May 6, 2003, Tuesday, FINAL EDITION

SECTION: LIFE; Pg. 1D

LENGTH: 2470 words

HEADLINE: Piracy has its hooks in

BYLINE: Edna Gundersen

BODY:
As growing swarms of online pirates continue plundering music's treasure chests, the $ 12 billion recording industry could be facing a walk down the plank.

Computer users download an estimated 2.6 billion music files monthly; most are illegal.

Aggressive legal action, drastic security measures and sophisticated counterattacks may not be enough to slow, much less halt or reverse, the illegal downloading that is taking a significant bite out of record sales. In its third year of slumping revenue, the recording industry has little reason to expect a turnaround.

"The record companies are history," says James Hetfield of Metallica, the band that stood up to file-swapping juggernaut Napster. "They won't be around much longer unless they get with it and morph into something new that's going to help get music directly to the masses. The Internet is about as direct as it gets. Putting a CD in a store is like putting a rotary-dial phone in front of a kid: 'What's that? There's no antenna.' Downloading is a sobering change."

Some punishing numbers that have labels down for the count:

* Record sales in the world's top 10 markets declined 6.8% in 2002, according to the International Federation of the Phonographic Industry. Research estimates that piracy accounts for 40% of the global decline.

* First-quarter album sales (144.7 million units) are down 10% from 2002 (160.7 million), according to Nielsen SoundScan.

* Roughly 1.7 billion blank CDs were sold in 2002, up 40% over 2001.

* The use of broadband, enabling quick downloads, grew 9% from October to March.

After early missteps, the five major labels -- Universal, Warner, Sony, BMG and EMI -- and the trade group Recording Industry Association of America are pursuing new anti-piracy approaches that may be too little and too late.

Among the strategies that are taking aim at file-swappers:

Suing them into submission

Strategy: Verdicts have gone both ways so far. A federal court ruled April 25 that peer-to-peer file-swapping systems like Morpheus and Grokster are not acting illegally since they don't track traffic. But the decision does say users are violating copyright law. Another ruling reaffirmed the industry's right to compel Internet providers to supply identities of suspected copyright violators. So the legal focus shifts to file sharers.

Last week, four college students sued by the industry agreed to shut down their campus file-sharing networks and pay up to $ 17,500 each. While it's implausible for labels to chase down every bandit, making examples of prolific abusers might scare off others.

Drawbacks: Pursuing students is far from cost-effective and will likely harden attitudes that labels -- whose prices for CDs have never dropped despite plunging production costs -- are rip-off agents.

Downloaders who wouldn't dream of shoplifting a CD at Tower blithely swipe songs from cyberspace without a twinge of guilt. Getting music gratis is only half the thrill; there's also a kick involved in joining a rebel cult and beating an overpriced system. Creating instant martyrs of file sharers can only intensify that sentiment.

"The image of record companies is so negative that peer-to-peer users aren't bothered by questions of legality," says Charly Prevost, former executive at Liquid Audio, which provides software for secure Net music.

Outmaneuvering them technologically

Strategy: Several trumpeted safeguards are in use or in development, but labels also are resorting to wily tactics, including "spoofing," or flooding cyberspace with defective files that confound users. Also possible are more drastic measures that would lock up users' computers.Drawbacks: Users have devised ways to skirt file-sharing hurdles. And declaring open war by freezing computers or Internet connections is no way to win back consumers. Decoy tracks from Madonna's American Life antagonized fans and prompted hackers to temporarily disable her Web site.

Rehabilitating them

Strategy: Warner Bros. Records chairman Tom Whalley says, "I'm pushing for awareness and education . . . to let fans know that stealing music hurts artists and people who make a livelihood off music."

Parents also are natural targets for the campaign.

"Years ago, we were under attack for our morality," Whalley says. "As a result, we put parental-guidance stickers on records. Don't parents know their children are stealing from the Internet? The people who spoke out against record companies are turning their heads in their own households. It's a moral issue."

Last week, the RIAA began an instant-message campaign that sends automated warnings to those distributing or downloading copyrighted music, reminding violators that the act harms artists.

Drawbacks: It's an uphill battle. Among Americans 12 and up, 28% have downloaded music, 18% within the past month, according to Ipsos-Reid marketing research firm. Of those 12 to 17, 48% downloaded music in the past month. And 42% of all file-sharers reported they copied a CD rather than buy it. An Ipsos-Reid study shows that only 9% say file-sharing is wrong, and just 20% say it hurts artists. Many file-sharers consider the RIAA volley a hostile nuisance.

Enticing them to buy

Strategy: Convenience and comfort may be the keys. Internet access options offer a parallel, says analyst Phil Leigh of Raymond James and Associates.

"The best way to combat piracy is to remove the incentive by providing a better alternative," he says. "The vast majority of us pay for Internet access. You can get it for free, but you have to live with constant pop-up ads and limitations. Only a tiny fraction of the public does that. We pay for Internet access because we cannot abide the annoyances. The renegade (file-sharing) networks have an abundance of pop-up ads, spyware, decoy files, viruses and sporadic crashes."

Drawbacks: Until recently, label-sanctioned sites were turnoffs. They were "expensive and the user experience was unsatisfying," Prevost says. "All the legal systems were difficult to use."

Apple's newly launched iTunes "is a positive evolutionary step" toward weaning users off illegal sites, Prevost says. "It's completely addictive, easier than Amazon. It's easier than the illegal sites. If you go to Kazaa for a popular track, you find 100 to pick through, and the quality is questionable. At Apple, it's fast, smooth, no typos, excellent quality."

Apple reports that iTunes sold more than 1 million digital songs in its first week. Competitors Pressplay, MusicNet and Listen have struggled to attract what analysts say is less than a combined 300,000 monthly subscribers. Apple offers 200,000 tracks at 99 cents each, with more songs to be posted today.

But meanwhile, the file-sharing cosmos is expanding. Recordable CDs outsell prerecorded music CDs by more than 2 to 1. Monster song-swapping service Kazaa has 218 million registered users. Sluggish dial-up connections, long an impediment to easy downloading, are on the wane as broadband spreads rapidly outside the corporate and university sectors to the residential realm, inviting more throngs into the free-for-all.

Once dismissed as fringe alarmists, doomsayers who predicted the demise of the music biz are breaching the walls of denial at labels, where alarming statistics are forcing a reassessment of old-school leadership and obsolete business models.

To survive, labels have to jump on the bandwidth wagon, says Prevost. "The delivery of music is critical," he says. "Labels have to figure out how to use the Internet, not replace it. We're seeing the end of the beginning of the industry."

Leigh says, "The chances of the labels reversing the trend toward Internet distribution are about as slim as an Apache Indian being elected pope. The labels have been intellectually aware of this for two or three years. Now they're feeling it at a gut level."

Labels headed for extinction?

Could the giant labels vanish? Some say collapse or serious shrinkage is inevitable if the perilous disconnect between corporations and customers persists. It started when labels ignored the Internet's rise and technological advances that sowed the seeds of online piracy. They resisted adapting to a changed environment and then fought the uprising rather than co-opting it early enough to foil thieves and lure loyal buyers. Says Leigh: "The labels anticipated that Internet distribution would arrive when Marriott opened a hotel on Mars. They didn't know what to do, so they proceeded on the characteristic path of litigation and legislation. But these peer-to-peer networks are as hard to stamp out as the Hydra. Cut off one head, and two grow in its place."

Established acts are watching profits plunge and prospects diminish as CD sales, the bread and butter for most recording artists, sink. Linkin Park took extreme precautions during recording and pre-release promotion of current album Meteora, and while the effort paid off in preventing leaks, the disc's entire contents were up for grabs online as soon as the album landed on shelves. Metallica is braced for a similar brushfire when St. Anger hits retail on June 10. The band hopes to lure buyers with such incentives as a DVD of rehearsals, a CD-ROM peek into the band's upcoming video game and an elaborate booklet.

"The idea was to throw out a bone that you won't get in a download," Hetfield says. He's relieved that security measures so far have thwarted leaks. "Recording was like working in a bank. The hard drives were in a safe. Nothing left the studio. But then you hand it off to the record company to mass-produce it, and you have to let it go."

Despite precautions, songs from Radiohead's aptly titled Hail to the Thief, due June 10, are circulating on the Net. When live versions of songs from 2000's Kid A saturated Napster within hours of the concert, Radiohead initially was amused that "there was suddenly this really cool global distribution system," says Adam Sexton of Macrovision's Audio Group. "Then it sunk in: 'What does this mean to our album?' The business was a bit caught off guard by the rapid spread of Napster. It was voiced as a theoretical problem before. By the time they realized they had a problem, it was already immense, and the genie was out of the bottle."

Internet music looting "definitely got ahead of us," says Whalley. "We got caught short in the beginning, and now we're catching up. We're the first industry really hurt by this. The movie industry will benefit from our suffering."

Tightened in-house security is preventing pre-release leaks. Of four Warner albums in the top 10, none reached the Internet before landing in stores.

"Once it hits the airwaves or is sent to retail, we lose control," Whalley says. Yet he sees cause for optimism. "The business is reinventing itself, and I'm excited to take on that challenge. You'll never wipe out piracy; no industry can. But we have a good chance of reaching the average, honest music fans out there and turning them around. The future is bright."

In the technology tug-of-war, the industry is gaining ground. Macrovision, which ships about 10 million copy-protected CDs internationally each month, helps labels combat piracy by producing "dual session" CDs that allow music to be played on PCs but inhibit file-trading and CD burning. The company, in conjunction with Microsoft, can produce protected CDs that let music be saved on a PC, exported to a portable player and burned onto a recordable CD but not uploaded and traded online.

"What we basically aim to do is put speed bumps up so that average consumers will say they might as well just buy it," Sexton says. The new configuration "gives consumers the flexibility they have come to expect. The rest of the world has moved ahead of the U.S. and taken an aggressive stance to protect intellectual property. Our goal (in the USA) is to have some test releases out in the summer and some major releases this fall so that by Christmas we'll see widespread use of copy protection on CDs."

Also in development is "controlled burning," in which songs burned onto a blank CD can't be copied.

"We have got to get music piracy back to a level that the industry can still survive with, so it's not one copy begets a thousand begets a million," Sexton says.

Far-reaching cultural effects

If industry efforts fail, the fallout will hurt more than the bean counters and stockholders. A crippled system would send ripples through myriad businesses and pop culture itself. A marketplace built around a physical artifact -- the silver disc inside a shrink-wrapped jewel box -- would shrivel.

"I don't see the day anytime soon when brick-and-mortar stores will be obsolete," Whalley says. "People will still enjoy browsing CD bins. But we'll see fewer stores. And the independent accounts around college campuses have been or are being put out of business by online piracy."

If piracy spreads unabated, the very culprits stand to suffer losses as well.

"The industry would not be able to produce and market the number of new artists it's offered historically," RIAA president Cary Sherman says. "It would mean far less investment in music. Record companies make money by selling music. There are very few other revenue streams available. If they can't sell music because people are downloading or burning it for free, they'll take fewer risks on fewer artists.

"If it weren't for Norah Jones having a record contract, her music would still be enjoyed by a few people in Texas at clubs. EMI invested in her and marketed her music, and now it's enjoyed by people all over the world. We have one of the most rich and vibrant cultures in the world, and it would be criminal if all of that disappeared, or contracted, because of uncontrolled Internet piracy."

Metallica drummer Lars Ulrich, branded as greedy by some fans for his criticism of online thievery, says the band fought for principles, not profit.

"It's not the Metallicas and Madonnas and Linkin Parks and Bruce Springsteens that take the hardest hit, it's the 10 developing bands each label has on its roster every month," Ulrich says. "That gets trimmed to three. Instead of getting $ 1 million to make videos and tour, you go home if nothing happens in the first five minutes of that project. Young artists won't have a chance."

Hetfield chimes in, "What about the band that's on the cusp of make it or break it? It's so ironic that a band won't be successful because the people who really like their stuff are stealing it."


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Contributing: Mike Snider and Jefferson Graham