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MP3: A Chart Topping Investment?

Back in January when Sequoia Capital, idealab capital partners and a few others invested $11 million in startup MP3.com the rush was on to find the player that would matter in the new world of downloadable music. Play it again Sam.

In 1994 I wrote a 10 year forecast for the music industry that envisioned music downloads. An updated forecast done recently estimates that as much as 5% (maybe as much as 10%) of music may be downloaded over the Net as primary channel by the year 2002. That's more than $2.5 billion worth on the low end by our estimates--if the emerging technology can find a way to pay the bills.

For the core of MP3, a protocol developed by the Motion Picture Experts Group (the movie folks defining the audio standard, wacky), allows the unlimited free distribution of music "ripped" (in MP3 lingo) from a CD and uploaded into the Web at one of several sites.

For sure there's more than pirating (to use a music industry perspective) going on. New artists are porting their catalog of offerings to the Web directly. And old artists signed with labels are doing the same, releasing MP3 songs much to the befuddlement of the labels who have traditionally owned the artist more or less.

The goal of the investors behind MP3.com is to make it the "Yahoo" of music on the Web. Indeed, MP3.com has more than 10 million downloads, a chart ranking system and artist sign up areas, serves as a guide.

Other downloadable music technologies do exist that don't allow downloading or place a security feature in the offering. These all agree on some level with the traditional model of music that's run by six companies the world over.

Does MP3.com make the top of the charts?

The explosion of interest in this area results from the inefficiencies of the traditional music model.

Musicians receive a fraction of the sale of their product. Each CD sold gets split about 10 ways and most of that goes to the record companies or retailers.

That's because the traditional model relies on the movement of a piece of silver-colored plastic in a jewel box. And huge studios, art budgets, pressings of the CD itself.

In one swoop the Internet does away with the food chain, replaces it. The Web is retailer, distributor, marketing channel, and more.

What the labels struggle with is how to apply the old rules to a new game. Copyrights, licensing fees, royalties.

Consider for a second the consumption of music to see how the battle is not MP3 it's perception. Sony just came up with a way to move music, play it without letting people "own" it.

Liquid Audio, a2bmusic are two rival formats but we think the platform battle so far has been won by MP3. So far, it's early.

The core hurdle for MP3 to scale is the business model, who gets paid and for what. But we think the best models here already exists--it's called radio.

Millions of people daily tune into radio in their cars and "consume" music for nada. Or they record movies off TV on video for personal consumption and it's perfectly legal.

Between "radio" and "personal use" precedents there seems to be a path to how MP3 could work as a business and not a college students network of pirated songs.

Now let's get back to if MP3.com itself becomes the Yahoo of the music space. Maybe. In the early days of the Internet great ideas could flourish and get to huge levels of critical mass without a lot of rivals.

Now, however, great ideas often get cherry picked by the large established sites with the capital and platform to deploy them. They acquire.

Occasionally great ideas sneak past the established players and become dominant leaders themselves. eBay (NASDAQ:EBAY) is one example, although its revenue growth probably dwarfs anything in the Internet music space at this time.

MP3 has a built-in problem also--the company name. Like naming your company "Eight-track Music" in the 1970s, being associated with a technology has its drawbacks. It's as if Netscape would have named the company Netscape 1.0.

Still, as the center of the storm for this new model we think MP3 may rise to the brand issue and perhaps become a valuable entity. We think that window of opportunity probably closes in six months as the large portals and community sites (which host a lot of MP3 from users by the way) turn on the jukebox themselves.

Accolades for Internet Stock Report:

"Fresh and provocative" -CBS Marketwatch, who named Steve Harmon one of the top Internet stock analysts and only independent one honored

"I am a huge fan of Steve Harmon's analysis" -Kleiner Perkins' John Doerr



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