Case Study: Business Model of Napster

The Napster brand has had a varied history. Its initial incarnation was as the first widely used service for ‘free’ peer-to-peer (P2P) music sharing. The record companies mounted a legal challenge to Napster due to lost revenues on music sales which eventually forced it to close. But the Napster brand was purchased and its second incarnation offers a legal music download service in direct competition with Apple’s iTunes.

Business Model of Napster

The original Napster

Napster was initially created between 1998 and 1999 by a 19 year old called Shawn Fanning while he attended Boston’s Northeastern University. He wrote the programme initially as a way of solving a problem for a friend who wanted to find music downloads more easily online online. The name Napster came from Fanning’s nickname.

The system was known as Peer to Peer since it enabled music tracks stored on other Internet users hard disks in MP3 format to be searched and shared with other Internet users. Strictly speaking, the service was not a pure P2P since central services indexed the tracks available and their locations in a similar way to which instant messaging (IM) works.

The capability to try a range of tracks proved irresistible and Napster use peaked with 26.4 million users worldwide in February 2001.

It was not long before several major recording companies backed by the RIAA (Recording launched a lawsuit. Of course, such action also gave Napster tremendous PR and millions of users used the service. Some individual bands also responded with lawsuits. Rock band Metallica found that a demo of their song ‘I disappear’ began circulating on the Napster network and was eventually played on the radio. Other well-known artists who vented their ire on Napster included Madonna and Eminem. However, not all artists felt the service was negative for them. UK band Radiohead pre-released some tracks of their album Kid A on to Napster and subsequently became Number 1 in the US despite failing to achieve this previously.

Eventually as a result of legal action an injunction was issued on March 5th 2001 ordering Napster to cease trading of copyrighted material. Napster complied with this injunction, but tried to read a deal with the record companies to pay past copyright fees and to turn the service into a legal subscription service. In the following year, a deal was agreed with German media company Bertelsmann AG to purchase Napster’s assets for $8 million as part of agreement when Napster filed for Chapter 11 bankruptcy in the United States. This sale was blocked and the web site closed. Eventually, the Napster brand was purchased by Roxio, Inc who used the brand to rebrand their PressPlay service.

Since this time, other P2P services such as Gnutella, Grokster and Kazaa prospered which have been more difficult for the copyright owners to purse in court, however, many individuals have now been sued in the US and Europe and the associations of these services with spyware and adware has damaged these services, which has reduced the popularity of these services.

New Napster in 2008

Fast Forward to 2008 and Napster now has around 830,000 subscribers in the United States, Canada and United Kingdom who pay up to £14.95 each month to gain access to about 1.5 million songs. The company is seeking to launch in other countries such as Japan through partnerships.

Revenue for financial year 2008 is expected to exceed $125 million, representing growth of 17%.

The online music download environment has also changed with legal music downloading propelled through increasing adoption of broadband, the success of Apple iTunes and its portable music player, the iPod which by 2005 had achieved around half a billion sales.

Napster gains its main revenues from online subscriptions and permanent music downloads. The Napster service offers subscribers on-demand access to over 1 million tracks that can be streamed or downloaded as well as the ability to purchase individual tracks or albums on an a la carte basis. Subscription and permanent download fees are paid by end user customers in advance either via credit card, online payment systems or redemption of pre-paid cards, gift certificates or promotional codes. Napster also periodically licenses merchandising rights and resells hardware that its end users use to store and replay their music.

BBC estimated that the global music market is now worth $33 billion ( £18.3 billion) a year while the online music market accounted for around 5% of all sales in the first half of 2005. Napster , quoting Forrester Research estimates that United States purchases of downloadable digital music will exceed $1.9 billion by 2007 and that revenues from online music subscription services such as Napster will exceed $800 million by 2007.

BBC   reports Brad Duea, president of Napster as saying: ‘The number one brand attribute at the time Napster was shut down was innovation. The second highest characteristic was actually free. The difference now is that the number one attribute is still innovation. Free is now way down on the list. People are able to search for more music than was ever possible at retail, even in the largest megastore.”

The Napster Online Music Service

Napster subscribers can listen to as many tracks as they wish which are contained within the catalogue of over 1 million tracks (the service is sometimes described as ‘all you can eat’ rather than ‘a la carte’). Napster users can listen to tracks on any compatible device that includes Windows Digital Rights Management software, this includes MP3 players, computers, PDAs and mobile phones. Duea describes Napster as an “experience” rather than a retailer. He says this because of features available such as: – Napster recommendations – Napster radio based around songs by particular artists – Napster radio playlists based on the songs you have downloaded – Swapping playlists and recommendations with other users

iTunes and Napster are probably the two highest profile services, but they have a quite different model of operating. There are no subscribers to iTunes, where users purchase songs either on a per track basis or in the form of albums. By mid 2005, over half a billion tracks had been purchased on Napster. Some feel that iTunes locks people into purchasing Apple hardware, as one would expect Duea of Napster says that Steve Jobs of Apple “has tricked people into buying a hardware trap”. But Napster’s subscription model has also been criticised since it is service where subscribers do not ‘own’ the music unless they purchase it at additional cost, for example to burn it to CD. The music is theirs to play either on a PC or on a portable player, but for only as long as they continue to subscribe to Napster. So it could be argued that Napster achieves lock-in in another form and requires a different approach to music ownership than some of its competitors.

Napster Strategy

Napster describe their strategy as follows. The overall objective is to become the “leading global provider of consumer digital music services”. They see these strategic initiatives as being important to achieving this:

  • Continue to Build the Napster Consumer Brand — as well as increasing awareness of the Napster brand identity, this also includes promoting the subscription service which encourages discovery of new music. Napster (2005) say ‘We market our Napster service directly to consumers through an integrated offline and online marketing program consistent with the existing strong awareness and perception of the Napster brand. The marketing message is focused on our subscription service, which differentiates our offering from those of many of our competitors. Offline marketing channels include television (including direct response TV), radio and print advertising. Our online marketing program includes advertising placements on a number of web sites (including affiliate partners) and search engines’
  • Continue to Innovate by Investing in New Services and Technologies — this initiative encourages support of a wide range of platforms from portable MP3 players, PCs, cars, mobile phones, etc. The large technical team in Napster shows the importance of this strategy. In the longer-term, access to other forms of content such as video may be offered. Napster see their ability to compete depend substantially upon our intellectual property. They have a number of patents issued, but are also in dispute with other organizations over their patents.
  • Continue to Pursue and Execute Strategic Partnerships — Napster has already entered strategic partnerships with technology companies (Microsoft and Intel), hardware companies (iRiver, Dell, Creative, Toshiba and IBM), retailers (Best Buy, Blockbuster, Radio Shack, Dixons Group, The Link, PC World, Currys, Target), and others (Molson, Miller, Energizer, Nestle).
  • Continue to Pursue Strategic Acquisitions and Complementary Technologies — This is another route to innovation and developing new services.

Napster Mobile

During 2007, Napster launched a wireless music service branded “Napster Mobile”. In conjunction with Ericsson, this offers ringtones, OTA (over-the-air) downloads and wallpapers via a variety of mobile carriers in the United States and Europe, including Cingular/ATT, O2 Ireland, TMN in Portugal, SunComm and Dobson. Using Napster Mobile, customers are able to purchase music downloads from our full music catalog using their mobile phone handset and have the songs delivered OTA to their handsets with a copy sent to their PC as well.

Napster’s Customers

The Register reported that in the UK, by mid 2005, Napster UK’s 750,000 users have downloaded or streamed 55m tracks since the service launched in May 2004. The company said 80 per cent of its subscribers are over the age of 25, and half of them have kids. Some three-quarters of them are male. Its subscribers buy more music online than folk who buy one-off downloads do and research shows that One in five of them no longer buy CDs, apparently.

Describing it’s marketing strategy Napster says in its SEC filing: “We primarily focus our marketing efforts on online advertising, where we can most cost effectively reach our target audience of 25-40 year-olds, as well as strategic partnerships where we can market our service with complementary products. In the United Kingdom and Germany, we also market our paid Napster service directly to consumers through a predominately online marketing program, consistent with the existing strong awareness and perception of the Napster brand. The marketing message is focused on our subscription service, which differentiates our offering from many of our competitors. Our online marketing program includes advertising placements on a number of web sites (including affiliate partners) and search engines”.

Napster Distribution

Napster’s online music services are sold directly to end users through the website (www.napster.com). Affiliate networks and universities that have procured site licenses (In the US, a significant proportion of subscribers are University users). Prepaid cards are also available through retail partners such as Dixons in the UK, who also promote the service.

Napster also bundle its service with hardware manufacturers such as iRiver, Dell, Creative Labs, Gateway and Samsung.

Distribution partnerships with mobile providers are a key aspect of it’s strategy and Napster has pursued agreements in this this are. In 2008, Napster launched Mobile music service with Telecom Italia which serves more than 35 million subscribers; Entel PCS, the leading Chilean mobile operator with more than 5.5 million subscribers and in Japan Napster Mobile for NTT DoCoMo.

Napster Competition

Napster see their competitors for online music services in the US as Apple Computer’s iTunes, Amazon, RealNetworks, Inc.’s Rhapsody, Yahoo! Unlimited, Sony Connect, AOL Music, MusicNet and MusicNow. In the UK, in 2005, new services with a subscription model were launched by retailers HMV and Virgin. They expect other competitors such MTV Networks to enter the market soon.

Napster believe that the main competitive factors affecting their market include programming and features, price and performance, quality of customer support, compatibility with popular hardware devices and brand.

Intellectual Property

“We may be unsuccessful in prosecuting our patent applications or patents may not be issued from our patent applications. Even if patents are issued and maintained, these patents may not be of adequate scope to benefit us or may be held invalid and unenforceable against third parties.

While we rely on patent, copyright, trade secret and trademark law to protect our technology, we also believe that factors such as the technological and creative skills of our personnel, new product developments, frequent product enhancements and reliable product maintenance are essential to establishing and maintaining a technology leadership position. We cannot assure you that others will not develop technologies that are similar or superior to our technology.”

Employees

As of March 31, 2005, Napster had 135 employees, of which 10 directly supported the online music service (maintaining content and providing customer care), 25 were in sales and marketing, 63 were in engineering and product development and 37 were in finance, administration and operations. The costs of managing these staff is evident in the table.

Napster Risk factors

In their annual report submission to the United States Securities and Exchange Commission, Napster is required to give its risk factors, which also give an indication of success factors for the business. Napster   summarises the main risk factors as follows:

  1. The success of our Napster service depends upon our ability to add new subscribers and reduce churn.
  2. Our online music distribution business has lower margins than our former consumer software products business. Costs of our online music distribution business as a percentage of the revenue generated by that business are higher than those of our former consumer software products business. The cost of third party content, in particular, is a substantial portion of revenues we receive from subscribers and end users and is unlikely to decrease significantly over time as a percentage of revenue.
  3. We rely on the value of the Napster brand, and our revenues could suffer if we are not able to maintain its high level of recognition in the digital music sector.
  4. We face significant competition from traditional retail music distributors, from emerging paid online music services delivered electronically such as ours, and from “free” peer-to-peer services.
  5. Online music distribution services in general are new and rapidly evolving and may not prove to be a profitable or even viable business model.
  6. We rely on content provided by third parties, which may not be available to us on commercially reasonable terms or at all.
  7. We must provide digital rights management solutions that are acceptable to both content providers and consumers.
  8. Our business could be harmed by a lack of availability of popular content.
  9. Our success depends on our music service’s interoperability with our customer’s music playback hardware.
  10. We may not successfully develop new products and services.
  11. We must maintain and add to our strategic marketing relationships in order to be successful.
  12. The growth of our business depends on the increased use of the Internet for communications, electronic commerce and advertising.
  13. If broadband technologies do not become widely available or widely adopted, our online music distribution services may not achieve broad market acceptance, and our business may be harmed.
  14. Our network is subject to security and stability risks that could harm our business and reputation and expose us to litigation or liability.
  15. If we fail to manage expansion effectively, we may not be able to successfully manage our business, which could cause us to fail to meet our customer demand or to attract new customers, which would adversely affect our revenue.
  16. We may be subject to intellectual property infringement claims, such as those claimed by SightSound Technologies, which are costly to defend and could limit our ability to use certain technologies in the future.

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