Running With Foxes

In case you haven’t heard, Lala bought defunct WOXY.com, the online radio station. WOXY went silent September 15th. For me, the main motivation behind the acquisition seems to be an attempt to draw more eyeballs (a quick look at the member list shows 7800 registered users in the forum) to the site in hopes of ramping up membership. Seems like WOXY’s in for another rebirth and death if they don’t come up with a sensible revenue model. WOXY’s own press covereage highlights the IP difficulties of webradio:

Royalties paid by Webcasters to SoundExchange range from 10 percent of their first $250,000 in revenue - and 12 percent above $250,000 - to a rate based on an aggregate tuning hour, which is $.0117 per listener per hour; that is, the number of listeners per hour times that rate.

Webcasting royalties for 2003 were $7.5 million, Simson said.

It seems like a tough slug ahead for Lala, but I have of late been intrigued by the economic model behind the service. They have created an online secondary marketplace for CDs, where they get a dollar for each transaction. Like any market, it can be broken down into supply and demand. At a $1 per CD it’s a great deal for buyers (and a lot healthier than what McDonald’s offers for the same price). I’m trying out the service right now. However, my overall feeling is that Lala’s biggest challenge will be keeping up a supply of CDs for sale in the marketplace due to the following problems:

• CDs are taken off the market after purchase as people listen to them
• The best CDs are the least likely to be traded (this can lead to mediocre inventory)
• Uncertainty in what CDs you will eventually get from the market
• Leechers

Note: Rampant piracy solves all of these problems.

The shrinking of people’s personal CD libraries is the most daunting issue. When people first receive a CD people will not want to turn around and ship it off again(unless they burn a copy of course, think snail-mail Napster). So, if people continually legitimately use the service, and collect the CDs they love, the number they will send out shrinks.

The degree to which the other problems are mitigated depends on how cleverly their karma algorithm is constructed. Leeching is the easiest to solve. Leechers may be given one free pass with the purchase of their first CD, but can quickly have their future transactions put on hold. The other two issues are caused by the riskiness of selling a CD on the market. If I buy a CD and it never comes, I lose a $1.75, but if I send a CD and can’t seem to get another one I’m interested in, I’m out my original CD. Reducing this exchange risk is key getting people to send out more CDs and increase the percieved value they receive when sending out a CD (I’m more likely to send CDs out when I know that I have good ones coming in).

I was just over at Lala’s office in Palo Alto today, meeting with some of the co-founders Bill Neguyen and John Kuch, as well as staffers Lindsey and Megan. They’re fun people, and kindly let me look at the product they’ve been selling since March. The meeting was filled with a lot of energy, especially from Bill, who aims to make this, his seventh startup, another success.

Lala is an online secondary marketplace for CDs priced at a buck a piece. That’s a whole DRM-free albumn or single, for one dollar. Users post their catalogue of CD to the site, and peruse the selection generated from other users for interesting titles they want. Each title is listed in a predefined database of 1.8 million albums that they license from a third party. This allows you to play a short sample of the CD before you buy. When someone buys your CD, you send it with or without cover art in a pre-postage marked envelope and jewel case that the company sends you (don’t worry, they keep you well stocked). This gets you the right to get one CD from the service in return. When you buy a CD you pay the service a $1 service fee and $0.75 for shipping.

Obvious problems are concerns over users never sending CDs, ripping and then sending, or sending a burnt copy to a buyer. Bill said, and I agree, that the IP issues aren’t the same for this industry since it’s a secondary sale (used music stores aren’t required to root out who “burned” a copy of the CD they’re selling). He also says their user community has been pretty good at policing themselves and claim to have a 98% success rate, meaning that after two weeks they either don’t hear from the user or get a positive response upon receiving the CD. Users are also disuaded from gaming the system or leaching from what they assure me is a clever Karma system ranking users behind the scenes. Shipping hard-to-get CD’s in high demand gets you good karma. Not shipping or sending broken CDs gets you bad karma. Karma plays into the equation when you’re ordering CD from other users and will allow users with better karma first dibs on requested CDs.

Thoughts - I joined up and poked around the site. I like the idea of getting a full CD for a dollar and it seems little to risk for an online purchase. They promise to refund for incomplete sales anyway. I noticed a lot of unnamed and repeated accounts. There is also some repetition of titles within peoples profiles. These bugs inflate the number of users and albums users carry.

Seems to me that the toughest challenge for a service like this is (a) getting enough CD in their library and (b) getting users to list their own collections. They seem to have done a good job at “a” and could bootstrap it by buying out a couple of used CD stores and writing it down as a cost of doing business anyhow. They probably are doing this to get some higher quality content.

Econ Alert -This also gets into a deep economic question based on the fact that the price of all CDs are a dollar, when the value users assign to them may be greater than a dollar (Maybe I’m holding on to my Bob Dylan album because I’d have to get $5 to part with it). Transactions will therefore only happen when the buyer values the CD for more than $1 (nearly always, unless it’s KFed) and the seller values the CD they’re selling (minus the value they assign to potentially getting the CD really want on the site) at less than one dollar. Example, I trade “Abbey Road” to someone because even though I’d normally want $5 for it, I have a good feeling that my karma is good enough that I’ll get the new “Strokes” album I really wanted (valued at least $4 to me. 5 - 4 = 1).

“B” on the otherhand, is more challenging. Lurkers, people who buy and don’t list, could really hurt a service like this. That kind of behavior would shift the burden of supplying CDs to a couple power users obsessively cataloging and trading music. Also, I’m not sure if people would list CDs they just bought on the site after they bought them, since they probably don’t want to entertain selling them for a while. Lala is going to have to register a lot of users to get the statistics for a site like this to work.

Stay tuned for more about Lala on TechCrunch.