On December 6, 1999, the Recording Industry Association of America (RIAA) sued the first file sharing platform Napster for copyright infringment. This was the start of a still ongoing campaign against file-sharing and related practises. On the occasion of the 15th anniversary of RIAA’s lawsuit against Napster, I would like to retell the story of Napster relying on Joseph Menn’s book “all that rave. The Rise and Fall of Shawn Fanning’s Napster” (2003) as well as on court documents and press articles.
In the fourth and last part the slow death of Napster is highlighted when Bertelsmann AG bought the sued file sharing service and failed to turn it into a sustainable business model.
The Music Industry’s Fight Against Napster – Part 4: Napster’s Slow Death
Napster immediately appealed against the preliminary injunction and requested for a stay from the Court of Appeals pending a full appeal. Although this kind of emergency requests are almost always turned down, the Court of Appeals surprised with its decision. The three-judge panel confirmed Judge Patel’s decision, but granted Napster’s request for an emergency stay since the case raised “substantial questions of first impressions” (Court of Appeals 2000a: 2). The oral arguments were set for October 2000. Thus, the Napster team got an additional deadline to avert the closing by meeting the district court’s order.
Napster, thus, did not just feverishly work on an effective filter system, but tried to bring about a settlement out of the court with the record companies. Napster CEO Hank Barry already got in touch with the record companies’ executives to discuss a collaboration. A few days before the oral argument, highest-ranking representatives of the record majors – Edgar J. Bronfman Jr, founder of Universal Music Group, Bertelsmann CEO Thomas Middelhoff, Sony Corp. CEO Nobuyuki Idei and Sony’s U.S. chief Howard Singer – met with Hank Barry and Napster investor John Hummer on July 13, 2000. Napster offered them a 60 percent share in the company. The majors’ representatives were positive about the proposal and suggested to hammer out an industry-wide deal (Menn 2003: 250). However, Napster’s majority shareholder John Hummer changed his mind after talking to Intel founder Andy Grove. Grove convinced Hummer that the record majors were not interested in a “super radio”, but wanted to control the entire file-sharing process. Thus, Hummer bluffed with a US $2bn take-over bid by AOL and was quoted in Fortune with “I’am the record industry’s worst nightmare”. Thus, the negotiations with the major record companies collapsed (ibid: 250-251).
Nevertheless, Bertelsmann CEO Thomas Middelhoff as well as the head of the Bertelsmann eCommerce Group (BeCG), Andreas Schmidt, believed in Napster as the future of the music industry. After the negotiations with the record majors came to an end, Schmidt continued to talk with Hank Barry and John Hummer on a further collaboration. Despite controversial talks with the Napster representatives and the fierce opposition of BMG’s head Strauss Zelnick, Bertelsmann eventually agreed in a loan to Napster of US $60m that could be converted into a 58 percent stake of Napster, Inc., if the other music majors stepped in. Otherwise the loan could be converted into just 35 percent of the Napster stock (Menn 2003: 264).
Middelhoff’s and Schmidt’s hopes that the other labels would join into the deal soon, were disappointed. The other record companies were not interested anymore in Napster and held up the lawsuit against Napster. Even worse, BMG CEO Straus Zelnick insisted that BMG was not part in the Napster deal and kept its part in the lawsuit alive. Thus, Napster became part of Schmidt’s eCommerce Group (ibid: 264-265).
The Bertelsmann-Napster deal was announced at a press conference in a New York City hotel in October 2000. According to the deal, Napster was allowed to continue its file sharing service, and Bertelsmann kept the lawsuit up as long as a new business model had not been launched. In other words, Napster had no sustainable business model and the deal did not change the legal status-quo for Napster. This was not a good precondition for other labels to enter the Bertelsmann-Napster deal. The Bertelsmann executives had erred and Middlehoff later recalled: “The rest of the industry didn’t see what was going on. They don’t have an end in this legal battle, and on the other hand Kazaa and MusicCity and all the others have tremendous growth rates, and nothing can stop them.” (ibid: 267).
Furthermore, the news from the court front were frustrating too. The hearing before the Court of Appeals on October 2, 2000, that was broadcast live by CNN did not bring any new insights in the case. The injunction remained stayed and the Court of Appeals for the Ninth Circuit confirmed the district’s court ruling that the Napster users were infringing copyright on a large scale on February 12, 2002. The judges argued that the Audio Home Recording Act could not be applied in the case, since the Napster users were not fair users. Thus, the Court of Appeals confirmed the district’s court assessment that “(1) a host user sending a file cannot be said to engage in personal use when distributing that file to an anonymous requester and (2) Napster users get for free something they would ordinarily have to buy” (Court of Appeals 2000b: 15). In addition, the Betamax case was not applicable since Sony had not control of the VCR usage after the devices were sold, whereas Napster had an ongoing role in the users’ infringing behaviour and even contributed to it. The three-judge panel (Court of Appeals 2000b: 24) concluded: “The district court did not err: Napster, by its conduct, knowingly encourages and assists the infringement of plaintiffs’ copyright.” The judges also shared Judge Patel’s assessment that Napster had a negative impact on CD sales. The Fader report, commissioned by Napster, was rendered as “of dubious reliability and value”, whereas the Jay-report and the Fine-report were positively perceived. The judges concluded “(…) that the district court made sound findings related to Napster’s deleterious effect on the present and future digital download market.” And even a “lack of harm to an established market cannot deprive the copyright holder of the right to develop alternative markets for the works” (ibid: 19). The appeals court’s only concession to Napster was, that the labels had to prove that a file offered for transfer by Napster violated their copyrights. The Napster case was returned to the district court for modification. Judge Patel worked out a modified preliminary injunction that was issued on March 6, 2001. Napster was ordered to install an effective filtering system to block file names listed by the record companies. The Napster users, however, circumvented the filter system by naming the files in a different way. Thus, the record companies again complaint about the holes in the system and Judge Patel ordered Napster to establish a perfect filtering software latest until June 28, 2001. Otherwise Napster would have to be closed down by the court (Menn 2003: 273-274).
Napster and Bertelsmann announced at press conference to pay US $1bn over five years from a future subscription service to the rights holders to get rid of the lawsuit. RIAA and the music majors felt mocked by this offer. It was more than questionable if a P2P file-sharing platform would ever collect subscription fees. Thus, RIAA demanded of Napster to stop copyright infringement, to stop delaying court decisions and to strengthen the efforts to build an effective filtering system. Otherwise, Napster would have to be shut down by the court. (Menn 2003: 273).
Napster, therefore, had to work intensively on a perfect filtering system. At the end of June Napster was able to present a new system that was able to filter 98 percent of infringing content. 98 percent, however, was not sufficient. Judge Patel had ordered a 100 percent filtering. Since the next court hearing was fixed for July 11, 2001, Napster decided to shut down the system on July 1, 2001. Thus, more than 2 million users were cut off from file sharing simultaneously (ibid: 276).
This marks more or less the end of Napster. Judge Patel ordered in the following hearing that Napster could only be reactivated if 100 percent of the copyright infringing content would be filtered. It was cold comfort that Metallica as well as Dr. Dre withdrew their lawsuits a day after the court order. Since a 100 percent filtering was technically impossible, Napster focused on setting up a fully licensed subscription service.
Hank Barry, therefore, was not seen as the person who could turn Napster into a legal service. Thus, Bertelsmann manager Konrad Hilbers was appointed CEO to settle the lawsuit with RIAA and to enter into a deal with the record majors. Hilbert immediately worked out a US $250 million-settlement with the majors. The negotiations seemed promising for both sides. The Bertelsmann executives, however, were not satisfied. The majors wanted to license 7,000 songs to Napster and only for use on personal computers. In March 2002, in became clear that a deal was out of sight (ibid: 282-287). At that time, Napster was a shadow of itself, whereas other file-sharing systems prospered. Napster had been shrunk to a very limited subscription service with no future potential to grow.
In a last desperate attempt, the Bertelsmann executives took over the control of Napster. Napster filed for Chapter 11 bankruptcy to get rid of Hummer Winblad and John Fanning. Napster had US $101m of liabilities, but just US $7.9m of assets. It owed US $91m alone to Bertelsmann (ibid: 300). Now Bertelsmann was in Napster’s driving seat. The record majors answered the coup by claiming a damage of US $85m.
Bertelsmann owners’ family Mohn had become increasingly nervous on Thomas Middelhoff’s expansive strategy. At the end of July, the Bertelsmann board decided to dismiss Middelhoff and to replace him by a conservative Bertelsmann veteran (ibid: 302). The new Bertelsmann CEO wanted to get rid of Napster as soon as possible. Thus, Napster had to file bankruptcy in November 2002. Napster’s brand, remaining assets and its Internet domain were sold for US $5.3 million to Roxio Inc. that had created a software to rip MP3 files from CDs (ibid: 307). So the story of Napster took an inglorious end. A company that was valued at US $100 million in 2000, was sold out for nearly nothing to a remaining bidder.
The detailed analysis of the Napster case allows several important conclusions. Digital natives such as Shawn Fanning, Jordan Ritter and Sean Parker challenged the established players in the music industry by introducing a disruptive technology (Christensen 1997). The record companies’ market power was attacked and they reacted in an inadequate way. When MP3 technology appeared it was initially ignored. When is could not by ignored any longer, its role for the record companies was played down. When its relevance for the music industry became could not any longer denied, the new practices such as file sharing were fiercely fought on the basis of copyright law. (Tschmuck 2012: 230-233).
The record companies hesitated to adopt the new technological possibilities for their business model and did everything to maintain control on music distribution. The music majors wanted to force Napster to play by their rules – to license their music catalogues for their own terms. The licensing costs should then be recouped by stake in Napster – a model that was later applied at Spotify. The main aim, therefore, was to control the copyrighted music content. The musicians’ interests played if any a secondary role, but they were stressed for promotional purposes. In the Napster trial the economic damage caused by Napster was most relevant issue. It triggered a variety of file sharing studies that tried to measure the impact of file sharing on recorded music sales.
Napster did not directly infringe copyright, but benefited from the infringements by its users and even promoted infringing usage of copyrighted music. However, when Napster went offline other more sophisticated file sharing systems had replaced Napster. File sharing was even more popular than in the best days of Napster. Thus, the music industry went on to sue file sharing and file hosting services and even individual file sharers.
 Napster’s appeal against the preliminary injunction in A&M Records et al. v. Napster Inc., July 26, 2000, case no. C99-5183-MHP.
 Order of the Court of Appeals for the Ninth Circuit in A&M Records et al. v. Napster Inc., July 28, 2000, case no. C99-5183-MHP.
 Fortune Magazine, “Big Man Against Big Music Think the record companies will bury Napster?”, August 14, 2000 (accessed November 21, 2014).
 Oral Arguments before the U.S. Court of Appeals for the Ninth Circuit, October 2, 2000.
 Opinion of the U.S. Court of Appeals for the Ninth Circuit in A&M Records et al. v. Napster Inc., February 12, 2001, case no. C99-5183-MHP.
A&M Records Inc. vs. Napster Inc., Complaint for contributory and vicarious copyright infringement violations of California Civil Code Section 980(a)(2) and unfair competition. Case no. C99-5183-MHP.
BBC News, “Napster settles Metallica law suit”, July 13, 2001 (letzter Zugriff: 2. November 2013).
Christensen, Clayton, 1997, The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail. Harvard: Harvard Business Review Press.
CNET, “Rapper Chuck D throws weight behind Napster”, May 1, 2000.
CNET, “Metallica fingers 335,435 Napster users”, May 1, 2000.
CNET, “Napster boots 317,377 members from service”, May 9, 2000.
CNET, “Dr. Dre chimes in with names to ban from Napster”, May 17, 2000.
Fader, Peter S., 2000, Gerichtsgutachten im Auftrag der Napster Inc. im Fall A&M Records Inc. vs. Napster Inc., Case no. C99-5183-MHP.
Fortune Magazine, “Big Man Against Big Music Think the record companies will bury Napster?”, August 10, 2000.
Menn Joseph, 2003, all the rave. The Rise and Fall of Shawn Fanning’s Napster. New York: Crown Business.
Tschmuck, Peter, 2012, Creativity and Innovation in the Music Industry, 2nd edition. Heidelberg etc.: Springer.
Wired Magazine, “Napster: Music Is For Sharing”, November 1, 1999.
Wired Magazine, “RIAA Suing Upstart Startup”, November 15, 1999.