Monday, September 8, 2003

By Kevin J. Delaney

Stockholm -- THE SWEDE behind the world's most popular song-swapping software is at it again.

Niklas Zennstrom, who co-founded KaZaA BV, the company that created the program of choice for sharing songs and videos online, is now offering Internet service providers PeerCache -- software that lets the ISP's users download commonly shared files from the ISP itself, rather than over the Internet from another user's hard drive.

The recording industry is taking note. The International Federation of the Phonographic Industry, a trade group, says it is investigating whether to file suit against Joltid Ltd., maker of PeerCache, or ISPs that use it. Legal experts say Mr. Zennstrom's new product poses a fresh threat for the music industry, which already blames KaZaA and similar programs for its sharp drop in sales in recent years. Sony Corp. estimates that file-sharing cost music companies $7 billion in sales over the past two years. Last week, Vivendi Universal SA's Universal Music Group slashed wholesale compact-disc prices some 30% to try to lure back buyers.

This week, the U.S. recording industry is expected to launch hundreds of lawsuits against individuals it claims illegally share large numbers of music files online, an attempt to strongly deter the dissemination of copyrighted materials via file-sharing services. The lawsuits are the main plank of an aggressive antipiracy campaign by the music industry, but the legal steps against consumers could create a publicity backlash.

"PeerCache is going to reduce the cost of file sharing to Internet service providers, which means the ISPs will have less incentive to cut down on the file sharing," says Ben Edelman, a fellow at Harvard Law School's Berkman Center for Internet & Society. "And it increases the speed for the users, which means they will just do it more."

It would seem that Mr. Zennstrom would be wary of taking on Big Music. The industry sued him last year, brandishing threats of criminal prosecution and millions of dollars in fines. He sold the KaZaA software and Web site in 2002 as his company's legal bills exceeded $100,000 a month.

Despite KaZaA's popularity, Mr. Zennstrom never struck it rich. He barely recouped the money -- some $220,000 -- he put up to finance the company, and he still rides a bicycle to work. But he is bracing for another fight. "Basically what the [music industry] should do is outlaw the Internet," he says, over lunch in a Stockholm cafe. "That's what they want to do."Mr. Zennstrom, 37 years old, says he doesn't download music; he buys compact discs. He spent the 1990s working for Internet and telecom affiliates of Sweden's Industriforvaltnings AB Kinnevik and a European telecom consortium. He and a partner, Janus Friis, decided to create KaZaA in April 2000, after seeing how traditional Internet file distribution -- using centralized computer servers -- strained networks. To write the software, Mr. Zennstrom hired a trio of whiz kids in Estonia who answered an online ad.

As they were gearing up to launch KaZaA, a U.S. judge ruled that Napster had to stop illegal music sharing, a ruling that contributed to the eventual shutdown of that service. Mr. Zennstrom gambled he wasn't vulnerable to a similar crackdown. He was a Swede running a Dutch company with programmers in Estonia, and he says he didn't expect many U.S. users. Unlike Napster, KaZaA didn't require his company to host a central directory, making it tougher to blame him for illegal swapping by others. And he planned to negotiate with a Dutch trade group to allow KaZaA's users to pay to legally share songs from musicians around the world.

When 500 people downloaded KaZaA from the Web in a single day that autumn, Messrs. Zennstrom and Friis went out for ice cream to celebrate. By this summer, almost three million people were downloading KaZaA each week, for a total of more than 270 million downloads world-wide, five times as many as with Napster. The recording industry fired back with legal actions in the U.S. and Europe.

When news leaked that music and movie companies were planning a suit against KaZaA in October 2001, Messrs. Zennstrom and Friis were in the U.S. The two worried they would be served subpoenas there, complicating any claims that they were outside of U.S. jurisdiction. So they had their lawyers negotiate a 72-hour moratorium with the Recording Industry Association of America. The two men say they drove around in a rental car outside the Beverly Hills, Calif., offices where the talks were taking place. After getting a cellphone call saying an agreement had been reached, they walked into a room packed with lawyers. An RIAA staffer pointed at them and threatened criminal prosecution, recalls their Dutch lawyer, Christiaan Alberdingk Thijm.

Mr. Zennstrom had an informal offer to sell KaZaA potentially valued at around $5 million, he says. But possible buyers disappeared once the lawsuit became public. He decided to sell the software and the Web site to Sharman Networks Ltd., located in the South Pacific island nation of Vanuatu, for roughly $500,000 in January 2002. Still, in July 2002, Mr. Zennstrom was personally added to the U.S. suit, and a judge ordered KaZaA's programmers to turn over information. An Estonian court blocked the order, but the lawsuit is still alive.

So is KaZaA, whose success has created a headache for Internet providers by swamping their networks with music files. Re-enter Mr. Zennstrom. He says file sharing represents 50% to 80% of many ISPs' traffic. It's the majority of traffic for some European broadband Internet providers, according to Jupiter Research of Darien, Conn. That slows service for everybody and can force providers to invest in bolstering their networks.

Mr. Zennstrom's solution: Install a massive hard drive that temporarily stores commonly swapped files. This way, files can be quickly routed, and providers can avoid paying fees to other telecom companies for carrying the extra traffic. He argues that the technique used by PeerCache -- unveiled this summer -- is legal in the U.S. and Europe. Even so, with hard drives holding copyrighted material being traded, the ISPs -- and perhaps Mr. Zennstrom himself -- could be vulnerable to legal attack.

The potential for legal action already has one PeerCache customer distancing itself from Mr. Zennstrom. After its use of PeerCache became public, Wanadoo's Paris headquarters put out a statement denying any connection with KaZaA. A spokeswoman says the Dutch unit was testing PeerCache and no longer uses it. Mr. Zennstrom says Wanadoo Netherlands paid Joltid to roll out the software across its network.