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Entertainment Industry Breaking the Wrong Rules

Last week, Swedish police raided the offices of an Internet service provider (ISP) that was hosting a popular file-sharing site, among other things. Fifty officers entered several hosting locations, seized every server, and arrested three of the site's operators.

Unfortunately, one of the other sites hosted on these servers was protected from seizure without a court order, being registered as a news outlet and protected by the freedom of speech clause in the Swedish constitution. That site was shut down along with all the other content hosted at the ISP, which is problematic from a legal point of view. The file-sharing site opened up for business again within three days -- this time in the Netherlands -- while four political parties organized a protest march in Stockholm, and a hacker organization launched a series of retaliatory attacks on police and government websites.

The fallout
The whole affair has moved from the arena of copyright and intellectual property and into a full-blown political scandal. In the blue corner, we have organizations dismissing the value of intellectual property laws, alongside those who feel that the rule of law was ignored in favor of political pressure from mostly American-based entertainment producers.

And in the red corner, we have the Swedish equivalent of the Recording Industry Association of America (RIAA) and the Motion Picture Association of America (MPAA). The entertainment industry is suspected to have applied political pressure to Swedish authorities in order to shut the file-sharing site down.

The winds of change
If you follow the entertainment industry at all, you may have picked up a few signs of the coming revolution. Today's music and video consumer wants access to content (all together now) whenever, wherever, and however they want it. Mostly thanks to Apple's (Nasdaq: AAPL  ) iTunes Music Store, online music sales are thriving and accelerating. Legal downloads make up about 7% of the total music market today, and that market share is projected to at least double this year.

That's a testament to the power of convenience and freedom of choice, and music labels like Sony (NYSE: SNE  ) BMG Music Entertainment and Vivendi (NYSE: V  ) Universal Music Group are raking in most of the revenue from the online sales. Apple receives a few pennies per song, but the music sales drive the high-margin iPod segment as well. With the proven success and bright outlook for the legal music download model, you'd think that movie studios would be falling over themselves to match the music model.

Well, you'd be wrong. The legal download alternatives available today, such as MovieLink, Vongo, and CinemaNow, all come with rather inconvenient license restrictions as to what you can do with the file you paid for. None of them will let you burn the content onto a standard DVD for playback outside of your PC, for example, although Vongo does give you the option of transferring the videos onto a portable device. Hook your handheld video player into your 60" plasma TV, and you're good to go.

But even then, the largest installed base of such players is excluded. The service requires Microsoft (Nasdaq: MSFT  ) PlaysForSure support, so the video iPod can't help you here. And so it goes. Bickering about license terms and worries about file sharing are holding back an entire industry from moving online en force. The Swedish raid looks like another battle in that war, a battle with many more losers than winners.

The pirate site wasn't shut down, innocent third parties that happened to be hosted by the same ISP can't get their equipment back until the whole affair is settled, and several government agencies are feeling the sting from a collective black eye. The file-sharing site, on the other hand, got some free publicity and a handful of accidental supporters who just want the constitution to be observed.

The future of entertainment
In the end, the thumbscrews will have to loosen up. There will be little incentive for today's media pirates to go looking for legal trouble when legal downloads are easy to find, reasonably priced, and not burdened with draconian restrictions. Music downloads have shown the way, and results from current experiments with cheap and less-restricted movie downloads in China and Korea are suggesting that piracy thrives in restrictive environments but dies when the same thing is legally available at reasonable terms.

As is usually the case, the pornography industry is scouting the field and trying out new delivery methods before the big boys go in. CinemaNow is offering adult titles burnable to regular DVD discs for $20 apiece. The more forward-looking studio executives are sure to pay attention to the success of this move.

But even potential rule breakers like Kevin Tsujihara, president of Warner Bros. Home Entertainment (a subsidiary of Time Warner (NYSE: TWX  ) ), and Disney (NYSE: DIS  ) CEO Bob Iger still have to deal with corporate inertia, groupthink, and appeasing a slew of old-line distribution partners (movie theater chains, TV station networks, and so on), and it's going to take guts to throw the first stone at the old business models.

But I think that whoever joins the new age first stands to benefit the most. I'm excited about where home entertainment is going over the next few years, and it's time for a few major corporations to start breaking some old rules. Just make sure you don't overstep legal boundaries in the process, OK?

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Time Warner and Disney are two selections of the Motley Fool Stock Advisor newsletter service. See why Tom and David Gardner think that these are the media companies of the future. Take Stock Advisor for a 30-day free trial.

Microsoft is aMotley Fool Inside Valuepick.

Fool contributor Anders Bylundowns stock in Disney but holds no position in any other company mentioned. Foolish disclosureis unrestricted and free for the asking.

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