- The Washington Times - Monday, October 9, 2000

To be an on-line music company is like driving to a destination on a road with no traffic signs. Yet half a dozen local companies are doing just that, hoping that road will lead to riches.

Pioneers in a fledgling industry, most of the founders of these on-line music companies know little about the recording industry and never have been involved with music other than as a hobby.

Their entrepreneurial spirit drove them to a new field, but they never expected the dark cloud of legal issues to follow them as it has. Because on-line music is new, it's not always clear how copyright laws apply to the technologies the companies use. This has led to lawsuits between the most popular music sites and the recording industry.

The precedents of these cases will affect the entire industry, which analysts predict will bring in a staggering $2 billion to $4 billion annually by 2003. In the long run, the on-line music industry could eat away at the mainstream recording industry's annual $15 billion, analysts say.

"On-line music is a big thing now," said Sasha Zorovic, an analyst with Robertson Stephens in San Francisco. "There is just a huge pent-up demand for it. And now suddenly, wherever you look, you see it."

The six local companies may not be on-line music giants like Napster Inc. or MP3.com, but they are marching boldly into the new industry, cementing the Wash-ington region as a mecca for innovative high-tech companies.

Investors also have realized the potential of on-line music. That's why Jim Lynch, managing partner of venture firm Draper Atlantic, invested in OneBigCD.com, a Sterling, Va.-based company that lets users access their CD collections on-line.

"We are betting on [the industry]," he said. "We like the application … people go to it every day."

One of the oldest digital-music companies is 4-year-old Music-Maker.com, based in Reston, with offices in New York. The company, which creates CDs based on consumers' choices of songs, was the only on-line music company in the area until last year.

Since then, five more have emerged, each tapping a different niche, trying to draw the blueprint for the new industry. All they have to do now is get beyond a thickening morass of legal issues.

"With all this legal stuff, if we knew what we were getting into, we probably wouldn't have," said Scott Eisenberg, president of OneBigCD.com.

The local picture

On-line music developed quietly after the mid-1990s. It began with companies selling CDs and entertainment news on line, and has expanded to start-ups that give users access to software that allows them to download music free of charge or for a fee. Then came technologies that compile CDs based on users' choices of music, and others that create customized play lists of users' music.

Some 90 percent of digital-music companies are based in Los Angeles and New York, the epicenters of music. But high-tech areas like Washington also have joined the innovative field.

The six local companies MusicMaker, ETantrum, Listen-Smart, OneBigCD, LighteningCast and PickTheHits follow a different business models. So far, none has made a profit.

MusicMaker follows the consumer market: It lets users pick songs that they like, compiles them on CDs and mails the disks to the users.

Some 223,000 users shopped at MusicMaker.com in June, making it the most popular of local digital music companies, according to Media Metrix, a New York firm that tracks Web sites.

ETantrum.com, of Sterling, is the next most popular with 200,000 visitors in June. Its patented technology identifies and fingerprints music files, or MP3s, based on a song's acoustic sound. It then learns a user's taste by how often he plays certain tunes, and then recommends similar music.

"Then there is the hidden side of things, the market research piece of it," said Steve Hole, vice president of business development. "Based on people's usage … we have the technology to produce real-time customized research reports on demographic data, like how many people in Reston listen to Michael Jackson from 9 a.m. to 10 a.m."

The founders of the company, Jonathon Perrelli and brothers Michael and Scott Shinn, all left local high-tech firms to start ETantrum.

Today the 30-person ETantrum has a few small clients who license their product, but its creators hope major record labels soon will recognize the value of their technology and pay to license it.

"We are in advanced talks with a lot of major and independent labels right now," Mr. Hole said.

Legal trouble

As with many fast-growing industries, progress for digital-music companies has been stymied by legal trouble.

A perfect example is One-BigCD.com. Around last Christ-mas, its founder, Mr. Eisenberg, was planning to contact the Recording Industry Association of America, the trade organization of the major labels, to make sure his company was in compliance with copyright laws before it went on line.

Just before he spoke with the RIAA, Mr. Eisenberg learned that another company, San Diego-based MP3.com, had started the same service: A digital music locker that verifies that users have certain CDs and then allows them to access those records on line.

"We spent two days moping around," recalled the entrepreneur, who left CyberCash, an on-line financial transactions company, to start OneBigCD.com.

"We realized we couldn't go and compete head to head … But we decided that even though we wouldn't be known as the first ones it was still a good business to be in."

But he had to change his plans: It turned out that MP3.com had not licensed the rights to copy the CDs from the record labels, and the RIAA and several major labels sued the company.

The company settled most of the cases, and in early September MP3.com lost its case against the Universal Music Group. Its locker service has been shut down, and MP3.com, which also allows users to search for and download music, has to pay the label as much as $250 million in damages.

"In some ways, we feel bad for them they took all the heat," Mr. Eisenberg said.

OneBigCD.com managed to stay on line using the same model only because Mr. Eisenberg worked with the RIAA to get the proper licenses.

The Napster phenomenon

But why has digital music become so hot? It saves the consumer a trip to the store, and it allows him to mix songs by any artist, rather than having to change CDs every time he wants to hear something different.

The popularity of industry icon Napster, which gives users software that lets them trade music files on line, is perhaps the best testimony to consumers' pent-up demand for digital music.

More than 20 million users discovered Napster in the first year after a 19-year-old college student, Shawn Fanning, wrote the software. This made San Mateo, Calif.-based Napster the fastest-growing Internet company ever, according to Media Metrix.

"When you see millions of people coming on line to get music like that, it really shows they are embracing the concept of on-line music delivery," said Mr. Zorovic, the analyst.

Once Napster made the news, its traffic jumped to nearly 30 million users in June. That was when the RIAA, rapper Dr. Dre and the rock group Metallica sued the site, claiming copyright infringement.

"The main legal issue centers over who controls copying and distribution of the music," said Marla Grossman, attorney and director of the Internet ventures group at Verner, Liipfert, Bernhard, McPherson & Hand in Washington.

The industry's position which the courts have supported so far is generally that the owner of the music has the exclusive right to copy, distribute or license these rights. But new technologies like Napster make it possible to copy and distribute music without a license and in a matter of minutes.

"Digital-music companies are concerned about the future of their world," said Jonathan Potter, executive director of Digital Media Association in Arlington. "But that's why we are here. Our job is to make sure that the laws written in the past 60 years are not used to the detriment of new media."

A group of some 800 industry members, attorneys, lobbyists and record labels, Mr. Potter's group is urging Congress to amend laws to accommodate technological advances.

"Any company whose business plan incorporates digital-music distribution needs to be keeping a very close eye on the court ruling in these cases because they are going to clarify the rules for digital copyright," said Ms. Grossman, the attorney.

Moneymaking models

None of the local digital-music companies can become profitable until the industry settles its differences with the recording industry, analysts say.

When MusicMaker.com went public in the summer of 1999, its shares were more than $23. But as legal battles intensified, the stock began to plummet. Today, its shares are priced at less than $2. Industry giant MP3.com has been equally hurt. It began trading on Nasdaq a week after MusicMaker with its shares opening at nearly $64. Today it is under $4.

Sean Fenlon, who was finishing his doctorate degree at Baltimore's Peabody Conservatory, discovered on-line music shortly before MP3.com went public. Mr. Fenlon, a solo independent musician whose style is a fusion of jazz and new age, said uploading his music on line so anyone could hear it was a mind-blowing experience.

"For an artist it makes your head swell, makes you think you can actually do this," he said.

But when MP3.com went public, Mr. Fenlon became upset that the company would make money without rewarding any of the artists whose music was on the site.

So he founded ListenSmart.com with the idea of sharing 50 percent of advertising revenues with the artists who upload their music on the site. He would pay out the money based each artists' popularity, and then would pick the top performers and try to get them record deals or radio airplay.

Although analysts say there is a large market for companies like this, the Columbia, Md.-based company so far has only six employees, no financing and few advertisers. But Mr. Fenlon is optimistic.

"This is the future of music," he said.

One thing that could help Mr. Fenlon is working with a company like LighteningCast.com, says its founder Tom Des Jardins.

The Alexandria-based company inserts audio ads at the start of MP3s. With 70 employees, LighteningCast has a sales group that finds companies who want to advertise, and then sells those ads to smaller digital music firms. The company's technology allows it to advertise at the start of an MP3 even after that file has been downloaded onto a user's computer.

Another local company, PickTheHits.com, plans to use some audio ads like LighteningCast.com's to make money.

But the Oakton, Va.-based company's main income comes from fees that record labels pay it to play new songs and get consumers' feedback before the songs hit the market.

"So [labels] get direct exposure to consumers and we also give them consumer feedback on the music," said Alan Burns, company president.

PickTheHits.com started in July. It still has only five employees, but it already is working with 15 major record labels like Warner Brothers and Universal.

"We are their buddies," said Mr. Burns, adding that his company is close to being profitable. "We are one of the ways the Internet can help them."

Aside from some audio ads, PickTheHits carries banner ads. Customers also can buy CDs through the site and participate in a weekly $1 million lottery.

Unlike the executives of the other five local digital-music companies, Mr. Burns has a background of radio and broadcasting. For 15 years, he has run his own consulting firm, Alan Burns & Associates, which helps radio stations with programming and marketing.

The audience

So just who are the millions of digital-music fans?

Industry foes tend to say they are just teen-agers and young adults. But studies have shown many people use digital music while at work. Media Metrix said in its report on usage in June that users older than 50 dominated on-line music sites that month.

The number of visitors 50 and older was up 92 percent from June of last year, outpacing the overall usage growth of 45 percent on music-related sites, the Web measurement group said.

This comes as no surprise to brothers Bruce and Marty Fries, who co-wrote "The MP3 and Internet Audio Handbook," a book about digital music.

"Part of it is that they are interested in older and less-commercial styles of music that aren't well served by the music industry," said Marty Fries, who also plays the piano for a blues band. "So on-line music is their only resource to find some of these older tunes."

The brothers, who are from Silver Spring, received so many calls of interest after they published their book in December that they began touring the country, giving seminars on digital music at bookstores, universities and for random music-lover groups.

"You never know who is going to show up," said Mr. Fries. "It's college students, elderly people. Then you have parents with kids, and the kids often know a lot more about it."

Bruce Fries, who runs his own publishing company, recently signed an author to work on a book about elderly computer users. A large section of it is dedicated to on-line music.

One of those users is the brothers' mother, who owns a ballroom dancing business in Silver Spring.

"Our mom is a pioneer in digital music use," said Marty Fries. "We set it up so that she could take her CDs and burn her own compilation CDs of ballroom-dancing songs."

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