AI
Monday, June 11, 2001 6:55:05 PM
NY TIMES interview w/ BMG ceo:
June 10, 2001
Thomas Middelhoff Has a Hunch
By DAVID D. KIRKPATRICK
Thomas Middelhoff, chairman and chief executive of the media giant Bertelsmann, kicked off his crusade to save Napster on the afternoon of Oct. 31 last year in the ballroom of the Essex House hotel on Central Park South. Before a crowd of journalists and camera crews, Middelhoff mounted a dais with Shawn Fanning, Napster's 19-year-old founder. Everyone knew Fanning: the bashful cult hero who had brought free music to the masses, the embodiment of the libertarian ethos of the Internet.
Not many recognized Middelhoff. Forty-seven years old, 6- foot-4, slender and broad-shouldered, he was dressed the part of a buttoned-down media baron -- thick knot in his cream-colored tie, starched collar and dark double-breasted suit. From Bertelsmann's headquarters in Gutersloh, Germany, Middelhoff presides over a media empire that includes the book publishing behemoth Random House; the record labels RCA, Arista and Windham Hill; an international portfolio of newspapers and magazines, including YM and Family Circle; and Europe's largest television studio, radio and television broadcaster, Internet portal and online store.
Speaking in an unmistakably German syntax, Middelhoff announced that Bertelsmann was coming to the rescue of Napster, the music industry's nemesis. The plan was that Bertelsmann would pay Napster $60 million to help convert its free music-sharing network into a fee-collecting subscription service that would pay copyright holders for permission to circulate their songs. Fanning, glancing down shyly and biting his lip, thanked Middelhoff with a Napster T-shirt.
"It looks very good," Middelhoff said, making the most of the unlikely scene. "I have five kids. They would die to get it." Getting a laugh, he hammed it up. "It is XXL." Then he turned to Fanning and opened his arms for a bear hug. To the befuddled audience, it was J.P. Morgan cuddling up to Pretty Boy Floyd, and for a moment even Fanning looked surprised.
Middelhoff met me at the hotel that morning and tipped me off to his bombshell. He clearly got a kick out of my momentary confusion. "Bertelsmann and Napster -- are you surprised?" he asked, leaning back in his chair and letting his long arms dangle to the sides. "Let's be honest," he said with a grin. "Napster is pretty cool."
The essence of Napster is file-sharing, a technology designed to let fans feed off one another's enthusiasm for music. Its users transfer their favorite songs from compact discs to files on their computers, and Napster's software allows other users to scan these collections from afar and copy the music they want directly onto their own hard drives. After a year and a half in business, its vast network of registered users -- more than 37 million at the time the deal was announced -- had digitized an estimated three billion recordings. Fanning and company even added chat rooms and instant messaging to facilitate user bonding.
Middelhoff was almost rhapsodic about the potential for building communities. "When a Napster user is sitting at his PC and he's connected with somebody in Europe or in Latin America or in Asia, then they don't share only the file," Middelhoff said. "They are saying, 'Hey, can you remember when this band performed, and what did you do, did you have your first kiss? And by the way, where do you live?' This was Shawn Fanning's genius."
Even before the ink on his Napster deal was dry, Middelhoff was predicting that Bertelsmann would find a way to apply the file-sharing model to every form of media imaginable, from family photos to video games, digital films and television, even electronic books. Consumers would share anything that could be browsed or disseminated, probably paying a monthly subscription fee to participate.
Plenty of people had tossed around similar ideas for video games or films, but few could figure out how to make money and respect copyright. And none of them were heads of major media companies. But here was Middelhoff, saying that file-sharing would eventually constitute a change in the consumption of popular culture as revolutionary as radio or cable television.
It would also constitute a major strategic coup for Bertelsmann. In exchange for a loan, Bertelsmann received the right to buy a majority stake in Napster later. This would secure a foothold on every user's hard drive. Napster isn't just a Web site that users choose to visit or skip. It is a piece of software users download to their own machines -- the Napster "client" that acts as a gateway to its network the way the Netscape browser is a gateway to the Internet. It provides a direct line to the consumer, through which a company could observe habits and pitch products. That intimate connection is the Holy Grail of the media business, driving Time Warner's merger with AOL, Universal's sale to the French company Vivendi and Rupert Murdoch's pursuit of the digital satellite television company DirecTV.
Of course, domesticating Napster into a legitimate business would require settling its lawsuit and winning the cooperation of Bertelsmann's rivals, including AOL Time Warner and Vivendi Universal. Most people at the record labels were convinced that Napster's principal attraction was giving away their music free.
But Middelhoff promised that Napster would allay those fears by limiting its sound quality, ensuring that users would still buy compact discs. He was confident that through his personal connections, he would be able to persuade his competitors to let Napster use their music once he explained its advantages as a new source of revenue and form of promotion. "I had dinner recently with the heads of the other media and entertainment companies," he told me the morning of the news conference. "They see that file-sharing is going to be a fact."
His powers of persuasion are formidable. I nodded along as he spoke in a torrent of enthusiasm about Napster's power. "Thirty-seven million users can't all be criminals," he said, leaning forward in his seat and staring intently into my eyes. Only after I left did I realize that he had told me next to nothing specific about making this fabulous vision a reality. Wouldn't charging fees alienate Napster's fans? Could he really convince his rivals to settle their suit? How many people actually wanted conversation along with their music?
Since then, the obstacles have only mounted. Neither of the top two executives at Bertelsmann's music division -- BMG Entertainment, which supports the suit against Napster -- attended the show at the Essex House, and over the next few weeks half a dozen BMG executives quietly resigned. (Bertelsmann says they left for other reasons.) Middelhoff's competitors have not settled their suit; instead, they won a court injunction, forcing Napster to pull copyrighted songs from its service. When the other companies announced plans for competing online jukeboxes, newspapers began preparing Napster's obituaries.
But you would never know it from talking to Middelhoff. Sounding more triumphant than ever, he now vows that Napster's new law-abiding, fee-collecting service will open for business this summer, in time to hold on to its franchise.
Middelhoff climbed to the top of one of the most careful and close-mouthed companies in the world through a combination of energetic showmanship, trust in his hunches and appetite for risk. His gambles have not always worked, but his instinct once paid off in a gigantic way -- seven years ago, when he staked his career at Bertelsmann on a partnership with a little-known entrepreneur named Steve Case and his beleaguered start-up America Online. Today, Middelhoff credits that venture with his position at Bertelsmann, and he believes his instincts about Napster are just as good. "When I saw file-sharing, I knew, Wow, this is now a phase of the Internet," he says. "I was convinced that Napster would be a big business just like I was convinced that AOL would be a big business -- because I knew it."
Middelhoff cultivates the image of a kind of goofy Superman. The first thing anyone notices about him is his remarkable pace, partly because he brings it up. He spends more than half his time jetting around the world, and he often talks of his frenetic travels as a kind of competitive athletic achievement. Sitting down at a meeting this winter in San Francisco, just moments after an all-night flight from Gutersloh, Middelhoff passed a note of mock concern to a colleague: "You look tired."
A few years ago, he made an agreement with his wife and five children to spend at least one day a weekend with them on their farm outside Gutersloh, but he has not been able to keep it. Wherever he is, he rises every morning at 5:45 to swim and work out, then begins returning e-mail by 7:15 and stops working around 10:30 p.m.
When he checks into a hotel, he carries his own bags, talking all the while on a hands-free cell phone. His long strides carry him so fast that his aides skip steps to keep up. In his suite of offices overlooking Times Square, he races from room to room, checking e-mail messages in one and dropping into meetings in another. In between, he raises his hand and calls out "Espresso!" which one of his secretaries instantly fetches. He is an avid skier and tackles the slopes the same way he handles the rest of his business: plunging straight down, immediately on his cell phone again for the trip up the lift.
Middelhoff's most memorable trait, however, is not his speed but his laugh -- a toothy guffaw that is a striking contrast to his otherwise courtly demeanor. He uncorks it even in formal settings, giving the disarming impression that you are old friends the first time you meet. He has an earnest faith in his own charisma and its power to motivate others. Last summer, he rented out Radio City Music Hall to introduce himself to Bertelsmann's 4,500 U.S. employees. He strode onto the stage before two video images of himself and threw his sport coat into the audience like a pop star. "Do you have passion?" he implored. "I love Bertelsmann. I would die for this company."
But the effect is leavened by a constant shtick, a penchant for laughing at his own grandiosity. Before the crowd at Radio City, he played a video starring some of his top executives. Strauss Zelnick, then head of Bertelsmann's music division, appeared on-screen, seemingly responding to Middelhoff's idea for Whitney Houston's next single to be a duet. "You singing with Whitney, Thomas?" Zelnick said, snapping a pencil in mock exasperation. Dan Brewster, head of Bertelsmann's magazine division, held up a prototype of YM's cover, with Middelhoff's head affixed to the body of Britney Spears in a bathtub of diamonds. To dramatize Bertelsmann's new thinking about the Internet, Middelhoff has begun appearing in German television commercials in a "Star Trek" uniform, with the slogan "We Pursue Big Ideas -- No Matter Where They Lead Us."
Middelhoff traces that new thinking back to Nov. 2, 1994, the day he first met Steve Case. It was probably the most formative event in his adult life. At the time, AOL was desperate for cash, but Case showed no sign of weakness. Instead, he boldly promised that one day AOL would dominate the market for consumer online services, and he eventually offered an apparently lopsided deal: for Bertelsmann to put up all $150 million for a joint European venture but give AOL a 50 percent stake for its expertise. He also insisted that Bertelsmann buy a stake in AOL.
Middelhoff saw the "stickiness" in AOL's consumer-friendly features, and it was the businessman's equivalent of love at first sight. "We had dinner, and after the dinner it was clear for me, I have to do it with this company," Middelhoff recalled. "I trusted him immediately." Middelhoff agreed to finance AOL Europe and to buy a 20 percent stake in AOL for $200 million. Bertelsmann's board, however, was outraged at the expense, and he reluctantly scaled back the deal to a 5 percent stake for $50 million.
Middelhoff describes his personal debt to Case with a remarkable ingenuousness, and he waxes nostalgic about his time spent on AOL's board. "I changed tremendously over these six years," he said. "I learned a lot about the Internet and so on, but also it changed my personal style, the way I am seeing the world. Before then, I was much more of a typical German business executive, but now I believe myself to be a real mixture: first American and then European."
For his part, Case, who is actually five years younger than Middelhoff, describes his development the way an older brother might. "I think what he takes away from the AOL experience is that a company took some bold bets at a point when basically everybody was criticizing them, stuck with those bets through a lot of ups and downs and created a significant new franchise."
As AOL's business exploded, the many naysayers on Bertelsmann's board began to rue the decision to limit their investment to 5 percent instead of 20 percent, and Middelhoff's stock at the company began to rise. Mark Wossner, his predecessor as Bertelsmann's chairman, insists that Middelhoff was picked to succeed him before the AOL partnership bore fruit. But it is a measure of Middelhoff's admiration for Case that he openly credits him with his own success. "It's not only a joke when I say, 'Thanks to the success of AOL and thanks to Steve, I got my chairman's position at Bertelsmann."'
As chairman, Middelhoff began to implement some of his lessons from America Online. For one thing, he began throwing open-collared shirts into his rotation of dark suits. He did away with the longstanding custom of addressing Bertelsmann executives as "Herr Doctor" in deference to their business degrees. He lectured executives on the importance of "low hierarchies, direct communication, direct access" and bought each of Bertelsmann's 74,000 employees a personal computer. He changed the official language for internal business from German to English. ("We are not a German company -- we are an international company," Middelhoff often repeats.) Again and again, executives at the company say, he admonishes them, "Yes, this is just like what Steve Case did at AOL. . . . "
"I am sure everybody at Bertelsmann hates me because of all of Thomas's stories," Case said. "But that is O.K. My sense is that I am used there as a kind of device to create change."
Middelhoff likes to say that he is importing American political values as well. After the European press unearthed evidence that Bertelsmann printed Nazi propaganda during World War II and then lied about it for decades, Middelhoff persuaded Reinhard Mohn, patriarch of the family that has controlled Bertelsmann for 166 years, to create an independent commission of historians to expose the truth.
His outspokenness about Bertelsmann's past has sparked its own controversies. Last month, Middelhoff became the first German ever honored by the Jewish U.J.A.-Foundation, which gave him its Steven J. Ross humanitarian award. His selection drew angry complaints from many Holocaust survivors, and he apologized for not anticipating the problem.
Perhaps the most significant lesson Middelhoff took away from AOL was that the Internet was fundamentally altering the media world, faster even than anyone predicted, and that now was the time for empire building. As AOL's stock soared, Middelhoff began to bet again on the next big idea. He tried unsuccessfully to buy Amazon.com, then poured money into a host of online stores, including CDNow.com, the joint venture BarnesandNoble.com and Web sites for Bertelsmann's book and music clubs. Like most online retailers, Bertelsmann's have yet to make profits. The company sank more than $300 million into Bol.com, which Middelhoff acknowledges was a big disappointment. Bol.com was recently folded into Bertelsmann's book and music clubs, and a third of its staff was laid off.
In 1999, however, when Middelhoff decided to sell Bertelsmann's stakes in AOL and AOL Europe, his timing was impeccable. It was the peak of the tech-stock boom, and Bertelsmann's $50 million investment in AOL had increased some 28 times in value, to $1.4 billion. AOL bought back Bertelsmann's stake in AOL Europe for about $8 billion. With the partial disposition of its other Internet investments, Bertelsmann was left with a war chest exceeding $16 billion. In four years, Middelhoff had more than doubled the size of one of the biggest media companies in the world.
Case elected to take advantage of his soaring stock price as well, by acquiring Time Warner, Bertelsmann's main rival, which meant that Case and Middelhoff were now officially competitors. "It is a little strange," Case admitted. "But you have to remember, the competition is about business. It isn't personal."
Middelhoff maintains that the companies compete only in isolated arenas, like music or magazines in the United States. "If we are in some sense competitors, O.K., then we compete, but fair," Middelhoff said. "I believe that today we are best friends."
n Feb. 12, Middelhoff's bold vision for Napster became a fight for its survival. A United States appellate court approved the record industry's request for a preliminary injunction, restricting Napster's use of copyrighted songs. Middelhoff had just arrived home in Gutersloh at 10:45 p.m. when Hank Barry, Napster's interim C.E.O., called with the news. Over the next two hours, Middelhoff decided on a response: Napster would take its case to the public in a news conference in San Francisco, the day before the Grammys, and he would fly over to lend the force of his personality to the cause.
The morning of the event, Hilary Rosen, president and C.E.O. of the Recording Industry Association of America, screamed at Barry over the phone, demanding that he call it off. But Middelhoff was already in the air. As the news conference began, he sat chewing candy and genially reached over to fix Shawn Fanning's collar. First, Barry laid out a proposal: if the industry would settle its lawsuit, Napster would promise to pay the music companies a total of at least $200 million a year as a kind of deposit on income from Napster's planned subscription revenue.
Then Middelhoff took the microphone, beginning his remarks with an account of his overnight flight. "We all together are having a huge and historical chance," he said, smiling cheerfully. "At least, Napster should be kept alive for an effective transition to a legal, paid service." He promised that Joel Klein, the former head of the U.S. Department of Justice's antitrust division, whom Middelhoff recently hired, was contacting the rest of the industry players.
After the meeting, Middelhoff ran out of the room, pausing just long enough to grab another handful of Gummi Bears. "I love Gummi Bears," he murmured, as his press secretary scrambled to catch up.
The offer was an obvious publicity stunt -- there was no guarantee Napster would be able to pay those bills, and $200 million was a tiny fraction of what the record companies claimed they stood to lose in sales. But the proposal was also a first salvo on a different front: Washington.
At Barry's suggestion, and after a few calls from Middelhoff, Senator Orrin G. Hatch urged Congress to hold a new round of hearings on digital music. "I was pleased when Bertelsmann took the initiative in harnessing the consumer demand evidenced by Napster," Hatch said on the Senate floor. "I again urge the other major music-industry players to take significant steps toward this end." Suggesting that the other labels were standing in the way of progress, Hatch intimated that Congress might mandate cooperation with Napster.
The other record companies, however, thought little of the proposal. "They need to shut down -- then we can talk," Richard Parsons, co-chief operating officer of AOL Time Warner, told reporters.
The next night, Middelhoff attended the Grammy Awards, where he sat near Parsons and Gerald Levin of AOL Time Warner. "Hey, Dick, great statement," Middelhoff teased. He kept up a resolutely cheerful front at BMG's own party after the awards, but there were signs that his campaign to rehabilitate Napster's image was failing to take hold. A spokesman advised a guest to remove the Napster pin from his lapel, saying, "You don't want to wear that in here." And Middelhoff found himself warmly welcomed into the V.I.P. lounge by a confused partygoer as "the man who put Napster out of business." He nearly spit out his wine.
By the time I met with Middelhoff a few days later, Bertelsmann's rivals were planning new digital jukebox services in an effort to steal Napster's 80 million registered users. AOL Time Warner was creating a service of its own, and Vivendi Universal and Sony Music teamed up to start another, to be called Duet. For one anomalous moment, Middelhoff seemed almost mournful about Napster's predicament. "What is Duet?" he said. "Nobody asked the consumers to know whether they like Duet. What we know is that these people love Napster." The music industry, Middelhoff was convinced, was squandering a rare marketing opportunity by dispersing Napster's millions of fans. "The music industry is killing their own music lovers. They are acting aggressively against the interests of their own consumers. So maybe Napster can't survive all these different circumstances. So what? It is not a problem for Bertelsmann and BMG. Everybody will survive. But the music industry will have made a tremendous mistake, a tremendous mistake. It is shame."
Since then, the struggle over the future of digital music has come down to a kind of media-mogul Realpolitik. Music industry executives all say they plan to license their catalogs of songs to anyone, but in the short term each hopes to use access to its music as leverage to build its own distribution service. Middelhoff holds a valuable card, an archive of copyrights stretching from Elvis Presley to Whitney Houston and Dave Matthews. Bertelsmann's rivals need Bertelsmann's music for their own digital jukebox plans as much as Bertelsmann needs theirs for Napster. And Middelhoff will let his rivals have access to his company's music only if they play ball with Napster. So, for now, it is a standoff.
On April 2, Middelhoff struck a deal that he now calls a crucial victory. Bertelsmann, AOL Time Warner, EMI Group and the Internet company RealNetworks formed a partnership called MusicNet that would pool their music catalogs and develop a common format for digital music. MusicNet will license its catalog to any service that meets security and legality requirements, including Napster, if it pulls off the promised transformation. "This was the breakthrough," Middelhoff told me the next day. "This means that Napster will definitely survive."
n truth, Napster's fate will probably be decided this summer, when all of the companies creating online music services plan to open them for business. AOL Time Warner and RealNetworks are basing theirs on MusicNet's technology and repertory. Sony and Vivendi struck a deal with Yahoo! to develop Duet using another platform and their own songs. With typical bravado, Middelhoff has vowed repeatedly that Napster will convert to subscriptions by July 1 -- If not, it should be shut down," he said.
But people involved say Napster will probably miss that deadline. And many obstacles remain. The lawsuit continues, leaving the threat of liability over Napster's head. It will now have to compete against huge companies with proven track records building online communities. Adding software that tracks usage and protects copyrights may gum up its works. And even if it succeeds, its competitors will be quick to imitate it.
As Napster has blocked access to hundreds of thousands of copyrighted titles, the most popular hits have vanished. What remains are mostly obscure older songs, bootlegs, small indie recordings and world music. The average number of songs available from each user has fallen from 220 in February to just 37 in April, according to the news and research firm Webnoize. The number of files downloaded has fallen from 2.79 billion in February to 1.59 billion in April. Still, the traffic remains high -- close to six million people still sign on every day, and hundreds of thousands volunteered to test an early version of its pay service.
And Napster remains, for the moment, the only contender banking on file-sharing rather than on downloading songs from a central server. That gives it a few distinctions. It provides the sense of interconnection that Middelhoff finds so inspiring; its open system offers a potentially limitless selection of recordings; and passing files directly between users can be more efficient than sending them all the way from a central server.
People around Middelhoff at Bertelsmann assert that his friends from AOL agree in their hearts about the future of file-sharing. But when I asked Case, he did not sound so sure. "The jury is still out in terms of how Thomas's bet on Napster plays out," he said. "A lot of people criticized it, and some still do. There are strong feelings about that at a lot of companies, including among people here at AOL Time Warner."
Was it naive of Middelhoff to think he could use his personal connections with rival media executives to bring them around? "Maybe a little," Case said. "Maybe overoptimistic. But that does not mean it wasn't the right decision to make. Time will tell, but everybody recognizes it was a bold move. A year ago, most people didn't talk about Bertelsmann or have much of an appreciation for it. But Napster has helped Middelhoff put himself on the map and put Bertelsmann on the map. It demonstrated that he had a seat at the table on these issues and he was willing to make bold bets. You know, Babe Ruth was the home-run king, but he struck out a lot."
Far from admitting defeat, Middelhoff is effectively doubling down. In February, he managed to persuade Mohn, whose family foundation owns Bertelsmann, to agree to sell a quarter of the company to the public within four years. The decision, which was a byproduct of a complicated European television deal, will greatly increase Middelhoff's power over Bertelsmann's far-flung divisions. It will also mean investors in the stock market will be scrutinizing Middelhoff's plans, including his scheme for Napster.
Middelhoff says that he is sticking to his instincts, just as he did when he first met Case. "When I did my investment in AOL, most analysts said, 'Oh, my God, this guy's company will be dead very soon,"' he says. "Maybe I am wrong, maybe I am right. I cannot predict how the consumer will react. But even if the judge closed Napster down completely, I have no regrets, because I believe that Napster has 18 months more experience in file-sharing technology. And it has a very powerful brand. If we leverage it, and if we add new content, then we have a realistic chance to be a worldwide brand for peer-to-peer file-sharing across every media. This technology is going to be enormous for the future."
June 10, 2001
Thomas Middelhoff Has a Hunch
By DAVID D. KIRKPATRICK
Thomas Middelhoff, chairman and chief executive of the media giant Bertelsmann, kicked off his crusade to save Napster on the afternoon of Oct. 31 last year in the ballroom of the Essex House hotel on Central Park South. Before a crowd of journalists and camera crews, Middelhoff mounted a dais with Shawn Fanning, Napster's 19-year-old founder. Everyone knew Fanning: the bashful cult hero who had brought free music to the masses, the embodiment of the libertarian ethos of the Internet.
Not many recognized Middelhoff. Forty-seven years old, 6- foot-4, slender and broad-shouldered, he was dressed the part of a buttoned-down media baron -- thick knot in his cream-colored tie, starched collar and dark double-breasted suit. From Bertelsmann's headquarters in Gutersloh, Germany, Middelhoff presides over a media empire that includes the book publishing behemoth Random House; the record labels RCA, Arista and Windham Hill; an international portfolio of newspapers and magazines, including YM and Family Circle; and Europe's largest television studio, radio and television broadcaster, Internet portal and online store.
Speaking in an unmistakably German syntax, Middelhoff announced that Bertelsmann was coming to the rescue of Napster, the music industry's nemesis. The plan was that Bertelsmann would pay Napster $60 million to help convert its free music-sharing network into a fee-collecting subscription service that would pay copyright holders for permission to circulate their songs. Fanning, glancing down shyly and biting his lip, thanked Middelhoff with a Napster T-shirt.
"It looks very good," Middelhoff said, making the most of the unlikely scene. "I have five kids. They would die to get it." Getting a laugh, he hammed it up. "It is XXL." Then he turned to Fanning and opened his arms for a bear hug. To the befuddled audience, it was J.P. Morgan cuddling up to Pretty Boy Floyd, and for a moment even Fanning looked surprised.
Middelhoff met me at the hotel that morning and tipped me off to his bombshell. He clearly got a kick out of my momentary confusion. "Bertelsmann and Napster -- are you surprised?" he asked, leaning back in his chair and letting his long arms dangle to the sides. "Let's be honest," he said with a grin. "Napster is pretty cool."
The essence of Napster is file-sharing, a technology designed to let fans feed off one another's enthusiasm for music. Its users transfer their favorite songs from compact discs to files on their computers, and Napster's software allows other users to scan these collections from afar and copy the music they want directly onto their own hard drives. After a year and a half in business, its vast network of registered users -- more than 37 million at the time the deal was announced -- had digitized an estimated three billion recordings. Fanning and company even added chat rooms and instant messaging to facilitate user bonding.
Middelhoff was almost rhapsodic about the potential for building communities. "When a Napster user is sitting at his PC and he's connected with somebody in Europe or in Latin America or in Asia, then they don't share only the file," Middelhoff said. "They are saying, 'Hey, can you remember when this band performed, and what did you do, did you have your first kiss? And by the way, where do you live?' This was Shawn Fanning's genius."
Even before the ink on his Napster deal was dry, Middelhoff was predicting that Bertelsmann would find a way to apply the file-sharing model to every form of media imaginable, from family photos to video games, digital films and television, even electronic books. Consumers would share anything that could be browsed or disseminated, probably paying a monthly subscription fee to participate.
Plenty of people had tossed around similar ideas for video games or films, but few could figure out how to make money and respect copyright. And none of them were heads of major media companies. But here was Middelhoff, saying that file-sharing would eventually constitute a change in the consumption of popular culture as revolutionary as radio or cable television.
It would also constitute a major strategic coup for Bertelsmann. In exchange for a loan, Bertelsmann received the right to buy a majority stake in Napster later. This would secure a foothold on every user's hard drive. Napster isn't just a Web site that users choose to visit or skip. It is a piece of software users download to their own machines -- the Napster "client" that acts as a gateway to its network the way the Netscape browser is a gateway to the Internet. It provides a direct line to the consumer, through which a company could observe habits and pitch products. That intimate connection is the Holy Grail of the media business, driving Time Warner's merger with AOL, Universal's sale to the French company Vivendi and Rupert Murdoch's pursuit of the digital satellite television company DirecTV.
Of course, domesticating Napster into a legitimate business would require settling its lawsuit and winning the cooperation of Bertelsmann's rivals, including AOL Time Warner and Vivendi Universal. Most people at the record labels were convinced that Napster's principal attraction was giving away their music free.
But Middelhoff promised that Napster would allay those fears by limiting its sound quality, ensuring that users would still buy compact discs. He was confident that through his personal connections, he would be able to persuade his competitors to let Napster use their music once he explained its advantages as a new source of revenue and form of promotion. "I had dinner recently with the heads of the other media and entertainment companies," he told me the morning of the news conference. "They see that file-sharing is going to be a fact."
His powers of persuasion are formidable. I nodded along as he spoke in a torrent of enthusiasm about Napster's power. "Thirty-seven million users can't all be criminals," he said, leaning forward in his seat and staring intently into my eyes. Only after I left did I realize that he had told me next to nothing specific about making this fabulous vision a reality. Wouldn't charging fees alienate Napster's fans? Could he really convince his rivals to settle their suit? How many people actually wanted conversation along with their music?
Since then, the obstacles have only mounted. Neither of the top two executives at Bertelsmann's music division -- BMG Entertainment, which supports the suit against Napster -- attended the show at the Essex House, and over the next few weeks half a dozen BMG executives quietly resigned. (Bertelsmann says they left for other reasons.) Middelhoff's competitors have not settled their suit; instead, they won a court injunction, forcing Napster to pull copyrighted songs from its service. When the other companies announced plans for competing online jukeboxes, newspapers began preparing Napster's obituaries.
But you would never know it from talking to Middelhoff. Sounding more triumphant than ever, he now vows that Napster's new law-abiding, fee-collecting service will open for business this summer, in time to hold on to its franchise.
Middelhoff climbed to the top of one of the most careful and close-mouthed companies in the world through a combination of energetic showmanship, trust in his hunches and appetite for risk. His gambles have not always worked, but his instinct once paid off in a gigantic way -- seven years ago, when he staked his career at Bertelsmann on a partnership with a little-known entrepreneur named Steve Case and his beleaguered start-up America Online. Today, Middelhoff credits that venture with his position at Bertelsmann, and he believes his instincts about Napster are just as good. "When I saw file-sharing, I knew, Wow, this is now a phase of the Internet," he says. "I was convinced that Napster would be a big business just like I was convinced that AOL would be a big business -- because I knew it."
Middelhoff cultivates the image of a kind of goofy Superman. The first thing anyone notices about him is his remarkable pace, partly because he brings it up. He spends more than half his time jetting around the world, and he often talks of his frenetic travels as a kind of competitive athletic achievement. Sitting down at a meeting this winter in San Francisco, just moments after an all-night flight from Gutersloh, Middelhoff passed a note of mock concern to a colleague: "You look tired."
A few years ago, he made an agreement with his wife and five children to spend at least one day a weekend with them on their farm outside Gutersloh, but he has not been able to keep it. Wherever he is, he rises every morning at 5:45 to swim and work out, then begins returning e-mail by 7:15 and stops working around 10:30 p.m.
When he checks into a hotel, he carries his own bags, talking all the while on a hands-free cell phone. His long strides carry him so fast that his aides skip steps to keep up. In his suite of offices overlooking Times Square, he races from room to room, checking e-mail messages in one and dropping into meetings in another. In between, he raises his hand and calls out "Espresso!" which one of his secretaries instantly fetches. He is an avid skier and tackles the slopes the same way he handles the rest of his business: plunging straight down, immediately on his cell phone again for the trip up the lift.
Middelhoff's most memorable trait, however, is not his speed but his laugh -- a toothy guffaw that is a striking contrast to his otherwise courtly demeanor. He uncorks it even in formal settings, giving the disarming impression that you are old friends the first time you meet. He has an earnest faith in his own charisma and its power to motivate others. Last summer, he rented out Radio City Music Hall to introduce himself to Bertelsmann's 4,500 U.S. employees. He strode onto the stage before two video images of himself and threw his sport coat into the audience like a pop star. "Do you have passion?" he implored. "I love Bertelsmann. I would die for this company."
But the effect is leavened by a constant shtick, a penchant for laughing at his own grandiosity. Before the crowd at Radio City, he played a video starring some of his top executives. Strauss Zelnick, then head of Bertelsmann's music division, appeared on-screen, seemingly responding to Middelhoff's idea for Whitney Houston's next single to be a duet. "You singing with Whitney, Thomas?" Zelnick said, snapping a pencil in mock exasperation. Dan Brewster, head of Bertelsmann's magazine division, held up a prototype of YM's cover, with Middelhoff's head affixed to the body of Britney Spears in a bathtub of diamonds. To dramatize Bertelsmann's new thinking about the Internet, Middelhoff has begun appearing in German television commercials in a "Star Trek" uniform, with the slogan "We Pursue Big Ideas -- No Matter Where They Lead Us."
Middelhoff traces that new thinking back to Nov. 2, 1994, the day he first met Steve Case. It was probably the most formative event in his adult life. At the time, AOL was desperate for cash, but Case showed no sign of weakness. Instead, he boldly promised that one day AOL would dominate the market for consumer online services, and he eventually offered an apparently lopsided deal: for Bertelsmann to put up all $150 million for a joint European venture but give AOL a 50 percent stake for its expertise. He also insisted that Bertelsmann buy a stake in AOL.
Middelhoff saw the "stickiness" in AOL's consumer-friendly features, and it was the businessman's equivalent of love at first sight. "We had dinner, and after the dinner it was clear for me, I have to do it with this company," Middelhoff recalled. "I trusted him immediately." Middelhoff agreed to finance AOL Europe and to buy a 20 percent stake in AOL for $200 million. Bertelsmann's board, however, was outraged at the expense, and he reluctantly scaled back the deal to a 5 percent stake for $50 million.
Middelhoff describes his personal debt to Case with a remarkable ingenuousness, and he waxes nostalgic about his time spent on AOL's board. "I changed tremendously over these six years," he said. "I learned a lot about the Internet and so on, but also it changed my personal style, the way I am seeing the world. Before then, I was much more of a typical German business executive, but now I believe myself to be a real mixture: first American and then European."
For his part, Case, who is actually five years younger than Middelhoff, describes his development the way an older brother might. "I think what he takes away from the AOL experience is that a company took some bold bets at a point when basically everybody was criticizing them, stuck with those bets through a lot of ups and downs and created a significant new franchise."
As AOL's business exploded, the many naysayers on Bertelsmann's board began to rue the decision to limit their investment to 5 percent instead of 20 percent, and Middelhoff's stock at the company began to rise. Mark Wossner, his predecessor as Bertelsmann's chairman, insists that Middelhoff was picked to succeed him before the AOL partnership bore fruit. But it is a measure of Middelhoff's admiration for Case that he openly credits him with his own success. "It's not only a joke when I say, 'Thanks to the success of AOL and thanks to Steve, I got my chairman's position at Bertelsmann."'
As chairman, Middelhoff began to implement some of his lessons from America Online. For one thing, he began throwing open-collared shirts into his rotation of dark suits. He did away with the longstanding custom of addressing Bertelsmann executives as "Herr Doctor" in deference to their business degrees. He lectured executives on the importance of "low hierarchies, direct communication, direct access" and bought each of Bertelsmann's 74,000 employees a personal computer. He changed the official language for internal business from German to English. ("We are not a German company -- we are an international company," Middelhoff often repeats.) Again and again, executives at the company say, he admonishes them, "Yes, this is just like what Steve Case did at AOL. . . . "
"I am sure everybody at Bertelsmann hates me because of all of Thomas's stories," Case said. "But that is O.K. My sense is that I am used there as a kind of device to create change."
Middelhoff likes to say that he is importing American political values as well. After the European press unearthed evidence that Bertelsmann printed Nazi propaganda during World War II and then lied about it for decades, Middelhoff persuaded Reinhard Mohn, patriarch of the family that has controlled Bertelsmann for 166 years, to create an independent commission of historians to expose the truth.
His outspokenness about Bertelsmann's past has sparked its own controversies. Last month, Middelhoff became the first German ever honored by the Jewish U.J.A.-Foundation, which gave him its Steven J. Ross humanitarian award. His selection drew angry complaints from many Holocaust survivors, and he apologized for not anticipating the problem.
Perhaps the most significant lesson Middelhoff took away from AOL was that the Internet was fundamentally altering the media world, faster even than anyone predicted, and that now was the time for empire building. As AOL's stock soared, Middelhoff began to bet again on the next big idea. He tried unsuccessfully to buy Amazon.com, then poured money into a host of online stores, including CDNow.com, the joint venture BarnesandNoble.com and Web sites for Bertelsmann's book and music clubs. Like most online retailers, Bertelsmann's have yet to make profits. The company sank more than $300 million into Bol.com, which Middelhoff acknowledges was a big disappointment. Bol.com was recently folded into Bertelsmann's book and music clubs, and a third of its staff was laid off.
In 1999, however, when Middelhoff decided to sell Bertelsmann's stakes in AOL and AOL Europe, his timing was impeccable. It was the peak of the tech-stock boom, and Bertelsmann's $50 million investment in AOL had increased some 28 times in value, to $1.4 billion. AOL bought back Bertelsmann's stake in AOL Europe for about $8 billion. With the partial disposition of its other Internet investments, Bertelsmann was left with a war chest exceeding $16 billion. In four years, Middelhoff had more than doubled the size of one of the biggest media companies in the world.
Case elected to take advantage of his soaring stock price as well, by acquiring Time Warner, Bertelsmann's main rival, which meant that Case and Middelhoff were now officially competitors. "It is a little strange," Case admitted. "But you have to remember, the competition is about business. It isn't personal."
Middelhoff maintains that the companies compete only in isolated arenas, like music or magazines in the United States. "If we are in some sense competitors, O.K., then we compete, but fair," Middelhoff said. "I believe that today we are best friends."
n Feb. 12, Middelhoff's bold vision for Napster became a fight for its survival. A United States appellate court approved the record industry's request for a preliminary injunction, restricting Napster's use of copyrighted songs. Middelhoff had just arrived home in Gutersloh at 10:45 p.m. when Hank Barry, Napster's interim C.E.O., called with the news. Over the next two hours, Middelhoff decided on a response: Napster would take its case to the public in a news conference in San Francisco, the day before the Grammys, and he would fly over to lend the force of his personality to the cause.
The morning of the event, Hilary Rosen, president and C.E.O. of the Recording Industry Association of America, screamed at Barry over the phone, demanding that he call it off. But Middelhoff was already in the air. As the news conference began, he sat chewing candy and genially reached over to fix Shawn Fanning's collar. First, Barry laid out a proposal: if the industry would settle its lawsuit, Napster would promise to pay the music companies a total of at least $200 million a year as a kind of deposit on income from Napster's planned subscription revenue.
Then Middelhoff took the microphone, beginning his remarks with an account of his overnight flight. "We all together are having a huge and historical chance," he said, smiling cheerfully. "At least, Napster should be kept alive for an effective transition to a legal, paid service." He promised that Joel Klein, the former head of the U.S. Department of Justice's antitrust division, whom Middelhoff recently hired, was contacting the rest of the industry players.
After the meeting, Middelhoff ran out of the room, pausing just long enough to grab another handful of Gummi Bears. "I love Gummi Bears," he murmured, as his press secretary scrambled to catch up.
The offer was an obvious publicity stunt -- there was no guarantee Napster would be able to pay those bills, and $200 million was a tiny fraction of what the record companies claimed they stood to lose in sales. But the proposal was also a first salvo on a different front: Washington.
At Barry's suggestion, and after a few calls from Middelhoff, Senator Orrin G. Hatch urged Congress to hold a new round of hearings on digital music. "I was pleased when Bertelsmann took the initiative in harnessing the consumer demand evidenced by Napster," Hatch said on the Senate floor. "I again urge the other major music-industry players to take significant steps toward this end." Suggesting that the other labels were standing in the way of progress, Hatch intimated that Congress might mandate cooperation with Napster.
The other record companies, however, thought little of the proposal. "They need to shut down -- then we can talk," Richard Parsons, co-chief operating officer of AOL Time Warner, told reporters.
The next night, Middelhoff attended the Grammy Awards, where he sat near Parsons and Gerald Levin of AOL Time Warner. "Hey, Dick, great statement," Middelhoff teased. He kept up a resolutely cheerful front at BMG's own party after the awards, but there were signs that his campaign to rehabilitate Napster's image was failing to take hold. A spokesman advised a guest to remove the Napster pin from his lapel, saying, "You don't want to wear that in here." And Middelhoff found himself warmly welcomed into the V.I.P. lounge by a confused partygoer as "the man who put Napster out of business." He nearly spit out his wine.
By the time I met with Middelhoff a few days later, Bertelsmann's rivals were planning new digital jukebox services in an effort to steal Napster's 80 million registered users. AOL Time Warner was creating a service of its own, and Vivendi Universal and Sony Music teamed up to start another, to be called Duet. For one anomalous moment, Middelhoff seemed almost mournful about Napster's predicament. "What is Duet?" he said. "Nobody asked the consumers to know whether they like Duet. What we know is that these people love Napster." The music industry, Middelhoff was convinced, was squandering a rare marketing opportunity by dispersing Napster's millions of fans. "The music industry is killing their own music lovers. They are acting aggressively against the interests of their own consumers. So maybe Napster can't survive all these different circumstances. So what? It is not a problem for Bertelsmann and BMG. Everybody will survive. But the music industry will have made a tremendous mistake, a tremendous mistake. It is shame."
Since then, the struggle over the future of digital music has come down to a kind of media-mogul Realpolitik. Music industry executives all say they plan to license their catalogs of songs to anyone, but in the short term each hopes to use access to its music as leverage to build its own distribution service. Middelhoff holds a valuable card, an archive of copyrights stretching from Elvis Presley to Whitney Houston and Dave Matthews. Bertelsmann's rivals need Bertelsmann's music for their own digital jukebox plans as much as Bertelsmann needs theirs for Napster. And Middelhoff will let his rivals have access to his company's music only if they play ball with Napster. So, for now, it is a standoff.
On April 2, Middelhoff struck a deal that he now calls a crucial victory. Bertelsmann, AOL Time Warner, EMI Group and the Internet company RealNetworks formed a partnership called MusicNet that would pool their music catalogs and develop a common format for digital music. MusicNet will license its catalog to any service that meets security and legality requirements, including Napster, if it pulls off the promised transformation. "This was the breakthrough," Middelhoff told me the next day. "This means that Napster will definitely survive."
n truth, Napster's fate will probably be decided this summer, when all of the companies creating online music services plan to open them for business. AOL Time Warner and RealNetworks are basing theirs on MusicNet's technology and repertory. Sony and Vivendi struck a deal with Yahoo! to develop Duet using another platform and their own songs. With typical bravado, Middelhoff has vowed repeatedly that Napster will convert to subscriptions by July 1 -- If not, it should be shut down," he said.
But people involved say Napster will probably miss that deadline. And many obstacles remain. The lawsuit continues, leaving the threat of liability over Napster's head. It will now have to compete against huge companies with proven track records building online communities. Adding software that tracks usage and protects copyrights may gum up its works. And even if it succeeds, its competitors will be quick to imitate it.
As Napster has blocked access to hundreds of thousands of copyrighted titles, the most popular hits have vanished. What remains are mostly obscure older songs, bootlegs, small indie recordings and world music. The average number of songs available from each user has fallen from 220 in February to just 37 in April, according to the news and research firm Webnoize. The number of files downloaded has fallen from 2.79 billion in February to 1.59 billion in April. Still, the traffic remains high -- close to six million people still sign on every day, and hundreds of thousands volunteered to test an early version of its pay service.
And Napster remains, for the moment, the only contender banking on file-sharing rather than on downloading songs from a central server. That gives it a few distinctions. It provides the sense of interconnection that Middelhoff finds so inspiring; its open system offers a potentially limitless selection of recordings; and passing files directly between users can be more efficient than sending them all the way from a central server.
People around Middelhoff at Bertelsmann assert that his friends from AOL agree in their hearts about the future of file-sharing. But when I asked Case, he did not sound so sure. "The jury is still out in terms of how Thomas's bet on Napster plays out," he said. "A lot of people criticized it, and some still do. There are strong feelings about that at a lot of companies, including among people here at AOL Time Warner."
Was it naive of Middelhoff to think he could use his personal connections with rival media executives to bring them around? "Maybe a little," Case said. "Maybe overoptimistic. But that does not mean it wasn't the right decision to make. Time will tell, but everybody recognizes it was a bold move. A year ago, most people didn't talk about Bertelsmann or have much of an appreciation for it. But Napster has helped Middelhoff put himself on the map and put Bertelsmann on the map. It demonstrated that he had a seat at the table on these issues and he was willing to make bold bets. You know, Babe Ruth was the home-run king, but he struck out a lot."
Far from admitting defeat, Middelhoff is effectively doubling down. In February, he managed to persuade Mohn, whose family foundation owns Bertelsmann, to agree to sell a quarter of the company to the public within four years. The decision, which was a byproduct of a complicated European television deal, will greatly increase Middelhoff's power over Bertelsmann's far-flung divisions. It will also mean investors in the stock market will be scrutinizing Middelhoff's plans, including his scheme for Napster.
Middelhoff says that he is sticking to his instincts, just as he did when he first met Case. "When I did my investment in AOL, most analysts said, 'Oh, my God, this guy's company will be dead very soon,"' he says. "Maybe I am wrong, maybe I am right. I cannot predict how the consumer will react. But even if the judge closed Napster down completely, I have no regrets, because I believe that Napster has 18 months more experience in file-sharing technology. And it has a very powerful brand. If we leverage it, and if we add new content, then we have a realistic chance to be a worldwide brand for peer-to-peer file-sharing across every media. This technology is going to be enormous for the future."
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