Facebook Dreams Of Easy Music While Religious Battle Rages Internally

In August I speculated that music may be the single biggest factor helping MySpace keep its commanding lead over Facebook in the U.S. market.

It’s not that Facebook hasn’t experimented with music over the years. Artists can set up pages and promote themselves, for example, although few choose to do so. Facebook also awarded iLike (the only music service with real traction on the site) with the cherished “Great Apps” designation over the summer, which theoretically gives iLike a level playing field with Facebook’s own applications.

Every time I’ve spoken with Facebook execs, they’re stressed that they have no intention of building their own music service to compete with iLike and other applications.

But all that changed a week or so ago when Facebook began an earnest effort to build a Facebook Music application (Venturebeat has some of the details, although parts of their story conflict with information we’ve obtained). They didn’t announce this publicly. Instead, Vice President of Business Development Dan Rose and his team reached out to 8 or 9 Internet music services to discuss what the service might look like. Facebook execs also met with major music labels in New York this week to discusss the project, says one source.

We believe, based on discussions with a number of sources, that Buzznet, iLike, iMeem, LaLa, Last.fm, Rhapsody and other services were contacted and provided with a document (sometimes referred to by sources as a RFP (request for proposal), other times called a term sheet) that outlined certain goals of the new Facebook music service.

The RFP requires the third party service to build and power a new Facebook Music Service that offers free music streaming and playlists, music downloads for a fee, and other music merchandising services such as ringtones, concert ticket sales and physical goods like tshirts (if this sounds like MySpace Music, it’s because it is exactly their model). The service must not only handle front end user requirements but must also be able to handle the very tricky tracking issues required by the labels to monitor music streams and fees.

The RFP also includes onerous termination provisions that allow Facebook to take ownership and control of the service and the user data under certain circumstances. In return, say our sources, Facebook will offer the third party a split on revenues generated from the service.

We’ve heard conflicting accounts of who will pay for the big up front fees labels require to get a music service up and running. Some estimates of prepaid royalty requirements are as high as $100 million, which Facebook is looking to avoid paying themselves. Other sources say that Facebook may be willing to pay these fees if they can’t force the third party to take them on.

It’s clear from our discussions that the third party music services are impressed by how one-sided the Facebook terms are. To do the deal Facebook requests, one source said, is “suicide.” But it’s also clear that no one wants to be left out of Facebook music, either. “It’s a no-win situation,” said one source.

The Facebook Platform Religious War

Facebook faces a problem – they can’t ignore music and expect to compete effectively with MySpace. But they’ve also promised their application developers, particularly iLike, a level playing field. Those developers have spent significant resources building on Facebook based on those promises. If Facebook now carves music out of that promise, developers won’t be able to trust them in any other area (rumor is Facebook has a similar RFP out for classifieds). The message will be clear: you guys can have all the niche stuff, but if something grows too big, we’ll come in and take it over.

There are three ways Facebook can go forward: (1) build their own music service like MySpace did and lose the trust of their application developers forever (plus it will take them a year or more to build the service and secure deals with labels and other rights holders), (2) partner with a third party to build out Facebook Music, and then compete on a somewhat level playing field with other third party developers, or (3) just acquire iLike (or another service) flat out, since they’re already a “Great App,” and show developers that if they really excel in their niche, they have a path to liquidity.

iLike isn’t the ideal partner for the service because they don’t have music label relationships (they stream music through Rhapsody). But they do already dominate the music scene on Facebook. And Facebook may be forced to forge those label relationships directly anyway, making iLike a good fit.

It’s far from clear which direction Facebook will go. Our understanding is that CEO Mark Zuckerberg doesn’t want to upset developers any more than they already have. Rose is supposedly championing a direct approach that leaves developers out in the cold.

The outcome of the battle will affect far more than Facebook’s music strategy – it will also signal if the company is at all serious about being a platform/operating system for the social graph, or if they just want to own everything of value on the Facebook platform.