Music Markets and Mythologies

(in press Seton Hall J. Sports & Ent. Law)

Henry H. Perritt, Jr.[1]

I.       Introduction

The revolution in the marketplace for music is in its early stages. Some emerging enterprises make available new ways to perform creation, intermediation, and consumption activities. As in the early days of e-commerce, circa 1998, it is too soon to know who will become hugely successful and who will fade from the scene. It is possible, however, to estimate the basic features of the new marketplace. It will not look at all like the old one.

Confronted with change, the major firms in the popular music industry have mounted a major public-relations and litigation campaign premised on the idea that the world of popular music is under a grave threat. This essay debunks the myth propagated by dominant players in the current music industry that the problem is illicit file sharing. It explains how new technologies based on more powerful PCs, portable music players, and the Internet are reshaping the marketplace for popular music so as to facilitate more direct access between musicians and their fans. It predicts that the overall demand for popular music will continue to increase because music is becoming more portable, that opportunities will increase for “indie” musicians,[2] even as the fortunes of the major record labels are eclipsed. It concludes by recommending some general directions for reform and application of copyright law in the new marketplace, and by describing new business models and labor markets for musicians.

II.    The myth versus the facts

If one were to believe the drumbeat of the major music labels, the world of music is facing a catastrophe. A future without music looms unless intellectual property laws are strengthened to expand the labels’ control over how music is distributed and consumed. Their message comprises four propositions:

CDs are music. The major labels publicize declines in CD sales as though those declines represent a decline in the willingness of consumers to pay for music.[3]

The major labels promote art. They characterize their own interests as equivalent to the interests of musicians.

Thieves are ruining everything. Consumers are less willing to pay for music and thus reward artists for their artistic efforts, the labels say, because of the misconduct of “thieves”—pirates who sell music of others below the cost of creating it and depraved high-school and college students who proliferate free copies.

Protecting copyright should be at the center of American foreign policy. They are distorting American foreign policy, inducing public officials to move intellectual property protection to near the top of the list of priorities for negotiations with major powers such as China, Russia and India, and with scores of developing nations.[4]

The facts are out of synch with the drumbeat.

The real goal is to stifle competition enabled by new technologies. The major labels’ trade association, the RIAA, has filed some 20,000 lawsuits, most against individuals engaged in file sharing.[5] Most of the suits do not go to trial because the RIAA employs contract collection agencies that threaten the defendants with ruin unless they “settle” for $8K-10,000, depending on the apparent wealth and income of the defendant. The courts have been sluggish in punishing such abusive practices.[6] It’s as though the law had empowered typewriter manufacturers to launch a blizzard of lawsuits to discourage the early use of word-processing software and hardware.

The avalanche of litigation is only the latest in a long tradition of major interests in the music industry trying to stifle competition resulting from new technology. Music rights holders fought phonographs[7] and music radio in its early days.[8] The major labels were found by the Federal Trade Commission to have violated the anti-trust laws in the late 1990s by prohibiting retailers from selling music CDs at discounted prices.[9] The industry’s campaign against use of the new technologies began before it was possible to buy music in digital formats. The industry had made sure of that by refusing to offer its catalog in any of the new formats until relatively recently.

The major record labels would not, of course, have attained their present size if they did not perform a useful function in the market. The problem they face, however, is not that they suddenly are under attack by teenage pirates; the problem is that the intermediation activities they have organized their bureaucracies to perform have become obsolete because of new technologies. In a music marketplace characterized by live performances in huge venues, recording of music on analog tape, sales of recorded music on physical artifacts such as vinyl records, cassette tapes and CDs, and over-the-air radio broadcasts, the major labels aggregated capital for capital-intensive recording sessions and concert promotion and production. They selected what they thought were the best among hundreds of thousands of aspiring musicians and signed “record deals” with them, managed the manufacturing process for the physical recordings, advertised their rock stars and other talent through their network of paid contacts with radio stations, music reviewers, and brick-and-mortar retailers, and warehoused and distributed the physical recordings.

But the institutional context in which the major labels have a comparative advantage is melting away like an iceberg under them. The threat they face is not one of attack on their property, but irrelevance. Analysis of the relative cost and efficiency of old versus new methods for selecting, recording, performing, distributing, and promoting music shows that a new architecture for the music marketplace is emerging quickly, an architecture which has little need for what the major labels do well.[10]

Music revenue is increasing even as sales of physical units decline. To be sure, revenue from CD sales has declined dramatically, and the decline continues, often accelerating, with each recent reporting period.[11] Declines in unit sales of albums on CDs are almost exactly the same as revenue declines in the first half of 2006.[12] In the same time period, however, unit sales of digital singles increased by 71.3%, and revenue from sales of digital singles increased by the same amount. Unit sales of digital albums increased 112% and revenue from sales of digital albums increased by the same amount.[13]

Moreover—and this is the important part—the total number of digital single sales was 286.3 million, exceeding for the first time the total number of CDs sold. Digital album sales were much less—12.3 million.

This shows, not a decline in the willingness of consumers to buy music, but a shift in consumer preferences from physical to digital formats, and to singles as opposed to albums. The hemorrhaging of major-label revenue may threaten the interests of the labels, but it does not prove that the music world is being savaged by thieves. It shows that consumers are willing to buy music. But it also shows that they prefer more convenient formats, that they resist having the songs they want being tied to songs they do not want, and that they want the prices they are charged to reflect the much lower costs of production and distribution which new technologies make possible.

Advertising and distribution costs are approaching zero. Apple iTunes is able to sell digital music at 99 cents per song and artists are able to sell songs for less than that and still make money because the combination of digital formats, the Internet, and pervasive e-commerce utilities, have reduced the cost of advertising and distributing music almost to zero, jerking the rug out from under a business model in which advertising and distribution costs dwarf other cost elements. In addition, the same and related technologies have dramatically reduced the costs of producing music, rendering obsolete other aspects of the business model in which access to capital-intensive recording and mastering has to be rationed to allow access only to those with the highest probability of producing blockbuster songs.

RIAA data for the first six months of 2006 shows $4.2 billion in CD sales for 2005 and $3.6 billion for 2006. The $630 million reduction was partially compensated for by a $183 million increase in revenues from sales of digital singles and albums. If one conducts no further analysis, the shift away from CDs to digital formats looks like a disaster for the industry. But closer examination is appropriate. About 37% of the revenue from a CD goes to manufacturers, distributors and retailers,[14]  whose functions are essentially obsolete when music is distributed and sold over the Internet. If one takes the CD revenue-decline figure of $630 million and subtracts the share for the now-obsolete functions, the revenue decline for the artist/composer/producer/label share is $271 million: much closer to the $183 million figure for increased revenue for digital sales.

Tied sales of songs are unpopular. The $88 million gap between the decline in CD revenues and the gain in digital sales revenues, adjusted to eliminate the share of brick-and-mortar intermediaries other than labels, results in part from the unbundling of song sales. Consumers now can purchase only the songs they want rather than having to purchase a collection of songs bundled by the dozen on CDs. The CD format ties less popular songs (or those the sellers believe would be less popular) to more popular songs. Now that consumers are free to purchase only what they want, they buy fewer copies of the less popular songs. Suppliers no longer can “push” songs by tying them to the coattails of other songs. This is not a bad thing for consumers, but it reduces revenue for suppliers of less popular songs.

Based on the same RIAA figures, consumers bought 37 million fewer CD albums in the first half of 2006 than in the first half of 2005. They bought 119 million more digital singles and 6.5 million more digital albums. That is about 30 million fewer album sales. If one assumes 12 songs per album, that represents a decline of 360 million in sales of individual songs. The increase in digital single sales was 119 million or almost exactly a third of the loss in individual songs on album formats. That consumers who are free to buy only what they want would choose to buy only about a third of what is available on albums is plausible.

As the portability of music increases, so does demand. Meanwhile, consumers are enjoying more music, not less. They are not at the mercy of major-label A&R personnel and executives to define their tastes. They get cheaper music. They can buy only the songs they want. The possibility of carrying hundreds of songs in their shirt pockets and listening to them whenever they want is not only more attractive than standing in line at the checkout counter to buy CDs selected from a limited inventory, it likely increases the overall demand for music because it opens up more hours per day during which it can be enjoyed.

The established industry was slow to satisfy this new demand. The attractiveness of the new technologies was strong enough that new enterprises sprang up to supply the exploding demand for music in .mp3 formats. It was not as though someone went to a 7-11 store where magazines were offered for sale and elected to steal one instead. It is more like a situation in which 7-11 refused to sell magazines and had made commercial deals with potential importers to prevent them from importing, and people wanting to read magazines smuggled them in. Smuggling, like copyright infringement is illegal. But copyright infringement in the form of unlicensed conversion of music to .mp3 formats and trading in those formats exploded only when the established industry tried to block the use of new technologies with significant consumer benefits.

Since the mid 1990s, of course, it has been possible to buy .mp3 files over the Internet and sales have mushroomed. People are perfectly willing to buy digital music, and only now is the industry beginning to cooperate fully in making music available in those formats, while pressuring Steve Jobs to raise prices for iTunes, and trying to throw a litigation monkey wrench into the works of the phenomenally successful MySpace.[15]

It surely is not immoral for the major labels to try to protect a past technology that produces higher margins, nor for the Tower Records of the world to try to protect a business that arose to manage transaction costs that are no longer present. But the problem for the labels is a backward looking business philosophy, not an erosion of morals in those who want to listen to music in the most convenient way possible.

New institutions for managing consumer search costs and musician promotion are emerging. “Time is money.” Time also is not unlimited. 350,000 new songs were released on CD format in 2006. If each one takes three minutes to play, and the average consumer listens to only one minute before deciding whether he likes it, it would require 350,000 minutes, or about 6,000 hours to sample all of them. That is 250 days per year, without allowing any time for sleep. No one is that compulsive about music — let alone the physiological problems of sleep deprivation. Furthermore, that does not allow for the other new songs created each year that never get released on CDs by major record labels, which surely number in the tens of millions. So consumers need some way to reduce search costs.

Under the old model, the labels reduced search costs by selecting only a small fraction of available music to produce, promote, distribute, and sell, leaving musicians without a major record label deal mostly out of the marketplace. Radio stations exposed potential consumers to new music, almost all of it sold by the major labels. Press and media coverage was focused primarily on artists with major record label deals.

The most interesting question about the evolution of the new marketplace, considered in the next section, is the shape new kinds of intermediaries will take as they meet the needs of consumers to manage search costs, and the needs of musicians to make consumers aware of their music.[16]

III.  What to expect in the future

The future of popular music will be determined by the same motivations and patterns of behavior that have defined the music marketplace of the past. Artists and consumers will continue to behave pretty much as they have in the past.[17] What will be dramatically different is that they will have different tools.

Most consumers, though interested in discovering new music, will remain relatively passive. Few will aggressively browse the Web to discover new musicians. Musicians will still have to push their message and their songs to consumers; just putting a new song or album on the Web will not be enough to attract fans.[18] New intermediaries must help consumers manage search costs and help artists push their music to consumers. “Push,” of course, reduces search costs; a consumer need not go out seeking music; he gets it put in his earbuds.

Mere awareness by consumers often is not enough.[19] What musicians also need is some way to build attachment by fans — a sense of affiliation between a performer and fans. Fan clubs have been a feature of the entertainment industry for a long time. New applications by intermediaries such as MySpace “friends” make it easier to build attachment—though being displayed as a “friend” of Oucho Sparks[20] is not like Dick Prall[21] putting his arm around you after a concert and autographing his CD while smiling and looking you in the eye.

iTunes and imitators will dominate and their availability will increase demand. Industry statistics cited earlier in this paper show that sales of digital formats over the Internet are accelerating as CD sales decline. Consumers are shifting their purchases from CDs to downloadable and portable formats, while overall demand is increasing.

The portability of music in digital formats contained on shirt-pocket-sized players increases the number of hours in each consumer’s day when he or she can listen to music. The ease of purchase and downloading formats directly into portable players from retail sites like iTunes and from artists’ websites reduces the inconvenience of buying new music. The result will be a significant increase in the demand for music.

While firm data is not yet available to substantiate this prediction, the explosive upsurge in purchases of music from iTunes reinforces the prediction. Even as prices fall because of lower costs for promotion and distribution, the increased demand will enlarge the total revenue stream available for musicians.

Major labels will decline. The market share for major labels will continue to decline. Music intermediaries historically have (a) assembled capital for investment in new music production, provided (b) production, (c) publication, and (d) distribution functions, (e) promoted new music to make consumers aware of it, and (f) “filtered” new music to reduce consumer search costs.[22]

Major labels represent an institutional structure designed for the past — a past in which the most important forms of intermediation were artist-selection to reduce consumer search costs, advertising, promotion and distribution of physical formats. Their enterprises are structured to reflect the economies of scale of CD manufacture, promotion of radio play by staffs of agents, and advertising in major publications.

Few enterprises are able to resist the desire to protect short-term revenue streams to support existing infrastructure and bureaucracy. The major labels will continue to divert resources into suing users of the new technologies; they will seek price increases for digital formats, and only grudgingly make their catalogs available to new distribution channels, encumbering them with DRM.[23]

Meanwhile, more artists will bypass the major labels, choosing to reach consumers directly or through new firms that have grown up around the new technologies.

CDs are dead and radio may be next. Few reasons exist to motivate a rational consumer of music to buy a CD from a brick-and-mortar retailer instead of downloading music from iTunes or from artist websites. CDs are inconvenient to buy; they require additional steps to transform the music contained on them into formats that can be played on portable music players.  Additionally, the graphics, lyrics, and other text until recently available only on CD liners now are available for downloading and presentation on music players with video capability.

As will any market transition driven by technology change, the transition in music formats will be incremental and the demand for CDs will never disappear altogether. Some consumers still prefer vinyl records and a few specialty shops still carry them. Nevertheless, within three to five years, CDs will be as much an artifact of the past as vinyl records and cassette tapes.

Music radio (including music played on general-programming stations) was a step toward portability of music consumption, now largely eclipsed by the greater ease and control of playing music on portable players. Music radio also helps to reduce search costs, helping consumers to discover new music. Radio will continue to have some role; it requires no intervention by consumers except to turn the radio receiver on and select the station. Some consumers some of the time will prefer the nearly complete passivity of listening that radio permits; even an iPod requires some greater effort to select particular songs, artists, or playlists. Also, some new music will continue to be discovered by consumers listening to the radio.[24]

A significant shift already is occurring, not only from listening to music on portable players instead of on the radio, but also from discovering new music through Web browsing instead of by listening to the radio. The existence of the shift is manifested by reduced interest by investors in owning music-oriented radio stations and the trend toward divestiture of radio stations by those already owning them.[25]

As labels retreat and contract they will provide even fewer opportunities for musicians. As the conglomerates that own major record labels retrench in the face of declining demand for the music formats in which they specialize and the means of intermediation they represent, less capital will be available to finance their approach to new music ventures. The labels will become more selective, concentrating their capital and attention on those musicians most likely to produce blockbuster songs and albums in the short run. Emphasis will shift away from new musicians toward those who already have a substantial following — established singers and bands and new faces who have become stars through television programs such as American Idol, or who have made a name for themselves as actors or athletes.

This will reduce opportunities for breaking through. As the major labels direct their attention away from new musicians, the opportunities for breaking through into the big leagues by signing a record deal will diminish. Independent musicians will recognize this and shift their energies in other directions to make a living off of their music. In other words, Chris Anderson’s “long tail” may predominate. "The Long Tail equation is simple: (1) The lower the cost of distribution, the more you can economically offer without having to predict demand. (2) The more you can offer, the greater the chance that you will be able to tap latent demand for minority tastes that was unreachable through traditional retail. (3) Aggregate enough minority taste, and you'll often find get a big new market."[26] Anderson points to a recent experiment by Universal Music to offer out-of-print songs through download only as validating his hypothesis.[27]

That will squeeze out those who get rich by becoming rock stars, while opening up opportunities for many more indie musicians to make a living off of their music.[28]

More opportunities exist for independent artists and amateurs. The unbundling of songs from the album format, while reducing revenue for major labels, also opens up some new possibilities for musicians: no longer must they wait until they have 10-15 songs ready to release in an album format; now they can release songs individually as they are completed. For musicians, this represents, among other things, a reduction in the “lumpiness” of capital: they no longer need to have enough money to carry on until they complete a dozen songs; now they can recover capital costs on a song-by-song basis. They also can keep their names more consistently in the public mind, without having to mobilize larger scale promotional campaigns for albums once every couple of years. E-commerce makes it possible for indie musicians, as well as for large firms to tap revenue streams resulting from “merch” sales.[29] Part V explores new business models for musicians.

New intermediaries will reduce market failure better than old ones. As major record labels intensify their efforts to protect the past, space will open up for new enterprises to use the new Internet-based technologies to perform search and sales functions in a reconfigured market. Apple’s iTunes is the most dramatic example of rapid success in this regard. The music labels did not embrace the opportunity to sell music at reasonable prices over the Internet, so computer-company Apple stepped into the breach. But this will not be the only example. CDBaby[30] makes it easy for musicians to sell CDs and downloadable formats to consumers with low transaction and monetary costs for both. CDBaby facilitates musician access to larger-scale Internet intermediaries such as amazon.com and iTunes. Snocap[31] is establishing relationships with musicians and with sellers, building a large catalog of music from throughout the spectrum of creators, ranging from unknown indie musicians to major-label stars and to deploying a technology which will make it easy for artists to specify and sellers to apply terms of sale that reflect artist preferences on price and license terms — whether consumers are allowed to share purchased music, for example.

MySpace, which has blossomed as a marketplace where indie musicians can show off their music and build networks of collaborators and fans, now makes it possible for musicians to sell their music as well on their MySpace sites. The acquisition of YouTube by Google portends the same with respect to music videos.

New technologies allow consumers to find music they have not encountered but may like, through “you-might-like-this” features on amazon.com and iTunes, and through new services such as Pandora,[32] which allow consumers to specify a song they like and receive recommendations of other songs that have similar melodic, harmonic, and rhythmic structures.

All of this represents new intermediation channels between musicians and music consumers and new ways to reduce search costs for consumers.

Piracy will continue but diminish in importance because pirates can’t compete with free either, and their music is not free. Consumers are shifting their acquisition of music from CDs to a combination of licensed purchases of downloadable and portable formats and illicit sources—commercial pirates and peers. No doubt the market share of illicit sources is higher than it was before downloadable formats were available.

Nevertheless, piracy is becoming less, not more, of a problem because some “pirates” are volunteer promoters, and really pirates “cannot compete with free.” The major labels are concerned about three kinds of piracy — although they routinely lump them together: (1) free file sharing among friends through informal networks, (2) sales of unauthorized copies of music, and (3) large scale free file sharing through organized networks such as Grokster. 

All three cases, the major labels say, represent a threat because, as many people put it, “you can’t compete with free.” (Tell that to sellers of bottled water and cable television.) The attractiveness of unauthorized copies of music is driven in part by the price of the copies, compared with the price of authorized copies. But it also is driven by the relative convenience of each, by loyalty to the performers, by fear of getting corrupted files and other harmful computer code, and by the fear of legal liability.

“Theft” in the first form of file sharing has never been a threat to music creation because it helps artists neglected by the major labels make consumers aware of their music. In the case of informal file sharing, preference for the unauthorized copy is usually driven by mere convenience. One’s friend hands him a CD or sends an .mp3 file, saying, “Hey, I think you’ll like this,” and one tries the music.

“Theft” in the second form provides the least social benefit; the pirate is simply seeking to make money off investment by the rightsholders. “Theft” in the third form has debatable effects: it provides greater exposure to otherwise unknown musicians, but it also undoubtedly undercuts sales by the rightsholders.

The wide availability of music for sale on services like iTunes and the increasing availability of full-length songs and albums on musician websites and on networks like MySpace is shifting demand away from large-scale illicit channels, even those that appear to offer music for free. Choosing among substitutes responds to what economists call “cross elasticity of demand.” What matters in cross elasticity of demand is relative price, not absolute price. So as the price for music from legitimate sources falls, economic theory says that less of the total demand will be satisfied by unauthorized sources.

Moreover, music through large-scale file-sharing networks is not really “free.” Any Internet network of strangers will be beset with spam, viruses, and phishing. Everyone’s e-mail box tells him that. Music consumers can reduce their exposure to such annoyances by dealing primarily with people they know or with legitimate commercial channels, whether they be iTunes, a specific musician’s website, MySpace, or YouTube.

File sharing reduces search costs and increases exposure of musicians to potential fans. Certain forms of file sharing increase the exposure of heretofore unknown musicians and increase the likelihood that consumers will buy their music. Several breakthrough bands such as Coldplay, Arctic Monkeys[33] and My Chemical Romance gained attention by giving away CDs for free and posting free downloads on their websites. Most music consumers have had the experience of being exposed for the first time to a band or a singer because one of their friends gave them a CD or emailed them an .mp3 file. Most of them responded to music they like by going to iTunes or a musician’s website to download more of that performer’s music.

DRM gets in the way of robust evolution of the new market. Many sellers of music naturally want to build walls around their music to prevent free-riding and other forms of competition. New technologies make it possible to build new kinds of walls.[34] Apple makes it difficult for iTunes purchases to be played on anything other than an Apple iPod. Rhapsody and other music subscription services encode their music to prevent playing when subscriptions lapse. Many proposals for reform of the music marketplace emphasize new digital rights management schemes through code embedded in digital music recordings.

All of these schemes increase transaction costs for both musicians and consumers. Few DRM systems work perfectly and almost all leave consumers vulnerable to the experience of having bought something but not being able to enjoy what they have bought. For example, songs paid for and downloaded from iTunes mysteriously disappear from music libraries on consumer computers. Creators of music are confronted with annoying and burdensome queries about registration when they try to upload their own music into music libraries in iTunes and Microsoft Media Player. New DRM schemes interfere with management of music files by their own creators and rights owners.[35]

Creators and other suppliers of music should be steadfast in their efforts to reduce transaction costs confronted by consumers who want to purchase music from legitimate sources rather that to acquire it from unlicensed file sharing sources. DRM is inconsistent with this objective and will drive a greater proportion of consumers back to illicit file sharing networks.[36]

IV.The law should not be a counter-revolutionary force

The law can make three contributions to accommodate the development of this new marketplace: first, it can make it clear that certain types of file sharing are privileged; second, it can avoid embrace of DRM; third, it can strengthen the copyright registration system so as to facilitate obtaining copyright permissions.

Legislatures and judges should resist entreaties to broaden the scope of IP protection. Major labels manage portfolios of intellectual property (“IP”) in music. Security of the IP is an important feature giving the portfolio value. The portfolio plays a role in financing new ventures because the IP can be pledged as security for loans. This interrelationship between IP and finance is essential for capital-intensive projects, such as the launch of a new album under traditional conditions. As upfront costs go down, however, the portfolio of IP becomes less important because less capital needs to be raised.[37] Accordingly, industry proposals for expanded IP protection for popular music should be viewed with skepticism as a matter of policy, and scrutinized for consistency with the power granted by the Copyright Clause of the United States Constitution.[38]

Copyright law should privilege file sharing. File sharing can help sell music or it can undercut sales depending on the nature of file sharing. Small-scale gratuitous file sharing reinforces word of mouth and increases demand for previously unknown music. Large-scale, fee-based, file sharing competes with authorized sellers for consumers.

This distinction should be accommodated by copyright law. A straightforward way to do this is to amend the Copyright Act by adding the following paragraph after ¶ (11) of 17 U.S.C. § 110:

(12) making and transferring a copy of a nondramatic musical work otherwise than sale  to the public, without any purpose of direct or indirect commercial advantage and without payment of any fee or other compensation for the copy, if-

(A) there is no direct or indirect charge for the copy; and

(B) the transferor and transferee have a previous family, personal or social relationship.

One asserting this privilege shall have the burden of proving the existence of the prior relationship.

This would make it clear, statutorily, that informal music file sharing among friends cannot give rise to liability for infringement.

Existing law also could privilege the same type of behavior the proposed amendment to section 110 covers, under the fair-use privilege recognized in section 107. The problem is that the recent caselaw applying section 107 in the file-sharing context is adverse. In the Napster case,[39] for example, the Ninth Circuit rejected arguments that file sharing was privileged fair use because it was used to sample music for possible purchase and because it was not commercial in character.[40]

Avoid embrace of DRM. Probably the greatest danger to the new market architecture is that a “compromise” such as that proposed by several commentators, including Fisher,[41] and Litman,[42] would be enacted. This compromise would define a technological framework for digital music sales and use through sophisticated DRM technologies, in exchange for a tax on blank media and, perhaps, a tax on portable music players. This would be a pernicious approach. The tax is not the problem, unless it were so great to increase the price of blank media or portable players, by more than, say, 10%. The problem is the DRM. As noted supra, DRM gets in the way of desirable developments because it negates some of the advantages of the new formats and channels for distribution. There is nothing wrong with allowing suppliers, intermediaries and consumers who want to use DRM to use it. The problem is the likelihood that legislatively sanctioned use of DRM would tend to exclude entry level musicians who do not have deals with major labels or other large intermediaries. The marketplace of the future should be one which accommodates and encourages the kind of competitive landscape now beginning to be visible with MySpace and the flourishing of artist websites offering music for sale—usually in the form of simple .mp3 files. DRM is not part of this landscape and it should not be imposed upon it.[43]

A new Internet-accessible music-rights registration system is needed. The Coase Theorem postulates that individuals will negotiate socially optimal bargains in the absence of law, but only if transaction costs are zero. The assumption that copyrighted music will be licensed on market-appropriate terms assumes zero transaction costs. Transaction costs are far from zero; no central database of copyrighted musical works exists, because there is no registration requirement; and penetrating the opaque bureaucracies of rights holders requires the patience of Job.

The present copyright system impedes obtaining permission when a music creator wants to base his creation on material that is subject to copyright. The Copyright Office is slow to update the Internet-available system for searching copyright registration. Music copyright holders are not required to register their copyrights or to deposit their works as a condition of copyright, and international law prohibits the U.S. from imposing such formalities as a requisite for a copyright coming into existence.[44]

As long as copyright law exposes creators of music to liability if they use material copyrighted by another in their own creations, the law also should facilitate their obtaining permission from the copyright holder, in exchange for whatever fee the copyright holder wants to charge — possibly subject to arbitration if the negotiations reach an impasse.

Incentives can be created for registration and deposit, by privileging development of derivative works unless the underlying material has been deposited and registered and unless the copyright holder agrees to submit to interest arbitration in the absence of agreement over the price of a license.

The law should let the new market evolve. The problem with this, if any, straightforward proposal for reform is that it is unlikely to be considered seriously by Congress,[45] and if Congress were to take it up, the resulting legislation probably would extend the scope of existing copyright without doing anything to privilege file sharing or otherwise promote the transition to the new marketplace.

The degree of capture of Congress by the established players in the industry makes it hazardous to attempt to move copyright reform through the Congress.

It likely is better simply to leave the statute alone. Technology eventually will prevail against the efforts by the major labels to use the law to thwart the new competition. Aggressive litigation by the labels will provide a desirable disincentive for large-scale commercial piracy, but it can never reach all of the smaller scale file sharing that will continue, promoting exposure for new musicians.

V.   New Business Models Will Emerge

“But if we cannot broaden the scope of IP protection and use DRM to limit what consumers may do with the music,” the industry advocates ask, “how are we to make money?” The more relevant question is not how Sony or Time Warner make money, but how can society assure that musicians keep making music and making it available to consumers? Both questions implicate business models for popular music.

The viability of any business model depends on the structure of the relevant market. As this article explains, the market structure for popular music will be one in which demand is increasing because of greater portability and the number of suppliers is increasing because of lower barriers to entry. If new levels of demand exceed new levels of supply, there will be more revenue to go around, if prices remain constant. But prices will not remain constant; they are falling and will continue to fall, as competition increases and new technological channels beyond the control of suppliers proliferate. The combined effect of demand, supply, and price trends is almost certain to reduce the total revenue available to each musician.

Unknown musicians will struggle in two ways in their efforts to achieve economic sustainability. They will struggle to get someone to notice them—to begin to build a fan base—and they will compete for their own share of revenue available for sales of recorded songs and for live performances. Major labels will take on fewer new artists and will be less generous in funding new-artist development.  New intermediaries will continue to develop to facilitate artists making contact with potential fans and to struggle to capture a tolerable level of revenue.

New sources of capital likely will emerge to replace diminishing capital available from the shrinking major labels.  Some investors may be motivated by the excitement of being close to the entertainers they fund. But at least some investors will not invest unless they have some plausible expectation of an adequate rate of return. One possible approach is to channel modest levels of investment through new hedge or private-capital funds specializing in financing new music ventures. With plausible assumptions about frequency of performances, CD, download, and merch sales, a four-year investment of $50,000 could produce an annual ROI of 20% for the fund.[46]

One can only speculate as to how many musicians would be willing to accept the terms suggested in the hedge-fund plan, and how many investors would be induced to invest by the terms and the protected return.  Surely some would.  But the problem is that the total revenue available is not likely to increase enough to provide these investment opportunities for more than a small fraction of musicians who would like to participate. So two questions present themselves: first, what will be the terms of competition for succeeding in the quest for new sources of capital; and second, what will the musicians do who do not succeed in the competition?

The terms of competition will not change dramatically from what they have been for several decades. They will involve evidence that an artist’s music resonates with an identifiable subset of consumers, available now from attendance at live performances, CD and download sales, and number of “friends” attached to an artist on social networks such as MySpace. They will involve identifiable features of music that connect with what investors believe will prove popular in the marketplace. They will involve personal charactereristics of performers such as stage presence and physical attractiveness that are well known lubricants of popularity. A more finely grained structure for investors and performers will allow for greater diversity in defining these incicia of likely success. A single definition of musical features, stage presence or physical attractiveness is far less likely to dominate in a market in which hundreds or thousands of investors apply their own definitions of success, compared with one in which A&R reps at a half-dozen major labels make these determinations.

All of that means more opportunity for artists to compete for  investment based on the peculiarities of their own art. But it is unlikely to make it possible for every artist to attract it. Only a subset of them will fulfill business plan expectations, and a still smaller subset will be able to make a living as full-time musicians.

What will all the others do? Some of them will be forced to give up, as the financial pressures of family obligations compel them to take up other, more remunerative, lines of work.  They will participate actively in the marketplace for five to ten years, and many of them will continue to make music sporadically thereafter.  Others will use subsidies available from family or friends and continue recording and performing for longer periods—some for their entire lives. Others will remain outside society’s mainstrain in informal communities of musicians who minimize housing, food and transportation costs by living together. Such arrangements can prolong the period of full-time involvement for another ten to fifteen years.

The income opportunities for most musicians will remain modest — and perhaps decline. The increased demand resulting from the portability of music will be spread over many more musicians who have access to the marketplace because of the new technologies. The maximum annual income, even for the most successful, will rarely exceed $50,000, and most will be lucky to earn $10,000 to $15,000. The resulting labor market likely will be one in which tens of thousands of new artists enter the market[47] each year, mostly in their late teens and early twenties. Some will drop out each year, as the demands of touring, the cost of recording, or slow sales, discourage them and other career or educational opportunities beckon. Few will still be creating music in a serious way when they are in their mid-thirties. In this scenario, the economic lifetime of a musician will be about ten years — not too different from that for professional and semi-professional athletes in football.[48]

This is not necessarily an unhappy scenario. Much music will be produced and consumed — some of it quite good. Many more young people than at present will have the gratification of having “succeeded” with their art. [49] Then they will “retire” early and go on to other careers.

 

 

    

 



[1] Professor of Law, Chicago-Kent College of Law. The author is an amateur songwriter, who uses the new technologies to record his music and then to make the music available through Internet-based intermediaries. See http://www.modofac.com; http://www.myspace.com/modofacprof; http://www.cdbaby.com/cd/modofac; http://www.cdbaby.com/found?artist=&soundlike=&album=fire+for+colors&style= (search for “Fire for the Colors” or “Tim Sandusky”); http://www.apple.com/itunes (search for “Modofac”);. He appreciates stimulating discussions about the future of music with his music collaborators Tim Sandusky, Jamie Gallagher, Darren Garvey, Aaron Allietta, and Andreas Kapsalis, with indie musicians Dick Prall and Evan Sult, with his colleagues Graeme Dinwoodie, Tim Holbrook, Ed Harris, and Richard Warner, with music attorney Albert Gieseman, and with his present and former students Ben Shanbaum, Matt Topic, Kurt Iselt, Jason Mollner, Mat Bloom, Ross Edwards, and Andrew Strong.

[2] “Indie” musicians are independent musicians without major record label deals.

[3] “Within the Internet culture of unlicensed use, theft of intellectual property is rampant. The music business and its artists are the biggest victims, and ultimately consumers suffer also.” Recording Industry Association of America, Online Piracy and Electronic Theft, http://www.riaa.com/issues/piracy/online.asp (RIAA issue paper) [last visited Nov. 13, 2006].

[4] See David Lague, U.S. Official Presses China to Punish Privacy, N.Y.Times, Nov. 15, 2006 at C11 (reporting on U.S. Commerce Secretary’s call to China to reduce infringement of U.S. intellectual property).

[5] Electronic Frontier Foundation, RIAA v. The People: Two Years Later at 5-6, http://www.eff.org/IP/P2P/RIAAatTWO_FINAL.pdf [last visited Nov. 11, 2006] (describing litigation and collection practices); see generally http://www.eff.org/share/ (describing abusive nature of music-label litigation).

[6] See generally Sosa v. DIRECTV, Inc., 437 F.3d 923, 928-939 (9th Cir. 2006) (rejecting RICO claims against satellite television service that sent more than 10,000 demand letters to consumers asserting legal claims that were "weak").

[7] See Stern v. Rosey, 17 App. D.C. 562, 566 (D.C. Cir. 1901) (affirming dismissal of suit by music rights holder against seller of phonograph wax cylinders).

[8] See, e.g. Buck v. Jewell-La Salle Realty Co., 283 U.S. 191 (1931) (holding that, in suit for injunction against hotel that make radio broadcasts of copyrighted songs available to hotel guests, the hotel's conduct constituted a "public performance" of the works).

[9] See http://www.ftc.gov/os/2000/09/musicstatement.htm.

[10] The author of this essay has written a longer article that carefully explores the changing economics of music production, distribution and consumption, and the relationship between these changes and copyright law. See Henry H. Perritt, Jr., New Architectures for Music: The Law Should Get Out of the Way, 29 Hastings Comm. & Ent. L. J. 3 (2007)(forthcoming).

[11] See 2006 RIAA Midyear Statistics, Manufacturer’s Unit Shipments and Dollar Value, http://www.riaa.com/news/newsletter/pdf/2006midYrStats.pdf (last visited Oct. 22, 2006) (showing 13.9% decline in CD unit sales for first-six months of 2006, compared with comparable period of 2005).

[12] Id. (showing 14% decline in total revenue for CD sales).

[13] Id.

[14] Robert G. Picard, The Economics and Financing of Media Companies fig. 3.5 at 58 (2002)

[15] See UMG Recordings, Inc. v. MySpace, Inc., Case NO. CV 06-07361 SVW AJWx (C.D. Cal. filed Nov. 17, 2006). The complaint alleges widespread infringement by MySpace subscribers.

[16] See Jon Pareles, 2006, Brought To You By You, N.Y. Times, Dec. 10, 2006, at 1. (reporting that the Internet has become an “incessant public audition,” diluting the winnowing down once performed by record label A & R departments, but multiplying choices “promise ever more diversity, ever more possibility for innovation and unexpected delight”).

[17] See Richard E. Caves, Creative Industries: Contracts Between Art and Commerce 2-10 (2000) (summarizing characteristics of creators and consumers). The Cave book presents a probing analysis by a distinguished Harvard economist of the peculiar characteristics of markets for music, theater, film, and visual art.

[18] Some surfing occurs, however. For example, indie musician Dick Prall got a Volkwagen car-show deal for several of his songs because the advertising agency surfed MySpace and liked the music he posted there for downloading.

[19] “It’s kind of absurd how many bands are here” [referring to October, 2006 CMJ Music Marathon]. Indie Rock Around the Clock, Rolling Stone, Nov. 30, 2006 at 34 (quoting Ryan Frederiksen, guitarist for These Arms Are Snakes).

[20] Oucho Sparks is an indie rock group in Chicago. See www.myspace.com/ouchosparks.

[21] Dick Prall is an indie singer-songwriter in Chicago. See www.myspace.com/dickprall.

[22] See Thomas F. Cotter (2006), Some Observations on the Law and Economics and Intermediaries, 2006 Mich.St.L.Rev. 67, 77 (identifying historic functions; music intermediaries still needed to perform filtering function, even if other functions have been overtaken by technology which permits them to be performed in other, cheaper ways).

[23] Cf. Jon Pareles, 2006, Brought To You By You, N.Y. Times, Dec. 10, 2006, at Arts & Leisure p. 1 (music industry will have to “remake itself with lower and more sustainable expectations along the lines of how independent labels already work”).

[24] See Jesse Fox Mayshark, One Way to Get Radio Play: Do It Yourself, N. Y. Times, Dec. 3, 2006, at 30 (satellite radio’s programming of slots for well-known musicians broaden opportunities for radio play; offering a middle ground between the Internet, “where it’s hard to get attention,” and narrowly programmed terrestrial radio, “where it’s hard to get airplay,” and marketing-survey driven radio stations are playing fewer and fewer songs)

[25] See Clear Channel suitors must bid by Monday, CNNMoney.com (Nov. 13, 2006), http://money.cnn.com/2006/11/13/news/companies/clear_channel.reut/?postversion=2006111307 (noting that advertising-supported radio broadcasters are challenged by "satellite radio, the Internet, and personal digital music players") [visited Nov. 13, 2006].

[26] Chris Anderson, The Economics of Abundance (Oct. 26, 2006), www.thelongtail.com. See also Chris Anderson, The Long Tail (2006).

[27] Online Music Fans Respond Strongly to Unversal Music's Deep Catalogue Initiative (2006) http://new.umusic.com/News.aspx?NewsId=432 (reporting on sales of 250,000 tracks of otherwise unavailable European recordings in first six months of 2006). See IPPR Report at 28 (predicting that music industry will shift toward long-tail phenomenon).

[28] See Indie Rock Around the Clock, Rolling Stone, Nov. 30, 2006 at p.34 (asserting that major labels lost market share in 2005, while indie musicians’ collective market share increased).

[29] See Jeff Leeds, Squeezing Money From the Music, N.Y. Times, Dec. 11, 2006, at p.C1 (reporting that “new definition” of a hit is a song or album that racks up less than 500,000 in sales but with several revenue streams, including record sales, music publishing, concert ticket sales, and merch sales). “Merch” refers to collateral goods such as tee-shirts and posters containing musician images or logos.

[30] www.cdbaby.com.

[31] www.snocap.com

[32] www.pandora.com

[33] See IPPR Report at 43-44 (reporting on Arctic Monkeys’ rapid rise to the top of the charts as a result of their making their music available for free through MySpace).

[34] See Lawrence Lessig, Code and Other Laws of Cyberspace (1999) (arguing that use restrictions implemented by computer programs and copy protection inhibit consumers more than traditional law).

[35] David Pogue, Trying Out the Zune: iPod It’s Not, N.Y. Times, Nov. 9, 2006, at C1, C8 (“What’s really nuts is that the restrictions even stomp on your own musical creations,” reporting on DRM in Microsoft’s Zune music player).

[36] See Henry H. Perritt, Jr., Flanking the DRM Maginot Line Against New Music Markets, 16 Mich.St.J.Int'l Law 577 (2007)

[37] William Davies & Kay Withers, Public Innovation: Intellectual Property in a Digital Age at 37-38 (Institute for Public Policy Research Report 2006), www.ippr.org (need for intellectual property protection is proportional to need for upfront capital).

[38] Compare United States v. Martignon, 346 F. Supp.2d 413 (S.D.N.Y. 2004) (dismissing indictment; “anti-bootlegging statute,” 18 U.S.C. § 2319A, is unconstitutional because it provides perpetual protection for non-fixed performances, thus violating both the “limited times” and the “:writings” limitations of Copyright Clause) with Kiss Catalog, Ltd v. Passport International Productions, Inc., 405 F. Supp.2d 1169 (C.D. Cal. 2005) (granting motion for reconsideration on petition by United States; 18 U.S.C. § 1101(a)(3) is constitutional under Commerce Clause; no need to consider limitations of Copyright Clause).

[39] A & M Records, Inc. v. Napster, Inc., 239 F.3d 1004 (9th Cir. 2001).

[40]  Id. at 1015 (commercial use under fair-use framework exists when repeated and exploitative unauthorized copies are made to save expense of purchasing authorized copies). See also Data Inc. v. Los Angeles County Sheriff's Department, 447 F.3d 769, 779 (9th Cir. 2006) (citing Napster Ninth Circuit opinion for proposition that repeated copying of copyrighted works is not fair use even if copies are not offered for sale).

[41] William W. Fisher III, Promise to Keep:  Technology, Law and the Future of Entertainment (2004).

[42] Jessica Litman, Sharing and Stealing, 27 Hastings Comm. & Ent. L.J. 1 (2004).

[43] See Perritt, note 38, supra.

[44] See Lawrence Lessig, Creative Economies, 2006 Mich. State L. Rev. 33, 38-39 (explaining why it is prohibitively expensive to obtain permississions).

[45] Lessig, 2006 Mich. St. L.Rev. at 40 (likelihood of appropriate Congressional response is “zero;” “a kind of IP McCarthyism reigns” over Washington debate).

[46] Suppose a private investment fund invests $50,000 in each band, with the revenue to be shared 50-50 between the fund and the band. The fund would control 25% of the total investment and use it for promoting the band, and it would be allowed 25% to cover its overhead. The band would use the remainder to cover its costs of recording, mixing, mastering, CD duplication, travel and street teams. The term of the deal would be four years. Assuming the band performs twice per week, gets an average of $200 per performance, sells 10 CDs at $8 and five tee shirts at $10 at each gig, sells another 500 CDs per year at the same price, and 200 downloads at $1 each, total revenue generated over the term would be just under $160,000. This would produce an annual rate of return of nearly 20% for the fund, and just under $80,000 income for the band. Some hedge-fund bands would do much better, and some would fail altogether.

[47] “Entering the market” is defined as completing an album and offering it for sale and/or performing in public for pay.

[48] See Disability insurance the only sure bet for pros, can't miss prospects, Baltimore Business Journal, Apr. 1, 2005, http://www.bizjournals.com/baltimore/stories/2005/04/04/focus3.html (noting that average career of professional athlete is four years) [visited Nov. 13, 2006]. The careers of athletes are frequently ended by injury, unlike that of musicians.

[49] See “[E]ach band can make a living off of what they do. A few years ago, that was just unheard of.” Indie Rock Around the Clock, Rolling Stone, Nov. 30, 2006 at p.34 (quoting Ryan Frederiksen, guitarist for These Arms Are Snakes).