Internet Studies Blog: November 2006

FAU APRIL 2004 SEMINAR
“BATTLING FOR OWNERSHIP OF THE ARTS”

HAS THE DIGITAL REVOLUTION KILLED THE MUSIC BUSINESS? PROBLEMS AND POSSIBLE SOLUTIONS.

By Adjunct Professor Ira Abrams

With the digitization of music and its delivery via the Internet, the music industry’s reliance on the sale of physical copies (CD’s, etc.) to generate cash flow is dying a sudden death. Record companies as they are presently constituted will cease to exist in five years or less, and industry insiders know it. The public, especially the younger segment, wants to be able to access a “Celestial Jukebox” that would contain a universal library of all music ever recorded, instantly available on demand, fully customizable to each listener’s particular taste. More specifically, they want to be able to download individual “singles,” not entire albums that may contain unwanted “filler.” Shifting this control to consumers threatens to totally disrupt record companies’ hit-driven album-based business model. Moreover, the public wants to be able to access recorded material that is no longer available to be purchased and is simply sitting in the record companies’ vaults.

We have to begin this discussion with the a priori principle that in order to fully realize our goals as a civilized society, we must democratize access to art and knowledge. Libraries, museums and, yes, especially the Internet, satisfy this worthy goal. For anyone who doesn’t adopt this approach, one must ask what special interest he is advocating.

Most copyrights in the music business are owned by record companies (in the case of sound recordings) and by music publishers (in regard to songs). These copyrights are rarely owned by recording artists, unless they are also songwriters and have reached a high level of success. Those who control content through copyright (copyright “maximalists”) want perfect control and protection of that content, to be compensated for the substantial investments they have made to find, produce, promote and market the content in the first place (not to mention the realization of profit) and to maintain their album-based business model. In short, they wish to cling to the status quo. Jim Griffin, the former Director of Geffen’s technology group refers to this mind-set as “Tarzan economics.” “They have to cling to a vine of revenue because it’s the vine they’re used to, and if they let go they fall to the jungle floor. You very quickly grab the next vine, but until it’s there for you, you cling to the one you’ve got. It’s a question of timing—when that vine will appear.”

With the advent of broadcast radio, ASCAP and BMI devised a model that embraced the performance of music as a source to pay rights owners, and this source is growing while sound sales revenue continues to fall. For the first time ever, it was recently reported that performance royalties for airplay yielded more income to songwriters and music publishers than mechanical royalties paid by record companies. With the Internet, we have become immersed in an explosion of anarchy of art and knowledge that can’t (and shouldn’t) be controlled. To a great degree, our society has been structured around this anarchic freedom. Locks and keys (“Digital Rights Management”) are regarded by the public in the same way as censorship of free speech—an evil to be avoided.

Griffin says that we have two alternative paths we may take here: We can continue to try to end the anarchy of art by killing the Internet as it now exists, or we can find palatable ways to monetize it. The Internet is not the first technological innovation to present this kind of problem to the music or film industries. Broadcasting started out as a pirate technology. However, the performing rights organizations ASCAP and BMI found an efficient way to monetize it by going to the U.S. broadcast industry and creating a bundled price with bundled choice, a kind of “theme park admission fee” for recorded music that allowed broadcasters and public venues to pay blanket license fees without having to seek permission from rights holders in each case, and then parceling out the income to writers and publishers depending on the frequency of airplay of particular records. The trick is to strike that delicate balance between the rights of the public to comparatively unrestricted access to the arts on one hand, and the money interests of the rights owners on the other. The media oligopolies and technologists continue to try to sell this “snake oil” of control, by suing their customers (the RIAA’s “legal jihad”) or in the guise of Digital Rights Management schemes devised by the technologists. Despite the music industry’s resistance to change, a paradigm shift has already begun and there is nothing the music industry can do to stop the transformation.

The industry-sponsored customer-survey market research studies mainly support the industry’s thinly disguised pre-determined conclusion that downloading hurts record sales. But this conclusion is controversial and is far from being established as objective fact. A number of economists and legal scholars argue that downloads of music have no negative effect on sales and indeed have a positive effect on sales of superstar artists (upon whose record sales the music industry depends.) On March 30, 2004 an empirical study that reached this exact conclusion was published by Harvard and University of North Carolina (Chapel Hill) economists Felix Oberholzer and Koleman Strumpf. This important study, which analyzed actual file-sharing behavior over a 17-week period in the fall of 2002 and compared that activity with actual music purchases during the same period (using Soundscan data), did not rely on subjective factors such as customer surveys, as previous studies had. This new study concludes that the record industry’s mantra that downloading hurts sales, is wrong and is not supported by the objective evidence. Interestingly, the study’s findings appear to be supported by the record industry’s own recent sales statistics showing that for the first quarter of 2004 music sales in the U.S. rose by 9.1% compared to the same period last year.

The study says that there are several “plausible candidates” for diminished sales in the recorded music industry over the past few years, none of which has to do with downloading:
(a) generally poor macroeconomic conditions;
(b) a substantial reduction in the number of album releases by the major record labels (who have become overly conservative and increasingly “bottom line” profit-driven). Less product, less income;
(c) growing competition from other entertainment media, such as videogames and DVD’s;
(d) a marked reduction in music variety stemming from the high level of consolidation in the radio industry and similar consolidation in the live concert promotion industry;
(e) the meteoric rise in independent promoter fees to gain radio airplay;
(f) the saturation of the market for CD’s following replacement of vinyl record collections by CD’s through the 1990’s; and possibly
(g) a consumer backlash against record industry strong-arm tactics involving copyright infringement lawsuits brought against hundreds of their customers.
The study is valuable because the researchers used an objective and scientific methodology to reach their conclusion. But, it may be argued that they chose a non-representative time period, or that the time frame was too short, or that the population sample was not representative of the record-buying public or not large enough. The study, however persuasive it may be, is not the final word on the issue of cause and effect and the jury is still out on this issue. Needless to say, the record industry gives the study the same credibility as it gives to the reality of the Tooth Fairy.

On the litigation front, the industry suffered a major setback when on April 1, 2004 a federal judge in Orlando, Florida denied the motion of sixteen record companies to force Internet service provider Bright House to reveal the identities of 25 individuals accused of copyright infringement using the FastTrack peer-to-peer network. The Court decided that both the record companies’ claims and the various unidentified “John and Jane Doe” defendants were improperly joined in the same suit. The defendants had nothing in common with one another other than their ISP and the Court found that their joinder in one lawsuit would cause “unreasonable prejudice and expense to the defendants” and cause “great inconvenience to the Court.” Almost simultaneously, the same result was reached in a case in a Pennsylvania federal district court. The courts are becoming much more aware of the need to protect defendants’ rights to privacy and due process. The record companies should no longer be able to lump many alleged downloaders together in a single lawsuit, but will have to sue each one in a separate action, increasing the industry’s cost of litigation exponentially.

Copyright “minimalists” recognize that copyright was designed for a world in which physical (“hard”) copies of data (including music, visual and literary content) are exchanged, bought and sold. They say, rightly, that the law of copyright is a bad fit for the digital delivery of music. Furthermore, they observe that the increasing monopolization of the media industries (music, film, books, television, radio and news journalism) into fewer and fewer hands and the media industries’ use of copyright to “lock up” culture and content will destroy the public’s choice over what it hears, views and reads. Consequently, the public will be unable to control the cost of access to creative works and, they say, there will be a general decline in the level of innovation and the quality and diversity of creative content.

A number of possible solutions to the problem of the digitization of content have been proposed or implemented in some fashion or another:

(1) Leave the law and business model as they are and simultaneously “educate” the public about the evils of copyright infringement by various propaganda campaigns and by filing civil lawsuits against illegal downloaders and uploaders. The problem with the litigation approach, however, is that it entails high transaction costs (the industry cannot afford to sue every illegal file-sharer) and more importantly, it alienates the very customer base upon which the music industry depends. In this scenario, copyright law might be likened to the 1920’s law of Prohibition (which was largely disobeyed by the public) and the RIAA to the Women’s Christian Temperance Union of that era.

(2) Further strengthen copyright laws and enforcement through criminalizing certain activity, such as the circumvention of encryption and copyright protection devices, prohibited by Section 1201(b) of the Digital Millennium Copyright Act. This approach embraces the concept of lengthening the term of copyright (a la the Copyright Term Extension Act, enacted in 1998) and would make the law uniform worldwide. We learned in the recent U.S. Supreme Court case of Eldred vs. Ashcroft that the courts will not interfere with what it considers to be Congress’ sole responsibility. Jack Valenti (former head of the MPAA) was vindicated. He had emphatically declared that the phrase “limited times” in the copyright clause of the federal Constitution means “anything up to one day short of Eternity”. Apparently, the Supreme Court agreed with him.

The problem with this solution is that it threatens to eliminate or seriously cripple the doctrine of Fair Use and radically diminish the public domain sector to the vanishing point, making it practically impossible for new artists to build on the work of their predecessors. In short, it will kill innovation and diversity in the arts. To illustrate the absurd lengths politicians are willing to go to satisfy the media oligopoly, a draft bill was recently circulated among members of the House Judiciary Committee that would, for the first time in our country’s history, lower the burden of proof in criminal prosecutions against file sharers. The bill would subject filesharers to penalties of up to ten years in prison and substantial fines. Senators Orrin Hatch and Patrick Leahy introduced another bill in late March, 2004 that would allow the Justice Department to pursue civil cases against file sharers.

(3) Those who favor technological solutions would devise additional technological “fences” that block non-fee-payors from access. These include people who support “DRM” (digital rights management), a “lock and key” system that may involve “micropayments” for each increment of use of a creative work. Technological fences have been famously unsuccessful so far. Every system yet devised has been defeated by groups of dedicated computer nerds (the “hackers”, so demonized by the copyright maximalists) who believe that for every lock there is a key and they’re willing to share those keys with the public at large, regardless of the consequences. “Timing out” content (where the disc becomes unplayable after a particular number of uses or after expiration of a period of time) has also been very unpopular with consumers. Timing out content destroys the illusion of ownership. Likewise, the Secure Digital Music Initiative (SDMI) never got off the ground due to limitations on the interoperability of the software (disks) in different playback devices, compounded by a lack of cooperation between hardware manufacturers. In the long run, technological fence systems should suffer the same fate as SDMI. Virtually all existing playback equipment would have to be replaced by SDMI-ready devices or, worse yet, the architecture of the Internet would have to be radically changed, neither of which is feasible nor desirable.

(4) Yet another alternative is the development of online paid subscription services, the most successful of which to date has been Apple’s iTunes, which brilliantly served as a platform for the sale of Apple’s iPod hardware; however, although Apple fixed its lack-of-interoperability problem by adding Windows-based software, the depth of the available catalog has been less than hoped for and consumer choice has been limited. Many consumers don’t stop to do the math: at 99 cents per song, it cost each consumer $15,000 to fill up a 60GB iPod.

(5) Among the more intriguing departures from the current business model is the administrative compensation system proposed by Harvard professor William Fisher. Under professor Fisher’s plan, all content capable of digital transmission would be digitally “watermarked”. Once the content was watermarked, systems would be developed by businesspeople to monitor how many items of each content were distributed. A surcharge would be imposed on devices such as CD/DVD burners, blank CD’s/DVD’s, MP3 players, and, most importantly, on ISP access services. The collected revenues would be distributed through an ASCAP-like non-profit organization to the parties in interest (record companies, artists, songwriters, music publishers and producers) in proportion to the amount and rate of public consumption of the content. A government agency would control and monitor the non-profit ASCAP-like organization to see that it performed efficiently and honestly. Because there would be a huge savings created by eliminating the manufacture, warehousing, packaging and delivery (through brick and mortar retail stores) of “hard” copies of CD’s, the profit margin to record companies and other rights holders would be increased enormously. Inevitably, a move in this direction will devastate stand-alone record retailers, an industry already plagued by many bankruptcies. But they will not be going out of business because of illegal downloads (a myth created by rights holders) as much as because the delivery system for music is undergoing rapid, fundamental and irreversible change.

Artists would certainly fare better under a purely digital delivery system: There would be no need for record companies to establish reserves for returns because once a song is downloaded there is no possibility of a “return”. Theoretically, this would put more money in the hands of artists a lot sooner than under the present contract regime where a large portion of artist royalties can be held back by the record label for up to two years as a reserve against returns. Likewise, the packaging deduction would be eliminated (although there might be a small deduction for webpage and artwork design). The present industry standard is that the record company deducts 25% from the Suggested Retail List Price (SRLP) of records sold and not returned.

Fisher’s proposal has attracted the most debate, especially among scholars and economists. As always, the industry is resistant to change and dismisses the plan as fanciful utopianism.

Stanford law professor Larry Lessig, in his new book, “Free Culture: How Big Media Uses Technology And The Law To Lock Down Culture And Control Creativity” (Penguin Press, N.Y., 2004) accurately observes that it is a mistake to lump together all Internet file-sharing. There are actually four different types:
(a) downloading content, like a major artist’s CD, instead of buying it;
(b) listening to the content (previewing it) on the Internet before buying it, to determine if it’s something you want to buy;
(c) downloading content that is no longer commercially available (i.e. the trove of recordings in the record companies’ vaults that have been “cut out” of their current catalogs); and
(d) downloading content that is not protected by copyright or is being given away freely by the authors who want to share it with the public without charge.
Only this last type of downloading is now legal. But Lessig says that types (b) and (c) [previewing content and downloading commercially unavailable content] do not displace any sales and do no harm whatsoever. In fact, pre-purchase listening to content very likely stimulates sales of superstar artists’ recordings (according to the Oberholzer/Strumpf study). Lessig says that we should not be regulating a technology in transition. The Internet is certainly in a state of substantial transition. We should instead adopt stop-gap measures to minimize harm to those whose economic interests are affected by the technology, while at the same time “enabling and encouraging the most efficient technology we can create.” How do we minimize the harm while maximizing the benefit to innovation? Lessig suggests that first we guarantee the right to download public domain content. Next, we permit non-commercial downloads of commercially unavailable content, either at no charge (my artist/songwriter clients would not like that alternative) or at a low or fixed statutory rate. As for downloading that displaces sales of currently available protected content, we should adopt a plan such as the one proposed by professor Fisher, but only to the extent actual harm to record sales can be demonstrated. Personally, I’d like to see the Oberholzer/Strumpf study performed again, but this time over an entire year’s period, using a major ISP as a test case, to see whether the results would be the same or different.

Five major record distributors control approximately 85% of the recorded music in the world: Universal Music Group [UMG] with a 28.3% market share at last count, Bertlesmann Music Group [BMG] with 20.3%, Warner Music Group [WMG] (13.8%), Sony (12%) and EMI (10.8%). BMG and Sony are likely to merge this year leaving the industry controlled by only four major record distributors. Demonstrably, consolidation is as bad for diversity and innovation in the music industry as it has been in the realm of radio, television, film, print journalism and telecommunications. In a recent Newsweek magazine interview of media mogul Barry Diller, he observes that while the Internet (“that wonderful self-publishing medium”) hasn’t yet become consolidated in any way, it is likely that DSL (digital subscriber lines provided by telecom companies) and Direct Broadcast Satellite “in the end will emerge as the dominant broadband distribution pipeline.” The key to media power, Diller says, is distribution, not content (unless the content is jointly owned with distribution). The goal of these Internet media giants is to create a tollgate through which the public must pay to cross. One cannot consider the impact of technology on the music industry without also taking into account the issue of media consolidation across the board. At some point it will all converge.

Record companies take the position that they are fighting for control of the musical arts for the benefit of their artists. But this does not square with the contracts currently being offered to artists at all levels: Artist advances against royalties have fallen to appallingly low levels; the majors still insist on reserve clauses and packaging deductions, even for Internet sales; the majors are requiring artists to transfer to the company the exclusive right to ownership of the artist’s website, not only during the term of the recording agreement, but in some cases perpetually afterwards; finally, the labels are insisting on sharing in a much bigger income stream created by the artist, such as an equal percentage of the artist’s merchandising and sometimes a percentage of the artist’s concert ticket sales income. The true savior of the record industry, that is, of good quality music, may well be the independent labels who will provide an alternative to the over-reaching majors.

Clearly, the record companies’ current policy of suing their customers is ill-advised and economically inefficient, despite whatever “feel-good” effect it may have on record company execs and their lawyers. Nor is it advisable to set up tollgates so that people must pay for each downloaded song.
Technology author Don Tapscott, in a New York Times article published on September 15, 2003 got it right when he said that
“Instead of clinging to late 20th-century distribution
technologies, like the digital disk and the downloaded
file, the music business should move into the 21st century
with a revamped business model using innovative tech-
nology...”
Tapscott calls the new approach “Everywhere Internet Audio”. Instead of downloading files (whether they use computers, home stereos, radios or handheld devices) music fans would have access to a huge database of everything ever recorded. Listeners could request that the song of their choice be instantly streamed to them through the Internet. The need to maintain individual libraries of music on hard drives or disks would disappear, the argument goes, because Internet subscribers could hear whatever they wanted whenever they wanted. Music collectors could still amass “hard” copies for their individual libraries, but the predominant way for music to be accessed would be via fully customizable, commercial-free streaming technology.

Requests for music to suit one’s tastes could be simple or intricate. One might request particular songs or artists, as consumers do now or, for example, “all rock tunes that made Billboard’s Top Ten lists during the years 1964-1975”, or “the music of current female jazz vocalists whose singing style is similar to Sarah Vaughn”, or “light classical music for dinner-party backround”, or “all recordings made by former members of the rock band Cream after the band’s breakup”. The possibilities are endless.

At the customer’s option, the system could be interactive. That is, it could learn about individual listener’s musical tastes and suggest new music accordingly. Tapscott says “If it worked, it would be as if we each had our own private satellite radio channels—customizable collections of tunes for hundreds of millions of audiences of one.” Music would be “narrowcast”-- not “broadcast”-- over the Internet. Simultaneously, pre-programmed music would be broadcast to those who have neither the time nor the inclination to customize music to their particular tastes.

The record companies, as owners of the content, could be at the forefront of designing a system such as this. Essential to the future of Everywhere Internet Audio is the continued development of wireless Internet access, because wireless means portability. Wireless technology is the key.

Some variation of Fisher’s Administrative Compensation system (e.g., surcharging ISP access and hardware, and creating a pool of revenue to allocate and disburse to rights holders) would fit nicely with Everywhere Internet Audio. The monitoring of downloads would have to be done in a way that fully protects consumers’ privacy rights.

Implementation of Everywhere Internet Audio would surely create a major benefit for the public—we would have unrestricted access to all the world’s music. Musical diversity and quality would flourish as never before. Every “niche market” could be satisfied. At the same time, record companies would have more economic incentive to promote and nurture new artists.
Tapscott is correct when he says that “market forces alone would not produce such a system. It would take enormous industry cooperation, which could only occur with governmental approval, lest it be deemed a violation of antitrust laws”.
This is the wave of the future.

Post Script (August 24, 2004):
On August 19, 2004 the United States Court of Appeals for the 9th Circuit ruled in MGM Studios, Inc., et al. v. Grokster, Ltd., et al that software distributors are not liable for copyright infringement (on theories of contributory or vicarious secondary copyright infringement) where the software is capable of substantial non-infringing uses, even where the software, as here, was being used by individuals for unauthorized “free” downloading of music files, a direct copyright violation. The Court relied upon and followed the Supreme Court’s holding in the landmark 1984 case of Sony Corp. v. Universal City Studios, Inc., 464 U.S. 417 (1984). The Court of Appeals distinguished the Napster case which involved a centralized set of servers that maintained an index of available music files. In contrast, Grokster and co-defendant Streamcast used a Gnutella-type decentralized network. No central index was maintained by the defendants. Further the defendants did not materially and actively contribute to the directly infringing activities of those who downloaded the software. Once the software was downloaded, the defendants were totally passive. They did not provide the site or the facilities for infringement. They were not “true access providers”, unlike Napster. Because they did not store files or indices, they had no power or ability to delete offending files or indices. They had no ability or right to supervise any of the activities of the direct infringers. The Court concluded that it is not up to the courts, but rather is the sole province of Congress, to address the problem of applying copyright law to new technologies.

The record companies and movie producers, no doubt, will file their appeal to the U.S. Supreme Court and will lobby Congress even more strongly than before, to enact new legislation favoring copyright holders (at the expense of technology companies and P2P file-sharers). Although for the time being software companies get a free ride, individual users remain liable for copyright infringement if they use the software to illegally download music or film files.

Further Post-script (Feb. 14, 2006): Sony and BMG have merged, leaving only four major record distributors in control of roughly 85% of the record market.

Also, on July 27, 2005 the United States Supreme Court reversed the 9th Circuit Court of Appeals and ruled squarely in favor of content providers (RIAA, MPAA, et al) and against the Morpheus/Fastrack software companies Grokster and Kazaa. The Court found Grokster and Kazaa to be liable as a secondary copyright infringers, despite the fact that the software could be used for non-infringing purposes (such as for the digital transmission of public domain works). The Court held that the 1984 Supreme Court opinion in the case of Sony vs. Universal City Studios did not apply, because the main purpose of the software was to infringe on copyright owners’ rights.

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