PUBLIC VERSION Before the COPYRIGHT ROYALTY JUDGES LIBRARY OF CONGRESS Washington, D.C. ) In The Matter Of: ) ) Determination of Royalty Rates ) 14-CRB-0001-WR (2016-2020) for Digital Performance in Sound ) Recordings and Ephemeral ) Recordings (Web IV) ) ) WRITTEN DIRECT STATEMENT OF THE NATIONAL ASSOCIATION OF BROADCASTERS Witness Testimony Volume 2 of 3 Bruce G. Joseph (D.C. Bar No. 338236) [email protected] Karyn K. Ablin (D.C. Bar No. 454473) [email protected] Michael L. Sturm (D.C. Bar No. 422338) [email protected] WILEY REIN LLP 1776 K St. NW Washington, DC 20006 Phone: 202-719-7000 Facsimile: 202-719-7049 Counsel for the National Association of Broadcasters October 7, 2014 A Before the COPYRIGHT ROYALTY JUDGES LIBRARY OF CONGRESS Washington, D.C. ) In The Matter Of: ) ) Determination of Royalty Rates ) 14-CRB-0001-WR (2016-2020) for Digital Performance in Sound ) Recordings and Ephemeral ) Recordings (Web IV) ) ) WRITTEN DIRECT TESTIMONY OF MICHAEL L. KATZ (On behalf of the National Association of Broadcasters) October 7, 2014 CONTENTS I. INTRODUCTION AND OVERVIEW ............................................................................ 1 II. QUALIFICATIONS .......................................................................................................... 9 III. THE STATUTORY STANDARD .................................................................................. 11 IV. THE ECONOMICS OF EFFECTIVE COMPETITION ............................................ 14 A. THE BENEFITS OF COMPETITION ............................................................................. 15 B. COMPETITIVE PRICES ............................................................................................. 17 C. REASONABLE, WORKABLE, OR EFFECTIVE COMPETITION ...................................... 20 D. BUYER CHOICE IS THE ESSENCE OF COMPETITION ................................................. 22 1. A monopolized market is not competitive. ................................................. 24 2. Suppliers of complementary products do not compete with one another. ...................................................................................................... 28 V. DR. PELCOVITS’S WEB II INTERACTIVE SERVICES BENCHMARK WAS SO SERIOUSLY FLAWED AS TO BE UNUSABLE. ...................................... 30 A. DR. PELCOVITS FAILED TO ACCOUNT FOR THE LACK OF COMPETITION AMONG RECORD COMPANIES SELLING TO INTERACTIVE SERVICES. ......................... 31 B. DR. PELCOVITS’S STATISTICAL ANALYSIS RELIED ON INAPPROPRIATE DATA. ..................................................................................................................... 35 1. Dr. Pelcovits based his analysis on data for services using a very different business model. ................................................................... 35 2. Dr. Pelcovits based his analysis on data for an industry that was not in equilibrium. .............................................................................. 38 3. Dr. Pelcovits relied on what is very likely a biased sample of contracts. ................................................................................................... 40 C. APPLYING DR. PELCOVITS’S METHODOLOGY TO ACCOUNT FOR NONSUBSCRIPTION SERVICES WOULD HAVE YIELDED A MUCH LOWER PER- PLAY ROYALTY. ...................................................................................................... 42 VI. THE NAB/SOUNDEXCHANGE WSA AGREEMENT IS NOT A VALID BENCHMARK ................................................................................................................ 43 A. SOUNDEXCHANGE POSSESSED MONOPOLY POWER................................................ 45 B. THE PARTIES’ EXPECTATIONS AND WILLINGNESS TO LITIGATE ............................. 46 C. THE ROLE OF PRECEDENT ...................................................................................... 49 i VII. THE ADVERSE EFFECTS OF THE WEB II RATES CONTINUE TO BE FELT .......................................................................................................................... 51 VIII. BOUNDS FOR SIMULCASTING RATES .................................................................. 52 A. THE LOWER BOUND OF THE ZONE OF REASONABLENESS IS ZERO PERCENT OF SIMULCASTING REVENUES. ................................................................................ 53 B. THE UPPER BOUND OF THE ZONE OF REASONABLENESS IS LESS THAN 13 PERCENT OF SIMULCASTING REVENUES FOR MUSIC-FORMATTED STATIONS. ............................................................................................................... 56 IX. CONCLUSION ................................................................................................................ 62 TECHNICAL APPENDIX ......................................................................................................... 63 A. A MONOPOLIZED MARKET IS NOT EFFECTIVELY COMPETITIVE. ............................ 63 B. APPLYING DR. PELCOVITS’S METHODOLOGY TO ACCOUNT FOR NONSUBSCRIPTION SERVICES WOULD HAVE YIELDED A MUCH LOWER PER- PLAY ROYALTY. ...................................................................................................... 65 CURRICULUM VITAE ............................................................................................................... 1 ii I. INTRODUCTION AND OVERVIEW 1. The Copyright Royalty Judges (“Judges”) have commenced a proceeding to determine reasonable rates and terms for public performances of sound recordings by means of eligible, nonsubscription transmissions, under Section 114 of the Copyright Act, and the making of an ephemeral recording in furtherance of making a permitted public performance of the sound recording, under Section 112 of the Copyright Act, for the period beginning on January 1, 2016, and ending on December 31, 2020.1 The Judges are charged with establishing reasonable royalty rates to be paid by eligible, nonsubscription services.2 In determining these royalty rates, “the Copyright Royalty Judges shall establish rates and terms that most clearly represent the rates and terms that would have been negotiated in the marketplace between a willing buyer and a willing seller.”3 2. At the request of counsel for the National Association of Broadcasters (“NAB”), I have conducted an economic analysis of what rates meet the statutory standard as I understand that standard as an economist. I have also examined the implications of this standard for the validity of certain benchmarks that have previously been used or that are likely to be proposed in the present proceeding. Previous rate proceedings have consistently considered royalties for the public performance and ephemeral recording 1 Determination of Royalty Rates for Digital Performance in Sound Recordings and Ephemeral Recordings (Web IV), 79 FR 412 (January 3, 2014) (hereinafter, Web IV Commencement). 2 Copyright Act, 17 U.S.C. § 801. 3 Copyright Act, 17 U.S.C. §§ 112(e) and 114(f)(2)(B). 1 rights in combination because there is no sound basis for attributing an independent economic value to the latter.4 I therefore consider the two rates together in my analysis that follows. 3. My central finding with respect to the validity of past benchmarks is that the statutory rates adopted in the second webcasting proceeding (“Web II”) were based on a severely flawed benchmark analysis conducted by Dr. Pelcovits that led to rates well in excess of those that would have been negotiated by a willing buyer and willing seller in an appropriate market. Moreover, by strongly influencing the private parties’ expectations regarding future statutory rates, the rates set in Web II created significant upward pressure on rates in the Webcaster Settlement Act (“WSA”) agreements subsequently negotiated and, thus, rendered those agreements inappropriate benchmarks for what a willing buyer would have paid a willing seller in the absence of the statute. In short, there is a need to break with the past by taking a close look at new benchmarks that are meaningfully similar to the licenses at issue and that do not reflect undue licensor market power. 4. With respect to appropriate benchmarks for the current proceeding, my central findings are that: (a) an analysis of the economic relationship between record companies and terrestrial radio broadcasters establishes that the lower bound for reasonable royalties 4 See, e.g., Determination of Rates and Terms for Preexisting Subscription Services and Satellite Digital Audio Radio Services, Final Rule, 78 FR 23054 (hereinafter, SDARS II Decision) at 23055-56; Determination of Royalty Rates for Digital Performance Right in Sound Recordings and Ephemeral Recordings, Final Rule and Order, 79 FR 23102 (April 25, 2014) (hereinafter, Web III Remand Decision) at 23104-105; Digital Performance Right in Sound Recordings and Ephemeral Recordings, Final Rule, 72 FR 24084 (May 1, 2007) (hereinafter, Web II Decision) at 24101-102. 2 to be paid by webcasters that simulcast terrestrial radio broadcasts (“simulcasters”) is near zero, and (b) an analysis of the statutory rate set in the most recent Satellite Digital Audio Radio Services proceeding (“SDARS II”)5 establishes that, when expressed as a percentage of a music-formatted radio station’s simulcasting revenues, a royalty of 13 percent or higher would be unreasonably high. In fact, percentage royalties that were lower but near 13 percent (or per-performance royalties that were equivalent to a rate near 13 percent) of simulcasting revenue would also be unreasonably high. Given