THE FORUM ON TECHNOLOGY & INNOVATION

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DIGITAL AUDIO:

WHO OWNS THE MUSIC?

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WEDNESDAY,

OCTOBER 20, 1999

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This transcript was produced from a tape provided by the Council on Competitiveness.A-G-E-N-D-A

SPEAKER: PAGE:

Welcome and Opening Remarks by

Peter W. Rooney, Executive Director

Council of Competitiveness 3

Introduction of Topic (Digital Audio,

Who Owns the Music?) and Presenters by

Senator Bill Frist. 5

Presentations:

Robert Kohn, Founder & Chairman,

EMusic.com 10

J.D. Heilprin, Executive Vice President,

RioPort.com. 25

Hilary Rosen, President & CEO,

Recording Industry Association of

America 33

Roundtable Discussion and Q&A 47 P-R-O-C-E-E-D-I-N-G-S

(12:15 p.m.)

MR. ROONEY: It's my pleasure to welcome you here today to another briefing of the Forum on Technology & Innovation. We're delighted you all could come. These briefings are brought to you by generous grants from the W.K. Kellogg Foundation, the Alfred P. Sloan Foundation, and the David and Lucille Packard Foundation, and we're very, very grateful for their support.

Today's format as usual is very simple. The two senators will briefly describe the topic and then introduce our featured speakers all at once, and each speaker will have ten minutes to tell you their view of the digital music revolution, and then the senators will open the floor to your questions and moderate the ensuing round table discussion.

We have briefing packets that all of you have picked up today, and there's a couple of items in there that I want to draw your attention to. During the question period we do have one floor mic, but because we're in such a tight space today, we're going to try something different. We have a portable microphone and the forum staff will be handing this out to you in the audience. If you're ready to ask a live question, and we very much encourage that, please raise your hand and we'll get this microphone to you.

As always we're here and the senators are here for the congressional staff and we give them priority at the microphone. So, we ask our other guests to refrain from asking questions until the staff have had a chance to do so. We give staff the privilege of anonymity, but any of the rest of you who ask a live question, members of the press, public or administration officials, we ask you to identify yourselves first so that the speakers know where you're coming from. It helps them address your question.

We also have, for those of you who are congenitally shy, we have question cards, these green cards that are in the front of your briefing packet. You can fill these out while the speakers are speaking. If you hold the card in the air, our staff will collect them from you, bring them up to the senators and the senators will ask questions on your behalf National Press Club style.

We do a mix of live and written questions but we really like to have, especially you congressional staffers, to get up and ask a question, it makes it much more interesting for us and much more interesting for the speakers.

Finally, we have in your packets these blue evaluation forms. We care very much about what you think. Your input helps shape these events. We need to hear form you.

There's really two things that we ask from you. We ask for you to participate in the discussion. It makes it much more lively and interesting for all concerned. And we ask you to give us your feedback. We love to hear from you. We want to hear what you think about the speakers and we'd love to have your suggestions, always, for new topics and new speakers. We're here for you and we want to make this work for you.

Senator Rockefeller, I understand, may be a few minutes late. We're going to get started.

Senator Frist is going to introduce the topic now. Thank you.

SENATOR FRIST: Thank you and welcome to everybody to our Forum on Technology & Innovation, ‘Digital Audio, Who Owns the Music?’.

As all of you know we keep these fast-paced, we keep them moving. We do like interaction. You hear a minimum from the United States senators for our panelists here today and for those of you in the audience. Basically we're here to facilitate, keep things moving, to learn, and it's a format that has proven it works at the end of an hour and a half. We do pretty much start on time and we are out on time.

At the end of that hour and half, we'll all leave here a little bit -- I think we going to be a little bit smarter than when we came in. I'm sure that I will, and it's a great, I believe, purpose and format that we have which seems to work.

Digitized sound recordings have been widely available since the introduction of the compact disc about 20 years ago, but the ability to distribute the digital music files over the Internet is relatively new.

I'm not an expert but, I, like so many of you, have children; and every time you come home in the afternoon or in the evening or late at night your child is there at the computer playing, exploring and it is very clear just through those observations of the revolution that we are touching upon, but which we as public policy agents, I believe, have a real responsibility to stay out of the way but also facilitate the integration of this technology as it comes forward.

The personal computer which today are increasingly inexpensive, the faster Internet connections, the broad band, the compression technologies, all make it possible to conveniently download digital music files.

Although the market itself, as we'll hear today, is fairly small, all of us know that it is in almost expotential growth. It will grow increasingly rapidly as digital hardware and software achieve greater penetration in this country and around the world.

Most observers today agree that electronic distribution of music will compete effectively with the existing physical distribution system and many believe, and we'll hear more about that today, that it may well supplant it.

Digital music is interesting from a policy perspective, because it really is a case study in all of the challenges that we have with the emergence of computer technology, information transfer, and e-commerce.

To date, we don't have a secure user-friendly system to protect the intellectual property rights for electronically distributed digital content; and we don't have a standardized secure payment system.

And the Internet doesn't recognize the geographic boundaries we're accustomed to or the jurisdictional boundaries that we are accustomed to.

Widespread distribution of digital music is frustrated by a web of competing laws, laws that are on the book today, and definitions, for example, with copyright protection and license.

As we enter upon this era of greater and greater bandwidth, of greater compression ability and capability and technologies, as all of these become more and more available, Internet distribution of digitized content will threaten in many ways the existing distribution systems for other industries, motion pictures, broadcast entertainment.

The manner in which the digital music revolution evolves could have profound consequences on our understanding, on our society, especially in cities such as my own, Nashville, Tennessee, where country music so dominates the local commerce of our community of that part of the state, but also as it spreads across this country and the world.

Now, we're fortunate today in having three outstanding panelists to help us understand many of the complexities that I have mentioned, plus expand our understanding of where we are today, where we are going, where we should be going.

Robert Kohn is Founder and Chairman of EMusic.com, one of the leading distributors of digital music over the internet. He is a seasoned high tech executive, a member of the California Bar, co-author of the 1500 page book, Kohn on Music and Licensing, a Practical Guide to Business and Legal Issues in the Music Industry. He has served as chief legal counsel for a number of West Coast software firms, including Pretty Good Privacy, Inc., Borland International, and the Ashton Tate Corporation.

J.D. Heilprin is Executive Vice President of RioPort, Inc., a leading player in the digital music revolution. He is responsible for overseeing the design and implementation of RioPort's internet strategy and played a leading role in securing RioPort's partnership with MTV Networks On Line.

Prior to joining RioPort, he was Vice President of Media and Entertainment at IXL and held positions at Creative Artist Agency, Western International Media, and Interactive Network.

Hilary Rosen is President and CEO of the Recording Industry Association of American, where she has been a leader in the industry's efforts to create a marketplace for digital music, while protecting the rights of artists and music producers.

She spearheaded the creation of the Secure Digital Music Initiative, a forum of music and technology companies that is developing a platform for secure digital music delivery.

We have asked, again in the interests of time and so we can maximize discussion, for each of our speakers to do their very best to limit their comments to about ten minutes. And then, as you heard, we'll have a round table discussion and we'll want to hear from as many of you as possible.

With that, the option is either to speak from where we are today, or you're welcome to go to the podium. I don't know, can you see in the back or would you rather people go to the podium? Is there any preference?

MR. ROONEY: We always get comments that they prefer to have people speak from the podium.

SENATOR FRIST: Okay, let's go to the podium, if we can. That way, people in the back will be able to see you.

Why don't we just go straight down and, Robert, begin with you and we'll come across the table.

MR. KOHN: I am a lawyer by trade, but being in high tech for so long, you had to, you know, put together some slides. So I'll just turn to my first slide quickly. There we go. All right. It's the first try. Two more slides. All right, I've brought an outline of the presentation. I always try to get a laugh, you know, just trying. It's the entertainment business, right?

Anyway, I'm going to discuss introducing music in our business model, share our perspective on the changing music industry and digital download.

I hope I'm not blocking the screen for too many of you.

I'll discuss some public policy issues and make some predictions.

So who am I? I think I've been introduced. I was an entertainment lawyer back in the early '80s. I worked for this guy, Mickey Ruden (phonetic sp.) who represented Frank Sinatra, Liza Minnelli, Cher, some TV producers and Warner Brothers Music.

I was a corporate lawyer for Ashton Tate. I was General Counsel for Borland, and co-author of a book with my father who is 80 years old today and five years ago he was about to fall into the public domain when Congress kindly granted him another 20 years. So, thank you, Congress.

All right, and I was at Pretty Good Privacy, which as many of you know, is a leading encryption software on the internet.

The MP3 phenomenon started in universities. I don't know whether many of you have seen it. I'm going to do a short, short demo. The kids were taking their CDs, their music CDs, popping it into their computers and then using what's called ripper software to take the zeros and ones off the tracks of the CD, laying it out into their hard disk, which was a 40 megabyte file of data, but that's too big and unwieldy, 40 megabytes, so someone came up with a compression technique that eliminated all the zeros and ones that the human ear can't hear and it was called MP3.

Simply, all MP3 is is a computer algorithm that eliminates the zeros and ones that the ear can't hear. So then you reduce the 40 megabytes using the software to 3-1/2 megabytes, like 11 to one, and now 3-1/2 megabytes is manageable. Because you can take that, download it off the Internet on a 56K modem in seven minutes or in a T1 line in like 20 seconds.

And once it's on your computer, I'll quickly show something called "Win.Amp" (phonetic sp.), which AOL just purchased, and I don't have this hooked up, but it's "Hey Jude" is playing on my computer off of my hard disc. It's simply an MP3 file and this is a play list on the side.

It looks like a boom box and a play list on the other side, and you just double click or let it play, and this is an artist that we're going to have on our web site, Brie Sharp singing a song called "America." I've got to promote, right?

And our web site -- I have ten minutes, so I'll go quickly and get this out of there.

(Laughter)

MR. KOHN: Our web site looks something like this. It's not terribly in focus, but you go to EMusic.com and you might click on a file, like Bush was selling a track, "Chemicals Between Us." You go on the web site, you click on that, it opens up three screen, 99 cents a track, $8.99 an album. You click on it. If your credit card is in, it will show you a screen and it will charge your credit card instantaneously like in eight seconds, and allow you to download the file to the hard disk of your computer where you just play it just the way I just showed you.

So back to the show. All right? So now kids were ripping their tracks and then encoding it in MP3 and then posting it on the Internet in FTP files, whatever, and using search engines to find illegal MP3 files. Madonna.MP3, you go find the illegal files and you download it off the Internet.

And MP3 became, because of this, the second most popular search term on the Internet, if using Yahoo or Alta Vista, the second most popular after the word, "sex." I'm not even going to mention what the next nine were or the next eight were.

And there are 20 million of those Win.Amp players and now Real Networks came out with Real Jukebox, something called "Real Jukebox" to play those MP3 files.

And the latest thing are these portable devices, like this one is the Rave Player by Century Science where now through a little cable from your computer --

PARTICIPANT: He's got something that he didn't even show you.

PARTICIPANT: He's got a Rio.

MR. KOHN: All right, I've got a Diamond Multimedia Rio too, okay.

(Laughter)

MR. KOHN: But we're giving away these free on our web site --

(Laughter)

MR. KOHN: If you purchase $50 worth of music, we'll send you this for free. It's about a $169 device. It's just that they offered us a better deal than Rio, but if they bring their price down, we'll be happy to give away theirs for free too.

(Laughter)

MR. KOHN: So anyway, you transfer your MP3 file from your hard disk through your parallel port into this and again it will play just like you heard here and you just have earphones and you can go jogging. There's no moving parts here. It's a flash memory device. This just simply has a chip in it and the music goes into a chip and it will hold, like, right today, about 64 minutes of music, and these guys will make announcements showing that you can hold a lot more music in this.

Someday, in maybe two years, you can have your entire CD collection in one of these, which is pretty amazing. Okay, so you got the portable players.

What is EMusic, what do we do? We're the leader in the sale of downloadable music. We sell MP3 files. We don't encrypt them. We don't protect them, we wanted to make it easy and convenient for consumers, and I'll discuss that in a moment. Ninty-nine cents a track, 8.99 an album. We currently have over 300,000 titles, licensed exclusively from independent record labels. There's about 200 of them now, I think.

Radio and TV commercials, we are spending $10 million right now. We're advertising on Comedy Central, radio stations, rock radio stations, are doing radio commercials for us, and we're actually promoting the music from the record companies that are on our site in these commercials.

We went public last year. We have 75 employees, did $180,000 in revenue that we announced yesterday for last quarter, and have a $600 million market cap. Go figure.

Anyway. All right, and our Board of Directors includes Eddie Rosenblatt who was the co-founder of Geffen Records. We pay royalties to record companies, independent record companies.

Every song involves two copyrights, every download. The first copyright is the sound recording. So if Sinatra records for Capital Records, "I've Got You Under My Skin," Capital Records would own the sound recording, and "I've Got You Under My Skin" is owned by Warner Brothers. It's the underlying song written by Cole Porter. There's two copyrights, one is the sound recording and the other is the underlying musical work. For the sound recording, we go to a record company and pay them an advance against royalties and pay them royalties.

For music, there's something under the Copyright Act called Section 115. It's a compulsory license, and you can compel Warner Brothers, the owner of the underlying music, to license us to allow us to download the song as part of the file for a statutory rate of 7.1 cents. This will be an interesting issue I'll bring up in just a moment.

So we have content that you know on the web site. We don't have unsigned bands on the web site. There's Tom Waite and there's Frank Zappa, Iggy Pop, a lot of current stuff, you know, Penny Wise, Offspring. We also have back catalog, Flock of Seagulls and Little Richard, and the Ventures and some sound track albums, Liza Minnelli.

Strategic alliances, primarily the big ones are AOL and Yahoo. They're guaranteeing us million of page views over the next three years.

So the changing music infrastructure, it always starts with the recording artists, and the recording artist does a deal, a record deal, with someone called a record label, and it might be a major label or an independent label.

A major label is defined as one that is associated or owned by one of the five major record distributors. There's WEA, which is Warner, Time-Warner. There's Universal, Sony, EMI and BMG.

Notably, four of the five companies are foreign companies and not U.S. companies, strangely enough, so the record industry is controlled by four of the five companies that are outside the U.S.

They did deals with retailers like Tower Records and such and mom and pop stores and CD Now.

Media companies are like radio and MTV, and of course eventually the consumer gets it.

Where things are going, we believe, is what's called a re-intermediation where the bricks and mortar in the middle changes to something else. You don't need the Tower Record stores, you don't need it.

Retail is going to be going to Starbucks, listening to music while you're sitting drinking coffee. They'll be like in the diners you have here on the East Coast, those jukeboxes and you'll be pushing buttons on an Internet kiosk and you download the music into your flash memory, swipe your credit card, pay for it, 99 cents, and then put it into here or put it in your car, drive your car home, press a button and it will sync up with your home stereo system, all the new music that you just bought while you were at Starbucks. So retail is not going away, it's just coming in a different form.

The downloadable music market inhibitors include the lack of high speed bandwidth. On a 56K modem it's seven minutes for a single song. That times 12 is an album, that's a lot of time to wait. It's better than Federal Express, but it is at least an hour or so. But on a DSL line it's like 30 seconds, the new digital signal loop that for $49 a month you can get faster lines. Or a T1 it's even faster.

The lack of mobility, but there's going to be ten of these competitors out on the market by Christmas, so mobility is being solved and there will be literally boom boxes with these things in it and there will be car stereo systems.

And the downloading process is still complicated, too complicated for main stream users. You know, we just started selling music last July, I mean in '98, and our focus was those college kids who were already stealing the music. We didn't have to train anybody.

Well, now we have to start doing things on the web site to train other people how to do it. So, you know, we looked at the MP3 phenomenon not as a threat, but as an opportunity. So we just jumped on it like perhaps the next Netscape.

What about piracy? Now, there are technology companies trying to sell technology to the music industry that won't work. It won't work technically and it won't work commercially. It won't work technically. It's simply the wrong technology.

Anyone who tries to sell encryption, which is what most of these systems are based upon. There's watermarking too, but encryption is certainly not a technology that will work. Encryption is as good at keeping a private conversation, someone out of the CIA or a third party out of a private conversation, but you've got to trust the recipient using encryption.

The recipient can take the message, play it, record it and send it to the New York Times. It's the wrong technology because you don't trust the consumer, that's the person you're trying to stop from recording and making a copy and all the kids are doing it. They're taking an encrypted file, playing it, putting a dummy sound driver, it's very simple to download this off the Internet, and it grabs the zeros and ones as it's played and lays it out on to your hard disk unprotected. So it's too easy too circumvent and it's not going to work technically.

And it won't work commercially. There's no consumer demand for something that inconveniences you. I mean that's basically what's going on here. I mean in the software business we try to, Lotus, you had to have Lotus in the disk drive in order to use it, you know, and people hated that.

VHS was a great example of Betamax versus VHS, and then DVX was a company that tried to say that you only can watch the movie twice and you've got to pay for additional views, a $330 million write-off and billions lost by hardware companies on it. So the past is prologue.

And the other side of it, it's getting harder to steal the music, to find the illegal music. The one thing that Hilary Rosen has done to earn her salary over the past couple of years, is working with universities. Now, it's easy to find -- if you're successful, it's easy to find the people who are successful at pirating. The guys at GeoCities for example or any administrator of a network at a university sees the URLs that are getting all the hits rise to the top, and the ones that are on the top, you know, they open it up and look at it and if it's on the network and it's getting all these hits, it usually has one of two things on it, a picture of a naked woman or an illegal MP3 file, and they push a button and it's off the network.

So a lot of these illegal sites are only lasting around 20 minutes, so it's harder to find.

Plus, the unsigned bands are taking their illegal music encoding it in MP3 and then putting a name on it like, you know, "Where the Streets Have No Name" by U2. So you spend 15 minutes downloading a song and it's not what you expected. You thought you'd get something, something that was quality. So the quality of the illegal stuff on the Internet is going down dramatically.

What we are doing is we're simply making it easier to buy than to steal. If it's 99 cents at a reasonable price, we're going to make it easier to buy than to steal. People will pay for convenience.

The real public policy issue was jurisdiction on the Internet. That's the big one, and let me give you an example. You'll be dealing with tax issues and privacy issues, which consumer protection laws apply when someone downloads music into Italy or buys a book from Amazon.com sent to Italy.

In our business it may be songwriter royalties. Just for an example, when a download originates from one country and the copy results in another country, under what jurisdiction do you pay that song royalty, the 7.1 cents that I mentioned earlier?

There are collection societies around the world saying well, they don't care whether it's a U.S. copyright that's involved and I got U.S. permission, an appearance in the U.S. If the download occurs in German, they want their cut and they want to be able to do it at their rate rather than the U.S. rate. Well, that's nonsense because the question is, you know, where do you do it? Can you calculate it on the country of download?

Well, we can ask the user where they're calling from, but if we have to charge more for Germany because the royalty rate is higher, they're going to cheat. If we can detect from their credit card where they're calling from, well you can order an American credit card over the Internet. So if Germany -- if we have to charge $1.10 for people in Germany, they're all going to order U.S. credit cards, and that's not going to be great for the German banking system.

The other thing is, can we detect where they're calling from, from an ISP? Well, if they're calling from AOL from Germany, it looks like they're coming in from Ohio, so we have no idea.

Plus, if we give the track away for free, we certainly have no idea where the download is going, yet we still have to pay a royalty and on what basis do we pay? The only logical thing here is the country of origination, where the merchant is or where the copyright owner really wants you to pay, and then we can decide whether to put it on the web site or not.

So predictions, we think open standards will win. MP3 and their successive formats, if there are other open formats, as long as it's open, anything that makes it inconvenient for users to listen to music will fail. Just like DVX did, just like all these schemes did.

Microsoft doesn't even protect its own software, they lose $40 billion a year to piracy. That's bigger than the entire recorded music industry, and they're not using the stuff, because they're not going to deal with the customer service problems.

I mean, what happens if your mom loses her private key or you want to switch computers? You've got to read documentation in order to do that.

SDMI and other proprietary formats will suffer the same demise as DVX. Labels will become more important. That's something that some people are missing. Some people think that the whole record industry is going to be going away, it's not. The distributors and bricks and mortar will. But with every unsigned band in the world being able to put their own music on web sites of their own or MP3.com on IUMA.com of ours, the noise level increases. And to break a new act it's going to take more A&R and more promotion, alright, not less.

Labels who do a great filtering job are going to be more important with the Internet and not less important, and that's why we partnered with them.

And finally, we believe by the year 2003 over 25 percent of music sales will be from digital downloads that sprout as opposed to bricks and mortar. It might occur first on alternative rock, and classical much later, but it's not a matter of "if," it's a matter of "when." Thanks.

SENATOR FRIST: Thank you, Robert.

J.D.? J.D., welcome.

MR. HEILPRIN: Thank you. I will not be using slides this afternoon. And I would like to really share with you some of our impressions on where we are in this space and where we're going over the next 18 months rather than really what RioPort is all about.

I'd like to start out, though, by thanking Senator Frist and Senator Rockefeller for having us participate in this distinguished forum.

Because of ethics laws, I can't present you with a Rio. If I had one of Bob's less expensive devices, maybe I could present you with one of those.

(Laughter)

MR. HEILPRIN: But instead, we want to give you a memory, a flash memory, so that when you do have a Rio some day, you can expand it and store more on it.

Let me set the stage for where we've been in the last 18 months. The last 18 months have been 18 months of phenomenal activity, controversial activity and excitement.

I mean, less than a year ago today we were involved in a lawsuit with the RIAA - with Hilary's organization, and today that lawsuit has been settled. We actually prevailed and all outstanding claims have been settled.

We have had an announced agreement with one of the major record companies, Universal Music Group, and an agreement with MTV Networks On Line to be their exclusive partner for all digital downloads.

Also in the last 18 months, the public has embraced MP3 as really the genesis for digital downloading going into the future.

You've seen the release of our own product less than a year ago today, and the release of a second generation of this product which has really captured the imagination of an entire generation of people who have seen the promise of digital distribution of music and other audio.

You've also seen the financial markets respond with the IPOs of companies like E.Music, MP3.com, Liquid Audio, Music Maker, Audible, and a host of other companies, who are all trading on the promise of the commercial viability of digital distribution of music.

All of these things really lead to the reality that digital distribution will be a viable activity once a number of hurdles are overcome. And you see that the advent of this secure digital music initiative, SDMI, is an attempt, it's actually the moment that the major record companies stopped viewing the Internet as a threat and started viewing it as an opportunity. Yet, SDMI can still work as a veil to shield the major record companies from actually distributing their music on line, and I want to get into that.

What I'd really like to talk about, though, in the few minutes that I have are the hurdles and the challenges that we face over the next 18 months.

And I've outlined six challenges. The first being technological challenges and engineering challenges that we have to address. We do not believe at RioPort today that security and secure solutions for the digital download of music are as futile as Bob may have presented.

We actually have a hope that there will be a secure framework for the distribution of music and encrypted music on line. And we truly believe that the availability of that type of solution will mean the flow of great content from the major record companies into the market.

So we are working hard on SDMI and working hard with companies like Microsoft and companies like Innertrust, companies like Reciprocal, to try to put into place a structure for the secured distribution of music. So technological hurdles are very high and they remain and we're working hard at it.

Secondly, the bandwidth issue that Bob brought up, delivery mechanisms. Digital delivery of music is not going to be commercially viable until consumers have a way to get it, other than a 56K dial-up connection. So broad band is the future. Cable modems, DSL, ISDN, that's the future. And when those are in place, we will be able to actually have a viable, commercial model for digital distribution of music.

The business model, there's no real business model in place for digital distribution of music today. And I talk about the mutual misperceptions by consumers and by the major record companies as to how that content will be priced and how it will be delivered.

Consumers have this idea that, because it's digital and because it's not tangible, that it therefore has less value than the physical product. They need to be educated to the fact that, just because it's digital, doesn't mean that the cost in developing those artists, the costs in creating the music, the cost in marketing that music, go away. Those costs are still very real.

The record companies, though, believe largely that they'll be able to charge as much for digital distributed music or more for digital distributed music because the consumers will be able to get it faster. That's something between the consumers' perception and the record companies' perception. There needs to be a balance and that's where the pricing model will come into play.

Also, we're going to evolve from a situation where people buy records, one, off physical CDs, to situations where people buy subscriptions to music. Now, that will involve a real shift in the delivery and distribution mechanisms that are in place today.

The consumer experience, the consumer experience today is not very great, it's not very good. We recently did a test with MTV two weeks ago. It was called "MTV Rock Weekend," and it involved MTV making available downloads of the next generation of rock artists at their site and promoting those rock artists on line, on line and on air on MTV.

It was very successful, but we learned a great deal and we'll continue to learn a great deal, and that is that the process for the consumer needs to be simplified greatly, and we're working very hard.

Our mission at RioPort is to really make the greatest quality and quantity of downloadable music and what we call "word programming," educational content, sports-related content, historical content, make it available on line, create a way that people can download it to their desktops.

This is the Rio Audio Manager, it's a manager software that allows people to download it to their desktops and them move it to devices, devices like this today, and an entire range of other devices in the future, appliance-like devices, stereo-type devices.

But the truth is that consumers will not be able to engage in that type of activity in any viable way until we make it easier and easier and easier. It needs to be granny proof.

Fifth, five, content must flow into the marketplace. The major record companies need to support this. And we believe that until several of these other issues are addressed, they will not support it.

Today you see some content flowing into the marketplace from the majors, mostly promotional content. We have a great deal of promotional content at RioPort that's used to support the sale of physical content.

We're in an interim period, though, where what we're looking for is to offer a great deal of content for sale, not just in a promotional on a promotional basis.

And sixth, the need to address the global copyright issues that Bob outlined as well. And this is a mission for groups like DEMA (phonetic sp.) to get into, and that is these issues of the geographic issues, the Wright Societies, the issues that if you're in France, why should a digital download cost more than if you're in Germany, or why should it depend on where your credit card origin is?

You know, in many ways the shift of distribution of music from the physical product to digital product is really analogous to an overall shift in our economy from a manufacturing-type economy based on heavy industry to an economy based on information and knowledge industries.

And that shift will cause the music industry to expand and build in new ways that it never has. You know, the video didn't kill the film industry. In fact it caused tremendous growth in the film industry. The CD didn't kill the music industry, it caused tremendous growth in the music industry. And we believe that digital downloads, once structures are in place, will cause tremendous growth in the music industry and have a tremendous benefit to consumers.

Thank you.

SENATOR FRIST: Thank you, J.D.

Hilary?

MS. ROSEN: Thank you, Senator.

Good morning. This is a very exciting time to be in the music business, and I feel really lucky that I have the job I do. We're kind of at this industrial revolution moment in music. And clearly the things that happen over the next two or three years are going to set the stage for, probably, change that we haven't seen almost since Thomas Edison's time.

I've heard recently this description that I thinks works perfectly for us, which is that "To date, the music industry has had this option of basically selling Coke in a 64 ounce bottle." You know, that was the only way that you guys could get music heretofore was to go into a record store and buy the CD or buy the cassette, and all of a sudden we have this medium, the Internet, where we can sell cans and we can do soda fountains, and we can do 100 other ways of distributing music, and that is an enormously exciting thing.

I was sort of tempted to let it go, but I feel obligated at this point, given my general combativeness. You know, one of the things that happens when you're in a job like mine is that people spend a lot of time talking about what you think and not a lot of time paying much attention to sort of what you're actually saying.

So I will just start out with three basic myths that I need to shatter. The record industry is not afraid of the Internet. We are not worried about piracy and I don't think that the MP3 phenomena has been a horrible thing. So let me start there basically.

The MP3 phenomena, in some respects, has been probably the greatest gift we could have in the music community, because they're sort of a snowplow of music fans interest in music. It has been a tremendous learning experience. Name another product that can sort of be so easily test marketed before you spend a nickel on it to gauge consumer interest. That's really what we have with MP3, and that's really how it is being viewed internally in the music industry.

There is a huge demand for music on line from our music fans and or job is to figure out how to get it to them.

The secured digital music initiative has gotten a little bit of talk this morning, and I won't spend a lot of time on it. A good resource on something like this, because it is extremely complicated, go to SDMI.ORG on line and there's a lot of background information on it.

But essentially SDMI was really started well before the MP3 phenomena took off for two reasons. One, it was absolutely clear that one of the most important things in buying music is the knowledge that when you walk into a record store and buy a CD and put it on any CD player in your house or car, it's going to play. That's like an important trust factor in the consumer purchase.

All of us who have played on our computers for the last ten years know that that is not the experience you have when you're at your computer, regardless of the software program, regardless of what you've done. There are no standards as complicated. You're not quite sure where to find the file once you've even downloaded it. And, so, finding a way for easing the consumer transaction was a principal concern of SDMI.

Security frankly, was an early concern, but is less of one now. And it's amazing -- I think we'll come back and do this panel next year, Senator, and everything will be different all over again. The paradigm has completely shifted in the technology community.

It used to be, just three years ago literally, that our friends in the technology industry said, "You know what, artists and record companies are probably going to have to give away all their music on line and if you want to make money, go on tour or sell your underwear or do something else." That was kind of the mind set because of the possibilities.

But that is not the mind set today. There is a tremendous enthusiasm within the legitimate technology industry, as you heard J.D. talk about, for the development of a legitimate music business, and, you know, Bob is on top of it at EMusic.

So the opportunities there are significant, and I think that that mind set shift happened in part as a result of SDMI, but just in part really as a result of the experience that people in the technology community were having with how difficult this consumer phenomena of MP3 was because it's just not the most pleasant consumer experience we can get, we can do better.

So SDMI is not a proprietary format. It's really merely a coalition of companies that are working together to try and establish sort of transaction rules.

So if you buy something, what are you allowed to do with it? It's really nothing that you've had to worry about before.

If you buy something, what are you allowed to do with it? Well, for the record industry I think we've been pretty open about this. What we've said is do whatever you want for yourself, make a hundred copies on your hard drive, put it your car, put it in your thing, this isn't about home taping.

The only sort of security feature that SDMI is even working towards is really to prevent the upload onto the Internet from a song file that you have either ripped or bought from a company like EMusic, to prevent it from going back up on to a bulletin board for distribution to thousands of other people. But there's certainly no consumer inconvenience or anything else that's anticipated there.

You know, J.D. mentioned the Rio lawsuit. Some of you might have questions about this, and in some respects I feel, I hope I can lose so well every year, because in may respects this was a tremendous win-win.

You know, if were in 1999 and everything was as it is now, we wouldn't be filing that lawsuit; but the mind sets of the industry in that past time, which was no connection, no working together, and no cooperation within the technology and music communities, that was, you know, in some respects just a different era.

Bob mentioned that MP3 is just a computer algorithm. I think my personal view is that the sound quality isn't quite as good as it should be regardless of whether it's a good thing or a bad thing.

We're going to do better than MP3. The technology allows us to have better compression. It's not just the stuff that you can't hear that gets eliminated. A lot of artists feel like MP3 doesn't have the kind of sound quality you want.

But the legitimate marketplace is blooming nonetheless. There are lots of market trials going on. You know, Fiona Apple yesterday announced a new trial with Launch.com. Rage Against the Machine's new record is going to be available for download. David Bowie did his album last week. There are market trials being announced every day, and market trials is indeed sort of the place that the music industry has gone to.

There is a company called Jupiter Communication -- that's Jupiter, right? Jupiter Communications that does analysis of the on line music business, and they outlined what I think is a reasonable kind of time line here for music on line.

There was the early piracy era which we have come out of. There is now the marketing era, which has probably about another two years. And then there is the real e-commerce era. And in essence what that means is we have no idea what consumers want.

You know, Bob is saying publicly that he's betting the farm that the business is going to be a downloading business, but I know that he's too smart and he's got a lot of guys working in the back room to figure out where to go if all of a sudden what everybody wants is subscriptions like JD thinks it's going to be.

That's one thing you learn in the Internet music business: everybody things everybody else is wrong.

So, you know, we have subscriptions where an artist like Todd Rundgren, who actually isn't even signed to a record label. For $50 a year, he'll send you two or three Todd songs that he's written and, you know, by the end of the year you're going to get 30 or 40 songs that he loves. You've paid $50, he's got the guaranteed income and that kind of subscription model really does have a lot of viability.

There is the Internet Jukebox model where maybe you're never doing download, you just get instant access by pushing buttons to what's called streaming music.

So, there are a lot of different business models out there available, nobody really knows what one is going to win, and I think over the next couple of years you're going to see a lot of them just tried and experimented with.

More than ever before, the consumers are going to drive this thing. I mean, consumers have an amazing amount of power in the Internet space and music is no exception. So, the consumers are going to be dictating the winning business models and the businesses, large and small, I think are going to follow.

Just a couple of other issues of challenges, clearly where artists go with this, people are talking how fun it will be to just sell singles, but yet the artists I've talked to this week are all talking about how excited they are about their concept albums. So whether we have singles or albums is still a big issue that hasn't yet quite been resolved.

Investment, frankly I think Bob is entirely right. Record labels aren't going away, we're just ending up spending more money because you're not only marketing at radio stations, you're marketing at retail stores. Nobody really thinks that that record that gets at the front of the bin in a record store, at Tower down the street, it's really because it's like the store manager's favorite record that week was that one, right? I mean, you pay for that space, you're marketing your music in the store.

And now obviously things like positioning and price marketing and artist marketing on line, so a huge amount more of investment is required in some respects to cut through the clutter, not less.

Since both Bob and J.D. talked about this licensing issue, I completely agree. I mean global licensing is absolutely critical for an efficient music business on line.

In some respects in the record industry we have it a little easier, because we do tend to run more worldwide businesses. And so, we have the ability to manage on a one for one, through database systems, worldwide licensing. And we have taken the position that payment occurs at the place of origination, and we do think that's appropriate.

But, you know, there's the song writing and music publishing community which is much more diverse and much in some respects more territorial. Everybody is familiar with ASCAP and BMI and the National Music Publishers here in the United States.

Well, there are counterparts to those institutions all around the world, and every one of them thinks that they should get paid in every one of their countries. And how that shakes out is going to be a significant issue.

I think rather than it being sort of a traditional judiciary committee copyright issue here, my sense is it's in some respects a trade issue, because what we're really talking about are market impediments. I haven't given that a lot of thought. Maybe I will at some point -- about what you guys might think about doing there.

Generally, I'll just sort of wrap up with my sense about how important this phenomena of the Internet is and how critically exiting it is for us to think about how our marketplace can expand.

There are two reasons why I identified -- who in this audience would be, on a survey, an identified music lover? Okay, not even half of you, that's a problem. These guys got to get a life, Senators.

SENATOR FRIST: That's right.

MS. ROSEN: There are two reasons why identified music buyers don't buy more music. The first reason, and in every single survey this comes up, the first reason is because they don't know what to buy. You walk into a record store, they're not the friendliest places, you think you sort of like Tori Amos, but you're not sure if you're going to like Sarah McLachlan. I don't know what to do about that, that's what the consumer experience is today.

The Internet completely changes that mind set, because all of a sudden you can have, you can have database marketing, you can do direct marketing with artists where, you know, Madonna on her web site is going to say these are my five favorite new albums this month, and if you like Madonna, guess what, you're going to go out and buy those albums. So having the ability for more of what we call sort of direct taste makers, really changes the minds.

And guess what? Since "Court and Spark," she's released five albums. You know, if I went to Joni Mitchell.com, I would see that there are five more albums that she had and I wouldn't have to leave my desk.

So the opportunity to buy or get music or whether that's, you know, you want to find, you know, you've sampled six songs and you want to download those into your RioPort or something, this is a net plus for the industry.

I'd like to say that right now we're a $40 billion -- we're a $90 billion worldwide industry squeezed into a $40 billion plastic skin. And, you know, just watch us over the next couple of years because this is going to grow expotentially.

So, thank you.

SENATOR FRIST: Hilary, thank you very much.

And I appreciate all three of the panelists keeping their remarks to right on schedule, because it leaves about 35 minutes to engage in discussion.

Before turning to Senator Rockefeller, let me just remind everybody that in your packet you have two cards. One is the green card and one is a blue evaluation sheet. A little bit before 2:00 I'll remind you to fill out the blue evaluation, that will help us as we move forward in these types of conferences on how to do things better.

Again, feel free to fill out the green card. Actually we prefer people coming to the microphone, it keeps a little bit more spontaneity involved.

With that, Jay, would you like to make a few comments?

SENATOR ROCKEFELLER: Not actually, but I'd like to ask a question. My sort of interest -- and this is to you, Hilary, and that is that my interest in music tends to be sort of Dietrich Buxtehude and Johann Sebastian Bach, and one of the interesting things is that classical music has never really risen above four to five percent in the CD market. And I see the potential for classical music, in that the younger generations are the ones who are buying more, declining further. Would you all agree with that?

MS. ROSEN: How cool is this is to be like sitting on a dais with a senator and speaking back into the mike?

(Laughter)

MS. ROSEN: Sorry, I've been around a really long time and this is a first.

SENATOR ROCKEFELLER: No, the better question, Hilary, is how cool is it for me to be sitting in the chairman's seat?

(Laughter)

MS. ROSEN: I can't say anything, you know, given Senator Frist from my hometown there.

SENATOR FRIST: That's right, be very careful, we can continue this.

MS. ROSEN: Two interesting statistics. One, that you're exactly right, classical music right now is about five percent of the market at retail. What we're finding is actually classical music is about ten percent of the market on line.

So there are people going to the web would not go into a record store because it's much more searchable, you can find what you want, you know, there are 45 sonata recordings and you can do much better research about which are the ones that are going to appeal to you. So that's number one.

The other thing is, as we have both the best -- we have the best I think of both circumstances, which is that music buyers of our generation are staying into the market longer.

You know, 20 years ago people our age didn't buy music, but since we've grown up with music, we're still in the marketplace, and we have the largest population in the last 20 years of the kind of "tween" crowd. That's the new word for, you know, the sort of 14 to 18 year olds.

And so in some respects I see this going both ways in terms of the expansion.

SENATOR FRIST: Okay, let's go to questions. Anybody at the microphone? While people are coming, let me just say, first question, we have a number of cards already been sent up. How will the field be regulated in the international arena? WTO?

To our panelist.

MS. ROSEN: Go ahead.

MR. KOHN: Is this on now? I'm not sure how it would be regulated. I think what we need to have is an overall agreement worldwide to put everyone on a level playing field.

There was an interesting global business forum in Paris a couple of weeks ago that Steve Case, the head of Time Warner, Gerald Levin, and the head of Burdlesman Worldwide, Thomas Middlehoff, had sponsored, which was a discussion on how to harmonize the world's laws on consumer protection, jurisdiction for issues of taxation and others, and how to solve some of these issues, and copyright royalties being another.

So there really is need for -- regulation isn't the right word, I think a need for harmonization so that someone downloading a song from Italy from the United States or from Germany knows that they can pay one price from wherever they're calling from.

And it's going to be a big boon, I think, not only to American music being sold overseas, but I think more importantly for people in Peoria to get music they would not otherwise have distribution on. And you might go to Tower Records and find Finnish folk music, and maybe not, but certainly on the Internet you can find it.

And I think to your question, Senator, there would be a lot of obscure pieces that would not otherwise get distribution because of the cost of physical distribution and returns in a small market. Niches will be very well served by the Internet because you can find the things.

Add to that the convenience of being able to do a search on Beethoven's Fifth, and then literally get a list in front of you of 50 different ones like Bernstein 1964 in New York, that's the one I want and I want to compare it against some other, or search on "Night and Day" and get Frank Sinatra's and Ella Fitzgerald's and all the different versions so you can have a collection of a particular song.

Those are the kind of conveniences and the impulse buy that the Internet are going to provide, and we think that's going to be an overall benefit to everybody.

MS. ROSEN: Just one bit of sort of factual information on the WTO. In the ministerial coming up in November, the U.S. does have on its agenda a, an extension of the moratorium on Internet taxes and that's a pretty high priority, I guess, of the Administration and obviously of the technology industry.

But some of the other issues like privacy and consumer protection are going to have significant jurisdictional issues. The EC is looking at their own regulations on this and yet they have countries, even within the European Community, that are very strong in particular ways. And Japan and the Far East has a whole other set of issues.

So I think these Internet sort of harmonization issues are going to be on the trade agenda for some years to come.

MR. HEILRPIN: If I could add just one comment. The immediacy of these issues reaching the agenda will become apparent in the coming months. Right now there is a tremendous amount of competition in the U.S. market and players getting involved in the U.S. market, but we're having discussions all over the globe with potential partners, and this is sort of the dirty secret that no one has really addressed yet, or there's some existing structures that aren't adequate for this.

But these are the issues that are going to come up very, very soon on the agenda, and that is as we make partnerships in these other markets, how to deal with this.

SENATOR FRIST: Okay, go ahead?

AUDIENCE MEMBER: (indiscernible)

SENATOR FRIST: Speak up, Rue (phonetic sp.) please.

AUDIENCE MEMBER: (speaking from an unmiked location) I'm sure you're all aware last year Congress passed two major -- (indiscernible) Copyright (phonetic sp.) Extension Act which is otherwise known as the Mickey Mouse Copyright Extension Act because it extended the period of copyright for 20 years while allowing Mickey Mouse to stay in private hands for another 20 years.

And I'm wondering if you could address how these changes in copyright law are affecting the music industry, and particularly with regard to the Copyright Extension Act, what do you think about a lawsuit alleging that it's improper to extend the life of copyrights for another 20 years, given that the Constitution said, while copyrights will be granted, they'll be granted for a limited term?

So could you get at the question of do you think it's appropriate that the copyright owners be given an added protection, vis-a-vis the public's right to make use of copyrighted music?

MS. ROSEN: Congress was clearly within its jurisdictional right to amend the copyright law. I don't think there's any question about that, Constitutional or otherwise.

You know, Mickey Mouse seems to be in pretty good hands, I don't know. The real issue I think on the music side was very much a trade issue, which is -- and again this was really a songwriter-music publisher issue, not a record company issue; but there were other jurisdictions, namely the EC in Japan that were protecting their works for 70 years and so you would put U.S. writers and publishers and copyrighters at a trade disadvantage, and I think that, you know, for that reason Congress made the right choice.

MR. KOHN: Yes, merely from an academic point of view, the argument of how -- the duration of how long the copyright should last or the scope of copyright is an argument or it's a debate that's gone back since Statute of Anne many, you know, centuries ago.

And it's a balance of how much incentive do you have to provide authors to create the work, and I think one of the -- and you can argue that there's got to be some logical end to the duration of copyright, because you only have to provide so much of an incentive to that person and his heirs.

But an argument was made that, since in the 20th Century lifetimes are a lot longer and there is a better way of tracking your descendants, that an extra 20 years seemed to be the right balance.

It is merely a philosophical question of what is the right, is it 100, is it 75, is it 60, etcetera, and I think, you know, Congress certainly was within its rights to determine what that balance is. And I think there is no real way of knowing what the exact number of years should be, but I think it had to be set.

SENATOR ROCKEFELLER: Another question from the audience is: the roll out of broad band telecommunications service has been slow everywhere, and it has been particularly slow in areas outside of metropolitan areas. And then the questioner from a congressional office says, "How much will this hurt the development of your business?" To which I would add, how much will that hurt the problem of equity within peoples being available to the service no matter where they live?

MS. ROSEN: Right. Well, go ahead.

MR. HEILPRIN: I would just say this, it's absolutely true that the roll out of broad band services will make available a commercial viability of downloadable music and the purchase of downloadable music will make it much easier for consumers.

So certainly in those areas where broad band is not available, there will be some disadvantage, and those people may also have disadvantages in not having access to the equipment that allows them to download, great computers that allows them to download content, and devices as well. So it's important that that distribution occur in the very near future and that it be equitable.

SENATOR FRIST: Let me follow up on that one matter. When we deregulated aviation, rural areas really suffered, and they developed then something called the "hub and spoke system," hubs being Chicago and New York and sort of the spokes being Charleston, West Virginia and someplace in Tennessee. And it potentially works very well because it says, the airlines are saying deregulate it, making their money in the big markets, we want as much business as we can get and we're willing to start purchasing, for example, regional jets to reach out into rural areas to bring that bit of business to us. Is there a comparable possibility in your business?

MS. ROSEN: Well, obviously the Internet is the single biggest equalizer for rural and urban areas that, you know, has existed in I can't think how long. But the investment that the telecommunications industry makes --

SENATOR FRIST: Are you pushing that investment?

MS. ROSEN: I don't really have any control over it. What we have tried to do --

SENATOR FRIST: Neither do we, but we're pushing it.

MS. ROSEN: You have more influence than I do, I assure you.

The things like in the entertainment industry showing people what would be possible if we had broad band. So in music it's not just delivery of music, it's music video. You know, your kids have never known music without pictures. Music video is an integral part today of the music business, and so finding opportunities that people can see, if you make the investment to expand in broad band, these entertainment options will open up for you is about the best we can do.

PARTICIPANT: This gentleman has a question, but we have to test to see if this mike is working.

PARTICIPANT: It's working.

PARTICIPANT: It's working? He's been waiting, thanks.

AUDIENCE MEMBER: Mr. Kohn discussed how the ability of ISPs to quickly shut down illegal MP3 sites is reducing and cutting down on piracy, but wouldn't just traditional e-mail and the ability to take these things and forward them on and on and on also be a huge threat, and if so, how do you combat that?

MR. KOHN: Well, you have laws on the books, all right, and I think you have to, you know, in the software business we knew we had the same problem, and the first thing you've got to do is trust your customer. If you're fair with the customer and let the customer know that you're also fair with the artist, because what's going to happen here is the consumer is going to get a better deal, they're going to be paying $8.99 an album or less, or 99 cents a track or less, they're not being forced to buy tracks that they didn't want to begin with, and the artist at the end of the day are going to get higher royalties, there's not going to be as much of a need for all that middle man, so the savings is going to get passed along to both ends.

There is going to be piracy. There is going to be even an increase in the level of piracy. But if you think about what is the potential here to outweigh it, right now you might, or my 13 year old daughter might learn about a record from her friend on a Tuesday night.

Well now, she is not likely to get to the record store until Saturday afternoon to buy the record, so the time between when she learns about the song or the record and the time she buys it is going to be collapsed to this. Because, if she's at her computer, she can download it immediately. In other words an impulse buy. Or she'll be -- you'll be sitting at Starbucks and you can order that song and purchase that track within moments and listening to it without even having to walk down the street.

So the impulse buy, we think, and the convenience they're giving to consumers -- think about this, and I hate to bring this up as an example like this in the U.S. Senate, but look at pornography on the Internet. I mean, look at the subject of pornography on the Internet. There is a lot of free porno all over the Internet and, believe me, it's a lot cheaper to develop and to create free quality pornography than it is to create quality music. A lot of free pornography, but if you look at who is making more money than anyone else on the Internet, it's the porno sites.

How do you explain the paradox of all this free porno and the porno guys are making all the money? They charge you $10 a month, whatever it is, I understand --

(Laughter)

MR. KOHN: They charge you $10 a month and you go there and it's convenient for you. I mean there are all the genres, right there right in front of you so you can pick and choose what you want.

People will pay for convenience. Yes, they'll e-mail dirty pictures to their friends, but look who's making all the money. So I think if you take a look at the world and how it operates.

And the other thing is people might buy music at work on a T1 line. You've got all these college students who have got time on their hands, but next year they're going to be earning $60,000 a year sitting in front of a T1 line in a cubicle, all right, with this money and not the time, and the corporation is not going to let them steal music anymore than they let them steal software. So for 99 cents a track, you go get it when you want without having to spend the hour looking for it or asking friends to give you the free track.

I think that the piracy issue has been overblown. I don't think you can inconvenience consumers to the point where they don't even want to download this piece of junk that's got this encryption key in it that you can't figure out or you don't really know whether it's going to work in your player to begin with.

I think you've got to give it an open format and that's going to I think increase the levels altogether. I mean we see our revenues increasing quarter after quarter. We don't protect the stuff.

AUDIENCE MEMBER: So the idea that someone might just take the track, go to their distribution list and say, "Check it out," to their 80 closest friends who expotentially send --

MR. KOHN: Well, it's illegal, it's wrong, okay, but for the honest consumer who does buy it, why inconvenience him? We've been dealing with --

MS. ROSEN: Well, I will tell you we do virtually all the on line music enforcement and have the largest on line enforcement operation for intellectual property in the world at the RIAA and, you know, we just don't have any interest in going into somebody's e-mail site. What we are interested in is somebody who puts up for the public on the web or on an FTP site a bulletin board for thousands of people to come at.

As far as I'm concerned, if somebody is e-mailing a song to their friend, it's because they love it and they are expecting their friend to love it, and hopefully they're going to go buy a record --

MR KOHN: Or download the rest of the album and pay for it.

MS. ROSEN: We'll never enforce against something like that. It's just like trading tapes with a friend.

MR HEILPRIN: Which is one of the reasons why we are hoping that the secure container technology is actually -- that it actually becomes viable because people want to share music that they love with their friends. And the ability for us to add business rules to a file and allow them to send it on their friends and allow those rules to be persistent with that file really presents some exciting opportunities for a new way of marketing music.

MS. ROSEN: Yes.

SENATOR ROCKEFELLER: You, sir, and then I'll have a written question.

AUDIENCE MEMBER: Yes. A question for Ms. Rosen, although anyone else should feel free to address it.

In a column published just five days ago Eric Shearer, who is an expert on audio technology with the Media Research Lab at Massachusetts Institute of Technology, the column was titled "The End of SDMI," so you can tell where he's coming from. But he goes through a number of criticisms of SDMI, some which we've heard about, cost of devices, consumer inconvenience, etcetera.

He had some others, lack of interoperability, the fact that a compliant device might subsequently be judged non compliant, the fact that RIAA wants to look at very proprietary information from hardware makers, and concludes what this adds up to is something I've heard from several SDMI participants, to most technical companies stamping their player "Not SDMI compliant" would likely be better marketing practice than playing by the rules set by RIAA.

Now, whether one agrees with that or not, when we look at the marketplace, we see the major labels entering into agreements with different incompatible security technologies and we see the million plus MP digital music players coming to market for this holiday season, some of them having security technologies again incompatible, but the only common technology being MP3 which seems to be the market standard chosen by consumers right now.

So my question is, wouldn't it appear that SDMI is simply vaporware and shouldn't the recording industry, rather than talking about how they're trying to figure out how to do this, just call Bob Kohn or some other people and start distributing their music on line?

MS. ROSEN: Such a big question. SDMI has in many respects achieved its purpose, because its purpose was to find a way to get the technology companies to work with the recording industry and that has occurred.

And so what you do have is the marketplace of deals like with J.D.'s company and lots of other companies that are bringing music forward, and that will continue, so that in some respects this is much more about the values originated by SDMI than anything else.

The idea though that there is incompatibility and interoperability is virtually entirely in the hardware industry and software industry's hands, not in the record industry's hands. And whether or not this is a good consumer experience technologically is entirely in the hands of the software companies and hardware companies who are sitting at the table, because they are the ones that have the proprietary standards for their players and their interoperable operating systems.

And so, the record companies have said, despite what that article you're saying says, is, "We will work with anybody and in any format, the more open the better," and that is happening.

And whether or not, though, Microsoft wants you to have a file that plays as easily on real networks system as it does on the Microsoft window system is going to be a decision that they are going to have to fight out. The record companies don't have a lot of options with that.

We just have to make sure, and SDMI is helping to make sure of that, that everybody will know where to go in the music file to read the necessary information.

So no matter what system they put out, the information in the music file has to be consistent enough that everybody can, in an open standards and specifications way, know how to build their systems to read those files. Whether or not the computers interoperate is not something that the music industry has control over.

SENATOR ROCKEFELLER: I want to say something at this point. This is generic. Some of these questions have come from congressional staff, some of them have come from trade associations and professionals.

The purpose that Senator Frist and I started all this for was for congressional staff to be able to ask and find out and learn, and we're a democratic, small D, society around here so everybody gets to ask questions. But I think we would both want to remind you that our first priority are those are those of you who work in congressional offices. So, we want to hear questions from you, and since I have one here, I will give it.

Will the cost of music -- this isn't anybody in particular. Will the cost of music come down as the music industry's costs come down? Will SDMI or other industries' security initiatives allow companies to mask efforts to prop up costs or restrict new competition?

MR. KOHN: From our perspective, yes, we do think the price of music is going to come down. You're saving -- there's no inventory, there's no returns, which is the biggest cost in the music industry, and no cost of goods. I mean the cost of goods isn't specifically very high on a CD, but the distribution systems and everything that go along with it, that cost savings is going to get passed along to the consumer on the one hand and the artist in higher royalties on the other. You can just see it.

We sell albums on our site that would normally be $16.99 that are $8.99 and 99 cents a track. So, yes, the price will come down.

And to the second part of the question regarding SDMI, the joke among the Internet companies, at least, when SDMI first came out, and it came out on the heels of a lawsuit to try to stop this product, was that SDMI meant some dubious motive initiative because it seemed that the five major record distributors were looking for some means of maintaining their control over the distribution of music.

It's not clear that they actually can maintain that control because the talk has always been "What are the majors going to do, what are the majors going to do, and everything is going to depend upon what the majors do." And the problem is the majors get all their new music from the independent record companies, the thousands of them that are out there, and now the indees have an alternative means of distributing their music. They do not have to go through the major distributors anymore.

MS. ROSEN: Will the gentleman yield?

MR. KOHN: I'll only yield for a question.

MS. ROSEN: It's just ridiculous. The fact is that today the leverage in the marketplace of the major record companies is much greater. In fact they need SDMI less than the small technology companies who are looking to get into this business of open standards --

MR. KOHN: Then why is ---

MS. ROSEN: -- and so there are companies out there now doing deals every day with the major record companies because they have the financial wherewithal to do those deals.

MR. KOHN: No, but SDMI is clearly financed by the five majors and the technology companies --

MS. ROSEN: It's not actually, it's financed by 120 technology companies.

MR. KOHN: Technology companies. But how many independent record companies pay the $10,000 that it took to get into SDMI?

We're a member of SMDI because we wanted to follow what was going on. We're one of the 110 companies. There are no indees. I'd like to see how many independent record companies are on that list. I doubt there are any, because they just simply couldn't aford it. $10,000 is the cost of producing an album.

MS. ROSEN: But the standards are open standards, that's the point of it. The specifications are open specs, so they get the benefit without paying anything.

MR. KOHN: I have about 200 record labels assigned to EMusic and none of them care. Some of these are the top independent record companies. None of them care about protection, SDMI or any kind of protection whatsoever.

MS. ROSEN: That's actually the beauty of SDMI, because if you want to protect your work, you can. You can flip one switch; and if you don't want to, you can flip another switch. So there are going to be some companies, large and small, who are going to say, "You know what, this is a new artist, I just want this to fly everywhere, throw it anywhere I can get promotion for it, I'm not flipping any switches." And they will do that. But then there's going to be another artist, you know, somebody like Madonna who is going to be a sure seller and doesn't want her music stolen --

MR. KOHN: Sparks always fly when we're on the same panel.

MS. ROSEN: -- who may want that switch flipped, because she knows that there is a marketplace of people out there who are going to buy it. So the choice is critically important in this equation.

MR. HEILPRIN: And I don't actually agree with you, Bob, that the independents haven't gotten involved in SDMI because of the $10,000 that it costs to join SDMI, but rather that they haven't gotten involved because they've made a decision that they want to be more aggressive in this space and don't want to be ruled by what the majors are doing.

MR. KOHN: That's true.

MR. HEILPRIN: Which I think is the real opportunity for the independents, and that is the independents have an opportunity to drive the price and set the price in the marketplace by not saying that they're going to be ruled by what the majors do.

MR. KOHN: That's right.

MR. HEILPRIN: And that's what I think is truly exciting about what the independents are doing. They have an opportunity to be more aggressive.

SENATOR ROCKEFELLER: Let's go back to the floor.

MR. LUSERRE: I'm Jim Lussierre with Prudential Securities Investor Weekly. I'd like to thank Peter Rooney for doing such a great program. It's really been extremely informative.

SENATOR FRIST: How about the two of us too now, Peter, come on.

MR. LUSERRE: Well, also Senator Frist.

A simple question is, do you see patents on business practices affecting the shape of your industry as it develops, and do you have views on the patent term reform bill that we may see out of the Senate sometime this year?

MR. KOHN: Oh, boy. Go ahead, do you want it?

MS. ROSEN: I don't know.

MR. KOHN: Well, I don't know anything about the bills, but generically there have been patents that have been allowed over at the patent office that are simply just outrageous. And the notion of a business model patent coming out is just beyond belief.

The software industry has been plagued by patents. It's pretty clear that innovation has been more derived from competition than it has from patents. People file patents after the discovery is made, and they're not making the discoveries, they're not creating the innovation, the new software, because of the patents, they're doing it because of competition.

And in the software business you've had a situation where you were protecting -- some of the underlying software was protected by copyright, what marginal value did patents have to protect that innovation?

Now, in this field, the business model patents, I mean, anyone can think -- everyone can watch Star Trek and see how the future is going to be and to be able to patent some of those ideas on Star Trek is just very difficult. So I think something ought to be done.

Right now the Patent Office views additional patents as good output. If you take a look, the former commissioner of patents used to have this chart about all the new patents, rising bars on a chart of new patents that were granted as though that was a good thing. So we really ought to take a look at that, not just in the music space, but I think just about everywhere.

SENATOR ROCKEFELLER: One written question and then I'll get to you, sir.

This is also from a congressional office. Does Internet-delivered music mean that we will see a period of disintermediation and lost jobs in the music industry? Does the music industry's experience give us a glimpse of dislocations to come in a host of other industries when they face e-commerce? And I think that's an interesting question.

MS. ROSEN: That's a great public policy question. My instinct is no, but that there will be different jobs. There will be some loss of jobs, I think Bob or J.D. -- somebody said this about manufacturing and distribution.

But I think the expansion of jobs in new kinds of delivery systems will make up for that. We certainly see this as an expansive opportunity, not a contracting opportunity.

SENATOR ROCKEFELLER: Making up for it in the ages, in the 20s, 30s and what about 40s, 50s and 60s, and how do you deal with that?

MS. ROSEN: Well, that's a good question. And it hasn't been dealt with yet, and there haven't been any layoffs in a CD manufacturing plant in, I don't know, probably ten years.

So there is still a tremendous growth opportunity for physical goods around the world. I don't see that business going away. But I do think that ultimately, just like any of the rest of the service's economy, some of those jobs are going to shift.

MR. HEILPRIN: I'd just like to say that I agree that it will involve a shift of people from those traditional jobs into the new distribution model. I teach a class at UCLA called "Music Revolution," how technology is changing the music industry, and every week I bring in speakers and every week every speaker talks about how difficult it is to find people, to hire people in our space. We are trying to staff up aggressively. It's very very difficult to find people.

Another thing that's difficult is to find people from all walks of life who understand this space. Generally the people who are qualified have been very young, computer savvy, highly educated, and we'd like to find more greater diversity in our hiring. It's important to us. But we are trying to hire people, as I know everyone in our space is.

MR. BROADSKY: Art Broadsky from Communications Daily. For each of the panelists, real quickly, are there any two or three things at this point that you think Congress should either do or not do that would either help or hurt your business as it develops?

And secondly, what is the effect of the Digital Copyright Act that was passed last year, does that settle most of your copyright problems?

MS. ROSEN: The DMCA last year was very productive in two specific areas. One, it has set a good working relationship with the ISP, the community and the copyright owners. And, as some of you may remember, that was probably one of the most contentious parts of the DMCA, was the phone companies fighting the intellectual property community. Indeed, in the marketplace, that has worked very well.

You know, it's a good question, Art, but, you know, and far be it for me not to think of something Congress can do to help me, but I think the most important thing for Congress to do is to continue to support positive trade initiatives, so that when we go into this globalized economy that the kinds of consumer protection standards and intellectual property standards and privacy standards that have become important in the U.S. marketplace hold around the world. And I think that that's probably my perspective about it.

MR. KOHN: I would agree too. I mean, very specifically to that point: Gerald Levin and Steve Case of Time Warner and AOL respectively, have this global business dialogue that I referred to earlier that is geared toward having a dialogue on this global harmonization on various issues on e-commerce and I think Congress should find some way to support that on way or the other.

So, these trade issues I think are probably the most important area for Congress to focus on.

There are a lot of monopolies and government-sanctioned monopolies overseas that are using their governments to try to protect their local industries here on the Internet and we really have to have commerce.

It's too big for even certainly a company like ours, and I think it may be too big for a trade association to deal with these kinds of issues.

SENATOR ROCKEFELLER: J.D., any comment?

MR. HEILPRIN: I would agree on this global harmonization. I would also say that for us this industry is certainly in a nascent period and we're trying to figure out the business model.

And while many people think they've figured out the business model, I would say that no one has really figured out exactly what the business model is.

So, to the extent that the government and Congress stay out of this area and don't try to regulate this area, it will allow us to figure out the business model and build a real industry here.

SENATOR FRIST: We have several other questions following up on the Digital Copyright Act was the question, do we need to amend the Digital Copyright Act? You said it helped a great deal last year?

MS. ROSEN: I don't think so.

SENATOR FRIST: Any comment?

MR. KOHN: I don't think so either.

SENATOR FRIST: Good. Any final questions from the floor?

(No response)

All right, we're going to bring things to a close.

And I again want to thank everybody for participating in what will be a rapidly evolving issue before us all. Please complete your evaluation forms as I mentioned earlier, and you can either leave them on your chair or as you go out.

The tech forum will be having a recess as we leave the United States Congress until late January and we will have messages to you and in your boxes. I look forward to our next event, which will likely be at the end of January. Thank you all very much for your participation.

MS. ROSEN: Thank you very much, it was fun.

(Whereupon, the proceedings in the above-entitled matter were concluded.)