Foundry Group recently invested in Next Big Sound, an online music analytics and insight business based in Colorado. Jason from Foundry writes:

As part of this future there will be new opportunities created to service these new direct-to-fan and Internet marketing models. We believe a key opportunity involves data. Currently, the industry-norm data report is from SoundScan. For thousands of dollars per month, industry professionals are able to see how many CDs and digital downloads have been purchased along with how many plays have occurred on terrestrial radio. We believe that this report is already mostly irrelevant. 

Sweet! This is encouraging as it further supports our investment thesis behind Feilio (Noank Media), a platform that measures digital content usage, that data will not only drive new opportunities in the music industry but also form the foundation for next generation business models. While it has taken longer then scripted for the industry to come around we remain optimistic that the tide is turning.

A new article about our portfolio company Feilio (Noank Media) in today’s New York Times titled “Building the Tools to Legalize P2P Video-Sharing” by Janko Roettgers. 

Would you be willing to pay your ISP five bucks a month to be allowed to download as much as you want from torrent sites and other file-sharing hubs? The idea of legalizing P2P through such a flat-rate licensing scheme has been getting more and more traction within the music industry in recent months. Noank Media CTO Devon Copley believes his company can be an essential part of such a flat-rate model.   

Click here for entire article. 

Today’s New York Times ran an article titled “Studios Try to Save the DVD” which mirrors an earlier post we filed titled “Why Warner Bros. did Toshiba a massive favor by going with Blu-ray (Rock Lobster)” after Toshiba bowed out of the HD format race in early Jan ’08. The Times article reads:

But the victory of Sony’s new Blu-ray high-definition disc over a rival format, Toshiba’s HD DVD, masks a problem facing the studios: the overall decline of the DVD market. [US] Domestic DVD sales fell 3.2 percent last year to $15.9 billion, according to Adams Media Research, the first annual drop in the medium’s history. Adams projects another decline in 2008, to $15.4 billion, and a similar dip for 2009.

We suspect the decline in DVD sales will accelerate in 2008 falling more than 11% to about US$14.3 billion in the US (need we even talk about China?) on the back of the proliferation and growing acceptance of the Internet based ad supported digital content model (free stuff), lower bandwidth costs and fatter pipes. Indeed, five years from now DVD sales will be 50% lower (conservatively) then where they are now.

Why the doom and gloom?! I mean, won’t the Studios come up with cool new interactive features that will pull consumers into their DVD web?! Not going to happen.

Okay, so what about all those ad supported models, you know those ones that give streams away for free yet charge for digital download or physical DVDs? This must be the answer the industry is looking for…right?! Hey, we’ve got all those social networks to monetize. Those dudes totally want our stuff. Hoorah! Hoorah! Hoorah! We’re saved…

Well, boys…you might want to sit down with Google and ask them about their ability to make money off social networking. Better yet…let’s chat with Google’s CFO George Reyes about 4Q 07 revenues. Hey Reyes, what’s up with Google’s US$900 million deal to supply ads to Myspace? According to a recent BusinessWeek article Reyes states:

“…[in 2007] social networking inventory is not monetizing as well as expected…”

Anyway you look at it…this whole selling content (both online and offline) is a genuine mess. Mark our words: 99% of all ad supported content models are doomed for failure. Why? For so many reasons, such as: (1) Because once a content provider does a deal with Google why would you go anywhere else to consume the same content? and (2) Ad revenues are going to polarize around “non-trendy, Web1.0 sites”, such as CNN.com where consumers are accustom to seeing advertising; and as a result of this polarization we’re going to get a lot of very unhappy dissatisfied studios, labels and artists hoodwinked by flashy sites promising sacks of cash. Whatever!

Moving forward, we think on-line ad supported content models will be the main catalyst (second only to online piracy) behind the continuing eyeball popping deflationary pressure on content for the foreseeable future. And no one will make any money (sans one or two sites) to boot. Talk about a pissed off world looking for CHANGE!

There is light at the end of the tunnel (cue soapbox) but a lot still needs to be done: The answer is blanket licensing at the ISP level…full stop. This is the only way to to properly compensate content providers and ensure some amount of recurring income those companies aggregating and distributing content on-line.

Lots of good stuff coming out of this week’s Midem Conference in Cannes, France – in particular, Kate Holton’s Reuters article titled “Music industry tries carrot after years of stick” where U2 manager Paul McGuinness comments that music could be provided as part of a subscription service for an Internet service provider. Holton writes:

“…the time had come for new thinking on how the music and technology sectors worked together, saying their ‘snouts have been at our trough feeding free for too long’. He touted the idea that music could be provided as part of a subscription service for an Internet service provider in the same way that some mobile phone companies have worked, with the revenue being shared…”

Below is the video from McGuinness’s speech that is posted on the MIDEM blog.Also coming out in support of this bundled sub model is International Music Managers’ Forum secretary general Peter Jenner in his blog titled “Thoughts on the Challenge of the New Digital Reality for the Recorded Music Industry“. Jenner notes:

“…this fee could be low…and be introduced as part of the bundle of features offered by the networks. The price should be negotiated by the music industry with the broadband and telecommunications companies and subject to renegotiation from time to time. A ‘feels free’ solution such as this makes sense for all parties and has the added benefits of making piracy economically unattractive as well as making the consumption of music free to consumers at the margin…”

For those keeping notes, this model was first suggested and implemented by Beijing’s very own Feilio.

We’ve been mouthing off for a long time (okay, a couple years) that eventually the stars will align and content providers (music labels, studios, publishers) with wake up to the benefits (and inevitability) of blanket licensing (BL) for digital content over the Web – we believe 2008 is the year that you’ll see BL jet in from obscurity and become “mainstream” in the digital content (music, video, and text) space.

Below are three articles/industry guys calling for the same thing:

Subscription Question Goes 2.0, Theoretical Possibilities Abound is from Digital Music News (thanks to Eric for emailing this to me) where leading music attorney Kenneth Hertz notes that…

“…this is the year that labels will embrace blanket licensing.”

Music Lessons is Seth Godin’s post where he lists 14 rules to live by in the music business – note that it takes him about 12 rules before he finally concludes that blanket licensing is the now but he gets there, and thus makes our list. Seth writes,

“The music business has thousands of labels and tens of thousands of copyright holders. It’s a mess. The biggest opportunity for the music business is to combine permission with subscription. The possibilities are endless.”

Last Major Label Gives Up DRM Related Issues, posted on Electronic Frontier Foundation by Fred von Lohmann knocks the covers off the bed with his posting and states:

“Next step (and I hear that at least one major label is considering it) will be a blanket license for music fans — pay a small monthly fee, and download whatever you like, from wherever you like, in whatever format you like. This is the inevitable end-game in a world where file sharing remains hugely popular and the labels want to prevent new retailers (like iTunes) from controlling distribution.”

Look, there are hundreds of content sites in China offering very similar experiences and content, all driving for that same advertising dollars – and yes, one or two of the free sites will remain, but by and large the odd US$200 million that has been invested in China’s user-generated/file sharing start-ups over the past couple of years will be earn a very low return (if anything at all).

Indeed, the business that learns (and is capable) to fully integrate blanket licensing, and thus can roll-out a legal digital content subscription model (on the back of fighting for those advert dollars, as an added revenue stream) is going to dominate this industry as they will have a sustainable business model.

And what’s more, think of the blue sky business opportunities (i.e. think lightweight applications running on top of this infrastructure) that present themselves once a developer/user has unrestricted access to 100% legal digital content – we’re talking virtual goods meets physical goods meets a online/off-line experience. To wit, this is the sort of excitement blanket licensing brings to the mix – to a digital content platform.

2008 is going to be a significant year in the content space – we’re expecting this year will kick-off several years of significant consolidation and flame-outs across the start-up board – putting premiums on ventures, such as Feilio, that have fully integrated blanket licensing at the core of their business models, and thus are positioned to weather the coming storm.

What’s missing from this excerpt of an article by Diane Garrett in Sunday’s Variety?

“…Warner Bros. will throw all its weight behind Blu-ray later this year, a decision that could serve as a death blow to the rival HD DVD format…”

I think something along the lines of “…Warner is doing Toshiba a favor by killing off their dinosaur…Sony should only be so lucky.” Indeed, Warner, in selecting Sony, just saved Toshiba over US$150 million in inceptive and junket fees – i.e. pay-offs to studios to adopt the HD DVD format – money that can now be used to invest in any number of content/community related start-ups/enterprises seeking to monetize digital content in such innovative ways that would never be possible in a clunky electronics behemoth.

Honestly, in a couple years, drawing hints from the performance of CD music sales (2007 Christmas shopping season saw CD music sales dropped 21% over last year) and the growing industry wide movement towards DRM free music tracks, where can the DVD industry go but down…down…down. (Rock Lobster, anyone?)

Hey, I get it, DVD sales still generate billions of dollars (about US$16 billion) in annual sales for studios…so, yeah, they’ve got to figure out a way to mellow the inevitable revenue erosion but is the solution Blu-ray and DRM?

No way…you can just smell the mindset of studio honchos…it just reeks of 2001 all over again (and yet, maybe we never left 2001). Isn’t it evident by now (after all the carnage from the music industry) that the solution is not new packaging or delivery format/technology but rather the solution is a complete 180 degree shift in the existing business model – or am I missing something?

Over the next couple of days, I’m sure the wires will be burning with chit chat from pundits, portals and web jockeys about a regulation that has been re-approved by State Administration of Radio, Film and Television (SARFT) and the Ministry of Information Industry (MII) that will ban (effective 31 January 2008) Internet Service Providers and portals from broadcasting video that, according to a Canadian Press article, involves:

“…national secrets, hurts the reputation of China, disrupts social stability or promotes pornography…providers will be required to delete and report such content…those who provide Internet video services should insist on serving the people, serve socialism…and abide by the moral code of socialism…”

And by re-approved, we mean that some form of this regulation has been on the books for several months but it was only this week that SARFT and MII decided it was now time to set about enforcing it.

The market is a bit unsure how this will play out and/or how this will impact existing user-generated video hosting services, such as Tudou.com (which claims to hold 22% of China’s vlogging market share) and 56.com (flush with US$20 million in fresh capital from Adobe Systems, CID Group, Steamboat Ventures, and Sequoia Capital).

Indeed, much of the uncertainty (as is the case with most, if not all, policy initiatives spun out of SARFT and MII) rests not in how closely these sites comply to the new regulations (as they won’t necessarily have a choice whether or not they want to work with a state-owned license holder – they just have to or close-up shop) but rather in the government’s interpretation of what “…hurts the reputation of China, disrupts social stability…”.

I’m guessing SARFT will move relatively quickly to provide the market with a “test case” so that they can frame their interpretation, sending a shot across the bow of some of the more adventurous entrepreneurs, especially in light of this summer’s Olympics.

We’ll get more viability on this over the next couple of weeks as more information is made available on the back of several meetings organized between the major portals and SARFT/MII.

Regardless, I’m pretty sure this puts the kibosh on any short to medium-term plans user-generated video hosting services had for raising additional (or seed) capital as investors’ will surely start dragging their feet – not so much because of the blue sky regulatory risk but rather because momentum seems to have been sucked out of the market (at least for the time being).

But…what about those sites legally distributing and hosting content directly from copyright owners (e.g. StarTV, Disney, and Tianyu)…how will this impact the one or two ventures operating in the legal content space? And by the “one or two” I think its obvious I’m talking about one specifically, Feilio, the Beijing based digital content services supplying Chinese ISPs with legal content (MP3, video, educational material).

If anything, SARFT and MII’s new policy places a premium on services which not only guarantee the authenticity of content but also complies with China’s existing content import regs. To wit, if I’m an ISP or a network in China (between now and summer) I’m not walking but running to legal digital content services – why leave anything to chance?

As a parting thought, it is important to note that we’re not advocating tighter regulatory controls as, way more often than not, aggressive regulatory regimes strangle innovation (boo) but you’ve got to adapt to the business environment your operating in…or risk becoming irrelevant…

Last week, Martin Soong, host of CNBC Asia Squawk Box, chatted Feilio CEO, Eric Priest, about why Feilio is one of China’s most innovative digital content services and how it could very well play an important role in resolving the ongoing screenwriter’s strike in America.You have the option to watch the video below or listen to the podcast.

Nokia’s new “Comes With Music” service – announced this past Tuesday – shows Feilio’s business model is right at the cutting edge. Nokia will bundle unlimited (though DRM compliant) music downloads with its very high-end mobile phones, for about US$5 per month.

Nokia still has some issues to overcome before its offering will be more attractive – like DRM. But we see this as a very positive move forward in the marketplace as it sets a good precedent for Feilio and their model. The bundled content strategy has now been endorsed by a major consumer electronics manufacturer (Nokia) and a major record company (Universal Music Group).

Nokia built its own back-end, which we believe will ultimately limit the Nokia service’s effectiveness. Feilio, on the other hand, has built the first open blanket licensing platform in the world that can service not only multiple licensees (e.g. many ISPs or handset manufacturers, not just one) but also multiple kinds of licensees (e.g. handset manufacturers, ISPs, and literally anyone that wants to bundle a content subscription as a value-add to any product or service). We believe Feilio’s right at the forefront of where media is headed.

On Tuesday, Sherman So from the South China Morning Post wrote “while the world’s big four music companies have failed to stamp out piracy in the mainland, Feilio, a Harvard university venture, may just have the solution…” read entire article

Today, the way digital media (e.g. video, text, and audio) is consumed in China online via search and social distribution (e.g. emailing links, blogging, etc) requires that content be virtually free to distribute and consume.

To wit, users want unprotected, legal content in quantity and at a low price.

So, one of the main barriers preventing such a content service from succeeding in China is the reluctance of major content providers to distribute their content without the protection of a Digital Rights Management (DRM) standard. Contrary to widespread belief, the fact that existing models fail in China has very little to do with the fact that illegal content accounts for more than 99% of all digital content on China’s web or the misguided belief that locals won’t pay for content, but rather because, until very recently, no one has come up with a scalable, profitable and legitimate solution that properly compensates content owners for their property.

And this is why we are so excited about our recent investment in Feilio as we believe they have the answer content providers, worldwide, have been pining for.

Feilio’s solution is a service that aggregates and distributes legal content to Chinese consumers while fairly compensating content providers for the use of their digital content.

The service works is as follows:

Content aggregation: Feilio registers content from publishers and producers of audio, video, and text media. Digital fingerprints are created to identify each media file, linked to its ownership and metadata. File usage is tracked on end-user devices using client software that also provides user interfaces, search, recommendation, and social networking functions to help people discover new media.

Content Distribution: Feilio provides content licenses to networks converting previously illegal file sharing and copying into legal activities, inoculating universities & networks against copyright infringement litigation. Users (e.g. students) need not change their current file sharing behaviors associated with free content sites.

The capital we are investing will go to scale Feilio’s platform, expand its nationwide network to +300 universities, and aggregate content.

We are thrilled to be part of Feilio, a groundbreaking company that seeks to not only remedy China’s digital content piracy problem but also ensure content owners are able to monetize file sharing.

Those of you who are familiar with HBO’s Entourage TV series – the day-to-day life of Vincent (Vince) Chase, a hot young actor in modern-day Hollywood, and his group of miscreant friends (the Entourage) – may remember the episode title “The Sundance Kid” where movie studio big wig Harvey Weinstein casts Vince as the lead in a surfing film he’s producing. After initially accepting the role in Weinstein’s film, Vince drops out to pursue James Cameron’s “Aquaman” throwing Weinstein in one of his legendary spitting temper tantrums.

Try, if you will, to envision Weinstein’s “condition” after discovering the new Michael Moore docu-drama, Sicko, Weinstein Co produced was bootlegged (ahead of its June 29th release date) on YouTube over the weekend. Well, hell have no fury like a pissed-off Weinstein.

And how did writer-director Michael Moore, known for his disdain for copyright laws, react to the news? According to a June 18, 2007 interview with Brandweek’s Steve Miller, Moore said that despite the Internet ripping his new film…

“[…he disapproves of copyright laws. It’s a stance] I’m sure is different than that of Harvey and Bob…I think the music industry’s response to Napster was misguided … and for me, it’s about getting people to see the movie and that’s what I want, so they will talk about it…I would never want to prosecute anybody who would download it…”

For the record, Ymer does not condone illegal file sharing however we are adamant that the existing pay-for-content model is dead. Weinstein and his fellow movie titians can either learn from the mistakes of the music industry and work with independent distribution channels, such as YouTube, to create a payment platform that leverages the viral natural of “good quality content” or not – the equivalent of the latter is losing just about everything.

Our views echo our desire to work with and support co-founder Eric Priest and his team at Beijing based Feiliu. While not revolutionary in design or concept, their business model of blanket content licensing, monthly subscription, unlimited sharing/usage and usage-based payments to content providers is, in our opinion, the most balanced and practical model we’ve seen in the market.

Some have argued that “digital music is a very difficult space to monetize” and a start-up in this space without a “massive user-base” will get crushed under the weight of industry leaders however what the public and investors are overlooking is the fact that content owners are less than excited about doing deals with established players given their less than stellar record on IP protection.

Indeed, this includes China’s leading Internet venture, Tencent, as it now faces several lawsuits from leading Taiwanese music label Rock Records. And therefore content providers will, by default, turn to independent enterprising companies, such at Feiliu, and their spotless IP track records.

Ethan Smith from the Wall Street Journal filed an article titled “Listen to music free, buy pay to carry” which is about a new Palo Alto, California-based music distribution portal called Lala Media Inc. The way the service works is that visitors to Lala.com can listen to streamed music (through a normal web browser) from Warner Music’s digital catalogue for free however if they so desire to download and cart the music away they must purchase an entire album. Smith writes:

“It’s like a subscription music service, but without the monthly subscription fee. Lala is betting that in return for getting all that free access to music at home, listeners will pay to buy the songs they want to take with them on iPods and other music players. Lala, whose owners include Bain Capital…is underwriting thr free offering by paying major labels $6 to $8 a user each month, about the same wholesale rate paid by online music subscription services like RealNetworks Inc.’s Rhapsody.”

To be fair – it is a clever idea. I particularly like the site as a music “discovery site” and the way the platform is device agnostic (i.e. mobile phone, iPod, etc). Though that is where my love affair with the site comes to an abrupt halt. What bothers me is that the music is streaming, quality is poor, you must purchase the complete album, and you’re still beholden to some form of DRM.For the record, I’m coming at this proposition slightly biased in that we have been working with Beijing-based Feiliu Media for several months now as they prepare to launch their content platform in September at Tsinghua University in Beijing, PRC.Feiliu’s business model is quite unique in that it not only provides a blanket content license on its content catalog but also tracks content usage – thus allowing users unlimited freedom to share music, video, etc while fairly compensating content providers.We believe the hidden gem in this platform is not so much in the “professional” or “industry” generated content, but rather in user generated content – to whit, Feiliu will be the first platform in China to compensate students, bands, whoever, with cold hard cash for their original work. Quite frankly, this is going to turn the business of collecting user generated content on its head – how can China’s incumbent video blogs, file sharing, and content aggregators compete with a site that pays users for their content? They can’t because they neither track usage nor earn an upfront fee from end-users – all existing sites are ad revenue models which are highly dependent on a high volume of free content.Feiliu’s CEO, Eric Priest, elaborates:

“On the music side, we deal only in full-track downloads, which no one has ever been able to make any money from in China, so most don’t seriously pursue that business. We don’t do ringtones at all, and we don’t add another intermediary to the existing online structure of SPs, etc. We’re a complete platform that deals exclusively with internet service providers (of which there are three in China: CERNET, China Netcom, and China Telecom). Our licensed content is served up via our platform and user interface with loads of rich value-added features like recommendation engines and social networking tools to help people discover new media.We serve up not only music but video and documents as well, including educational materials (English lessons, Harvard lectures, TOEFL classes, etc.). We provide this complete platform for a small fee bundled into every user’s monthly ISP access bill, so we are paid by the ISP, not the user. In return, we license the whole network to freely download and share the content in our system. In order to fairly divide our content revenue pool among copyright owners, we count not just downloads but also plays and copies of each media file, accumulating the most detailed and extensive data on user media consumption in the world. End users can upload user-generated content into our system, promote it among their peers through our platform, and get paid a portion of total revenues for each time the media is watched or listened to. Imagine how important that feature will be on college campuses among bands and student filmmakers.”

In short, Feiliu provide ISPs with the technology and licensed content to serve up all the best content in exactly the way users want it–high quality, reliable, fast, no technological restrictions, in an attractive online environment that helps you smartly navigate content and discover new things you like. What if users prefer to download their content from illegal sites and use a player different from ours? No problem. They are still paying the bundled content fee to the network, which Feiliu still collects and distributes to copyright owners, and Feiliu can still log those users’ content usage because their counting technology is entirely player agnostic, and they need not get the file from Feiliu. Once they have it, Feiliu ID it, count it, and pay the copyright owner.We’re confident there’s no one in this space doing anything close to this business model.

A couple days ago, HBO (Home Box Office) petitioned the FCC (Federal Communications Commission) in the United States to prevent consumers from recording their content (Subscription Video On Demand) – either with a VCR, DVD, or TiVo device. Sure this doesn’t have a direct impact on those of us living in Hong Kong and China – where HBO doesn’t have the traction it has in the US – yet HBO is representative of the losing battle the incumbents (broadcast networks) fighting – and losing dearly.

My general thesis is that all content will be free in the very near future and that DRM (Digital Rights Management) is not a sustainable technology. I’m not supporting piracy; I just believe it will be very difficult to generate any revenue from content alone. Where the money will be made is on product placements and side promotions, for example. Listed companies, such as Tom.com are spending a lot of money in rights to content that they won’t be able to control – in other words, their business strategy is dead wrong.

The companies that will be the winners, the next Google, will be the companies that develop technologies to harness, distribute and monetize this free content. Yahoo, for example, if a big buyer of networks and page views (note its purchase of Flickr’s 8 million users); yet they are not a buyer of technology…

The reason I believe this sector (e.g. BitTorrent) is a massive opportunity for start-ups is simply because there is: (1) demand, (2) users, (3) exits. The “demand” and “users” are clearly defined, but the “exits” – how will they come? I believe “exits” will come from the major portals, such as Baidu, Sina, and Tencent. The reason is simple: these listed companies can’t develop this technology in-house, but it isn’t because they don’t have the capability, it just that they can’t be seen publicly supporting file sharing, for example.

This is why technology start-ups (in this space), especially in China and Hong Kong, are so attractive (at least to us) and why we believe the next MONSTER company will come from this space.

Last.fm is a great Web2.0 example – social networking, tagging, free, user generated playlist…

Last.fm is the flagship product from the team that designed the Audioscrobbler system, a music engine based on a massive collection of Music Profiles. Each music profile belongs to one person, and describes their taste in music. Last.fm uses these music profiles to make personalized recommendations, match you up with people who like similar music, and generate custom radio stations for each person

Truth be told, the Last.fm’s Player is a bit, well, weak, but, that aside, I’m really happy with the music I’m getting pushed, for example: Laura Pausini’s “Viveme”; Jurassic 5’s “Hey”; and Long Beach Dub All Stars’ “Kick Down”.

There’s a lot of talk about increasing royalty payments for streaming services – we’re not sure if this would be the best move given the weaker economics (at least, with early adopters) of web streaming v traditional radio – what we’d like to see would be some type of blanket licensing – thus allowing for numerous subscription opportunities/possibilities.