Lala, John Kuch
Paul Sakuma  /  AP
Lala.com business developer John Kuch poses next to a huge CD collection at his office in Palo Alto, Calif., Monday, June 4, 2007.
updated 6/5/2007 8:24:17 AM ET 2007-06-05T12:24:17

Entrepreneurs behind Silicon Valley startup Lala.com hope to transform the CD-swapping site into a music portal where members can download songs directly to their iPods, bypassing the computer hard drives where most music is stored.

The Palo Alto-based company has an agreement in principle to sell nearly 200,000 songs from Warner Music Group Corp. for 99 cents each, starting Tuesday.

Members will also be able to play the Warner songs for free, and the company will pay Warner a penny each time someone listens to a song.

“This is a turning point for music companies and the entire industry,” said co-founder Bill Nguyen, 36, who founded six previous startups, including several that went public and one that sold for $850 million. “I have no idea if it will work — this is a bet.”

Most other sites that provide streaming music charge a subscription fee or stream 30-second samples.  Napster Inc., which has 830,000 members, has subscription fees and advertisements.

Lala.com contains no advertisements; revenue comes from members who buy new CDs or swap used CDs with each other for a fee of $1 per disc. The site has about 300,000 members and is backed by venture firms Bain Capital and Ignition Partners.

Nguyen estimated the 23-person company would pay $140 million for licensing fees over the next two years if member numbers grow as projected. Executives are talking with the other big labels: Sony BMG, EMI and Universal.

“We’ll be reporting some crazy losses at first but we’re prepared to weather the storm,” said Nguyen, who sports a boyish grin and flip-flops.

Huge risk?
Analysts said Lala is taking a huge risk. As a full-service music site, it will compete not only against Apple Inc.’s iTunes, which sells 5 million songs a day, but e-commerce powerhouses Amazon.com Inc. and eBay Inc.

“It’s an audacious plan,” said Mike McGuire, vice president of research at Gartner Inc. “They’re not saying what a lot of new media companies say — ‘We want to leverage your content without taking on any of the cost or risk.’ They’re saying to the labels, ‘We’ll deal with you, we’ll license the content and we’ll pay for it.’ It’s an old school move.”

To download songs to an iPod, members must download a 3-megabyte plug-in that runs on all major browsers on Windows and Macintosh computers. Because the songs aren’t stored on the PC hard drive, the primary source for files pirated on peer-to-peer networks, Lala will dispense with traditional digital rights management, which controls which devices can play a song.

Founders were secretive about how the technology works, noting that they’ve filed for numerous patents. The technology worked well in demonstrations last week.

Susan Kevorkian, a consumer audio analyst with research firm IDC, said Lala could cut into iTunes’ base but would most likely be a windfall for Apple.

“ITunes has historically been about driving hardware sales,” she said. “If there’s another compelling source of music for the iPod, it makes the experience of owning an iPod that much more compelling.”

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