Resnikoff’s Parting Shot: Illegal Business

  • Save

The highly-disruptive music industry is simply irresistible to many entrepreneurs.

The reason is that almost everyone has an emotional connection to music, and many have brilliantly identified pain points in the current landscape.  The sexiness factor on music is undoubtedly high, and emotion often trumps hard profitability projections.

But most music-related companies – startup or otherwise – have difficulty generating cash.  That makes it a tough bet for VCs, and a bad choice for many would-be entrants.

But once in the game, what is the best path towards profitability?  A great idea always helps, but the pitfalls are tremendous in this space.  And startups are usually forced to make some unsavory choices right upfront.

From a licensing perspective, difficult decisions present themselves immediately.  One path is a play-it-legal, above-board model that frequently requires heavy spending on major label licenses.  This door allows you to avoid a lawsuit, but obtaining major recording and publishing authorizations requires extreme amounts of time and capital.

The stark reality is that labels want serious levels of upfront capital, just to play ball.  And if you want brand-name artists that more mainstream consumers demand, the labels are a necessary hurdle.  Well-funded startups like Lala can foot the bill, but others face difficult conversations with reluctant financiers.

Sick of that reality?  Introduce any shortcutting funny business into the equation, and the majors will leave you hanging at the altar – just ask Qtrax.

And once a vessel successfully sets sail, the anchor of heavy licensing continues to drag.  The reason is that available capital is now reduced for other development areas, including engineering, general staffing, marketing, and competitive executive salaries.

The piper gets to set the price, though distressed executives often wonder if draining an early-stage startup is merely a short-term profit-play for the labels.  “There’s too much squeeze up front, and companies can’t survive five, seven years,” explained David Del Beccaro, president and founder of Music Choice at the recent Digital Music Forum in New York.

Bigger, more-established companies like RealNetworks, Nokia, and Yahoo can afford the licensing bill, but the economics are still punishing.  Just look at Napster, a company that has been bleeding millions every quarter since its reincarnation.  And its profitability and survival prospects still remain tenuous.

Surely there must be a better, more renegade path towards success.  Indeed, there is a riskier route – and the success ratios might be higher.

But tread carefully on this gamble.  The grayer option is a more dangerous choice, one that involves the illegal use of content – usually couched within a gray interpretation of copyright law.  This door requires more modest initial investments, though lawsuits can quickly start draining capital and distracting attention away from product development and strategy.

LimeWire – owned by Lime Group LLC – is one of these, though other P2Ps have mostly been buried by RIAA lawsuits.  Others in the category include YouTube, which eventually licensed major label content despite streaming massive amounts of authorizing videos.  But that story is much larger than music, and Viacom has been far less willing to negotiate with mega-owner Google.

In the middle is the independent label licensing route, one that taps into a more pliable and experimental music community.  A prominent example comes from eMusic, which successfully licensed MP3s from thousands of independent labels years ago, and wrapped the content into a combination subscription and download model.  Some labels – most notably Victory Records – balked at the plan, but those are mostly exceptions.

Of course, there are endless variations and successful models that mostly avoid licensing headaches.  TuneCore is a distribution company that allows artists to upload and distribute their music onto iTunes.  CD Baby, an early-stage seller of CDs online, offers a similar service.  Elsewhere, digital distributors like the Orchard and IODA work for their label clients to gain greater traction across various digital outlets.  A  more complete discussion on other variations – frequently within the B2B space – would be endless.

Then, there exists a more piratical, black market that features a prominent middle finger to major content holders.  The Pirate Bay is perhaps the most obvious present-day example, though the path towards distributed online music started with another f-you warrior, Napster.

But back to the grayer approaches.  Can entrepreneurs make them pay off?  A seriously misleading article in the Washington Post on Friday – called “Breaking the Law to Get a Break,” pointed to a success story from media-focused social network Imeem.  The story discussed an illegal start, a major lawsuit by Warner Music Group, and an eventual coming-to-terms.  “Getting sued by one of the biggest record labels played a pivotal role in its success,” the piece asserted.

The Post continued by explaining that “Warner now regards the site as a powerful word-of-mouth marketing asset,” while referring to licenses with all four major labels and a dropped suit.

Fairy tales are always nice, but the reality is more difficult for this company – just ask executives close to the situation.  If you thought the major label licensing process was difficult for a young startup, try approaching it as a more established player under legal duress.  Instead of the usually heavy-duty licensing fees, executives keep pointing to Imeem negotiations that featured extra-onerous demands at gunpoint.

Perhaps Michael Robertson phrased it best.  “Under a dark cloud of looming lawsuits, Imeem entered into a crushing financial agreement that allows them to survive as long as venture capital money continues to flow into the company, but spells almost certain financial calamity once outside funding halts,” Robertson described.

Insiders know that Robertson carries a considerable amount of anti-label baggage – and is a frequent defendant against the big four.  But time will tell whether Imeem successfully charts a course from lawsuit to profitability, or dies under the weight of lopsided licensing agreements.

Paul Resnikoff, Publisher.