Napster, Inc.

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Napster, Inc.

455 El Camino Real
Santa Clara, California 95050
U.S.A.
Telephone: (408) 367-3100
Toll Free: (866) 280-7694
Fax: (408) 367-3103
Web site: http://www.napster.com

Public Company
Incorporated: 2000 as Roxio Inc.
Employees: 360
Sales: $99.3 million (2004)
Stock Exchanges: NASDAQ
Ticker Symbol: NAPS
NAIC: 518210 Data Processing, Hosting, and Related Services

The one-time renegade provider of music file-sharing software, Napster, Inc. has been reborn as a legitimate Internet music subscription service that offers the work of more than 45,000 artists on an on-demand basis. All told, the Napster music library includes some 700,000 individual songs and 65,000 albums. The Santa Clara, California-based company offers two levels of service. Napster Light is designed for people who merely wish to purchase music, which costs 99 cents per track and $9.95 for an album. Users also are permitted to search for music and listen to 30-second clips. Purchased music can then be played on a computer, burned to a CD, or transferred to a portable device. In addition, Napster Light users have access to music library functions, allowing them to use Napster to play CDs, create custom play lists that can then be shared with other Napster subscribers, import nonsecure WMA and MP3 files into their library, import tracks into a Napster library, and organize the music collection using Napster software. In addition to these "lite" features, monthly subscribers can listen to the Napster library on demand and receive a discount on music purchases. They also receive 50 radio stations and the ability to build custom stations.

Founder Born to Single Mother in 1980s

The man who conceived of the original Napster program was a college freshman named Shawn Fanning. He was born in Brockton, Massachusetts, in 1980, the result of a teenage pregnancy. His mother, Coleen Fanning, was one of eight children raised in a working-class family in the Boston area. At a sibling's high school graduation party held at the family house, a local band played, and Coleen met the guitarist, Joe Rando, who would become Shawn's father. (It was also during this party that his uncle, John Fanning, 14 years old at the time, got his first taste of business by passing the hat to pay for the band and accumulating a few thousand dollars. He would become a self-styled entrepreneur and play a prominent role in Napster's rise and demise.) Just 18 years old and the product of a much wealthier family, Rando ended the relationship when he learned Coleen was pregnant. She decided to have the baby and attempted to raise Shawn herself.

Coleen Fanning eventually married a truck driver and with him came four more children. Money was tight, resulting in a great deal of tension at home. Nevertheless, as a teenager Shawn emerged as a good athlete and a solid student. It was during this time that John Fanning took his nephew under his wing, rewarding him with money for good grades and buying the youngster his first computer, an Apple Macintosh. Shawn became obsessed with programming and the Internet, spending a great deal of time conversing with likeminded teens via Internet Relay Chat (IRC). He taught himself how to write software programs in UNIX code and became an aspiring hacker (as opposed to a "cracker," who used programming knowledge for nefarious deeds). He further indulged his new passion during the summers while working for his uncle's Internet venture. Never able to complete his degree at Boston College, John Fanning had bought a struggling computer company that eventually dissolved. He then launched an Internet company called Chess.net, a site where players could meet and play online. For programmers, he relied on several Carnegie Mellon University students who had developed an Internet chess server. It was from these students that Shawn Fanning refined his programming knowledge. He became proficient enough as a hacker that he was invited to join an exclusive IRC channel called w00w00, home to hackers and crackers alike, where members could share their programming interests. For his nickname on the channel, Fanning used what he had been called on the basketball court, Napster, because of his short, nappy hair. It was to w00w00 that Fanning turned when he began developing a pet project that would allow people around the world to share each other's music files. It was also where he connected with the two young men who would cofound Napster.

Shawn Fanning Entering College in 1998

Shawn Fanning applied to Carnegie Mellon, but was turned down and instead enrolled at Northeastern University in Boston in 1998. He was soon bored by his computer classes, which were too elementary for his skill level, and he began spending an increasing amount of his time toying with an idea to make music sharing on the Web easier. By now the MP3 format for compressing CD-quality music into digital data had become the norm, and some sites offering music files had cropped up. But there were some serious shortcomings: the songs were often not available because the index was out of date or the link was broken. Some sites also required users to know File Transfer Protocol (FTP) commands, a relic of the pre-browser days of the Internet. Shawn Fanning began thinking about a better way to make music available on the Web and conceived of a realtime index of all the sites available at any given moment. To achieve this, users had to log on to a central server, which acted as a matchmaker. But in order to download music files, users had to make their own music files available to anyone else who wanted them. As a result, the amount of available music grew as the number of people using the system increased.

To help develop the program that would become known as Napster, Fanning turned to fellow hackers on w00w00, sending them an early version of the Napster application. One of them was Jordan Ritter, who was a couple years older and employed at BindView, a security software firm. He became increasingly more involved in refining the program and eventually was put in charge of the Napster server, becoming one of the company's cofounders. Another of Fanning's IRC friends was Sean Parker, who combined an interest in computers with an entrepreneurial spirit, and became Napster's other cofounder. During his freshman year at college, Fanning spent most of his time working on his filesharing program and found it more productive to work at his uncle's offices on the weekends than in his dorm room. By early 1999 he decided to quit school and devote himself completely to Napster, working out of the Chess.net offices, where he was oblivious to the fact that the business was failing. According to Joseph Menn in his All the Rave, John Fanning took note of his nephew's project and, sensing an opportunity, had papers drawn to incorporate Napster Inc. He then convinced Shawn in May 1999 to assign 70 percent of the business to him, leaving 30 percent for his nephew, arguing that investors would only come on board if an "experienced businessman" were in charge. More familiar with the ways of business than his friend, Parker was stunned that Shawn had agreed to such terms. On future occasions John Fanning introduced himself as Napster's founder, a claim that was true in the sense that he was the one who incorporated the business. But instead of attracting investors, he reportedly drove them away, and instead of building a business, one that forged a partnership with the music industry, his truculent nature led to costly litigation and ultimate disaster for the company.

Parker had already been busy lining up backers for Napster. The basic business model was to get as many people as possible to use the web site, then sell them ancillary merchandise, like T-shirts and concert tickets. As for the record companies, the hope was that they would eventually decide it was in their best interests to cut a deal. While John Fanning was meeting with interested investors, involved in negotiations that seemed like an end unto themselves, Napster went online. At first Shawn Fanning shared a test version with 30 friends he met through IRC, all of whom pledged not to tell anyone about the project. But Napster proved irresistible and within a matter of days the word had spread and some 15,000 people downloaded the program. Napster spread across the Internet world, especially among college students, who took advantage of their high-speed connections through their schools' computer center servers. Only slowly did administrators realize that their bandwidth was being consumed by a single Internet service they had never heard of. Traffic grew so heavy that servers were often clogged with Napster transfers, so that by the early months of 2000 schools began to block the service.

In the meantime, after alienating several potential investors, John Fanning finally managed to strike a deal with Napster's first outside investor, Yosi Amram, who insisted the company be located in northern California where he could keep an eye on it. He installed as interim chief executive a veteran Silicon Valley venture capitalist, Eileen Richardson. Shawn Fanning relocated to the West Coast, bringing with him Parker and Ritter. His uncle remained in the Boston area, but he was still the company's largest shareholder and continued to influence the future of the company, which would soon become caught up in a firestorm of publicity and litigation, because not only did young people become aware of the power of Napster, so too did the music industry, which quickly concluded that Napster was a serious threat. Napster was branded as little more than a site that facilitated music pirating, and the industry did not accept Richardson's argument that Napster did not violate the law because it did not actually host the music. Her contention that Napster would actually spur CD sales by exposing people to new music also fell on deaf ears. In December 1999 the Recording Industry Association of America sued Napster, contending copyright infringement. At first all the suit accomplished was to further publicize Napster, playing some part in the woes to be experienced by university computer centers.

Company Perspectives:

Napster is back with the answer for both the music industry and music fans: safe, legal and reliable access to hundreds of thousands of songs.

Musicians were split about Napster, with unknown bands and those with poor-paying record deals supportive. Backing the industry, however, was the best-selling heavy metal group, Metallica, which dealt a serious blow to Napster's reputation by filing its own copyright infringement suit in April 2000. In the midst of legal maneuvering and publicity firefights, Napster also was attempting to secure more funding. Amram and Richardson convinced venture capital (VC) firm Kleiner Perkins Caufield & Byers to invest in Napster, but John Fanning, who likely would have been ousted from the Napster board of directors, had enough shares of stock to scuttle the deal. Richardson approached other VC firms, but none could satisfy John Fanning. Finally, Hummer Winblad Venture Partners made an offer, at a time when Napster was becoming desperate for money. Instead of valuing the company at $100 million like previous deals, Hummer Winblad assigned a $65 million valuation, but it also agreed to let John Fanning retain his seat on the board. Fanning signed on, but was soon maneuvered off the board.

Bertelsmann Investing in 2000

Having stayed longer than expected, Richardson stepped down as CEO, replaced by venture capitalist Hank Barry, whose background as a corporate lawyer was a welcome addition. But even the addition of attorney David Boies (who would gain greater attention later in the year litigating the presidential election between George W. Bush and Al Gore) could not prevent a federal judge in July 2000 from ordering that Napster be closed. An appeals court stayed the injunction two days later. In dire need of funds, Napster now attempted to build a legitimate business, and in October 2000 it found an unlikely partner when the German publishing conglomerate Bertelsmann AG, owner of the BMG record label, agreed to lend Napster $50 million to develop a commercial music service. Although the third largest record label, BMG had been performing poorly, and Bertelsmann felt it was worth a chance to align itself with Napster in the hope that the addition of an online distribution system might revive BMG's fortunes. The company expected the other labels to fall in line and to sign up as well, but they were instead incensed that Bertelsmann had provided Napster the financial resources it needed to continue fighting them in court. The possibility of cutting a deal with the other labels was then given a crippling blow in February 2001 when an appeals court ordered Napster to stop allowing copyrighted material to be shared on its web site. Napster exacerbated the situation by Barry holding a press conference to make an offer to the record labels, promising $1 billion over five years, the money to come from a new subscription service Napster had in the works. Because that amount made little difference to the record companies, and on a per-song basis was a pittance, the public offer backfired. Nothing less than unconditional surrender and the shutting down of the Napster site would satisfy the labels. Only then would they be willing to discuss the possibility of negotiating a realistic licensing agreement.

Napster attempted to comply with the court order and developed a filtering system to prevent the copying of songs from lists provided by the labels. Napster's engineers and outside consultants cobbled together a system that worked reasonably well, but still allowed 1 or 2 percent of the banned songs to slip by, due in large part to problems with copyright infringement notices. Rather than be in contempt of court, Napster voluntarily shut down its site on July 1, 2001.

Although it vowed to be back online soon, Napster remained dormant and essentially dead. A new CEO, Konrad Hilbers, made a last-ditch effort to negotiate a compromise with the record labels but failed. Napster began laying off staff in the early months of 2002 and turned to Bertelsmann for more funding. Bertelsmann now decided that it would be better off simply buying Napster outright and take its chances in cutting a licensing deal with the major record labels. In May 2002 Bertelsmann made an offer for the company, but the deal was all but sabotaged by John Fanning, who attempted to stage a coup and wrest away control of the board by filing suit against the board of directors. The Bertelsmann offer lapsed but was revived later when Bertelsmann offered to acquire the Napster assets for $8 million as part of a bankruptcy proceeding. In June 2002 Napster filed for Chapter 11 bankruptcy protection. But Bertelsmann's attempt to position itself as Napster's largest creditor, and thus have the inside track to acquiring Napster's assets, failed because its infusion of cash was not considered a loan but, rather, a backdoor attempt to gain an equity stake in Napster, an arrangement that was intended to shield Bertelsmann from any liabilities Napster incurred in its litigation with the music industry.

In November 2002, Roxio Inc., maker of CD-creation and digital-media software, emerged the winner in bankruptcy court, paying $5 million for the Napster name and its intellectual property. Parker and Ritter were long gone, and Shawn Fanning served briefly as a paid consultant. It was the name that clearly had the most value, as Napster retained a high level of brand awareness, becoming what the New York Times called "the Kleenex of downloadable music." Roxio began building a music subscription business, helped greatly by the May 2003 $40 million acquisition of Pressplay, a digital music service jointly created by Sony and Universal. As a result, Roxio was well stocked with licensing agreements when the new Napster went live later in 2003. Roxio sold its other assets and assumed the Napster name, fully committed to its new business. It faced competition from a score of other music services, but was betting that the power of the Napster brand would provide a competitive edge. Napster's founder, Shawn Fanning, in the meantime was busy developing a new project called Snocap, in effect a clearinghouse for legitimate online music file sharing. It would serve as an accountant to make sure that registered copyrights were not infringed. The record labels were impressed and began signing up to register their catalogs, more than willing to forgive the young man whose revolutionary idea had caused them so many headaches.