The Knockoff Economy (35 page)

In this Epilogue, we’ll look at the music industry’s long-running battle against mass copying. In a decade, the industry’s revenues shrank by over 60% (adjusted for inflation) as millions of fans took for free what they used to pay for. Today, the music industry’s revenues continue to plummet and piracy continues, largely unabated. And yet—this is crucial—musical creativity is flourishing. It is not far-fetched to say that music, in the midst of its alleged decline, is more creative than ever.

The story of the music industry’s war against online piracy has been told at length elsewhere.
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But we do want to use the basic outlines of the story to make two important points.

First, copying has clearly harmed some parts of the music industry. Yet music itself is not going to disappear. In fact, quite the opposite: some of the very changes that enabled widespread copying of music have also dramatically lowered the costs of producing and distributing new music. That is one reason the supply of new music is up, not down.

Second, the music industry’s plight is not irreparable. Perhaps the industry can restructure itself by mimicking some of the practices of industries such as fashion and comedy. This new tack can be a useful supplement to vigorous copyright enforcement or, in some instances, can substitute for it. The music industry can change the way it works, with the goal of building resistance to copying—and perhaps even the ability to benefit from it—into its business model.

Music and the music industry are not the same. The “music industry” is often just shorthand for the interests of the major record labels, such as the Warner Music Group and Sony Music Entertainment. When people say that Internet piracy is killing “the music industry,” they are really talking about the major labels. And, in a sense, they are right. The labels have been deeply harmed by illegal downloading.

Yet music itself is very much alive. As we described in the conclusion to this book, musicians once had to rely on expensive studios and highly trained engineers to record their music, and big companies to manufacture and distribute it. Retail stores—even the biggest of them, like Tower Records—could only carry a small amount of stock. The result was an expensive distribution scheme that excluded most artists and restricted consumer choice.

All of this has now changed—for the better. With a laptop, artists can produce high-quality recordings on their own, and distribute them easily via the Internet. In this more wide-open world, even virtual unknowns can make a living while bypassing the traditional industry players. And because online retailers like Amazon are reachable by anyone with an Internet connection, have unlimited virtual shelf space, and much lower costs than physical retailers, consumers now enjoy much greater choice in what music to buy.
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The result is a great flowering of music of all kinds. In fact, judged in terms of the diversity and quality of music available today, the ease of obtaining it, its low price, and the amount of information available to guide consumers to the music they want, we are living in a musical golden age.

This is better not only for consumers. It is also better for many musicians. When success meant distribution through a major label, the market produced a few very rich superstars and a large number of broke nobodies. Today, a wide range of musicians use technologies like home studios, blogs, YouTube, MySpace, Facebook, and Twitter to carve out decent careers on their own. Music, in short, is thriving—even in the face of vast amounts of copying.

Still, it is undeniable that the fortunes of the major labels are declining. This decline is driven by technology, but technology is not the only factor. The labels themselves made some strategic missteps, and they failed to recognize the opportunities, not just the harm, inherent in these technological transformations. We elaborate on this point here because it is underscores an important element:
it is often not copying per se that is a problem, but how copying is understood and addressed.

To begin, take a look at the following chart, which we have constructed from the industry’s own data.
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In 1999, total record company revenues hit an all-time peak of $14.5 billion. This followed a decade of vigorous growth in which revenues increased from $6.5 billion to $14.5 billion between 1989 and 1999, a 220% increase (or 170% adjusted for inflation). Yet this growth was deceptive, for it was driven primarily by a one-time event: the format shift from LPs to CDs. CDs, first introduced in 1982, outsold vinyl records by 1988, and in subsequent years consumers spent huge sums replacing their old vinyl records.

FIGURE 6.1 Recorded Music Industry Revenues (1999-2010) (RIAA data]

But the good times did not last. By the end of 2009, total revenues were down to just over $7.6 billion—a fall of almost 50% over 10 years. And that figure doesn’t capture the full extent of the decline. Adjusted for inflation, record company revenues fell by approximately 60% over the last decade. That trend continued in 2010: as the Recording Industry Association of America’s (RIAA) latest figures show, total revenues dropped by another 11%, to just under $7 billion. And there’s no end in sight.

What happened? Napster happened. The creation of Shawn Fanning, then a 19-year-old college student, Napster was the first music filesharing service to gain a huge following. Napster attracted almost 50 million users within months of its release. It was appealing because it was so easy to use: Fanning’s elegant design made it simple to go online and find exactly the song you wanted. But by far the biggest reason for Napster’s viral growth was that it had everything: pretty much any song you wanted, instantly and free.

The huge amount of music available on Napster was, in turn, due mostly to the system’s “peer-to-peer” architecture. Napster didn’t collect music on a server. Instead, it used the Internet to connect the computers of millions of users. When a user asked for a song, Napster consulted its constantly updated list of music files and then connected the requesting user with another user’s computer that had the relevant file.

The music industry’s reaction was unsurprising and, given the scale of the copying Napster was enabling, understandable. In 1999, the RIAA sued Napster, asking for $100,000 for each song downloaded—billions of dollars in total—and a court order directing Napster to shut down. In 2001, a federal court agreed, ordering the company to remove all unlicensed content from its network—which quickly led to Napster’s shutdown. Facing extinction, Napster offered the major labels a deal worth about $1 billion to license their catalogs. The envisioned “Napster 2.0” service would charge users between $2.95 and $9.95 per month and use the revenue to fund yearly payments to the record companies of $200 million.
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The labels turned down Napster’s offer. And in retrospect, this looks like a major mistake. If Napster had become a pay service, some of its users would certainly have left to find new sources of free music. But the runaway success, years later, of Apple’s iTunes shows that a lot of people are perfectly willing to pay for music, at least if they are getting what they want conveniently (and safely) at a fair price. A Napster pay service would have enjoyed a significant head start. So many people were using Napster in 2001—especially young people, the biggest consumers—that the labels would have at least been able to make a case that paying a reasonable price for convenient online music was better than stealing it. That case would have been more powerful if the labels had embraced the new technology, and trumpeted a Napster settlement as the beginning of a new and better deal for consumers.

Instead, Napster was shut down. But the genie could not be put back in the bottle. New services arose in Napster’s wake, including Grokster, Kazaa, and BitTorrent, and millions of Napster users migrated to the newer networks. The music industry again went to court. In 2005, in a major decision, the Supreme Court held that Grokster could be held liable for “inducing” copyright infringement. Here too, however, the victory was more apparent than real. Grokster was not found guilty of directly infringing copyrights—unlike
Napster, when Grokster users shared digital files, they did so without any direct assistance from Grokster. Instead, Grokster was found guilty of essentially provoking piracy. The Supreme Court held that the company had induced copyright infringement by intentionally choosing a name that sounded like Napster, and then encouraging Napster users to use Grokster to download free music.

These acts amounted, in the Court’s view, to an open invitation to break the law. They are also unlikely to be repeated. Unsurprisingly, the decision in
Grokster
had little lasting impact. Grokster shut down, but new platforms quickly emerged, and filesharers migrated again. The RIAA’s litigation strategy, in short, was like playing Whack-a-Mole, only in this version new and faster moles kept appearing.

A current example is BitTorrent. By some accounts, files shared over Bit-Torrent comprise as much as one-third of current Web traffic. Users can search BitTorrent using public search engines like the Pirate Bay. However, an increasing amount of BitTorrent filesharing occurs via “closed” search engines that are accessible only by invitation—basically, clubs that share files among their members. New technological tools make detection of file-sharing much less likely and more expensive.

And even newer technologies are coming online, such as the file-hosting and “cyberlocker” sites. To distribute music via a file-hosting site, a user uploads a file to a site like Rapidshare, and then distributes a Web address that permits visitors to download the file. The large number of file-hosting sites, their independence, and the fact that many are located in foreign jurisdictions with weak legal systems makes cracking down on them very difficult.

The music industry, in short, has remained one step behind the technologies used for illegal downloading. And while it has won many court victories, these have been largely Pyhrric. The copying of music is more prevalent today than when Napster was invented.

The major labels likely would have done better had they struck a deal with Napster when they had the chance. Providing an attractive legal alternative to copying would not have stopped piracy altogether. Yet the market for paid online music is very big indeed: as we noted in the Conclusion, iTunes has provided well over 16 billion paid song downloads. Perhaps if the labels had
co-opted the Napster model, as Napster proposed in its settlement offer, that would have helped to reduce piracy to a level that would no longer be a fundamental threat.

Such a system implies a different business model, of course: one much more like iTunes than A&M Records. Consumers would buy their music one song at a time rather than in higher priced bundles of a dozen or so songs. And they would pay less. These changes would mostly benefit consumers.

In the longer term, however, the labels likely would have benefited as well—certainly relative to the disastrous losses they’ve suffered over the past decade. Not least, the industry’s costs of distribution would have fallen dramatically. Napster would have functioned, in effect, as an efficient and scalable retailer. There was another, perhaps even more important, potential gain—
information.
Napster’s network was based around a central server that could have been used to store customer identification information and transactions. Millions of music fans had gathered in one place, Napster’s central server knew how to find them, and the labels could have used this to target products and services to the Napster user base. In one stroke, a deal with Napster would have allowed the record labels to adjust their business model to account for the rise of the Internet.
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Instead Napster was shuttered. The technologies that rose up to take its place were much less promising as potential business partners. These networks were decentralized, and so were much harder to control or coopt.
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The simple fact is that Napster made music incredibly easy to find, and it was the first example of filesharing to really hit it big. That made Napster the perfect partner.

As it became clear that downloading technologies would not disappear, the record labels tried a second strategy. Beginning in 2003, the labels filed suit against 261 individuals who had shared music illegally. Under US law, those
defendants were liable for damages of up to $150,000 per song shared. Ultimately, the labels would file or threaten suits against more than 30,000 people, including a dead person and a 13-year-old girl.