Online Music Final

7/31/2019 Online Music Final

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High Technology Entrepreneurship and StrategyProfessor Ron Adner

June 2002

CARLYLE GordonGOLDBLAT FernandGONTHIER RomainGREEN JasonWAMBERG Thomas

ZEIN Walid

Online music battles: FullAudio vs. Pressplay


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Table of contents

1 Executive summary .................................................................................................................3

2 Context.....................................................................................................................................4

2.1 Online music: Market expectations, time and magnitude ................................................4

2.2 From the traditional to the online music value chain: changing roles and new players...4

2.3 Online music introduces new consumption modes ..........................................................9

2.4 Online music creates value...............................................................................................9

2.5 Adoption Analysis ..........................................................................................................11

2.5.1 Demand side adoption .............................................................................................11

2.5.2 Supply side adoption ...............................................................................................16

3 Pressplay Universal and Sonys efforts to enter online music ...........................................18

3.1 Background.....................................................................................................................18

3.1.1 Entry Strategy: Timing and Tactics.........................................................................18

3.2 Pressplay - Company Profile ..........................................................................................20

3.3 Limitations and Key Success Factors.............................................................................22

4 FullAudio A start-ups approach to online music................................................................24

4.1 History ............................................................................................................................24

4.2 FullAudios position on the value chain.........................................................................25

4.3 How is FullAudio building its position?.........................................................................26

4.4 Is their position sustainable and scalable........................................................................28

5 FullAudio vs Pressplay: Comparison of the two approaches ................................................30

Sources......................................................................................................................................31


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1 Executive summary

The world music market reached a saturation state in 1995 after a strong growth period that

was initiated by the introduction of the CD format in 1985. Between 1995 and 2000, the

music market experienced a 1.5% CAGR decline in value (Exhibit 1).

Source: Merrill Lynch

Exhibit 1: World Music Sales ($bn) 1969 - 2000

A new threat to the established music industry emerged in the late 90s with the appearance of

Internet sites such as MP3.com and Napster allowing free access to music. Although the risk

of widespread piracy remains a major threat to the music industrys ability to capture value

from the production of original music, law suits against MP3.com and Napster have shown

the legal limits to the free music model. We will assume in this paper that a secure standard

for online music distribution enforced by governmental regulation and supported by value

offered above and beyond copied music will limit piracy to current levels and allow the

establishment of a legal, fee-based music distribution model over the Internet. This new

model may thus transform into a major opportunity for the music industry reviving its sales in

the same way previous innovations did in the past.

The value created by this new distribution mode for music attracts many players. Both

incumbents and new entrants are building their capabilities to compete in this market. Their

different approaches are a consequence of their different current positions and competitive

advantages. The purpose of this paper is to compare the approach of a start-up, FullAudio,


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with that of Pressplay, the JV that Universal Music and Sony have created to establish their

online distribution presence.

We first set the context of the online music industry. We start by outlining the expectations

about the online music market in time and magnitude. We then expose the mutation of the

value chain from the traditional model to the online model, identifying the new roles to be

filled and the new players that are filling them. We then introduce briefly the new products

and services that this new model provides and the new consumption opportunities it opens to

music consumers. We also show how online music creates value by decreasing the costs

along the value chain and increasing the volume of sales. We then turn to the adoption

barriers and describe both the demand-side and supply-side barriers. We arrive to the

conclusion that the current state of the industry is about to begin crossing the chasm to mass

adoption.

Pressplays and FullAudios approaches are then presented. In presenting these approaches,

we analyze how these companies established their positions, what is the basis of their

competitive advantage and the conditions under which this advantage will be sustainable in

the future. We conclude the paper by comparing the two approaches and drawing conclusions

as to what might happen in the years to come.

2 Context

2.1 Online music: Market expectations, time and magnitude

The expectations on the time and magnitude of the takeoff of the online music business varies

according to industry analysts. Merrill Lynch in its music industry in-depth report published

in November 2001 projects that legitimate online music will grow from an estimated $8

million in 2001 to $1,409 million in 2005 with an uncertainty ranging from $900 million to

$2,480 million. The market is forecasted to grow to $22 billion in 2010, part of it being made

at the expense of the traditional music industry.

2.2 From the traditional to the online music value chain: changing roles andnew players

The traditional music value chain is depicted in Exhibit 2. It features 7 key players starting

with the artist and ending with the consumer.


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TRADITIONAL MUSIC VALUE CHAIN

ArtistComposerPerformer

ArtistComposerPerformer

Identify,sign anddevelopartists

Identify,sign anddevelopartists

PublisherPublisher LabelLabel ManufacturerManufacturer DistributorDistributor RetailerRetailer

Producerecord

Producerecord

Promoteand market

record/artist

Promoteand market

record/artist

Repackage/resell back

catalog

Repackage/resell back

catalog

ConsumerConsumer

BroadcastRadio, TV

BroadcastRadio, TV

Exhibit 2: The traditional music value chain

Artist:

The Composer is the writer of the song (lyrics and music). He holds the rights of the song in

all forms of its interpretation.

The Performer is the artist or band that interprets the song. Often the Composer is also the

Performer.

Publisher:

Acts as a proxy, collecting the royalties due to the Composer.

Label:

Labels are the primary driving force behind the music industry. They are responsible for

Discovering new talent and bringing them to the market

Managing the back catalog of their established artists

The main activities of a Label thus include

A&R (Artist and Repertoire): Artist management, matching artists with songs

Marketing: Overall strategy to market an artist or an album

Promotion: Pushing records on radios, TVs, promoting artists through public relations

Sales: Pushing CDs in main retail outlets

The 5 Majors (Universal Music, Sony, Warner Music, EMI and BMG) hold collectively a

76.5% market share of the global music market. The rest of the market is crowded by

independent labels, often operating on a local repertoire.


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Content Providers Service Providers Consumers

ArtistComposerInterpreter


PublisherPublisher LabelLabel

StorageStorage

Format conversionFormat conversion

Security and DigitalRights Management


Packaging,

bundling

Packaging,

bundling

Downloadand play locally


Online

streaming

Online

streaming

CD burning,portable music

CD burning,

portable music

ONLINE MUSIC VALUE CHAIN

Online

retailingplatform

Online

retailingplatform

OnlineRetailing

Online distributionOnline distribution

Exhibit 4: The online music value chain

Content Providers:

These are the providers of digital content encompassing music but also complementary

contextual material such as artist news, photos and video clips.

Service Providers:

This is where most of the new players in the online music field are appearing.

Storage: Provision of networked memory space to store the enormous amounts of

data accessed by consumers

Format Conversion: Several encoding formats allow music to be stored using a

fraction of the memory required by a CD. The process requires that some of the digital

information on a CD be discarded. This results in degradation of sound quality. Many

formats currently exist, the most popular being MP3 (MPEG open standard), WMA

(Microsoft), AAC (Dolby), RA (RealNetworks) and SAF (InterTrust). An encoding

format must be compatible with the media player that the end user uses to access the

music. The existing media players, produced by Microsoft and Real Audio, are

compatible with all the above listed formats, however there is no guarantee that this

will continue into to future.

Security and Digital Right Management (DRM): DRM is concerned with

protecting the copyright nature of music content. A DRM system protects content


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against copying and allows the definition of rights to access it. Although the Secure

Digital Music Initiative (SDMI) was set up in 1998 amongst content providers and

electronics companies to agree on standards for DRM and watermarking technologies

(that limit the copying of a CD to a limited number of copies), they have been

unsuccessful in establishing a standard due to feuding between interested parties. As a

result the industry remains fragmented. Main DRM providers include specialized

companies like InterTrust and Liquid Audio as well as end-user players providers like

Microsoft and RealNetworks.

Packaging, bundling: Packagers combine individual music tracks (and other content)

that they source from different content providers and create a packaged product to

be sold online. Packagers satisfy demands for flexible consumption modes and adapt

their bundle to the service offering (i.e., download, streaming, limited vs unlimited

track life). Loudeye is a good example of such players.

Online distribution: These players are responsible for the online distribution of

music content to different e-retailers. These are typically the online arm of the music

Majors, Pressplay and MusicNet.

Online Retailing:

Online retailers provide the online music service to the end-consumer. They also deal with the

e-payment by the consumer and subsequently pay the upstream suppliers of content and

service. The music e-retailers include specialized retailers such as Pressplay, MusicNet,

FullAudio and Rhapsody, more traditional internet retailers such as Amazon and generic

portals music channels such as Yahoo!Music and MSN Music.

Consumers:

Online music entails a number of different consumption modes. These are detailed in the

following section. In order for consumers to be able to listen to online music, they need a

player (software) to be installed on their end-user device. Main providers of such a player

include RealNetworks and Microsoft.

In the online value chain, the artists gain a stronger position as they have the ability to

distribute their content without going through the Publishers/Labels. Established artists who

will not open their own distribution outlet will nevertheless try to renegotiate their contracts

so as to capture some of the value of their online music from the labels. Also, the online

model allows the independent labels to limit their disadvantage vis--vis Majors as the

Internet presents a cost-effective channel for promoting and marketing new talent. Service


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providers bargaining power will depend on their technological edge. Packagers hold

potentially a strong crossroads position that they might well leverage to build scale and

capture value. Finally big e-retailers (the likes of Amazon) are likely to replicate the offline

strong bargaining power of large retailers like Carrefour or Virgin.

2.3 Online music introduces new consumption modes

Forrester Research has identified a number of new consumption modes that are offered by

online music (Exhibit 5). These are differentiated by their format and type of ownership (real

time vs. limited time vs. unlimited time). New pricing schemes are also being built to adapt to

the differentiated Willingness To Pay of consumers for these different consumption modes.

Source: Forrester Research

Exhibit 5: New consumption modes

2.4 Online music creates value

Value creation can be measured as the difference between the Willingness To Pay (WTP) of

end consumers and the Cost of providing the music product or service multiplied by the

volume of sales:

Value = (WTP-C)xVolume

We will look at the impact of moving to the online music model on each of these 3

parameters.


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WTP

It is still unclear as to whether the online music model will increase or decrease the WTP of

end consumers. On the one hand, the consumer might associate the disappearance of the

physical aspect of the music support to a loss of value which in turn would reduce his WTP

for it. On the other hand, the transformation of the pre-recorded music industry from a

product, the CD, to an experience (c.f., different types of consumption modes) will

provide new value to end consumers for which they might be willing to pay beyond what they

used to pay for an individual CD. The Dinner Party Mix type of offering is a good

illustration of this new value for the consumer. One main risk exists however: with the

process of unbundling music in the online distribution model, consumers WTP for an artists

album will very certainly decrease. The traditional model whereby consumers end up buying

an album CD for one or two songs they really wanted to buy is no longer enforceable on the

Internet where consumers got used to selecting their music on a track by track basis.

Costs

Cost savings will occur on 3 different levels:

Manufacturing and distribution costs: Online music distribution will eliminate the

costs of manufacturing the physical CD, distributing it to the retail outlets and holding

CD stocks. It will also eliminate the cost of returns of unsold CDs. Part of these costs

typically amounting to 45% of a retail CD price will be replaced by the costs of ma-

king the music available online, e.g. storage, format conversion, DRM handling, pack-

aging. These costs are largely fixed and hold a potential for huge economies of scale.

A&R costs: The Internet has a very strong potential in reducing A&R costs by

improving the return on new talent investment. Currently, 90% of artists signed fail to

recover the investments that the Labels allocate to their initial discovery and

promotion. The Internet will allow Labels to test the consumers taste and interest in

an artist before bringing this artist to the forefront and investing heavily on his

promotion. The upfront risky investment can thus be tremendously reduced.

Marketing costs: The Internet with its one-to-one marketing potential allows the

music companies to target their audiences a lot more efficiently than they do today.

The mass advertising campaigns to launch a new album can be then replaced to a

certain extent by more focused online campaigns using the information gathered on

consumer tastes and previous purchases. Promotions can be done on an individual

basis and bundles can be creatively created to market new releases and back catalogue

music.


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Volume

The volume of music sold is expected to increase with the advent of online music. Indeed, the

browsing and searching features of the Internet will allow consumers to access very easily a

huge amount of music tracks. The physical limitation associated with holding an inventory of

CDs will disappear with the storage of music tracks in digital format on the e-retailers

servers. This will allow the back catalogue accumulated over the past decades to be readily

available to end consumers who would otherwise be daunted by the perspective of searching

for their favourite music. Beyond breaking the cost of storage/variety compromise and

empowering the consumers through browsing and search tools, the other driver of volume of

online music will be the enhanced products and services that the new model provides as

described in the previous section. This will very certainly open new consumption

opportunities driving the sales of music on an upward trend.

It is then clear that online music distribution will create value for the participants in the value

chain. It is unclear however who will be able to capture this newly created value. In the early

days, the dominant players seemed to be willing to leave all the money on the table thereby

allowing the consumer to capture the total additional surplus. Moving forward, the emergence

of new enhanced services will be instrumental in convincing consumers to pay for online

music. It is too early however to say whether the current pricing schemes will prove to be the

right ones to drive an accelerated mass adoption of the fee-based online music model. The

Internets potential for price discrimination will very certainly be leveraged to the maximum

extent by the different players to maximize their profits under these constraints.

2.5 Adoption Analysis

We now turn to analysing the adoption process for online music.

2.5.1 Demand side adoption

This section considers consumer adoption of fee-based on-line music. Thus, it assumes that

on-line piracy can be limited effectively.

The existing off-line environment

In the off-line environment, music is available in a variety of formats, CD, minidisk, LP and

cassette. Prerequisites to widespread adoption of these formats were availability of expansive

content and ubiquity of playing devices, (hi-fi, in-car, portable).


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Now established, three key attributes determine the customers willingness to pay for music

provided on a particular format. These are: sound quality, physical attributes and

additional information provided with the music. The increase in prices upon introduction of

the CD clearly demonstrates the customers willingness to pay for improvements in these

attributes. This new format offered improvements in sound resolution, in robustness, aesthetic

appeal and in the information included in multi-page documentation. We can also be

confident of the criticality of these attributes when we observe that consumers are willing to

pay an average $15 for an album that they could equally copy from a friend onto cassette or

minidisk.

The on-line environment

The on-line format offers a number of additional attributes that we can expect the customer tobe willing to pay for. They are:

Ease of manipulation: This includes the ability to store music in a limited space and to aid

retrieval via intelligent archiving and browsing software. It would also be possible to facilitate

transfer to other playing devices, to transfer the music between listening environments, from

lounge, to car, to the train to work.

Ease of access: Firstly, on-line music is convenient to purchase from home. Secondly, access

options can be more varied than in the off-line business (track search and browsing, packaged

services like the Dinner Party Mix). Finally, on-line sites offer the possibility for

independent artists to offer their music without the intermediary of a label, thus increasing the

choice available to the consumer.

Multimedia enhancement: i.e., video clips, pictures, lyrics, access to websites and

newsgroups.

Adoption lifecycle

We argue that online music is entering into the phase of crossing the chasm towards mass

adoption (Exhibit 6). After the initial period (1998-2002) where some players carved out a

niche in the online music business, a new period is starting that will lead eventually to a wider

adoption of this new mode of distribution.


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1998-2002

Carving out a Niche2002-??

Crossing the chasmPlayers Napster

MP3.com Gnutella

Full Audio Pressplay Musicnet

AdoptionDrivers

Free Anti-establishment Novelty

Growing availability of players Napster not around Storage improved

AdoptionInhibitors

PC only Download time and Storage

Ubiquity of playing devices Download time

Exhibit 6: Adoption lifecycle of online music

This will be possible with complements required for mass adoption becoming available:

Availability of expansive content: US legislation has required record labels to make content

available to internet sites and the record labels themselves have banded together to supply

their own on-line offer.

Ubiquity of playing devices: End user devices are now hitting the market. These include

portable products such as the Apple iPod ($399), which can carry 1000 song tracks and

SONICblues Rio Riot ($400) that extends this to 400 complete albums. There is also a

proliferation of jukebox type products such as the Darwin Jukebox ($500), that integrate into

an existing audio stereo system. Hence the complementary devices required to listen to MP3

music directly are now available and can be expected to drop to price levels acceptable to the

mass consumer within a short period. Secondly, CD burners are now widely available at lowprices making is possible to transfer on-line distributed music to existing audio systems.

Bandwidth: With a 28kbps modem connection it takes approximately 2.5 minutes to

download one song, i.e 30 minutes to download the typical album. This would be considered

overly long by the general paying customer. Typical broadband connection speeds are 1Mbps

making it possible to download an album in MP3 format in around 1 minute. This type of

speed gives on-line music appeal in mass consumer segments. Broadband is currently

available in 15% of US households and is projected to increase to 41 % by 2006.

98-02 02-?? ?? ?? Time

Incrementaladoption

InnovatorsEarly

adoptersEarly

majority

Late

majority Laggards

Time

Incrementaladoption

InnovatorsEarly

adoptersEarly

majority

Late

majority Laggards

Crossingthechasm


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Disruptive potential of on-line music

Although the gap is being bridged, on-line music currently provides less traditional value to

consumers than CDs, as it offers lower sound quality and does not provide the tactile

experience offered by a CDs physical attributes. However, the key question is at what point

will these performance inferiorities be overcome by the value created from on-line musics

unique attributes?

Value category Drivers for improvement Complements requiredSound quality Quality improvement

Hi-fi perception

Compression technology

Digital Music Players

Additional information Downloadable lyrics, pictures Bandwidth / Compression

Equipment with advanceddisplay features

Physical attributes Key physical attributes can not beretained

Backup must be ensured

Backup, re-supply functionfrom provider

Ease of manipulation Ease of transfer between listeningenvironments

Ease of archiving and retrieval of

music

Common exchange format

Compatible devices

Storage capability

Archiving software

Ease of access Diversity and widespread availabilityof on-line offer

Rapidity of download

Sites with innovative serviceproposition

Bandwidth / Compression

Multimedia enhancement Inclusion of multimedia content Bandwidth / Compression

Equipment with advanceddisplay features

Exhibit 7: Attributes for online music to be disruptive

Disruption can be driven on two fronts. Firstly by closing the gap between on-line music and

CD with regard to traditional attributes.

Customer value created

02468

1012

141618

CD On-line

now

On-line to

disrupt

Multimedia

enhancement

Ease of access

Ease of manipulation

Physical Attributes

Additional information

Sound quality


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On-line sound quality could be improved by better CODEC technology, this is already

available in the form of the Dolby AAC format. However, actual sound quality is less of an

issue than perceived quality. Online formats are seen as sufficient for the PC given its audio

constraints. However, to move to the mainstream, online format music must be perceived as

acceptable for general purpose and genuine audiophile applications. This requires

development and marketing of specific end user devices. We are currently seeing the launch

of this type of product, so sound quality should shortly disappear as a constraint.

The additional information provided with online music could be improved by the ability to

download more from online sites and having advanced display possibilities on end-user

devices.

One area where on-line music can do little to compete with CD is in the physical attributes

offered by the incumbent format. Consumers derive value from the aesthetics and tactile

attributes of CD. They are also confident that CDs are robust and that they will not lose their

content. On-line music does not currently provide this security, as music is stored on a hard

drive or equivalent with the risk of failure and loss of the consumers entire library. The on-

line music industry must eliminate this possibility is some fashion, perhaps the easiest by

maintaining records of purchases and allowing re-download of material in case of loss. Until

then, CD burning of downloaded music provides a transitional solution.

Secondly, disruption can be driven by improvements in the on-line formats own unique

possibilities. To make advances on these two fronts, key complements are required:

More bandwidth: A multimedia type product would constitute around 150 to 500MB of data.

Download via traditional broadband would require 3 to 15 minutes. This is likely to be

acceptable to the mass consumer hence further advances in bandwidth will be required.

Advanced equipment: Non-PC equipment, offering high quality display screens will be

required, to allow multimedia and additional information display. Equipment will need to be

compatible so that content can be conveniently transferred between devices in different

listening environments. Storage capacity will need to be augmented to accommodate

multimedia content.


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New service offers: Content providers and sites will need to offer consumers new and

exciting material and services.

Demand side conclusionOn-line music now has, or shortly will have, the necessary complements to cross the chasm to

mass adoption. At this stage, consumers will most likely continue to burn their downloaded

music onto CD for use in conventional music playback systems. As such, on-line music will

remain a complement to CD. However, there are conditions under which on-line formats can

supplant the CD. These conditions are not yet present at equivalent price points. It remains to

be seen whether content providers will be keen to instigate a switch by offering on-line music

at a discount to CD.

2.5.2 Supply side adoption

An essential concern held by the majors has been that on-line distribution will increase illegal

copying of content and lead to a reduction in sales. Copying has existed since the advent of

the cassette recorder, however the Internet has made it possible to exchange copies on a

massive scale posing a genuine threat to music sales. One can hypothesise a scenario where

following the initial sale of new content, piracy makes the material available to all. Original

music would become a public good. The corollary would be that funds would no longer be

available to find and promote bands, and there would not even be incentives for bands to

embark on a creative career. In 2000 pirating was estimated to have cost the industry $4.2

billion. This figure is a lower bound, as it is calculated using local prices for copied material

and it does not include Internet piracy.

Two key complements will be required for expansion by established music companies into

the on-line space:

A legal framework to protect copyrights

Digital rights management software

Legal framework

A brief history of legal developments in the US:

Date ImplicationFair use: It is entirely legal for a consumer to copy music he has purchased, provided the copy is forpersonal use, e.g. recording a CD onto a cassette for car use. This is known as the principle offair use.However, the consumer cannot legally sell the content.

1976 The 1976 Act: This allows a claimant whose copyrights have been infringed to sue for statutorydamages above and beyond any actual economic losses incurred as a result of the infringement. Thiswas effectively used against mp3.com resulting in an award of $150 million in damages in January2000.

1992 Audio home recording act: This act required manufactures to pay royalties on sales of digital

recording equipment (2%) and on blank recording formats such as CD-R (3%). These royalties areshared between artists, labels, writers and publishers.


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1997 No electronic theft act: This act made swapping of files a commercial transaction based on themarket value of the content transferred. This made file swapping over the web equivalent to a sale, andhence illegal.

1998 Digital Millennium Copyright Act (DMCA): This requires sites to obtain licenses from publishersand record labels if they wish to provide uninhibited access to content. A loophole exists which allowssites to provide a personalised net cast, which effectively downloads music know to be to the

consumers tastes. This process is treated as would be a radio broadcast and does not necessitate alicense. The act also makes it illegal to circumvent anti-copying devices. This is at odds with the fairuse principle.

2002 Hollings bill: This bill, introduced by a US senator, legally requires all digital equipment to carry anti-copying devices. This bill is not expected to be passed in its current form, but it seems likely that someanti-pirating legislation will be imposed on digital hardware manufacturers.

Source: Raymond James Digital Media Industry Report

The modifications in US law described above have been essential to enable music companies

to combat on-line piracy. Indeed, the law has been exploited to bring effective lawsuits

against Napster and mp3.com. However, it should be recognised that the law can be of only

limited value. There always remains the possibility of on-line pirates relocating to countries

outside the US with less stringent copyright laws, or a challenge under the fair use argument.

Another significant problem is that as peer-to-peer swap sites become more numerous, it

becomes impractical to pursue each through the courts. Despite this, the majors are in an

environment more conducive to copyright protection than any time since the advent of on-line

music. They also fear that they will not be able to restrict access of independent sites to their

music because of anti-competition legislation. Furthermore, they are conscious that MP3

copies of the majority of their catalogues are already available on the web.

Digital Rights Management (DRM) software

DRM technology is a critical complement required for adoption by suppliers of content to the

on-line music industry. However, piracy will always exist for two fundamental reasons.

Firstly, there are a multitude of hackers intent on cracking any encryption software. A recent

example of the inefficacy of encryption comes from Sonys attempt to produce copy proof

CDs. These included a bogus first track that confused a pcs CD ROM. Within a few days

of launch, hackers found that the system could be neutralised by applying green felt tip pen to

the edge of the CD. Secondly, music must be converted to analogue for it to be heard. This

analogue signal can always be recorded digitally providing an unprotected digital copy, this

phenomenon is known as the Analogue hole.

Supply side conclusion

The major record labels do not have a perfect set of complements to facilitate full adoption.

However, there is a drive to adopt the format, both to capture the cost savings it offers, and to

secure a place in the market by establishing a brand rather than allow independents todominate the space. Hence, conditions are now ripe for mass adoption by suppliers.


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3 Pressplay Universal and Sonys efforts to enter online music

3.1 Background

The emergence of illegitimate online music web sites in 1999 combined with increased CD

burning and ripping activities posed a serious threat to Universal and Sony, two important

music majors. Before venturing in the online music space, the initial reaction by the two

companies was to join forces with other heavyweights of the music industry to lobby for new

laws against online piracy and to litigate. Vivendi Universal, however, soon acquired online

music companies such as Emusic and MP3.com in order to rapidly acquire the technology and

capabilities to give Universal the option to enter the online space before its competitors.

The reaction of Sony and Universal was mainly defensive, as an early entry into the online

music segment would not only expose them to more piracy but would also cannibalize their

lucrative traditional music business. Realizing, however, that online music represented an

irreversible shift in the industry, the two companies decided to join forces to launch an online

music service at the beginning of 2001. The equally held joint venture, initially called Duet,

was launched in December 2001 under the name Pressplay.

Universal and Sony have opted for a sequential roll-out of Pressplay, focusing first on the US.

Pressplays management and its shareholders have been cautious not to reveal or promise

expected volume and financial results in order to manage the expectations of its shareholders

and of the financial community. Indeed, the numerous uncertainties affecting upstream and

downstream players of the value chain provide low visibility on the evolution of Pressplays

online music service model.

3.1.1 Entry Strategy: Timing and Tactics

Timing

Universal and Sony have been slow to enter the online music space. Pressplay is still a very

small player today with a limited customer base compared with peer to peer systems (P2P)

such as Gnutella and file sharing service sites such as Music City and Kazaa. Despite the

potential access to a huge music catalog comprising of the three largest record companies-

Sony, Universal and EMI-, Pressplay currently only offers approximately 10% of that catalog

because agreements still need to be reached with most artists concerning royalty levels and

payment schemes for online music.


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Entry Mode

Sony and Universal decided to establish an alliance rather than setting-up operations

independently. The rationale for this structure is mainly to pool the two companies music

catalogs and share the risks of the venture. Furthermore, from Universals perspective, a co-

operation with Sony Music Entertainment offers the prospect of successful developments of

complements such as end-usage storage and listening devices by other divisions of the Sony

conglomerate (the Sony memory stick).

The decision to set-up an autonomous entity rather than a sub-unit of one of the music majors

allows the venture to maintain an entrepreneurial, flexible and innovative spirit, which is

required to operate in the online music space at this early development stage.

Pressplay has opted for a simple shareholding structure (50/50 JV) rather than bringing-in

several partners. This structure might prove to be an advantage compared to its competitor

MusicNet, which has a more complex ownership structure comprising 4 different

shareholders (EMI, AOLTime Warner, BMG and RealNetworks) and is therefore more

difficult to manage and has more potential for conflicts of interests.

Does Reach Make Sense?

By entering the online music space, Sony and Universal are trying to attract new types of

consumers: people currently visiting free/illegal music sites. Their traditional music business

model is still profitable, despite the recent decline in overall sales experienced in the last two

years. Pressplay is indeed a vehicle to establish a new distribution channel for the majors

existing products. By reaching to new consumers, the two music majors do not need to make

changes that will have serious repercussions on their core activities as entering online music

does not require any drastic change on their traditional publishing and recording activities. On

this basis, reach has limited risks as it does not represent a change to the core business and is

not hard to reverse. The following chart highlights Pressplays position on the matrix of

business attractiveness/contex v.s. core.


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Exhibit 8: Does Reach Make Sence

Commitment level of Sony and Universal to New Online Music

The two music majors have shown their commitment to the online music through the launch

of Pressplay and through the appointment of high profile and seasoned executives to lead the

joint venture. However, Sony and Universal have adopted a cautious approach given the

uncertainty of the current model and the unproven adoption of the music subscription service

concept. Indeed, on the supply-side, the yet unsettled discussions with artists about royalties

for online music, provides uncertainty concerning the future costs of the service to pressplay.

On the demand-side, the slow take-off of the service indicates that consumers are yet to be

convinced of the additional value they would get by subscribing to pressplay, versus using

existing free services.

3.2 Pressplay - Company Profile

Brief Overview

Pressplay is an online music service joint venture between Vivendi Universal and Sony. The

company offers on-demand access to music that can be streamed, downloaded, or burned onto

a CD. Music catalogs available include those of the three largest record companies Sony,

Universal and EMI- as well as those of several independent labels. Pressplay services are

distributed to consumers through affiliates which include Yahoo!Music, MSN music and

MP3.com. The service is currently only available in the US but will soon be launchedinternationally according to management.

Reachmight

makesense

Reach haspotentialfor greatestdamage

Reachmight makesense

Reachmakes

sense

Existing business

prospects

Context

Core

Attractive Unattractive

Disrupted elementsof business model


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Key Milestones

Feb. 2001 Sony and Vivendi Universal announce their joint-venture,

initially called Duet

Jun. 2001 Announcement of high-profile management team,

consisting of seasoned executives who previously held

key positions within Warner Brothers, MTV and

Universal

Yahoo announces it will support Pressplay services

JVs name is changed from Duet to Pressplay

End-Dec. 2001 Launch of Pressplay in the US and its territories; 6-month delay

versus original launch schedule.

Feb. 2002 Pressplay announces an agreement with Zomba -the worlds

largest independent label- adding music from artists such as

Nsync, Britney Spears to its catalog.

Business Model

The JV was set-up to allow Sony and Universal to develop a presence in the fast expanding

online music and offer a more attractive alternative to peer to peer systems (P2P) such as

Gnutella and file sharing service sites such as MusicCity and Kazaa. Pressplays strategy is to

offer superior quality, service, and reliability in order to capture value currently given away

for free to consumers. The two companies want their online efforts to compensate for stagna-

ting offline music business and generate growth by capturing value in the online music space.

Pressplay acts as both a content distribution platform and as a retailer. As a content

distribution platform, Pressplay is responsible for digital rights management and royalty fee

payments to publishers and artists. As a retailer, pressplay offers a subscription service, which

is offered to consumers on affiliate sites (Yahoo, MSN etc.). In order to securely deliver the

music in its online catalog, Pressplay is using various DRM technologies, inclu-ding

Microsofts Windows Media DRM technology and CD burning control technology (Roxio).

The revenue model is based on a multi-tier monthly pricing plan starting from US$ 9.95 to

24.95 offering various combinations of streaming, downloading and CD burning. The scheme

is designed to optimize value capture through price differentiation. It is too early at this stage

to determine whether the price offering of the service is below target consumers willingness

to pay.


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Optimal pricing model: In order to build a large customer base and capture value in the online

music space, Pressplay needs to offer a balanced and transparent pricing scheme. It is also

important to have a different pricing between streaming services and download services as

consumers attach much more value to download services. Pressplays current price offering

reflects those differences and is easy to understand for consumers. Furthermore, the multi-tier

pricing scheme should allow the company to efficiently price-discriminate between various

consumer types.

Portability: Pressplays development will be dependant on the development of portable music

device as the value of downloadable music will increase if consumers can play it in their car

or on their Walkman.Complements such as the Sony Memory Stick, which can store music

and is compatible with various devices, or upgraded MP3 players will allow for portability.

Pressplay is better positioned than its competitors to benefit from and influence the

development of such devices since it can leverage the Sonys expertise in that field.


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4 FullAudio A start-ups approach to online music

This section will discuss how FullAudio have approach the online music industry since its

start-up in 1999. First we will briefly introduce FullAudio and its business model andthereafter we will analyse how FullAudio have attained its position in the industry. Finally we

will discuss how sustainable FullAudios position is in the future online music industry.

4.1 History1

FullAudio was founded in April 1999 by Chris Gladwin and Gary Cohen, approximately at

the same time as Napster, and it launched its digital music subscription service, MusicNow, in

April 2002. Unlike Napster, FullAudio have since the beginning been committed to protecting

the rights of the artists and the assets of the music companies.

In September 1999 FullAudios concept was presented for the first time at a software

investment conference in Chicago and this led to a first round of financing of $4,5 million in

December 1999. Nine months later, September 2000, FullAudio raised $15 million in a

second round of financing and a third round of financing is about to go through, where

FullAudio expects another $15-20 million.

In February 2001, James Glicker a former BMG VP was appointed president of FullAudio,

resulting in its first licence agreement with BMG in June 2001. This was apparently the

tipping point because soon after licence agreements were established with EMI in October

2001, Universal November 2001 and Warner in April 2002. According to Chris Gladwin 2

Sony will be the next to come thereby representing all five majors. In addition an agreement

was made with the Harry Fox Agency, the largest agency in the music industry for licensing

reproduction and distribution of music.

In February 2002 FullAudio presented Clear Channel, one of the worlds largest radioproviders, as its first distributor, with the initial plan of presenting FullAudios subscription

services on 30 radio websites throughout the US. FullAudios services will also be presented

on Microsofts WindowsMedia.com, a website with 8 million monthly users.

FullAudio has also partnered with the major technology players, e.g. the subscription service

is based on Microsofts Windows Media Audio (WMA) and Windows Media Digital Rights

Management (DRM) platforms, resulting in near CD quality download.

1 Based on information from FullAudios website, www.FullAudio.com.2 Interviewed over telephone the 4th of June 2002


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The key milestones are summarized below.

1999 April FullAudio was founded by Chris Gladwin and Gary Cohen

2001 February James Glicker, a former BMG VP is appointed president

2001 June BMG licence agreement published

2001 October EMI licence agreement published

2001 November Universal licence agreement published

2001 November Clear Channel retailing agreement published

2002 April Warner licence agreement published

2002 February FullAudios choise of Microsofts Windows Media for platform is

published.

2002 April Subscription service is launched on Phoenix Clear Channel radio

stations

4.2 FullAudios position on the value chain

FullAudio offers a digital music subscription service through retail partners. Currently they

are partnering with Clear Channel Communications, the largest radio station owner in the US,

but they are also looking for additional retailers. The retailers are offered a co-branded

service, called MusicNow, Powered by FullAudio, where FullAudio is handling all issues

like customer care, billing, rights and royalty management, thereby making the proposition to

the distributors very simple to handle.

Unlike some competitors offering streaming music services, e.g. Rhapsody (www.listen.com),

FullAudio offers a patent pending cache-download solution, resulting in high sound quality

(CD-quality) and offline playback. Pricing is on average subscription industry level and starts

at $7,50 (Gold plan) for 50 downloadable tracks per month and $15,00 (Platinum plan) for100 downloadable tracks per month. In more details FullAudios service allows subscribers to

search one of the most extensive music library, build a collection of downloads, learn about

new artists each week in a special Artist Spotlight and receive playlists from radio stations.

FullAudios choice of Microsofts Windows Media Player as the basis for their service,

makes it very convenient for their customers, as they will not have to download specific

players and as the Windows media player format is very likely to be one of the standards for

future digital music players.
http://www.listen.com/http://www.listen.com/http://www.listen.com/


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Content Providers Service Providers Consumers



PublisherPublisher LabelLabel

StorageStorage

Format conversionFormat conversion

Security and Digital

Rights Management


Packaging,bundling

Packaging,

bundling


Download

and play locally

Onlinestreaming

Onlinestreaming

CD burning,portable music

CD burning,

portable music

Online

retailingplatform

Online

retailing

platform

Online

Retailing

Online distributionOnline distribution

FullAudio

Pressplay

MusicNet

Rhapsody

Clear Channel

AOL, Amazon

(FullAudio, Pressplay)

With the above mentioned products and offerings FullAudio is placed on the digital music

value chain mainly as a service provider/distributor of music, but also partly as a retailer, even

though founder Chris Gladwin mainly see FullAudio as a service provider.

Exhibit 9: FullAudios placement on the online music value chain.

4.3 How is FullAudio building its position?

Despite limited funds FullAudio has been the only web based subscription service able to

attract four out of the five majors, with Sony soon to come. According to Chris Gladwin they

have been able to do so through being the first independent start-up to consistently show a

high commitment to protecting the rights of the artists and the assets of the music companies,

in a time where all web based start-ups were creating volume by giving away everything for

free. We have seen that the majors favour a subscription model for on-line distribution,

(Pressplay, Musicnet). FullAudio has also adopted this model, thus making it easier to

convince the majors to partner with them. Finally it seems that FullAudio have established

alliances by leveraging their excellent contacts, mainly with BMG.


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Exhibit 10: When Best-of-Breed-Partner Leverage Makes Sense. Profits and the Internet:

Seven Misconceptions. S. Rangan and R.Adner, MIT Sloan Management Review 2001

Going through the above model and being able to answer Yes to all of the questions, it

seems that it makes sense for FullAudio to use a Best-of-Breed-Partner leverage strategy,

except for the majors own online service providers Pressplay and MusicNet that can pose a

threat to the alliance, but unfortunately FullAudio has no other serious alternative.

When Best-of-Breed-Partner Leverage Makes SenseDoes the new opportunity promise positiveNPV?

Avoid the approach

Does the new opportunity call for, orwould it benefit from, considerablecoordination and cospecialization withyour existing business or with potentialpartners.

Use the market mechanism (establish abuyer/supplier relationship). Example:Yahoo and Reuters

If tackled using internal resources, is thenew opportunity going to dilute fit orfocus?

Internalize the opportunity (bring itinside the company).

Whether to proceed depends on how thefollowing three questions are evaluated:

Is the number of partners small?(Coordination challenges can riseexponentially)

Is value creation in the partnershipgoing to be based primarily onagreement over interface standards andtechnology (rather than on ongoinginterpersonal relations and the properexercise of discretion by partners)?

Is the likelihood low of companiesstraying into adjacent core space? (Arevalue appropriation fears low?)

Can problems be mitigated by:

Reducing the number of partners.

Developing a protocol that regulatespartner discretion and ensures greaterconsistency.

Selecting less problematic partners and

agreeing upon core-space firewalls

Best-of-Breed-Partner leverage is

a sensible approach

Forego the opportunity

Yes

No

Yes

Yes

Yes

Yes

No

No

No

No

No


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The first alliance with BMG was probably the most important, as it legitimated FullAudio as

serious company, and as it made them able to leverage on the BMG alliance to establish their

alliances with the other majors, but also with Microsoft, The Harry Fox agency and Clear

Channel. New alliances with retail partners, such as music publishers and with Sony, are now

much easier to establish, than it was less than a year ago when the BMG agreement was

announced. In addition, the fact that FullAudio is a small independent player and that the

alliance has evolved around them, makes the alliance attractive to other major players in

music and music technology, as these new players do not compete directly with FullAudio.

Now that FullAudio have almost completed the alliance it is important that they maintain their

position by creating sufficient value for all the partners in the alliance, including themselves.

Primarily they have to offer value to the consumer, in terms of an attractive music experience

at a reasonable price. Secondly they have to grow the market, in order to make the volumes

attractive to all of their partners, and in this second requirement FullAudio have chosen an

interesting approach. Instead of choosing the slow route by growing the market themselves,

capturing relatively high profits, they have chosen the fast track to grow the market by

partnering with retailers and sharing the profits on high volumes.

By doing this they are not only creating value for the retailers, but also for their suppliers of

music and technology and for themselves. Clearly they will have lower margins by choosingthis route, but the volume and lower costs, mainly marketing, will ensure them profits and

they will much faster be an established player in the rapid changing online music industry,

thereby making FullAudio very attractive for their partners.

4.4 Is their position sustainable and scalable

Before discussing the sustainability of FullAudios business model, it is important to have a

clear definition of their competitive advantages. We see these as primarily their download

technology, their alliance with major players in the industry and an early mover advantage.

Sustainability

The patent pending download technology that FullAudio uses is superior to its competitors

technology and they are currently the only one who can offer near CD-quality downloads. In

addition they are using the DRM technology from Microsoft that seems to be the standard for

the future online music. The sustainability of this advantage depends highly on the pending

patent, and if it goes through it seems sustainable in the short run. In the long run thesustainability is questionable as competitors probably will find other equal quality solutions.


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FullAudios alliance is unique for the industry as they are the only company to partner with

four out of five majors and with publishers, giving them access to an extensive music

catalogue. With this alliance FullAudio is able to grow its business faster then any competitor

and thereby strengthening the alliance.

It is also from the alliance that an early mover advantage is established, as the majors,

according to Chris Gladwin, have expressed that they are only willing to support 3-4

distributors of online music. So the fact that FullAudio is one of the first distributors and may

pre-empt competitors from entering, is the most important reason for why the alliance as a

competitive advantage is sustainable both in the short and long run.

The early mover advantage also has a new economy source, as FullAudio and the other 2-3

players who will be representing the majors, will be able to establish a critical mass of

customers before new competitors are entering, thereby being able to lock-in consumers with

a compatibility trap, e.g. if consumers switch to a new service they will not be able to listen

to their old downloaded tracks on a new service.

The conclusion to whether FullAudios position is sustainable is positive but it depends very

much on majors commitment to only having 3-4 distributors of online music. Likewise it also

important for the subscription service model to establish a critical mass of consumers,

relatively fast, in order to maintain the confidence of their partners and preventing them from

seeking new ways of establishing a new online music model.

Scalability

But are FullAudio (being a 28 employee company) ready to serve the volumes the early

majority will bring? In other words is their operation scalable both technologically and

financially?

The subscription service business model has a rather simple interaction with the customers

and orders are all handled the servers, so it appears that large volumes should be rather simple

to handle even for a small company like FullAudio.

Financially FullAudios business model is not very demanding, as they depend on their retail

partners, like Clear Channel, to promote their services across the US and potentially around

the world. Of course it cuts their profits, but it makes their business model highly scalable.


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5 FullAudio vs Pressplay:Comparison of the two approaches

When Sony and Universal founded Pressplay in February 2001, they were motivated partly by

opportunities available from moving along the value chain to capture rents from the online

channel. However, it seems that this was also a defensive move; Sony and Universal believe

that by controlling on-line distribution they can limit the risks to their existing business.

The remaining majors founded MusicNet at the same time for the same reasons, promising a

duopoly in on-line music.

However, both the EU and the US launched probes into both Pressplay and MusicNet

following anti competition concerns. This provided an opening for companies like FullAudioand Rhapsody, as this forced the majors to share their catalogues with independent

distributors. This has been the principal reason that FullAudio has been able to gain access to

the catalogues of the majority of the major labels over the past year.

When looking at the offerings from Pressplay, MusicNet, Rhapsody and FullAudio they are

strikingly similar. It is very likely that Rhapsody and FullAudio have to conform to the wishes

of the majors to retain access to their material. By both entering the market and obliging

independents to conform to their wishes, the majors intend to control the evolution of online

music. Hence, after a number of years dominated by renegades, on-line music is set to enter

the mainstream.

FullAudios strategy is to operate as a complement to the established players in the industry.

As such, FullAudios future success is highly dependent on the majors commitment to online

music. The majors efforts to promote the web as an alternative sales channel will also

determine whether the industry as a whole will cross the chasm to mainstream adoption.


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Adner R. and Rangan S.. 2001.Profits and the internet: Seven Misconceptions. MIT SloanManagement Review.

Gladwin, Chris CEO and founder of FullAudio. Interviewed June 4 th 2002.

Hardie M., McCarthy J., Schmitt E. and Butt J.. January 1998. Musics Internet Era. TheForrester Report.

Hardie M. March 1999. Virtual Music Rocks. The Forrester Report.

Raymond James. March 2002. Digital Media Industry Report. The Second Coming of OnlineMusic.

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Lehman Brothers Equity Research, April 2001. The Music Industry, Going down to the onlinecrossroads.

Merrill Lynch, November 2001. Music Industry, Can Majors Control Online Growth.

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Wingfield, Nick. May 16th 2002. Music Web Sites Get Friendlier. Wall Street Journal.

www.FullAudio.com

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www.MusicNet.com

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