Napster receives funding from unexpected source

Napster, the renegade Silicon Valley start-up that brought the music industry to its knees, had its first turncoat Oct. 31. Bertelsmann, a German media conglomerate that started as a Bible publisher in 1835, gave Napster $50 million.\nThe money helps Napster stave off a cash crunch and will be used to help it design technology to provide its service for a monthly fee. In return, Bertelsmann has the option to take an equity stake in the company.\nBertelsmann CEO Thomas Middelhoff said he wants to push his old-line company into what he sees as the future of content distribution: the Internet.\n"Napster has pointed the way for a new direction for music distribution," he told The Economist earlier this month.\nIn the 18 months since Napster started, it has built an unprecedented user base of more than 38 million people. A survey conducted by Webnoize, an online music research firm, found that 68 percent of these users said they are willing to pay $15 a month for the service. That adds up to nearly $390 million in annual revenues. If Middelhoff develops a successful way to distribute music using Napster, he said he plans to expand into distribution of Bertelsmann's other product lines, increasing Napster's money-making potential.\nBertelsmann owns publishers and record labels such as Random House, Doubleday, Bantam Dell, Arista Records and RCA. Its subsidiaries also publish such well-known magazines as McCall's, Fitness and YM.\nThe move might sound like a no-brainer for both companies, but there are two major hurdles they must overcome before the plan can succeed.\nFirst, although Bertelsmann has agreed to drop its suit against Napster (should Napster develop a lucrative business model using its technology), the four other major music companies haven't dropped their suits. But Middelhoff might just be the best person to convince them to follow his company's example. \nKnown in the industry as a great networker with powerful allies in major media companies, Middelhoff is close to AOL CEO Steve Case and sits on AOL's board. Bertelsmann has a 5 percent stake in the company, which is in the process of getting regulatory approval for its merger with Time Warner. Middelhoff is also close to Jean-Marie Messier, head of Vivendi, a French utilities firm in the process of acquiring Seagram, owner of Universal. Time Warner and Universal are two of the companies pressing charges against Napster.\nTo satisfy the other media companies, Middelhoff must convince them file sharing is the industry's only option for survival. The worry is that using a service like Napster will squeeze profit margins and still won't prevent the widespread piracy that has plagued the Internet.\nTheir second hurdle is technological. Napster must develop a method that prevents users from downloading the music and posting it on free Web sites, such as Gnutella. Napster is working on a technology that uniquely identifies files and can be used to spot illegal downloads and remove stolen files.\nWhen asked in an interview with Business Week how he will handle this problem, Middelhoff said, "If we demonstrate it's possible to develop business models that accept the principle of intellectual property rights, I think we can fight the others. If we didn't do anything, the music industry would die"