Computer/Law Institute

P2P Music Distribution: a Burden or a Blessing?

Paper presented at the IViR – BUMA/STEMRA Conference ‘Copyright and the Music Industry: Digital Dilemmas’, Amsterdam, 4-5 July 2003

Kamiel J. Koelman

Traditions and habits shaped the music business. In the online environment, new players, some of them are peer-to-peer system providers, are entering the arena and struggling to obtain a position in the value chain. They may displace other actors who currently play a major role. The law – in particular copyright law –  determines to a large extent whether they will succeed. In this paper, the question is addressed whether the law should support record companies in their efforts to remain the key intermediaries in the music industry. Additionally, different legislative approaches are discussed which might ensure that artists are rewarded for peer-to-peer distribution and that competition may evolve in the area of online music distribution.

The Dutch Kazaa Decision

Peer-to-peer (p2p) systems have been the subject of several judicial decisions. At first, the (US) courts tended to decide against the p2p system providers. The most publicized decision was the Napster ruling.[1] However, the latest decisions favor the providers of p2p software. The first court to hold that the providing of p2p software is lawful was the Amsterdam Court of Appeals. Remarkably, the case was not initiated by copyright owners, but by Kazaa, a provider of p2p software. Kazaa had tried to negotiate a tariff for p2p distribution with BUMA/STEMRA, the Dutch collecting societies for composers’ performing and mechanical rights, but just after Napster lost its case, the collecting societies abruptly broke off the negotiations. Kazaa then sued them for continuation of the negotiations. The p2p software provider argued that BUMA/STEMRA had misused its monopoly – i.e. violated anti-trust law – by refusing to grant or even to negotiate for a license. In response, the collecting societies contended that Kazaa infringed copyrights, or at least contributed to copyright infringements, and therefore acted unlawfully. The court of first instance acquiesced to the collecting societies’ arguments.[2]

On appeal, the main issue was whether Kazaa acted unlawful, either by directly or by indirectly infringing copyrights.[3] The Appellate Court felt that it was confronted with an all-or-nothing choice. Contrary to the US Napster Court, it assumed that the p2p-povider could do nothing to stop actual infringements. Therefore, either the Court would have to regard the provision of p2p-software unlawful – which would imply that p2p-technology would be completely forbidden and (assuming that the law is abided) unavailable to everyone – or it would allow to offer p2p-systems, which would then often be used to distribute copyrighted works without the right owners’ permission. The Court held that Kazaa neither directly infringes copyrights, nor unlawfully contributes to infringements, because its system is not just used for distributing works without a proper license, but also for making available files with the rightholders’ consent. In terms of US copyright law, one could say that the Court ruled that the Kazaa program has “substantial non-infringing uses” and therefore may lawfully be made available – a ruling very much similar to the recent US MGM v. Grokster decision.[4]

Veto on New Technology

Both the Dutch and the US Court presumed that there is no “third way”, for instance, similar to the treatment of hosting service providers who have to promptly take down infringing material whenever they are notified of it residing on their systems. Essentially, therefore, the courts had to decide whether the law should allow copyright owners to hinder the introduction of new distribution technology. The key issue is then which interest must prevail: that of the right holders or that of the progress of distribution technology and of the efficiency gains associated with it?

Often, in discussions on copyright law, the term “rightholder” denotes both the author (or the artists) and the publisher (or the record label). However, in answering the above question, it is useful to differentiate between the role of the musician and the role of record company. Very broadly speaking, the first creates the product, while the second ensures that it reaches the customer. In the days that recordings were distributed exclusively on vinyl or on CDs, the only way for an artist to reach a large audience was through a record label.[5] But the artist and the label did not conclude a mere distribution agreement. Instead, the rights were transferred or an exclusive license was granted by which the record company in effect replaced the artist as the copyright (or neighboring rights) owner.

Should the record companies, on the basis of those contracts, be able to prevent new players from distributing music in new ways? From a strictly legal viewpoint, one could argue that if they could not, they would – in a way – be disowned. However, from a more general perspective, one might say that if they could hinder newcomers to the market, it would be as if the Wild West’s Pony Express were in the position to obstruct the telegraph operators in setting up their business, because the Pony Express’s clients had agreed on a fifty-year contract to deliver their messages.[6] Of course, like any analogy, this one does not fit exactly. One important difference is that the record companies regularly invest in the producing of recordings by providing a recording budget – which often is recoupable on the artist’s royalties.

Nonetheless, according to Ginsburg, even if copyright holders shared a part of the risks of developing a product, US courts tend to reject their claims when they feel that the copyright owners are trying to prevent new modes of dissemination from becoming available to the public.[7] This happened when in the early twentieth century piano rolls emerged as a new means of distributing music[8], and much later when the courts had to decide on the status of cable retransmissions[9], of VCR’s[10] and of portable MP3 players.[11] The US Grokster decision may be viewed to be in line with those precedents. The difference between the Napster and the Grokster decisions could be explained by a shifting perception of the courts, who, instead of focusing on the (potential) losses of the recording industry, as they did initially, start to attach more weight to the free development of new distribution technologies.

Indeed, until very recently, the record companies mostly applied the acquired exclusive rights to frustrate others who tried to develop online distribution schemes.[12] They appeared to be reluctant to license the rights for online distribution to third parties or to go online themselves.[13] There were some small-scale initiatives of the record companies in the area of online exploitation, but mostly those were joint initiatives of the big five. Generally, new players were being kept out.[14]

Probably, it is a rational approach for the record companies to prevent online distribution until they are absolutely sure that they are able to play as crucial a role online as they do offline. They are the key middlemen in the offline environment, and may lose that position in the online environment. If it were no longer necessary for artists to conclude agreements with record companies, because the artists could reach a worldwide audience themselves or because other parties are better at online distribution than the labels are, clearly, the record companies – as we know them – could become redundant, at least in their distribution function.[15] If they can apply the acquired copyrights to keep others from getting a head start in setting up online distribution schemes, the established industries have a better chance of remaining the inevitable intermediaries.

Network Effects

The economic phenomenon of the so-called “network effects” may well determine who will be the major players in the online future.[16] It is exactly those effects, which cause the p2p-networks to be so much of threat to the position of the record companies. Economic theory predicts that it is likely that in markets which are influenced by network effects – generally speaking, those are markets where communications are of importance – one player will prevail and will serve the largest part of the market. That is to say, the characteristics of the market inevitably result in a monopolized market. This is because the economies of scale which the bigger networks enjoy, allow them to offer more value for money than the smaller ones can. The bigger the network is, the more attractive it becomes and the less chance smaller parties have to obtain a considerable market share.

With regard to the online distribution of music, network effects play double role. The largest distribution channel will be the most attractive to consumers and the most attractive channel for consumers will be the one that artists prefer. Their market will be larger, if they use the more widespread means of distribution. Since p2p-systems (currently Kazaa, and previously Napster) have by far the largest online user base, they appear to be very well positioned to become the dominant party in the future. On the other hand, the more content a service has to offer, the more consumers will come by and, again, the more customers there are, the more attractive the service is to the artists. This is the advantage that the record companies may have. They own the rights to popular older recordings and if they could – legally and factually – prevent newcomers from offering them, the newcomers would probably not pose a large threat to the future position of the record companies.

The US Napster decision favored the recording industry. The Court ordered that the p2p provider had to promptly delete references to infringing songs from its search database, as soon it was notified of users disseminating the files. When it became clear that Napster could not fulfill this obligation, the service had to shut down. Clearly, if p2p providers could and would effectively block access to infringing content, their systems would lose a lot of their appeal. However, the Napster decision evoked others to design p2p systems of which all functions are distributed. That is to say, all functions – the up and downloading, as well as the search functions – are executed at the level of the individual users. Allegedly, it is therefore impossible for the p2p software providers to stop or control the distribution of infringing content by their users.

Thus, the newer p2p-systems forced the courts to make an either-or decision. Either p2p systems would be completely forbidden, which would deny society efficient new ways of online communication, or they would be allowed, which would probably continue the virtually unstoppable mass infringements. As is explained above, the Dutch Kazaa Court opted for the second option, as did a US lower Court in MGM v. Grokster. The prospects for the music industry are therefore not getting any better. For now, it looks like the p2p providers have a double advantage: their systems are widely used and they – or rather: their users – can offer the entire world repertoire. Moreover, they can offer it for free.

Remuneration for Artists

One may question whether the law should back the record companies in frustrating competition in the area of the online distribution of music. In a free market, it is only natural that new parties come up and older ones vanish if they do not adjust adequately to changing circumstances. It may – in terms of economic theory – be “inefficient” if copyright law intervenes in this process. However, probably most will agree that authors and artists should be rewarded for their creative labor. Until now, they generally were not remunerated for distribution through p2p-systems. The best chance – albeit a very small chance – for an artist to make a living of recording music, is still by concluding a contract with a record label.

Kazaa tried to broker a deal with BUMA, which would have ensured that authors would be remunerated, but the collecting society broke-off the negotiations. Indeed, according to some scholars, collective administration would be the preferable approach in the online environment.[17] A levy would be paid on broadband internet access and/or on devices that are used for storing or playing content. Users could then freely download, use, remix and redistribute music files. They would pay through a tax on services and devices. A collecting society or a similar institution would then distribute the monies over the authors and artists. Some scholars have proposed elaborated schemes for this purpose. As one commentator envisages, if such a levy system were introduced, no longer would there be a place for the record companies, except perhaps for marketing purposes.[18]

The legislative tendency, however, is in the opposite direction. Although, in the EU, mandatory collective management exists with regard to the rights of performing and of broadcasting phonograms,[19] the EU Copyright Directive of 2001 in effect prohibits the EU Member States to introduce obligatory collective administration with regard to the right of making protected material available on demand online.[20] Of course, the rightholders to the sound recordings – i.e. the record companies – could voluntarily agree to be represented by a collecting society, but the above may suggest that they are unlikely to do so. They would lose the power to prohibit others to distribute music files online, which would deprive them of the ability to hinder (potential) competitors.

The Copyright Directive’s approach may help the recording industry. Whether it actually turns out to be to the advantage of artists remains to be seen. If collective management were mandatory, artists would likely be entitled to a substantial part of the income extracted of on demand distribution, as they are with regard to performances and broadcasts (in The Netherlands they get 50 %). In most cases, the percentages that they can claim on the basis of recording agreements are much lower. However, if the record companies were to succeed in earning more of online distribution than the collecting societies can, the absolute amount paid to artists could be higher. Of course, it remains to be seen whether they actually will. The labels do not yield a large turnover of online distribution yet.

Ironically, the record companies were – about a century ago – themselves favored by a compulsory licensing scheme. At the time, it was felt that the composers’ copyrights should not allow them to monopolize the emerging businesses of producing records and of manufacturing the machinery on which to play them. In the US, therefore, right owners were empowered to prohibit the making of the first recording, but once the first recording was authorized, any other record label could, after paying the statutory fee, produce its own recording of the composition.[21] Thus, the copyright owners were rewarded and at the same time, it was ensured that competition among record producers would evolve.[22] It is likely that, if the scheme were not introduced, the music publishers would have been able to extend their market power to the recording business. In most countries, the above situation still exists. Even if the law does not expressly oblige them to do so, the collecting societies for mechanical rights (to the compositions) license the necessary rights to any record producer who pays the set price.

Interestingly, in the US a somewhat similar regime was proposed for online distribution. Under the Music Online Competition Act, once a copyright holder would have licensed the rights to one online distributor, or disseminated a work or a recording himself, he would have to license the rights to any other online distributor under non-discriminatory terms. The aim of the bill was to enhance competition in the area of online distribution.[23] However, as the bill was introduced in 2001 and has not moved forward since, it does not seem reasonable to assume that it will eventually be enacted. Furthermore, although collective management or a compulsory licensing scheme may have several advantages, the most important one being that composers and artists get rewarded for p2p distribution while technological advance is not hindered – i.e. it could constitute a “third way” which the courts in the recent p2p decisions were unable to find – it appears unlikely that mandatory collective administration will be introduced in the near future.

An alternative solution could be provided by DRM systems. If those systems were to enable automatic enforcement, artists and authors would automatically be rewarded for usage of recordings and compositions, even if they were distributed through p2p systems. It appears that the record industry and the legislature are betting on this scenario. However, the record companies may have put their money in the wrong place. If DRM systems would actually facilitate the safe distribution of music files and would guarantee that artists are remunerated for any usage, the operator of a DRM-system could take over the role that record companies play. That is to say, he would ensure that the recordings reach the end-users and that the monies flow in the opposite direction. In this view, Microsoft – as the developer of a DRM system which will likely have a huge installed base – may pose as great a threat to the record companies, as do the p2p systems.

Finally, a legislative approach could be to establish that contracts concluded before online distribution had taken off, do not include the rights necessary for the online distribution of music. In fact, in some countries the law already provides that rights to future forms of exploitation cannot be licensed or transferred.[24] Thus, even if they have granted an exclusive license to a record company, the artists are free to conclude distribution agreements for online exploitation with other parties who they feel will serve there interests better. Clearly, such an approach could foster competition in online distribution. If online distributors – e.g. p2p providers – could convince artists that they do a better job, it could enable them to acquire the rights for distributing older recordings, which the record companies until now generally refuse to license.

Interestingly, the first signs may be observed of new parties offering to artists services which they could previously only obtain of the record companies. Altnet, which is affiliated with Kazaa, claims to offer the combined service of p2p distribution and DRM.[25] The billing would be handled through pre-paid mobile phone accounts. Altnet hopes to replace the record industry’s marketing function by offering high rankings in the Kazaa search results. Interestingly, the famous rapper Ice T. announced to sell his latest record though Altnet’s service.[26] The nineteen-track album will be available for $ 4,99, which is much cheaper than a regular CD or than most other (legal) online services – currently they charge about one dollar or euro per track. Nevertheless, the rapper contends that he will earn more than through the record companies. Probably, per unit sold this will be the case. It will be interesting to see, however, how many Kazaa users will actually buy music files if those files are offered alongside freely downloadable ones. But if many do purchase them, that may show that online distribution through p2p systems can be to the advantage of consumers – who get more for less – as well as of artists.

Freeloaders and Leechers

All parties are struggling to come out on top if online distribution eventually were to replace the offline sale of music – which it does not do yet.[27] And all try to free ride on others as much as they can. Of course, like their users, the p2p providers are free riding on the efforts of artists, composers and – to the extent that they invested in (marketing) the recordings – of record labels. Altnet, for instance, is consciously using the Kazaa user base, which is built up by offering music files for free, to lure artists. The “peers” are free riding on each other’s resources as well. A study shows that about 99 % of the files on the Gnutella p2p network are uploaded by just 1 % of its users. All others, the so-called “leechers”, just “suck up” the files and the available bandwidth.[28]

The study goes on to argue that this pattern of behavior may facilitate the entertainment industry’s battle against p2p file swapping. The industry should target the (relatively few) peers who make the files available. It should scare them out of offering files for downloading, which could result in less copies of a file being available on the networks. If less copies are available, downloads will be slower – or the download queues will be longer – which may cause the relative attractiveness of the networks to decline. In fact, the industry appears to have adopted this strategy.[29] Now that the p2p software providers cannot be held liable, it goes after the peers. Additionally, Bertelsmann, who bought Napster after it was shut down, and some venture investors who financed p2p software providers are being sued for billions of dollars.[30] The music industry is carrying out the message that whoever has (had) anything to do with p2p takes the risk of being sued to death. Again, one could argue that this approach may unduly deter others from investing in improving distribution technologies.

Even though the record industry is fighting back fiercely, it may be viewed as a (possible) victim of technological advance. Not only are others freeloading on its accomplishments, the industry may even become redundant, as others may take over its role in distributing recordings. That does, however, not necessarily mean that the record companies have no part to play in the digital future. When recordings replaced sheet music as the predominant way of distributing music, the (sheet) music publishers managed to stay involved in the business – although at first sight, they appeared to have become redundant, at least in their function of music distributors.

Nevertheless, many artists/composers – or singer/songwriters – still assign or license their rights to music publishers. In effect, this results in the publishers getting a share of the monies collected by the collecting societies. The publishers claim that they have a vital role to play in promotion, administration and enforcement,[31] but quite often, they merely sit back and let the revenues flow in. In any case, the collecting societies seem to perform administration and enforcement functions quite well. Consequently, there does not appear to be a real need to sign up with a publisher. One could therefore say that many music publishers are merely free riding on the efforts of composers, artists, and of recording companies, who may have invested in promoting the (recorded) song. If online distribution were to substitute the distribution of hard copies and if newcomers were to take on the role of middlemen that the recording companies currently have, perhaps the future function of the labels could be similar to the one of the publishers. Another party would, by virtue of tradition, have obtained a hard to explain position in the industry.

Concluding Remarks

The music market is in a state of transition. At this stage, it is impossible to predict how it will develop. However, the law may well influence the way the market evolves. The question is in which direction the law should direct the various players. Obviously, there is no easy answer to this question. I therefore conclude with a few topics for discussion:

·        Should the law focus on technological advance – driven by competition among online distributors – or on protecting the interests of copyright holders, who are not necessarily the authors and artists?

·        Would a levy system perhaps provide a good solution? An advantage of a levy system could be that it may reconcile two policy goals: it could foster the free development of distribution technology and at the same time ensure that artists and authors are remunerated for online distribution. An argument against such a system may be that it may forestall the development of new, yet unforeseeable and perhaps even more efficient ways of exploitation – for instance, through DRM systems.

·        On the other hand, copyright itself affects the free development of the market. In effect, it constitutes a form of entry policy. It allows the party who owns the rights to control distribution. Should the legislature rethink its entry policy in the area of online music distribution?