Bertelsmann Claims Net Music Crown

By Robert Menta- 11/06/00

When Bertelsmann purchased CDNow several months back, I wasn't all that surprised the buyer was one of the major labels. It made too much sense.

Bertelsmann Music Group (BMG) already had a CD club similar to Columbia House - buy the first CD for full retail, get the rest for under $5 then pay exorbitant shipping fees - which they were spending considerable dollars trying to bring to the Net. Like any startup, the money went to staffing needs, equipment, and heavy marketing to produce the traffic that will eventually turn it profitable.

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But profitability on the Net is more elusive than expected. CDNow was the leader in online record sales, only to watch Amazon, Barnes and Noble and other Net heavyweights enter the market. Despite the competition, they still pulled in three millions of users a month.

In the end, they couldn't make balance this high traffic with profitability and saw their stock plummet. Unable to find investors to keep the company afloat, the deathwatch was on for the CDNow.

It was about this time that I wrote a story on another web site, (Major MP3 Site up for Sale on Ebay). They put their site up for sale on for $10 million and in that article I wrote this:

OK, you own a personal web site and you built up some significant traffic. Traffic so noteworthy that you outdraw a site that loses tens-of-millions-of-dollar per quarter just trying to build its traffic. has put PC Data Online's report on MP3 site traffic for December 1999. It shows as the third largest drawing site on the net among sites with the letter MP3 in them. With 599,000 unique users, outdraws (530,000), (520,000), and (485,000).

The point of this article was that it's more cost effective to buy an entire site that carries your target users than it is to blow two million on a Super Bowl ad. We suggested Sony, who are in need to promote their MP3 competing ATRAC3 format, could be well served by such a site. They would just have to manipulate it in a way that would serve them (This is a link site to "pirate" MP3 files after all, a conceptual challenge for traditional record labels) while retaining the audience loyalty.

Sony instead decided it could put the site out of business and, along with its fellow RIAA members, used its money to sue The case is yet to go to trial.

With CDNow, Bertelsmann chose a different path from Sony. They waited until the company was only a few months from running out of cash, and then bought them and their three million monthly users. That move put them instantly in the lead in Net presence among the major labels.

Bertelsmann recognized the competitive advantages of breaking from the pack, investing in established Net music companies rather than eliminating them.

The game plan of the music industry - desperate to gain control over the same online music they dismissed two years earlier - was to wreck the existing leaders in this arena and then take it over with there own sites, rebuilding Net music in their image.

But, traditional music companies are still flailing at what that image is to be. Outside of the RIAA's legal actions in their name, they have not been united in anything that might resemble a vision. For example, the labels have been unable to jointly focus on what secure format they will use to protect their copyrights, each selecting a different codec from Bluematter (Universal) to ATRAC3 (Sony) to Liquid Audio and WMA (EMI). This indecision serves only strengthens MP3's position as the standard, the opposite of what they wish to achieve.

We seem to forget that outside of the various Net lawsuits, these labels are rivals not brethren.

Collusion is in the history of the major labels too as the recent price fixing scandal revealed, but colluding on the Net is a much more daunting task. Understanding (let alone re-building) the Net music industry is something the major labels are still grappling with, lending doubts that they are ready for the undertaking on their own.

The fact is Net music companies are more Net savvy than the traditional music companies who want to replace them.

If You Can't Beat Them, Buy Them

When faced with the logic that Net music companies already have the skills the major labels still need, why not buy them? You get a built-in audience and the ideological expertise, both resources that would take time and significant investment dollars to re-create. So far, the first offerings from the major labels have met with mixed results (Major labels distort ideal ease of downloading).

Bertelsmann seems to be the first to accept this fact, playing coy while values dropped on Net stocks and then swooping in before their true competitors, Sony, Universal, EMI and Time Warner, came to the same conclusion.

Which brings us to Napster. With we were talking about 600,000 users. CDNow pulls three million users a month. Napster offers 38 Million and climbing.

More people use Napster right now than AOL, the company that seemed in better position to buy Napster and convert it to a subscription service.

AOL is already a successful subscription service with the structure and seasoned staff Napster is looking for. To blend Napster into its regular service could be as simple as clicking a checkbox on AOL's opening splash screen.

But Time Warner has shown its distaste for Web music companies, successfully petitioning AOL to kill new services offered by its Nullsoft division, makers of Winamp, Shoutcast, and the now renegade Gnutella. They no doubt would veto a Napster/AOL union.

Bertelsmann Music group (BMG), the music division of the parent company, also attempted to veto such a union.

The parent company vetoed them (see Hungry for Market Share and Status, Bertelsmann HQ Overrules BMG Objections on Napster Deal ).

Why? 38 million users mean money and power and control.

Part of competitive advantage is knowing who the real competition is. Bertelsmann has thought long about this as have the rest of the RIAA membership, but only they have aggressively acted on the facts.

Bertelsmann bought two of the most active web properties at a fire sale (Napster's user base alone could eventually be leveraged into billions of dollars). They achieved what the courts have been unable to give them fast enough, a significant level of control over Net music. Unlike Internet startups, they also have the deep pockets to wait for their investments to pay off, giving them a significant competitive advantage over web competitors like and AOL/Time Warner have missed their opportunity.

Now Bertelsmann has to figure out a way to utilize Napster that works.This includes charging for the service without alienating fans. The task will not be an easy one as it requires a good deal of forethought. Also, the traditional side of the company's music business will try to suppress parts of its evolution if only to protect their own interests. But Bertelsmann the conglomerate is a full fledge member of the net industry now.

Bertelsmann is parent to a Net music company (CDNow) and is in line for a significant equity stake in another (Napster). They must attempt to grow the new industry just as the smarter banking houses embraced the online trading that transformed their traditional broker/customer relationships. Merrill Lynch shunned online trading at first and they came to regret what became serious error in judgment.

The bottom line is Bertelsmann, in just a few months, has become the biggest player in how the Net music industry will evolve.

Which bring us to another Web property out there, the one that just dropped to the second biggest player in Online Music. has watched its stock drop from the mid-100's to about $3.00 a share where it trades at now.

Wouldn't it be interesting if Bertelsmann bought a 25% share in that company? How about Don't look so shocked, somebody may before the end of the year.

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