Creative, technological and legal architectures for music
Henry H. Perritt, Jr.
The adjudication of the Grokster case by the United States Supreme Court focused public attention on the economics of musical entertainment. The Grokster case itself involved relatively arcane questions of the liability of certain kinds of intermediaries for vicarious and contributory infringement of the copyrights owned by those selling music. The larger point is that the copyright laws are intended to—indeed, the Congress is empowered only to write copyright laws that—create appropriate incentives for the production of creative works. In order to do that, intellectual property law must walk a fine line between making it too easy for people to steal music and making it illegal for people to enjoy it.
The premise for copyright law is that creators need to be protected against a particular kind of externality known colloquially as “free-riding.” The creator of music incurs higher costs than someone who copies his song and then sells the copy in competition with the creator. The copier gets a “free ride” on the creator’s capital investment.
The free ride means that that the pirate can sell the song at a lower price than the creator. The creator must cover all of his costs, including not only his reproduction and distribution costs, but also recovery of his investment. The pirate only need cover his copying and distribution costs. Being unable to cover his investment, the creator will stop producing, or will produce less—unless non-economic motivations for the creator induce him to subsidize consumption.
The risk of free riding is proportional to the gap between the creator’s costs and the pirate’s costs. Changes in technology have narrowed the gap because they have reduced the creator’s costs more than they have reduced the pirate’s costs.
Technology changes, and as it changes, it changes the equilibria that exist in worlds with and without transaction costs. For example, before Thomas Edison invented the earliest sound recording devices, there was little concern about the need for law to protect music from transaction costs that undermine incentives to produce. Once audio recording devices existed, it was possible to produce recorded music and to sell it, and also possible for third parties to engage in free riding because they could copy the recording.
Each major technological revolution—improvements in the techniques for manufacturing phonograph records in large quantities, the invention and commercialization of magnetic recording, and, most recently, the development of low-cost techniques for producing digital recordings on cheap plastic media--altered the equilibrium and raised questions about what role law and technology should play in preserving appropriate incentives for producing and consuming music. Now, ease in distributing .mp3 files via the Internet has increased opportunities for musicians and their producers—but also increased the possibilities for piracy.
The impact of technology is widely recognized by the public and by legal experts. But, too often, the focus has been only on those technological advances that increase the risk of free riding. Insufficient attention usually has been given to those technological advances, usually part of the same technologies, that reduce capital costs of original producers. If the costs of both original producer and free rider go down at the same time, the economic risk of free riding does not necessary increase; indeed, it may be reduced, depending on the relationship between the free rider’s costs and the original producer’s costs after the new technologies are introduced.
The article explores the economics of music production in a world in which compact disc recorders are part of almost every personal computer, a world in which studio quality audio recordings can be produced in anyone’s living room with the benefit of equipment costing only a few thousand dollars, and in which robust markets exist for exchange of music through the Internet using software such as Grokster and commercial services such as iTunes and Google.
It argues that the bleak scenarios painted in public policy venues by the music industry about the risks of piracy are considerably exaggerated. It argues that the reality is that the technological threat jeopardizes, not the position of musicians and other creative actors, but rather the embedded capital of an elaborate, sophisticated, and arguably bloated system of intermediation that was designed to deal with old technologies and therefore is in substantial part obsolete. As Professor Michael Carroll has observed, “Removing copyright protection from musical works and sound recordings would not eliminate professional musicmaking. On the contrary, historical evidence strongly suggests that demand for the services of a class of professional musicians and composers is sufficient to induce society to find alternative means to enable this group to practice its art.”
Writing and enforcing law aimed at protecting obsolete methods of intermediation represent dead weights on society.
Changes in technology have influenced the creation and content of music for hundreds of years. Technologies for musical instruments changed the style of performance and created a niche for composers as distinct from singers. Printing technology changed the way music was disseminated, enlarging the possibilities beyond live performances by the creator. Development of the phonograph record influenced audience choice in favor of singers like Caruso, whose voice range matched the audio bandwidth capabilities of early phonographs. The flexibility afforded by analog tape recorders made it possible to create (mix) recorded music as something distinct from merely recording a live performance, and later, digital technologies made the recording process orders of magnitude cheaper without sacrificing quality. Jukeboxes permitted listeners to develop their own playlists, concomitantly increasing the demand for vinyl records.  Radio broadcasting of music and Motorola’s automobile radio receivers made music enjoyment portable, as did the later development of transistorized portable radios and then pre-recorded cassette tapes and the Sony Walkman portable cassette player.
Leapfrogging between playback and recording technologies alternately promised to increase markets for, and to increase the supplies of, music, benefiting and threatening the positions of established stakeholders. Vinyl records and, later, recording media killed live bands. Cassette tapes and the Walkman killed vinyl records and the turntable. CDs and CD players killed cassette tapes. Now downloadable music threatens to kill the CD.
Throughout all these changes in technology, those already established in the music industry usually have denied the utility—or at least the impact—of new technologies at first, and then sought changes in the law and in quasi legal arrangements to protect themselves from competition. Rarely have they been the early adopters of the new ways of making or disseminating music. Inevitably, however, the pressure of consumer demand, which could be satisfied in new ways through new technologies, has swept away the objections of the defenders of the status quo—and often the objectors themselves.
Network externalities exert strong influence on consumers of popular music. Consumers want to share a common culture. So once a song or a performer becomes popular there is an important bandwagon effect. The more popular a performer becomes, the faster his popularity accelerates.
This suggests that demand can be increased by giving music away, much as America Online built its consumer base by giving away its software. For a time in the late nineties, one could not open one’s mailbox, or open the newspaper or a magazine without a free disk with AOL software on it falling out. But it also is true that not all giveaway programs are successful. The cemeteries of the dot-com bubble are littered with enterprises whose business models were premised on building market share—or “attracting eyeballs,” in the parlance of the Web venture-capital and entrepreneur culture—at a loss, with profits to come automatically once a customer base was established. The profits never came.
It is likewise entirely possible for a musician or a promoter to spend money on producing music, to give it away in the expectation that he will build audience for download sales or for concerts, and for the paying customers never to materialize in sufficient numbers to offset the investment in the promotion.
Rankings affect demand. Some analysts conclude that superstars exist not because of differences in talent but because consumers want to share a common culture. In either event there is an important bandwagon effect--high network externalities, in more formal terms. The more popular a performer becomes, the faster his popularity accelerates.
New technologies have very little effect on the cost or quality of the human capital involved in producing music. Voice quality, and creativity with respect to lyrics, melody, and chord progressions, are a combination of innate talent and training and experience. While Internet technologies may make it easier for musicians to interact with each other and even participate in replicas of jam sessions without being physically in the same room, the effect of this on ability to produce good music is modest at best.
The technical skill—technique--of a musician is another important factor for producing music. Good technique, even more than good voice quality and composing ability, is the result of practice and experience. There are some technological training aids that may facilitate practicing, but these also are unlikely to have significant effect.
One area in which changing technologies do affect basic music inputs is with respect to changing musical instruments. The electric guitar, synthesizer, and fuzz box, are examples in the second half of the Twentieth Century. The existence of high-tech musical instruments increases the options available to musicians.
But, in sum, the cost of human capital to make music has not changed much over the 20th Century except for changes in wage rates and therefore opportunity costs.
Historically, the development and low cost availability of amplification and loudspeaker systems significantly changed the possibilities for music performances. These technological advances increased the possible scale of a performance. Without sound amplification, the maximum audience size was in the hundreds. With amplification, it in the tens of thousands, constrained not by the reach of the sound but by the size of possible arenas. Advances in audio technology over the 20th Century have reduced the cost of sound systems by an order of magnitude or more. In addition, advances in video technology, more recent in their low cost availability, have nudged the feasible scale of performances higher. Now, one can see a much-greater than life-sized image of performers on a large screen and get greater satisfaction from watching a live performance at a considerable distance than would be possible if one could barely see the musicians or had to use binoculars to see them.
Live performances have high fixed costs and very low marginal costs. But only a small fraction of the fixed costs is in capital goods for sound amplification. Accordingly, the impact of technology on the production function for live performances is minimal.
Technology has had a greater impact on recorded music than on live music performances. It has enormously reduced the costs of advertising, marketing, and distribution, and reduced the cost of recording significantly but by a smaller amount.
The second greatest impact of technological advances on the music industry is in the capital costs for high-quality recording and mixing equipment. In 1990, the audio equipment in a recording studio cost hundreds of thousands to millions of dollars. Its cost and size made it very unlikely that a musician would have his own equipment. In 2005, the possibilities have increased greatly and the cost has been reduced even more. Even an amateur musician can afford studio-grade recording and mixing equipment.
The Internet has enormously opened up possibilities for marketing music. All that one needs is a Web site, and reasonable knowledge of techniques for increasing the chances that the Web site will be picked up by search engines such as Google. Annual hosting fees are not likely to exceed $1,000. Even if one has a professionally designed Web site, developed under contract with state-of-the-art e-commerce features, such as ones that permit users of the Web site to pay for and order or download CDs, MP3 files, and merchandise, the cost is unlikely to exceed $10-$20,000.
In addition, major e-commerce sites such as eBay, Yahoo!, Google, and MSN, offer paid placement on their Web sites. This is the virtual equivalent of being able to buy prominent space in the CD section of Borders or in a Tower Records music chain store. Not only that, the virtual presence is global rather than purely local.
This replaces a system of methods of marketing that required human marketing representatives to visit distributors, newspaper, radio, and television advertising and required printing and physical distribution of printed brochures or leaflets.
Undoubtedly the greatest economic impact of small-computer and Internet technologies is on options for distributing music to the end user. It is possible for someone to buy a song and download it from a well designed site like Apple’s Music Store in about 30 seconds. This presents much lower transaction costs to purchasers than going to a physical store, finding the desired CD and standing in line to pay for it. As important, online distribution enormously reduces the distribution costs of music producers. One need only produce an .mp3 file and put it in one place on one server with adequate capacity to handle the expected demand. No longer is it necessary to manufacture CDs and to inventory them and ship them.
Eventually, unless copyright law impedes taking advantage of new technologies, the same technologies that reduce the cost and open up new alternatives for music production also will reduce the price of music for consumers. But the main effects on the demand function are related to features other than price. The most important of these builds on a phenomenon that accelerated with the first Sony Walkman, and began with transistor radios and boom boxes. With iPod technology, music is completely portable. One can have thousands of songs recorded on one’s iPod and carry it around in one’s shirt pocket.
If one wants to enjoy the music recorded on an iPod as part of a group, one simply plugs the iPod into an amplifier and all of the amplification and speaker options are available that would be available for playing a CD or a vinyl record.
Portability through this technology has enormous implications for how consumers will express their demand for music. One can still buy a CD and download the songs to a PC and then copy them to an iPod, but it is much easier simply to buy the songs online and copy them directly to an iPod. This is exactly how Apple’s Music Store works.
While the copying incident to music file sharing is prima-facie infringement, the transaction costs of enforcing copyrights against every individual engaging in file sharing are enormous.
Twenty years ago Ithiel De Sola Pool suggested that technological bottlenecks always will be natural focal points in intellectual-property regimes. Thus the concentration of music rights holders on ISPs, peer-to-peer file-sharing hosts using Napster and similar technologies and the writers and distributors of file sharing software employment Grokster and similar technologies is not surprising.
If intellectual property law needs to be tweaked to get the balance right so that resources allocated for the production and consumption of music are optimal from a societal standpoint, it may be that the tweaking needs to clarify privileges for certain types of music consumption that no longer represent appreciable risks to the legitimate expectations of music performers. Moreover, those who would redesign intellectual property law should focus not on the business models of the major record labels and recording studios, but instead on the new business models represented by Grokster, iTunes, and Google, and consider what, if anything, the law needs to do to protect the legitimate expectations of those who would invest in these new technologies. Law should encourage the design and erection of these new marketplaces within which search costs—one of the originally important categories of transaction costs in music economics—are substantially lower than in older market configurations.
Conclusions differ about the overall effect of file sharing on different elements of the music industry. Some economists conclude that social welfare is increased, with less-known musicians benefiting the most, at the expense of intermediaries and super stars. Others, of course, conclude that social welfare is diminished.
The law should recognize an express privilege for exchanging recorded much among friends and maybe for any non-profit public distribution. Such an approach is certainly within Congressional capability to enact. For example, non-public performances of musical works "without any purpose of direct or indirect commercial advantage and without payment of any fee or other compensation for the performance to any of its performers, promoters, or organizers, are, subject to certain limitations, already expressly privileged.
This approach offers several advantages. It would conform the law to reality, eliminating the undesirable result of making millions of (mostly) young people outlaws. It would encourage the kind of social intercourse with respect to music that would promote discovery of new artists, and according to the Oberholzer-Gee/Stumpf study, well might increase sales of physical formats or downloads through services such as iTunes. It also would mitigate the risk of increased free-riding by permitting enforcement and litigation resources to be focused on the real free-riding culprits—those who seek profit from free riding on another’s creative effort.
Unless the law gets in the way, one can predict the following future for music performance, production, distribution and consumption:
1. CDs are dead; music radio is next. The convenience of downloading a song or an album into a portable music player overwhelms the inconvenience of going to Tower Records or Borders hoping to find the desired CD, standing in line to pay for it, and then transferring the songs to a portable player. Having your own playlist is better than listening to the DJ’s
2. People will pay to download music. The risks of viruses, spyware and spam are far less on iTunes than on free file sharing networks and the search costs are less because almost everything is (or will be) available from iTunes.
3. mp3 and Web technologies reduce the barriers to breaking through, based on talent; compare the experience of Clap Your Hands Say Yeah with Jimi Hendrix or Bob Dylan
4. Managing search costs will continue to drive the industry; the current industry behemoths were designed for the search costs of the last century; search costs in the 21st century are still important but new tools are available to reduce them: music blogs, reviews on pitchforkmedia.com, and file sharing. Soon services like iTunes will offer “we think you’d also like . . .” just as amazon.com does today for books. As Chris Dahlen put it, “Artists can now let consumers and their friends do the work of getting the word out.”
5. Most of the income stream for artists will continue to come from live performances, for which CDs were, and mp3 files now are, essentially advertising.
6. The risk of piracy will stimulate creation of new music as the lead-time advantage for creators gets shorter, and performers will want a new song to steal back the audience just as the pirate gets ramped up to deliver the old one. The model is the same as that for new versions of PC software.
7. A shift from purchases of albums to purchases of singles will put pressure on creators to produce higher quality singles.
8. Piracy is becoming less of an economic threat because technology is narrowing the gap between creator costs and pirate costs. Technology reduces fixed costs and promotion and distribution costs for creators.
9. The law should distinguish between informal free-file sharing, which improves the functioning of the market, and piracy, which should be redefined as charging money for someone else’s music.
 Michael W. Carroll, Whose Music Is It Anyway? How We Came to View Musical Expression as a Form of Property, 72 U.Cin.L.Rev. 1405 (2004) (describing competing positions on whether music should be protected by copyright law and how much)
 72 U.Cin.L.Rev. at 1412.
 [Musical instruments have been around for a long time. Need something here to illustrate the impact of the harpsichord, the pianoforte, the pipe organ, and cheap, portable instruments such as the acoustic guitar, the harmonica, and then the electric guitar and the synthesizer/keyboard] See Playback at 115-154 (chronicling evolution of disco DJ manipulation of turntables into music synthesizers)
 Carroll I at ___.
 Mark Coleman, Playback 18 (2003) [hereinafter “Playback”]. Mark Coleman’s book is a fascinating and readable chronicle of the interaction between technology and music, exploring how technology influences the creation and content of music as well as its distribution.
 Playback at 58.
 Playback at 42-46.
 Playback at 82 (people listen to radio while they are doing something else).
 Id. at 86.
 Playback at 155-158.
 Playback at xix-xxiii.
 Princeton Study at 35.
 See See generally Michael Abramowicz, An Industrial Organization Approach to Copyright Law, 46 William & Mary L. Rev. 33, 87 nn. 153, 155 (2004) (noting that the demand for music experiences network externalities--"I invest in music to be in the cool crowd"--but each investment may "harm others by diluting their relative coolness quotient"). According to Metcalfe's law, the usefulness, or utility, of a network equals the square of the number of users. John T. Nakahata, Regulating INformation Platforms: The Challenge of Rewriting Communications Regulation from the Bottom Up, 1 J. Telecomm. & High Tech. L. 95, 135 (2002) (analyzing network effects in terms of tendency toward monopoly in communications networks).
 Princeton Study at 30 ("when you play music at a party, you would like your guests to enjoy the music").
 Princeton Study at 35.
 See See generally Michael Abramowicz, An Industrial Organization Approach to Copyright Law, 46 William & Mary L. Rev. 33, 87 nn. 153, 155 (2004) (noting that the demand for music experiences network externalities--"I invest in music to be in the cool crowd"--but each investment may "harm others by diluting their relative coolness quotient"). According to Metcalfe's law, the usefulness, or utility, of a network equals the square of the number of users. John T. Nakahata, Regulating Information Platforms: The Challenge of Rewriting Communications Regulation from the Bottom Up, 1 J. Telecomm. & High Tech. L. 95, 135 (2002) (analyzing network effects in terms of tendency toward monopoly in communications networks).
 See In re Charter Communications, Inc., Subpoena Enforcement Matter, 393 F.3d 771 (8th Cir. 2005) (vacating subpoena compelling ISP to disclose identities of subscribers who were using peer-to-peer music file sharing services) Elektra Entertainment Group, Inc. v. Does 1-9, No. 04 Civ. 2289 (RWS), 2004 WL 2095581 (S.D. N.Y. Sep. 8, 2004) (discussing difficulties encountered by plaintiff music copyright holder in ascertaining the identities of individuals engaging in music file sharing); Sony Music Entertainment, Inc. v. Does 1-40, 326 F. Supp. 2d 556 (S.D.N.Y. 2004) (enforcing subpoena to compel ISP to identify individual defendants accused of downloading music)
 See Ithiel de Sola Pool, Technologies of Freedom 248-50 (Belknap Press, 1983).
 Princeton Study at 60-61 (reviewing studies).
 117 U.S.C. sec. 110(4).
 Playlist at 214 (reporting on independent study showing that free file exchange did not diminish sales of recorded music and might have increased it).