It's All Free!

PHOTO-ILLUSTRATION FOR TIME BY MICHAEL ELINS

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This isn't how it was supposed to be. A little more than three years ago the Recording Industry Association of America (R.I.A.A.), which represents most U.S. record labels, filed suit against Napster, the granddaddy of file-sharing services, for "contributory and vicarious copyright infringement." The R.I.A.A. won; Napster lost. A judge ordered its servers shut down. End of story?

Hardly. The file-sharing services didn't go away. They evolved, getting smarter and more decentralized and harder to shut down. Napster's network relied on a central server, an Achilles' heel that made it easier to unplug and shut down. But Kazaa, now the most popular file-sharing software, is built around a floating, distributed network of individual PCs that has no center. There's no single plug to pull. Kazaa has savvily chosen a decentralized business strategy too: it's a mirage of complicated partnerships with the official owner, Sharman Networks, tucked away on the South Pacific island of Vanuatu. So far, its diffuse structure has kept its management off U.S. soil and out of U.S. courtrooms.

It isn't just the file-sharing companies that are evolving; the Internet is too. Broadband Internet access has become cheaper and more widespread analysts expect the number of households with broadband to jump 41% this year and that means we can move bigger, fatter files in less and less time. Personal computers have also evolved. In 1992 the average hard drive was 120 megabytes. Now it's 40 gigabytes, 300 times as big perfect for stashing whole libraries of audio and video. CD and DVD burners used to be expensive peripherals; now they come standard. Every new PC is a self-contained entertainment studio, right out of the box. What we have here is not a failure to communicate; it's a raging, runaway success.

The consequence of the high-tech evolution is a new generation of technologically empowered consumers for whom free entertainment isn't a windfall, it's a basic right. Just ask Sean Farrell, a senior at Yale. A sophisticated listener, he dabbles in jazz and classical along with the usual hip-hop. But he hasn't bought a CD in four years. Instead, he has 5,000 songs on his computer's 430-GB hard drive, and more in the 20-GB MP3 player an Apple iPod that is permanently attached to his hip. When he and his roommates have parties, they don't bother with CDs, they just run cables from the computer in Farrell's bedroom to the stereo in the common room and blast the free tunes straight off his PC. "I don't feel really guilty," he says. "The music industry has to realize that this is here to stay; it's not going away." See the pattern yet?

For years people wondered whether all this downloading would actually affect the entertainment industry's bottom line. Now that last year's numbers are in, we have the answer. According to Nielsen SoundScan, CD album sales slid from 712 million units in 2001 to 680 million in 2002. CD sales in the first quarter of 2003 were down 15 million units from last year. Or look at it this way: in 2000 the top 10 albums in America sold 60 million copies; in 2001, 40 million; in 2002, 33 million. Nobody knows for sure exactly how much of the decline is caused by piracy, but it's safe to say the answer is somewhere between "some of it" and "most of it." Sure, the economy had a down year, but people found enough spare change in their couches to boost sales of MP3 players 56% over 2001. And while consumers bought about 680 million albums last year, they purchased 1.7 billion blank CDs up 40% from the year before. The clear implication: users are downloading free music and burning it onto blank CDs. Industry analysts are reduced to fairy-tale metaphors to describe the change. The genie is out of the bottle. Pandora's box is open. The dikes have burst, and the Dutch boy has gone surfing.

Which isn't to say music executives are sitting around wringing their hands. It takes time for any corporation to recognize that its universe has changed, and major labels don't exactly turn on a dime. For Martin Bandier, chairman and CEO of EMI Music Publishing, the dime dropped three years ago when his 11-year-old son Max gave him a present: his 100 favorite Motown songs. "I said, 'But we have hundreds of copies!'" Bandier recalls. "He said, 'This is in a different place on my hard drive.' It was scary." Bandier immediately convened a war council to figure out how to protect EMI's precious song catalog, which ranges from Judy Garland to Norah Jones. "People did not think it was real in the beginning," he says. "It's as real as can be."

Reality bit, and deep. In 2001 EMI brought in new top management, including chairman of EMI Recorded Music Alain Levy, to help navigate the brave new digital world. The administration promptly laid off 1,800 employees (20% of EMI's staff), which helped absorb the impact when sales fell 10% in 2002 and created an executive position, global head of antipiracy. It also brought in executive vice president John Rose, an e-commerce ace from consulting firm McKinsey. "The fundamental premise of hiring someone like me," says Rose, "is that this industry needs to be re-engineered." Since last summer, EMI has been holding weekly three-hour lunch meetings with artists, managers, agents and lawyers, a dozen at a time, to explain to them, as Rose puts it, "how the world needs to evolve."