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Testimony of PROFESSOR STEVEN S. WILDMAN

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Testimony of PROFESSOR STEVEN S. WILDMAN Testimony Of PROFESSOR STEVEN S. WILDMAN Michigan State University East Lansing, Michigan Before the COPYRIGHT ARBITRATION ROYALTY PANEL Washington, D.C. April 2001 TABLE OF CONTENTS Page I. QUALIFICATIONS II. PURPOSE OF TESTIMONY III. SUMMARY OF CONCLUSIONS IV. DISCUSSION .. A. The Different Objectives B. Reliance on Musical Work Rates. 1. Importance of Defining the Market and Considering Cost and Demand Characteristics. 2. The Different Markets For, and Cost and Demand Characteristics of, Sound Recordings and Musical Works. 10 C. Reliance on Negotiated Agreements . 13 1. Relevance of Negotiated Agreements. 15 2. Significance of the RIAA/Webcaster Agreements. 16 I ~ QUALIFICATIONS My name is Steven S. Wildman. I am the James H. Quello Professor of Telecommunication Studies and Director of the James H. and Mary B. Quello Center for Telecommunication Management and Law, both at Michigan State University. I hold a PhD in economics from Stanford University and have had over twenty years of experience as an economist. Prior to assuming my current position in August 1999, I served on the faculties of Northwestern University (1988-99) and the University of California, Los Angeles (UCLA) (1979-83). I also spent five years with the economic consulting firm, Economics Incorporated, in Washington, D.C. (1983-88). A substantial portion of my academic and consulting career has focused on economic issues in media industries. More than half of my publications and research reports, including two co-authored books, two co-edited books, and numerous articles and book chapters have dealt with these issues. I have taught several courses on media economics and have undertaken research and consulting assignments for, among others, the National Association of Broadcasters (NAB), CBS Inc. (including the former CBS Records), Broadcast Music Inc. (BMI) and the Recording Industry Association of America (RIAA). My studies and other research have examined economic issues associated with, among other things, performance rights in sound recordings; competition in the radio industry and in the cable television industry; the economics of new recording technologies; royalty payments for the performance of musical works by the cable industry; the relative contributions to the commercial value of sound recordings made by different segments of the recording industry, including the recording companies, authors and composers, the artists whose performances are recorded, and publishers; the economics of international trade in recorded music; and bundling of information goods, such as computer operating systems and internet browsers. A principal focus of my work has been on the importance of investments in the content of media products in determining both the costs and demands for those products. I have testified as an expert witness before the Copyright Royalty Tribunal (CRT) and the Copyright Arbitration Royalty Panel (CARP). I testified for the NAB in 1985 (before the CRT) and in 1995 (before the CARP) in proceedings to allocate the cable compulsory licensing royalties. In 1997 I testified for RIAA (before the CARP) in proceedings to set the compulsory licensing royalty rate that certain subscription digital audio services pay to transmit sound recordings. My testimony in each of those proceedings considered whether particular evidence provided a reasonable estimate of market value. My curriculum vitae is attached. II. PURPOSE OF TESTIMONY In 1995 Congress enacted the Digital Performance Right in Sound Recordings Act (DPRA), which gives certain subscription audio services a compulsory license to transmit sound recordings via cable and satellite systems. In 1997 a Copyright Arbitration Royalty Panel (CARP) conducted a proceeding to establish the royalty fee for that license. The CARP in that proceeding recommended a rate equal to 5% of the services'ross receipts. The Register of Copyrights found that the CARP had acted improperly in certain respects and increased the rate to 6.5%. In 1998 Congress enacted the Digital Millenium Copyright Act (DMCA), which gives certain nonsubscription services (known as "webcasters") a compulsory license to stream sound recordings over the Internet. A CARP must now set a compulsory licensing fee for this license. I have been asked by RIAA to offer my opinion, as an economist, on whether the rate adopted in the DPRA Subscription Services Proceeding is an appropriate benchmark for the rates to be adopted in the DMCA Webcaster Proceeding. III. SUMMARY OF CONCLUSIONS The rate adopted in the DPRA Subscription Services Proceeding does not provide an appropriate benchmark for setting the rates to be adopted in the DMCA Webcaster Proceeding. That I would come to this conclusion should not be surprising, since both the CARP and the Register in the Subscription Services Proceeding were quite explicit in stating that their rates were not intended to reflect the fair market value of the subscription services'ompulsory license. Here, by contrast, the goal is to determine a fair market rate. Even if the subscription services rate were intended to approximate a market rate, it would still not constitute a reliable benchmark due to serious economic errors in the analysis underlying the CARP's and the Register's recommended rates. The CARP and the Register tied the subscription services'ate to the license fees that those services pay to perform musical works. But transactions for musical works and sound recordings occur in different markets with very different cost and demand characteristics. While one would normally expect prices to differ substantially in such differing circumstances, no attempt was made by the CARP or the Register to show that prices in the markets for these two different goods would be similar. Furthermore, the Register concluded that subscription services should pay 6.5% — less than their musical work fee — because three major record companies had agreed to accept a comparable fee from one service (Music Choice). Here, RIAA has negotiated separate agreements with 23 webcasters concerning the rates and terms for the DMCA statutory licenses. These agreements, unlike the Music Choice agreement, involve the same rights, in the same market, for which the CARP must set a royalty. Therefore, in setting a webcaster royalty, it is much more appropriate for the CARP to rely on the RIAA agreements than on either the Music Choice agreement or on the subscription services royalty that was based in part on that agreement. In addition, unlike the situation in the DPRA Subscription Services Proceeding, I understand that the RIAA agreements require the webcasters to pay sound recording fees that are greater than their musical work fees (and greater than the fee in the Music Choice agreement). This constitutes market- based evidence of the relative levels of compensation market negotiations would produce for digital performance rights for works and recordings. IV. DISCUSSION A. The Different Objectives The DPRA directed the CARP to adopt a royalty for subscription services that achieves the four objectives in Section 801 of the Copyright Act: (A) To maximize the availability of creative works to the public; (B) To afford the copyright owner a fair return for his creative work and copyright users a fair income under existing economic conditions; (C) To reflect the relative roles of the copyright owner and the copyright user in the product made available to the public with respect to relative creative contribution, technological contribution, capital investment, cost, risk, and contribution to the opening of new markets for creative expressions and media for their communication; and (D) To minimize any disruptive impact on the structure of the industries involved and on generally prevailing industry practices. The CARP in the DPRA Subscription Services Proceeding concluded that these objectives do not require adoption of rates approximating those that would be observed in a free market." RIAA challenged this conclusion but the Register of Copyrights agreed with the CARP. The DMCA revised the statutory criteria to be employed by a CARP in setting a statutory rate for the webcaster statutory license. Rather than the four Section 801 criteria that applied under the DPRA, the DMCA contained the simple directive that, if prospective buyers and sellers of digital nonsubscription performance rights cannot negotiate agreements voluntarily, the copyright arbitration royalty panel shall establish rates and terms that most closely represent the rates and terms that would have been negotiated in the marketplace between a willing buyer and a willing seller. This standard reflects the basic economic understanding of the process that determines the marketplace values of goods and services generally. In short, the rate adopted in the DPRA Subscription Services Proceeding was not intended to provide fair market value. The rates to be adopted in the " CARP Report (RIAA Exhibit No. 117 DP), paragraph 124. Register's Decision (RIAA Exhibit No. 118 DP), pages 25399-400, 25403 and 25410. 17 U.S. Code Sections 112(e)(4) 8 114 (f)(2)(B). In determining the willing buyer/willing seller rates and terms, the CARP must base its decision on the "economic, competitive and programming information" presented by the parties, including information on the relative roles of the copyright owner and webcaster and the promotional and/or displacement effects of webcasting. 17 U.S. Code Sections 112(e)(4) 8 114 (f)(2)(B). This provision also says that the CARP "may consider" voluntarily negotiated agreements. DMCA Webcaster Proceeding, however, must be those to which a willing buyer and a willing seller would agree in a free market, t.e., they must provide fair market value. For this reason alone, it would be inappropriate to use the subscription services'ate as a benchmark for setting the royalty that webcasters must pay to transmit sound recordings. The non-market rate for subscription services does not provide any useful guidance as to what the market rate would be for webcasters. B. Reliance on Musical Work Rates Even if the subscription services'ate were intended to be a market rate, that rate still would not provide an appropriate benchmark for setting the webcaster rates.
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