High Technology Entrepreneurship and Strategy Professor Ron Adner June 2002

CARLYLE Gordon GOLDBLAT Fernand GONTHIER Romain GREEN Jason WAMBERG Thomas ZEIN Walid

Online music battles: FullAudio vs. Pressplay

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

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,

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 and new 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.

TRADITIONAL MUSIC VALUE CHAIN

Artist Artist Composer Composer Performer Performer

Publisher Publisher

Label Label

Manufacturer Manufacturer

Distributor Distributor

Retailer Retailer

Consumer Consumer

Identify, Identify, sign and sign and develop develop artists artists

Produce Produce record record

Promote Promote and market and market record/ record/ artist artist

Repackage/ Repackage/ resell back resell back catalog catalog

Broadcast Broadcast Radio, TV Radio, 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.

Manufacturer: Physically manufactures the CDs and the packaging. Distributor: Runs the physical distribution of the CDs to retail outlets. Retailer: Different types of retailers include large-scale record stores (e.g., Virgin), supermarkets (e.g., Carrefour), specialized music stores, and music clubs. Consumer: Typically buys CDs in retail outlets. Listens also to music on the radio and TV.

The breakdown of the revenue from a CD among these different stages of the value chain is shown in Exhibit 3. Although the biggest chunk of the revenue is retained by the labels, labels need nevertheless to leverage their economies of scale in order to cover their high upfront costs of marketing and promotion of new albums and artists.

Source: Lehman Brothers

Exhibit 3: Revenue breakdown of a UK CD Moving to the online music distribution model largely disintegrates the traditional value chain and gives birth to a number of new players (Exhibit 4)

ONLINE MUSIC VALUE CHAIN

Content Providers Service Providers Online Retailing Consumers

Storage Storage Artist Artist Composer Composer Interpreter Interpreter

Download Download and play locally and play locally

Format conversion Format conversion Online Online retailing retailing platform platform

Security and Digital Security and Digital Rights Management Rights Management Publisher Publisher Label Label Packaging, Packaging, bundling bundling

Online Online streaming streaming

CD burning, CD burning, portable music portable music Online distribution Online 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

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

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.

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 making the music available online, e.g. storage, format conversion, DRM handling, packaging. 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. 10

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 to be 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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Incremental adoption

Innovators

Early adopters

Crossing the chasm

Early majority

Late majority

Laggards

98-02

02-?? ??

??

Time

1998-2002

2002-??

Carving out a Niche

Players

Crossing the chasm

Adoption Drivers Adoption Inhibitors

Napster MP3.com Gnutella Free Anti-establishment Novelty PC only Download time and Storage

Full Audio Pressplay Musicnet Growing availability of players Napster not around Storage improved 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 low prices 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.

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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?

Customer value created

18 16 14 12 10 8 6 4 2 0 CD On-line now On-line to disrupt
Multimedia enhancement Ease of access Ease of manipulation Physical Attributes Additional information Sound quality

Value category
Sound quality Additional information

Drivers for improvement

Complements required

Quality improvement Hi-fi perception Downloadable lyrics, pictures

Physical attributes

Ease of manipulation

Ease of access

Multimedia enhancement

Key physical attributes can not be retained Backup must be ensured Ease of transfer between listening environments Ease of archiving and retrieval of music Diversity and widespread availability of on-line offer Rapidity of download Inclusion of multimedia content

Compression technology Digital Music Players Bandwidth / Compression Equipment with advanced display features Backup, re-supply function from provider Common exchange format Compatible devices Storage capability Archiving software Sites with innovative service proposition Bandwidth / Compression Bandwidth / Compression Equipment with advanced display 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.

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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 online 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 conclusion On-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 Implication
Fair use: It is entirely legal for a consumer to copy music he has purchased, provided the copy is for personal use, e.g. recording a CD onto a cassette for car use. This is known as the principle of fair use. However, the consumer cannot legally sell the content. The 1976 Act: This allows a claimant whose copyrights have been infringed to sue for statutory damages above and beyond any actual economic losses incurred as a result of the infringement. This was effectively used against mp3.com resulting in an award of $150 million in damages in January 2000. 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 are shared between artists, labels, writers and publishers.

1976

1992

16

No electronic theft act: This act made swapping of files a commercial transaction based on the market value of the content transferred. This made file swapping over the web equivalent to a sale, and hence illegal. Digital Millennium Copyright Act (DMCA): This requires sites to obtain licenses from publishers 1998 and record labels if they wish to provide uninhibited access to content. A loophole exists which allows sites 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 a license. The act also makes it illegal to circumvent anti-copying devices. This is at odds with the fair use principle. 2002 Hollings bill: This bill, introduced by a US senator, legally requires all digital equipment to carry anticopying devices. This bill is not expected to be passed in its current form, but it seems likely that some anti-pirating legislation will be imposed on digital hardware manufacturers. Source: Raymond James Digital Media Industry Report

1997

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 to dominate the space. Hence, conditions are now ripe for mass adoption by suppliers. 17

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 companiesSony, 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 cooperation 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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Context

Reach might make sense

Reach makes sense

Disrupted elements of business model

Core

Reach has potential for greatest damage

Reach might make sense

Attractive

Unattractive

Existing business prospects

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 launched internationally according to management. 20

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 End-Dec. 2001 Yahoo announces it will support Pressplay services JVs name is changed from Duet to Pressplay

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 stagnating 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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3.3 Limitations and Key Success Factors

Limitations

Royalties from artists: Universal and Sony will have to re-negotiate royalties paid to artists as most contracts do not yet cover royalty payments for online music. Whilst this issue may disrupt and delay the availability of a comprehensive music catalog, there are no reasons to believe that artists will be able to obtain a higher share of profits than for the off-line music sale.

Competition: Sony and Universals rivals such as BMG might become formidable competitors if they acquire P2P sites. If they can introduce adequate DRM technology, offer an acceptable subscription service to the large base of the acquired P2P service, they could seriously threaten Pressplays position.

Digital Rights Management (DRM): piracy has hindered an earlier entry by majors. However, recent advances in DRM have given majors sufficient confidence that they can control and limit access to music content. are a clear impediment to the development of Pressplay and other online music services. It can therefore be assumed that DRM will represent less of a limitation in the future.

Key Success Factors: How to creat WTP?

Superior services: in addition to offering the most comprehensive music catalog online, Pressplay should offer additional services to further differentiate itself from competitors and from free music sites. Additional services could include customized information about artists and new releases and perhaps leverage Sonys and Universals strength in the movie industry to include for example downloadable previews of new films.

Superior sound quality: There is substantial room for improvement in music quality for online offerings. Sound quality is an attribute that is expected to be highly valued by customers and Pressplay should seek to improve its technology and work closely with complements producers (storing and listening devices manufacturers) to that purpose.

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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 and thereafter 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 Gladwin2 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 radio providers, 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 2

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

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The key milestones are summarized below. 1999 April 2001 February 2001 June 2001 October 2001 November 2001 November 2002 April 2002 February FullAudio was founded by Chris Gladwin and Gary Cohen James Glicker, a former BMG VP is appointed president BMG licence agreement published EMI licence agreement published Universal licence agreement published Clear Channel retailing agreement published Warner licence agreement published 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) for 100 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.

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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.

Content Providers

Service Providers

Online Retailing

Consumers

Storage Storage Artist Artist Composer Composer Interpreter Interpreter

Download Download and play locally and play locally

Format conversion Format conversion Online Online retailing retailing platform platform

Security and Digital Security and Digital Rights Management Rights Management Publisher Publisher Label Label Packaging, Packaging, bundling bundling

Online Online streaming streaming

Online distribution Online distribution

CD burning, CD burning, portable music portable music

FullAudio Pressplay MusicNet Rhapsody

Clear Channel AOL, Amazon (FullAudio, Pressplay)

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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When Best-of-Breed-Partner Leverage Makes Sense

Does the new opportunity promise positive NPV?
Yes

Avoid the approach

No

Does the new opportunity call for, or would it benefit from, considerable coordination and cospecialization with your existing business or with potential partners.
Yes

No

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

If tackled using internal resources, is the new opportunity going to dilute fit or focus?
Yes

No

Internalize the opportunity (bring it inside the company).

Whether to proceed depends on how the following three questions are evaluated: Is the number of partners small? (Coordination challenges can rise exponentially) Is value creation in the partnership going to be based primarily on agreement over interface standards and technology (rather than on ongoing interpersonal relations and the proper exercise of discretion by partners)? Is the likelihood low of companies straying into adjacent core space? (Are value appropriation fears low?)
Yes

No

Can problems be mitigated by: Reducing the number of partners. Developing a protocol that regulates partner discretion and ensures greater consistency. Selecting less problematic partners and agreeing upon core-space firewalls

No

Best-of-Breed-Partner leverage is a sensible approach

Forego the opportunity

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.

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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 choosing this 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 the sustainability is questionable as competitors probably will find other equal quality solutions. 28

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 FullAudio and 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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Sources
Adner R. 2002.When are technologies disruptive? A demand-based view of the emergence of competition. Strategic Management Journal. Adner R. and Rangan S.. 2001.Profits and the internet: Seven Misconceptions. MIT Sloan Management Review. Gladwin, Chris CEO and founder of FullAudio. Interviewed June 4th 2002. Hardie M., McCarthy J., Schmitt E. and Butt J.. January 1998. Musics Internet Era. The Forrester Report. Hardie M. March 1999. Virtual Music Rocks. The Forrester Report. Raymond James. March 2002. Digital Media Industry Report. The Second Coming of Online Music. Johnson, Carrie A.. January 2000. Digital Downloads Accelerate. The Forrester Report. Lehman Brothers Equity Research, April 2001. The Music Industry, Going down to the online crossroads. Merrill Lynch, November 2001. Music Industry, Can Majors Control Online Growth. Putnam, Michael. April 1999. Digital Distribution Wars. The Forrester Report. Wingfield, Nick. May 16th 2002. Music Web Sites Get Friendlier. Wall Street Journal. www.FullAudio.com www.Listen.com, Rhapsody www.MusicNet.com www.Pressplay.com Ulph, Rebecca. October 2000. Repackaging Downloadable Music. The Forrester Report.

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