeat
has exclusive rights for provide content that the company can leverage in various
strategic applications, such as programming and content production for third-party
online media companies. NetBeat can bundle the music with its in-house editorial and
programming to provide interesting music packaging for these portals. As an example
of its in-house programming, NetBeat has succeeded in signing Annie Nightingale, one
of the best-known independent DJs, to lead a new online music show on the site.
Netbeat has expanded across Europe opening offices in both London (in July
2000) and Paris and has plans further expansion towards the end of this year,
including entering the German market and aiming to establish a presence in
Scandinavia, Italy and Spain in the mid-term future. The sites, operating in the local
language, offer a full mix of news, reviews, gig guides, interviews and live webcasts to
help attract customer flow. The content on the site is principally new music but covers
a wide range of genres. Revenue model for the company is diverse, as you would
expect in the early stages of this channel, with a large chunk still coming from CD sales
and advertising.
We think NetBeat has several things going for them. The company has a strong
management team, which represents an ideal combination of music industry and new
media expertise, and the inroads it is making in the indie scene place it in a strong
position to take advantage of this emerging channel.
Figure 47: NetBeat web site
Source: NetBeat.com
100
Vitaminic
Piazza Amendola 3
Milan
20149 Italy
+39-02-4333 171
www.vitaminic.it
Founded: April 1999

Key investors:
Kiwi Ventures
Chase Capital Partners
Access Technology Partners
Mediatel Capital
Ticker: VIT NM, VIT.MI

Price:
Mkt Cap: P
Management team:
Gianluca Dettori CEO and co-founder
Andrea Rosi - COO
Franco Gonella VP Marketing and co-founder
Adriano Marconetto VP Content Development and co-founder and Chairman
Business model: online platform for promotion and distribution of music.

Vitaminic is an online platform for distributing and promoting music. Launched in
June 1999 in Italy, the company has expanded from its Italian base to cover eight local
country sites in Europe and in the US. The English and German sites launched in
September 1999, and the French and Spanish sites launched in October 1999.
Currently 70% of traffic and revenues come from outside Italy, the companys home
country.
Vitaminic is about aggregating content (music) and distributing and promoting it
using various digital platforms. Essentially it follows the online media model of
monetising audiences, and Vitaminic does not aim to be an e-tailer of music files.
Vitaminic works with and aggregates content from both record labels and unsigned
artists, operating with the philosophy that anyone can upload music on the Vitaminic
site at no cost. Vitaminic does not pose any quality restrictions for the artists (as
opposed to Peoplesound which has its own A&R function vetting artist candidates).
Currently Vitaminic has over 15,000 artists on its sites, and over 64,000 tracks. For
unsigned artists this is very attractive as they are able to promote their music and make
it available to a global audience at no costs. In practice, however, artists may find it
hard to gain exposure among a pool of 15,000 other artists. However, despite a large
proportion of Vitaminics catalogue is unknown to the public, the company has signed
up well-known artists as well. The companys pan-European scale allows it to feature
extensive catalogues of local artists.
For consumers, Vitaminic is building an online community of music. Each site
has around 250 different genres or sub-genres, and a search engine enables
consumers to find music that is similar to their more well-known favourites. This is
done by artists providing Vitaminic with names of those artists that they see themselves
resembling, which is then indexed into the catalogue and thus picked up by the search
engine. Vitaminic also has online radio stations broadcasting 24 hours a day, featuring
Vitaminic artists. The company has around 300,000 registered users in eight countries.
101
Vitaminic is working with record labels on promotion initiatives. The company

has relationships with all five majors, who use Vitaminic as a promotional help in new
launches. For record labels Vitaminic is providing an A&R service, whereby the labels
subscribe to a service and receive frequent recordings of selected Vitaminic artists.
This is designed to save time for A&R executives and provide some pre-selection.
Vitaminic has agreements with 500 independent labels for rights to distribute their
catalogue digitally. These are non-exclusive agreements, as Vitaminic prefers not to
shed money on buying up exclusive rights. The company believes that all digital music
will eventually be commoditised because of barriers to access will come down.
Investing in exclusive rights now presents a risk with very little visibility on how these
rights can be monetised.
The business model is primarily an advertising model. During the first half of 2000,
97% of Vitaminics revenues were generated from advertising. The remaining
revenues come from sales of CDs or downloads and content licensing to third parties.
Vitaminic recognises that retailing music files is not a viable revenue model for the time
being, preferring to extract revenues in a way that will allow it to achieve maximum
scale. At this stage of the industrys development Vitaminic has in our view made the
right decision and gone after those revenue streams that can be done, which is
advertising and other ways of monetising traffic. Advertising revenues will represent a
majority of the revenue streams for the next couple of years, and the company sees
any revenues from digital download retail as an upside, however this will not create any
significant uplift over the next two years. For transaction revenues Vitaminic has a
revenue-sharing agreement with the artists. So far Vitaminic has been able to attract a
respectable pool of well-known brands, such as Coca Cola, Apple, Dell, Ford, Levis
and Procter & Gamble.
As Vitaminic features an extensive library of music (albeit most of it is
commoditised, from unknown artists), it is able to offer this content to third
parties. Syndication revenues, where Vitaminic delivers music to other sites, have
already started to feature in the financials, generating LQ UHYHQXHV GXULQJ +
2000. This Vitaminic-branded content has been featured on portals such as Lycos,
Excite and Yahoo Italia.
Vitaminic is also making inroads on wireless platforms by providing voice
services to network operators. The company has an agreement with Omnitel to
deliver music to Omnitels mobile subscribers, in a very simple feature that requires the
user to dial a number, which allows the selection of songs using the mobile keypad,
and these can be listened on the phone. Vitaminic has a revenue sharing agreement
with Omnitel (users are billed ca. SHUPLQXWHIRUWKHVHUYLFH:HOLNHWKLVUHYHQXH
stream, as it is a clever way of monetising content on mobile phones at a time when
most operators are struggling to make WAP more user friendly. Vitaminic is already
margin positive on this service, which produces small but steady stream with no
additional platform investments. In the future digital delivery to mobiles on a
subscription basis will be implemented.
th
Vitaminic shares (VIT NM) started trading on the Nuovo Mercato on October 12 ,
2000 providing us with the first published financials from an European online music
company. In the first six months of 2000, Vitaminic generated around 808,000 in
revenues and made an operating loss of PSales of digital music generated a
mere GXULQJ WKH VL[PRQWK SHULRG, reflecting the sectors inability to drive
revenues in this channel at this stage. Vitaminic expects the revenue mix to change
markedly over the next three years: in 2003, advertising should deliver 36% of total
revenues, whereas e-commerce should deliver 32%. On digital download sales the
company is factoring in a gross margin of 35%, and it expects sales of traditional CDs
as well as custom-burned CDs will still feature in revenues in 2003. Vitaminics 2003
revenue target is approximately P
The company raised PLQLWV,32ZKLFKIXQGVWKHFRPSDQ\XQWLOLWUHDFKHVEUHDN
even in 2002, on the companys forecasts.
102
Figure 48: Songs delivered per month (000)

3,000
2,431
2,500
2,551
2,042
2,000
1,794
1,477
1,500
1,213
1,000
672
Jun-00
May-00
Apr-00
Mar-00
Feb-00
Jan-00
Dec-99
Oct-99
361
Nov-99
231
Sep-99
Jun-99
107 161
Aug-99
9
0
45
Jul-99
500
Source: Vitaminic
Figure 49: Vitaminic UK web site
Source: Vitaminic.co.uk
103
Freetrax AS
Sagvn. 17
0459 OSLO
Norway
Tel: 47 23 22 81 60
www.freetrax.com
US Office:
Freetrax LLC
333 Washington Avenue, Suite 33
Minneapolis
MN 55401 USA
Founded: August 1998
Number of employees: n/a
Key Investors: Owned by Berggraf Studio AS
Private company
Management team:
Hans Petter Vereide CEO
Alf Gskjnli CTO
Business model: Music community and distribution site for independent artists
Freetrax is a Norway-based music community and digital distribution site with an
emphasis on Scandinavia and the United States. The catalogue it carries is small
but expanding and covers all genres from heavy metal to trance. Freetrax offers a
secure medium for digital distribution of music content in MP3 format using the Mode
platform. It aims to work with record labels to distribute signed artists, however at the
moment the site acts as a platform for unsigned artists where anyone is invited to post
their music on the site. The artists are offered the opportunity to promote and distribute
their music and publicity material through having a presence on the Freetrax site. They
can get feedback from the users and assign a price for their music (decided by the
artist), and any revenues generated from downloads are split between Freetrax and the
artist, with the artist receiving 70%. However, most tracks available on the site are free
to download.
The Freetrax site aims to offer interactivity and community to its users allowing
them to post reviews, vote which new artists from the wannabe section (where new
artists post their work in a category of their choice) should make it to the main
catalogue page, and even submit their own music. Registered users are able to
construct their own homepages within the site and can participate in discussion groups
or find other users with similar tastes. Users can sample tracks in Low-Fi Realaudio
before deciding whether a track is worth downloading in MP3. In short, the site aims to
be a meeting place for artists, audience, record labels, clubs, agents and others in the
music scene.
The model is very similar to the MP3.com and Vitaminic models, and relies heavily on
advertising revenues generated by traffic flow. Because any aspiring back-room
musician with a synthesizer can get music published on the site, customers inevitably
will have to plough through large amounts of music with dubious quality. An ultimate
music democracy, but we are still looking for a more user-friendly interface for
navigating unsigned music.
104
BeSonic Ag
Groneumarkt 50
20459 Hamburg
GERMANY
Tel.: +49-40-3496270
www.besonic.com
Launched: October 1999

Number of employees:
Key investors:
Bertelsmann Ventures
Private company
Management team:
Andre Schnoor - CEO
Jason Franklin-Stokes VP Business Development, Founder
Martin Eras VP Finance
Patrick Schlie VP Marketing
Philipp Wittgenstein VP Intl. Development
Business model: Online platform for distributing and promoting music from
unsigned artists
BeSonic is an online community for unsigned artists and music fans. On the Besonic
site, any aspiring artist can upload content (music, text, artwork) to be browsed and
downloaded by BeSonic users. In addition to music from the broad genres rock, pop,
etc, additional 164 sub-genres are featured, and there is even a regional breakdown
(users can search for bands from Manchester). There are charts listing most popular
downloads. Most of the downloads are free, although the artist can price them as they
wish. The company aims to supply labels with new talent from its site, helping artists to
be discovered.
Currently BeSonic has around 25,000 titles from 9,500 mostly unsigned artists on the
site, with new titles being added daily. The company has also established a publishing
arm with the intention to sign deals with artists that have commercial potential. BeSonic
aims to work with record labels and offer them music industry services such as artist
promotion in BeSonic radio and on BeSonic network on Yahoo, Freenet and MTV, and
e-commerce.
BeSonic has built several community features into its platform. It includes an
index of various music industry players, ranging from singers and teachers to
producers and even groupies! Registering on this music community index is free.
Reflecting BeSonics German origins, a majority of listings are of German groups or
individuals. Users can also build personal websites with playlists containing their
favourite BeSonic music.
In addition to downloads from unknown artists, BeSonic also has several radio
channels broadcasting around the clock. We believe this is perhaps a more
attractive feature of the BeSonic business model, since among music sites BeSonic
falls behind in terms of scale and selection. BeSonic has a radio licence, operating
from its base in Germany, and it offers broadcast music from both well-known and
BeSonic artists. There are artist-specific channels, for example Fat Boy Slim Special
and Santana Special. BeSonic DJs host daily live shows and users can even listen to
music based on moods. Advertising is served in the window as the music is broadcast.
The key revenue streams for the company are advertising revenues, and
increasingly going forward, content syndication, sale of custom CDs and subscription
fees. BeSonic has been one of the first download sites in Europe to implement
subscription fees. The download area has a limited number of advertisers and we
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suspect the online radio to be the main driver for the company. In addition to German,
BeSonic also has sites in English, Italian, Spanish and Portugese. The companys most
significant partnership is MTV Europe, where BeSonic participates in MTV unsigned
by supplying MTV with aspiring artists. Other distribution partners are Ebay, Fireball,
Freenet, LineOne, Listen.com, Ministry of Sound, Web.de and Yahoo.
Figure 50: BeSonic web site
Source: BeSonic.com
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ICrunch
nd
2 Floor
326 Kensal Road
London W10 5BZ
UK
+44-(0)20-8354 4800
www.icrunch.com
Launched: March 1999

Key investors:
Nomura
Private company
Management team:
David Phillips CEO
Allan Rowley Head of Finance
Jo McNevin Commercial & Operations Director
Tony Duckworth Music Content Director
Garreth Keogh Editorial Director
Tor Petersen Marketing Director
Tom Boyd Technical Director
Business model: digital retailer of independent dance and alternative music

Launched in 1999, Icrunch was Europes first company retailing legitimate
downloads. The company is a destination for digital downloads from independent
record labels, and one of the major distribution service providers for the independents.
Headquartered in London with local offices in Hamburg, Paris and Los Angeles,
iCrunch has acquired exclusive distribution rights for 55 independent record labels and
over 800 artists, with tracks available in MP3 or Windows Media downloads. Labels
signed with exclusive rights include Soma, Chemikal Underground, Glasgow
Underground, Nuphonic and Jeepster. The music is bundled together with original
editorial, multimedia and community features and accessed through multiple platforms.
These included the iCrunch localised web sites as well as third-party sites, mobile
phones and iDTV.
Tracks on the site are sold on the site at 99p each, making Icrunch one of the few
European companies generating revenues from downloaded music. The exclusive
rights cover many rarities and hard-to-find promo tracks from many well-known artists
such as Belle and Sebastian (Brit Awards Winner), Groove Armada (2000 Brit Award
Nominee for Best Newcomer) and Les Rythmes Digitales. ICrunch is also featuring
streaming music videos from certain artists, including Belle & Sebastians Legal Man.
By signing up independent labels, the company is able to offer users licensed
music from artists they perhaps already know, thus making it easier to justify
charges for downloads. The company believes that the A&R function should be left to
the record labels, and focuses on distribution only music that has passed the labels
own quality controls. As the independents typically do not have the resources to
execute large-scale distribution on a global basis, Icrunch is able to offer the labels
immediate access to an international customer base (over 50% of the companys
revenues come from outside UK) and a platform that ensures accurate processing of
royalties for the artists work.
The companys focus is right at the sweet spot of emerging digital music
distribution. By initially going after the UK dance music sector, Icrunch is tapping into
a user base where demographics play well onto the internet: Dance music fans tend to
be young and very technology-hungry. This consumer group is one of the early
adopters or emerging technologies and new customer applications, and very
sophisticated in their use of internet and other digital channels. By targeting the UK
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dance music market the company is essentially covering a large share of the entire
European market in this genre.
An essential element in the Icrunch model is to weave rich community and
editorial content into music merchandising. The web site is a true lifestyle
destination with news, reviews, features and an interactive community devoted to the
alternative music scene. The site also includes content and mixes from well-known
DJs such as Paul Oakenfold, Carl Cox, Timo Maas and Andrew Weatherall. These
DJs also enjoy an international fan base that iCrunch can tap into. On the site users
can access unique content such as behind-the-scenes streaming videos of artists and
DJs. In that way the Icrunch site becomes a demographic play, catering for people
interested in the dance and alternative music scenes.
Note that over the past 10 years dance music has become one of the largest youth
culture movements in the Western world, with a strong lifestyle element focused
around the club scene. UK is renowned for its clubs (Ministry of Sound, Cream and the
legendary Hacienda having a loyal following all over the world) and its position at the
cutting edge of discovering and developing new dance acts. In Europe, events such as
the Love Parade in Berlin attract millions of visitors annually, and Ibiza and other
European holiday destinations have made their name through the club scene they
offer: Amnesia, Pasha and Space are already household names among the everimportant 18-30 consumer group.
However, iCrunch is not purely about dance music: Although iCrunch has made its
name for distributing dance and alternative music (which has provided the company
with attractive user demographics at the outset), the company is planning to expand
into other genres in order to leverage its infrastructure and expertise. The company is
also planning to expand its offering with non-exclusive content.
Similarly to most early entrants in this sector, Icrunch is driving revenues from
several directions while waiting for a sizable market for the new digital formats to
emerge. ICrunch derives revenues both from its own services, which include ecommerce and advertising, and third-party client services. A significant proportion of
revenues are derived from the syndication and licensing of content and music rights to
third-party distribution partners. These revenues take the form of up-front fee
payments, advances/royalties, development fees, access revenue sharing or other
commissions related to consumer usage of content. We see these revenue streams as
the most attractive opportunity in the near term.
Transaction revenues are generated from sales of downloads (pay-per-download,
although the company is shortly launching a subscription service) on the web site, in
addition iCrunch has an affiliate programme called iCrunch Partners, which should
provide customer acquisition at low cost. In addition, by positioning itself as a lifestyle
play, iCrunch is able to generate transaction revenues in a variety of categories outside
music downloads. ICrunch is currently merchandising books, music hardware and
videos through a variety of retail partners, and opportunities in the near future should
be in event/travel area, as although the company is already providing listings some
additional revenues could be derived from ticket sales or travel commissions.
Advertising plays an important part for now, and iCrunch is able to offer a very focused
demographic play: 78% of the audience is male, 75% are aged between 16 and 34,
and 58% are located in the UK. Music marketing is a new revenue stream in this area,
and this is where iCrunch is working with companies wishing to use music content as a
marketing tool and part of their overall marketing message.
Future development opportunities for the company should be found in enhancing the
label services as well as syndication and licensing revenues. One of the companys
strengths is in its community of users, and we believe iCrunch can build on its current
services by adding broadband content (richer multimedia) as well as more interactive
features.
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Source: iCrunch
Source: iCrunch web site
109
MODE International
4th Floor
Crown House
72 Hammersmith Road
London W14 8TH
UK
Tel. +44-(0)20-7559 3550
Email: info@mode.net
www.mode.net
Founded: November 1996 in the Netherlands, incorporated in the UK in
November 1999
Key Investors:
Private company
Telenor Venture AS
Private investors from US, France, UK and Scandinavia including Archie
Norman
Management team:
Iain Clark CEO
CTO Ian Foley
Business model: Content management and distribution service provider
Founded in 1997, MODE International (formerly known as Music On Demand) grew
out of a European Commission sponsored research project studying the potential for
music distribution through the Internet. The company e-commerce enables content
through provision of technology and management services along the length of the
value chain. MODE provides record labels and content owners a suite of applications
and services to build their own on-line music sales system. Or, MODE services
retailers who want to sell digital music on their sites. In short, the application will
encode, encrypt and digitally watermark music content, store it on secure servers,
handle all billing and payment transactions and deliver files either as file downloads or
streams.
The MODE platform is a European solution, and built to solve the challenges of
multi-country content management. Over 60% of music sold in Europe is local content
and from this follows that copyrights are often territorial. The MODE system is built to
cope with these restrictions, which allows for local control of content. The company
believes its competitive advantage rises from its superior understanding of the
European market, in addition its platform and products are a result of a three-year
research and development process. We believe that local solution providers should be
able to gain an edge vis--vis US competition, as US players have been slow to move
to Europe because of the complexities of the marketplace. For example, if a Swedish
customer downloads an album from an UK-based online retailer and the artist is
French with a German label how is it paid for and how are royalties collected and
distributed? MODE is able to do multicurrency processing, in addition because the
platform is hosted locally through an international network of servers, delivery
performance does not depend on the customers geographical location. The MODE
platform should also become attractive for US content owners who are looking to enter
Europe.
MODE generates revenues from subscription and commission fees for
application and hosting services. The core service offers a complete and ready to
go e-business platform with content management, data warehousing and CRM. To
this core service Mode can add value with additional capabilities:
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Encoding service Mode can digitally code and watermark any form of music
content into the most popular codec formats, i.e. MP3, ePAC and WMA.
Web integration service Mode can allow integration of commercial functionality

into an existing web site using their digital fulfilment capabilities or take control of
the entire web infrastructure through a fully managed service.
Advanced Transaction Reporting and Marketing Analysis Using the transaction

database a number of detailed marketing and sales analytics can be produced to
provide retailers with an overview of sales and transactions.
Marketing Management tools Modes marketing tools enable e-tailers to

selectively market to groups and individuals creating a personalised experience for
customers, which should improve the conversion from browsers to customers.
Mode has developed its platform using alliances with four key industry partners:
1) ViaTech
Mode uses ViaTechs eLicense technology within its Digital Rights Management
system. The eLicense technology allows the use of software to be controlled by the
publishers after it has been distributed. In return Mode is the exclusive supplier of
ViaTechs download music and DRM technologies within Europe.
2) Lucent Technologies
Lucent technologys R&D arm Bell Labs has a long history in developing the cutting
edge technologies within the music industry. Mode uses the EPAC version of Lucents
Perceptual Audio Coder compression algorithm as a format for music distribution at
128 kbps. This offers superior security and sound quality to the MP3 format.
3) Xpedior
Xpedior, an e-business integrator with strategic, technical and creative expertise
worked with Mode in developing the secure content management and digital
distribution fulfillment system incorporating royalty reporting and tracking of intellectual
property rights.
4) Muze
Muze is a leading provider of interactive entertainment information, providing
catalogues several online retailers in this sector. Muze and Mode have a joint
marketing agreement whereby Muze promotes Mode as its preferred supplier of
fulfilment services to Muzes existing and prospective clients. Reciprocally Mode
promotes Muze to content providers and record labels as a supplier of retail catalogues
in Europe.
Mode can also facilitate the smaller players and independents entry to the
market. Several distributors such as Freetrax.com are already using the Mode system.
In addition, Modes technology can be expanded to other products for digital distribution
including books, films and software.
One of the key strengths the company has is its management team. The CEO Ian
Clark has inside experience of the music industry, having been a drummer with the
legendary rock group Uriah Heap. Board directors include Archie Norman, the former
Asda chairman. The companys chairman, John Preston, is a former chairman of
BMG, one of the five record majors.
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Popwire.com
Kungsbroplan 3A
112 27 Stockholm
Sweden
+46-8-652 80 60
www.popwire.com
Founded: May 1999
Key Investors:
Investor Growth Capital
Private Investors
Private company
Management team:
Anders Andersson - CEO
Carl-Johan Krigstrm CFO
Andres Nordstrm COO
Kay Johansson Head of Technology
Business model: pop star generator - enabling artists to be discovered by
record labels
Popwire is a music download site as well as a pop star incubator. Popwire
showcases and distributes music from emerging artists on the www.popwire.com
website, through webcasts on Popwire TV, by featuring them in the Popwire online
magasine, or by streaming their music in Popwire online radio channels. Popwire also
develops, produces and distributes content for various portals.
Artists can send MP3 files to be uploaded on the site and their music can be browsed
and listened to by Popwires users. Currently Popwire has music from all the major
top-level genres, from Dance to Classical, however there is no detailed navigation tree
as the number of artists appears still to be limited. There is very little quality control,
although Popwires own A&Rs listen to the music in order to separate the most
promising artists for the sites Featured Artists section.
The model is similar to Peoplesound.com, albeit in a much smaller scale and without
A&R scrutiny, in that Popwire aims to sign publishing deals with those artists offering
most attractive potential. In addition, Popwire works towards securing record contracts
for the signed artists, and for record labels the artists exposure in Popwire gives them
a measurable track record on which to base investment decisions. The feedback from
the audiences becomes valuable market data that the music industry can use in order
to estimate how a particular artist would be received by the consumers. The company
has already secured record deals for a number of artists.
In addition to publishing revenues, Popwire hosts advertising on the site. So far
Popwire has been signing a handful of distribution agreements, among them are MTV
Undiscovered, where Popwire supplies MTV new music and artists, and Euroseek.com
and Everyday.com, where Popwire supplies the portal with customised music content.
Popwire Technology is a team within the Popwire Group that develops technologies
and solutions for broadcasting streaming media content on the internet and 3G mobile
networks. Popwire Master Control is a stream mixer capable of mixing streams/feeds
in several formats transmitted via the internet. The solution enables real-time mixing of
live and pre-recorded material, and allows the broadcaster to transmit via a
conventional TV or the internet. Popwire Broadcaster 3G enables live broadcasts over
the internet via a mobile phone. In addition, Popwire Technology has a range of
webcast services, for example the company managed the live webcast of Swedens
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independent Emmaboda Festival, in addition Popwire is delivering live concerts on the

internet from New Yorks CBGB rock club.
We think that, just like Peoplesound.com, this model is one of the most attractive
approaches to the online music space. However, Popwires success depends on the
scale of both content and traffic on the site. Given that Peoplesound.com has already
gone a long way by establishing a brand in UK the largest music market in Europe
Popwire will have its work cut out for them. Popwire has currently only 3,000 songs on
the site from approximately 800 artists. However, they have been making inroads in
music publishing with 50 deals signed, and 22 Popwire artists have gone on to sign
record deals.
Figure 53: Popwire web site
Source: Popwire.com
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Worldpop
Syon Lodge
201 London Road
Middlesex
TW7 5BH
+44-(0)20-8232 8222
www.worldpop.com
Launched: January 2000
Key Investors:
3i
Chase Capital Partners
Amadeus
Private company
Management team:
Peter Powell Chairman
Geoff Smith Joint MD
Liam Hamilton Joint MD
Crispin Hayhoe Finance Director
Gurtej Sandu - CTO
Business model: Pop music news network
Worldpop is a music portal and online media company focusing on the pop music
genre, utilising various digital media platforms for distributing its content. Worldpop
has a team of in-house editors which produce proprietary content accessed by
Worldpop users or syndicated to third-party services.
To date Worldpops primary platform has been its web site, where the companys
editorial team delivers news, reviews, concert listings, interviews, feature articles and
other information content. So far the company has been successful in for example
delivering exclusive interviews with the likes of Madonna, Britney Spears and Steps.
On the site there is also a pop music chart, which is likely to be developed into an
official UK chart through a sponsorship deal with BPI/BARD. The company also
delivers pop music news to over 1,500 DJs and music industry professionals.
Worldpop has licence agreements with record labels to provide its users with 30second stream samples of selected songs. Therefore, users do not have access to
music, instead the service is very much built on band/artist news and gossip, charts,
chat and other community features, listings etc.
On TV, Worldpop has produced a series of 6 programmes on dance music for ITV, in
addition the company has a slot in the popular CD:UK music show. On mobile phones
the company has been operational since April on BT Genie portal, and it delivered SMS
services in for holidaymakers in Ibiza throughout the summer season 2000. The
company is in the process of developing additional services such as Worldpop Radio,
and broadband as well as print applications, however these developments are still in
plans and proposals only and we do not have information on how and when they will
materialise. The company is also planning to expand overseas, however the size and
structure of its international operations is still unclear.
Majority of the revenues come from advertising, and the company is currently achieving
CPMs at around 25 for banner ads (current monthly unique visitors are running at
around 150,000). However, the company is profiling itself as a B2B service provider to
the music industry, which would include market testing, music marketing to Worldpop
user base, and other promotional help. Eventually, Worldpop sees itself as becoming
a music marketing consultancy. Other ideas include record store locator and e114
commerce services (with Worldpop branded storefront for CD sales currently in

development).
Worldpop is currently delivering syndicated content to several digital distribution
platforms, such as Reuters (Worldpop is Reuters exclusive music news provider in the
UK), Yahoo, AOL, MSN and Freeserve. To date these have been mainly delivering
traffic, but the company is aiming to convert these into paying contracts in the near
future.
Worldpop has a client portfolio of attractive advertisers, such as Woolworths, Sony,
and Kodak, with several additional brands participating in last summers mobile
promotional activities in Ibiza.
Launched in January 2000, Worldpop has so far generated 30,000 registered
members, with 20,000 of these receiving a regular e-mail newsletter. Currently
Worldpop has several ideas in development and they have identified many potential
revenue streams. However, we view the company still very much as a music portal,
where revenues are dependent on scale of traffic that the company manages to attract.
With 150,000 unique visitors and 30,000 members, there is still a long way to go. In
addition, we think the companys plans to provide marketing services to music
companies would be supported better if it had a significant traffic base to build on.
Music news syndication is a viable revenue stream even on a small scale, however
here the company has competitors such as Music365 and Clickmusic. We do not
believe that wireless applications will develop into a viable retail channel anytime soon,
and although the company claims to be the first to deliver music marketing services,
there is no first mover advantage in that sector.
Figure 54: Worldpop web site
Source: Worldpop.com
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Tornado Group Plc

Tornado House
Pound Lane
Marlow
Buckinghamshire SL7 2AF
UK
Tel: +44-(0)1628-498 600
www.tornadogroup.com
Founded: Late 1999
Number of employees:
Ticker: TDO LN
Exchange: AIM
Price: 125p
Mkt Cap: 50.7m
Management team:
John Kinnear Executive Chairman
Ian Watson Managing Director
Gareth Roblin Finance Director
John Gildersleeve Strategic Development Officer
Neil Ferris Commercial Director
Jim Dickie IT Director
Peter Donnelly Non Executive
Business model: Content management and distribution service provider
Tornados approach is essentially to wholesale digital content, aggregating
media from an array of content providers into a central virtual catalogue, which is
open to online retailers. This model differentiates them from competitors such as
MODE who take a more managed approach as a DRM solution provider.
To date Tornado Group has generated no revenues. The companys revenue
model is to charge a transaction fee per download and a storage charge to content
providers. Tornado will not charge a subscription fee to retailers. The major costs to
Tornado in operating the system are for storage and bandwidth. These costs are
dependent on the quantity of data Tornado is hosting and the number of files being
downloaded from the system and hence will not grow unless the company is generating
revenues.
Revenues should cover further costs for expansion and system
development, expansion of the system will only be required if it is running near capacity
and hence would be generating revenue.
In the short term Tornado group has to bring its production system into
operation, aggregate content, and expand upon partnerships with retailers.
Tornado group expects to be generating its first revenues within the next six months.
When the system is operational, 100% of hits and bandwidth usage should be
attributable to sales, end users having purchased the right to download music from the
system on a separate B2C retail website. Tornado will not be visible to the end user
and has no costs for the development of supporting content and shop fronts.
Tornado announced in October that it has entered an agreement with EMI
Recorded Music to begin trials using the system and has also entered into a trial with
game developer Electronic Arts for the distribution of games content. Both deals are
for pan-European distribution. The company is in advanced stages of negotiation with
several, as yet unnamed owners of music and games content.
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As the company enters the operational post development phase the staffing bias will
change from technical and development which is presently at its peak towards sales
and marketing which currently numbers 6 personnel. It is projected that the number of
employees will increase to 60 by the end of the year and then settle to 50 total over the
mid-term.
Tornado Group Plc. floated on AIM in March 2000 raising 15m, giving the
company a valuation of 60m. Pre float Tornado raised private equity of 500-600k.
The pre-production Tornado system was completed in August 2000, on schedule, for a
build cost of 3-400k and continues for trials and development with content providers
and retailers. The production system will be operational in November and was built at
a cost of approximately 3m. After other expenses, i.e., operation, establishment, nonsystem capex, and working capital over the first 6 months the company is left with
approximately 9m cash and has a burn rate of 250k a month.
The Tornado system is designed to link copyright owners and content suppliers
to retailers. Tornado will provide the expertise for rights management, storage,
transaction execution and delivery. The system will work in the background providing
the content and infrastructure to e-tailers and distribution and storage to the content
providers and is adaptable to games, books, software and films as well as music.
Content provided by artists and labels is watermarked using Tornados Secure
Intellectual Property System to make data traceable and show ownership. As data is
added into the system it is passed through a series of firewalls. Information about
content is held in a Virtual Catalogue from which e-tailers can offer music to customers
for download. Customers will browse for content and purchase music on e-tailers' own
sites or internet connected booths or kiosks in traditional music retailers, such as HMV,
Tower and Virgin. Once a customers bank or credit card company has validated a
transaction they are provided with a receipt or key enabling digital to download of the
purchased media. Customers connect directly to the Digital Media Distribution System
controlled by Tornado from their PC bypassing the retailer. In integrating with the
retailer, Tornado takes all of the bandwidth of the download transaction ensuring the
retailers site does not suffer from performance loss when downloads are at peak
levels. The transaction reporting system provides the necessary logs to bill retailers on
behalf of the content owners. Tornado would then take their fees before passing on the
balance to the content owner. Alternatively the logs can be provided directly to the
content owner who would bill the retailer themselves; in this case Tornado would
invoice the owners to collect their fees. The system can host content in all digital
formats including Liquid Audio and Microsoft Windows Media.
It is not inconceivable that other players could try to enter this field and build their own
systems from scratch, buying database and encryption software from established
providers and their own hardware. It has taken Tornado Group just six months to
develop their system. However, Tornado has benefits such as the strategic alliance
with Oracle, without whose expertise it would be difficult to develop such a system.
Tornado believes their expertise in linking the components of the system would be
harder to reproduce.
Tornados success over the next few months and years will depend upon securing
agreements with content providers to distribute their media through the Tornado
system. The content Tornado aggregates has to be popular enough for customers to
be prepared to pay to download it, this essentially means deals with the major labels
and artists. But their open, wholesale approach should attract artists and labels that
wish for their music to be available to a wide audience. Without management or
subscription fees from retailers, ultimately their revenues and future profits will require
large transaction volume through their system, and a broad catalogue.
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Poptones
PO Box 32022
London NW1 8GJ, UK
Tel: +44-20-7586 5556
www.poptones.com
Ticker: POP LN
Exchange: AIM
Price: 2.25p
Mkt Cap: 12.9m
Management team:
Alan McGee - CEO
Business model: Online independent label
Poptones is the new independent record label founded by Alan McGee, former founder
and head of Creation Records, the legendary independent label that signed Primal
Scream, Jesus and Mary Chain and Oasis (one of the most successful UK bands ever
selling 24m records).
Poptones has so far signed six artists, and on its web site it offers live online radio
programmes. Music fans can also find information on the artists, listen to and buy
music online, and hear about live events. The artists are also showcased through the
labels digital radio station on the site. The label plans to sign 15 new artists during its
first year of operations, and move on to webcasting. We think this company is a great
example of how fast-moving start-ups can approach the traditional record label
business model in a new way, utilising digital distribution channels and
disintermediating several parts of the value chain. Fans have direct access to the artist
and the label on the web site, and are able to buy music directly from the label
without.having to find it from retailers.
Figure 55: From Poptones web site
Source: Poptones.com
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Playlouder.com
8-10 Rhoda Street
London E2 7EF
UK
Tel: +44-(0)20-7729 4797
www.playlouder.com
Founded: n.a
Number of employees: n/a
Key investors:
Beggars Banquet
Private Investors
VCs
Management team:
Paul Hitchman Managing Director
Jim Gottlieb A&R Director
Andy Heath Labels Director
Tim Burnell Finance Director
Business model: A diversified online music company, download site
Playlouder is a diversified online music company operating in the alternative
mainstream music market. Alternative mainstream is a very broad genre, consisting
of practically everything that can be considered mainstream but is outside the pop
music genre, therefore covering a large section of the entire music market (the
company estimates this to be 30% of all music sales). UK is a leader in alternative
music, producing many of the biggest bands and artists in the genre, such as Oasis,
Radiohead, Prodigy and Chemical Brothers. The company believes that this is a very
definable market, and sees the Glastonbury Festival as depicting its core market.
The key audience in this market consists of 16-30year old heavy music
consumers, which until now have not been well served by traditional media, bar
selected music magazines. A large share of the music in alternative mainstream is
supplied by independent labels, which has been restricting its promotion and
distribution. Artists value creative control, hence Playlouder has been aiming to work
directly with artists as well as with the labels.
Playlouder aims to become a recognisable brand in Alternative Mainstream
Music. A key focus and determinant in this strategy is content acquisition, securing
digital rights from labels and artists to distribute their music to Playlouder customers.
So far the company has succeeded in signing Beggars Banquet Group, one of the
largest and most successful group of independent labels worldwide. Beggars Banquet
Group owns the rights for acts such as Prodigy, Artful Dodger, The Charlatans and
Cult, and Playlouder has exclusive rights to online distribution of its digital content in
the UK. Playlouder has also signed a licencing agreement with Mushroom records as
well as several high profile artists such as Garbage, Paul Oakenfold and Ash. In
addition, through the companys partnership with Glastonbury Festival, Playlouder was
the exclusive web broadcaster in this years event.
The company aims to generate revenues from sales of digital downloads both from its
signed labels and other labels, content syndication, original programming (for TV,
cable, radio etc), and exploitation of music rights. Content production and packaging
will feature heavily in the companys strategy, with opportunities arising in creation of
branded programmes to TV/cable/radio.
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Playlouder has attracted a management team consisting of several big names in

the UK music industry. Non-executive directors include Martin Mills, Chairman of
Beggars Banquet Group and Derek Green, an A&R star with legendary signings such
as Police, Sex Pistols, Bob Marley and Morcheeba.
We believe Playlouder has an attractive partnership with Beggars Banquet
Group, however the company needs to boost up its portfolio of content rapidly in order
to secure its position in the increasingly competitive market. With iCrunch increasingly
moving into the alternative music space in the UK and internationally, Playlouder needs
to build scale in order to present an attractive partnership opportunity for both record
labels and media companies.
Figure 56: Playlouder.com web site
Source: Playlouder.com
120
MP3 European Alliance (MP3 EU)

MP3.fr
MP3.de
MP3.it
MP3.es
Management team
Andreas Otto CEO, MP3.de
Gilles Babinet CEO, MP3.fr
Thierry Scelles CEO, MP3.es
Fabrizio Morrone CEO, MP3.it
Business model: Alliance of national MP3 sites offering local platforms for
unsigned artists
MP3 European alliance was formed from four national sites with MP3 in their
domain name. These sites are MP3.fr, MP3.de, MP3.es, MP3.it. The sites are not
connected with MP3.com, the Nasdaq-listed online music company (ticker MPPP),
although having the term MP3 in their URLs is equivalent to owning prime online real
estate, and these sites are likely to benefit from the association. MP3 is one of the
most popular search terms on the net. The alliance aims to develop synergies between
the national MP3 sites and their respective markets (a user base of an estimated 34
million).
All members of the alliance will have links to the partners sites and host the MP3 EU
logo, although the national sites operate as independent companies and no unified
front end is pursued. The catalogues in the national sites are almost entirely local, and
many of the most popular downloads are local language songs/artists. The alliance
aims to link all national catalogues in order to present a unified European catalogue,
and other sites may also join the alliance. The business models of the national sites are
very similar to that of MP3.com or Vitaminic. The sites provide a platform for unsigned
artists to upload their music and distribute it to the online audience.
MP3.fr is run by Musiwap SA, a French WAP music portal on the Itineris network. It is
the largest of the four MP3 sites with over 50 employees, they are currently in the
process of completing second round of funding. MP3.fr was launched in July 2000 and
currently has over 150 artists featured on the site and average page views of 900,000
per month. Musiwap has been operating since March 2000. In the companys plans
are a subscription service and more deals in the wireless arena. Artists on the site can
retail CDs and music can be uploaded either in MP3 or RealAudio formats. Artists can
have their own websites hosted on MP3.fr, with e-mail facility and regular traffic reports.
MP3.de is one of the largest German download sites. On the site users can search
music by region as well as by artist name and genre. In addition to free downloads from
unsigned artists, there is also comprehensive information on hardware and software
players as well as music news and good FAQs on MP3-related topics. Revenue model
is advertising, and the site features a broad range of genres in a well-designed front
end.
MP3.it is an online music resource page, with various music search engines for
locating MP3 files, such as Scour.net and Musicseek. There are links to download
software players and rippers, as well as information on hardware players and MP3 the
compression format.
MP3.es has a strong following in Latin America, as more than 25% of its traffic is
generated from that region. Many artists have a heavy Latin America influence. The
site links to retailers and provides news and discussion forums for the users.
121
Figure 57: MP3.de front page
Source: MP3.de
Figure 58: MP3.fr front page
Source: MP3.fr
122
APPENDIX
Technology Made Simple: How it all works

The term used in digital downloads, MP3, is a compression technique. Despite it
attracting a barrage of fierce media coverage, the format has actually been around for
some time, in addition it is only one of the many compression formats available. The
sheer number of available technologies has held back emergence of a winning standard,
which in turn is one of the barriers for adoption of this delivery model. In this section
we dig into the actual mechanics of audio compression and encoding, and discuss the
existing formats as well as software players.
CD is converted into
MP3 by ripping it
Music on a PC
When CD-ROM drives were introduced into PCs in the late 1980s it became possible
to play music on a computer simply by inserting a CD into the drive. In the mid 1990s
it became possible to transfer the music from the CD onto the hard disk and store it in a
compressed format, commonly as an MP3 file. This process in known as ripping and
uses an application called a ripper to compress the audio file by a factor of about 11
times with little perceivable loss in sound quality. The process was traditionally in two
steps; transferring the CD audio into a large temporary wave file, which was then
compressed to the MP3 format, however many of the latest generation of rippers
convert from CD audio (CDA) to MP3 in just one step. The smaller file sizes achieved
by compression allow computer owners to transfer their music collections onto their
hard disks and to share ripped tracks across the Internet.
Music file formats and coding
Digital audio formats are differentiated by the 2 or 3 letter acronyms of their file
type extensions, e.g. MP3, cda (referring to CD audio files we discussed above) or
wav. The best known of the compressed formats is the ubiquitous MP3 but there are
several competing technologies such as AAC, Windows Media Audio (WMA) and
VQF. The compressed formats reduce the file size compared to CD audio using Lossy
and Lossless audio compression techniques. These techniques are conceptually
comparable to the JPEG compression standard for picture files, accepting a small loss
in sound quality for a large reduction in file size. The competing formats are built
around the basics of MPEG Audio Coding, described below.
Compact Disc Audio (CDA)
To understand the advantages of audio data compression in terms of reduced storage
and bandwidth requirements, lets consider the plain CD audio format (CDA). CDA is
in waveform, sampled at a rate of 44.1 kHz, in stereo (2 channels) with 16 bits per
sample. So one minute of stereo quality sound results in the following file size:
44100 samples/s 2 bytes per sample 2 channels 60 s/min = 10.1 MB per minute.
Sampling rate indicates

the quality of the sound
WAV is an uncompressed
format
Note that sampling rate means the quality of the music. Over a 56 kbps modem (which
is still the most widely used internet access technology in home usage) in a format it
would take about 25 to 30 minutes to download just one minute of music. Thus CDA is
an impractical and inefficient format for online music distribution and storage.
Wave file (WAV)
WAV is the default audio format for PCs. Sounds generated within the PC are in the
wav format, uncompressed, in waveform with sound quality again dependent on the
sample rate. If CD quality sound is required, this equals a sampling rate of 44.1 kHz,
whereas for FM radio quality the sampling rate need only be 22.05 kHz. Hence wav
files do not reduce the size of the audio file without a corresponding loss in the audio
quality.
123
Compression requires
both encoding and
decoding of the music
Compression
Compression involves two stages: 1) encoding - transforming the data from the CD
Audio or wave file into coded audio data, and 2) decoding - reconstruction of the audio
from the coded file. The decoded audio signal is not the same as the original audio but
sounds similar, ideally indistinguishable to the human ear. The end sound quality
depends upon the amount of compression performed and the efficiency of the coding
algorithm, or codec, employed.
Sounds are built up of vibrations over a spectrum of frequencies. Audio coding
alters the sound file by removing superfluous information at the frequencies within the
sound signal that can not be distinguished by human ear. Auditory sensitivity is
represented by the Threshold in Quiet, which means the decibel level at which a
particular frequency has to be played to be perceivable. Humans can perceive sounds
in the range 0.02 to 20 kHz and have greatest sensitivity for frequencies between 2.5
and 5 kHz. Therefore there is a considerable amount of redundant data in the
uncompressed audio outside this frequency range.
Compression deletes
redundant sounds from
the file
Psychoacoustic model
calculates the necessary
deletions from the file
Dominant tones in an audio signal mask other frequencies in the spectrum rendering
them inaudible by raising the threshold (the decibel level sufficient to make them
audible) around them. For every tone a masking threshold can be calculated with only
those tones that lie above the threshold perceivable, the tones below the threshold are
masked and irrelevant to the listener. The codec programme compresses audio files by
performing a process called perceptual noise shaping using psychoacoustic
modelling to eliminate these redundant parts of the signal beneath the masking
threshold. Or, in plain English, audio compression effectively deletes all unnecessary
(inaudible) sounds from the music files, therefore reducing the size.
Encoding requires a lot of computing capacity, and uses a psychoacoustic model.
The model compares audio inputs in consecutive time blocks and applies a frequency
transform to determine the frequency components in each block. The masking
threshold at which sounds will be just audible across the spectrum is calculated and
audible frequencies in the signal are timefrequency mapped and encoded. The
decoding process is much simpler, reconstructing an audio signal from the coded data
according to the bitstream;
Figure 59: Sound Quality In Audio Compression
Source: The Fraunhofer Institute
124
Quality is indicated by
bit rate
MP3 was developed by

Moving Picture Experts
Group (MPEG)
The quality of a compressed audio file is described by its bit rate, which describes
the average number of bits that make up one second of audio data. This is quoted in
kbps (kilo bits per second), where a file in MP3 format in near CD quality sound
requires bit rates of 96 or 128 kbps the bit rate of a digital CD is 1411.2 kbps.
Compression therefore reduces the file size by up to one 14th from the original CD
Audio file.
The Moving Picture Experts Group (MPEG), the organisation behind the popular
MP3 format, is non-commercial body in charge of the development of standards for
compression, decompression, processing, and coded representation of digital audio and
video. MPEG was established in 1988 by the International Organization for
Standardization (ISO) in response to the growing need for compression algorithms for
audio and visual signals. MPEG-1, is the standard for storage and retrieval of moving
pictures and audio upon which MP3 is based and was approved by the group in
November 1992. MPEG-1 was quickly followed by MPEG-2 and MPEG continues to
develop standards and the current focus is on standards MPEG-7 and MPEG-21 for
multimedia applications.
Key Compression Formats
Quality is indicated by
bit rate
MP3 (MPEG-1 Layer 3 and MPEG-2 Layer 3)

MP3 is the most common audio compression format and a high quality sound is
obtained at a low bitrate of 128 kbps although the standard can work at bitrates
between 16 and 384 kbps. The key developers of the MP3 format were the German
Fraunhofer Institute and Thomson Multimedia who hold the patents for the technology
and operate licenses for its use in software and hardware players and encoders. They
also charge a royalty for commercial distribution of MP3 encoded music. Usage of
MP3s exploded when the software player Winamp first became available as shareware
in 1997 and was facilitated by download sites such as MP3.com, the music-sharing
program Napster and the availability of encoding programs. There are now many
rippers and players for MP3s freely downloadable from the Internet. ID Tags are
included within MP3 files to give information about the author, artist, album, genre and
track. A typical 3 minute track at 128 kbps is just over 2.7 MB in size and would take
less than 10 minutes to download through a standard modem (56 kbps), whereas to rip
a track from a CD to MP3 takes about 1 minute.
The standard MP3 compression does not have a built in security feature (as does
not the regular CD). What initially alarmed the record industry was the arrival of the
portable playback devices, such as Diamonds Rio, which meant that consumers could
play MP3 files away from their PCs. The record industry had reasoned that even if
people could download music to their PCs, they would still have to go and buy the CD
if they wanted to listen to the music away from their PCs. The fact that it is possible to
convert MP3 files back to the original CD format by burning them onto a CD ROM has
also made piracy extremely easy. In addition, whereas a regular CD usually holds a
maximum of 15-20 songs, as MP3s are 10 times smaller one CD can contain up to
around 180 songs.
The Fraunhofer Institute is currently working on two approaches to Digital
Rights Management for the MP3 format, which are aimed to address the security
issues within the format. The initiatives are implemented under SDMI (Secure Digital
Music Initiative, a non-profit coalition consisting of various music industry parties).
These are watermarking to embed information into the track and Audio Scrambler
protection, which encrypts a section of the audio bitstream.
125
Windows Media Audio (WMA)

Launched in May 1999 by Microsoft the WMA compression format is designed for use
with the Windows media player but can also be played by some of the most popular
MP3 players. WMA uses a modified VQF coding and sound quality is claimed by
Microsoft to be as good as MP3 at half the bitrate. This is not generally considered to
be a fair claim and the quality is not better than MP3 even at the same bitrate. But the
quality at low bitrates required for streaming is quite acceptable. However with
Microsoft behind the format and the Windows media player 7 being bundled with the
Windows ME operating system WMA may be here to stay.
Real Audio (RA)
Real Audio and Real Player (the adjoining software player) were developed by
RealNetworks. Real Audio has had a strong presence in the streamed media field for
several years and their audio formats were designed to meet bandwidth requirements
rather than produce high quality audio. The RealAudio format can only be played on
Realplayer and the Realjukebox.
Advanced Audio Coding (AAC)
Based upon MPEG-2 layer-1 and using Dolby AC3, AAC is designed to give the
highest quality audio in smallest file size across multiple channels (surround sound as
opposed to plain stereo). AAC technology advances the MP3 standard, optimising
block size compared to MP3 and introducing features such as Stereo Channel Pair
Coding and Prediction. Because AAC performs a more sophisticated compression than
MP3 it requires more computational capacity from the PC/player to code and play AAC
files, but they are up to 30% smaller. There have been several competing standards
under the AAC name, some of which are not compatible with the ISO source code.
Names to be familiar with are Homeboy, Astrid / Quartex and K+K AAC. The
technologies being developed will include DRM (Digital Rights Management) under
SDMI but the numbers of tracks available in the AAC format remain small at the
moment in comparison to MP3. In addition there are few available players and
encoders.
Liquid Audio (LQT)
The Liquid Audio format uses secure AAC technology in the companys online music
distribution platform. Liquid Audio files can not be converted into the MP3 format and
secure files can only be transferred between PCs with a key obtained only on supply of
credit card details. There are about 70,000 songs available in the Liquid Audio format
from around 900 sites with 6,000 of these available for secure purchase, however many
of these are subject to territorial restrictions. The secure files can only be played on the
Liquidplayer but other players, e.g. Realjukebox, can play non-secure files in LQT.
VQF (Twin VQ Format)
VQF is developed by NTT / Yamaha and despite being quite a new format has gained
some popular support because of the high quality sound for low bitrates. The files are
25% smaller than MP3s but require more computing power to play and much more
power to encode than MP3. Encoding is about one third as fast as for MP3 and to
encode VQF in real-time at CD quality requires a 700MHz processor. The resulting
audio from a 96 kbps encoding sounds equivalent to a 128 kbps MP3. There are only
three players compatible with this format, which are Yamaha, K-Jofol and Winamp
with the VQF plugin installed.
126
Digital audio software players (Decoders)

Software players
File size
Application
Version
MB
Winamp
2.65
2.0
Sonique
1.63
2.0
Windows Media Player
7
9.0
Liquid player
5
5.0
Musicmatch
5.1
7.0
Cowon Jet-Audio
4.7
8.0
Source: Lehman Brothers

Research
To listen to compressed music from the Internet or ripped from a CD on a PC a

software player has to be installed. Over 150 players and 70 rippers can be
downloaded from the internet, for example from the site download.cnet.com, most on a
free or shareware basis. The most popular players are Winamp and Sonique, both are
freeware and approximately 2 MB in size (smaller than a MP3 track). Sonique is
generally considered to produce better quality sound than Winamp but many users
prefer the Winamp interface. The players offer very similar functionality playing MP3,
CDA, WAV and other audio formats. Some players such as Liquid Player have
territorial restrictions.
As the demand from the music industry for secure content has grown a new group of
software players has been developed. The most significant is likely to be Microsoft
with its Windows Media Player 7 but there are others such as the Liquidaudio player.
These players offer DRM (Digital Rights Management) technology and are built for
AAC or WMA formats whilst retaining capabilities for CDA, MP3 and WAV.
Winamp ( www.winamp.com)
Developed by Nullsoft, Winamp is the most popular software MP3 player. In addition
to MP3, it supports other music formats as standard or through plugins. The latest
version (2.65) is a 2.06 MB download for Windows 95 / 98 / NT. The interface is easy
to use featuring four self-docking windows, playlist editor, equalizer and a
minibrowser. Over 16,000 skins are available for download allowing customisation
of the interfaces appearance. There are a number of plugins for visualisations that
synchronise with the music, in addition the minibrowser enables users to search online
for tracks.
Figure 60: Winamp interface
Source: Winamp
Sonique ( www.sonique.com)
Team Sonique, part of the Lycos group, primarily developed Sonique to decode MP3
format audio files under the Windows OS, but the 2 MB application also plays WMA,
WAV and CDA. Sonique is the second most popular software MP3 player; its website
claims 10,000 daily downloads. The windowless interface features CD player type
controls and includes shuttle control, a 20 band graphic equalizer, playlist editor, and
127
Sonique interface
visualizations. The player automatically notifies users when updates become available,
allows online searching for MP3s and gives access to the Sonique music distribution
site. In the near future Sonique will incorporate Intertrusts DRM system, e-commerce
capability and online media guides.
Windows Media Player ( www.microsoft.com/windows/windowsmedia/)
Version 7 of the Microsoft Windows Media Player was launched in July 2000 as
freeware for all the current Windows operating systems. At 9.3 MB it is a significantly
larger application than either Winamp or Sonique but it has video as well as audio
capability. The application supports DRM and Windows Media Audio format as well
as MP3, WAV and CDA. Windows Media Player allows efficient management of all
the media stored on a users PC, automatically labelling tracks according to Album,
Artist, Title or Label. Media Player 7 is bundled with Windows Millennium Edition
(the upgrade to windows 98), in this way it will have automatic presence with new and
upgrading PC users. WMP 7 had 2.5 million downloads from download.cnet.com in
the first 3 months of release, indicating this players strong consumer appeal.
Figure 61: Skins and visualisations for Windows Media Player 7
Source: Microsoft
Liquidplayer (www.liquidaudio.com)
Copy protected Liquid Audio files can only be played with the dedicated Liquidplayer.
The 5 MB application also plays CD, WAV and MP3 formats and has all the common
features including skins, visualisations, etc. The player can burn to CD, has functions
for previewing and purchasing music online and provides extras such as lyrics, art and
notes about artists. The player may be an example of what is to come for digital music
but until the availability of tracks in the format improves take up may be limited.
Other popular players include Music Match and Realjukebox, both of which
encode and manage music collections. These are available in limited functionality
freeware versions or more sophisticated commercial versions for approximately $30.
The market shares of various software players are featured in Figure X below: Winamp
is still the undisputed leader in terms of popularity with over 13m downloads at the end
of September 2000, however we expect Windows Media Player to start showing
traction as a result of Windows Millenium launch. It will be interesting to observe
whether there will a re-run of the Netscape-Explorer wars, because in effect Microsoft
will be incorporating Windows Media Player into the package in a similar fashion.
128
Figure 62: Number of players downloaded since release (end of September

2000, 000)
13,415
14000
12000
10000
8000
6,067
6000
4000
2,430
1,022
2000
Cowon JetAudio
Musicmatch
Windows
Media
Player 7
Sonique
1.63
Winamp
2.65
695
Source: download.cnet.com
Streaming
When media is accessed over the Internet be it music, a news summary or a film trailer
it can either be downloaded as a file and stored permanently or streamed and held
temporarily on the PC as it is being consumed. The major difference is that downloaded
media can be used many times and re-played as and when it is wanted as the file stays
in the users possession. Streamed content, on the other hand, is consumed online as it
is played and the content remains with the provider. In streamed audio the user listens
to the file as it comes through the connection. The file is stored in a buffer as it is
played, and the file stays in the owners server. We think streaming audio has more
advantages from the content owners perspective as it allows for security of copyright;
as the file does not change owners, it cannot be copied or redistributed.
Because streamed media content is played as it is accessed, the quality is limited
by the bandwidth of the connection, instead of the compression technique.
Buffering techniques are used to smooth out the data stream, holding a few seconds of
data in a reserve. The less reliable the connection the larger the data buffer that has to
be held. Downloads normally take longer than the actual playtime of the media but
allow the quality to be much higher. Examples of streamed media include online radio
and webcam broadcasts of events such as fashion shows, pop concerts and the Big
Brother house. These web broadcasts have matured from the novelty-act days when
small web-cam views of bus stops or fish tanks used to attract thousands of internet
users, to new applications that can provide panoramic views and interactivity.
Realplayer has been the standard for streamed media for several years.
The usability of streaming is so far limited to its lack of portability, as the user
cannot save music files to be carried on a portable MP3 player. However, with the
arrival of wireless broadband, streams can be accessed from internet-enabled mobile
phones. Some of the new mobile handset already have built-in MP3-players installed,
such as the new Samsung phone. Bandwidth on mobiles will be the limiting factor for
take-up of mobile streaming, so until 3G infrastructure is in place we do not expect this
to be the killer application in online music.
129
Key Thoughts:
Downloading music from the internet requires reducing the size of compact disc music files.
Compression involves two stages: encoding and decoding.
There are several compression formats available and no clear standard has yet emerged.
MP3 is the most popular format, however it does not have any built-in security features. Other
formats include Windows Media Audio and Real Audio.
To listen to music from the internet a software player needs to be installed, such as Winamp or
Sonique.
Streaming means that the music file stays with the owner and music is listened to as it comes
through the connection.
130
European Internet
Ian McEwen
(44) 20 7260 2961
Content/New Media
Heidi Fitzpatrick
(44) 20 7260 2964
iamcewen@lehman.com
hfitzpat@lehman.com
Sharon Corr
(44) 20 7260 1191
Tarek Robbiati
(44) 20 7260 3028
Heidi Fitzpatrick
scorr@lehman.com
(44) 20 7260 2964
hfitzpat@lehman.com
Julien Roch
(44) 20 7260 2099
George Garafas
(44) 20 7256 4568
Rufus Grantham
jroch@lehman.com
Software/Infrastructure
Elise Horowitz
(44) 20 7260 2972
(44) 20 7260 3028

trobbiat@lehman.com
Brian Skiba
(44) 20 7256 4289
(44) 20 7260 1981
George Garafas
(44) 20 7256 4568
ggarafas@lehman.com
ISP/Portals
Tarek Robbiati
trobbiat@lehman.com
ehorowit@lehman.com
bskiba@lehman.com
rgrantha@lehman.com
B2B
George Garafas
(44) 20 7256 4568
ggarafas@lehman.com
Mobile
Jo Oliver
(44) 20 7260 2237
Mairi Johnson
(44) 20 7256 4287
ggarafas@lehman.com
Elise Horowitz
(44) 20 7260 2972
ajoliver@lehman.com
ehorowit@lehman.com
e-Tail
Heidi Fitzpatrick
Karen Emanuel
e-Leisure/Travel
Heidi Fitzpatrick
(44) 20 7260 2964
hfitzpat@lehman.com
(44) 20 7260 2535
kemanuel@lehman.com
(44) 20 7260 2964
majohnso@lehman.com
Incubators
Sharon Corr
scorr@lehman.com
Rob Misselbrook
(44) 20 7260 2593
Asia Internet
Mike Leary
Steve McKeever
David Freddi
(852) 2869 3835
smckeeve@lehman.com
Juliette Chow
Richard Urwick
(852) 2869 3118
mleary@lehman.com
framzan@lehman.com
e-Finance
Alan Broughton
(44) 20 7260 1821
rmisselb@lehman.com
hfitzpat@lehman.com
Fraser Ramzan
(44) 20 7260 1191
(852) 2869 3026
jlchow@lehman.com
(44) 20 7260 1532
abrought@lehman.com
(44) 20 7260 1542
rurwick@lehman.com
US Internet
Holly Becker
(44) 20 7260 1535
Michael Gross
dfreddi@lehman.com
(1) 212 526 1764
hbecker@lehman.com
(1) 212 526 5285
migross@lehman.com
For additional copies of Lehman research reports, call :

for US reports: (1) 201-963 0572 or fax 201-216 0705
for European reports: (44) 171-256 4672
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4 = Underperform (expected to underperform the market by 5-15 percentage points); 5 = Sell (expected to underperform the market by 15 or more percentage points); V = Venture (return over multiyear
time frame consistent with venture capital; should only be held in a well-diversified portfolio).
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INTERNET

Music And The Internet:

Get ready to be dazzled, because it is definitely show time in the music

Executive Summary ............................................................................................................ 6

Overview of the music industry.......................................................................................... 9

Evolution of the online music market .............................................................................. 27

Drivers behind digital music take-up ............................................................................... 44

How the internet will impact music: opportunities ......................................................... 56

How the internet will impact music: threats .................................................................... 79

The European landscape .................................................................................................. 90

Tornado Group Plc ............................................................................................................ 116

10) Appendix .......................................................................................................................... 123

Technology made simple: How it works

Figure 1: Global music sales growth, 1984-1999

Figure 2: Global Recorded Music Sales, 1983-1999 ($bn)

Figure 3: Share of global music sales, 1999

Figure 4: World CD and LP Unit Sales 1983-1999 (millions)

Figure 5: Album sales of selected artists (m)

Figure 6: Bon Jovi album sales (unit m)

Figure 7: Number of albums launched in the UK all formats (1990-1999)

Figure 8: Share of Top 200 Albums (US,%), 1998-1997

Figure 9: % Of Music Sales in Domestic Repertoire

Figure 10: Average repertoire origin

Figure 11: Music Company Operating Margins, 1993-1999

Figure 12: Reasons for Downloading Music

Figure 13: The Music Industry Value Chain

Figure 14: Revenue Distribution of A CD

Figure 15: Total Western European Online Penetration (% of population)

Figure 16: US online music share of total music retail

Figure 17: % Of total retail sales sold online in 2005 (Europe)

Figure 18: Average Online price of music by Madonna in various

Figure 22: Estimated European Download Sales, 1999-2005E (em)

downloading will have on their CD purchasing behaviour

Figure 25: Music Sales by Age Group, 1998

Figure 28: Obstacles for digital distribution take-up

Figure 29: Broadband Access Connections in Western Europe, 1999-2004E

Figure 30: Broadband households as a % of all households, Western Europe

Figure 31: Mobile Handsets

Figure 32: Evolution of music content online

Figure 33: MODE system

Figure 34: Programme schedule of Storm, a major UK internet radio station

Figure 35: Digital music value chain

Figure 37: Everad advertising during download

Figure 38: Three ways to micropay by mobile phones

Figure 39: How Napster Works

Figure 40: Gnutella user session

Figure 41: Gnutella user session

Figure 42: Levels of domestic piracy, 1999 (units)

Figure 43: What compels you to visit a web site?

Figure 44: Peoplesound.com web site

Figure 45: Peoplesound.com web site

Figure 46: Clickmusic front page

Figure 47: NetBeat web site

Figure: 48: Songs delivered per month (000)

Figure 49: Vitaminic UK web site

Figure 50: Besonic web site

Figure 51: iCrunch web site

Figure 52: iCrunch web site

Figure 53: Popwire web site

Figure 54: Worldpop web site

Figure 55: From Poptones web site

Figure 56: Playlouder.com web site

Figure 57: MP3.de front page