Digital Distribution and the Music Industry in 2001: a Case Study of Napster

By Julius Danjuma

IS650: Telecommunications Management Summer 2012

Overview:
Shawn Fanning created Napster in his dorm room at Northeastern. It was the fastest-growing application in the history of the Internet which changed the world but failed to achieve business success. Napster started out as a free download tool but the goal was to make it into a real business in partnership with the record labels.
The goal at Napster was to be the online distribution channel for the record labels, much like iTunes for example. There were several offers made to the labels that would have given them the vast majority of all of the revenue. The numbers were staggering. There were over 50 million users, many of whom were willing to pay $5 per month or $1 per download for digital music. That translates to about $250M a month or $3B per year. Even if Napster kept just 10% of the revenue that would be $300M per year against expenses of less than $10M. At the stock market multiples of the day that would have been a $15B IPO.
The economics of the record industry are puzzling and their accounting methods are very creative. At the time CD’s were sold for about $17 at retail. The retailer and distributor took more than half of the price as their mark-up. The manufacturing costs took another couple bucks. The promotional costs of advertising, music video, payola to radio stations, and other PR typically ate up all the rest of the revenue. Only the most successful artists made any money from recording contracts, and even then only $1 or so per CD. The vast majority of music groups never make any money for themselves, and barely covers costs for the labels. Cost is a flexible term in the music business, and the way those costs get allocated can be creative indeed. The successful artists