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WP: I was wondering about David Birch, the computer journalist who stood up at a DRM conference in Barcelona and asked, "Why don't you tell the content owners to just get stuffed? Hollywood is not even a $10 billion industry. [It's] small compared to the telecom industry. Why don't you take a stronger line? Consumers don't want DRM at all. You can't sell DRM."

FvL: That's right. Unfortunately, the more you know about this, the more complicated the story becomes because the computer guys really see convergence as a huge new business opportunity for them. Let's face it, most computers today are already too powerful for your typical desktop business use—which means there's less incentive for the typical two-year replacement cycle, which means a lot of corporate and enterprise clients are slowing down their purchasing cycle. So the way to get people to buy more computers is to get the home-theater PC machines going, because high-def video is one of the few applications that requires the power that the latest processors provide. Computer companies see this as a real growth window for them over the next five years or so.

Hollywood knows this, but Hollywood couldn't care less about convergence. Hollywood's main interest is the consumer electronics business. If you compare the number of stand-alone DVD players in American living rooms to the number of home-theater PCs, the difference is pretty staggering. As a result, the computer industry feels as though it's over a barrel—the computer industry may be 10 times the size of the entertainment industry, but Hollywood is basically the gatekeeper on the entire convergence game. If Hollywood says that HD DVD or Blu-ray or any of the HD DRM-protected formats for cable has to shut out the computer industry, it can do that relatively easily. As a result, the computer industry has been timid. Hollywood has been very effectively gaming the CE guys off against the computing industry by saying, "If you Microsoft guys won't give us the content protection we want, then we'll just shut you out of the next generation of DVD—it'll be a CE-only format, just like SACD."

That almost happened with DVD. Hollywood almost went ahead with DVD as CE only, but Intel and a few other companies rushed in at the last minute and got DVDs to work on computers. That memory is why you're seeing more and more DRM features rolled out by Microsoft and Intel.

The computer industry is brilliant at taking disadvantages and turning them into advantages. I don't think computer companies want DRM or like it, because it creates all kinds of interoperability complexity, but from their point of view, if they're going to be stuck with it anyway, they would rather turn it into a competitive advantage in their platform wars. For example, you're going to see Microsoft rushing to be certified before everybody else to be the cable-card–capable home-theater PC solution. Nobody else will have that. You won't see it from Linux, and it will probably take Apple 12–18 months to jump all the hurdles and negotiate with cable labs to get there. So, from Microsoft's perspective, DRM may be bad, but as long as Microsoft can use it to create a barrier for entry to its competitors, well it's not all bad.

It's not just the other players in the computing world that the computer companies are competing with, either. They're eager to take some of those consumer dollars that would have otherwise flowed into CE devices, such as Tivos, PVRs, and DVD players—and once they have a beachhead in the living room, there's all kinds of upselling they can do. That's why a lot of people have interpreted the Xbox 360 as a 60% gaming/40% convergence device, aimed at getting Microsoft into the living room to displace a variety of CE components.

Most analysts believe that the Xbox is initially going to lose money, although that'll change as time goes on. Of course, the first thing you do when you buy an Xbox is go buy Halo, a Microsoft product. And then you'll want to upgrade your Windows and your PC in your den to a media center PC, so you can stream all of your music and movies from your den PC to your living room media setup.

Hollywood can pull the plug on that any time it wants by manipulating the DRM standards and claiming the PC is not secure enough to be the platform for the next format—which keeps the computer industry toeing the line.

I took us off topic for a few minutes, observing that game makers didn't seem to generate as much enmity as the record labels.

FvL: If you consider how many hours of entertainment you get out of games, they do offer good value—and they include value-added features, such as licenses for multi-player online versions of the games.

I think that record labels inevitably have to do something similar, but unfortunately these companies have been incredibly slow to react to the digital reality. The reasons are complicated: As companies, labels are relatively mature, aren't used to moving quickly, and have been selling the same product in the same way for nearly 30 years. They just aren't used to turning on a dime. The other problem—and this is one I don't feel people fully appreciate—is that the record industry has absolutely no exposure to its customers.

If you talk to record label executives, most of them have never seen a music fan. They sell product wholesale to distributors, who in turn sell to retailers, who sell to the customers. It's a culture shock for record labels to now realize that they have to actually think directly about customers—that used to be the retailers' problem. If people weren't coming into stores, well that was Tower Records' problem. The model where the label put the records on the radio and the stores worried about selling them, well, that collapsed almost overnight and the labels are still in denial about it.

When the labels, foolishly perhaps, cast around for a candidate to be the next retailer substitute, Apple stepped up and said, "Okay, we'll take that business from you." I hear from inside the labels that they are belatedly waking up and adapting to this new world—they're not doing a good job yet, but they're trying. We'll see.

It's interesting to hear that online music services are starting to say to the labels, lose the DRM. The people who are trying to meet the customers in the marketplace are starting to carry the message back to the labels: It's going to take lower prices, no DRM, and better inventory to revive the music industry.

WP: I was surprised when I listened to Yahoo's Dave Goldberg's talk at Music 2.0. It wasn't all that revolutionary—boil it down and all he said was, "You've got to give the customers what they want."

FvL: Bingo! You have to understand that in the music business, that is revolutionary. I've been to a few National Association of Recording Merchandisers (NARM) conferences, and I was surprised to see how much the retailers hated the record labels. The irony is that giving BestBuy and Walmart price incentives that the small record stores couldn't get deprived consumers of the outlets that gave them deep music experiences.

At the Music 2.0 conference, I should point out, lots of people were delivering that ditch DRM message—I was one of them. It's not news when the EFF says it, but it sure was when Dave Goldberg said it. Many of us argued that people can get exactly the same content for free on file-sharing networks forever—you can't stop a motivated music fan from getting what he or she wants. The successful strategy has to be offering them incentives to pay for it: convenience, selection, discovery, playlists, and lots of things besides access to the track. Music 2.0 was the first time I've heard people really come to grips with the fact that the peer-to-peer universe is not going to go away.

I always remind people that we wouldn't have an iTunes Music Store, we wouldn't have Rhapsody or Yahoo Music Service, if it weren't for P2P file sharing. There's no way record label executives would have agreed to unbundling albums and selling singles or selling all-you-can-eat services for $7/month for millions of tracks. We are so much further along than we would have been if record executives were in charge of the evolution of this business.

The bottom line is that more people are listening to more music now than ever before—that has to be good news. Right now, they're not all paying you for it, but the good news is they still want your products. You can build your business from demand; the worst news is when you can't give your product away.

If you go back to 1997, when the music industry scored its all-time revenue peak, people just weren't engaged by or talking about or caring about music nearly as much as they are today. It's quite clear that more people care about music today—look at all of the MP3 blogs, at MySpace, and all of the energy that's devoted to music today that just wasn't there in '97. By any meaningful measure, that has to be good news. The business just has to figure out how to sell the music fans what they want.

I bought 76 CDs last year and 87 CDs the year before—I'm buying more music than I ever have before, in large part because I'm exposed to more music through Rhapsody, which I treat as a try-before-you-buy listening booth.

That enthusiasm for music works for high-end audio, too. Despite the prevalence of low bit-rate audio...anything that gets people excited about music opens the door for high-end, once the marketers figure out how to harness that excitement. The big threat to high-end audio isn't MP3, but home theater. I have friends who basically don't listen to music any more, their leisure time is devoted to watching movies. If you want to sell audio, you have to keep people listening to music.