Digital Distribution and Music Industry

There are six key new market disruptions concerning the digital distribution of music: the creation of a new and broad customer base, the possibility of an annuity versus a per-unit revenue model, the gatekeeper advantage for a record company having proprietary access to a new digital distribution infrastructure, understanding of a technology that could be applied to other digital content, need for balance between physical and digital distribution strategies, the strategy the incumbent should adopt with respect to the evolving war over digital distribution standards. Was there a disruption or an evolution?

The story really begins with Napster and its free software that allowed users to swap music across the Internet for free using peer-to-peer networks. While Shawn Fanning was attending Northeastern University in Boston, he wanted an easier method of finding music than by searching IRC or Lycos. John Fanning of Hull, Massachusetts, who is Shawn's uncle, struck an agreement which gave Shawn 30% control of the company, with the rest going to his uncle. Napster began to build an office and executive team in San Mateo, California, in September of 1999. Napster was the first of the massively popular peer-to-peer file sharing systems, although it was not fully peer-to-peer since it used central servers to maintain lists of connected systems and the files they provided--directories, effectively--while actual transactions were conducted directly between machines. Although there were already media which facilitated the sharing of files across the Internet, such as IRC, Hotline, and USENET, Napster specialized exclusively in music in the form of MP3 files and presented a user-friendly interface. The result was a system whose popularity generated an enormous selection of music to download. Napster became the launching pad for the explosive growth of the MP3 format and the proliferation of unlicensed copyrights.

Peer-to-peer is a communications model in which each party has the same capabilities and either party can initiate a communication session. Other models with which it might be contrasted include the client/server model and the master/slave model. In some cases, peer-to-peer communications is implemented by giving each communication node both server and client capabilities. In recent usage, peer-to-peer has come to describe applications in which users can use the Internet to exchange files with each other directly or through a mediating server.

On the Internet, peer-to-peer (referred to as P2P) is a type of transient Internet network that allows a group of computer users with the same networking program to connect with each other and directly access files from one another's hard drives. Napster and Gnutella are examples of this kind of peer-to-peer software. Major producers of content, including record companies, have shown their concern about what they consider illegal sharing of copyrighted content by suing some P2P users. Meanwhile, corporations are looking at the advantages of using P2P as a way for employees to share files without the expense involved in maintaining a centralized server and as a way for businesses to exchange information with each other directly.

PC became a powerful multimedia tool in the 90s with high bandwidth Internet connections. A digital compression format was born, the MP3. MP3 uses a lossy compression algorithm that is designed to greatly reduce the amount of data required to represent the audio recording, yet still sound like a faithful reproduction of the original uncompressed audio to most listeners. It was invented by a team of European engineers at Philips, CCETT (Centre commun d'йtudes de tйlйvision et tйlйcommunications), IRT and Fraunhofer Society, who worked in the framework of the EUREKA 147 DAB digital radio research program, and it became an ISO/IEC standard in 1991.

MP3 is an audio-specific format. The compression removes certain parts of sound that are outside the hearing range of most people. It provides a representation of pulse-code modulation -- encoded audio in much less space than straightforward methods, by using psychoacoustic models to discard components less audible to human hearing, and recording the remaining information in an efficient manner. Similar principles are used by JPEG, an image compression format. MP3s could be put on CDs easily through a process called "ripping". CDs could easily be put into MP3 formats making them easy to distribute electronically to friends and family or through P2P networks.

MP3s were in demand, but threatened the music industries oligopoly. It threatened copyright protection. All of this contributed to a need for new strategies and standards when it came to the Internet as a distribution channel. DRM, Digital Rights Management, technology was a new term invented to solve the problem of this new distribution channel and was considered to be the "holy grail" for the media and entertainment industry. The real problem was the strategy the incumbent should adopt with respect to the evolving war over digital distribution standards. The industry needed to come together and adopt user-friendly, secure, standards to protect their intellectual proprietary properties in the new Internet, digital world that was starting to take shape around them.

2003, music was a $37 billion global market. From 1991-2000 in the U.S. Market the total value actually decreased from 1999 to 2000 by almost 2%. The total value of the market had increased for every year prior. This was right around