1 DCIA P 2 P Music Models Proposed

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DCIA P 2 P Music Models Proposed Business Models for Digital Music Distribution Distributed Computing Industry Association February 2004 2

About DCIA P 2 P Music Models The first of the following business models was presented at DCIA’s Fall General Meeting 10/8/03, the second at the Western Show 12/4/03, and the third at a Press Conference 2/5/04. Our primary purpose in developing three alternative models was to spur discussion of positive business solutions among affected parties. DCIA’s objective is to provide qualified proposals from multiple sources with an openand-honest hearing, to shape options, and to help principals decide upon one or more optimal business models to implement as expeditiously as possible. DCIA plans to fulfill the role of the honest broker in facilitating constructive solutionfocused discussions among music labels and publishers, telcos and broadband ISPs, P 2 P software companies, and relevant technology suppliers. These business models are based upon marketplace experience of DCIA Members, input from technology providers and music industry representatives, and independent music industry research and analysis. Detailed assumptions as well as the mathematical formulae that support these models are available upon request to DCIA members. Non-members, please contact the DCIA to schedule a private confidential meeting at which to review this detailed information. 3

The Current Situation – Music Sales Are In Decline • According to 2003 RIAA data, US retail music sales were about $990 million per month. • The industry's retail sales are forecast to continue to decline at a compound annual rate of 2. 1% over the next 4 years. Music Industry Sales… $ …should be growing with GDP (+2. 7%) …instead will continue to decline if no solution is implemented (-2. 1%) "The root cause for this drastic decline in record sales is the astronomical rate of music piracy. … Computer users illegally download more than 2. 6 billion copyrighted files (mostly recordings) every month. At any given moment, well over five million users are online offering well over 1 billion files for copying through various P 2 P networks. ” Mitch Bainwol, RIAA CEO 4

The Current Situation – The Music Industry’s Response • The music industry is resisting P 2 P while encouraging online content in a limited way – – Licensing content to non-P 2 P Internet sites for limited online distribution Suing P 2 P software companies to slow technology proliferation Lobbying Congress to curtail P 2 P expansion in various ways Suing consumers to drive them away from P 2 P usage • But… – The major labels have not tried legitimate online sales of music in a domain that already has over eighty million users in search of content – the existing P 2 P marketplace. If the music industry pursued a similar strategy in the offline world, the consequences would be devastating… If it refused to sell music through large chains like Wal-Mart, Target, and Best Buy – music sales would be crippled. 5

The Solution • The music industry can use the P 2 P marketplace for legitimate sales, thereby minimizing copyright infringement and capturing the thriving online consumer demand. • The whole-hearted embrace of online distribution by the music industry could grow retail sales at a nearly 10% compounded annual rate over four years – outstripping projected GDP growth. Music Industry Sales… $ …or can grow greater than GDP through the embrace of the efficient, consumer-chosen P 2 P marketplace … can continue to decline Over the last 100 years, every major technological breakthrough in entertainment has resulted in an acceleration of industry growth. 6

DCIA P 2 P Music Model A Proposed Business Model for Digital Music Distribution DCIA Quarterly General Meeting October 8, 2003 7

The Solution: Staged Implementation • Sell content to consumers in the P 2 P marketplace – first by using DRM, then through universal ISP-based billing. • Implement and build-out the new business model in three phases: – Phase 1: Make the content of top-five major labels available for sale in the P 2 P marketplace with existing credit-card billing – Phase 2: Expand payment options for consumers by adding the option of charging music track downloads to phone bills – Phase 3: Implement ISP-based billing that will allow for universal payments for the majority of downloads of copyrighted content 8

Phase 1 – P 2 P Music Sales With Existing Credit-Card Billing • Expand current business model of selling legitimate content in the P 2 P marketplace by adding top-five major labels • Implementation and build-out steps: – Establish DRM – WMA library of content with existing digital assets and new assets provided via licenses from majors – Populate content in priority position and activate to use credit-card payment – Continue to deliver content into Ka. Za. A and other P 2 P applications in the marketplace – Promote the benefits of legitimacy and quality of content to users – Target results at approx. 600 million licensed downloads per month with a portion of those being paid for by credit-card registration with low conversions to transactions but showing growing acceptance and promise • Prepare for phase 2 – telco-based billing: – Negotiate payment deals with telcos to enable bill-to-phone – Evaluate regulatory issues to ensure consistent fair rates – Record artist bill-to-phone messages, intro value-add and other up-sell 9

P 2 P Adaptation of Business Practices from Successful Search Engines As with sponsored links on search engines, licensed music will be placed at the top of P 2 P search results The Monetization of P 2 P Content Searches is in its Infancy – Comparable to 1992 in the Traditional Web Search Market 10

Phase 2 – Expand Payment Options With Telco Billing • Expand P 2 P legitimate sales by making user experience more seamless with a bill-to-phone option • Implementation and build-out: – Turn on bill-to-phone features in DRM payment gateway – Promote use of phone and artist voice connectivity as benefit over unlicensed music – Monitor results and begin to add complimentary smaller label and independent music into P 2 P platforms – Project growth to approx. 1. 7 billion licensed downloads per month with some expansion of proportionate credit-card utilization and much larger share of telephone usage so that monthly retail revenues in this time frame rapidly ramp to over $40 M per month 11

Phase 3 – Implement ISP-Based Billing • Make payment of online music through P 2 P systems universal using ISP-based billing and file-hash-signature monitoring • Implementation and build-out: – Work with ISPs collectively to enable bulk-billing solutions and pricing that resembles previously negotiated telco rates – Explore possible need for legislation to ensure solutions develop for capturing data tags on traffic flowing between ISPs and end users – Negotiate with router manufacturers to provide a packet header and file hash turnstile billing solution to be implemented at the ISP level – Work with the music industry to establish databases of copyrighted files using file hashes – Target 1. 8 billion downloads of copyrighted files per month with sales revenue rapidly ramping to approx. $900 M per month with credit card and telco billing enduring as a niche – Online music sales will grow to outperform traditional music sales – ISP deliverables: • Implement router solutions within a fixed time frame • Bill for registered copyrighted music flowing through their networks • Agree to suitable payment terms for music content 12

Projections – Phases 1 & 2 Without the broken market, the industry would normally be expected to grow in line with GDP (2. 7% per year) If the music Industry does not embrace the new online distribution model, it will likely continue to see an erosion of sales (forecast to be -2. 1% CAGR over 4 years) In the short-term, credit card- and telco-based billing models create a niche retail segment and help to modify online consumer behavior 13

Projections – Phase 3 The new business model will yield market expansion greater than the traditional model – growing at a 9. 9% GAGR over 4 years The advent of ISP-based billing will radically change the way consumers consume music online -- They will be required to pay for downloads Traditional sales will never fully disappear because many will prefer not to interface with a computer or will want to buy special edition releases Massive Monetization of the P 2 P Channel 14

Overcoming The Gating Factors • Overcoming Political Gating Factors – Commercial players to agree and convey support to business model – Considered legislative actions need to be consolidated and focused upon solutions – RIAA members need to stop discrediting P 2 P and engage in substantive discussion • Overcoming Trade Gating Factors – – Granting open licenses from major labels and establishing cohesive industry view Establishing functional bill-to-phone suppliers at reasonable rates Establishing ISP billing providers and technical support at reasonable rates Continuing to build successful user interfaces at application levels • Overcoming Revenue Growth Gating Factors – – – Lack of instant micro-billing (without registration) is key impediment to growth P 2 P software companies must initially support a contiguous DRM solution Telcos & ISPs must support final phases of new industry model RIAA consumer education – to continue Labels need improved digital production and marketing techniques 15

DCIA P 2 P Music Model B Proposed Business Model for Digital Music Distribution The Western Show December 4, 2003 16

The Solution: Staged Implementation • Sell content to consumers in the P 2 P marketplace – first by means of a universal basic subscription, then through tiered genre-and-theme channels, and ultimately per-track sales. • Implement and build-out the new business model in three phases: – Phase 1: Impose a monthly music-access fee to be paid by all broadband ISP subscribers who have installed P 2 P file-sharing applications – Phase 2: Introduce optional premium channels of newer music and editorial content using broadcast encryption technology – Phase 3: Add DRM protected a la carte offerings of individual music tracks of newest releases with value-adding features 17

Phase 1 – P 2 P Music Universal Basic Subscription • Impose a monthly fee on all broadband ISP customers with P 2 P file-sharing apps to compensate music rights holders • Implementation and build-out steps: – Establish statutory rate, revenue sharing, operational roles, and initial term – assemble multi-industry coalition to present proposal to Congress – Work through legislative process to enact P 2 P music subscription as law – Develop operational elements for statistical tracking, billing and collections, etc. – Communicate the benefits of legitimized music file-sharing to consumers – Target results at approx. 40 million subscriptions per month at time initial payment mechanisms are initiated and project growth to track with consumer broadband deployment • Prepare for phase 2 – genre-and-theme channels: – Develop secure broadcast encryption technologies needed for implementation – Package newer music content with editorial features and create service marks – Prepare marketing communications programs to launch these optional services 18

Phase 2 – Add Genre-and-Theme Music Channels with Broadcast Encryption • Introduce tiered P 2 P services featuring newer music and editorial content as add-ons above basic universal service • Implementation and build-out: – Prepare and launch several alternatives appealing to major listener segments – Promote benefits of multi-pay subscriptions over basic-only P 2 P music service – Monitor results and begin to add complimentary niche music services into P 2 P platforms – Project growth to approx. 225 million pay subscriptions per month at an average 3: 1 pay-to-basic unit ratio with an 80% cost differential so that total monthly retail revenues in this time frame ramp to over $600 M per month • Prepare for phase 3 – individual music track sales – Develop new P 2 P-specific DRM technologies to protect brand new music releases – Compliment such security with consumer-friendly micro-payment technologies – Integrate new content protection and billing with existing CRM systems 19

Phase 3 – Implement Per-Track P 2 P Music Sales • Add DRM protected a la carte offerings of individual music tracks of newest releases with value-adding features and inaugurate sequential distribution • Implementation and build-out: – Perfect secure P 2 P DRM technologies with off-premises backup facilities – Develop plans for promotional programs to optimize per-track music sales in early release window – Define business practices for moving titles from a la carte to premium channels to universal basic service levels to maximize total revenue over life of property – Create and launch campaigns to introduce this final level of P 2 P music distribution – Target 600 million downloads of a la carte music files per month and total P 2 P music revenue ramping up to approx. $900 M per month with premium channels and universal basic service enduring as foundation – Online music sales will grow to outperform traditional music sales 20

Projections – Phase 1 Business Model Comparison - Monthly US Music Retail Revenue $1, 200. 0 $1, 000. 0 Without the broken market, the industry would normally be expected to grow in line with GDP (2. 7% per year) $ millions per month $800. 0 $600. 0 If the music Industry does not embrace the new online distribution model, it will likely continue to see an erosion of sales (forecast to be -2. 1% CAGR over 4 years) $400. 0 In the short-term, P 2 P music universal basic subscriptions create a revenue stream for music labels and publishers to offset decline $200. 0 $0. 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 Months from Present New Model Sales – P 2 P Music Universal Basic Subscriptions New Model Sales – Adding Premium Channels and Per-Track New Model Sales - Traditional Media Traditional Music Sales without Broken Market Traditional Music Sales with Broken Market 21

Projections – Phases 2 & 3 Business Model Comparison - Monthly US Music Retail Revenue $1, 600. 0 $1, 200. 0 $ millions per month Traditional sales will never fully disappear because many will prefer not to interface with a computer or will want to buy special edition releases The new business model will yield market expansion greater than the traditional model – growing at nearly 10% GAGR over 4 years $1, 400. 0 $1, 000. 0 $800. 0 $600. 0 Massive Monetization of the P 2 P Channel The advent of premium channels and per-track sales will significantly increase the total revenue generated from P 2 P music distribution $400. 0 $200. 0 $0. 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 Months from Present New Model Sales – P 2 P Music Universal Subscriptions New Model Sales - Adding Premium Channels and Per-Track New Model Sales - Traditional Media Traditional Music Sales without Broken Market Traditional Music Sales with Broken Market 22

Overcoming The Gating Factors • Overcoming Political Gating Factors – Commercial players to agree and convey support to business model – Legislative actions need to be consolidated and focused upon solution – RIAA members need to stop discrediting P 2 P and engage in substantive discussion • Overcoming Trade Gating Factors – – Labels, publishers, ISPs, and P 2 Ps to establish cohesive industry view Establish technical path from statistical to actual P 2 P music file tracking Develop broadcast encryption and robust P 2 P DRM at reasonable rates Continue successful user interfaces at application and content package levels • Overcoming Revenue Growth Gating Factors – – – Lack of instant micro-billing (without registration) is key impediment to growth P 2 P software companies must ultimately support a contiguous DRM solution Music companies and ISPs must support final phases of new industry model RIAA consumer education – to coordinate with phased roll-out of model Labels need improved digital production and marketing techniques 23

DCIA P 2 P Music Model C Proposed Business Model for Digital Music Distribution Press Conference Call February 5, 2004 24

The Solution: Staged Implementation • Sell content to consumers in the P 2 P marketplace – first by digital watermarking and DRM, then through uploader incentives and user participation programs • Implement and build-out the new business model in three phases: – Phase 1: Combine digital watermarking with DRM for label-seeded and consumer-originated copyrighted music in P 2 P – Phase 2: Provide incentives to high-volume file-sharers to convert legacy music collections and become licensed redistributors – Phase 3: Introduce user-friendly software to permit consumers to register and monetize original musical works 25

Phase 1 – Watermarking and P 2 P DRM • Introduce digital watermarking system and apply DRM to copyrighted music in P 2 P distribution regardless of point -of-origin • Implementation and build-out – Establish watermarking technologies – fingerprints applied in post-production to ID same recordings of songs whether seeded or ripped into P 2 P – Agree on ID-reading / DRM-applying software and hardware solutions – Contract P 2 P software companies and/or broadband ISPs to deploy systems and serve as online P 2 P music resellers – Unregistered music files continue to be redistributed in P 2 P as currently – Target results at approx. 400 M paid downloads per month representing 2/3 of major music file-sharing activity with 50% conversion rate and revenue approaching $320 M 26

Phase 2 – Extend P 2 P Reselling Opportunity to End-User Uploaders • Incentivize active file sharers with revenue-sharing program for upgrading and applying DRM to music files they redistribute • Implementation and build-out – Promote incentive program to heavy uploaders in advance of deployment – Deploy pre-existing music file removal/replacement and DRM-application software – Develop micro-distributor channel with marketing support programs for most productive cyber-DJs and file-sharing mixologists – Project total P 2 P music sales growth to approx. 600 M licensed downloads per month including continued expansion and improved efficiency of label-seeded and consumer-originated new release files with revenue of approx. $420 M 27

Phase 3 – Expansion to Include Amateur Original Musical Works • Ubiquitously deploy ID/DRM system to protect consumerproduced as well as label-produced musical works • Implementation and build-out – Develop technologies to permit consumers to insert file-fingerprints and register their own recorded musical works for P 2 P distribution – Define economics for consumers to become self-publishers and self-distributors of such original music – Roll-out program broadly to consumers and closely monitor adoption rate – After full marketplace acceptance, evaluate TBD methods for potentially filtering unknown music files in manner acceptable to all affected parties – Target 2. 25 B downloads of copyrighted DRM encrypted files per month at average effective price of $. 40 per track with sales revenue ultimately ramping to $900 M per month. Online music sales will grow to outperform traditional music sales 28

Projections – Phase 1 Business Model Comparison - Monthly US Music Retail Revenue $1, 200. 0 $1, 000. 0 Without the broken market, the industry would normally be expected to grow in line with GDP (2. 7% per year) $ millions per month $800. 0 $600. 0 If the music Industry does not embrace the new online distribution model, it will likely continue to see an erosion of sales (forecast to be -2. 1% CAGR over 4 years) $400. 0 In the short-term, watermarked/DRM P 2 P music sales and non-P 2 P online music sales create a revenue stream to more than offset decline $200. 0 $0. 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 Months from Present New Model Sales – P 2 P Music Universal Basic Subscriptions New Model Sales – Adding Premium Channels and Per-Track New Model Sales - Traditional Media Traditional Music Sales without Broken Market Traditional Music Sales with Broken Market 29

Projections – Phases 2 & 3 Business Model Comparison - Monthly US Music Retail Revenue $1, 600. 0 $1, 200. 0 $ millions per month Traditional sales will never fully disappear because many will prefer not to interface with a computer or will want to buy special edition releases The new business model will yield market expansion greater than the traditional model – growing at nearly 10% GAGR over 4 years $1, 400. 0 $1, 000. 0 $800. 0 $600. 0 Massive Monetization of the P 2 P Channel The advent of licensed uploader content redistribution and consumer-applied DRM will dramatically increase the total revenue from P 2 P music distribution $400. 0 $200. 0 $0. 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 Months from Present New Model Sales – P 2 P Music Universal Subscriptions New Model Sales - Adding Premium Channels and Per-Track New Model Sales - Traditional Media Traditional Music Sales without Broken Market Traditional Music Sales with Broken Market 30

Overcoming The Gating Factors • Overcoming Political Gating Factors – Commercial players to agree to and convey support for business model – Considered legislative actions need to be consolidated and focused upon solutions – RIAA members need to stop discrediting P 2 P and engage in substantive discussion • Overcoming Trade Gating Factors – – Labels, publishers, ISPs, and P 2 Ps to establish cohesive industry view Establish technical path for watermarking and DRM applications Develop technologies to securely bring these to consumer level in stages Continue successful user interfaces at application level as consumer role grows to micro-distribution and publishing of DRM-protected work • Overcoming Revenue Growth Gating Factors – Lack of integrated watermark-reading / DRM-applying / instant micro-payment charging system is key impediment to growth – P 2 P software companies must ultimately support a contiguous DRM solution – Music companies and ISPs must support implementation of new industry model – RIAA consumer education – to coordinate with phased roll-out of model – Labels need improved digital production and marketing techniques 31

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