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Smiles fade at Napster

It was a breakthrough deal that would have put the Napster kitty on millions of Hewlett-Packard computers.

But in the days leading up to Napster’s re-launch in late October, HP suddenly – and without explanation – returned Napster’s $250,000 check and canceled the agreement to install a link to Napster’s online music service on its computers. Worse, in January HP announced a surprise partnership with Napster rival Apple Computer to feature the iTunes Music store on HP computers and sell Hewlett-Packard branded iPod music players.

Neither HP nor Napster’s parent company, Roxio, would comment on the soured deal, whose details were confirmed by sources familiar with the agreement. But its collapse was one of several setbacks since the reintroduction of Napster, the pioneering song-swapping renegade, as a paid music service.

Napster is losing money, and top executives have left the company, including its president, chief financial officer, vice president of programming and head of corporate communications as well a key board member. On Wednesday, Roxio began laying off people at its Napster division. A Roxio spokeswoman said the company was “eliminating redundancies in the organization” but declined to say how many people lost their jobs.

And while Napster can legitimately claim it’s the second most popular online music service, information provided by insiders at two of the major music labels shows it sells only about a quarter the number of downloads from their artists as Apple’s market-leading iTunes store. Napster refused to release download figures.

“I think it’s a very competitive market with very ugly economics and there’s just no money in the download business,” said Steven B. Frankel, managing director of Adams, Harkness and Hill, a Boston investment bank.

Napster 2.0 launched with a celebrity-studded bash at the House of Blues in Los Angeles and the bold pronouncements of its chairman and chief executive, Chris Gorog, who hailed the reborn Napster as the best-known brand in online music.

The reality of reincarnating the onetime bete noir of the music industry into a legitimate music service proved more sobering. Napster lost $15 million in its first two months of operation. And the most recent sales data reported to two of the major music labels shows Napster with an estimated 12 percent share of the download market, compared to Apple’s 56 percent. Analysts estimate Napster’s market share at 15 percent to 20 percent.

No music players to sell

Perhaps more telling is the state of Napster’s subscription business, which is widely perceived as more lucrative than selling 99-cent songs. That’s especially key for a service like Napster, which unlike Apple, derives no income from the sale of a branded music player.

Napster declined to provide specific subscriber numbers for its service, aside from noting that downloads and subscriptions each contributed equally to Napster’s $3.6 million in revenue for the last three months of 2003.

That means Napster has attracted about 90,000 subscribers in its first two months – ranking it fourth, behind RealNetworks’ Rhapsody service, America Online’s MusicNet and MusicMatch.

Gorog said he resists comparisons with other subscription services because of incongruities in the way subscriber numbers are reported. But he expects the business will mature as users realize it’s cheaper to pay a flat fee for access to 500,000 tracks than to pay $1 a song.

Gorog was upbeat in a conference call last week with analysts and investors. He said he expects sales to reach $20 million within 12 months – possibly even double that, as the Napster service launches in Europe.

“We are very pleased with our performance,” said Gorog. “It will again not only prove the strength of our service, but the extraordinary value of the Napster brand.”

Promoting Napster cards

Gorog points to key retail partnerships as spurring growth. An eclectic group of 20,000 nationwide retailers – from Radio Shack to 7-Eleven and Exxon service stations – sell prepaid Napster download cards. And this week, Target kicked off a nationwide Napster promotion, selling pre-paid music cards and kitty-branded merchandise.

In an interview with the Mercury News, Gorog said investors recognize the inherent value of the Napster brand and are patient enough to wait for the services to gradually attract customers and become profitable. They don’t expect an overnight sensation, he said. Indeed, Napster raised $22.5 million as recently as January.

Differences over strategy have created tension with some music label veterans who came to Roxio through its acquisition of the Universal-Sony Music online music venture, pressplay.

Indeed, the new Napster appears to be plagued by the kind of management turmoil that marked the old Napster.

Music industry veteran Mike Bebel is gone as Napster’s president. So is Lawrence Kenswil, the lone board member representing Roxio’s largest shareholder, Universal Music Group. Alex Luke, the long-time vice president of music programming, who left shortly after the service’s launch to join the rival Apple service. And Roxio’s chief financial officer, Elliot Carpenter, who resigned for family reasons.

“You’re after something that I don’t think is there,” said Gorog, when asked about top executives leaving the company.

Key executives with music industry backgrounds – including Napster’s chief operating officer, Laura Goldberg – remain with the company.

“The question is how long can they hang in there? The answer is, for a while,” said Gene Munster of the Piper Jaffray & Co, which has an investment banking relationship with Roxio.

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