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Napster and E-Commerce

Napster was a company ahead of its time. It accessed a massive market of music fans in a new and exiting way. The business potential for Napster was limitless. At the same time, the company suffered from the lack of a clear business model and a failure to account for potential legal issues ahead of time. Analyzing the history of Napster helps reveal both the promise and the peril of the emerging digital economy. For those entering that market, the presence of sound business planning and principles is more important than ever. Napster in E-Commerce: Blazing a slippery trail

Napster is a company borne of 21st century technology and idealism. In many ways it is a company still trying to find its niche. In its short history, Napster has acquired millions of loyal users, struggled with constant legal issues, taken bankruptcy and attempted to reemerge using an entirely different business model. The company was founded in 1999, closed its doors less than two years later, and re-emerged to face an entirely different marketplace. The environment of P2P (peer to peer) E-business is not only growing rapidly, it is changing dynamically. In this environment traditional business models do not always apply.

Napster did as much to popularize the P2P platform as any single entity. The lack of a clear and effective business model, however, would hurt Napster’s long-term viability. Napster was alone in its early years as a large-scale music swapping entity. By the time it attempted to emerge from bankruptcy and legal challenges the digital music market had exploded. In contrast to Napster’s humble origins, many of the new digital music services are sponsored by huge media conglomerates. To survive against this level of competition, the company will have to find a way to set itself apart from the other music subscription services.

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The owner of Napster had both the heady experience of acquiring 23 million members and the demoralizing experience of bankruptcy sell-offs within the same year. If nothing else, an analysis of Napster should alert current and future entrepreneurs to the potential, and to the danger of entering the burgeoning E-business world. The only antidote for mitigating the potential pitfalls is sound business planning, including a focused and effective business model for company success. Inception, Growth and Early Troubles Napster had its humble genesis in a Brockton, Massachusetts office.

Shawn Fanning, an on and off student at Northeastern University, had an idea while searching the internet for downloadable music. He wanted to create a service that, instead of direct selling of music, allowed users to share music files by means of a central repository. Incidentally, “Napster” was Fanning’s college nickname. Fanning would use a modified version of P2P (peer to peer) technology. Users would connect to other users, not directly, but through a centralized server. A database holds a master list of clients and the songs available for sharing. The user then requests a file via a network handshake.

From there, a direct connection is made between users and files are transferred under FTP (file transfer protocol). While developing the necessary software, Shawn enlisted the help of his Uncle John. John Fanning constructed the business strategy for the 1999 start-up of the company and helped to line up investors. The start-up strategy was both incredibly simple and cost-effective. The Fanning’s simply gave the new software to a few dozen friends they had met in internet chat rooms. Within days, the software had been downloaded by over 3000 users (Ante, 2000).

The instant popularity of the service enabled the Fanning’s to raise several hundred thousand dollars in investment capital. From the beginning, the Fanning’s knew that legal issues might arise in connection with the free swapping of copyrighted music. Instead of taking a proactive approach to head off these issues, the company took a “wait and see” approach that would prove costly in time. Major artists and corporations were angered by the absence of royalties paid on digital music. In the early, unregulated, world of E-business the company was able to thrive none the less.

The recording industry would become a powerful critic of Napster. This industry had the clout to elevate the issue of copyright infringement to a national priority. Before Napster could gain solid footing in the E-commerce marketplace several legal issues would have to be resolved including the legality of a free trading service, internet regulation and issues surrounding the digitization of music. Meanwhile, the popularity of the new service was exploding throughout 1999. Cash-strapped, but computer savvy, college students were logging in to the service in droves.

At one point in that year, The University of Illinois at Champaign-Urbana reported that 75% of its network bandwidth was being occupied by Napster downloads (Squatrigna, 2002). As downloads rose into the millions, it became clear that Napster would need a more professional and forward-looking management team. After much discussion, Boston venture capitalist Eileen Richardson was retained as the first CEO. Her tenure would be brief, however, as management instability continued through the early years of the company. After the first year, Napster had an astonishing 25 million users (Squatrigna, 2002).

It was the fastest growing web site in history. Company founders had predicted a large response to the new service, but did not have a phased management strategy in place to stay ahead of the curve. Napster management was put in the catch-up position it occupies to this day. Adding to Napster’s problems, the recording arts industry of America (RIAA) filed suit against the company in December, 1999. There were failed attempts to negotiate a settlement with the RIAA, but John Fanning believed that the industry “never really negotiated in good faith” (Ante, 2000). Individual artists also began to take up sides for or against Napster.

Many new and emerging artists turned to Napster in order to expose their music to a mass market. Some even premiered their music exclusively on Napster. For these artists, it was a win-win situation. Widespread exposure is invaluable to a new artist and, in the traditional structure, very hard to come by. Napster, in turn, gained a reputation as a source for cutting edge music. Some more established artists advocated vigorously against Napster. Most notable among these opponents was the rock band Metallica. The band scorned not only Napster, but also the users who downloaded their songs.

They acquired lists of usernames responsible for the downloads and demanded legal action be taken in response. As the ongoing RIAA case worked its way through the court system negotiations to end the standoff remained unproductive. In later years, the record companies would begin to take advantage of the digital music format. At the turn of the century, though, they still saw more benefit to destroying Napster than working with it. The recording arts industry was not the only prominent critic of Napster. Software developers also feared the effect the company would have on that industry.

As early as 2000, Jack Krumholtz of Microsoft warned that “We’re beginning to see software programs shared and traded over Napster” (Taft, 2000). The power of the RIAA and the software industry ratcheted up the pressure even more on the company. In response to industry complaints the issue was brought before Congress. Most committee members were sympathetic to those complaints, including William Delahunt (D-Mass. ) who said that “What Napster is doing is absolutely outrageous” (Taft, 2000). The pressure would ultimately force Napster to reconfigure its business model upgrade its technology and devise a new marketing strategy.

Even as the RIAA Appeals Court case was being heard, Napster managed to acquire millions in additional investment capital. The still optimistic company relocated from Massachusetts to San Mateo, California in the vaunted “silicon valley. ” At this point the company was not completely oblivious to the challenges it faced. It attempted to recruit a management staff that was better enabled to negotiate with artists and recording companies. A partial settlement was reached at the end of 2001 that required Napster to pay over $20 million in royalties. In addition, they had to make a pre-payment of $10 million for future royalties.

For this incarnation of Napster, though, it was too little, too late. The United States District Court in San Francisco issued a scathing ruling dismissing Napster’s legal arguments. Napster was then ordered to cease the trading of copyrighted music on their servers. In order to pay its fines and avoid further legal action the company announced a plan to convert to a subscription service. The company intended to reopen promptly, but things would get worse before they got better. The Mysterious and Evolving Business Model The original business model of Napster relied upon the concept of a free music swapping service.

The technology was also designed with that concept as central. Once the company could no longer operate a free service, everything would have to change. Unable to operate only with non-copyright music the company shut down its servers. Soon after, it filed for bankruptcy. In 2002, a bankruptcy “fire sale” signified the low point for the company. Bargain seekers at a San Francisco auction snapped up everything from old printers to Shawn Fanning’s laptop computer. A month earlier the company name and its intellectual property had been sold to a private investor.

Napster’s early business model was enigmatic. As Carl Gauze puts it, “A few thoughtful people wondered, how is song swapping supposed to make any money for Napster? ” (Gauze, 2002). An obvious answer to that question might be “advertising”, but Napster did not use advertising. At a Boston press conference in 2002, Shawn Fanning was still coy about the company’s early business model. Stunningly, he did reveal that the company was bankrolled by several major recording artists (Gauze, 2002). By helping Napster, they had hoped to hurt the record companies that had controlled and manipulated in the past.

A company founded solely for that purpose will not survive. It is still unclear if the original owners had a phased transition plan to move beyond this. New, more corporate-minded, owners took over the company and moved it toward a more traditional structure. The inevitable switch to a paid subscription service was made. Agreements and partnerships were forged with record companies, corporations and individual artists. The company still struggles to gain copyright permissions, however, as many large corporations are starting their own music services.

Even if its management was behind the curve, Napster’s P2P technology was ahead of it. Some have referred to the technology as “notorious” but it is extremely popular none the less. Savvy individual users recognized this before the large record companies. The record companies still operated within a 20th century business structure. Legal problems would doom the original Napster even as the technology it helped develop spread into numerous other fields. Individual “pirates” continued to use the software to illegally trade music, but if Napster was to survive as a company it would have to switch its tactics drastically.

It would have to start from scratch, finding a way to make money from a music subscription service. Napster’s new approach as a subscription service is highlighted by its collaborations with major corporate partners. In 2003, the launch of Napster 2. 0 signified the re-emergence of the company. Napster partnered with software giant Microsoft to take advantage of its Windows Media Player 9 functionality. Users could now store and transfer more files. The Windows Media Player technology also provides better sound quality, while also decreasing file sizes and download times.

The new system provided greater mobility and file types that were supported by a wider array of devices. In addition to technological advancements, customers are lured by T. V. , radio and internet advertising. Incentives, such as “first month free”, are often provided. The company also moved its headquarters to Los Angeles, California where it can forge ongoing ties with the record industry. The new corporate image of Napster was evidenced by its new President Mike Babel who indicated that “We have an extensive relationship with Microsoft” (Microsoft, 2003).

Over one hundred million copies of Windows Media Player 9 software had been downloaded by that time, ensuring Napster access to a massive potential audience. This development compares starkly to the “go it alone” business model of previous years. Napster was now collaborating fully with one of the corporations attempting to put it out of business only two years later. Still, the re-formed version of Napster must now compete with the second generation of online music services, some taking advantage of the P2P format it first popularized. The reconfigured version of Napster is making a gradual comeback.

The service now has over 500,000subscribers. Its year-to-date sales in 2007 are over $111 million. That figure represents a 17. 3% increase over the past year (AOL Finance, 2007). The acquisition of copyright licenses has grown to about two million songs. The Napster music service also merged with AOL music, immediately adding several hundred thousand users to Napster’s client base. Napster’s stock value has increased steadily over the past three years while the stock value of its main competitors has remained flat. The new Napster uses advertising, the traditional means of making money on the net.

In an innovative twist, it also uses the lack of advertising to make money. Users, for an additional charge, can opt for an ad-free service. Users also must maintain their service in order to play the music they download. Once the service is canceled, the music will no longer play. The old Napster and the new Napster are two completely different businesses. As such they require two different business models. The original free service has been compared to internet radio (Rosenbush, 2006). The new service is essentially a rental service.

Rental services which charge a fee will automatically have less access to consumers. Therefore they must work harder to keep technology current, make the service affordable and provide just the right experience to keep users coming back. Napster now faces competition from a number of sources, including companies that sell songs individually without a subscription fee. Analysis and Conclusion In analyzing the Napster experience, moral characterization of the company as “good” or “bad” should be avoided. These terms have been attached to the company by self-interested parties since its inception.

At times, the rhetoric became very loud and very public. What gets lost in the characterizations are the potential lessons learned by carefully weighing what Napster did right and what it did wrong. The P2P networks developed by Napster are now among the most popular application programs. They are now used in a host of industries to exchange information. There is an ongoing concern about security of information in these networks, but programmers are continuing to work on ways to make them more secure. As successful as P2P was for Napster, critics point out other weaknesses.

For example, it is well known that the majority of users on a swapping service will take far more than they contribute to the service. A system of incentives for contributors could have better ensured full participation and consistent growth of the company. In this area and others, early Napster management was lacking. Napster had the foresight to see the legal problems that might arise, but did not have an effective plan to deal with them. Because of the lack of business planning, a series of events was set into motion that resulted in the company being shut down only two years after it opened.

Having plans to deal with unexpected success is just as important as having plans to deal with unexpected failure (Altman, 2007). In the unpredictable e-business climate, the effects of not having these plans are magnified. The new corporate version of Napster bears little resemblance to its predecessor. The new Napster works closely with the record and software industries; it has improved its marketing plan and has taken a more traditional approach to E-commerce. While Napster reorganized as a subscription service several other players emerged in the digital music marketplace.

Itunes, Yahoo Music and others have made inroads into the market by providing specialized services at a reasonable cost. The good news for Napster is that the digital music marketplace is exploding with no slowdown in sight. The original free Napster service was doomed to failure. Legal issues overwhelmed the company. Still, those problems alone did not have to prove fatal. If Napster had been planned better those problems could have been mitigated. It is highly unlikely that the service could have remained free, but it is very possible that some accommodation short of bankruptcy could be made.

As it is, the Napster experience shows the importance of planning in an E-business environment. Planning, in this context, includes anticipating the market, anticipating legal issues, having effective funding and marketing strategies, and staying at the cutting edge of technology. Even well-planned companies fail in E-business, but those who are not well planned face certain failure.


Altman, Daniel. (2007). Connected: 24 hours in the global economy. New York: Farrar, Straus and Giroux. Ante, Spencer E. (2000). “Inside Napster: how the music sharing phenom began, where it went wrong and what happens next. ” BusinessWeek Online. Aug. 14. Retrieved 7/3/2007 from: http://www. businessweek. com:/2000/00_33/b3694001. htm? scriptFramed . AOL Finance. (2007). “Quotes: Napster Inc. ” Retrieved 7/9/2007 from: http://finance. aol. com/quotes/napsterinc/naps/nas/profile? icid=rbox_stock_quotes. html Gauze, Carl F. (2002).

“Fanning unveils failed Napster business model. ” Ink19. Apr. 1. retrieved 7/3/2007 from: http://www. ink19. com/issues/april2002/features/napsterBusinessModel. html . Microsoft. (2003). “New Napster Music Service Powered by Windows Media 9 Series.

” Press Release. Oct. 9, Redmond Wash. Squatrigna, Chuck. (2002). “Napster history sold for a song. ” San Francisco Chronicle. Dec. 12, pA01. Suppa, Carly. (2001). “Napster Technology Pays a Visit to the Doctor. ” ITWorld Canada. Feb. 9. Retrieved 7/3/2007 from: http://www. itworldcanada. com/a/Network-World/3e671b76-ae95-4d76-b813-1d94052694d3. html . Rosenbush, Steve. (2006). “Napster on the block? ” BusinessWeek Online. Aug. 3. Retrieved 7/5/2007 from: http://www. businessweek. com/the_thread/dealflow/archives/2006/08/napster_on_the. html

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