Sound Recording Market: the Ambiguous Case of Copyright ...

Sound Recording Market: the AmbiguousCase of Copyright and Piracy

FR A N C E S C O SI L V A a and GI O V A N N I B. RA M E L L O a , b

(aIstituto di Economia, Università Carlo Cattaneo, Castellanza, Italy andbERSICO, Université Jean Moulin Lyon III, Lyon, France)

This paper attempts to analyse the organization and the economics of informationindustries starting from the case of the phonographic market. The focus here is on therelationships between copyright, the pivotal element of the market, and unauthorisedsound reproduction, its main lamented infringement. The trade-off between the push todiffusion and the push to exclusion, at the root of the market functioning, is herediscussed to show that unauthorised reproduction should be considered as an endogenousconstituent because of the institutional setting and which has positive effects for theindustry itself.

1. IntroductionIndustries producing and distributing information protected by copyright1

(IPC2)—software, the press, publishing, cinema, music, etc.—are today asignificant part, both quantitatively and qualitatively, of the economies ofpost-industrial countries. In the UK their share of the gross domestic productincreased from 2.9% in 1980 to 5.5% in 1994; in the USA from 2.1% in 1980to 5.7% in 1994 (International Intellectual Property Alliance, 1996). In 1993copyright industry exports were second in the USA (US $45.8 billion), afterthe car industry (US $47.3 billion) and before agriculture (US $42.2 billion)(Copyright Council of New Zealand, 1994). In 1996 they were ranked first

© Oxford University Press 2000

415

1 Copyright belongs to the common law systems while civil law countries speak of authors’ rights andneighbouring rights. But a comparative analysis of the judicial institutions is not the focus of the paperand the term ‘copyright’ will here be used for both. [For detailed studies see Goldstein and Strowel(Strowel, 1993; Goldstein, 1994) and books on general intellectual property (Barrett, 1991)]. Note,however, how the two rights increasingly converge on the basis of market needs and internationalagreements.

2 The intellectual property standard doctrine asserts that copyright protects ‘the expression of an idea’,its ‘fixation’. Thus, the story in a movie is not protected, but its expression, i.e. the script and the filmitself, is. As a consequence, we will define IPC industries producing and trading ‘expressions of ideas’.

(US $60.18 billion) (International Intellectual Property Alliance, 1998).Technological change in the fields of telecommunication and entertainmentlato sensu will lead to a further increase in the future.

The development of these activities rests on a system of intellectualproperty rights which protect the economic exploitation of ideas. Thus theprotection of intellectual property is becoming the burning problem of theinformation industries. In 1990, the estimate carried out by the InternationalChamber of Commerce indicated that up to 6% of total world trade was inproducts which infringed intellectual property rights (Davies, 1994) and eventhis trend seems to be increasing, reducing the profits of the legal market.

This article studies the links between IPC market development andunauthorised reproduction in the sound recording (phonographic) industryand suggests a rationale which can be applied to other similar industries. Infact, even though each IPC industry stands out for its own peculiarities, as awhole they present common features and regularities allowing general con-siderations which become even more pertinent as the digital transformationof information makes advances.

The production process of these industries is divided into three phases:creation of a prototype, its duplication and the commercialization of copies.In the first, ‘mastering’, an idea is created and transformed into a ‘master’ bya single individual or a number of individuals through a more or less complexand expensive process: from the manuscript to the draft of a book, from a filmscript to the master copy and so on. In the second phase, ‘manufacturing’, theprototype is reproduced as a number of copies (phonographic, paper, etc.) bythe author him or herself or, more often, by his or her licensee (the publishinghouse, the record company, etc.)3. In the third phase, ‘marketing’, the licenseemanages the marketing and commercial distribution of the copies.

In these industries the copyright plays a pivotal role: it grants to the owneror to the licensee the right to exploit the idea exclusively (in its physicalexpression) for a statutory term, thereby granting them a pro-temporemonopoly rent. In this way the copyright forbids any illegal reproduction ofthe ‘prototype’ and/or distribution of copies by anyone else, either by a singleconsumer (i.e. private copying) or an illegally organized economic activity (i.e.piracy).

All IPC industries are also characterized by marked differentiation, bothvertically and horizontally, as each ‘expression of the idea’ is a differentproduct and the different ‘forms of expression’ (written texts, recorded music,

Sound Recording Market

416

3 The rights owner may be different from the author, either by a (economic) rights transfer or becauseit is so-called ‘work made for hire’, in which the employer becomes the owner of rights created by hisemployees (Barrett, 1991; Goldstein, 1994).

etc.) are different markets. Each market, or market segment, includes a veryhigh number of products with different qualities/characteristics. Quality issometimes measurable by objective technical performance,4 but it is alsoconnected with intrinsic features measured by success in the market itself: arecord or a film is of high quality if the ‘charts’ decree their commercialsuccess. The latter often depends on the author’s and the performer’sreputation. In other terms quality is less objective than for other products:quality and market success are two sides of the same coin.

Moreover, though each market has a large number of different products,firms are highly concentrated and firms producing a single product are rare,while few firms using several trademarks often have a prevalent share ofnational and/or sometimes international markets.5

In spite of the importance of these industrial fields, up to now fewtheoretical and practical studies of industrial organization have examined theway they function.6 Exhaustive studies on the way copyright has shaped themarket are lacking. While the economic aspects of patent protection7 arecontinually discussed, copyright is mostly neglected. A vast legal literaturedeals with this topic, but economists have mainly concentrated on theproblem of private copying in the publishing field.8

Nevertheless, there are many problems still unsettled which need ananswer: what is the effect of copyright on the supply of ideas, on the firms’and market’s organization and on prices? Does copyright, as defined, allowthe maximization of consumers’ welfare? Are the unauthorized activities(private copying and privacy) a pathological or a physiological aspect of themarket?

In this article, analysis of the phonographic industry has a dual aim: todescribe and to interpret the peculiar competitive process and to attempt toexamine the existing interactions between ‘legal’ and ‘illegal’ markets.


417

4 For example, the technical quality of sound is measured by the signal-to-noise ratio. The technicalquality of books concerns printing, colour and photographic fidelity.

5 The publishing industry belongs to the first case, as linguistic barriers still divide domestic markets.The entertainment industry belongs to the second case, where concentration is higher, i.e. in thephonographic industry, where five multinational groups with a complex structure, characterized by aprincipal trade mark (i.e. label) and many subsidiary ones control over 80% of the world market.

6 Plant’s historic contribution to books and copyright should be remembered (Plant, 1934); Black andGreer, Alexander and Ramello for the phonographic field (Black and Greer, 1987; Alexander, 1994;Ramello, 1997).

7 Among others see Gilbert and Shapiro (1990), Klemperer (1990), Merges and Nelson (1990), Ordover(1991), Merges (1993) and Lerner (1994, 1995). For aspects of competition and anti-trust see Bowman(1973) and Lavey (1982).

8 Compare Benjamin and Kormendi (1974), Besen (1986), Liebowitz (1986, 1993), Besen and Kirby(1989) and Besen and Raskind (1991). Stephen Breyer’s brilliant contribution, also in economic terms,should be remembered (Breyer, 1970). The most significant recent contributions on unauthorisedproduction were Takeyama’s (Takeyama, 1994, 1997).

This paper shows that unauthorized sound recording is the outcome of theparticular institutional setting of this industry and it may have positive effectsfor consumers and, under certain conditions, even for producers.

Phonographic firms favour a repressive policy against free copying and askfor the general respect of the international agreements on protection.9 Thisposition is understandable, but a deeper examination of the costs and benefitsof copyright and repression of ‘illegal’ activities suggests a more balancedposition.

The paper is organized as follows: sections 2 and 3 give surveys, respect-ively, of the legal and illegal markets. Section 4 studies the configuration andthe competitive mechanisms of the market, paying special attention toconcentration. Section 5 discusses the interaction between the legal andunauthorized markets, showing that under certain conditions piracy canincrease both present and future profits for producers and welfare forconsumers. Section 6 presents the conclusions.

2. The Legal Industry: Main Features

2.1 Growth and Concentration

The phonographic market is in good health. In the 1990s, in spite ofincreasing unauthorised reproduction, the market has grown by 4% in valueand 5% in quantity, confirming the positive trend of the post-war period(Figure 1). Over 80% of sales are concentrated in North America, Europe andJapan, leaving ample room for development in other countries [comparenumbers in International Federation of Phonographic Industry (IFPI) (IFPI,1998)].

The present production scene is dominated by five big firms, Sony, Warner,BMG, EMI and Universal Music Group (PolyGram + MCA), called theMajors, belonging to diversified industrial groups in the fields of technology


418

9 The main international agreement on copyright (or rather author’s rights) is without doubt the BerneConvention for the Protection of Literary and Artistic Works, adopted in 1886 by 10 nations. On 12thDecember 1997 the nations became 128. Specifically on records, see the Rome Convention on theProtection of Performers, Producers of Sound Recordings and Broadcasters of 1961, the GenevaConvention for the Protection of Record Producers against Unauthorized Duplication of 1971, theAgreement on Trade Related aspects of Intellectual Property Rights (TRIPS) of 1993 after the Uruguayround of GATT agreements, up to the WIPO Treaty of 1997. The Council of European Communities haspublished several documents on copyright and related rights, among which are the Directive on the RentalRight and Lending Right and on Certain Rights Related to Copyrights in the Field of Intellectual Property(92/100/EEC), Directive on the Harmonising the Term of Protection of Copyright and Certain RelatedRights (93/98/EEC) Regulation no 3295/94 (on the circulation of counterfeit and pirated goods) and theGreen Paper on combatting counterfeiting in the single market (569/98).

and entertainment (among others). They control over 80% of the worldmarket.10

The remaining part of the market is crowded with thousands of little firms,the so called Independent labels (referred to as Indies) which operate locallyand with a low turnover in no way comparable to the Majors’ income.11

Therefore, although there are many ‘extras’ on the market that vary fromcountry to country, there is a great level of concentration and centralizationwhich can not be found in other production areas. The Economist (Anonymous,1998, p. 13) recently asserted that ‘Most of the world’s top media companies[Majors included] operate from a rectangle 20 blocks south of New York’sCentral Park and four blocks across’ and so music, as ‘entertainment, is aglobal business run[ning] from a village’.12

The multinational nature of firms and their financial stability, assured bytheir wide diversification, keep the major sector steady, whereas the

FIGURE 1. Phonographic world market, recorded music sales and value, 1991–1997 (IFPI,1998).


419

10 The industrial configuration is changing very quickly, as witnessed by the very recent merger (2000)between Warner Music and EMI (rumour has it that BMG and SONY also are considering the opportunityof a merger). However, no recent data are available, thus we refer here inevitably to the past. CR5 hasvaried according to observer: in 1996 it was 82.5% according to Business Week, 70% according to theObserver and 73.7% (surveys in 17 countries) according to Music & Copyright (source Music & Copyright). Inany case, after Seagram’s acquisition of PolyGram (end of 1998), which already possessed MCA (previouslyaccounted for in the ‘others’ category), has no doubt increased CR5.

11 Wallis and Malm assert (Wallis and Malm, 1984, p. 85) that, as several Indies depend on the Majorsfor distribution, the word independent is scarcely valid. We will discuss it later.

12 With regard to this, The Economist asserts that ‘Philip’s sale to Seagram earlier this year of PolyGram,its music-films subsidiary, illustrated the problems of running a global entertainment company fromEurope’ (‘Survey of Technology and Entertainment,’ The Economist, 21 November 1998, p. 13).

independent sector is crowded and continuously changing because of the highdeath and birth rates.13

Several Indies are structurally too weak to sustain the costs of competition:many of them rely on the Majors in order to fulfil some stages of theproduction and in this way they grant to Majors the control of a noticeableshare of the small independent market segment. Therefore, considering themarket share indirectly controlled by the Majors, the level of marketconcentration is still higher than we said earlier.14

On the other hand, Indies, besides producing for niche markets (specialisedconsumers, special local music) which are of limited interest to big companies,have a very important role in the industry: they create musical innovation anddiscover new artists, acting as ‘Schumpeterian innovators’, who take on therelated risks of failure. New artists are the seeds of the music market: theydevelop new ideas and/or represent new potential stars. They are the objectsof experimentation by the Indies, which act as R&D laboratories (Manuel,1993; Monopolies and Mergers Commission, 1994). Majors receive the mainbenefits from this activity. As a matter of fact, they can draw new talent orthe successful label from the Indies.15

The rationale is as follows: a new musical idea that has already beensuccessfully trialled by an independent label can be more easily launched onthe market and pay high dividends but it requires heavy marketinginvestment and significant distribution effort of which only big companies arecapable. As in many other differentiated markets, the appreciation of qualityis not uniformly distributed across the population of consumers. Somepreferences are more frequent. In the sound recording market they correspondto the music or songs played by famous artists standing out on theinternational and national music scenes. This success needs continuous andexpensive marketing investment and entails higher royalties for the artists.So, successful new artists can be easily captured by the Majors:16 a star is atalent who generates high income and he/she therefore earns high royaltiesafter promotional and marketing investment, which, again, are the preserve


420

13 Most Indies last as long as a product or a lucky season last.14 Frith underlines how symbiosis between Indies and Majors reduces potential competition (Frith,

1987).15 The history of the phonographic industry confirms this (Silva and Ramello, 1999b). See Haring for a

brilliant report on this phenomenon (Haring, 1996). Manuel significantly affirms: ‘The Majors can affordto take the risks, but generally avoid doing so; rather they prefer to wait until a group or artist has madea name on an Indie label, and then they acquire that act from the Indie, thus letting the Indies bear thecost of research and development’ (Manuel, 1993, p. 22).

16 As a confirmation, Manuel, among the others, asserts: ‘Artists themselves often prefer to work withMajors, which offer superior marketing networks and greater reliability in terms of royalty payments’(Manuel, 1993, p. 22).

of big corporations. By the same token, the artist market is dominated bystars who gain the largest share of copyright income.17

2.2 Prices

In the legal market, products are divided into three large groups according totheir selling price (Monopolies and Mergers Commission, 1994; AutoritàGarante della Concorrenza e del Mercato, 1997; Silva and Ramello, 1999b).These price differences are to be found in most countries regardless ofexchange rates, different taxes and market facilities.

Full price is the name given to new releases and to old recordings that stillsell well.18 They are the ‘best’ products, the strongest sellers at the top of thecharts. Sometimes their price is further increased, in which case they becomefull deluxe price products: artists who stand out on the music scene and whohave an exclusive power over ane audience can often command higher prices.In many domestic market this category accounts for the larger share of sales.19

The second group is called mid price and includes older recordings whoseselling dynamic has slowed down. This is a normal development over theperiod of the music product cycle. These releases, which represent a relativelyobsolete product, satisfy the residual demand of consumers unwilling to paya high price for a fashionable record. Some new releases whose success isexpected to be lower are sometimes included immediately in this price range.Mid price products sell for 60–70% of full price products.

Finally, there is the budget price level, which is about 50% of the full price.All the so-called marginal products that do not enter the product life cycle justdescribed are sold at this price. This is true for example of certain classical musicrecordings without famous artists, of less popular famous artists’ works and of‘specialised’ products which, as such, cannot be targeted at large audiences.

It is important to stress that full price sales concern above all the Majors’market, while Indies releases are found in the other segments.


421

17 Silva and Ramello have shown that in Italy in 1995 and 1996 over 80% of Italian musicians of theItalian Collecting Society (SIAE) did not receive any copyright income and this percentage increased withthose artists who did not have a meaningful income (that is equivalent to GDP per capita) (Silva andRamello, 1999a). Towse showed similar results for UK and other European countries (Towse, 1999). For asurvey of the mechanisms of the star system compare McDonald and Rosen (Rosen, 1981; McDonald,1988).

18 Note that piracy activities mostly concentrate on this category.19 The IFPI reports that full price releases in the USA and UK represent 76% of trade, 75% in France

and 68% in Italy (IFPI, 1998).

2.3 Quality

Before discussing the working of competition in the legal market and the roleof unauthorised activities we need a more precise understanding of thecomplexity of the recorded ‘product’ as understood in the market.20

Consumers demand music or, more precisely, different types of music anddifferent authors. The utility of a record depends essentially on its quality,which has many dimensions, but in general can be given no precise andabsolute measure. The notion of quality involves, as noted above, twodifferent and unrelated features: the technical quality and the musicalmessage (i.e. artistic quality). We shall see that the technical quality alone isnot an ‘absolute value’ for consumers (Manuel, 1993; Anonymous, 1996c).

As far as the musical message is concerned, there is no intrinsic valuemeasurable, for instance, by the absolute and neutral judgement of an expert.In this sense, quality is what is perceived by the market, which judges howfashionable and/or creative the artist and the music are and their value. Fame,however, depends heavily on time and on the promotional campaign. Artisticquality, quantity and price are therefore closely connected: the success of abest seller means that its perceived quality is high and consequently its pricecan be high because elasticity of demand is inversely related to perceivedartistic quality.

3. The Unauthorized Phonographic Market

3.1 Phenomena

As we have implicitly asserted, the ‘copyright’ control, understood as anexclusive right to market and sell ‘an artist’ concerned with a certainquality/quantity potential, plays an important role in explaining both theexistence and organization of the legal and illegal markets. Before dealingwith this subject we will give a more detailed explanation of the ways in whichthis right can be infringed by unauthorized reproduction. This general andwidespread term covers many kinds of illicit and illegal activity.

Private copying is carried out on a unit scale by individual consumers usingtheir home equipment. It became established after the introduction ofrecording equipment by Philips and other producers in the late 1960s


422

20 Majors have a policy of risk minimization through portfolio diversification and cross-subsidy betweensuccessful and unsuccessful products. Thus their title list is their product. However, the present paper willnot deal with this subject.

(Manuel, 1993; Millard, 1995). Its rise is connected with the opportunity forthe consumer to build up a music library of recordings at a fraction of theprice at which original recordings were on sale (Monopolies and MergersCommission, 1994). Private copying is not illegal and is accepted, with somedegree of controversy, in many countries.21

Counterfeiting consists of manufacturing products that are identical to theoriginals, both as to content and to packaging. The strategic role here isplayed by the distributor, whose behaviour is opportunist in two ways. First,he/she takes account of the income differential between market price andmanufacturing cost. In this case, the recording company and the artists arethe damaged parties to the extent that the counterfeited products replace theoriginals. Collusion between the illegal reproducer and the distributor enablesthem to exclude the record company from the sale proceeds. The secondconsists of the fraud committed against the consumer who believes thathe/she is buying and paying for a different commodity from the one he/sheactually purchases.

Genuine piracy issues onto the market unauthorized copies of a recordwhich is already in circulation, producing competition in which the free-loader producer does not have to sustain any cost connected with masterproduction, royalties, promotion and marketing, therefore, he/she enjoys acomparative advantage with respect to regular labels. Piracy reaches highlevels in countries where legislation is inadequate and it peaks in those whosedeveloping markets are weaker and where scarce or even non-existent controlsexist along with a low per capita income.

Bootlegging comes last in the genealogical tree of unauthorized repro-duction. It was once considered a sort of ‘childhood disease’ of the recordingindustry, as a limited form of illegal reproduction of unlawful recordings ofconcerts or radio broadcasts, as something useful to meet a localized demandof a small group of fans that acted at most as a propellant for the star system.Bootlegging is also an example of parasite behaviour with respect to theMajors and benefits from the externalities stemming from the promotion ofregular products without bearing the risks of failure, since this kind ofcopyright infringement is always connected with artists in vogue, who ensuresales. The quality is normally lower than that of legal recordings because ofthe very nature of the recordings, which are casual and technically sloppy.


423

21 It is difficult to deal with this aspect of the law. In many countries private copying is not illegal if thecopy is made by the owner of the recorded medium for personal use, while it is illegal if the copy is madefor third parties, as it becomes public (i.e. a protected work is reproduced and distributed). Actually, theborder between the two is difficult to define. However, the proposition by the EU of a new directiveCOM(1999)250 def.–97/0359(COD) to ban every kind of private copying, if applied, will bring about adramatic change, with great damage to both consumers and the electronic industry.

3.2 Size and Spread

Illegal market sizes are listed in Table 1.22 In order to complete thepicture, the figures regarding private unauthorised reproduction, referred toas private copying, need to be added to these numbers. In 1992, for example,687 000 000 long-playing albums (CDs, LPs and cassettes) were sold in 17European countries, as against 1100 000 000 blank tapes. Various sourcessuggest that about 90% of these tapes were used for illegitimate repro-duction. What is more, the standard format 90 min blank cassette can recordthe equivalent of two standard commercial products, so the amount of musiccopied in Europe can be assumed to be nearly three times greater than theamount of music bought (Davies, 1994; Monopolies and Mergers Com-mission, 1994).23 There are no significant data on the recent introduction ofCD recorders in the consumer market.

The geographical distribution of unauthorized production also deservessome attention, since it provides important indications and keys to inter-pretation. Although piracy and the other offences present similar forms inlocal markets, they are spread unevenly in terms of quantity and type acrosscontinental regions and within national borders. This heterogeneity is due tothe different political, legal and, ultimately, economic contexts of singlecountries provided with a common denominator which can be summed up asfollows: unauthorized sound reproduction, in manufacturing and commercialterms, finds fertile soil in countries where per capita income is low, the market

TABLE 1. World Retail Sales of Unauthorized Recordings

Year Units (millions) Value (US $ billions)

1991 512 14741992 741 20951993 786 19611994 1041 22461995 955 21001996 1950 50001997 1870 5300

Source: IFPI.


424

22 There are no details about the inferential method used and the statistical validity of the IFPI data hasbeen questioned. The authors have pointed out the invalidity of the Italian data, magnified for instrumentalpurposes (Silva and Ramello, 1999b). This paper will however refer to the reported data.

23 In this situation, the measures taken by 10 European countries to impose a royalty on blank tapes tobe redistributed to copyright companies should be regarded more as evidence of the governments’willingness to attempt a correction of the market distortion than as the beginning of effective strategies ofreaction and redress.

is more backward and, as a result, the legislative measures to control illegalactivities are imperfect or altogether non-existent (Figure 2; the estimatedelasticity of the following IFPI data set is almost 0.86, showing a certain linkbetween per capita GDP and piracy level).24

These numbers are in line with results of a study on the effectiveness ofinternational copyright conventions (Burke, 1996, p. 63) which indicates that‘economic development rather than copyright legislation seems to be the mostimportant feature distinguishing low from high piracy nations’.

Although the foregoing figures do not cover all the countries of the world,they do, nevertheless, support the claim that piracy sales are more widespreadin developing markets. Furthermore, the presence of illegal copying is in linewith the familiar economic division of the world: in the poorest countries percapita income prevents the majority of people from buying original recordedproducts at market prices and illicit activities largely replace legal trade. Thesame pattern appears at the national level, where both systems are present.

4. The Structure of the Legal Market: a Differentiated Oligopoly

4.1 Horizontal Product Differentiation

Generally speaking, firms do not like price competition because it squeezes

FIGURE 2. Piracy level (%) versus GDP per capita (US $) scattergram, 1995. Source: IFPI.


425

24 Results of the simple (and not exhaustive) bivariate regression model areln(piracy) = 9.75288 – 0.859788 ln(GDP) r2– = 0.43771SE = 1.040579 0.121812 r2 adj. = 0.42892t = (9.373) (–7.058) F = 49.81943

DW = 1.70933.

profits. Differentiation is a way to weaken it. Now, as we said earlier, thequality perceived by consumers is vital for the success of a product and everyrecorded product, which is technically identical to any other, differs in itscontent, as every piece of music is distinct. Therefore, the intrinsic differ-entiation of musical releases and their original non-replaceability allow firmsto reduce the possibility of price competition and allow competition to belinked to non-price elements. In other terms, the competitive game is playedon the definition of the perceived quality of the product which is obtainedand/or amplified by heavy marketing investment. This is frequent in IPCindustries.25

Copyright, offering the institutional instrument of property attribution ofsingle products, helps the differentiation strategy.26 Through the copyright,the owner or her/his licensee acquires the right to exploit a recording‘exclusively’, in a monopoly regime. As a consequence of both copyright andperceived quality, any release is a unique product not subjected to price com-petition by other firms.27

If we assume that the size of the market is given and that each labelproduces a unique release, n producers would be present, where n is also thenumber of releases. If this were the case we could interpret the configurationof the market using the linear city model (Hotelling, 1929; D’Aspremont etal., 1979) where n horizontally differentiated firms compete.

In this model the market share of each firm depends on sunk costs andconsumer preferences, while the price differentiation among the n com-petitors depends on the substitution costs of each product/firm. Both costsare given.

In the recording industry marginal costs of manufacturing (i.e. duplicationof copies) are constant, relatively low and similar for every firm. In contrast,sunk costs due to mastering and especially to marketing can be quite differentand firms with higher sunk costs control a larger share of the market. The


426

25 For an application to the broadcasting field see Motta and Paolo (Motta and Paolo, 1996). For thephonographic industry see Black and Greer for a formal analysis (Black and Greer, 1987) and Monopoliesand Mergers Commission and Autorità Garante della Concorrenza e del Mercato for descriptive analyses(Monopolies and Mergers Commission, 1994; Autorità Garante della Concorrenza e del Mercato, 1997).

26 Copyright is a bundle of rights, as continental Europe’s definition of author’s rights and neighbouringrights better describe, and so its management may raise exceptions and complications. For a disc, forinstance, the rights of the owner of the recording (e.g. the musician and/or the recording company label),the performers’ rights (e.g. if there are recording artists) and the composer’s rights (who, in pop music,95% of the world market, is often the recording musician himself) are recognized. In general, in therecording market the ownership of the rights on copied discs (normally reinforced with exclusiveagreements of the artists with a record company) is fundamental.

27 The Monopolies and Mergers Commission agrees and asserts: ‘The economics of competition in therecord industry are different from most areas of manifacturing because each recording is unique and,through the copyright system, can be marketed only by the owner of the rights or his licensee’ (Monopoliesand Mergers Commission, 1994, p. 24).

price differences depend on the substitution costs between products for theconsumer: the higher they are, the stronger is the monopoly power of theproducer and the greater are the price differences. Therefore, we could expectan industry configuration where the number, size and prices of competingfirms depend on the market size and on the distribution of sunk andsubstitution costs.

A few market characteristics can be explained by this model, especiallyprice differentiation within the mid and budget price segments, where sunkcosts are lower and rather uniform among releases. However, the real industryshows other features which cannot be explained by this simple model. Themarket is a concentrated oligopoly where Majors offer many trade marks,28

each of them representing a certain kind of music or a certain level of productquality.29 Firms sell more than one release and the concentration level cannotbe explained simply by given differences in sunk costs and in substitutioncosts. Marketing costs cannot be considered as exogenously given: theydepend on the strategy of the firm.

Moreover, at least in the full price category, price competition is weak. Themid price category is a peculiar price discrimination, which actually operatesas if products were different in perceived quality.30 On the other hand, thereis stronger competition in the budget price category, i.e. where perceivedquality is lower. These outcomes cannot be understood using the linear citymodel and need a different explanation. Sunk and substitution costs are notexogenous and costs functions are more complex: copyright introduces localmonopolies and the phonographic market is a continuous sequence of localmonopolies.

4.2 Vertical Product Differentiation

Concentration The competition process in the recording industry (con-centration and price policy) is better explained by the vertical differentiatedoligopoly model with endogenous sunk costs (Shaked and Sutton, 1987;Sutton, 1991). In particular a model of this sort helps to interpret the con-centration level, the structural difference in prices among quality categories.

Besides scale and scope economies peculiar to this industry, the endogenous


427

28 For instance, in 1995 the Major EMI owned 65 record labels in 37 countries.29 Unlike the other sectors, the quality of the product is defined by the product/artist and only minimally

by the trade mark (e.g. a specific title by Michael Jackson, a specific orchestra conducted by Muti, etc.).The trade mark (i.e. the label) plays a bigger role in classical music (but it is only 5% of the market) where,for instance, Deutsch Grammophon means higher quality than Decca, although both of them belong toPolyGram.

30 Compare the paragraph on price competition.

nature of sunk costs is the fundamental factor explaining concentration. Toclarify this proposition we need to step back and observe the functioning ofthe market: the perceived quality of a new release depends essentially on theartist (composer, musician, singer) and on marketing. A firm which wants tosell successful releases must invest large amounts of money in artists able togain an audience.

Indeed, each Major seeks steady relations with successful artists in order toguarantee a strong and stable position in the market of the strategic input ofits activity.31 Therefore, it must pay significant costs, which are sunk, inmarketing (i.e. promotion, advertising, merchandising, etc.) and in distri-bution, which also requires high and sunk set up costs. These costs are a greatpart of a Major’s total costs.32 Furthermore, every Major has its own directsale channels and tries to control independent distribution channels. In thehistory of the music business we see that, beginning in the 1950s, with anacceleration after 1980, the recordings market had a similar increasingconcentration, both in production and in distribution (Black and Greer, 1987;Alexander, 1994), thus creating the sharp separation between the major andindependent segments. On the one hand, high marketing costs restrictedentry to the market of competitors able to pay for them; on the other, highdistribution costs further restricted the chances of steady presence in themarket for these competitors.33

In addition, concentration is also due to the nature of the cost function,which presents both scale and scope economies. Several costs, for the artists’presence in the market, for the label’s and the single artist’s advertising, aswell as for distribution, may be spread over a number of releases.34

Scope economies also arise from sharing fixed costs among many releases.Risk diversification reduces costs. A new product is not always successful, evenif the marketing costs are high and the artist is successful: sometimes anexpected success does not come about. The ghost of failure is always present,thus every Major reduces the expected costs by dividing the failure risksamong a number of new releases. It is worth noting that the availability of anartists’ portfolio (or a recordings’ portfolio) is an asset which allows the firmto minimize risks through cross-subsidy, since successful releases pay for those


428

31 A Major is usually owner of the rights or licensee of a wide catalogue of recordings (thousands of titles)(Autorità Garante della Concorrenza e del Mercato, 1997).

32 According to what the Majors say about the British market (Monopolies and Mergers Commission,1994, p. 101) these costs may amount to between £30 000 and £250 000 ‘depending on the stature ofthe artist’.

33 Being able to make recordings, without being able to promote and/or distribute them, has nocommercial meaning.

34 It is worth noting that Majors don’t plan the production of a single record, but of a catalogue, so thatmany costs actually apply to the latter and are paid to market all the products as a whole.

which fail.35 This is a fundamental difference between the Majors and Indies:the lack of a wide catalogue gaining positive profits has been the cause of thefailure of independent distribution (which nowadays survives only on themarginal fringes), while the impossibility of building an efficient distributionnetwork has been (and is nowadays) a significant barrier to entry (Black andGreer, 1987) for new firms.36

All this helps to explain the market concentration: copyright, through itsstatutory monopoly, stimulates promotion investment, which has the dualeffect of increasing substitution costs (reinforcing the monopolistic position)and stimulating demand. The recent extension of copyright length furtherreinforces these types of behaviour.37

Price Competition The vertically differentiated oligopoly model predictsdifferent prices for different qualities: in the recording industry prices aredifferentiated across various segment, full, mid and budget price, whichrepresent different qualities. Nevertheless, they are closely aligned in the fullprice segment, which accounts for the largest share of sales, while they aresometimes differentiated within the mid and budget price segments. Thelatter differentiation can be seen as the outcome of a market horizontallydifferentiated within a single segment (Sutton, 1991, p. 71). On the otherhand, the price uniformity in the full price group is not an obviousconsequence of the model. This peculiarity calls for an interpretation.

In recent years, both the British and Italian Antitrust Authorities haveinstituted proceedings to verify behaviour allegedly restricting competition(Monopolies and Mergers Commission, 1994; Autorità Garante dellaConcorrenza e del Mercato, 1997). In the UK the Monopolies and MergersCommission made inquires into Majors maintaining high prices to thedetriment of consumers (above all in respect of the US market) and concludedthat ‘although we have found two monopoly situations to exist,38 we have notfound they operate against the public interest’ (Monopolies and MergersCommission, 1994, p. 5). Investigating the existence of collusion among the


429

35 cf. the Monopolies and Mergers Commission (Monopolies and Mergers Commission, 1994, p. 26).The Italian Antitrust Authority asserts that varied and wide catalogues are a real asset ‘constituted by thequality and the number of the artists, who have exclusive agreements’ and grant ‘steady incomes’ reducingthe firm’s risk in launching new items (Autorità Garante della Concorrenza e del Mercato, 1997, p. 12).As for the domestic market, it then says: ‘on the basis of what is maintained by the parts, the proceedsfrom the catalogue are 1/3 of the total income of a record company [Major]’.

36 The network is so concentrated that ‘many fringe firms and new entrants are unable to obtain nationaldistribution’ (Alexander, 1994, p. 121). Moreover, one of the most frequent causes of the failure of anindependent label is the lack of effective national and international distribution (Baskerville, 1990).

37 The European Community has recently expanded this limit up to 70 post mortem autoris (50 forrecordings), Directive on Copyright Duration 93/98/EEC (27th October 1993).

38 In the phonographic industry and in retailing.

Majors, the Italian Autorità Garante della Concorrenza e del Mercato madethe opposite conclusion, finding ‘decided and artificial compression ofcompetition spaces’ (Autorità Garante della Concorrenza e del Mercato, 1997,p. 88).39 What then is Majors' price policy? And what kind of competitionprevails on the national markets where they operate?

In every country the price of full price releases is uniform (Monopolies andMergers Commission, 1994; Autorità Garante della Concorrenza e delMercato, 1997) and in the Italian antitrust case the Majors have been accusedof charging uniform prices to the retailers. This one price regime, however, isdue neither to competition, as it is a very concentrated oligopolistic market,nor is it the result of collusive behaviour.

The three price groups define different qualities and vice versa. This doesn’timply straightforwardly that within the same class prices have to be closelyaligned among releases: after all, the appeal cannot be the same for everyrelease. Actually, given the monopolistic position attributed by copyright tothe producer, we could expect some kind of price differentiation deriving fromthe substitution costs between products.

There are a few reasons which can explain why price parallelism makessense for full price products. As we said before, marketing costs act upondemand and increase the substitution costs among products, decreasing pricecompetition. Consequently, cross-price elasticity among releases is low.Therefore, a strategy which, in order to gain additional consumers, reducesthe price of an existing release or puts on the market a new one with a lowerprice than that of releases belonging to the same class would not be rational.40

Majors prefer to compete on the artist market and through promotionalcampaigns, because varying the relative prices of the releases would have littleeffect on sales. 41 However, this doesn’t yet explain why prices are aligned.

While sunk costs vary according to the release and the record company, thevariable marginal costs (manufacturing costs and some distribution costs) aresimilar. On the other hand, the success of each release is in any case uncertain,depending also on random elements. Therefore, the Majors have to assumean expected demand function that is the same for each full price recording,since they cannot know ex ante the demand curve for each release.42 In otherwords, from the firm point of view, sunk costs, once paid, attribute to a record


430

39 This conclusion has been criticised (Ramello, 1998) as the conduct actually found (parallel behavioursand prices) in this peculiar market system is consistent with competition and so it is not a proof of secretpacts. An analysis of the British market (Kaes, 1997) has given similar results.

40 Differentiating sale prices to distributors may be useful in increasing the purchase of certain releasesby varying distributors’ margins. This justifies the Italian case.

41 These conclusions have been drawn by Kaes and Ramello (Kaes, 1997; Ramello, 1998).42 The probability of event success reflects the expectations of the firm for a typical full price product

and is, therefore, the same for every release.

an average desirability level, an average substitution elasticity and,consequently, an expected demand curve which is the same for all productsbelonging to the full price segment.43 Price equality is then the outcome ofmonopolistic behaviour, since marginal costs and marginal revenues are thesame, and it is the result of the desire to avoid price competition for thereasons given above.44

In addition, there is a further element which helps to explain priceuniformity: because of the large number of releases and the coexistence of oldand new ones, transaction costs determined by a strong differentiation ofprices would be very high for the Major and would create confusion andmistaken expectations for the consumer. The policy of a unique price for eachtype of release minimizes these costs and communicates clearer information.In this sense, indeed, price can be a simple and unequivocal signal of qualityfor the consumer, i.e. high price corresponds to high quality.45

Price differentiation policies, however, exist among different segments ofthe markets. A new full price release at time t is a product whose success isprogrammed in t time. The same release, at t + 1, is perceived by consumersin a different way: it is not a record which ‘must’ be bought, but which ‘can’be bought. Its perceived quality and its substitution costs are smaller. Att + 1 then, old releases launched at time t have developed different char-acteristics (and become mid price). They enjoy better conditions for pricecompetition: t + 1 releases are generally sold at a lower price than they wereat t, so there is a greater heterogeneity in the sale prices of the differentreleases as they are more interchangeable. In this price segment marketingcosts are low, perceived quality is not exactly the same among products andas a consequence expected demand is less homogeneous. Therefore, there is asituation of horizontal differentiation.

The t + 1 demand for an earlier release means that some consumers didnot buy the release at time t in the legal market but are now willing to buyit for a lower price, which does not include the ‘reward’ of the time t purchase.This situation is the basis of the emergence of unauthorized reproductions, aswe will see below.


431

43 It is important to stress that marketing costs determine the quality of a product: high costs serve toput a release in the full price segment, but, because of the uncertainty and the risk minimization strategy,they are considered by the firms as a whole to be divided over all the full price releases. Consequently, theexpected demand for each full price product is the same.

44 This claim corresponds to that of the Monopolies and Mergers Commission. In particular, ‘theunpredictability of demand meant that in practice it was not possible to price records on a cost plus basis’(Monopolies and Mergers Commission, 1994, p. 26).

45 ‘If quality of individual units cannot be observed at the time of purchase’, Riley asserts, ‘but buyersdo eventually learn average quality, goods will be traded at a price which reflects buyers’ belief about thisaverage’ (Riley, 1990).

Budget price records represent yet another situation: they are perceived aslow quality products and so they have a smaller expected audience. Thesubstitution cost with the records of the other two segments is high and thisexplains the different prices. Moreover, sunk costs for producing andlaunching these products are low. Thus the budget price market includesproducers who sustain limited marketing costs. As expected this segment ismore competitive, less concentrated and price variety is greater.

The coexistence of different market segments, all of them ruled bycopyright, but each showing a different outcome in terms of concentrationand price competition, suggests an additional consideration. The existence ofa budget price market means that releases are offered even if competition isstronger and prices are lower. In other words, there is a market even withoutthe great artists created by the Majors. This result raises a question: if a fullprice market and its related hopes of success did not exist, would the supplyof artistic ideas by unsuccessful, and thus worse paid, originators be lower?We do not want to give an answer, but the question is important. Indeed, ifthe supply of ideas were independent of hopes of great incomes, the principalargument in favour of copyright, i.e. its power to increase the supply of ideas,would be weaker.46

5. Interactions Between Legal and Unauthorized SoundReproduction

Unauthorized reproduction appeared as a consequence of technologicalinnovation, i.e. the introduction in the late 1960s of the compact cassette byPhilips, which was at the same time the holder of the patent of this technologyand the owner of a Major (until late 1998). This technology allowed thereproduction of recordings at low cost for a vast public and, especially, had agreat effect on the market, on sales and on consumption.47 However, the‘endemic spread of piracy’ and private copying also began, generating a sortof historical nemesis (Manuel, 1993, pp. 30 and 78).

As cassettes widened the market, it is reasonable to assume that Majors didnot immediately perceive the economic long-term consequences for copy-right infringement: for example, between 1979 and 1983 they earned overUS $1 000 000 000 in Nigeria, without in the least worrying either about


432

46 The question is relevant. Anthropology and ethnomusicology have found the existence of music inevery culture, even where market does not play any role. For a first and deep reading on the question, seeJohn Blacking, How Musical is Man? (Blacking, 1973).

47 At the end of the decade, the introduction of the WalkMan (using the compact cassette format) bythe Sony Corporation based on the invention of Masuru Ikanu and Akio Morita, multiplied theconsumption of recordings (Millard, 1995; Silva and Ramello, 1999b).

copyright (on the contrary, giving a ridiculously low lump-sum payment tomusicians) or about its enforcement (Robinson and Cuthbert, 1991). Yet inAfrica (but not only there) compact cassettes increased recording con-sumption, but, because of piracy supported by an institutional void oncopyright law, acted as a brake on the rising domestic recording industry(Wallis and Malm, 1984), thus eliminating possible future competition to theMajors and acting as a deterrent against the entry of competitors.

Indeed, the presence of a buoyant pirate market has been a generalprerequisite for future consolidation, through the enforcement of copyrightlaw, of the legal one dominated by multinational groups. In the last twodecades there have been many examples, including Hong Kong, Bulgaria andThailand (Anonymous, 1996a,b).48 Moreover, albeit partially and in differentways in different countries, piracy has made created a more uniform taste, bydrawing together the preference for international pop music which involvesthe greater part of the Majors’ activities.49

The ability to reproduce recordings, feasible for individuals (private copying)or for illegal economic organizations (piracy), changed the rules of the market.Copyright has been the legal tool by which was possible to turn music, and anyother information, into a commodity, as soon as technology permitted theirappropriability. The new technology offered a device to violate this rule of thegame: in this way the recordings market has been faced with a basic contra-diction, a trade-off between the push to diffusion and the push to exclusion.50

The rationale is as follows: Majors set a monopolistic price which excludesa section of consumers from buying a given release, but they are unable todiscriminate prices at time t, because in this case consumers would be able tobuy the same product at the lowest price.51 In the short term this policyproduces negative welfare effects, due to monopolistic pricing, however, it isusually assumed that in the long term copyright has a positive effect as anincentive to creative activity.52

Nevertheless, it has not been considered that record companies could alsodraw some positive side effects from copyright infringement. Let’s examinethe various aspects of this complex matter.


433

48 Note the eloquent title of a special issue of Music & Copyright, a supplement of the Financial Times,‘Majors Move into Bulgaria as Music Piracy Starts to Decline’ (Anonymous, 1996a).

49 The question of monopoly and cultural pluralism is a delicate theme which has interested mediatheorists. For a deeper discussion see Manuel and, above all, McQuail and Mattelart (Manuel, 1993;McQuail, 1987; Mattelart, 1997).

50 The new possibilities offered by digital transformation of information accentuate the situation evenfurther.

51 However, they can behave as intertemporal price discriminators, for the reasons given above.52 This is the standard assumption in economic theory, but there are several critics. For a survey see Van

der Bergh (Van der Bergh, 1998).

First of all, there are important differences between private copying andpiracy, from the points of view of both market structure and welfare. Inprivate copying, reproduction is done by an individual at a high andincreasing cost, both in terms of time spent and in equipment. Private repro-ductions by definition are for private use only and it would be inappropriateto talk about a ‘private copying market’. Moreover, it reasonable to assumethat consumers are separable into two groups, differing in their willingness topay for an original product,53 so that private copies are not competing withlegal products or they are competing for the marginal fringes of consumers.

Private copying merely puts some limits to an absolute monopolistic power,causing some profit reduction, but also some benefit, for the producers, forthe artists and for social welfare. The implications for the latter have beenwidely discussed in economic literature referring to the publishing market.This literature introduces the idea that the monopoly created by copyrightexcludes from the market consumers unwilling to pay monopolistic prices andmay induce them to get private copies paying lower prices or sustaining lowercosts (i.e. by photocopying or by home taping). If this is true, demand forunauthorized sound products (or photocopies) might not upset the demandfor originals and might satisfy a greater number of consumers, withoutcompelling the monopolist to decrease prices. Of course, this result is cruciallybased on the previous assumption that the two groups of consumers areseparable. In this case it has been shown (Benjamin and Kormendi, 1974;Besen, 1986; Besen and Kirby, 1989) that the monopolist can also indirectlygain profits in the secondary market, if he is able to evaluate how much morethe ‘official’ consumers are willing to pay for an original product plus thepossibility of copying or reselling it. In other words, the selling price of aproduct may already include an adjustment for this market ‘distortion’. Thus,the producer would not be penalized and the consumers’ welfare wouldincrease because more people are able to use the information.

According to Novos and Waldman the interaction between legal and illegalreproduction is generally determined by the structure of costs (Novos andWaldman, 1984). As we said earlier, the marginal reproduction costs ofprivate copying are high, where the time spent in reproduction (given by theopportunity cost of an alternative use of time) must be added to the initialcost of the hi-fi hardware and to the cost of the blank tape, which is lower forthose who have a lot of free time (this fully explains why this phenomenon isparticularly common among the young who, on the whole, have a lot of freetime and a low income). We suppose that the sum of these components is


434

53 This feature also applies to the piracy case.

significantly higher than industrial reproduction and has an average costgreater than large-scale copying and sharply decreasing returns of scale.Private copying competition is then necessarily limited.

This literature doesn’t consider an additional factor: quality is the pivotalelement of the market and the quality of private copies is generally lower thanthat of a legal copy.54 This, again, sharply divides consumers. For these tworeasons it is reasonable to assume that private reproduction skims from thelegal market a limited number of low income consumers.

Moving to long-term considerations, it has been shown that strictprotection of copyright has a negative welfare effect when the damage arisingfrom the application of the monopoly exceeds the advantages arising from theincentive to create (Liebowitz, 1986).

The case of piracy presents similar features (for which we can apply someof the above arguments) and a few important different features which are thefocus of the following analysis:55 the reproduction costs of pirate products isequal (or similar) to that of legal ones and it is a non-increasing function ofthe number of copies reproduced. Consumers could buy a pirate copy at aprice which is much lower than that of the legal product, because it doesn’tinclude other costs (royalties, promotion, etc.). On the other hand, the qualityis lower than legal products. The difference in quality is due to technicalcharacteristics or even to the fact of being sold through a different commercialchannel. This aspect will be discussed more deeply later. For now it isimportant to observe that consumers wanting to buy a ‘high quality’ productgenerally won’t buy a ‘low quality’ pirate product. Only when the quality isthe same are the implications quite different, as we shall see.56

There is limited literature dealing with the subject of piracy. The problemhas a few analogies with smuggling, which will offer the first reference. The


435

54 In this case the total quality is lower for technical reasons, because of poorer packaging, etc.55 Bootlegging, when it becomes large scale—Langford stresses how bootlegging is a multinational and

multimillion dollar business (Langford, 1994)—is assimilated with piracy, because it is the same kind ofactivity, with the exception that the master phonogram, instead of being a commercial release, is recordedfrom a concert, radio broadcast, etc. Otherwise traditional bottlegging is small scale. The true bootleg isnot a substitute but is a new release with a special ‘nature’ with respect to the authorised phonogram. Itcan be harmful to the commercial strategies adopted by companies and to artistic choice, since they maynot correspond to the promotional and image-developing policies chosen by musicians and entrepreneurs,but it usually increases different mechanisms which are parallel to the market (i.e. the star system) (Manuel,1993).

56 This is unlikely because consumers can always distinguish between legal and illegal products andconsequently the quality is different. They cannot only in the case of counterfeiting which, however, cannotbe particularly widespread for a variety of reasons. First, it requires an illegal collusion between areproducer and a large number of distributors who have not yet been informed. Second, the recordingcompany should be able to detect the phenomenon relatively easily, once it exceeds a marginal level forone or more distributors. Their existence as well as the number of records they acquire from the recordcompany are known and, moreover, the record company keeps track of the alleged number of records soldby the distributor.

theoretical analysis of smuggling generally focuses on the trade aspects of theproblem. The welfare implications are ambiguous and depend on the initialrestrictive conditions (Bhagwati and Hansen, 1973; Sheikh, 1974; Pitt,1981). Moreover, these contributions do not examine the changes caused bysmuggling to the structure of the market and to price policy and assume thattaxes are the only cause of smuggling.

Only some more recent developments have considered a hidden linkbetween welfare and the higher competition introduced by illegal activity(Thursby et al., 1991). In any case, the goods considered [e.g. agriculturalproducts (Norton, 1988)] have a very different nature from recorded productsand imply different behaviours.

A new contribution by Constantatos, Larue and Touil (Constantatos et al.,1999), studying the case of cigarette smuggling in Canada, pays moreattention to these questions, drawing some interesting conclusions. Theauthors make two critical assumptions: smugglers behave as perfectcompetitors and the social stigma associated with illegal product consumptionand other psychological factors lower the perceived quality of pirate productsand keep differentiation among products effective.57 Under these assumptionssmuggling can arise even without taxation on the legal market if smugglersare efficient. A monopolist sells legal products at a higher price than illegalones, though the technical quality is the same, and uses smugglers toimplement a price discrimination scheme.

The case of Canadian cigarettes gives some hints for interpreting our case.The perceived quality of pirate products (inferior in their technical charac-teristics, their different packaging, the irregular distribution channels, etc.)distinguishes those products and markets from the legal ones. Pricedifferentiation in the market, inpracticable by Majors in the full pricesegment, materializes by means of the pirate competitors. As for privatecopying, if the perceived quality of the products is different, the consequencesfor the legal producers, for the working of the market and in terms of welfareare multifaceted and uncertain. Generally speaking inferior pirate productsmeet a secondary market attracting low income consumers, who cannot affordto enter the full price market.58 Only a marginal fringe of legal consumersmay be attracted by illegal products.


436

57 In the case of cigarettes, the illegal products are exactly the same as the legal ones, being legalcigarettes that are illegaly imported. Even in this case smuggling can led to profit maximization for legalfirms, but, it must be said, the markets and products are quite different.

58 This is confirmed by observation: in non-developed markets, where the willingness to pay isstructurally much lower than legal prices, the exchange of legal products is unlikely to take place at marketprice while piracy, offering lower quality (and price) products, permits the existence of recordingsconsumption and feeds future legal demand.

Of course, the results would be quite different if the qualitative gap couldbe filled and pirate products became qualitatively equal to the legal ones.Majors could then disappear from the market. Therefore, the implication isthat while legal producers can accept illegal reproduction, which feeds thatpart of the market excluded by their price policy, they cannot compete witha vast and well-organized pirate organization. The question needing answer-ing is whether it is possible for pirate products to have the same perceivedquality as legal products. So far this hasn’t happened.

These conclusions are confirmed by well-consolidated experience ashitherto, in spite of three decades of piracy, the recording industry has showna positive growth trend. This coexistence, in spite of repeated declarations ofalarm by the operators, has continued without compromising the Majors andthe market.

Further considerations, which apply both to private copying and to piracy,must be considered. Unauthorized reproduction is mostly concentrated in thefull price segment, i.e.in that artistic arena in which mainly successful artists,who already gain high royalties, compete.59 Consequently, it is doubtful thatadditional income gained through a stricter control of private reproductioncould spur them to create more music.

Also, as stressed by Takeyama, in the general case of unauthorized repro-duction there are demand network externalities, especially in those countrieswhere income level prevents the majority from entering the market and theconsumption of illegal products creates a network of potential buyers ofquality products (as confirmed by the historical experience previouslymentioned) and increases the effect of the building of perceived qualityassociated with an artist’s name (Takeyama, 1994).60

Intertemporal discrimination practised by the Majors introduces anotherconsideration. Unauthorized reproduction at time t absorbs a small part of thefuture demand for a release, allowing a Major to make a credible commitmentto keep its price stable until time t + 1, when the product will change itsperceived quality. The Major may then impose a monopolistic price to its highquality releases without feeding expectations of lower prices in the short term.Takeyama proved that this strategy increases both the Majors’ profits andsocial welfare, as it permits the satisfaction of both high and low qualitydemand at time t (Takeyama, 1997).61


437

59 This assumption is verified in the case of piracy (Anonymous, 1993, 1994a,b) but it reasonable alsofor the case of private copying.

60 Unauthorized private or piratical reproduction feeds the star system and then helps to increase thequality of the copied products.

61 Takeyama, analysing the software context, asserts that this is the basis of the campaigns of the freegive away of ‘light’, i.e. scaled down, versions of certain products (Takeyama, 1997).

In the long term, the legal producers will benefit from the musical culturefostered by unauthorized, and cheaper, listening: as income grows, todaysunauthorized consumers may turn out to be tomorrows full price consumers.One could object that consumers may be damaged in the long term becauseof a decrease in creation caused by the lower incentives to artists. This resultis very unlikely if the products are created for the world market, where highprofits are ensured by the sale performances to richer consumers.

If we put on one side of the balance the negative effects of unauthorizedreproduction and on the other the short-term positive welfare effects, thepossibility of indirect appropriability, the multiplier effect and the demandnetwork externalities, these positive effects seem to balance or even to exceedthe disadvantages, particularly in the private copying case.

6. ConclusionsThis paper starts from the consideration of the increasing importance ofactivities protected by copyright and from copyright enforcement in thenational economies as a consequence of the spread of unauthorized repro-duction. In this sense, the recordings market is a model for many industriesproducing information protected by copyright.

This industry presents some features interpretable by a model in whichboth horizontal and vertical product differentiation coexist. In this way it ispossible to explain the strong price variety among product categories whichrepresent different perceived qualities. The high quality segment is anexception: peculiar demand characteristics and the nature of costs cause priceuniformity and, because of the lack of price differentiation, this is the domainof unauthorized reproduction.

The simplistic standard argument is that piracy and private copying upsetthe legal market and thus are to be condemned and, where possible, to belegally prosecuted. However, analysis of the structure of the market and ofthe competition mechanisms shows a more complex situation whereunauthorized reproduction is a natural consequence of the institutionalsetting and generates the peculiar dynamics of a market based on a double(and contradictory) push both to diffusion and exclusion (via copyright). It ispossible to assert that copyright and piracy are closely connected and probablyinseparable.

Historical experience also proves a profitable coexistence, in the last threedecades, between the recording industry and unauthorized sound repro-duction. Consumption of legally recorded music (and recorded information ingeneral) needs habits and tastes, which illegal products can help to create. In


438

addition, demand network externalities, including feeding of the star system,contribute to differentiating the perceived quality of the products, which isthe motor of the market and which reinforces the monopolistic power ofproducers.

On the other hand, the supposed losses of which the record companiescomplain, may be fully regained by including in the mark-up the possibilityof reproduction and allowing a sui-generis price discrimination.

All these considerations lead to some important policy implications: thedemand for strong repression of all forms of unauthorized reproduction,private and pirate, by producers cannot be accepted because it doesn’t takeinto account the increasing costs and the negative effect on social welfare,while the marginal effect on creation is questionable. A more balanced policy,taking into account the needs of both producers and consumers, has to beconsidered. If the statutory monopoly granted by copyright serves socialobjectives as an incentive to creation, it is only in the light of these objectivesthat it is necessary to avoid the negative consequences of such a measure byreducing the monopoly degree to a minimum. The private copying case is animportant paradigm because it shows that unauthorized reproduction canbring about welfare improvements without significantly affecting firms’profits. The piracy case, of course, is more questionable because it concernsillegal activities. However, what emerges is that it has economic reasons toexist due to price policy and it is endemic to the configuration of the industry.

In this perspective, the recent measures taken in this domain, such as the textof the new directive62 drafted by the European Union to ban every kind ofprivate reproduction, transforming home copiers into criminals, the recentapplication of copyright to new subject matter and the extension of the lengthof term to 70 years post mortem autoris will probably have incongruous effects.They will increase the number and ownership of the monopolies, as well as theconcentration of IPC firms, with perverse consequences for consumers, and theywill also dramatically increase the contradiction as the basis of the existence ofunauthorized reproduction. If the effects of such changes will be uncertain inincreasing social welfare, their costs on society will certainly be high.

AcknowledgementsThe authors are grateful to Dr Ruth Towse and to two anonymous referees fortheir helpful comments on earlier draft of this paper. The usual disclaimerapplies.


439

62 COM(1999)250 def.-97/0359(COD).

ReferencesAlexander, P. J. (1994), ‘New Technology and Market Structure: Evidence from the Music RecordingIndustry,’ Journal of Cultural Economics, 18, 113–123.

Anonymous (1993), Breaking Down the Sound Barriers. IFPI: London.

Anonymous (1994a), ‘CD Piracy,’ IFPI for the Record, April, 1–4.

Anonymous (1994b), ‘IFPI Unauthorised Sound Recordings,’ IFPI for the Record, May, 1–4.

Anonymous (1996a), ‘Majors Move into Bulgaria as Music Piracy Starts to Decline,’ Music & Copyright, 85,8–10.

Anonymous (1996b), ‘Majors Move into Thailand,’ Music & Copyright, 85, 2.

Anonymous (1996c), ‘Presses Pound at Full Tilt – Though Many are Illegal,’ Music Business International,December, 55–57.

Anonymous (1998), ‘Wheel of Fortune. A Survey of Technology and Entertainment,’ The Economist,November 21, 1–22.

Autorità Garante della Concorrenza e del Mercato (1997), ‘Associazione Vendomusica/Case DiscograficheMultinazionali-Federazione Industria Musicale Italiana Provvedimento no. 5385 (I/207),’ Presidenza delConsiglio dei Ministri, Bollettino anno 7, no. 41, 5–64.

Barrett, M. (1991), Intellectual Property. Emanuel Law Outlines: Larchmont.

Baskerville, D. (1990), Music Business Handbook. Sherwood: Los Angeles, CA.

Benjamin, D. K. and R. C. Kormendi (1974), ‘The Interrelationship Between Markets for New and UsedDurable Goods,’ Journal of Law and Economics, 17, 381.

Besen, S. M. (1986), Private Copying, Reproduction Costs, and the Supply of Intellectual Property, InformationEconomics and Policy 2, pp. 5–22. Elsevier North-Holland: Amsterdam.

Besen, S. M. and S. N. Kirby (1989), ‘Private Copying, Appropriability and Optimal Copying Royalties,’Journal of Law and Economics, 23, 255–280.

Besen, S. M. and L. J. Raskind (1991), ‘An Introduction of the Law and Economics of Intellectual Property,’Journal of Economic Perspectives, 5, 3–27.

Bhagwati, J. and B. Hansen (1973), ‘A Theoretical Analysis of Smuggling,’ Quarterly Journal of Economics,May, 172–187.

Black, M. and D. Greer (1987), ‘Concentration and Non-price Competition in the Recording Industry,’Review of Industrial Organizatiion, 9, 85–98.

Blacking, J. (1973), How Musical is Man? University of Washington Press: Seattle, WA.

Bowman, W. S. (1973), ‘Patent and Antitrust Law: a Legal and Economic Appraisal,’ University of Chicago.

Breyer, S. (1970), ‘The Uneasy Case for Copyright: a Study of Copyright in Books, Photocopies andComputer Programs,’ Harvard Law Review, 84, 281–351.

Burke, A. E. (1996), ‘How Effective are International Copyright Conventions in the Music Industry?,’ Journalof Cultural Economics, 20, 51–66.

Constantatos, C., B. Larue and C. Touil (1999), ‘Using the Black Market to Price Discriminate: the Case ofCigarettes Smuggling in Canada,’ Cahiers du CRÉA Research Series R.99.9.

Copyright Council of New Zealand (1994), Export Growth in the Copyright Based Industries. Copyright Councilof New Zealand: Auckland.

D’Aspremont C., J. Gabszewicz and J. F. Thisse (1979), ‘On Hotelling’s Stability in Competition,’Econometrica, 17, 1145–1151.

Davies, G. (1994), ‘Piracy in the Audiovisual Sector,’ in Proceedings of The Economics of Intellectual Rights,October 6–8. ICARE: Venice.


440

Frith, S. (1987), ‘The Industrialisation of Music,’ in J. Lull (ed.), Popular Music and Communication. Sage:Newbury Park.

Gilbert, R. and C. Shapiro (1990), ‘Optimal Patent Length and Breadth,’ RAND Journal of Economics, 21,106–112.

Goldstein, P. (1994), Copyright’s Highway. Hill and Wang: New York.

Haring, B. (1996), Off the Charts. Birch Lane: New York.

Hotelling, H. (1929), ‘Stability in Competition,’ Economic Journal, 39, 41–57.

International Intellectual Property Alliance (1996), Copyright Industries in the U.S. Economy. InternationalIntellectual Property Alliance, Washington, DC.

International Intellectual Property Alliance (1998), Copyright Industries in the U.S. Economy. InternationalIntellectual Property Alliance, Washington, DC.

Kaes, M. (1997), ‘Sociotechnical Constituencies, Game Theory, and the Diffusion of Compacts Discs. AnInter-disciplinary Investigation into the Market for Recorded Music,’ Research Policy, 25, 1221–1234.

Klemperer, P. (1990), ‘How Broad Should the Scope of Patent Protection Be?,’ Rand Journal of Economics, 21,113–130.

Langford, M. (1994), ‘Bootleg Battle Needs Recruits,’ IFPI for the Record, July, 2–3.

Lavey, W. G. (1982), ‘Patent, Copyrights, and Trademarks as Sources of Market Power in Antitrust Cases,’Antitrust Bulletin, 27, 433–455.

Lerner, J. (1994), ‘The Importance of Patent Scope: an Empirical Analysis,’ RAND Journal of Economics, 25,319–333.

Lerner, J. (1995), ‘Patenting in the Shadow of Competitors,’ Journal of Law and Economics, 28, 463–495.

Liebowitz, S. J. (1986), ‘Copyright Law, Photocopying, and Price Discrimination,’ Research in Law andEconomics, 8, 181–200.

Liebowitz, S. J. (1993), ‘Copying and Indirect Appropriability: Photocopying of Journals,’ Journal of PoliticalEconomy, 93, 945–957.

Manuel, P. (1993), Cassette Culture. University of Chicago Press: Chicago, IL.

Mattelart, A. M. (1997), Storia delle Teorie della Comunicazione. Lupetti: Milan.

MacDonald, G. M. (1988), ‘The Economics of Rising Stars,’ American Economic Review, March.

McQuail, D. (1987), ‘Communication Technology: the New Media in Society,’ Journal of Communication, 37,4.

Merges, R. (1993), ‘Uncertainty and the Standard of Patentability,’ High Technology Law Journal, 7, 1–70.

Merges, R. P. and R. R. Nelson (1990), ‘On the Complex Economics of Patent Scope,’ Columbia Law Review,90, 839–916.

Millard, A. (1995), America on Record. Cambridge University Press: Cambridge.

Monopolies and Mergers Commission (1994), The Supply of Recorded Music. HMSO: London.

Motta, M. and M. Paolo (1996), ‘Beyond the Spectrum Constraint: a Model of Persistent Concentration inthe Broadcast Industry,’ mimeo.

Norton, D. A. G. (1988), ‘On the Economic Theory of Smuggling,’ Economica, 55, 107–118.

Novos, I. F. and M. Waldman (1984), ‘The Effects of Increased Copyright Protection: an AnalyticalApproach,’ Journal of Political Economy, 92, 236–246.

Ordover, J. A. (1991), ‘A Patent System for Both Diffusion and Exclusion,’ Journal of Economic Perspective, 5,43–60.

Pitt, M. M. (1981), ‘Smuggling and Price Disparity,’ Journal of International Economics, 11, 447–458.

Plant, A. (1934), ‘The Economic Aspects of Copyright in Books,’ Economica, May, 167–195.


441

Ramello, G. (1997), ‘Copyright e Pirateria nel Mercato Fonografico,’ l’Industria, 18, 317–339.

Ramello, G. (1998), ‘Provvedimento dell’Autorità Garante della Concorrenza e del Mercato no. 5385(I/207).Riflessioni sull’Applicazione della Dottrina Antitrust,’ Economia e Politica Industriale, 97, 203–227.

Riley, J. G. (1990), ‘Signalling,’ in The New Palgrave. MacMillan: London.

Robinson, D. E. B. and M. Cuthbert (1991), Music at the Margins. Popular Music and Global Cultural Diversity.Sage: London.

Rosen, S. (1981), ‘The Economics of Superstars,’ American Economic Review, 71, 845–858.

Shaked, A. and J. Sutton (1987), ‘Product Differentiation and Industrial Structure,’ Journal of IndustrialEconomics, 36, 131–136.

Sheikh, M. A. (1974), ‘Smuggling, Production and Welfare,’ Journal of International Economics, 4, 355–364.

Silva, F. and G. Ramello (1999a), ‘Il Mercato delle Idee,’ Economia e Politica Industriale, 101/102, 291–327.

Silva, F. and G. Ramello (eds) (1999b), Dal Vinile a Internet. Economia della Musica tra Tecnologia e Diritti.Fondazione Giovanni Agnelli: Turin.

Strowel, A. (1993), Droit d’Auteur et Copyright. Bruylant: Brussels.

Sutton, J. (1991), Sunk Costs and Market Structure. MIT Press: Cambridge, MA.

Takeyama, L. N. (1994), ‘The Welfare Implications of Unauthorized Reproduction of Intellectual Property inthe Presence of Demand Network Externalities,’ Journal of Industrial Economics, 17, 155–165.

Takeyama, L. N. (1997), ‘The Intertemporal Consequence of Unauthorized Reproduction of IntellectualProperty,’ Journal of Law and Economics, 15, 511–522.

Thursby, M., R. Jensen and J. Thursby (1991), ‘Smuggling, Camouflaging, and Market Structure,’ QuarterlyJournal of Economics, August, 789–814.

Towse, R. (1999), ‘Incentivi e Redditi Derivanti dal Diritto d’Autore e Diritti Connessi nell’IndustriaMusicale. Considerazioni a Partire dai Nuovi Diritti degli Artisti Esecutori nel Regno Unito,’ in F. Silva andG. Ramello (eds), Dal Vinile a Internet. Economia della Musica tra Tecnologia e Diritti. Fondazione GiovanniAgnelli: Turin.

Van der Bergh, R. (1998), ‘The Role and Social Justification of Copyright: a “Law and Economics” Approach,’Intellectual Property Quarterly, 1, 17–34.

Wallis, R. and K. K. Malm (1984), Big Sounds for Small People: The Music Industry in Small Countries. Pendragon:New York.


442

Date post:	29-Jan-2022
Category:	Documents
Upload:	others
View:	3 times
Download:	0 times

Sound Recording Market: the Ambiguous Case of Copyright ...

Documents