e.Digital Corporation (fka EDIG)

[culater33]

I got music, I got algorithm
How does a startup with a strong technology form needed partnerships with major record labels? Very carefully.
By Michael Parsons
May 9, 2002

Shazam entertainment's service will be ideal for the kind of music fan who gets into arguments in bars about whether what's playing on the jukebox is, say, the original cut by Gladys Knight and the Pips or a nasty modern rip-off. The service will let mobile phone users in the United Kingdom identify songs they hear in public places: when users call the service, it will identify the recording they're listening to and send their phones a text message with the title of the track and the name of the artist who recorded it. And for those who want to spread the soulful majesty of "Midnight Train to Georgia," they'll be able to forward a 30-second audio clip of the track to their friends, along with a text message.


This service allows a mobile phone user to identify a tune as if she were an experienced DJ. Shazam bills it as magical, hence the company's name. Founded in 2000 by CEO Chris Barton, the London-based company has attracted $7.5 million in venture funding from IDG Ventures Europe, Lynx New Media Ventures (a joint venture of Bear Stearns and the Virgin Media Group), and Belgium's FLV Fund.

Shazam plans to launch the service this spring. It expects at least two U.K. mobile operators to offer it as a premium service.

The technology behind the service is proven, but the young company still needs to tackle a very different issue: winning approval from the major music labels in order to exploit the commercial potential of the service. At press time, Shazam was negotiating with major labels, but had yet to secure a commitment.

THE SORCERER'S PHONE

Shazam's "magic" happens through a pattern recognition-software algorithm developed by Avery Wang, the company's chief scientist. The algorithm picks out the salient characteristics of the song, or its "fingerprint," and then matches that fingerprint against a music database. The company's algorithm pares the musical sample down to the barest information needed to make a positive identification, which speeds the processing time to get a match and minimizes storage requirements.

For Shazam's service to be effective, it needs a database that contains most of the music that users are likely to hear in public: the modern urban soundtrack of shops, bars, clubs, and pubs. Shazam says its service could accurately identify most songs if its initial database contained 40,000 or so titles--about the same number of songs that could be found at one of the U.K.'s largest music stores, like a Virgin Megastore.

The company is scanning tracks into the database according to sales figures, entering the most popular songs first. Given the surprisingly small number of tunes that are ubiquitous at any one time, first scanning in only the most popular music means that--despite having only some 10,000 songs in its database--the service can be extensively tested well before its official launch. The scanning will continue in order to keep Shazam up to date and to expand its database. Building the database is one challenge; building a business from it is another.

A premium wireless information service like Shazam's works by keeping people on the phone. Forwarding 30-second music clips could easily drive up call times. And mobile phone operators can charge extra for a service like this. In the United Kingdom, for example, callers are charged 75 cents a minute for calls to directory assistance.

The labels are interested for their own reasons. They are keen to find new ways of getting music in front of consumers, and because word-of-mouth recommendations are extremely powerful in driving music sales, they see this as a potentially strong marketing platform. They wouldn't mind at all if Shazam-like services took off, and U.K. consumers (who buy more music per head than consumers in any other country) start recommending music to each other over their mobile phones. Ronnie Planalp, EMI-Europe's senior vice president for new media, describes Shazam as "a really cool development." And Blair Schooff, director of new media at BMG, says the company is "one of the smartest to come to the table."

Despite the interest in the service, it seems that no one knows how to value it. Premium mobile phone services in the United Kingdom are normally a three-way split between the operator, the service provider, and, as always, the tax collector. For example, if a horoscope service earns $100 in call charges, $17 would go to the government for value-added tax, and the remaining $83 would go the mobile operator and the service operator. If the horoscope service splits revenue with the operator down the middle, the service would have about $40 to pay for expenses like new horoscope software, a computer network, leased line connections to the mobile operators, and rights to copyrighted horoscope predictions. If the service had to pay a "Zodiac Rights Body" 15 percent, or $15, to license its intellectual property, then the service would soon be out of business. But if it paid the rights body only 5 percent of revenue, then the service would see prosperity rising.

Cutting such a low-percentage deal matters to Shazam. One benchmark Shazam can use in negotiations is the 5 percent in royalties that radio stations in the United Kingdom pay on their revenue for the right to play a label's music. The labels, aware of their clout, naturally want more.

Five entertainment giants--BMG Entertainment, EMI Recorded Music, Sony Music Entertainment, Universal Music Group, and Warner Bros. Music--control between 70 and 80 percent of music sold worldwide. In the United Kingdom, music-rights negotiations are typically handled by industry bodies like the Mechanical-Copyright Protection Society, which administers rights for copying and reproducing the work, and the Performing Right Society, which collects the royalties for broadcast, cable, and public performances of the work.

At the moment, these organizations don't have mandates to manage anything as vague and newfangled as online music rights. To address this, the major U.K. labels, as well as the Association of Independent Music (AIM), which represents the United Kingdom's 500 or so independent record labels, have established their own new-media groups to negotiate rights with startups like Shazam.

LONDON CALLING

For Philip Inghelbrecht, director of business development at Shazam, it isn't quite as simple as meeting with the head of new media at a particular label. "In reality, you speak to everyone: artist and repertoire, publishing, promotion, and marketing," he says. "The record business is very decentralized." And in the United Kingdom, the local offices of the big five need to get sign-offs from their corporate masters back home. "Typically, the end responsibility goes back to the U.S.," he adds.

But before Shazam can persuade anyone to make that call to Los Angeles, the company must prove to them that the service works. One executive of a major label tested Shazam's service on his own office CD collection--15 times in a row. "There is a sense that what we're doing is slightly unbelievable," says Mr. Barton. "So that does create an extra hurdle." Moreover, music executives have had far too many meetings with promising startups that haven't been able to make any money for either themselves or the labels.

Shazam, however, could help promote the labels' music and thus boost their revenue. And if it could strike the right deal, Shazam could make money for itself. "The record labels like Shazam, and they want it to happen; they don't want the company to go out of business," says Mr. Inghelbrecht. "The struggle I have is to first make sure that Shazam survives."

The figures that the labels and Shazam are discussing are too sensitive for either camp to divulge. Shazam's strategy, in part, is to present a classic elevator pitch: invest in the service, and take a small cut that builds a big company. "Shazam is looking for a rate that lets them stay in business," says BMG's Mr. Schooff. "Obviously, so are we."

ENTERTAINMENT VALUE

Shazam needs investors and partners to agree on the future value of its business. Throw in music rights as well, and the situation gets complicated fast.

The physical limitations of radio, television, and live performance have been built into a common understanding of their associated rights. But ubiquitous digital formats mess all this up, which means rights holders have to work out new ways of valuing their intellectual property. This can be a bit of a minefield.

"You still speak to people who say, 'I've bought the CD, why can't I put it up on my Web site?' Or they say that music is too expensive," says Gavin Robertson, general manager of new media at AIM. "To which I usually reply that they must have bought a lot of music they didn't like. Only CDs you don't like are too expensive."

Shazam is anything but naÔve when it comes to understanding the value labels place on their songs. Two former executives from EMI are closely involved in Shazam: Colin Southgate, an angel investor and former executive chairman of the EMI Group, and Jeremy Silver, an adviser who used to be EMI's vice president of new media in Los Angeles.

KNOW YOUR RIGHTS

The basic problem that Shazam faces is determining what music-rights protections, if any, are applicable to its service. The two areas that music-rights holders are most keen to protect are the rights to use their content for entertainment and for distribution; these are areas that Shazam is eager to avoid. "We view our service as 100 percent promotional," says Mr. Inghelbrecht. "We're not distributing anything."

Mr. Barton says his service's basic fingerprinting process doesn't require music rights at all, because there is good precedent in the media-monitoring services, which are used to track radio airplay. However, Shazam does need rights in the United Kingdom to use 30-second clips, and it sees other marketing opportunities that could be exploited by working closely with the music industry.

As the labels and Shazam circle each other, they recognize that the result of their efforts could be a bridge between existing cultural assets and new technologies. Shazam has worked hard to position its technology as a complement, rather than a threat, to music-rights owners. The company understands that it is the music, not clever software, that will draw consumers to its service. In doing so, it has avoided the mistake made by other Internet music ventures, like, say, Napster.

"The biggest problem is that people devalue our product," says Mr. Schooff of BMG. "They don't see that the content is the linchpin that makes their business run." Or, as Ms. Planalp from EMI-Europe puts it, "We are often educating startups that content isn't free."

Ms. Planalp estimates that a relatively straightforward deal between EMI and Shazam could happen within three months. Mr. Inghelbrecht is eager to get a deal, but he admits, "I don't really know the answer. Everyone says two to three months. I don't expect it to go on into 2003."

There is a certain irony to this situation. The music industry is highly consolidated. With only five companies controlling almost all the world's music markets, one would think that they could all get together and agree on some way to value digital music in various formats.

A single rights agreement would make life a lot easier for Shazam. However, antitrust concerns make this unlikely. If the big five were to agree on a graceful business model for providing digital rights to their back catalogs, they essentially would have gone into business together; and one man's responsible market coalition is another man's corrupt cartel. "We feel as if we are damned if we do and damned if we don't," says Ms. Planalp.

"All of us would agree, if we were putting ourselves in the shoes of the consumer, that we would like to make available to the consumer the balance of all music," says Mr. Schooff. "We are all looking forward to the time when you can come to one shop front."

For now, Sony, Universal, and EMI have collaborated on the online subscription service Pressplay, and Warner, BMG, and EMI are collaborating on MusicNet, a similar service.

Napster's legal defeat demonstrated to the record labels the amazing public interest in having a variety of ways to interact with music, but it also showed that incumbent intellectual-property holders are not going to let others pick their pockets. Most important, however, it illustrated the power of partnerships, particularly in a tightly knit industry.

By treading softly, Shazam has manifested the savvy needed to form alliances. Moreover, it is eager to neutralize contentious licensing issues and work with the music establishment to help the industry reach new consumers. Shazam has won the support of music business insiders, like Mr. Southgate, who have the right contacts. He is more than capable of reaching out to someone like Ms. Planalp, who is no stranger to tech startups herself, having worked previously in business development at the Internet portal Excite.

As the service prepares for a launch late this spring, relationship building from London to Los Angeles will remain a priority. "The music industry is still pretty much about people with little black books," says Mr. Robertson of AIM. "If you recruit somebody with a little black book, half your problems will be solved."

Write to Michael Parsons.
http://redherring.com/vc/2002/0509/2759.html
culater