Out Of Tune

The threat of a PR disaster was huge. What if, perhaps, they caught a handicapped, homebound downloader who found joy only through free file sharing--someone who would generate a lot of sympathy? Senior executives from the Big Five music labels--Sony, Universal, EMI, AOL Time Warner and Bertelsmann--were meeting recently on their weekly conference call, and imagining everything that could go wrong with their planned lawsuits against serial downloaders and uploaders. They knew the names and addresses of their 261 targets, and nothing else. "When you fish with a net, you are going to catch a few dolphins," a top music spokeswoman later said. "We were prepared for big headlines, and lots of different PR issues."

Sure enough, the offensive started badly. The New York press seized on one of the lawsuits' targets, Brianna LaHara, a 12-year-old who lives in public housing in Manhattan, as the poster child of the issue, seemingly helpless in the face of the industry's bullying. But within hours, music lawyers extracted a $2,000 payment from Brianna's mother, Sylvia Torres, and a public apology that sounded as if it should be written 100 times on a blackboard: "We understand now that file sharing the music was illegal.'' For an industry in a life-and-death struggle with its own customers, it was a rare piece of good news. "There are people who are saying, 'Come and get it, here are thousands of songs'," says David Johnson, Warner Music's chief in-house lawyer. "That sounds like somebody is trying to take away our business."

In another hopeful sign for the industry last week, downloading sites Rhapsody and Apple's iTunes bragged that paying customers were flocking their way. And Apple, NEWSWEEK learned, quietly informed some music insiders that it's moved up the date for expanding its current Mac-only iTunes for the vast universe of Windows-based PCs to mid-October. Apple couldn't be reached for comment. As weeks go, it was a good one for the record industry.

Too bad about the last few years. Not that long ago, the industry was fat with profits. The advent of the CD in 1982 fueled global sales, exceeding $40 billion by the mid-1990s. But since then, U.S. revenue alone has shrunk by a third. And the rise of file sharing, kicked off by Napster in 1999, is largely to blame. Forrester Research said in a report this month that downloaders had reduced industry revenues by at least $700 million. The soft economy also has hurt sales. And CD prices have remained stubbornly high--how else to pay for the lavish excesses of overly generous contracts to me-too bands and $1 million videos to pump up interest in mediocre music? Young buyers saw a cheaper alternative--free is a powerful marketing concept--and abandoned record stores for online music, DVDs and videogames. Says Andrew Lack, a veteran TV exec now running Sony Music: "The industry seemed slow to react to the pressures.''

Music execs insist they weren't blind to the revolution in digital distribution. "The opportunity to market, promote and sell directly to fans was obvious," says Michele Anthony, Sony's executive vice president. But industry officials concede that trying to adapt to the new technology was excruciating. An entirely new food chain was needed for tracking, protecting and paying various industry players. Antitrust laws made it difficult for the labels to collaborate, and it didn't help that they couldn't agree to license their music for pay services.

They may have lost their chance; the business looks increasingly like one that nobody wants. When the troubled French conglomerate Vivendi began auctioning off its various entertainment divisions this year, Universal Music wasn't even included in the deal. It would inevitably make the package less attractive. Many of the Big Five labels would love to sell out to the highest bidder, but the only buyers they're likely to find will be each other. Indeed, many expect a merger someday soon of Warner Music and Bertelsmann's BMG.

The industry is now desperately seeking a new business model. Perhaps dropping prices will inspire people to buy more, and the higher sales will cover thinner profit margins. This month Universal Music Group, the leading label, slashed CD prices by almost one third, pressuring its four rivals to follow suit. Universal may be onto something. A NEWSWEEK Poll found that 48 percent would be more likely to buy CDs than download if discs were a third less expensive (70 percent of people under 40 think the record labels overcharge). The labels are also trying to make CDs appear to be a better value by packing more than just songs on the disc. CDs from some of music's biggest artists, including Mary J. Blige, Metallica and 50 Cent, now come with DVDs of music performances and other content. If they're played on a computer, they can link to prize-packed Web sites.

The labels also hope to encourage more people to buy songs online. The quick success of Apple's iTunes shows that people are willing to pay for downloads. With only a sliver of the personal-computer market, Apple has still generated 10 million downloads at 99 cents a song. Look for a huge jump when Apple expands iTunes for Windows. And there are plenty of alternative pay sites, including PressPlay and MusicNet, and they plan to make a big advertising push this fall. Some heavyweights that are soon to enter the fray: Microsoft, a reincarnated Napster, Sony and Amazon. All that competition will likely lead to cheaper prices for downloaded songs, expanding that market. Indeed, 28 percent of those polled by NEWSWEEK said they would pay a dollar or more per download; 20 percent said they would pay no more than about 50 cents.

Technology is creating new markets for music as well. The music giants are banking on an exploding U.S. market for dialing up music on cell phones--in effect, you would use your phone as a portable player. It's already a multibillion-dollar business in Europe and Japan. Last week Sony's Lack presided over a meeting to set up a division dedicated to the service. Music companies have already dabbled in this new business with ringtones--songs from artists used as phone rings. Industry forecasters have projected that the business will soar in the United States to $790 million in 2008 from $94 million this year. Warner Music and others have already signed agreements with wireless carriers like Sprint and AT&T. Since this spring, fans have purchased 360,000 ringtones by Warner Music star Sean Paul at about $2 each.

So music execs have reason to be excited. Then again, hope is in the DNA of the business. They have to get all parts of this business working in sync. They need to make peace with their customers, and deliver pay-downloading services that are as stylish and easy to use as iTunes. They have to keep cutting costs (even while adding the expense of hiring piracy sleuths like BayTSP), but not skimp on developing new artists. If nothing else, the drastic step of suing their customers last week was an acknowledgment by industry brass that they were in deep trouble. "We are going through a transitional period," concedes Zach Horowitz, Universal Music's president. Adds Charles Goldstock, president of BMG's RCA division: "We're all in a race against time." Granted, the industry is never going to win the kind of sympathy lavished on, say, a dolphin. The best to hope for is that its customers won't give up on the industry as if it were some one-hit wonder.