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LIBRARY OF CONGRESS For access to the docket to read the final parties may agree.’’ 17 U.S.C. 115(c)(3)); determination and submitted The Judges included the designation Copyright Royalty Board background documents, go to eCRB and (2018–2022) in the docket number for search for docket number 16–CRB– this proceeding for the purpose of 37 CFR Part 385 0003–PR (2018–2022). designating the relevant five-year period [Docket No. 16–CRB–0003–PR (2018–2022)] FOR FURTHER INFORMATION CONTACT: with the knowledge that affected parties Anita Blaine, CRB Program Assistant, by may agree to successor rates and terms Determination of Royalty Rates and telephone at (202) 707–7658 or by email for a different or additional period. In Terms for Making and Distributing at [email protected]. this proceeding, each party included in Phonorecords (Phonorecords III) its Proposed Findings of Fact (PFF) and SUPPLEMENTARY INFORMATION: AGENCY: Copyright Royalty Board, Proposed Conclusions of Law (PCL) a Final Determination Library of Congress. designation of the rate period as January 1, 2018, through December 31, 2022. ACTION: Final rule and order. The Copyright Royalty Judges (Judges) commenced the captioned proceeding to The Judges, therefore, adopt that agreed SUMMARY: The Copyright Royalty Judges set royalty rates and terms to license the rate period. announce their final determination of copyrights of and For the reasons detailed in this the rates and terms for making and publishers in musical works made and Determination,1 the Judges establish the distributing phonorecords for the period distributed as physical phonorecords, following section 115 royalty rate beginning January 1, 2018, and ending digital downloads, and on-demand structure, and rates, for the period 2018 on December 31, 2022. digital streams. See 81 FR 255 (Jan. 5, through 2022. DATES: 2016). The rates and terms determined Effective Date: February 5, 2019. herein shall be effective during the rate For licensing of musical works for all Applicability Date: The regulations period January 1, 2018, through service offerings, the all-in rate for apply to the license period beginning December 31, 2022. Under the performances and mechanical January 1, 2018, and ending December Copyright Act, royalty rates for uses of reproductions shall be the greater of the 31, 2022. musical works shall end ‘‘on the percent of service revenue and Total ADDRESSES: The final determination is effective date of successor rates and Content Cost (TCC) rates in the posted in eCRB at https://app.crb.gov/. terms, or such other period as the following table.

2018–2022 ALL-IN ROYALTY RATES

2018 2019 2020 2021 2022

Percent of Revenue ...... 11.4 12.3 13.3 14.2 15.1 Percent of TCC ...... 22.0 23.1 24.1 25.2 26.2

The Judges also adopt for the new rate treated both motions as general motions works in the making and distribution of period existing royalty floors in effect governed by 37 CFR 350.4 and issued phonorecords. 17 U.S.C. 115. For for certain streaming configurations. their ruling on the motions by separate purposes of section 115, phonorecords In the Initial Determination issued on Order dated October 29, 2018. The include physical and digital sound January 27, 2018, the Judges Judges incorporate the reasoning and recordings embodying the protected promulgated regulatory terms that made rulings in that Order and to the extent musical works, digital sound recordings changes in style and substance of the necessary for clarity, include portions of that may be downloaded or streamed on regulatory terms governing that Order in this Final Determination. demand by a listener, and downloaded administration of the section 115 The final text of the amended telephone ringtones. Entities offering regulations is set out below this licenses. In February 2018, the Judges bundled services and digital SUPPLEMENTARY INFORMATION section. received a motion from Copyright music lockers are also permitted to do Owners (Owners’ Motion) and a joint I. Background so under the section 115 compulsory motion from four Services (Services’ license. Motion) seeking clarification of A. Statute and Regulations regulatory terms promulgated with the The Copyright Act (Act) establishes a The section 115 compulsory license Initial Determination.2 The Judges compulsory license for use of musical created in 1909, reflected Congress’s attempt to balance the exclusive rights 1 This rate determination is not unanimous. Judge 2 National Music Publishers’ Association and of owners of copyrighted musical works Strickler prepared, to a disproportionately large Nashville Songwriters Association International with the public’s interest in access to degree, the initial drafts of this Determination. together filed the Copyright Owners’ Motion for the protected works. However, Congress Notwithstanding the Judges’ concurrence on most Clarification or Correction . . . (Owners’ Motion). of the factual recitation and economic analysis, they Amazon Digital Services, LLC; Google Inc.; Pandora made that right subject to a compulsory were unable to reach consensus on their Media, Inc. and USA Inc. filed a Joint license because of concern about conclusions. Judge Strickler’s dissenting opinion is Motion for Rehearing to Clarify the Regulations monopolistic control of the piano roll appended to and is a part of this rate determination. (Services’ Motion). The Judges did not treat the Note that all redactions in this publication were motions as motions for rehearing under 17 U.S.C. market (and another burgeoning made by the Copyright Royalty Judges and not by 803(c)(2), as neither requested a literal rehearing of invention, phonorecords). 17 U.S.C. 1 the Federal Register. evidence or legal argument.

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(1909); see also H.R. Rep. No. 60–2222, when the consumer purchases a a 10-year period. At the beginning of at 9 (1909). This license is often referred permanent digital copy (download) of January 2006, the mechanical rate was to as the ‘‘phonorecords’’ license, but is the phonorecord (PDD), and (3) the larger of 9.1¢ per track or 1.75¢ per also identified, synonymously, as the inclusion of a musical work in a minute of playing time or fraction ‘‘mechanical’’ license. purchased telephone ringtone. Subpart thereof. See 37 CFR 255.3(i)–(m); see Congress revised the mechanical B regulations include licenses for (1) also 63 FR 7288 (Feb. 13, 1998). license in its 1976 general revision of interactive streaming and limited In 2006, with expiration of the the copyright laws. The 1976 revision downloads. The regulations in subpart C previous settlement term nearing, the also created a new entity, the Copyright relate to limited offerings, mixed Judges commenced a proceeding to Royalty Tribunal (CRT), to conduct bundles, music bundles, paid locker adjust the mechanical rates under periodic proceedings to adjust the services, and purchased content locker section 115. On January 26, 2009, they royalty rate for the license.3 services. The current regulations issued a Determination, effective March In 1995, Congress passed the Digital resulted from a negotiated settlement of 1, 2009. In that Determination, the Performance Right in Sound Recordings the previous mechanical license Judges noted that the parties had settled Act (DPRA),4 extending the mechanical proceeding. their dispute regarding rates and terms for conditional downloads, interactive license to ‘‘digital phonorecord B. Prior Proceedings deliveries’’ (DPDs), which Congress streaming, and incidental digital defined as each individual delivery of a Until 1976, Congress legislated phonorecord deliveries (i.e., rates in the phonorecord by digital transmission of royalty rates for the mechanical new subpart B) (2008 Settlement). See a sound recording which results in a reproduction of musical works and Mechanical and Digital Phonorecord specifically identifiable reproduction by notes. In 1980, the CRT conducted the Delivery Rate Determination, 74 FR or for any transmission recipient of a first contested proceeding to set rates for 4510, 4514 (Jan. 26, 2009) phonorecord of that sound recording, the section 115 compulsory license. The (Phonorecords I). The parties who regardless of whether the digital CRT increased the then-existing rate by negotiated the 2008 Settlement included transmission is also a public more than 45%, from the statutory 2.75¢ the National Music Publishers performance of the sound recording or rate per phonorecord to 4¢ per Association (NMPA) and the Digital 6 any nondramatic musical work phonorecord. 45 FR 63 (Jan. 2, 1980). Music Association (DiMA), the trade embodied therein. 17 U.S.C. 115(d). By 1986, the CRT had increased the association representing its member Accordingly, the section 115 mechanical rate to the greater of 5¢ per streaming services. Written Direct mechanical license now covers DPDs, in musical work or .95¢ per minute of Testimony of Rishi Mirchandani, Trial addition to physical copies. playing time or fraction thereof. 46 FR Ex. 1, at ¶ 59 (Mirchandani WDT). By statute, the Judges commence a 66267 (Dec. 23, 1981); see 37 CFR The 2008 Settlement rates that the proceeding to determine royalty rates 255.3(a)–(c). The next adjustment of the Judges adopted maintained the existing and terms for the section 115 license section 115 rates was scheduled to begin rate and rate structure at the greater of every fifth year. See 17 U.S.C. in 1987. However, the parties entered 9.1¢ per song or 1.75¢ per minute of 803(b)(1)(A)(i)(V). The Act favors into a settlement setting the rate at 5.25¢ playing time (or fraction thereof) for negotiated settlements among interested per track beginning on January 1, 1988, physical phonorecords and permanent parties, but in absence of a settlement, and the CRT established a schedule of digital downloads (PDD). The Judges the Judges must determine ‘‘reasonable rate increases generally based on also adopted a license rate of 24¢ per rates and terms of royalty positive limited percentage changes in ringtone, a newly regulated product. 74 payments. . . .’’ The Judges must the Consumer Price Index every two FR at 4515. Physical sales, PDDs, and years over the following 10 years. See 52 further set rates that comport with the ringtones were included in subpart A of FR 22637 (June 15, 1987). The rate itemized statutory policy considerations the regulations. increased until 1996, when the rate was described in section 801(b)(1) of the Act. In 2011, the Judges commenced a set at 6.95¢ per track or 1.3¢ per minute Rates and terms for the mechanical proceeding to again determine section of playing time or fraction thereof. See license are codified in chapter III, part 115 royalty rates and terms. See 76 FR 37 CFR 255.3(d)–(h). 590 (Jan. 5, 2011). The participants in 385, title 37, Code of Federal The rates set by the 1987 settlement Regulations. that proceeding negotiated a settlement were to expire on December 31, 1997. (2012 Settlement) that carried forward As currently configured, the The Librarian of Congress announced a the existing rates and added a new applicable regulations are divided into negotiation period for copyright owners 5 subpart C to the regulations to cover three subparts. Subpart A regulations and users of the section 115 license in several newly regulated service offering govern licenses for reproductions of late 1996. The parties reached a categories, viz., limited offerings, mixed musical works (1) in physical form settlement regarding rates for another service bundles, music bundles, paid (vinyl albums, compact discs, and other ten-year period to end in 2008.7 Under locker services, and purchased content physical recordings), (2) in digital form the settlement, ultimately adopted by locker services.8 The Judges adopted the the Librarian, the parties agreed to a rate 3 participants’ settlement in 2013. See In 1993, Congress abolished the CRT and for physical phonorecords of 7.1¢ per replaced it with copyright arbitration royalty panels Adjustment of Determination of track and established a schedule for (CARPs). Copyright Royalty Tribunal Reform Act of Compulsory License Rates for 1993, Public Law 103–198, 107 Stat. 2304. In 2004, fixed rate increases every two years for Congress abolished the CARP system and replaced Mechanical and Digital Phonorecords, it with the Copyright Royalty Judges. Copyright 6 The United States Court of Appeals for the 78 FR 67938 (Nov. 13, 2013) Royalty and Distribution Reform Act of 2004, Public District of Columbia Circuit affirmed the CRT. (Phonorecords II). Law 108–419, 118 Stat. 2341. Recording Industry Ass’n. of America v. Copyright The present section 115 proceeding is 4 Public Law 104–39, 109 Stat. 336. Royalty Tribunal, 662 F.2d 1 (D.C. Cir. 1981) (1981 the third since the establishment of the 5 For clarity, references to the regulations Phonorecords Appeal) (remanded on other applicable to the sec. 115 license are to the grounds). Copyright Royalty Board (CRB) program regulations as configured before conclusion of the 7 The Librarian initiated the 1996 proceeding present proceeding. The Judges discuss appropriate during the CARP period, when controversies 8 Once again, the parties to the negotiations regulatory changes in section VII of this regarding royalty rates and terms were referred to included the NMPA and DiMA. Mirchandani WDT determination. privately retained arbitrators. at ¶ 59.

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under the Copyright Royalty and rates and terms.’’ See 17 U.S.C. phonorecord performance right. The Distribution Reform Act of 2004.9 In the 801(b)(7)(A)(iii). As a part of the second Judges have no role in setting the Phonorecords II settlement, the parties settlement, SME withdrew from this performance right license rates. Further, agreed that any future rate proceeding. The Judges published the performance right licensees pay the determination presented to the Judges agreed subpart A regulations as a Final performance royalties to music for subparts B and C service offering Rule on March 28, 2017.14 publishers and songwriters. Services configurations would be a de novo rate During the course of the present pay mechanical royalties primarily to determination. See 37 CFR 385.17, proceeding, the Judges dismissed some music publishers. 385.26 (2016). participants and other participants withdrew. Remaining participants at the II. Context of This Proceeding C. Statement of the Case time of the hearing were NMPA and A. Changes in Music Consumption In response to the Judges’ notice NSAI, representing and Patterns and Revenue Allocation commencing the present proceeding, 21 publisher copyright owners (Copyright In recent years, music consumption entities filed Petitions to Participate.10 Owners) and GEO, a songwriter/ patterns have undergone profound The participants engaged in negotiations publisher/copyright owner, appearing shifts—first from purchases of physical and discovery. On June 15, 2016, some pro se. Copyright licensees appearing at albums to downloads of digital singles, of the participants 11 notified the Judges the hearing were Amazon Digital and then from downloads to on-demand of a partial settlement with regard to Services, LLC (Amazon), Apple Inc. access through digital streaming rates and terms for physical (Apple), Google, Inc. (Google), Pandora services. These shifts in music phonorecords, PDDs, and ringtones, the Media, Inc. (Pandora), and Spotify USA consumption patterns have led to service offerings covered by the extant Inc. (Spotify), (collectively, the corresponding changes in the magnitude regulations found in subpart A of part Services). and relative mix of income streams to 385. The Judges published notice of the Beginning on March 8, 2017, the copyright owners; in particular, partial settlement 12 and accepted and Judges conducted a hearing that copyright owners note an increased considered comments from interested concluded on April 13, 2017. During the reliance on performance royalties as parties.13 course of the hearing, the Judges heard compared to reproduction and On October 28, 2016, NMPA, oral testimony from 37 witnesses.15 The Nashville Songwriters Association distribution royalties. Witness Judges admitted over 1,100 exhibits, Statement of David M. Israelite, Trial International (NSAI), and Music exclusive of demonstrative or Entertainment (SME) filed a Motion to Ex. 3014, ¶ 63 (Israelite WDT). illustrative materials the participants While earlier format changes (piano Adopt Settlement Industry-Wide. The offered to explicate oral testimony. The rolls to wax cylinders to lacquer or vinyl motion asserted that SME, NMPA, and participants submitted Proposed discs to CDs) had altered the way NSAI had resolved the issue raised by Findings of Fact (PFF) and Proposed households consumed music, they did SME in its response to the original Conclusions of Law (PCL) on May 12, not fundamentally alter the distribution notice. The Judges evaluated the 2017, and Replies to those filings on of music. For all these music formats, remaining objection to the settlement May 26, 2017. Under 37 CFR copyright owners distributed music to filed by George Johnson dba GEO Music 351.4(b)(3), a participant may amend its consumers physically, either directly or Group (GEO) and found that GEO had rate proposal at any time up to and through record stores. In addition, with not established that the settlement including the time it files proposed the exception of ‘‘singles,’’ after agreement ‘‘does not provide a findings and conclusions. In this conversion to the vinyl format, reasonable basis for setting statutory proceeding, Copyright Owners and purveyors of music typically distributed Google filed amended rate proposals a bundle of songs (an album). Witness 9 Public Law 108–419, 118 Stat. 2341. contemporaneously with their 10 Initial Participants were: Amazon Digital Statement of Bart Herbison, Trial Ex. Services, LLC (Amazon); Apple, Inc. (Apple); respective PFF and PCL. The parties 3015, ¶ 20 (Herbison WDT). Broadcast Music, Inc. (BMI); American Society of delivered closing arguments on June 7, By the early 2000s, digital data Composers, Authors and Publishers (ASCAP); 2017. compression and higher-bandwidth David Powell; S.A. (Deezer); Digital Media Based on the record of this internet connections allowed relatively Association (DiMA); Gear Publishing Company (Gear); George Johnson d/b/a/GEO Music Group proceeding, the Judges have determined fast transmission of recorded music files (GEO); Google, Inc. (Google); Music Reports, Inc. that the mechanical license rate shall be over the internet, drastically altering the (MRI); Pandora Media, Inc. (Pandora); Recording an All-In rate derived from a Greater-Of distribution and consumption of music. Industry Association of America, Inc. (RIAA); rate structure. Weighing the advantages Music services 16 began to offer Rhapsody International Inc.; SoundCloud Limited; Spotify USA Inc.; ‘‘Copyright Owners’’ comprised and disadvantages highlighted by the individual tracks or songs online as of National Music Publishers Association (NMPA), participants in this proceeding, the ‘‘digital downloads.’’ In 2008, The Harry Fox Agency (HFA), Nashville Judges conclude that a rate that balances approximately 435 million albums were Songwriters Association International (NSAI), a percent-of-service revenue with a sold in the U.S. (both digital and Church Music Publishers Association (CMPA), Songwriters of North America (SONA), percent-of-TCC (total cost of content) physical). By 2015, that number fell to Group Limited; and publishers filing jointly, shall be the basis for the All-In 249 million.17 Sales of singles, by (UMG), phonorecords royalty. The mechanical Entertainment (SME), (WMG). portion of the royalty shall be the 16 Digital download sales gained popularity in 11 The settling parties were: NMPA, NSAI, HFA, greater of those figures, less the actual 2003 when Apple introduced the iTunes Music UMG, and WMG. As part of the settlement Store. The iTunes Store provided a convenient way agreement, UMG and WMG withdrew from further amount services pay for the for iTunes users to purchase a song or an entire participation in this proceeding. album, legally, with a single click of the computer 12 See 81 FR 48371 (Jul. 25, 2016). 14 See 82 FR 15297 (Mar. 28, 2017). mouse. The iTunes Store also allowed users of 13 Three parties filed comments. American 15 By stipulation of the participants, the Judges Apple’s iPod to sync songs directly to the device. Association of Independent Music (A2IM), Sony also accepted and considered written testimony Expert Report of Jui Ramaprasad, Trial Ex. 1615, at Music Entertainment (SME), and George Johnson from six additional witnesses who did not appear. 25–26 (Ramaprasad WDT). Prior to the launch of dba GEO Music Group (GEO). A2IM urged adoption Amazon designated and other participants counter- the iTunes Music Store, virtually all music was sold of the settlement and SME approved of all but one designated testimony from the Phonorecords I as albums. Eisenach WDT at 44, n.58. provision of the settlement. GEO objected to the proceeding, which was admitted as Exhibits 321 17 Some evidence in the record suggests, however, settlement. and 322. that since 2013, with the inclusion of ‘‘streaming

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contrast, have remained fairly stable B. Emergence of New Streaming products members purchase. Amazon over the same period, averaging Services Prime reportedly has approximately 23 approximately one billion per year from Many diverse enterprises have [REDACTED] subscribers. For its 2008 to 2015 (with a peak of 1.4 billion launched music streaming services to music service offering, Amazon bundles in 2012). Expert Report of Jeffrey A. meet growing consumer demand for interactive streaming at no additional Eisenach, Trial Ex. 3027, at ¶ 67 & Table streaming. Currently, there are at least cost with its Prime membership. In 4 (Eisenach WDT). 31 music streaming services available addition to the Prime Music service offering, Amazon’s U.S.-based business Changes in consumption patterns from 20 identifiable providers. Some of the well-known of these include: also includes a physical music store, a have had an impact on industry digital download store, a purchased revenues. For example, between 2004 Amazon, Apple, Google (and its recently acquired YouTube), Deezer (partnered content locker service, Amazon Music and 2015, revenues from with Cricket/AT&T), iHeartRadio, Unlimited (a full-catalog subscription physical sales declined from $15.3 , Pandora, SoundCloud, Spotify, music service), and Amazon Music billion to $2 billion, while digital and Tidal (partnered with Sprint). Unlimited for Echo (a full-catalog revenues increased from $230 million to Written Rebuttal Testimony of Jim subscription service available through a about $4.8 billion. Id. at ¶ 44. In 2004, Timmins, Trial Ex. 3036, ¶ 20 (Timmins single Wi-Fi enabled device, Amazon 24 over 98% of music industry revenue WRT). Most of the companies entering Echo). In launching Prime Music, was the result of physical sales. the on-demand streaming music market Amazon relied on the section 115 Copyright and the Music Marketplace: A have done so recently. Id. ¶ 21. In the license as it did for Amazon Music Report of the Register of Copyrights 70 last five years, new entrants to the Unlimited and Amazon Music 25 (Feb. 2015) (Register’s Report), citing market have initiated at least five Unlimited for Echo. RIAA-sourced chart.18 Digital interactive streaming services, joining Google describes its ‘‘Google Play’’ downloads made up most of the Spotify which launched in the United offerings as its ‘‘one-stop-shop’’ for the purchase of Android applications. The remaining revenue. Id. By 2013, States in 2011. See id. ¶ 22. Google Play Store allows users to revenues from physical sales fell to 35% The largest players in the interactive browse, purchase, and download 19 streaming market by song catalog are of industry total revenues. Digital content, including music. Google Play downloads, which made up 1.5% of Apple Music, Google Play, and Spotify, each of which each has a catalog that Music is Google Play’s entire suite of industry revenues in 2004, had climbed music service offerings. Google Play to 40% of industry revenues. exceeds [REDACTED] million songs. Tidal, which provides an outlet for Music, launched in 2011, is bundled Changes in music consumption 21 with the YouTube Red video service unsigned artists, has a catalog of over 26 patterns have coincided with an 40 million songs. See Written Direct subscription. It includes several increase in the use of musical works. Testimony of Michael L. Katz, Trial Ex. functionalities: (1) A Music Store; (2) a Review of relevant market factors imply, 885, ¶ 34, Table 1 (Katz WDT). By one cloud-based locker service; (3) an on- however, that the ways in which those estimate, in 2016 there were 18 million demand digital music streaming service; works are used currently do not U.S. on-demand subscribers: Spotify and (4) a section 114 compliant non- interactive digital radio service (in the compensate copyright owners as well as accounted for [REDACTED] million, U.S.).27 Levine WDT, Trial Ex. 692, ¶ 43. they did in the past. See Register’s followed by Apple Music (4 million), The evidence is conflicting regarding Report at 72–74.20 Rhapsody and Tidal (2 million each) whether the market for streaming and all others accounting for the services is faring poorly financially or equivalent’’ albums, overall album consumption remaining 4 million. See id. performing about the same as other may have increased. See Katz WDT at 42. Some of the services that offer music emerging industries. See, e.g., Timmins 18 The Judges cite the Register’s Report as a source streaming are pure-play music WRT, Trial Ex. 3036, ¶¶ 16–17; Levine of industry background, developed by the Register providers, such as Spotify and WDT ¶ 16 (‘‘streaming music services of Copyrights following public hearings held Pandora.22 Others, such as Amazon, nationwide in 2013 and 2014. The Judges do not generally remain unprofitable Apple Music, and , base their conclusions in this Determination on any businesses’’ with content acquisition are part of wider economic background information from the Register’s Report costs being ‘‘the biggest barrier to that the parties did not also present as evidence in ‘‘ecosystems,’’ in which a music service profitability.’’) For example, Spotify, this proceeding. is one part of a multi-product, multi- 19 one of the largest pure-play streaming Industry total revenues in this analysis include service aggregation of activities, services, has reportedly [REDACTED]. digital downloads (40%), physical sales (35%), including some that are also related to subscription and streaming (21%), and ringtones Katz WDS at ¶ 65. Some estimates place and ringbacks (1%). Copyright and the Music the provision of a retail distribution channel for music. For example, Marketplace at 70, citing RIAA-sourced chart. 23 Amazon Prime is a $99-per-year service that 20 Musical works copyright owners complain that Amazon is a multi-faceted internet retail offers Amazon customers access to a bundle of streaming services are at least partially responsible business. Amazon offers a buyers’ services including free two-day shipping, video for the paucity of revenues that the musical works program for an annual fee (Amazon streaming, photo storage and e-books, in addition to generate for writers and publishers. They blame Prime) that affords loyalty benefits to Prime Music. Expert Report of Glenn Hubbard, Trial streaming services’ business practices that favor Ex. 22, at 15 (Hubbard WDT). growth in user base and market share over members, such as free or reduced rate 24 Mirchandani WDT at 5. maximizing profitability. Digital services counter shipping or faster delivery on the 25 3/15/17 Tr. 1315–16 (Mirchandani). that they pay a substantial portion of the revenues 26 Google’s experience with music licensing dates they receive to license copyrighted works and 21 An ‘‘unsigned artist’’ is one recording music at least far back as 2006, when it acquired YouTube. compete with terrestrial radio, which is exempt but not under contract to a recording company. Written Direct Testimony of Zahavah Levine, Trial from paying performance royalties. Digital services 22 Until late 2016, Pandora operated as a Ex. 692, at 3 (Levine WDT). Google’s music services and broadcasters also argue that the lack of royalty noninteractive streaming service that, did not incur were part of Google’s Android Division but were compensation that makes its way to content creators a compulsory license fee for mechanical royalties. recently combined within the YouTube business is due in large part to the content creators’ Pandora recently began offering more interactive unit. Id. at 3–4. agreements with intermediaries, which, they argue, features, including a full on-demand tier. Pandora 27 Section 114 of the Act includes requirements keep a large portion of royalties earned by content WDS Introductory Memo at 1–2; Written Direct for the compulsory license to perform digitally creators for their own account or to recoup Testimony of Christopher Phillips, Trial Ex. 877, at sound recordings over noninteractive internet advances. Id. at 76–77. 8 (Phillips WDT). music streaming services.

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Spotify’s market value at more than $8 performances. Id. Recording artists can Each of these offering characteristics billion, suggesting perhaps, investors’ also derive income from live can be combined independently with expectations regarding future profits. performances, sale of merchandise, and almost every other characteristic, Written Rebuttal Testimony of Marc other sources. Id. at 69–70. resulting in a very complex web of rate Rysman, Trial Ex. 3032, ¶ 11, n.3 The shift in consumption from calculations. In the 2012 Settlement, the (Rysman WRT).28 Spotify forecasts physical sales to streaming coincided parties structured rate calculations for being profitable in [REDACTED]. Id. at with a reallocation of publisher revenue both subpart B and subpart C into three ¶ 65 n.80. sources. In 2012, 30% of U.S. music arithmetic segments. publisher revenues came from In the first step of the calculation, the C. Effects of Streaming on Publishers’ performance royalties and 36% from parties determine the All-In royalty and Songwriters’ Earnings mechanical royalties, with the rest pool; that is, the royalty that would be Although many songwriters perform coming from synch royalties and other payable based on a formula balancing their own musical works, it is also sources. See Register’s Report at 70. By the greater of a percent-of-service common for songwriters to compose 2014, 52% of music publisher revenues revenue and a percentage of one of two songs to be performed by others. came from performance royalties 31 other expense measures. One expense Songwriters typically enter into while 23% came from musical works measure if a percent-of-royalties contractual arrangements with music mechanical royalties, with the services pay to record companies for publishers, which promote and license remainder coming from synchronization sound recording performance rights, the songwriters’ works and collect royalties and other sources. Id at 71, differing depending upon whether the royalties on their behalf. Music n.344, citing NMPA press release. By sound recording licenses are pass- publishers and songwriters negotiate a one estimate, mechanical license through or not pass-through. For certain split of the royalty payments. In some revenues from interactive streaming subscription services, the percent-of cases, songwriters are commissioned to services accounted for only service revenue is balanced against the write a song and are compensated with [REDACTED] percent of total music lesser of two or three other potential a flat fee for the work in exchange for publishing revenues in 2015. Katz WDT mathematical outcomes.33 giving up ownership rights to the song ¶ 42.32 The second calculation reduces the and any royalties it might earn. Evidence in the present record All-In royalty pool to the ‘‘payable’’ The four largest publishers—Sony/ indicates that total publishing revenue royalty pool in a two-step process. First ATV, Warner/Chappell, Universal declined by [REDACTED] percent the parties subtract royalties the services Music Publishing Group, and Kobalt between 2013 and 2014, but increased pay for musical works performance Music Publishing—collectively by [REDACTED] percent between 2014 rights from the All-In royalty accounted for just over 73 percent of the and 2015. See Katz WDT ¶ 58. Large established in the first calculation. This top 100 radio songs tracked by publishers, such as Sony/ATV, UMPG, remainder is considered the payable Billboard 29 as of the second quarter in and Warner Chappell, were royalty pool for certain service offerings; 2016. In addition, there are several other [REDACTED] in 2015, earning a viz., non-subscription, ad-supported, significant publishers, including BMG combined $[REDACTED] million from purchased content lockers, mixed and Songs Music Publishing, and many U.S. publishing operations for that year. service bundles, and music bundles. For thousands of smaller music publishers Id. ¶ 59. subscription service offerings, whether and self-publishing songwriters. See III. The Present Rate Structure and standalone or bundled, and depending Katz WDT ¶ 46. Rates upon whether the offering is portable or Songwriters have three primary non-portable, streaming only or mixed sources of ongoing royalty income, Subpart B of the current regulations use, determining the payable royalty which they generally share with music contains mechanical royalty rates pool requires a balancing of the publishers: Mechanical royalties, payable for the delivery and offering of mechanical remainder against a set rate interactive streams and/or limited synchronization (‘‘synch’’) royalties for for ‘‘qualified’’ subscribers per month to downloads. There are three product use of their works in conjunction with determine the greater-of result. The set distinctions within the subpart B rate video or film, and performance rate for qualified subscribers differs for royalties.30 See Katz WDT ¶ 41; structure: • each variation of subscription offering. Copyright and the Music Marketplace at Portable vs. Nonportable Services The final step in the rate 69. Songwriters who are also recording • Bundled vs. Unbundled Services • determination for each service offering artists receive a share of revenues from Subscription vs. Ad-Supported is an allocation among licensors based Services their record labels for the fixing of the upon the number of plays from each 37 CFR 385.13. The regulations also musical work in a sound recording. licensor’s catalog.34 separate certain promotional uses for Sound recording royalties include those The Services, the licensor participants separate treatment, setting the rate for from the sale of physical and digital in the present proceeding, refer to this those promotional uses at zero. albums and singles, sound recording convoluted process as the establishment synchronization, and digital of royalty rates with ‘‘minima.’’ 31 Performance royalties are administered primarily by Performing Rights Organizations acting According to the Services, these minima 28 In 2016, Spotify had over [REDACTED] million as collectives and clearinghouses for songwriters are designed to protect copyright monthly active users, [REDACTED]% of which and publishers as licensors, and broadcasters and owners from the potential downside of were in the U.S. [REDACTED] million of those U.S. streaming services as licensees. Services’ business models that might users were also Premium subscribers. Written 32 It is noteworthy that the shift from mechanical Direct Testimony of Barry McCarthy, Trial Ex. 1060, royalties to performance royalties coincides with ¶ 2 (McCarthy WDT). the shift from sales of physical phonorecords (e.g., 33 The lesser-of prongs include a per-subscriber 29 This Billboard measure tracks songs played on CDs) and downloads, for which no performance per month prong and percent-of-service payments AM–FM terrestrial radio broadcasters, which are royalty is required, to the use of interactive for sound recording royalties, differing depending not required to license the works or the sound streaming, which pays both a mechanical royalty upon whether the sound recording licenses are recordings they play. (when a DPD results) and a performance royalty, pass-through or not pass-through. 30 Another revenue source is folio licenses, lyrics, and to the use of noninteractive streaming, which 34 Calculation of royalties for paid locker services and musical notations in written form. See Katz historically pays only a performance royalty but no varies slightly from this formula, but the complexity WDT ¶ 31. mechanical royalty. is similar.

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minimize service revenue and thus included in the regulations to the per of a copyrighted musical work lasting 30 manipulate the percent-of-service subscriber minimum and subscriber- seconds or more. Apple Inc. Proposed revenue rate standard. The Services, based royalty floor that would otherwise Rates and Terms (as amended) at 3–4 whose current royalty payments are apply under the current regulations; (3) (Apple Amended Proposal). Apple determined under the minima prongs of a discount for annual subscriptions proposed defining a use as any play of the formulae, point to the minima as a equal to 16.67% of the minimum royalty a sound recording of a copyrighted work reason to keep the percent-of-service rate (or rates) and subscriber-based lasting 30 seconds or more. revenue ‘‘headline’’ rate low, reasoning royalty floor (or floors) that would Additionally, Apple proposed an that the headline rate is not, or is rarely, otherwise apply under § 385.13; and (4) exemption for a ‘‘fraudulent stream,’’ binding in any event. 15% discount to the minimum royalty which it defined as ‘‘a stream that a Notwithstanding the parties’ prior rate (or rates) and subscriber-based service reasonably and in good-faith agreement to the apparent complexity, royalty floor (or floors) to reflect a determines to be fraudulent.’’ Id. at 2. the alternative calculation methods, or service’s actual ‘‘app store’’ and carrier For paid locker services, Apple the variations in the descriptions of the billing costs, not to exceed 15% for proposes a $0.17 per subscriber fee, also service offerings, evidence presented in each. Amazon Proposal at 1–2. as a component of an All-In musical this proceeding does not support b. Pandora works royalty rate that would include continuing the fractionalization of the the ‘‘subpart C’’ royalty. Id. at 7–8. For rate determination for the service Pandora’s amended proposed rates purchased content locker services, offerings at issue. At the conclusion of and terms (Pandora Amended Apple proposed a zero royalty fee. Id. at the tortured rate calculations required Proposal),35 seek the following changes 7. by the present regulations, the evidence from the current regulations: (1) suggests that differences in the rates Elimination of the ‘‘Mechanical Floor;’’ 3. Google Services pay are not great enough to (2) elimination of the alternative In its amended proposed rates and justify the complexity of the formulae. computation of sub-minima I and II now terms (Google Amended Proposal),37 Some of the rate determination prongs in § 385.13 and in § 385.23 (for subparts Google parts company with the other are rarely if ever triggered. Despite the B and C, respectively) ‘‘in cases in Services and proposes that the rate myriad configurations of rate which the record company is the section structure ‘‘eliminat[e] . . . different calculations, some of the service 115 licensee;’’ (3) A broadening of the service categories’’ in both subparts B offerings are incapable of categorization present ‘‘not to exceed 15%’’ reduction and C and replace them with ‘‘a single, under the extant rate structure. Apple of ‘‘Service Revenues’’ in § 385.11 to greater-of rate structure between 10.5% and Google entered the digital music reflect, in toto, an exclusion of costs of net service revenue and an uncapped delivery marketplace by negotiating attributable to ‘‘obtaining’’ revenue, 15-percent TCC component.’’ Google direct licenses covering several ‘‘including [but not expressly limited to] Amended Proposal at 1.38 That 15% compulsory licenses, avoiding the credit card commissions, app store TCC rate is reduced to 13% for pass- regulatory scheme entirely. commissions, and similar payment through licenses (i.e., where a record 36 IV. Analysis of Rate Structure process charges;’’ and (4) a discount company is the licensee under section Proposals on minimum royalties for student plans 115, and the record company has ‘‘not to exceed 50%’’ off minimum granted streaming rights to a service). Id. A. Parties’ Proposals royalty rates set forth in § 385.13. Id. at at 33–34. Google’s proposed rate does 1. The Services (Excluding Apple and 1, 7. not include a ‘‘Mechanical Floor.’’ Google) c. Spotify Similar to one of Amazon’s proposals, Google also seeks a discount in rates for The Services propose rates and rate In its amended proposed rates and ‘‘carrier billing costs’’ and ‘‘app store structures that, while varying in their terms, Spotify proposed the following commissions,’’ plus ‘‘credit card particulars, share a number of common changes from the current regulations: (1) commissions’’ and ‘‘similar payment elements. Broadly, the Services propose Removal of the ‘‘Mechanical Floor’’ for process charges,’’ all not to exceed 15%. a rate structure that, in the main, all licensed activity; and (2) a Id. at 6 (for subpart B); 26 (for subpart continues the current rate structure. broadening of the present ‘‘not to exceed C).39 In addition, Google’s proposal More particularly, the Services’ 15%’’ reduction of ‘‘Service Revenues’’ includes a zero rate for certain free trial proposals share core elements: (1) An in § 385.11 to reflect, in toto, an periods. Id. at 35–37. ‘‘All-In’’ rate for mechanical and exclusion of the actual costs attributable performance rights; (2) based upon a to ‘‘obtaining’’ revenue, ‘‘including [but 37 The Google Amended Proposal amended its 10.5 percent-of-service revenue headline not expressly limited to] credit card original proposal filed on November 1, 2016. Google rate with minima; (3) without a commissions, app store commissions originally proposed a subpart B rate structure that ‘‘Mechanical Floor.’’ similar payment process charges, and generally followed the existing structure. Google actual carrier billing cost.’’ See Second Written Direct Statement, Introductory a. Amazon Memorandum at 3 (Nov. 1, 2016). Amended Proposed Rates and Terms of In its Proposed Rates and Terms 38 ‘‘TCC’’ is an industry acronym for ‘‘Total Spotify USA Inc., passim. Content Cost’’, a shorthand reference to the extant (Amazon Proposal), Amazon proposes regulatory language describing generally the that the rate structure as currently in the 2. Apple amount paid by a service to a record company for applicable regulations rollover into the Apple proposed that the Services pay the section 114 right to perform digitally a sound 2018–22 rate period, except: (1) The per recording. Google’s proposed regulatory terms $0.00091 for each nonfraudulent stream retain some of the distinctions in service offerings subscriber minimum and/or subscriber- for purposes of computing per-work royalty based royalty floors for a ‘‘family 35 The Pandora Amended Proposal superseded its allocations. See, e.g., id. at 29–31. This does not account’’ should equal 150% of the per original proposal filed on November 1, 2016, by affect the total royalty charged to the service. subscriber minimum and/or subscriber- adding definitions (for ‘‘fraudulent streams’’ and 39 Google describes this proposed change as a ‘‘play’’) that do not directly relate to the royalty change in the definition of ‘‘Service Revenue,’’ based royalty floor for an individual rates. See Pandora PFF/PCL, Appx. C. unlike Amazon, which described its proposed 15% account; (2) a student subscription 36 Pandora does not expressly describe this discount as a change in rates. The difference is account discount of 50% should be change as a change in rates per se. mathematically irrelevant.

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4. Copyright Owners (Excluding GEO) B and C streaming services’’ would be 80% of PDS revenues for the same two The Copyright Owners proposed that required to include a ‘‘buy button’’ that licenses. Johnson Second AWDS at 4–5. the Judges adopt a unitary rate structure ‘‘allows customers to voluntarily buy or In his written direct statement Mr. for all interactive streaming and limited purchase a work as a permanent paid Johnson does not propose any downloads that are currently covered by digital download.’’ § 385 Regulation benchmark or other evidence that would subparts B and C.40 Copyright Owners’ Redline and Changes of George D. justify a ‘‘buy button’’ requirement with Amended Proposed Rates and Terms, at Johnson (GEO) at 4 (Feb. 20, 2017) a rate of 80% or 84% of PDS revenues. 3 (May 11, 2017) (CO Amended (Johnson Redline and Changes). Mr. He does assert, however, that it is the Proposal). The Copyright Owners Johnson proposes that the cost to the ‘‘only reasonable proposal that captures structured the proposal as the greater-of consumer for these permanent paid the true value of a music copyright a usage charge and a per-user charge. digital song sales would be, for 2018: today and historically.’’ Johnson Second Specifically, under the Copyright $1.00; 2019: $1.50; 2020: $2.00; 2021: AWDS at 5. Ultimately, Mr. Johnson Owners’ proposal, each month the $2.50; 2022: $3.00. Id. concedes that the Judges previously rejected his proposal to combine the licensee would pay the greater of (a) a Mr. Johnson also proposes that per-play fee ($0.0015) multiplied by the section 112/114 and 115 rates in Web IV proceeds from sales of permanent and that the proposal continues to be number of interactive streams or limited downloads purchased through the downloads during the month and (b) a impracticable. 3/9/17 Tr. 433: 2–3, 11– 41 proposed ‘‘buy button’’ be allocated to 12 (Johnson) (‘‘that didn’t happen in per-end user fee ($1.06) multiplied by the following groups of interested the number of end users during the Web IV and . . . it won’t happen here parties under one of two alternatives (A . . . it’s so segmented, all the different month. Id. at 8. The license fee would or B): Artist ($.19 or $.18 per dollar paid be for mechanical rights only, and licenses, it’s probably impossible.’’). by the consumer), ‘‘record’’ (presumably While the Judges appreciate Mr. would not be offset by any performance the label or record company) ($.21 or Johnson’s participation in the royalties that the licensee paid for the $.20), ‘‘AFM’’ (presumably American proceeding, they must view his proposal same activity. Id. Federation of Musicians) ($.01), through the prism of the Copyright Act. 5. GEO Music Group ‘‘AFTRA’’ (presumably American Nothing in section 115 would authorize The Judges accepted written and oral Federation of Television and Radio the Judges to require all Services testimony from Mr. George Johnson dba Artists) ($.01), Songwriter ($.21 or $.20), availing themselves of the section 115 GEO Music Group. Mr. Johnson Publishers ($.21 or $.20), and Services license to include a mandatory ‘‘buy appeared pro se. Mr. Johnson is a self- ($.16 or $.20). Id. Mr. Johnson refers to button’’ as part of any service offering. employed songwriter, music publisher, the alternative allocations as royalties Services may install a ‘‘buy button’’ if and performer, who formerly operated but they appear instead to be shares of they wish, but the Judges cannot his own recording company.42 The sales proceeds that he would allocate to mandate that service business other participants in the proceeding what he believes are all of the interested innovation as Mr. Johnson proposes. agreed to preserve objections to Mr. parties. He does not explain why or Likewise, the Judges have no Johnson’s testimony to avoid when alternative A should be applied as authority to set the price that Services interruptions and to submit any opposed to alternative B. charge consumers for purchasing a objections in writing after his testimony. download whether from a PDD service The allocations he proposes would offering or through Mr. Johnson’s The crux of Mr. Johnson’s case is that include royalties for the section 112/114 ‘‘songs and copyrights have real proposed buy button. Even if the Judges licenses and the section 115 license, had the authority to impose a ‘‘buy intrinsic value in dollars’’ and that divided equally between the section 115 current royalty rates do not fairly button’’ requirement on the Services, it and section 114 copyright owners. is unclear what purpose that button account for that value. Second Johnson Redline and Changes at 4. Amended Written Direct Statement of would serve other than to alert However, under his proposal the George D. Johnson (GEO) for Proposed consumers to the possibility of buying a copyright users (the Services) would Subpart C or New Subpart D Rates and song they happen to stream. The Judges still pay a mechanical royalty for Terms at 3 (Johnson Second AWDS). believe consumers of music are already streaming performances of ‘‘$.0015, Mr. Johnson proposes what he refers to aware that if they want to buy a song as a ‘‘Buy Button’’ or ‘‘Paid Permanent etc.’’ Johnson Second AWDS at 4. It is they can do so. Perhaps Mr. Johnson unclear what year the $.0015 rate would believes with a buy button, consumers Digital Song Sale’’ (PDS) under a newly 43 created subpart C or subpart D of the apply to and what the ‘‘etc.’’ means. might be more willing to click on the applicable regulations. Id. at 2. Mr. In short, Mr. Johnson proposes two button and buy the song than if the Johnson contends that the PDS would alternatives for allocating revenues from button were not visible and readily ‘‘eliminate the unpaid limited download sales that might occur if a customer available. Mr. Johnson provides no in 37 CFR 385, Subparts B and C.’’ Id. were to buy a song directly from a evidence to support that premise. As for at 3. Under Mr. Johnson’s proposal all Service. Under Alternative A, the the 80% or 84% combined royalty that ‘‘interactive and non-interactive Subpart Services would effectively pay in the Mr. Johnson proposes for the section aggregate 84% of the PDS revenues to 112/114 and 115 licenses, he provides 40 The Copyright Owners’ rate proposal would all copyright owners for licenses under no evidence upon which the Judges apply the subpart A rates to so-called ‘‘music both the section 114 (which includes might base such a royalty other than his bundles’’ (‘‘offerings of two or more subpart A section 112 royalties) and 115. Under belief that it is the ‘‘only reasonable products to end users as part of one transaction’’) which are currently covered by subpart C. Id. at 3 Alternative B, the Services would pay proposal that captures the true value of nn. 2 & 4. a music copyright today and 41 The proposal would consider each paying 43 In his oral testimony, Mr. Johnson appears to historically.’’ See Johnson Second subscriber to a service, or each active user, to be an concede that if a customer purchased a song and AWDS at 5. Mr. Johnson’s opinion alone ‘‘end user.’’ Id. at 8–9. paid whatever price he proposes that an additional is insufficient evidence upon which to 42 At the time of hearing in the present streaming rate might not be necessary. 3/9/17 Tr. proceeding, Mr. Johnson had stepped back from his 432: 14–17 (Johnson) (‘‘my proposal is that if you support his ‘‘buy button’’ proposal. music business and was employed in real estate. paid up front . . . you might not need those Given the lack of sufficient substantial See 3/9/17 Tr. 418–19 (Johnson). Subpart B [streaming] rates.’’). and persuasive evidence to support the

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GEO proposal, the Judges will not when calculating royalty payments. See these arguments is that an inflexible further analyze it.44 The Judges Brodsky WDT ¶ 76; Ghose WDT ¶¶ 80, ‘‘one size fits all’’ rate structure would respectfully decline to adopt Mr. 81, 82; Ramaprasad ¶¶ 4, 38, 42–44; be ‘‘bad for services, consumers, and the Johnson’s proposed approach to rate Rysman WDT ¶ 57; Tr. 2865 (Ghose); Tr. copyright owners alike.’’ See Services’ setting. 824 (Joyce); Tr. 247778 (Dorn). Joint Proposed Findings of Fact (SJPFF) Beyond the issue of complexity, at 89. B. Arguments Concerning Elements of Copyright Owners and Apple argue that the Proposed Rate Structures First, the Services argued that an interactive streaming services do not upstream per-play rate would not align 1. Per-Unit Rate need the present upstream rate structure with the downstream demand for ‘‘all- Copyright Owners and Apple in order to adopt any particular you-can-eat’’ streaming services. As emphasize that a per-play royalty rate downstream business model. Rather, Professor Marx testified, a per stream fee structure, as compared with a percent- Copyright Owners and Apple assert that introduces a number of distortions and of-revenue structure, provides a per-play structure would establish a inefficiencies, encouraging a capping of transparency and simplicity in reporting level of equality in the royalty rates downstream plays and reduces to songwriters and publishers, because across the Services, without regard to incentives for services to meet the it requires only one metric besides the business models. Songwriters and demand of consumers ‘‘who are going to rate itself, i.e., the number of plays, publishers would be paid on the same stream a lot of music.’’ Written Direct making it much easier to calculate, transparent, fixed amount without Testimony of Leslie Marx, Trial Ex. report, and understand. See, e.g., Expert advantaging any one business model 1065, ¶¶ 130–131 (Marx WDT). In this Report of Marc Rysman, Trial Ex. 3026, over another. 3/23/17 Tr. 2849, 2863 vein, Pandora’s then-president, Michael ¶ 56 (Rysman WDT); Wheeler WDT, (Ghose). Thus, Copyright Owners and Herring, noted that a per-play Trial Ex. 1613, ¶ 19; Expert Report of Apple maintain that a royalty based on consumption-based model where the Anindya Ghose, Trial Ex. 1617, ¶¶ 83– the number of plays aligns the revenue is fixed creates uncertainty and 84 (Ghose WDT); Expert Report of Jui compensation paid to the creators of the volatility, which discourage investment Ramaprasad, Trial Ex. 1615, ¶ 41 content with actual demand for and and hamper profitability. 3/14/17 Tr. (Ramaprasad WDT); Witness Statement consumption of their content. Ghose 894–95 (Herring). Mr. Herring noted that of Peter Brodsky, Trial Ex. 3016, ¶ 76 WDT ¶ 84; Rysman WDT ¶¶ 9, 58; this is a general economic problem that (Brodsky WDT); 3/22/17 Tr. 2476–78 Testimony of David Dorn, Trial Ex. occurs when a retail subscription (Dorn); 3/23/17 Tr. 2855–56 (Ghose). 1611, ¶ 33 (Dorn WDT). business has fixed subscription Copyright Owners further argue that Relatedly, Copyright Owners argue that revenues per customer, but variable the present rate structure’s failure to a transparent metric tied to actual usage (and unpredictable) costs derived from measure royalties based on per-play is superior because, under the consumption is counterintuitive, variable (and unpredictable) alternative percent-of-revenue approach, because it permits a decreasing effective downstream usage. Written Rebuttal services might manipulate revenue per-play rate even as the quantity of Testimony of Michael Herring, Trial Ex. through bundling, discounting, and songs listeners consume via interactive 888, at ¶ 17 (Herring WRT); 3/14/17 Tr. accounting techniques, or might defer streaming is increasing. Israelite WDT 894–98 (Herring); see Mirchandani WDT service revenues and emphasize ¶ 39. Copyright Owners note, for ¶ 39 (one-size-fits-all rate is not increasing market share rather than example, that listening to [REDACTED] ‘‘offering agnostic’’ as Copyright Owners profits. See Rysman WDT ¶¶ 43–45. claim, but rather is ‘‘offering Copyright Owners and Apple contrast increased from [REDACTED] streams in July 2014 to [REDACTED] streams in determinative.’’). their proposed per play approaches with Second, the Services argued that there the current rate structure, which they December 2016, a [REDACTED] increase in the number of streams. Rebuttal is no ‘‘revealed preference’’ in the characterize as cumbersome and marketplace for a per-play royalty rate convoluted. They emphasize that under Report of Glenn Hubbard, Trial Exs. 132–33, Ex. 1 and ¶ 2.22 (Hubbard structure for licensing musical works or the current rate structure, the Services sound recordings rights, as opposed to must perform a series of different greater WRT); 4/13/17 Tr. 5971–72 (Hubbard). However, contemporaneously a percent-of-revenue (with minima) of and lesser of calculations, depending [REDACTED]’s mechanical royalty royalty structure. In particular, they on a service’s business model, to payments to the Copyright Owners only contended that mechanical royalties determine which prong of the rate increased [REDACTED], from have never been set on a per-play basis. structure is operative. See Copyright $[REDACTED] in mechanical royalties See Herring WRT ¶ 19. The Services Owners’ Proposed Findings of Fact in July 2014 to only $[REDACTED] in also pointed to the interactive services’ (COPFF) (and record citation therein). December 2016. Hubbard WRT ¶ 3.9; 4/ direct licenses with music publishers, Copyright Owners assert that because of 13/17 Tr. 5971–73 (Hubbard). The PROs and record companies, claiming this complexity, publishers and upshot, Copyright Owners assert, is that, that all rely on a percent-of-revenue songwriters cannot easily verify the as streaming consumption increased royalty calculation. SJPFF ¶¶ 174–175 accuracy of data the Services input dramatically from 2014 to 2016, the (and record citations therein). They effective per stream mechanical acknowledged that some of the direct 44 Mr. Johnson’s oral testimony went well beyond his ‘‘buy button’’ proposal and included criticism royalties paid by [REDACTED] to license agreements with record of the current Copyright Act as well as criticism of Copyright Owners decreased from companies contain alternative per-user the Services’ rate proposals and business models [REDACTED] per hundred streams in prongs but they noted that this is and other concerns about the music industry more July 2014 to [REDACTED] per hundred consistent with the existing rate generally. While the Judges considered Mr. structure which already contains a per- Johnson’s testimony in determining the appropriate streams in December 2016—only royalty rates for the upcoming rate period, as a lay [REDACTED]% of the effective per subscriber minimum, but not a per-play witness sponsored by no party other than himself stream rate in July 2014. 4/13/17 Tr. prong. Id. ¶ 175. Further, the Services the Judges placed little weight on his opinions 5972–73 (Hubbard). noted that Apple, which is proposing a regarding the various rate proposals of the Services per-play rate, in fact has [REDACTED]. and the condition of the industry. As for his The Services made four arguments in criticism of the Copyright Act, those opinions are opposition to the use of a per-play See 3/23/17 Tr. 2857 (Ghose); 3/22/17 more appropriately directed to Congress. royalty rate. The overarching theme of Tr. 2479 (Dorn).

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Third, the Services discounted the assert that examination of a comparable (present structure serves customer argument that Copyright Owners’ circumstance obviates the need for segments with variety of preferences proposed rate structure is superior to experts and the Judges to build a and WTP).47 Professor Rysman, an the present rate structure because the theoretical model from the ‘‘ground up.’’ expert for Copyright Owners, latter is too complicated or See 3/13/17 Tr. 691–2 (Katz). hypothesized that under the current rate cumbersome. They characterized this The Services’ experts opine that, for a regime overall revenues might be criticism as ‘‘overblown’’ and assert that number of reasons, the 2012 rate increasing because of movements any problems arising in the use of a structure is a highly appropriate ‘‘down the demand curve’’ (i.e., changes revenue-based headline rate is mitigated benchmark. First, they note that it in quantity demanded in response to by the inclusion of per subscriber and applies to (1) the same rights; (2) the lower prices), rather than because of, or TCC minima. SJPFF ¶ 174. They further same uses; and (3) the same types of in addition to, an outward shift of the noted that section 801(b)(1) does not list market participants. See 3/15/17 Tr. demand curve (i.e., increase in demand as a criterion or objective that the rates 1082–83 (Leonard); 3/13/17 Tr. 551, at every price). 4/3/17 Tr. 4373–74 be simple, easy to understand, or 566–67 (Katz). Additionally, the (Rysman). Professor Hubbard perceives otherwise ‘‘transparent.’’ Services’ Joint Services maintain that because the 2012 a link between the existing rate Reply to Apple PFF (SJR(Apple)) at 34, rate structure resulted from a negotiated structure and the ‘‘growth in the number 36. Thus, they argued, the Judges cannot settlement, it reflects market forces, of consumers, number of streams, entry, jettison an otherwise appropriate rate including an implicit consensus on such the number of companies providing the structure because some unquantified issues as substitutional effects. See 3/ streaming services, and the identity of segment of the songwriting community 13/17 Tr. 580, 722 (Katz). More broadly, the companies providing those services might be uncertain as to how their the Services assert the 2012 Settlement . . . .’’ 4/13/17 Tr. 5978 (Hubbard); see royalties were computed. demonstrates the ‘‘revealed preferences’’ Hubbard WDT ¶ 4.7 (settlement rate Separate from these four arguments of these economic actors. See 3/15/17 structure provides ‘‘necessary flexibility against per-play rate proposals, the Tr. 1095 (Leonard); see also Amended to accommodate the underlying Services noted a practical problem Written Direct Statement of Gregory K. economics of [REDACTED]’s various related to Apple’s specific proposal: Leonard, Trial Ex. 695, ¶ 72 (Leonard digital music service offerings.’’); 48 Apple’s proposal calls for deducting AWDT) (direct license agreements that 3/15/17 Tr. 1176 (Leonard) performance royalties from the per-play track statutory structure evidence (notwithstanding changes in streaming mechanical royalty, yet it does not ‘‘revealed preference’’). Finally, the marketplace, economic structure of explain how to convert the typical Services assert that the 2012 Settlement marketplace, which made percent-of- percent-of-revenue performance royalty rate structure as benchmark is relevant revenue appropriate, has not changed). into a per play rate in order to perform and helpful because, although it was The Services’ experts further assert 45 that computation. The Services noted adopted five years ago, it is nonetheless that the multiple pricing structures that Apple Music’s Senior Director, a relatively recent agreement, covering necessary to satisfy the WTP and the David Dorn, was unable to explain how the current rate period. See Katz WDT differentiated quality preferences of this calculation would be made. See 3/ ¶¶ 6, 71; 3/13/17 Tr. 608–09 (Katz); downstream listeners relate directly to 22/17 Tr. 2508–09 (Dorn). Thus, the Leonard AWDT ¶ 45 et seq.; 3/15/17 Tr. the upstream rate structure to be Services asserted that Apple’s proposal 1082 (Leonard). established in this proceeding. Professor The Services’ experts candidly would introduce ‘‘more complexity, not Marx opines that the appropriate acknowledge that the rate structure they less,’’ SJR (Apple) at 34. upstream rate structure is derived from advocate cannot be construed the characteristics of downstream 2. Flexible Rate economically as the ‘‘best’’ approach to The Services propose a rate structure pricing in this market. See, e.g., 4/7/17 demand. 3/20/17 Tr. 1967 (Marx) (rate for configurations in extant subparts B Tr. 5574–76 (Marx). Rather, the structure upstream should be derived and C that follows the structure in the Services’ experts uniformly link the fact from need to exploit WTP of users existing regulations adopted after the that the marginal physical cost of downstream via a percentage of 2012 Settlement.46 The Services streaming is zero to the need for a revenue). This upstream to downstream asserted that they are not advocating flexible rate structure, such as now consonance in rate structures represents preservation of the basics of the exists. See, e.g., 3/20/17 Tr. 1829 an application of the concept of settlement rate structure merely to (Marx); 3/13/17 Tr. 558 (Katz); 3/15/17 ‘‘derived demand,’’ whereby the preserve the status quo. See 3/13/17 Tr. Tr. 122 (Leonard). Indeed, Copyright demand upstream for inputs is 564 (Katz). Rather, the Services, through Owners’ economic experts acknowledge dependent upon the demand for the their economic experts, argue that the this underlying fact. See, e.g., 3/30/17 47 In more formal economic terms, Professor Katz settlement rate structure as an Tr. 4086 (Gans) (streamed music is noted that the present structure enhances variable appropriate benchmark for the Judges to ‘‘non-rival good.’’); 3/27/17 Tr. 3167 pricing that allows streaming services ‘‘to work weigh, consider, adjust (if appropriate), (Watt); 4/3/17 Tr. 4318 (Rysman); 4/13/ [their] way down the demand curve,’’ i.e., to engage and apply or reject, as they would any 17 Tr. 5917–18 (Hubbard). in price discrimination that expands the market, Professor Katz noted that the existing providing increased revenue to the Copyright proffered benchmark. The Services note Owners as well as the Services.’’ 3/13/17 Tr. 701 that considering the current rate revenue-based rate structure captures (Katz). structure as a benchmark is instructive important specific aspects of the 48 The Copyright Owners sought to rebut because it allows for identification of economics of the interactive streaming Professor Hubbard’s argument by confronting him market value by analogy. The Services market, accounting for the variable with the offerings of Tidal, a streaming service that does not compete by offering a low-cost service. willingness to pay (WTP) among Eisenach WDT ¶¶ 49–50. However, Tidal’s offering 45 This problem is irrelevant to Copyright listeners and the corollary variable of a higher priced subscription service that provides Owners’ proposal, because they propose the demand for streaming services. See 3/ enhanced features such as hi-fidelity sound quality elimination of the All-In provision in the rate 13/17 Tr. 586–87 (Katz); see also actually proves the point that Professor Hubbard structure. and the other Service economists are making: There 46 Except when it doesn’t. The Services seek the Written Rebuttal Testimony of Leslie M. is a segmentation of demand across product elimination of the ‘‘Mechanical Floor,’’ a significant Marx, Trial Ex. 1069, ¶¶ 239 et seq. characteristics and WTP that permits differential departure from the existing structure. (Marx WRT); 4/7/17 Tr. 5568 (Marx) pricing in this industry.

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final product downstream. Id.; see P. preference) the practicality of a revenue- Settlement rate structure created a Krugman & R. Wells, Microeconomics at based royalty system. See 3/13/17 Tr. number of ‘‘buckets’’ to deal with 511 (2d ed. 2009) (‘‘[D]emand in a factor 766–67 (Katz).50 problems of this sort, although he market is . . . derived demand ... Although the Services’ economic acknowledged that there was no reason [t]hat is, demand for the factor is experts extol the benefits of the current why adjustments could not be made to derived from the [downstream] firm’s rate structure, they acknowledge the the ‘‘buckets’’ going forward. 3/15/17 output choice’’). problem, whether hypothetical or real, Tr. 1227–28 (Leonard); see also 3/13/17 The Services’ economists also that the Services have an incentive and Tr. 670–71 (Katz) (did not analyze contend that the existing rate structure a capacity to minimize the amount of whether to adjust ‘‘specific rates’’ of the has produced generally positive revenue that is attributed to the revenue minima). practical consequences in the base. Further, even absent any wrongful Copyright Owners criticize the 2012 marketplace. As the Services’ joint intent with regard to the measurement rate structure because of the inherent accounting expert, Professor Mark of revenue, the Services recognize that problems with measurement of revenue. Zmijewski testified, the decrease in attribution of revenue across product/ Specifically, Copyright Owners focus on publishing royalties from the sale of service lines of various service offerings deferral and displacement problems. product under subpart A since 2014 has can be difficult and imprecise. See, e.g., See Rysman WDT ¶ 13. With regard to been offset by an increase in music 4/5/17 Tr. 5000 (Katz). Additionally, the revenue deferral, Copyright Owners publisher royalties (mechanical + Services might focus on long-term profit argue that the services’ attempt to grow performance royalties) over the same maximization, thereby deferring shorter- their customer base and future profits is period. Expert Report of Mark E. term profits through temporarily lower fueled by a strategic decision to lower Zmijewski, Trial Ex. 1070, ¶¶ 38, 40 downstream pricing in a manner that retail prices, thus sacrificing current (Zmijewski WRT); 4/12/17 Tr. 5783 suppresses revenue over that shorter- revenue for future economic benefits. (Zmijewski). Professor Hubbard term. The Services might also use music Id.; see also 3/21/17 Tr. 2081–83 dismisses as economically as a ‘‘loss leader,’’ displacing streaming ([REDACTED]). ‘‘meaningless’’ the argument that revenue to encourage consumers to The Services concede that there is a Copyright Owners have suffered relative enter into the so-called economic period in the life-cycle of a streaming economic injury under the current rate ‘‘ecosystem’’ of the streaming services, service when ‘‘user numbers’’ may be structure simply because the increase in especially the multi-product/service more important to a service, its their revenues from interactive firms in this proceeding, such as investors, and its market price; however streaming has been proportionately less Amazon, Apple, and Google. The there comes a time, in the ‘‘late-stage than the growth in the number of operators of these multi-product private and public markets,’’ when interactive streams. 4/13/17 Tr. 5971–73 environments might assume music ‘‘[REDACTED].’’ Written Rebuttal (Hubbard). There is no evidence in this consumers can be exposed to other Testimony of Barry McCarthy, Trial Ex. record that, if the price of the services goods and services available for 1066, ¶¶ 37 (McCarthy WRT).51 The available to these low to zero WTP purchase. Third, the Services might Services argue, however, that Copyright listeners had been increased, they obscure royalty-based streaming Owners misunderstand the emphasis on would have paid the higher price. In revenue by offering product bundles long term growth. That emphasis, they fact, the only survey evidence in the that include music service offerings argue, relates to the Services’ record suggests that listeners to with other goods and services, rendering willingness to sacrifice short-term streaming services have a highly elastic it difficult to allocate the bundle profitability by incurring up-front costs, demand, i.e., they are highly sensitive to revenue between royalty-bearing service which has no bearing on current period price increases.49 revenue and revenue attributable to revenues. 3/21/17 Tr. 2085 On the Licensee Services’ side of the other products in the bundle. ([REDACTED]). The Services Professor Katz testified, however, that ledger, Professor Katz identifies the nonetheless acknowledge that they the existing rate structure entry of new interactive streaming focus currently on the second derivative accommodates these bundling, deferral, services and new investment in existing of revenue—the ‘‘growth of the and displacement issues by the use of interactive streaming services during the growth’’—rather than revenue growth. minima that are triggered if the royalty present rate period as evidence that the The Judges find that the record in this resulting from the headline percent-of- present rate structure is ‘‘working.’’ 3/ proceeding indicates that the Services service revenue falls below the 13/17 Tr. 667 (Katz). He notes the do seek to engage to some extent in established minima. Katz WDT ¶¶ 82– ubiquity of percent-of-revenue based revenue deferral to promote a long-term 83; 3/13/17 Tr. 670 (Katz). Moreover, he royalty structures in the music industry, growth strategy. A long-term strategy concluded that because the marketplace indicating (as a matter of revealed that emphasizes scale over current appears to be functioning, the revenue can be rational, especially 49 alternative minimum rates must be In a real-life example of this phenomenon, when a critical input is a quasi-public adequately handling revenue [REDACTED] explained [REDACTED]’s internal good. Growth in market share and analysis of the marketplace impact of measurement issues. Id. at 738; 4/5/17 [REDACTED]’s decision to discount the monthly Tr. 5055–57 (Katz). In similar fashion, revenues is not matched by a subscription price of its [REDACTED] service Dr. Leonard opined that the 2012 commensurate increase in the cost of [REDACTED]. The analysis indicated that inputs, whose marginal cost of [REDACTED]% of the subscribers were new to the interactive streaming segment of the market, and 50 There is a facially discordant aspect to the production (reproduction in this [REDACTED]% came from existing subscribers to Services’ argument. They are consistently incurring context) is zero. It appears to the Judges other services at the standard $9.99 monthly price. losses under this rate structure and the present that the nature of the downstream As [REDACTED] explained, music publishers rates, yet they are essentially content for the present interactive streaming market and its would lose royalties on $[REDACTED] of revenue rates and structure to be continued. The presence on the [REDACTED]% who migrated away from a of chronic losses would facially suggest that the reliance on scaling for success, results $9.99 service, but would add royalties on the Services would be in need of rate reduction (as $[REDACTED] for each subscriber who was part of some of their experts suggest would be proper given 51 No witness offered any testimony that might the [REDACTED]% cohort. See 3/16/17 Tr. 1576– their analyses). This conundrum is explained by the indicate whether the currently operating Services 1639 ([REDACTED]); see also 3/21/17 Tr. 2243–44 Services’ engaging in competition for market share, perceive themselves to be at the beginning, middle, (Hubbard). as discussed infra. or ‘‘late-stage’’ of this cycle.

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necessarily in a competition for the month, compared to the full streaming services to performing rights market rather than simply competition $[REDACTED] per month price. organizations (PROS) for the musical in the market. This competition Amazon determined that Prime works performance right. All five emphasizes the importance of the members who were unwilling to pay the Services urge the Judges to establish a dynamic creation of new markets and full [REDACTED]/month subscription statutory rate structure for the ‘‘new demand curves,’’ recognizing that price for [REDACTED] could be enticed forthcoming rate period that contains short-term profit or revenue to pay $[REDACTED] per month less, this ‘‘All-In’’ feature; whereas Copyright maximization might be inconsistent subscribing to [REDACTED] service at Owners request that the rate for the competing for the market long-term. $[REDACTED]/month. Id. ¶ 22. forthcoming rate period be set without When the Services pay royalties as a [REDACTED] maintains these regard to the amounts the Services pay percent of their current revenue, the [REDACTED] created ‘‘unique PROs for the performance rights. input suppliers, i.e., Copyright Owners, distribution channels’’ generating new According to the Services, a key are likewise deferring some revenue to listeners and thus new royalties for the aspect of the 2008 and 2012 settlements a later time period and assuming some licensors without cannibalizing higher was the deduction of expenses for risk as to the ultimate existence of that royalties at the full $[REDACTED] per public performance royalties; in other future revenue. One way the Copyright month subscription price. Id. ¶¶ 25, 21– words, the top-line rate the Services Owners could avoid this impact would 22.52 [REDACTED] asserts that the net paid under the section 115 license be to refuse to accept a percent-of- benefits of its pricing strategies are would be added to the performance revenue form of payment and move to confirmed by a consumer survey rights royalties for an All-In musical a fixed per-unit price. Another way undertaken by [REDACTED] Mr. Robert works fee from the Services’ point of would be to establish a pricing structure L. Klein, Chairman and co-founder of view. Levine WDT ¶ 35; Written Direct that provides minima and floors, below Applied Marketing Science, Inc. Testimony of Adam Parness, Trial Ex. which the revenue could not fall. The (‘‘AMS’’), a market research and 875, ¶ 7 (Parness WDT); 3/8/17 Tr. 298– bargain struck between Copyright consulting firm. In that survey (Klein 99 (Parness). According to Apple, the Owners and Services in 2012 is an Survey), Mr. Klein identified absence of any value in the mechanical example of the latter structure. [REDACTED]. At a high level, the Klein license separate from the performance In this proceeding, the Services assert Survey results indicated that license is underscored by the fact that there is no evidentiary support for [REDACTED]’s music listeners had an interactive streaming is the only Copyright Owners’ conclusory assertion overall high elasticity of demand for distribution channel that pays both a that the Services intentionally displace streamed music, meaning that their performance royalty and a mechanical revenue by engaging in ‘‘cross-selling’’ subscription demand was highly royalty. Noninteractive services, or revenue bundling. See SJPFF at 308. sensitive to changes in subscription SDARS, and terrestrial radio pay a The Judges agree that there is no prices. Written Rebuttal Testimony of performance royalty but not a support for any sweeping inference that Robert L. Klein, Trial Ex. 249, ¶ 67 mechanical royalty, whereas record cross-selling has diminished the (Klein WRT).53 companies pay a mechanical royalty revenue base. Copyright Owners attack the Klein under subpart A but not a performance Regardless of the existence or extent Survey on several fronts. The arguments royalty. Rebuttal Testimony of David of cross-selling, Copyright Owners argue made by Copyright Owners are Dorn, Trial Ex. 1612, ¶ 10 (Dorn WRT). that the Services manipulate revenue insufficient, however, to seriously According to the Services this All-In calculations in their favor, allegedly weaken the probative value of the Klein rate structure is consistent with the defining revenue in opportunistic ways. Survey. In the end, the Judges are not parties’ expectations in settling See Rysman WDT ¶ 44; Rysman WRT persuaded by the Copyright Owners’ Phonorecords I and II. See SJPFF ¶ 112. ¶ 15; see also Ghose WDT ¶¶ 78 (arguing revenue bundling arguments not to Additionally, the Services note that on behalf of Apple that ‘‘service revenue adopt a flexible, revenue-based royalty many direct licenses between musical for . . . bundles is subjective and can be rate. works copyright owners and streaming interpreted differently by different services incorporate the ‘‘All-In’’ feature service providers’’). Copyright Owners 3. All-In Rate vs. Independent of the existing section 115 license. See maintain that they cannot discern the Mechanical Rate SJPFF ¶¶ 143–145 (and record citations alleged manipulation and opportunism The current mechanical royalty rate is therein). as it occurs, because the booking of calculated as a so-called ‘‘All-In’’ rate. Separately, Apple concurs in the revenue among lines of business is When calculating the mechanical rate proposal of an ‘‘All-In’’ rate in the ‘‘opaque to publishers.’’ Rysman WDT the parties subtract from the base rate forthcoming rate period. According to ¶ 43; Rysman WRT ¶ 15; Ghose WDT the amount paid by the interactive Apple, the Judges ¶¶ 80–81. In support of this assertion of should adopt an All-In rate for interactive revenue manipulation, Copyright 52 More precisely, although some [REDACTED] Owners point to [REDACTED]. listeners might have paid the full subscription streaming because (1) mechanical and Before [REDACTED] engaged in price, the [REDACTED] pricing analysis indicated performance royalties are complementary rights that must be considered together in [REDACTED], it engaged in a pricing that any revenue losses arising from discounts obtained by these sub-groups were dwarfed in term order to prevent exorbitant costs, (2) the analysis to determine its optimal price of revenue gains from the new subscribers at the current statute use an All-In rate, (3) All-In point for [REDACTED] and interactive lower discounted rates [REDACTED]. [REDACTED] rates provide greater predictability for streaming access. See [REDACTED] WRT ¶ 22. businesses, and (4) recent fragmentation and Pricing Study—Final Report, Trial Ex. 53 It is important to note that Copyright Owners’ uncertainty with respect to performance 113 ([red] Study). [REDACTED] attacks on the Klein Survey are not levelled by any licenses threaten to exacerbate the problems witnesses, nor contradicted by their own survey of high costs and uncertainty already present contends its pricing analysis expert, because Copyright Owners elected not to demonstrated that [REDACTED]. Trial proffer such an expert in their direct (or rebuttal) in the industry. Ex. 111, ¶ 14 n.9 ([REDACTED] WRT). cases. Rather, Copyright Owners elected to make a Apple PFF ¶¶ 138, et seq. (and record descriptive argument regarding the elasticity of In conjunction with [REDACTED]. demand among different segments of the market, as citations therein). Apple maintains that, [REDACTED] lowered the [REDACTED] opposed to a survey-based or econometric study of as a policy matter, an All-In rate helps subscription price to $[REDACTED] per price elasticity. maintain royalties at an economically

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efficient level because it sets a single Copyright Owners’ initial response to approach, if adopted, would leave the value for all of the rights that interactive the All-In structure is a jurisdictional mechanical rate indeterminate, subject streaming services must obtain from argument. They emphasize that this is a to negotiations or judicial action publishers and songwriters. See proceeding to set rates and terms for the regarding the performance license rate. Rebuttal Report of Professor Jui section 115 compulsory mechanical See id. ¶ 320. Indeed, Copyright Owners Ramaprasad, Trial Ex. 1616, ¶ 13 license to make and distribute note, under the Services’ ‘‘All-In’’ (Ramaprasad WRT) (separate phonorecords, not to perform works. 17 proposal, the mechanical rate could be mechanical royalty could lead to U.S.C. 115, 801(b)(1). More particularly, zero (if performance royalties are agreed ‘‘unreasonably high combined royalties Copyright Owners note that, the section to or set by the Rate Court at a rate that for publishers and songwriters’’); 3/23/ 115 compulsory license explicitly is greater than or equal to the ‘‘All-In’’ 17 Tr. 2667–69, 2670 (Ramaprasad); see applies solely to the exclusive rights rate proposed by the Services here). also Leonard AWDT ¶ 56; Katz WDT bestowed by clauses (1) and (3) of Copyright Owners argue that a ¶ 94; Written Direct Testimony of section 106; that is the rights to make mechanical royalty rate of zero ‘‘is Michael Herring, Trial Ex. 880, ¶ 59 and to distribute phonorecords of anything but reasonable. . . .’’ Id. (Herring WDT). Accordingly, Apple [nondramatic musical] works.’’ This ¶ 322. proceeding does relate to the exclusive asserts that adoption of an All-In rate In an evidentiary attack, Copyright right provided by clause (4) to perform will ensure that these two Owners demonstrate that the only the work publicly. 17 U.S.C. 106, 115. complementary rights are considered in percipient witness who engaged directly tandem, with the cost of one offset Thus, Copyright Owners argue, the public performance right provided by 17 in the 2008 negotiations involving the against the cost of the other. See Dorn ‘‘All-In’’ rate was the NMPA president, WRT ¶ 15; see also 3/13/17 Tr. 587–588 U.S.C. 106(4) is an entirely separate and divisible right from the mechanical right David Israelite. By contrast, the (Katz); 3/15/17 Tr. 1191–92 (Leonard); Services’ two witnesses, Mr. Parness Herring WDT ¶ 59. at issue in this proceeding and is not subject to the section 115 license. See and Ms. Levine, did not participate Apple, consistent with the other COPCOL ¶ 314 (citing 17 U.S.C. 106, directly in those negotiations. See Services, argues that the All-In rate 115, 201(d) and 2 Nimmer on Copyright Copyright Owners’ Reply Proposed structure is particularly important sec. 8.04[B] (‘‘[T]he compulsory license Findings of Fact ¶ 125 (CORFF). Thus, because of recent ‘‘fragmentation’’ 54 does not convey the right to publicly Copyright Owners assert that the and uncertainty in performance rights perform the nondramatic musical work Services cannot credibly argue based on licensing. The Services all claim this contained in the phonorecords made what the negotiating parties actually potential fragmentation threatens to under that license. Similarly, a grant of intended with regard to, inter alia, the 57 exacerbate existing uncertainty over performing rights does not, in itself, ‘‘All-In’’ rate. royalty costs. See Dorn WRT ¶¶ 17–18; confer the right to make phonorecords Copyright Owners also take aim at the Ramaprasad WRT ¶¶ 13, 63; Parness of the work.’’)). Services’ argument that it matters not WDT ¶¶ 16–20; Katz WDT ¶¶ 87–94; 3/ Copyright Owners note that whether they pay royalties designated as 13/17 Tr. 602–04 (Katz). Apple notes performance royalties are negotiated ‘‘performance’’ or ‘‘mechanical,’’ that this problem may be amplified between licensors and licensees, subject because the same rights owners are also because of the emergence of a fourth to challenge in a Rate Court proceeding. receiving performance royalties. PRO, Global Music Rights (GMR) in They conclude that the Judges cannot According to Copyright Owners, this addition to SESAC which, like GMR, is set an ‘‘All-In’’ rate because they have argument (1) ignores the Copyright Act’s not subject to musical works ‘‘not been vested with the authority to separate and distinct mechanical and performance license proceedings in the set rates for performance rights because performance rights; (2) ignores that the Rate Court.55 Parness WDT ¶ 18; Katz they are not covered by section 115.’’ rates for the use of those two rights, to WDT ¶ 91; see 3/9/17 Tr. 382–83 Copyright Owners’ Proposed the extent not agreed, are set in different (Parness); 3/13/17 Tr. (Katz) 602–04.56 Conclusions of Law ¶ 315 (COPCL). jurisdictions; and (3) ignores the The Services also raise the specter of Copyright Owners further note that the disruption that would be caused by future ‘‘withdrawals’’ by music Services have not provided evidence in eliminating mechanical royalties, e.g., publishers from one or more PROs. this proceeding to justify an ‘‘All-In’’ disruptions arising from (a) the fact that rate, such as evidence showing the rates mechanical royalties are the most 54 In this context, ‘‘fragmentation’’ refers to the and terms in existing performance significant source of recoupment of existence of more than one owner of copyrights to licenses; the duration of such licenses; advances to songwriters; and (b) a single musical work. benchmarks for performance rights songwriters receive a greater share of 55 Since 1941, ASCAP and BMI have been subject licenses; and the impact of interactive to Consent Decrees they reached with the mechanical royalties than they do of Department of Justice in a DOJ antitrust suit. See, streaming on other sources of performance royalties (both because of e.g., United States v. Broadcast Music, Inc., 1940– performance income, including non- the standard splits in songwriter 43 Trade Cas. ¶ 56,096 (W.D.Wis. 1941). interactive streaming, terrestrial radio, agreements and the fact that 56 Apple also claims that there is recent legal and satellite radio income. Further, performance income, unlike mechanical uncertainty because of the 2016 decision regarding Copyright Owners point out that the fractional licensing in United States v. Broadcast income, is diminished by PRO Music Inc., 64 Civ. 3787 (LLS), 2016 WL 4989938 PROs and all music publishers would be commissions). COPCL ¶ 323; COPFF (S.D.N.Y. Sept. 16, 2016), which Apple claims has necessary parties for any such ¶ 640. created even more market power for the owners of determination. See id. ¶ 319. musical works. Apple hypothesizes fractional For these reasons, Copyright Owners licensing ‘‘almost certainly will lead to higher total 57 Copyright Owners take this argument one step payments for performance rights, higher decry as mere ‘‘sophistry’’ the Services’ further—maintaining that consequently the Services transactions costs, and greater uncertainty.’’ Parness argument that they are not asking the ‘‘have presented no competent evidence that an WDT ¶ 20. In the BMI case, according to Apple, the Judges to set performance rates, but ‘‘All-In’’ rate structure ‘‘is consistent with the Rate Court confirmed that PROs can grant licenses rather only to ‘‘set’’ a ‘‘mechanical’’ rate parties’ expectations in settling Phonorecords I and for fractional interests in musical works, meaning II.’’ CORSJPCL ¶ 112. It is difficult to conclude that that in order to offer a work, interactive streaming that permits them to deduct what they this fundamental rate structure, agreed to in two services must obtain licenses from every entity with pay as a performance royalty. More separate settlements between the parties, was not any de minimis interest in the work. Id. particularly, they argue that this consonant with their ‘‘expectations.’’

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Copyright Owners also assert that ‘‘a 73, 77–78 (2d Cir. 2015), aff’g 6 F. Supp. Mechanical Floor in the forthcoming single All-In payment will . . . 3d 317 (S.D.N.Y. 2014).58 rate period. In support of this position, diminish payments to songwriters, and the Services assert that they acquiesced 4. Mechanical Floor will negatively impact the publishers’ to the Copyright Owners’ insistence on ability to recoup advances, which will, Copyright Owners urge the Judges to the Mechanical Floor in the 2012 in turn, negatively impact the size and retain the feature of the extant rate Settlement, because they believed the number of future advances.’’ Witness regulations establishing a Mechanical Mechanical Floor was ‘‘illusory,’’ i.e., Statement of Thomas Kelly, Trial Ex. Floor; that is, a rate below which the that it was ‘‘highly unlikely to ever be 3017, ¶ 66 (Kelly WDT); Witness calculated mechanical license rate could triggered. . . .’’ SJPFF ¶¶ 127, 160 (and 59 Statement of Michael Sammis, Trial Ex. not fall. They emphasize that the record citations therein).61 According to 3019, ¶ 27 (Sammis WDT); Witness revenue displacement and deferral the Services, experience has shown that Statement of Annette Yocum, Trial Ex. problems they perceive under a percent- the Mechanical Floor in the current rate 3021, ¶ 23 (Yocum WDT); Israelite WDT of-revenue rate structure are alleviated structure has added uncertainty and has ¶ 71. with a Mechanical Floor because that led to Services paying ‘‘windfall’’ rate is based on a per-subscriber royalties to Copyright Owners well Copyright Owners counter the calculation. COPFF ¶¶ 639–40. above the stated ‘‘All-In’’ amount. See Services’ claim that increasing Copyright Owners maintain that the Apple PFF ¶¶ 85, 165; see also Google ‘‘fractionalization’’ of licenses justifies Services’ desire to eliminate the PCOL ¶ 22 (triggering of Mechanical an ‘‘All-In’’ rate as a red herring. Mechanical Floor is nothing other than Floor caused in some circumstances by Specifically, they argue there has always a ‘‘thinly veiled effort to sharply reduce Copyright Owners leveraging market been fractional licensing of performance the already unfairly low mechanical power). rights by the PROs; there typically are royalties.’’ COPFF ¶ 644. The import of The Services argue that the multiple songwriters and publishers the Mechanical Floor is underscored by Mechanical Floor is tantamount to a with ownership rights in a song and Dr. Eisenach who testifies that, in 2015, separate rate and defeats the benefits of they might not all be affiliated with the the Services triggered the Mechanical an All-In rate. Apple PFF ¶¶ 164–167 same PRO. The recent litigation only Floor in over 43% of service-months (66 (and record citations therein). They confirmed that there is no legal basis on of 152 such months). Written Rebuttal acknowledge the mechanical rights and which any one PRO has the right to Testimony of Jeffrey A. Eisenach, Trial public performance rights are ‘‘perfect license rights it does not have. Rebuttal Ex. 3033, ¶ 115 (Eisenach WRT). complements’’ from the perspective of Witness Statement of David M. Israelite, Copyright Owners further argue that an interactive streaming service, but Trial Ex. 3030, ¶¶ 65–66 (Israelite the Mechanical Floor is necessary to assert there is no economic rationale for WRT); 3/29/17 Tr. 3662–63 (Israelite); 3/ preserve a source of publishers’ setting the two rates separately from one 9/17 Tr. 372–373 (Parness). advances to songwriters and another. Id. ¶ 88. The Services fear the recoupments of prior advances. COPFF alternative minimum Mechanical Floor Moreover, contrary to the Services’ ¶ 640 (and record citations therein). could supersede a ‘‘reasonable headline assertions, they presented no evidence They assert that songwriters benefit royalty rate.’’ Marx WDT ¶ 165; see that the presence of GMR, a new PRO, more from publishing agreements than Leonard AWDT ¶¶ 54, 80–81 (‘‘perfect has altered the extent of fragmentation from performance agreements with complements’’ argue for elimination of in any manner, let alone increased the PROs because, under current publishing Mechanical Floor). The Services also degree of fragmentation in the agreements, songwriters typically argue that removal or adjustment of the marketplace. Copyright Owners point receive 75% or more of mechanical Mechanical Floor would improve out that the Services admitted that GMR royalty income; whereas, PRO’s split economic efficiency. Marx WDT ¶¶ 135, represents fewer than 100 songwriters performance royalty income 50/50 165. and has a meager market share of between publishers and songwriters. Id. roughly 3 percent of the performance 5. Greater-Of per Unit/per User Moreover, PROs charge songwriters an Structure market. 3/9/17 Tr. 365–67 (Parness); see administrative fee, further reducing the Copyright Owners’ proposal Israelite WRT ¶ 59. Copyright Owners value of the performance royalty income constitutes a ‘‘greater of’’ rate structure, also note that the Services presented no relative to mechanical royalty income. whereby the royalty would equal the evidence either that there has been an Id. increase in performance rates in licenses Despite their proffer of the 2012 rates greater of $.0015 per play and $1.06 per- issued by GMR, or, more generally, of as an appropriate benchmark, the end user per month. In support of this approach, Copyright Owners contend it any actual or potential impact of this Services 60 propose elimination of the alleged ‘‘fragmentation’’ of the establishes a value for each copy of a performance rights marketplace on their 58 See also Determination of Royalty Rates and musical work, independent of the interactive streaming businesses. 3/9/17 Terms for Making and Distributing Phonorecords Services’ business models and pricing Tr. 381 (Parness)). (Phonorecords III); subpart A Configurations of the strategies. Rysman WDT ¶ 89. They Mechanical License, Docket No. 16–CRB–0003–PR, argue that the greater-of structure is no Finally, Copyright Owners note that, 82 FR 15297, 15298 n. 15 (March 28, 2017). more complicated than a per-play rate if it ever were a justification for an All- (‘‘[M]usic licensing is fragmented, both by reason of the Consent Decree and the fragmentation of the alone and is much less complicated In rate, the issue of publisher statutory licensing schemes in the Act. These issues withdrawals from PROs has been are beyond the scope of authority of the Judges; rate, subtracting public performance royalties, and overtaken by events. Specifically, they they can only be addressed by Congress.’’). allocating per work) (May 11, 2017). Google’s note that the ASCAP and BMI Rate 59 If the All-In Rate calculation results in a dollar revised rate proposal, which also does not rely on royalty payment below the stated Mechanical Floor the 2012 rate as a benchmark, does not include a Courts in the Southern District of New rate, then that floor rate would bind. Mechanical Floor. See, Google Amended Proposal, York, the Second Circuit, and the 60 Although Apple does not join in the at 1. Department of Justice have determined endorsement of the 2012 rates as benchmark, Apple 61 This claimed ‘‘illusion’’ became a reality, as the that partial withdrawals by publishers does propose elimination of the Mechanical Floor [REDACTED], has been paying the vast majority of are not permitted. Israelite WRT ¶¶ 62– for the upcoming rate period. Apple Inc. Proposed its royalties pursuant to the Mechanical Floor, as Rates and Terms, at 4, 7–8 (royalties calculated by has [REDACTED]. See, e.g., Marx WDT ¶ 76; Marx 63, citing In re Pandora Media, 785 F.3d multiplying number of streams times per-stream WRT ¶ 40.

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than the 2012 Settlement rate structure. emphasized by Copyright Owners in based royalty is either too low or According to Copyright Owners, a per- this proceeding. See Apple PFF 284.64 inapplicable. user rate adds only one additional According to Apple, even Copyright By contrast, Copyright Owners seek a metric for royalty calculation. Brodsky Owners’ own expert, using different radical departure from the present rate WDT ¶ 76. Copyright Owners also assert data, found that if the Copyright structure. First, Copyright Owners seek that their usage-based structure is Owners’ proposal had been in effect, to eliminate the All-In rate, thus aligned with the value of the licensed [REDACTED] of the [REDACTED] decoupling the mechanical rate from the copies because couples rates with usage Services he reviewed would have been performance rate. Second, they advocate and consumption. CORFF at 22. Finally, required to pay under the per-user for a replacement of the ‘‘percent-of- Copyright Owners note that in music prong in December 2015. Rysman WRT revenue with minima’’ structure and a licensing agreements it is not ¶ 87, Table 1. Professor Rysman’s data substitution of a rate equal to the greater uncommon to find royalty rates set in a for December 2014 indicated that of a per-play royalty and a per-user greater-of formula that includes a per- [REDACTED] of the [REDACTED] royalty. Copyright Owners’ Amended Proposed Rates and Terms at 8. user and a per-play prong, as well a Services would have been required to pay under the per-user prong. Id. at Copyright Owners criticize using the percent-of-revenue prong. See CORFF at 2012 rate structure as a benchmark for 97 (and record citations therein). Table 2. Copyright Owners do not dispute the rates in the present market. Copyright The Services assert that the greater-of statistical analyses; rather, they claim Owners contend that results of a aspect of Copyright Owners’ rate that the binding nature of the per-user negotiated settlement have limited proposal would lead to absurd and prong is not problematic. They cite evidentiary value in the present context. inequitable results, well above the rates sound recording performance license They also argue that the parties arrived established under Copyright Owners’ agreements in which a per-user of prong at the 2012 rate structure and rates in a per-play rate prong. Professor Ghose, binds interactive streaming services at a market that was not mature and that, one of Apple’s economic expert rate of $[REDACTED], well above the thus, the settlement rates were merely witnesses, calculated that under $1.06 proposed by Copyright Owners for ‘‘experimental.’’ The Copyright Owners Copyright Owners’ greater-of structure, mechanical licenses. See CORPFF further contend that any benchmark interactive streaming services would (Apple) at 104. Copyright Owners also based upon a compulsory, statutory rate pay under the per-user prong if the attempt to support the higher effective is suspect because of the ‘‘shadow’’ of number of monthly streams per user per play rates by explaining that per- the statutory construct. averaged less than 707. 4/12/17 Tr. user rates reflect the value of access to 1. Evidentiary Value of Settlement Rates 5686–87 (Ghose). In other words, the the publishers’ repertoires, not just the Copyright Owners criticize the hypothetical service would be required value of an individual stream. See relevance of the 2012 settlement-based to pay $1.06 per user rather than CORPFF (Apple) at 104–05 (and rate structure. First, they note that, as $0.0015 per stream.62 Id. at 5687. citations therein). terms in a settlement, the elements of Importantly, Apple argues that the C. 2012 Settlement as Rate Structure the rate structure do not reflect the record in this proceeding shows that Benchmark structure the market would set, but Services’ monthly streams have been rather reflect the parties’ own historically less than 707 per user per The Services request a rate structure understanding of how the Judges would month. Specifically, relying on data in that (although not uniform in the rule in the absence of a settlement. Dr. Leonard’s Written Rebuttal respective particulars) generally tracks Second, Copyright Owners assert that, Testimony, Apple contends that the the present rate structure (including the assuming arguendo that the current rate annual weighted average number of All-In rate approach, but excluding the structure can be used for benchmarking streams per user per month across present Mechanical Floor). More purposes, the Services have not current subpart B and subpart C service particularly, they propose a structure presented competent evidence or offerings has been below [REDACTED] based on a ‘‘headline’’ percent-of- testimony as to the intentions of the in each year from 2012 to 2016, while revenue royalty, but, subject to certain settling parties who had negotiated the the average number of streams per user minima that are triggered if the revenue- 2012 settlement, or, for that matter, the per month has exceeded 707 (which 2008 settlement that preceded it. would trigger the per play prong) only 64 This analysis underscores the inconsistency Specifically, Copyright Owners claim between Copyright Owners’ claim that each stream [REDACTED] according to service-by- of a musical work has ‘‘inherent value.’’ See, e.g., that the witnesses who were called by service data. Id.; 63 see Written Rebuttal Israelite WDT ¶ 39 (it ‘‘makes no sense’’ if ‘‘[e]ach the Services to testify did not negotiate Testimony of Gregory K. Leonard, Trial service effectively pays to the publisher and directly with the Copyright Owners. 3/ Ex. 698, at Ex. 3b (Leonard WRT). Apple songwriter a different per-play royalty’’). But in 29/17 Tr. 3621–22 (Israelite).65 More reality, Copyright owners understand that each argues that these historical data indicate musical work also contributes to a different value— particularly, the two Services’ witnesses that the Services would consistently pay access value (what economists call ‘‘option who provided testimony concerning the more than the $0.0015 per play rate value’’)—when the musical works are collectivized negotiations, Adam Parness and and offered through an interactive streaming Zahavah Levine, acknowledged they service, resulting in different effective per play rates 62 Professor Ghose used a hypothetical scenario in paid by services if the per user prong is triggered. had no direct involvement in the which a service had one user who listened to 300 To explain this inconsistency, Copyright owners Phonorecords I negotiations, and Ms. streams in a given month. Under Copyright Owners’ note the existence of a second ‘‘inherent value’’— Levine did not engage in direct $0.0015 per play prong, the service would pay $ not created by the songwriter in his or her negotiations with regard to the 0.0015 × 300, or $.45 in royalties. Under Copyright composition—but rather created by the user—who Owners’ per user prong, the service would pay a inherently values access to a full repertoire. But Phonorecords II settlement either. 3/9/ royalty of $1.06 for the one user, which is an these two purportedly ‘‘inherent’’ values are 17 Tr. 339–40 (Parness); 3/29/17 Tr. effective per play rate of $0.0035 per play ($1.06 ÷ inconsistent (which is why there are two prongs in 3885–86 (Israelite); Israelite WRT ¶ 14 300) or more than twice the $0.0015 per-play rate. the proposal) and, given the heterogeneity of (indicating that Ms. Levine had left Real 4/12/17 Tr. 5687 (Ghose). listeners, the ‘‘access value’’ is not ‘‘homogeneous 63 Deezer averaged [REDACTED] streams in 2014 throughout the market. These points illustrate but Networks in 2006, before her former and Tidal averaged [REDACTED] streams in 2016. some of the reasons why a single per play rate is Id. inappropriate. 65 See supra note 57 and accompanying text.

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subordinate was negotiating the 2008 the business and Copyright Owners 3. The ‘‘Shadow’’ of the Statutory settlement). lacked knowledge as to the future License Mr. Parness testified, at the time of development of the interactive market. Copyright Owners assert that any the Phonorecords I settlement, he was Thus, they claim to have accepted the benchmark, including the Services’ Director of Musical Licensing for present rate structure because it offered proffered benchmarks, based on rates set RealNetworks, Inc., an interactive protection against poorly monetized for a compulsory license, is inherently streaming service and a member of services, through the establishment of suspect, because they are distorted by DiMA, its bargaining representative. In the alternate prongs. In fact, it was the so-called ‘‘shadow’’ of the statutory that capacity, Mr. Parness was ‘‘actively Copyright Owners that first proposed license. This is a recurring criticism. involved’’ on behalf of Real Networks. the three tiered rate structure that now See, e.g., Web IV, 81 FR at 26329–31. Parness WDT ¶ 5. Substantively, Mr. exists, but the specific percentages and More particularly, Copyright Owners Parness testified to his understanding rates were the subject of negotiation. argue: ‘‘The royalty rate contained in that the important aspects of the Copyright Owners’ understanding of the virtually any agreement made by a Phonorecords I negotiations and characterization of the 2012 rates is music publisher or songwriter with a settlement were: (1) An agreement that informative; Mr. Israelite, who engaged license for rights subject to the noninteractive services did not need a in the negotiations, did not view the compulsory license will be depressed by mechanical license; (2) the interactive minima in the structure as minima, but the availability of the compulsory mechanical license would be calculated rather as alternative rate prongs by license.’’ COPFF ¶ 708 (and record on an ‘‘All-In’’ basis; (3) the rate would which Copyright Owners would be paid citations therein). In summary, this be structured as a percent-of-revenue the greatest of the rates calculated. 3/29/ alleged shadow diminishes the value of with certain minima; and the headline 17 Tr. 3637 (Israelite). Copyright a benchmark rate that was formed by rate would be 10.5%. Parness WDT ¶ 7. Owners acknowledge that they had no private actors who negotiated the rate He noted that the rate minima were idea which prong would bind—because while understanding that either party included at the behest of Copyright they had no control over the services could refuse to consummate a contract Owners, who were concerned that low business models or over the and instead participate in a proceeding retail pricing by the services would performance rates that are deductions to cause a revenue-based rate to result in the All-In rate—so they negotiated all before the Judges to establish a rate. too little royalty revenue. Id. ¶ 8. Mr. three alternatives to reflect that Thus, neither side can utilize any Parness further testified, with regard to uncertainty. Id. at 3636–38. bargaining power to threaten to actually the 2012 negotiations, that he directly With regard to the Mechanical Floor, ‘‘walk away’’ from negotiations and negotiated with Mr. Israelite and the Copyright Owners assert that they refuse to enter into a license. In that general counsel for the NMPA– required this provision in part to protect sense, therefore, any bargain they struck negotiations that led to the parties’ against a severe or complete reduction would be subject to the so-called agreement essentially to maintain the in mechanical royalties that would as ‘‘shadow’’ of the regulatory proceeding. subpart B structure and to create what possible by virtue of the All-In The metaphorical shadow actually became the new subpart C rate structure. See Israelite WRT ¶¶ 19–22, can be cast in two ways. First, when the structure. Id. at 11; see also 3/9/17 Tr. 29, 81; 3/29/17 Tr. 3632, 3634–36, 3638, parties are negotiating, they are aware of 325–27 (Parness). 3754, 3764–65 (Israelite); 3/8/17 Tr. 259 the rates established in prior Ms. Levine, who was employed by (Levine).66 proceedings, which shape their Google YouTube at the relevant time, The Services assert that there is no expectations of the likely outcome if testified that in the Phonorecords II record evidence, beyond Mr. Israelite’s they do not enter into a negotiated negotiations, Copyright Owners sought testimony, that the existing rate agreement. Second, there is the alleged an increase in the subpart B rates, the structure was, or remains, experimental. shadow of the upcoming proceeding, services refused, and Copyright Owners They further note that by 2012, when should the parties fail to negotiate an ultimately withdrew that demand. this rate structure was renewed, agreement. That in futuro shadow Written Rebuttal Statement of Zahavah consumer adoption of streaming was reflects not merely the prior rulings of Levine, Trial Ex. 697, ¶ 2 (Levine WRT). obvious, contrary to Copyright Owners’ this tribunal (and its predecessors), but Ms. Levine was not directly involved in allegations. Levine WRT ¶ 5. The also any predictions the parties may the negotiations, however, as DiMA Services also assert that numerous make regarding, for example, the Judges’ represented the interests of the services services, including those backed by likely positions with regard to the in those negotiations. Knowing the large companies, such as Yahoo and present and changing nature of the outcome of the negotiations does not Microsoft, had already entered the industries involved, the economic illuminate the thought processes (or the market, and some of those services had issues, the weight of various types of horse-trading) that actually drove the achieved significant subscriber evidence, the credibility of witnesses negotiations or shaped the settlement numbers. 3/8/17 Tr. 155–57 (Levine); and the Judges’ application of the structure. see also Parness WDT ¶ 12. 801(b)(1) standards. The Copyright Owners proffered no The Services also dispute the The argument that the shadow taints specific testimony as to how or why the assertion that there was no significant the use of statutory rates, and direct provisions of the 2008 and 2012 market development by the time of agreements otherwise subject to the settlements were negotiated and valued, Phonorecords II. Levine WRT ¶¶ 5–6; 3/ statutory license must be considered in either in their constituent parts or as 8/17 Tr. 171–72, 270–72 (Levine). light of section 115 of the Copyright Act, they were integrated into the rate Numerous services, including the more which provides that in addition to the structure ultimately adopted. recent large new entrants, had already objectives set forth in section 801(b)(1), in establishing such rates and terms, the 2. The 2012 Rates Were ‘‘Experimental’’ entered the market, with some realizing significant subscriber numbers. Id. at Copyright Royalty Judges may consider Copyright Owners maintain that the 155–57 (Levine). rates and terms under voluntary license current rate structure was agreements described in subparagraphs ‘‘experimental,’’ i.e., when it was first 66 The Mechanical Floor is discussed in greater (B) and (C). 17 U.S.C. 115(c)(3)(D). agreed to there was no data to evaluate detail, supra, section IV.B.4. Subparagraphs (B) and (C), respectively,

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refer to agreements on ‘‘the terms and In the present proceeding, the parties 801(b)(1). However, if on further rates of royalty payments under this weigh in on the shadow issue with analysis, the Judges find that provisions section’’ by ‘‘persons entitled to obtain several additional arguments. Copyright arising from a settlement reflect the a compulsory license under [17 U.S.C. Owners emphasize that the purpose of statutory principles set forth in section 115(a)(1)]’’ and ‘‘licenses’’ covering their benchmarking approach is to avoid 801(b)(1), then the Judges may adopt the ‘‘digital phonorecord deliveries.’’ Id. the distortions of the shadow, by provisions of that settlement if it is Thus, it is beyond dispute that Congress utilizing the unregulated sound superior to the evidence submitted in has authorized the Judges, in their recording agreements between labels support of alternative rates and terms. discretion, to consider such agreements and interactive streaming services and as evidence, notwithstanding the then applying a ratio of sound recording With regard to the alleged impact of argument that the compulsory license to musical works royalties, also in the shadow, Professor Katz offers a may cast a shadow over those unregulated contexts, to develop a perspective. He opines that the so-called agreements. benchmark wholly free of the shadow shadow imbues licensees with Additionally, the Judges may consider cast by the statute. See Eisenach WDT countervailing power, to offset or the existing statutory rates themselves ¶¶ 34–40. The Judges agree that a mitigate the bargaining power of as evidence of the appropriate rate for strength of the Copyright Owners’ licensors who otherwise have the ability the forthcoming rate period. Indeed, the benchmarking approach is that it allows to threaten to ‘‘walk away’’ from Judges may consider existing rates as for the identification of marketplace negotiations and thus decimate the dispositive evidence when setting new benchmarks, so that the Judges can licensees’ businesses. 3/13/17 Tr. 661 rates. Music Choice, supra, 774 F.3d at ascertain whether there are analogous (Katz). The Judges find merit in this 1012 (the Judges may ‘‘use[ ] the markets from which statutory rates can perspective, because it underscores the prevailing rate as the starting point of be derived. fact that a purpose of the compulsory their Section 801(b) analysis’’ and may The Services’ experts discount the license is to prevent the licensor from shadow argument and, indeed, ultimately find that ‘‘the prevailing rate utilizing or monetizing the ability to essentially rely on the statutory rates in was reasonable given the Section 801(b) ‘‘walk away’’ as a cudgel to obtain a factors.’’). Of course, the fact that the subpart B and in subpart A as their better bargain. In this limited sense, the Copyright Act and the D.C. Circuit grant benchmarks. Professor Marx opines that agreements created under the so-called the Judges statutory authority to the statutory rates are superior in at consider statutory rates and related least one way, because they incorporate shadow thus are beneficial, to the extent agreements as evidence does not the elements the Judges must consider— that they provide one potential way in instruct the Judges as to how much both the market forces and the section which to offset the complementary weight to afford such agreements. The 801(b)(1) factors that are the bases for oligopoly power of the record exercise of that judicial discretion the statutory rates. 3/20/17 Tr. 1843–44, companies, especially the Majors. remains with the Judges. 1914 (Marx); see also 3/13/17 Tr. 575 Indeed, this countervailing power Further, there is no reason to find (Katz) (the shadow leads the parties to argument is consistent with the Judges’ such benchmark agreements per se meet the 801(b)(1) objectives). ‘‘shadow’’ analysis in Web IV, 81 FR, at inferior to other marketplace benchmark However, when the rates are the 26330–31 (noting the counterbalancing agreements that may be unaffected by product of settlements rather than a effect of the statutory license in the shadow, because the latter may be Determination by the Judges, they do establishing effectively competitive subject to their own imperfections and not reflect the Judges’ application of the rates).69 elements of section 801(b)(1). Rather, incompatibilities with the target market. Professor Leonard presents yet the settlement rates reflect (implicitly) Thus, the Judges must not only consider another perspective on the statutory (i) the importance, vel non, of any the parties’ predictions of how the benchmarks, arguing that the alleged ‘‘shadow-based’’ differences between Judges may apply such factors. shadow they cast acts as a ‘‘focal point’’ the regulated benchmark market and an Although the Judges reasonably can, around which parties negotiate, with the unregulated market; but also (ii) how and do, accept the parties’ those differences (if any) compare to the understanding of how market forces statutory license acting as either a differences (if any) between the shape their negotiations (indeed, ceiling or a floor. 3/15/17 Tr. 1263 unregulated market and the target economic actors’ agreements are part (Leonard). In a second-best market market (e.g., differences based on and parcel of the market),68 the Judges where price discrimination is complementary oligopoly power, cannot defer to any implicit economically appropriate, the bargaining constraints and product ‘‘mindreading’’ by the parties as to the continuation of a rate structure, over differentiation).67 Judges’ application of the elements of two rate cycles, might suggest the section 801(b)(1). Rather, the Judges parties’ acceptance of that structure as 67 The Judges note that one of the two have a duty to independently apply the an efficient ‘‘focal point,’’ absent benchmarking methods relied upon by Copyright statute. Accordingly, the Judges reject sufficient evidence to the contrary. Owners subtracts the statutory rate set in Web III the idea that rates and terms reached for noninteractive streaming from a royalty rate However, as the Judges noted in Web IV, derived from the unregulated market for sound through a settlement can be understood whatever theoretical appeal there may recording licenses between labels and interactive to supersede—or can be assumed to be in this focal point analysis (if any), streaming services. This would seem to violate the embody—the Judges’ application of the it cannot be credited as an independent Copyright Owners’ own assertion that statutorily set statutory elements set forth in section rates cannot be used to establish reasonable rates. basis for using an existing statutory rate, However, Copyright Owners’ expert testified that, absent ‘‘a sufficient connection between in his opinion, the Judges in Web III accurately an approach takes us back to the point the Judges theory and evidence.’’ Id. at 26630. identified the market rate for noninteractive made at the outset in this section: Any rate set by streaming, so that rate could be utilized as if it were the Judges or influenced by the Judges’ rate-setting set in the market. 4/4/17 Tr. 4643 (Eisenach). This process must be considered on its own merits. 69 The Shapley analyses conducted by Professors assertion proves too much. If one expert on behalf 68 For example, the Judges regularly assume that Marx and Watt also eliminate this ‘‘walk away’’ of a party may equate a rate set by the Judges with the parties have ‘‘baked-in’’ the values of promotion power by valuing all possible orderings of the the market rate, why cannot the Judges, or any other and substitution when agreeing to rates. See, e.g., players’ arrivals. See discussion, infra, section party’s expert, do the same? The end result of such Web IV, 61 FR at 26326. V.D.1.

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D. Greater-Of Percent of Revenue/TCC support the reasonableness of Google’s feature is unlawful because the Judges Rate Structure proposed rate structure, do not regulate performance rates. The In its revised rate proposal Google notwithstanding variations among the All-In feature does not constitute a presents an all-in royalty rate for all agreements and between many of the regulation of the performance rate, but service offerings set as the greater of agreements and Google’s rate proposal. rather represents a cost exclusion (or 10.5% of revenue and 15% of TCC. TCC At the time, Google was proposing a deduction) from the mechanical rate. is one metric used in computing structure that (like other of the Services’ The Judges and the parties recognize mechanical royalties under the 2012 proposals) largely followed the statutory that the royalties otherwise due under a rates and numerous direct licenses. In rate structure, but without a Mechanical revenue-based format may exclude the 2012 rate structure a percentage of Floor. Nevertheless, Dr. Leonard’s certain costs. See 73 CFR TCC is generally combined with analysis demonstrates that the 385.11(Definition of ‘‘Service Revenue,’’ 73 percentage of revenue in a greater-of marketplace supports a number of rate paragraph (3) therein). calculation, but is capped by a fixed structures, and that no single structure, Two of the proposed rate structures— per-subscriber royalty. See, e.g., 37 CFR or element of a structure, is the Services’ variations on the existing 385.13(a)(3), (b). A number of direct indispensable. The Judges find that Dr. structure and Google’s proposed licenses in the record mirror this Leonard’s analysis, and the marketplace structure—have the foregoing elements. approach, or directly incorporate the benchmarks that he relies on, support Of those two, the Judges find that terms of 37 CFR part 385. See, e.g., the rate structure that Google proposes Google’s proposal is superior for the Leonard AWDT ¶ 54 (describing royalty in its amended rate proposal. following reasons. calculation methodology in direct First, the use of an uncapped TCC E. Judges’ Conclusion Concerning Rate metric is the most direct means of licenses between [REDACTED] and Structure several music publishers, including implementing a key finding of the In their rate determination [REDACTED], [REDACTED], and Shapley analyses conducted by experts proceedings, the Judges are informed, [REDACTED]; License Agreement for participants on both sides in this but not bound, by the parties’ proposals. between [REDACTED] and proceeding: The ratio of sound The Judges’ task is to analyze the record [REDACTED], Trial Ex. 749, at ¶ 6(a) recording royalties to musical works evidence and determine a rate structure ([REDACTED]). royalties should be lower than it is Several direct licenses between and rates that are reasonable, even under the current rate structure.74 [REDACTED] and music publishers base though they might vary from any one Incorporating an uncapped TCC metric royalties on a straight, uncapped 70 party’s proposals. Weighing all the into the rate structure permits the percentage of TCC, with no ‘‘greater-of’’ evidence and based on the reasoning in Judges to influence that ratio directly.75 prong. See, e.g., Music Publishing this Determination, the Judges conclude Second, an uncapped TCC prong Rights Agreement between [REDACTED] that a flexible, revenue-based rate effectively imports into the rate and [REDACTED], Trial Ex. 760, at structure is the most efficient means of structure the protections that record ¶ 5(a) (all-in mechanical rate of facilitating beneficial price companies have negotiated with discrimination in the downstream services to avoid the undue diminution [REDACTED]% of TCC); accord Leonard 71 AWDT ¶ 64 (describing terms of market. The Judges, therefore, reject [REDACTED] direct licenses with music the per-play/per-user rate structures 73 The Judges recognize that the reduction of the proposed by the Copyright Owners and mechanical rate interim calculation by the amount publishers including [REDACTED], of the performance rate in ‘‘Step 2’’ (see [REDACTED], [REDACTED], Apple. The Judges also find that the All-In § 385.12(b)(2)), acts as an exclusion from royalties [REDACTED], and [REDACTED]). Still rather than a deduction from revenue (by analogy, rate is a necessary and proper element other direct licenses include an just as a tax credit is a subtraction from taxes, of a mechanical rate determination and uncapped TCC metric in a three- whereas a tax deduction is a subtraction from conclude it must remain in the rate income). However, there is no statutory or pronged ‘‘greater-of’’ calculation (along structure for the forthcoming rate regulatory impediment that prohibits this exclusion with percentage of revenue and a per- from royalties, especially given the economic period. Specifically, the Judges find that subscriber fee). See, e.g., [REDACTED] interrelationship between performance rights and the deduction of performance royalties Music Publishing Rights Agreement mechanical rights, discussed in the text infra. accounts appropriately for the perfect 74 The Shapley analyses are discussed infra, with [REDACTED], Trial Ex. 757, at complementarity of the performance section V.D. ¶ 4(a)(ii) and (iii). Some direct licenses 75 and mechanical licenses.72 The Judges Google notes, concerning its proposal, that the eschew TCC entirely and compute removal of a cap on TCC ‘‘does leave the services reject the argument that the All-In royalties as the greater of a percentage exposed to the labels’ market power, and would of revenue and a per-subscriber fee. See warrant close watching if adopted.’’ GPFF ¶ 73. 71 Rates based on a percent-of-revenue (even While true, Google fails to note that the services are Leonard AWDT ¶ 71 (describing terms without any alternative rate prongs) are themselves already exposed to the labels’ market power. Record of six agreements with [REDACTED]). a form of price discrimination. See J. Cirace, CBS companies could, if they so chose, put the Services Dr. Leonard, an expert for Google, v. ASCAP: An Economic Analysis of a Political out of business entirely. Uncapping the TCC rate reviewed and analyzed a number of Problem, 47 Ford. Rev. 277, 288 (1978); W.R. prong does not change that. Nor can any decision Johnson, Creative Pricing in Markets for Intellectual by this tribunal. While the possibility of the record direct licenses that Google and other Property, 2 Rev. Econ. Res. Copyrt., Issues 39, 40– companies using their market power in a way that services have entered into with muCsic 41 (2005). To the extent they incorporate revenue- harms the Services is a real concern, the Judges publishers for, inter alia, mechanical sharing in the underlying licenses between services cannot allow that concern to grow into a form of rights. Dr. Leonard found the and record companies, percent of TCC rates are also paralysis, where any change from the status quo is a form of price discrimination. deemed too dangerous to contemplate. Any increase agreements to be useful benchmarks due 72 As discussed infra, the fact that the in mechanical royalty rates, whether or not they are to the similarity of rights, parties, performance right and the mechanical right are computed with reference to record company economic circumstances, and time necessary complements to the licensees does not, royalties, has the potential of leading to a bad period. See 3/15/17 Tr. 1084 (Leonard). however, end the inquiry. As Copyright Owners outcome for the Services. Even maintaining the point out, the publishers use mechanical royalties status quo could lead to a bad outcome for the He found the direct agreements to in part to fund advances to songwriters or to assure Services, as it surely would for the songwriters and their subsequent recoupment. The Judges will, publishers. Ultimately the Judges must go where the 70 In other words, TCC is not part of a ‘‘lesser-of’’ therefore, retain the ‘‘Mechanical Floor’’ for the evidence leads them and, as with any economic calculation with another metric such as a per- upcoming rate period, to ensure the continuation of exercise, trust in the rational self-interest of the subscriber fee. this important source of liquidity to songwriters. market participants.

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of revenue through the practice of agreements that were reached outside to royalties from which they can recover revenue deferral.76 The Judges find that the context of litigation. They are thus their heating costs. Liquidity funding for the present record indicates that the free from trade-offs motivated by songwriters is a necessity, just as heat is Services do seek to engage to some avoiding litigation cost, as distinguished a necessity—the complementary nature extent in revenue deferral in order to from the underlying economics of the of the rights to the Services is of no promote their long-term growth strategy. transaction. The same cannot be said of relevance. A long-term strategy that emphasizes the existing rate structure. While both The Judges also reject Apple’s scale over current revenue can be are affected by the ‘‘shadow’’ of the argument that the Mechanical Floor rational, especially when a critical input compulsory license, the Judges find the should be eliminated because of the is a quasi-public good. Growth in voluntary agreements more informative potential for fragmented musical works market share and revenues is not of the behavior of market participants. licenses due to threatened publisher matched by a commensurate increase in The Judges adopt Google’s proposed withdrawal from PROs, and the creation the cost of such inputs, whose marginal rate structure for the foregoing of new PROs. The Services have offered cost of production, or reproduction as in reasons.79 However, the Judges modify no evidence that the introduction of the this case, is zero. It appears to the Google’s proposed rate structure by new PRO, Global Music Rights, will Judges that the nature of the including the Mechanical Floor from have any impact on the performance downstream interactive streaming certain configurations in the existing royalty rate. As confirmed by recent market, and its reliance on scaling for rate structure. The Mechanical Floor litigation, partial withdrawals are not success, results necessarily in a appropriately balances the Service’s permitted by the rate court, the Second competition for the market rather than need for the predictability of an All-In Circuit, or the Department of Justice. simply competition in the market.77 rate with publishers’ and songwriters’ There is no evidence of a trend of Revenue deferral argues against need for a failsafe to ensure that increasing performance rates. Fractional adopting a pure percent-of-revenue rate mechanical royalties will not vanish (a/k/a fragmented) licensing has always structure. either through the actions of the been present in the market. See CORPFF Third, in the absence of Congressional Services or the PROs and the Rate Court. at pp. 87–90 (and record citations guidance as to the meaning of a Testimony of publishers and therein). ‘‘reasonable rate,’’ the Judges determine songwriters has established the critical Finally, the Judges reject Google’s that, as a matter of policy, transparency role that mechanical royalties play in proposed rates within that structure. and administrative rationality are making songwriting a viable Google’s proposed rates are derived factors in determining whether a rate is profession.80 from the subpart A benchmark that the ‘‘reasonable.’’ Those who pay and The Judges reject the Services’ Judges have rejected. See GPFF ¶¶ 21, receive royalties, those who calculate arguments for eliminating the 26–30.81 The Judges look elsewhere in the royalties, and those (like the Judges) Mechanical Floor. For example, the the record for reasonable percent-of- who are sometimes called upon to Judges find the Services’ argument that revenue and TCC rates to use in the two interpret the regulations implementing the mechanical right has no standalone prongs of Google’s proposed greater-of the royalties, are best served by a rate value to be incomplete and, to an extent, rate structure. structure that is understandable and self-serving. To the music publishers The Judges’ adoption of a Mechanical administrable. Absent compelling and songwriters, the mechanical right Floor for the selected streaming services reasons to adopt a more complex rate does have a value in the funding of satisfies the objectives of section structure (which are not present in the songwriters, a value not provided by the 801(b)(1). The Mechanical Floor offers record), simpler is better.78 Google’s performance royalty. By analogy, the protection for Copyright Owners, thus proposed rate structure reduces the cost of any publisher input, not just the maximizing the availability of creative Rube-Goldberg-esque complexity and cost of providing liquidity to works to the public. The ‘‘safety net’’ of impenetrability of the existing, songwriters, such as, for example, the the Mechanical Floor assures a fair settlement-based rate regulations. In cost of heating the buildings in which return to Copyright Owners, serving as particular, it merges ten separate rates songwriters toil, has no standalone a counterweight to the All-In rate, for different service offerings into a value to the Services, yet no one would without an unfair impact on the income single rate that would apply to all assert that the licensors are not entitled of the copyright users. The balanced service offerings, thus avoiding the protection of the songwriter’s livelihood potential for confusion and conflict as 79 The Copyright Owners have two overarching afforded by the Mechanical Floor new service offerings emerge that do not objections to Google’s revised rate proposal. The recognizes the contribution of musical fall neatly into any of the existing first is a procedural objection: Google’s revised works to all music delivery proposal was submitted after all evidence was taken categories. and the Copyright Owner’s had no opportunity to mechanisms. Finally, the current Fourth, Google’s proposed rate cross-examine any witness about it. See CO Reply regulations include Mechanical Floor structure is supported by voluntary to GPFF at 1–2, 18. Google was entitled, under the rates; the Judges’ retention of those rates Judges’ procedural regulations, to change its rate for streaming services is not disruptive proposal up to, and including, the filing of 76 See 4/6/17 Tr. 5215–16 (Leonard); see also to the music industry. GPFF ¶ 73 (arguing that ‘‘removing the caps allows proposed findings and conclusions. 37 CFR the TCC prong to flexibly protect against downside 351.4(b)(3). Google did so—at the Judges’ request. In the Owners’ Motion, the Copyright risks associated with revenue deferment, See 4/13/17 Tr. 6019. The Judges find no merit in Owners argued that the Judges’ displacement, or attribution issues.’’). the Copyright Owners’ procedural objection. elimination of a subscriber-based 77 This is the form of dynamic competition known The Copyright Owners also argue that Google’s minimum fee for paid locker services as Schumpeterian competition (named after the revised rate proposal is without evidentiary economist Joseph Schumpeter). Such competition support. See, e.g., CO Reply to GPFF at 2, 15–18. and limited downloads could only have emphasizes the importance of the dynamic creation The Judges do not rely on Google’s proposed been an oversight. For all the reasons of new markets and ‘‘new demand curves,’’ findings. Rather, the Judges rely upon the evidence detailed in the Judges’ Order on the recognizing that short-term profit or revenue in the record they deem relevant and persuasive. motions for clarification, the Judges’ maximization may be inconsistent with the The Judges have found sufficient evidence to rationality of competing for the market in this support the rate structure, and the rates within that decision was purposeful. Paid locker manner. structure, as detailed in this Determination. The 78 ‘‘There is beauty in simplicity.’’ 3/23/17 Tr. at Determination speaks for itself. 81 The subpart A benchmark is discussed infra, 2855 (Ghose). 80 See infra, section VI.A. section V.B.3.

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services and limited offerings are intellectual property rights which are which sound recording and musical licensed uses that are of a nature totally subject to compulsory licenses is to works rights are both required in order different from other streaming services. examine market-based valuations of to ascertain the relative value of the two The existing regulations treated them reasonably comparable benchmark rights as actually reflected in the differently and afforded them an rights—that is, fair market valuations marketplace.’’ Id. (emphasis added). alternative minimum royalty. The determined by voluntary negotiations.’’ Through this examination, Dr. existing minimum for these services was Eisenach WDT ¶ 8 (emphasis added). In Eisenach concluded that these proposed not a Mechanical Floor. selecting potential benchmarks, Dr. benchmarks ‘‘establish upper and lower Eisenach identified what he understood bounds for the relative value of sound V. Determining Royalty Rates to be key characteristics’’ that would recording and musical works rights . . . Establishing a rate structure resolves make a benchmark useful: estimate[d] to be between 1:1 and only one aspect of the overall rate ‘‘[U]nderlying market factors . . . ; the 4.76:1.’’ Id. To make these ratios more determination. The next issue for the term or time period covered by the instructive, the Judges note that the Judges to decide is the setting of rates agreements; factors affecting the relative inverse of these ratios (e.g., 1:4.76 within the appropriate rate structure. In bargaining power of the parties; and instead of 4.76:1) can be expressed as a that regard, it is noteworthy that several differences in the services being percentage. Thus, the ratio of 1:4.76 is of the Services’ expert economists have offered.’’ Id. ¶ 80. equivalent to a statement that musical asserted that, although the 2012 rate Dr. Eisenach found useful the license works royalties equal 21% of sound structure is an appropriate benchmark, terms for the sound recording rights recording royalties in agreements struck the rates within that structure should be utilized by interactive streaming in the purported benchmark market. 82 modified. Thus, the Judges must services, because they are negotiated More obviously, the 1:1 ratio means consider the record evidence that relates freely between record companies (a/k/a that, in agreements within that to the rates themselves in order to labels) and the interactive streaming purported benchmark market, musical determine the rates to be set for the services. Id. These rates made attractive works royalties equal 100% of sound forthcoming rate period within the price inputs for his analysis because they: (1) recording rates. By converting the ratios discriminatory rate structure. Relate to the same composite good—the into percentages, it is easier to see that A. Rejection of the Copyright Owners’ sound recording that also embodied the the high end of Dr. Eisenach’s Approach musical work; and (2) the interactive benchmark range is almost five times as streaming service licensees were the large as the low end of the range. Copyright Owners proposed a single same licensees as in this proceeding. per-unit rate (in their greater-of format). Thus, to an important degree, Dr. b. Dr. Eisenach’s Potential Benchmarks They did not propose a set of different Eisenach found these agreements to Dr. Eisenach considered a variety of rates (per-unit or otherwise), that would possess characteristics similar to those benchmark categories in which the be applicable to a rate structure similar in the mechanical license market at licensee was obligated to acquire to the 2012 rate structure. Thus, the issue in this proceeding. Moreover, Dr. licenses for musical works and licenses Judges consider the benchmarking Eisenach found that ‘‘[d]ata on the for sound recordings. His selection and approach undertaken by Copyright royalties paid under these licenses are consideration of each category of Owners for the purpose of determining available and allow . . . estimat[ion of] benchmark markets are itemized below. whether any portions of their the rates actually paid by the benchmarking exercise provides [interactive] streaming services to the i. The Current Section 115 Statutory evidence of rates that the Judges should labels for sound recordings on both a Rates properly incorporate into the per-play and a per-user basis.’’ Id. The current statutory rate structure differentiated rate structure they are However, as Dr. Eisenach noted, these contains several alternate rates adopting in this determination. benchmark agreements related to a explicitly calculated as a percentage of Copyright Owners’ proposal for a per- different right—the right to a license of payments made by interactive streaming unit rate is based on an overarching sound recordings—not the right to services to the record companies for premise: A single musical work has an license musical works broadly, or to the sound recording rights. Such rates are ‘‘inherent value.’’ See, e.g., Israelite mechanical license more specifically. identified in the industry as the ‘‘TCC’’ WDT ¶¶ 29, 31, 33, 48; Herbison WDT Thus, as with any benchmark that does rates, an acronym for ‘‘Total Content ¶ 35; Brodsky WDT ¶ 68. To make that not match-up with the target market in Cost.’’ Id. ¶ 82.84 In the subpart B principle operational, Copyright Owners 83 all respects, Dr. Eisenach had to category, the TCC is 22% for ad- presented a benchmarking analysis examine how the rates set forth in the supported services and 21% for portable through Dr. Eisenach, one of their benchmark agreements for interactive subscriptions. Id.; see also 37 CFR economic expert witnesses. streaming of sound recordings could be 385.13(b)(2) and (c)(2).85 These 1. Dr. Eisenach’s Methodology utilized. Id. More particularly, Dr. percentage figures correspond to sound Eisenach posited that there may be a a. Benchmarking recording to musical works royalties of relationship (or ratio) between the 4.55:1 and 4.76:1, respectively. Dr. Eisenach sought to identify sound recording royalty rate and the Dr. Eisenach notes that these statutory benchmarks that support Copyright musical works royalty rate. To that end, rates were not set by the Judges Owners’ per-play and per end-user rate he ‘‘examine[d] a variety of markets in pursuant to a contested hearing, but for the mechanical license. He began by rather reflect two settlements, one in noting that ‘‘an economically valid 83 The lack of a perfect identity is essentially tautological. If a ‘‘benchmark’’ was identical to the approach for assessing the value of 84 target market, it would be the target market. The This rate prong is sometimes identified as issue for economists and for the Judges is to identify ‘‘TCCi,’’ which is an acronym the parties adopted 82 To be sure, those Services’ witnesses advocated the differences, weigh the importance of those for ‘‘Total Content Cost Integrity.’’ for a reduction in the rates, but their differences, and then either rely on the benchmark, 85 Lower percentages apply if the record acknowledgement that the usefulness of the 2012 reject or adjust the benchmark so that it is companies’ revenue includes revenue to be ‘‘passed structure does not ipso facto demonstrate the probative, or find that the proffered benchmark is through’’ by them to pay mechanical license appropriateness of the 2012 rates is a general point so inapposite that it, even with any proffered royalties. However, according to Dr. Eisenach, such that the Judges readily accept. adjustments, it must be disregarded. ‘‘pass-throughs’’ are not typical. Id. at 82 n.67.

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2008 and the other in 2012. Id. ¶ 83. According to Dr. Eisenach, the Dr. Eisenach finds this 1:1 However, Dr. Eisenach discounts the similarity of these direct contract rate relationship to be important benchmark value of these settlement rates for three ratios to the statutory ratios reflects the evidence, concluding: reasons. First, he notes that they were ‘‘shadow of the statutory license,’’ by The synch and micro-sync examples established prior to the ‘‘marketplace which direct negotiations between confirm that in circumstances in which success’’ of Spotify in the interactive parties regarding rights that are subject licensees require both sound recording and streaming industry.86 Second, he notes to (or can be fashioned to be subject to) musical composition copyrights in order to that the settlements, although voluntary, a statutory license are influenced by the offer their service, and where that service is ‘‘were negotiated under the full shadow presence of statutory compulsory rates not entitled to a compulsory license for either and/or the prospect of a future rate right, the sound recording rights and the of the compulsory license.’’ Third, he musical composition rights are in many cases finds that, although the settlement proceeding. 4/4/17 Tr. 4591 (Eisenach) equally valued, that is, the ratio of the two incorporates rate prongs based on a (‘‘The underlying problem with looking values is 1:1. percent of sound recording rates (the at an agreement negotiated under the Id. ¶ 98. TCC prongs), those provisions are part shadow of a license’’ is that [i]t shifts of a ‘‘lesser of’’ segment of the rate bargaining power from the compelled iv. YouTube Agreements structure, and thus capped by party to the uncompelled party by the 87 Dr. Eisenach also examined licenses alternative per subscriber rates. Id. & very nature of the exercise.’’). between: (1) YouTube (owned by Given these limitations, Dr. Eisenach n.70. Thus, Dr. Eisenach concludes: ‘‘In Google) and record companies; and (2) concluded, as he did with regard to the my opinion, the evidence . . . indicates YouTube and music publishers, to actual section 115 rates licenses, that that the relative valuation ratios implied determine their potential usefulness as ‘‘[i]n my opinion, the evidence by the current section 115 compulsory benchmarks. He noted that they provide license . . . represent an upper bound presented . . . indicates that the relative further insight into the relative value of on the relative market valuations of the valuation ratios implied by the . . . sound recordings and musical works. sound recording and musical works negotiations under [the statutory] He added that, because these licenses rights.’’ Id. ¶ 92 (emphasis added). (As shadow—ranging from 4.2:1 [23.8%%] also include [REDACTED] (which, he an ‘‘upper bound,’’ these ratios would to 4.76:1[21%]—represent an upper noted, are not [REDACTED] uses) these represent the lower bound of the bound on the relative market valuations rights are partially outside the reciprocal percentage of the value of the sound recording and musical purported shadow of compulsory musical works rights relative to sound works rights.’’ Eisenach WDT ¶ 92. licensing. Moreover, these agreements recording rights, again, 21% and 22%.). iii. Synchronization Agreements essentially grant to YouTube The Judges note that Dr. Eisenach Synchronization (Synch) agreements [REDACTED], analogous to the provision of on-demand streaming by identifies the 21% and 22% TCC rates are agreements by audio-video the interactive services licensed under within the current rate structure. Thus, producers, such as movie and television subpart B. Additionally, Dr. Eisenach for example, if the sound recording producers, with, respectively, music noted that these YouTube agreements royalty rate for interactive streaming is publishers and record companies, met certain standards for a useful 60% of revenue, then, using these TCC allowing for the use, respectively, of the benchmark, viz. the parties, the figures, the implied musical work musical works and the sound recordings domestic (U.S.) market and the time royalty rate is calculated as 12.6% of in ‘‘timed synchronization’’ with the × period all correspond to the parties, revenue (.21 .60) (a ratio of 4.76:1), or movie or television episode. See × market and time period involved here. 13.2% (.22 .60) (a ratio of 4.5:1). generally D. Passman, All you Need to Id. ¶ 100. For these reasons, Dr. Again, because Dr. Eisenach opines that Know About the Music Business 265 Eisenach concluded that ‘‘for purposes these are upper bounds on the relative (9th ed. 2015). Dr. Eisenach found these of assessing the relative value of the market valuations,’’ that is the Synch Agreements to be a mixed bag in sound recording and musical works equivalent of opining that they terms of their value as a benchmark. On rights, the YouTube agreements represent the lower bound of a the one hand, he recognized that the represent reasonably comparable percentage-based royalty calculated via licenses they conveyed ‘‘do not apply to benchmarks for the purpose of assessing this ratio approach. music streaming services as such’’ but, the relative value of sound recordings on the other hand, they ‘‘are negotiated ii. Direct Licenses Between Parties and musical works rights.’’ Id. completely outside the shadow of the Potentially Subject to a Section 115 In his original Written Direct compulsory license. . . .’’ Id. ¶ 93. Dr. Compulsory License Testimony, Dr. Eisenach relied upon Eisenach notes, from his review of other seven agreements between YouTube and Dr. Eisenach also examined direct testimony and an industry treatise, that several music publishers pertaining to agreements between record companies these freely negotiated market [REDACTED]. Id. ¶ 101 n.93. In those and interactive streaming services that agreements grant the musical [REDACTED] agreements, Dr. Eisenach contained rates for sound recordings composition royalty payments equal to found that publishers receive and mechanical royalties, respectively. the corresponding royalty paid for the [REDACTED] when the video is See, e.g., id. ¶¶ 84–91. In such cases, the sound recording,’’ which is the [REDACTED]. However, with regard to ratio of sound recording to musical equivalent of a 1:1 sound recording to the revenue received by the record works royalties ranged tightly between musical works ratio.88 Id. ¶¶ 94–95 & companies, Dr. Eisenach could only 4.2:1 and 4.76:1, closely tracking the nn.87, 88. regulatory ratios implicit in the section speculate based on public reports as to the percent of revenue received by the 115 TCC. Id. ¶ 92. (The 4.2:1 ratio 87 The Judges discuss the issue of the ‘‘shadow’’ equates to a TCC rate of 23.8%, and the of the statutory license in section IV.C.3. record companies for the sound 4.76:1 ratio equates to a mechanical rate 88 Dr. Eisenach finds this 1;1 ratio to be present of 21%.). in the two types of Synch agreements he identified. ‘blanket’ synch licenses, in that the license grants One version represents an agreement relating to a the right to synchronize not just one particular song specific musical work and sound recording . . . but any song in the publisher’s catalog (or a 86 Spotify was launched in the United States in combination. The other version, a ‘‘Micro-Synch’’ significant portion thereof). . . .’’ Eisenach WDT the summer of 2011. See 3/20/17 Tr. 1778 (Page). agreement, which he describes as ‘‘essentially ¶ 96.

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recordings embedded in the posted in those direct agreements might not be [REDACTED]% noted above for actual YouTube videos. Id. ¶ 102. Thus, he was subject to rate court review.89 agreements in force in 2018 to unable to make an informed argument Given this phenomenon, and given [REDACTED]%, almost a in his original written testimony that the markets and parties involved in [REDACTED]% [REDACTED] based on regarding the ratio of sound recording the Pandora agreements are somewhat the extrapolation alone. Id. ¶¶ 104; 128 royalties to music publisher royalties in comparable to the markets and parties at & Table 8, Fig. 13. (This [REDACTED]% 90 his YouTube [REDACTED] benchmark issue in this proceeding, Dr. Eisenach ratio would correspond to a musical analysis. concluded that these agreements works rate of [REDACTED], assuming provided ‘‘significant insight into the the sound recording rate is 60%.) However, after the Judges compelled relative value of the sound recording However, the assumption behind Dr. Google to produce in discovery copies and musical works rights in this Eisenach’s regression was not borne out. of the YouTube agreements with the proceeding.’’ Id. In 2015, the Second Circuit Court of record companies, Dr. Eisenach filed Dr. Eisenach compared the musical appeals affirmed a 2014 decision by the (with the Judges’ approval) works rates in these ‘‘opt-out’’ Southern District of New York, Supplemental Written Rebuttal agreements with the sound recording prohibiting such partial withdrawals. In Testimony (SWRT) addressing these royalty rates paid by Pandora, which he re Pandora Media, 785 F.3d 73, 77–78 agreements. In that testimony, Dr. obtained from the revenue disclosures (2d Cir. 2015), aff’g 6 F. Supp. 3d 317, Eisenach examined 49 YouTube in Pandora’s Form 10K filed with the 322 (S.D.N.Y. 2014). Subsequently, in licenses with eight record labels and SEC that provided royalties (‘‘Content August 2016, the Department of Justice four form agreements (under which Costs’’) as a percent of revenue, and he issued a statement announcing that, approximately 1,350 independent labels also relied on data contained in prior consistent with these judicial decisions, are actively licensed), spanning the rate court decisions. Eisenach WDT it would not permit partial withdrawals period 2012 to 2019. Eisenach SWRT ¶ 6 ¶ 125 & Table 6. With this data, he under the existing consent decrees. See & n.5. Dr. Eisenach identified nine of calculated that the ratio of sound Eisenach WDT ¶ 114, n.109. Moreover, these licenses specifically in his SWRT, recording: Musical works royalties in there were actual Pandora ‘‘Opt-Out’’ and noted that YouTube paid to existing agreements was [REDACTED]:1 agreements that set rates through 2018 for 2018, i.e., the musical works rate [REDACTED] for sound recordings in a that established a sound recording to equaled [REDACTED]% of sound [REDACTED]—which Dr. Eisenach musical works ratio of [REDACTED]:1, recording royalties. This [REDACTED]% found to be the comparable YouTube that Dr. Eisenach chose to disregard in ratio would correspond to a mechanical favor of his extrapolated lower ratio. category—whereas the [REDACTED] rate of [REDACTED], assuming, received [REDACTED]. Id. & Table 1. Having calculated these five arguendo, the sound recording rate is benchmarks, Dr. Eisenach applied them As Dr. Eisenach accurately calculated, 60%. in two separate methods to estimate the the [REDACTED] revenue split reflects a Dr. Eisenach also made an estimation mechanical rate to be adopted in this ratio of [REDACTED]:1, (a musical and forecast, linking the passage of time proceeding. works rate equal to [REDACTED]% of to an assumption that after the Rate the sound recording rate), whereas the Court proceedings concluded (and all c. Dr. Eisenach’s Ratio Equivalency [REDACTED] revenue split reflects a appeals were exhausted) the parties, Approach ratio of [REDACTED]:1 (a musical works without further legal uncertainty, would Dr. Eisenach testified that ‘‘[f]or music rate equal to [REDACTED]% of the permanently be ‘‘permitted to negotiate users that require both sound recording sound recording rate). freely outside of the control of the rate rights and musical works rights, the two courts.’’ He made this estimation and sets of rights can be thought of in v. The Pandora ‘‘Opt-Out’’ Deals forecast through a temporal linear economic terms, as perfect complements regression, extrapolating from the prior in production: Without both inputs, Dr. Eisenach also examined certain [REDACTED] in these Pandora ‘‘opt output is zero.’’ Id. ¶ 76 (emphasis direct licensing agreements entered into out’’ musical works rates. See Eisenach added).91 Dr. Eisenach also notes that, between Pandora and major music WDT ¶ 129. Dr. Eisenach’s linear ‘‘for interactive streaming services, the publishers from 2012 through 2016, to regression further [REDACTED] the ratio two categories of rights [sound determine whether they constituted to [REDACTED], which would be recordings and musical works] are useful benchmarks in this proceeding. equivalent to [REDACTED] the musical further divided into a reproduction Id. ¶ 103. Pandora had negotiated these works rate, as a percentage of sound license [i.e., the mechanical license] and direct agreements with major publishers recording royalties, from the a performance license . . . .’’ Id. (Thus, for musical works rights after certain the mechanical license and the publishers had decided to ‘‘opt-out,’’ 89 The ‘‘rate court’’ is a short-hand reference to performance license likewise are perfect i.e., to withdraw their digital music the proceedings before designated judges in the U.S. District Court for the Southern District of New York, complements with each other and with performance rights from performance who set performance royalty rates, pursuant to the sound recording license.) rights organizations (PROs), and existing consent decrees between the U.S. asserted the right to negotiate directly Department of Justice and, respectively ASCAP and 91 Google’s economic expert, Dr. Gregory Leonard, with a digital streaming service. As Dr. BMI. made an important qualification regarding this 90 At the relevant time, Pandora operated a point: At the time a musical work is selected by a Eisenach acknowledges, the music noninteractive service and only paid the label for recording by an artist, ex ante recording, publishers’ legal right to withdraw these performance right royalty, not the mechanical right the label can choose among competing and rights remained uncertain during that royalty, for the right to use musical works. Because substitutable musical works. Thus, it is only ex post five year period. Nonetheless, Pandora the parties agree that the performance right and the recording that the particular musical work that had mechanical right are perfect complements, actually been selected is necessary to create a level negotiated several agreements with an Pandora’s payments for the performance right are of output (and value) greater than zero. 4/5/17 Tr. understanding that the rates contained relevant and probative. 5180–81 (Leonard).

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Dr. Eisenach acknowledges that [t]he but, Dr. Eisenach finds the royalties set MRMW = Mechanical Rate for Musical Works relative value of sound recording [to] by the Judges in Web III to reflect a SRIS = Sound Recording Rate for Interactive musical works licenses may depend on market rate. 4/4/17 Tr. 4643 (Eisenach); Streaming (All In) a variety of factors, and traditionally the see also Eisenach WDT ¶ 136 & n.123. SRNIS = Sound Recording Rate for Non- relationship has differed across different Interactive Streaming (Performance 3. The interactive streaming services Only) types of services and situations.’’ Id. require a mechanical license (the license RVSR/MW = Relative Value of Sound ¶ 78. Dr. Eisenach eschewed at issue in this proceeding), whereas the Recording to Musical Works Rights. unnecessary ‘‘assumptions, noninteractive services are not required complexities and uncertainties to obtain a mechanical licenses.92 Eisenach WDT ¶ 140. associated with theoretical debates’’ as 4. According to Dr. Eisenach, the Dr. Eisenach determined the per play to why the particular existing market difference between the rates paid by rate paid by interactive services by ratios existed. Id. ¶ 79. Rather, instead of interactive services and non-interactive identifying certain services and ‘‘put[ting] forward a general theory of services for their respective sound ‘‘tally[ing] the total payments . . . and relative valuation,’’ he found it recording licenses equals the value of divid[ing] by the total number of ‘‘sufficient . . . to assume that the the remaining license, i.e., the interactive streams the service reports.’’ relative values of the two rights should mechanical license. Id. ¶ 137 (‘‘[T]he Id. ¶ 148. The average sound recording be stable across similar or identical difference between these two rights is per play royalty calculated by Dr. market contexts.’’ Id. akin to a ‘mechanical’ right for sound Eisenach was $[REDACTED] (or recordings, directly paralleling the $[REDACTED] per 100 plays), when d. Dr. Eisenach’s Two Methods for excluding [REDACTED]. Id. Table 11.94 Estimating the Mechanical Rate mechanical right for musical works in this proceeding.’’).93 The final inputs for Dr. Eisenach’s i. Method #1 5. The mechanical rate implied by Method #1 have already been identified, i.e., the $0.0020 per play (or $0.20 per Dr. Eisenach’s Method #1 for this difference in sound recording rates must be ‘‘adjust[ed] for the relative 100 plays) royalty rate estimated for estimating the mechanical rate is based noninteractive streaming, and the on the following premises: value of sound recordings [to] musical works’’ (as discussed supra). Id. ¶ 140. several benchmark ratios of sound 1. The sound recording royalty paid Dr. Eisenach combines these steps recording: Musical works royalties in by interactive streaming services is the markets selected by Dr. Eisenach. unregulated and thus negotiated in the and expresses his Method #1 in the form of an algebraic equation: After Dr. Eisenach inserted the foregoing marketplace. Eisenach WDT ¶ 16. data into the algebraic expression set ¥ 2. The sound recording royalty paid MRMW = (SRIS SRNIS)/RVSR/MW, forth above, he presented his data in the by noninteractive services is regulated, Where following tabular form: MUSICAL WORKS MECHANICAL PER 100 PLAYS RATE CALCULATION [Method 1]

SRIS per 100 SRNIS per 100 Difference RVSR/MW MRMW per 100

(1) (2) (3) (4) (5)

$[REDACTED] ...... $0.20 $[REDACTED] ...... 1:1 ...... $[REDACTED]. $[REDACTED] ...... 0.20 $[REDACTED] ...... [REDACTED]:1 ...... $[REDACTED]. $[REDACTED] ...... 0.20 $[REDACTED] ...... [REDACTED]:1 ...... $[REDACTED]. $[REDACTED] ...... 0.20 $[REDACTED] ...... [REDACTED]:1 ...... $[REDACTED]. $[REDACTED] ...... 0.20 $[REDACTED] ...... 4.76:1 ...... $[REDACTED].

See id., Table 12.95 Thus, applying his Method #2 ‘‘derive[s] an All-In musical Id. five potential benchmark ratios, Dr. works value based on the relative value Dr. Eisenach calculates PRMW, as an Eisenach determined that the of sound recordings to musical works average of $[REDACTED] per 100 plays mechanical works royalty rate the and then remove[s] the amount of for the licensees that he included in his Judges should set in this proceeding public performance rights paid for data analysis. Id. ¶ 156, Table 13. ranged from $[REDACTED] per play to musical works, leaving just the Applying all the inputs across the $[REDACTED] per play (see column (5) mechanical rate.’’ Id. ¶ 142. The above, dividing by 100 to reduce the algebraic expression for Method #2 is: various benchmark ratios, the results rate from ‘‘per 100’’ to per play). from Dr. Eisenach’s Method #2 can also MRMW = (SRIS/RVSR/MW) ¥ PRMW, be depicted in tabular form, as set forth ii. Method #2 Where PRMW is the public performance below: Dr. Eisenach describes his Method #2 royalty rate for musical works, and the as an alternative method of deriving a other variables are as defined and market-derived mechanical royalty. His described in Method #1.

92 The affected industries have agreed through deriving the mechanical rate implied by his benchmarking approach and the criticisms levelled settlements that interactive services pay mechanical analysis (as noted in the subsequent step), and the by the Services. royalties but noninteractive services do not. See Judges choose to consider the final rate developed 95 Dr. Eisenach testified that the [REDACTED]:1 Parness WDT ¶ 7. No party in the present by Dr. Eisenach in Method #1 as the ‘‘implied ratio should be revised [REDACTED] to proceeding has sought a mechanical license rate for mechanical rate’’ he advances through this method. noninteractive services. [REDACTED]:1, to reflect the sound recording 94 93 Dr. Eisenach refers at times to this difference Dr. Eisenach’s decision to rely on a per play royalty rates in the [REDACTED] licenses he in sound recording royalties as the ‘‘implied value calculation that excluded [REDACTED] and all of examined after the Judges compelled [REDACTED] of the mechanical right.’’ See, e.g., id. ¶ 138. Dr. Eisenach’s challenged data selections, are to produce [REDACTED]’s agreements with record However, this difference is only an input for discussed infra in the Judges’ analysis of his companies.

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MUSICAL WORKS MECHANICAL PER 100 PLAYS RATE CALCULATION [Method 2]

SRIS RVSR/MW Ratio adj. (Avg.) PRMW MRMW (1) (2) (3) = (2) × (1) (4) (5)

$[REDACTED] ...... 1:1 ...... $[REDACTED] ...... $[REDACTED] ...... $[REDACTED]. $[REDACTED] ...... [REDACTED]:1 ...... $[REDACTED] ...... $[REDACTED] ...... $[REDACTED]. $[REDACTED] ...... [REDACTED]:1 ...... $[REDACTED] ...... $[REDACTED] ...... $[REDACTED]. $[REDACTED] ...... [REDACTED]:1 ...... $[REDACTED] ...... $[REDACTED] ...... $[REDACTED]. $[REDACTED] ...... 4.76:1 ...... $[REDACTED] ...... $[REDACTED] ...... $[REDACTED].

See id., Table 14. However, the data that Dr. Eisenach compromises the value of rates set After considering all of his identified was not sufficiently clustered therein as useful benchmarks for an benchmarks from both of his methods, to establish a predictive ratio within the ‘‘effectively competitive’’ market. In Dr. Eisenach concluded that ‘‘the data set. That is, the problem does not Web IV, the Judges were provided with YouTube and Pandora [Opt Out] lie in the analysis, but rather in the evidence of the ability of noninteractive agreements represent the most implications from the data regarding services to steer some performances comparable and reliable benchmarks, ratios of sound recording royalties to toward recordings licensed by record implying ratios of [REDACTED]:1 and musical works royalties. The Services companies that agreed to lower rates in [REDACTED]:1, respectively, with a make this very criticism, noting the exchange for increased plays. Here, the mid-point of [REDACTED]:1.’’ Id. ¶ 130 instability of the ratio across the several Judges were not presented with such (The Judges note that converting these markets in which Dr. Eisenach evidence, likely because an interactive end-points and mid-point of his range to identified potential benchmarks. See streaming service needs to play any TCC percentages results in a range from SJRPFF ¶ 241 (and record citations particular song whenever the listener [REDACTED]% to [REDACTED]% and a therein). Apple finds that the wide seeks to access that song (that is the mid-point of [REDACTED]%.) 96 range of ratios is unsurprising, because essence of an interactive service). Thus, 2. Analysis of Dr. Eisenach’s Benchmark Dr. Eisenach’s benchmarks do not relate the Judges have no direct evidence Methods to the same products and same uses of sufficient to apply a discount on the the two rights. Indeed, Apple’s interactive sound recording rate to a. Dr. Eisenach’s Ratio of Sound [REDACTED], confirming, according to adjust that potential benchmark in order Recordings-to-Musical Works Apple, that there is no fundamental to fashion an effectively competitive The Judges find Dr. Eisenach’s market ratio that can be applied in this rate, as required by the ‘‘reasonable attempt to identify comparable proceeding. Dorn WRT ¶¶ 6, 24, 28–29. rate’’ language in section 801(b)(1). benchmarks and corresponding ratios of To be sure, this point does not go sound recording rates to musical works unnoticed by Dr. Eisenach, who focuses b. Dr. Eisenach’s Specific Benchmarks rates to be a reasonable first step in on the royalty ratios arising from two i. Section 115 Benchmark seeking to identify usable benchmarks. potential benchmarks in the middle of The Services assert that Dr. Eisenach’s The Judges find potentially useful his his range—the Pandora ‘‘Opt-Out’’ calculation of a section 115 ‘‘valuation decision to rely on empirics over agreements and the User Audio ratio’’ of 4.76:1 is incomplete, because abstract theory, viz., that a tightly YouTube agreements. he limited this statutory ratio to the clustered set of ratios across several The Services assert an additional and 21% and 22%TCC prongs. They note markets would tend to support applying fundamental criticism of Dr. Eisenach’s that under the percentage-of-revenue a reasonably central tendency from approach. They note that his use of prong of section 115 (10.5%), this among those ratios to identify a ratio sound recording royalties paid by statutorily-derived ratio would have that could aid in the identification of interactive services embeds within his ranged between 5:1 and 6:1, see 4/5/17 97 the statutory rates. analysis the inefficiently high rates that Tr. 5152 (Leonard), implying a musical arise in that unregulated market through works rate equal to only 16.67% to 20% 96 Dr. Eisenach also calculates a per user rate, the complementary oligopoly structure using his Method #2. As he explains, ‘‘this is of sound recording royalty rates. The of the sound recording industry and the Judges agree that Dr. Eisenach’s accomplished by calculating All-In publisher Cournot Complements inefficiencies royalties on a per user basis and subtracting the statutory benchmarks would have been average effective per-user performance royalties to that arise in such a market. See more comprehensive if he had included publishers, leaving an appropriate rate for Corrected Written Rebuttal Testimony of mechanical royalties.’’ Id. ¶ 159. He finds that the the ‘‘valuation ratios’’ derived from this Michael L. Katz, Trial Ex. 886, ¶ 56; headline prong of the present royalty sound recording rate per user is $[REDACTED] (the Marx WRT ¶¶ 137–141; Hubbard CWRT per user analog to the $[REDACTED] per 100 plays rate structure. However, the fact that the in his per play analysis). Applying the same ratios ¶¶ 6.26–6.27; Leonard WRT ¶¶ 24, 44. existing rate structure, on which the and utilizing similar market data as in his per play The Judges agree with this criticism. Services rely in this proceeding, approach, Dr. Eisenach concludes that a The Judges explained at length in Web includes the potential use of the 21% ‘‘mechanical rate of between $[REDACTED] and IV how the complementary oligopoly $[REDACTED] per user reflects the range of relative and 22% prongs, demonstrates the nature of the sound recording market values for sound recordings and musical usefulness of this benchmark as a works. . . .’’ Id. ¶ 165. Finally, he notes that, at the representation of a rate the parties are [REDACTED]:1 ratio (his mid-point of the YouTube this regard, the Judges understand that Dr. Eisenach and Pandora benchmarks, the ‘‘mechanical only’’ was following a well-acknowledged principle of willing to accept. rate would be $[REDACTED] per user (greater than economic analysis, articulated by the Nobel laureate the $1.06 per user rate proposed by Copyright economist Milton Friedman, who famously ii. Direct Licenses Owners.) Id. eschewed excessive theorizing that failed to match The Services disagree with Dr. 97 Dr. Eisenach eschewed unnecessary the predictive power of empirical analysis. See M. ‘‘assumptions, complexities and uncertainties Friedman, The Methodology of Positive Economics, Eisenach’s minimization of the associated with theoretical debates’’ as to why the reprinted in D. Hausman, The Philosophy of relevance of this benchmark. They argue particular existing market ratios existed. Id. ¶ 79. In Economics at 145, 148–149 (3d ed. 2008). that the direct licenses between

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interactive services and music useful ‘‘[b]ecause of the large degree of market the sound recording of any given publishers ‘‘are by far the most directly its incomparability.’’ See Phonorecords musical work identified by the movie or apposite benchmarks used in Dr. I, 74 FR at 4519. The Judges find that television produce is a substitute good, Eisenach’s analysis,’’ because they, like nothing in the present record supports in competition with any other existing the section 115 rates and terms a departure from that prior finding. The or future sound recording of the same themselves, possess the characteristics lack of comparability remains because musical work for inclusion in the movie of a useful benchmark, viz. they: (1) Are the synchronization market differs in or television show. voluntary; (2) concern the same important economic respects from the iv. YouTube Licenses licensors/publisher; (3) relate to the streaming market. See Leonard WRT same market; and (4) pertain to the same ¶ 39. Because synch rights pertain to The Services disagree with Dr. rights. See Katz WDT ¶¶ 97–113; media such as music used in films or in Eisenach’s opinion that the YouTube Leonard AWDT ¶¶ 45–70; see also 4/5/ television episodes,98 the historical licenses on which he relies constitute 17 Tr. 5152 (Leonard) (noting that, for equal valuation of publishing rights and strong benchmarks. As an initial point, services paying under the percentage-of- sound recording rights arises from the they note that, from a statutory revenue prong under section 115 and particular conditions faced in those perspective, the video component of the based on prevailing sound recording industries. Id. Movie and television YouTube licenses renders those licenses rates, ‘‘[t]he ratio would be more like producers may have a certain musical inapposite as benchmarks in this . . . 5-to-1 to 6-to-1’’). work in mind as a good fit for a proceeding. See SJRPFF ¶ 249 (and The Judges find that these direct particular scene in the film. Id. record citations therein) (noting that licenses are as useful, if not more so, However, these producers have the YouTube’s ability to utilize the ‘‘safe than the 115 benchmark itself. The so- option of making their own sound harbor’’ provisions of 17 U.S.C. 512 called ‘‘shadow’’ of section 115 provides recording of that musical work, and for provides YouTube with strong a default rate for the licensing parties, this reason, cover songs are quite negotiating power against publishers so direct licenses that deviate in some common in films. Id.; see also Ex. 1069, and labels because the copyright holders manner from the rates in the statutory Marx WRT ¶ 149 (‘‘Both film and must identify unauthorized uploadings license are revealing a preference for television production companies have and issue ‘‘take down notices,’’ a other rates and terms that, at least the option of recording their own cumbersome and often futile process). marginally, are below the statutory rate. versions of songs, rather than paying The Judges agree that this statutory Thus, as the Services note, these royalties to use a pre-recorded provision significantly alters the bargaining landscape between the sound benchmarks are useful, because ‘‘these song.... This option gives the users of recording and the musical works agreements . . . were voluntarily synch rights, such as movie producers, licensors, on the one hand, and entered both in 2008 and 2012, by the more bargaining power relative to the very same publishers in the same YouTube as the licensee, on the other. labels than would be the case with The Services further maintain that, markets and for the same rights. . . .’’ streaming services.’’). Thus, the SJPFF ¶ 261 (and record citations even assuming YouTube licenses are contribution to value of the sound appropriate benchmarks, Dr. Eisenach therein). More generally, the Judges find ` recording is less vis-a-vis the musical has relied on the wrong type of that the so-called ‘‘shadow’’ of the work in the synch market. Leonard WRT statutory license on a benchmark does YouTube licenses for his benchmark ¶ 39. analysis. As noted, Dr. Eisenach not disqualify that benchmark as useful Additionally, in the case of evidence, though it goes to its weight. selected the agreements and rates synchronization rights, the marketplace pertaining to [REDACTED]. He selected iii. Synchronization Licenses for sound recording rights is more this type of YouTube contract because The Services also take issue with Dr. competitive than other music licensing neither the musical works license nor Eisenach’s inclusion of synchronization contexts because individual sound the sound recording license is subject to licenses in his collection of benchmarks. recordings compete against one another the section 115 license. See SEJRPFF See, e.g., Leonard WRT ¶¶ 37–40 for inclusion in the final product (e.g., ¶ 350 (and record citations therein). (testifying that synchronization licenses a movie or television episode). By However, the Services maintain that are not comparable for interactive contrast, in the interactive streaming the more appropriate YouTube streaming licenses because market, services must build a catalog of benchmarks would be the agreements synchronization differs in important sound recordings and their included between YouTube and publisher and economic respects from streaming); musical works, so that many works can record companies, respectively, for Hubbard CWRT ¶¶ 6.31–6.32 (testifying be streamed to listeners. Id.99 That is, in [REDACTED]—agreements that contain on various ‘‘economic characteristics of the interactive streaming market, the a [REDACTED] royalty rate, rather than synch licenses, that render the ratio sound recordings are ‘‘must have’’ the [REDACTED] figure from the between sound recording royalties and complements, not in competition with [REDACTED] YouTube agreements. If musical works royalties different each other. However, in the synch the Services’ are correct in their between synch and interactive assertion that the [REDACTED] 98 streaming services’’); Marx WRT The Copyright Owners also rely on blanket YouTube agreements are the appropriate (‘‘microsynch’’) licenses by which publishers grant ¶¶ 148–151 (‘‘Synch royalty rates are a their entire catalogs for use in synchronized audio- benchmark inputs, the sound recording: poor benchmark for streaming royalty video productions, and they also rely on synch Musical works ratio (applying the rates’’). Even Dr. Eisenach licenses for mobile and video game applications. [REDACTED] royalty rate) thus acknowledged that, at best, the low ratio The Judges’ critique of synch licenses as increases to as low as [REDACTED], benchmarks is equally applicable to these licenses. in the synch licenses indicates an 99 As discussed infra, Dr. Leonard makes an implying a ratio as high as unusually high musical works royalty analogous point with regard to the weaker [REDACTED]:1, implying a musical rate among his collection of bargaining position of musical works when record works rate of [REDACTED]%, far lower benchmarks. 4/4/17 Tr. 4671, 4799 companies and artists select a song to be recorded. than Dr. Eisenach’s calculated YouTube Like the movie or television producer who can (Eisenach); Eisenach WDT Appx. A–9. choose among a number of somewhat substitutable royalty of [REDACTED]% (but still In a prior proceeding, the Judges recordings, a can choose among a above Copyright Owners’ proposed rejected the synch license benchmark as number of somewhat substitutable musical works. rate). If the [REDACTED] royalty rate of

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[REDACTED]% is applied instead, the bargaining power depresses the His change in the ratio to ratio rises to [REDACTED], or copyright holders’ royalties, ‘‘[s]ince the [REDACTED]:1 was driven by [REDACTED]:1, implying a musical DMCA safe harbor applies equally to expectations regarding the likelihood of works rate of [REDACTED]%. sound recording and musical works an uncertain change in the legal The Judges find that the static-image copyrights, there is no reason to think landscape regarding publisher YouTube rates are more analogous to that their relative valuation would be withdrawals from performing rights the interactive market, compared with affected.’’ Eisenach WRT at 66. organizations. Such uncertain potential the YouTube agreements concerning However, Copyright Owners do not changes are not well-captured by embedded videos. The salient rationale provide any factual support for this mapping them over a time horizon. in Dr. Eisenach’s analysis is the sound conclusory assumption of a ‘‘relative Moreover, as the Services note and as recording to musical works ratio, so value’’ effect, and the Judges thus Dr. Eisenach concurs, even assuming injecting the video as another element of cannot find with sufficient certainty that such a change in relative uncertainty value into the mix renders the sound it in fact is likely that the enhanced could be captured in a regression, other recording to musical works ratio too bargaining position of YouTube affects regression forms, such as a quadratic difficult to identify with sufficient the publishers and the labels equally. form, could be used to demonstrate a certainty. However, the Services assert Accordingly, the Judges do not find the return of the ratio to its prior level (an that, given that the Majors comprise YouTube market and licenses to be equally plausible future event) rather [REDACTED]% of the YouTube market, sufficiently analogous to the interactive than a continuation of its shorter-term the appropriate ratio should be streaming market to make the increase. See 4/5/17 Tr. 495963 (Katz); [REDACTED], implying the benchmark derived from the YouTube Katz CWRT ¶¶ 104–107, Table 1, F; 4/ [REDACTED]% of sound recording analysis to be useful in determining 4/17 Tr. 4807–08 (Eisenach) (linear form percentage identified above. The Judges rates in this proceeding. of regression not ‘‘material’’). find that it would be proper to weight v. Pandora ‘‘Opt-Out’’ Agreements c. Dr. Eisenach’s per Play Sound the YouTube benchmark by applying a Recording Rate [REDACTED]% weight to Together with his YouTube [REDACTED]%, and a [REDACTED]% benchmark, Dr. Eisenach finds the The Judges also have difficulty relying weight to [REDACTED]%, which results Pandora ‘‘Opt-Out’’ agreements to be the on the data set Dr. Eisenach developed in a benchmark rate of [REDACTED]% most useful among the several potential for his estimation of a $[REDACTED] ([REDACTED]).100 benchmarks he examined. The Judges per play sound recording royalty rate. Finally, the Services take issue with agree. The Judges agree with Dr. He used that $[REDACTED] per play Copyright Owners’ assertion that Eisenach that the Pandora ‘‘Opt-Out’’ figure in several benchmark ratios. Two YouTube is a competitor to interactive agreements are useful benchmarks. principal problems with Dr. Eisenach’s streaming services, despite the These agreements have the level of data are: acknowledgements by those services comparability necessary for a 1. The data covered a non-random sample that such competition is present. benchmark to be useful. However, the of only approximately 15% of all interactive Compare CPFF ¶¶ 263–266 (and record Judges do not agree with Dr. Eisenach’s plays; and citations therein) with SJRPFF ¶¶ 263– attempt to extrapolate from the actual 2. the data excluded [REDACTED]’s 266 (and record citations therein). The rates in those Opt-Out Agreements. [REDACTED] services, large portions of the Judges find that competition does not in Rather, the Judges find that the interactive streaming market. Inclusion of those [REDACTED] services would have itself make the rates in those YouTube [REDACTED]:1 ratio Dr. Eisenach identified for the year 2018 in existing reduced his per play rate from $[REDACTED] agreements particularly helpful to $[REDACTED]. Inclusion of only benchmarks, because the addition of agreements is the most useful [REDACTED] service would have reduced the video content creates a bundling of benchmark derived from the ‘‘Opt-Out’’ $[REDACTED] estimate to $[REDACTED]. data. As the Services note, Pandora’s value distinguishable from the value of SJRFF ¶ 22 (and record citations interactive streaming alone. However, most recent direct license agreements during the ‘‘Opt-Out’’ period with the therein). Google’s/YouTube’s acknowledgement Dr. Eisenach explained his small data publishers who control many of the of the competitive posture of YouTube sample as resulting in part from his works embodied in the sound vis-a` -vis interactive streaming services deliberate decision to omit several recordings performed by Pandora renders the ratio of sound recording: sound recording labels [REDACTED], provide that publisher royalties will be Musical works royalty ratio in the which he asserted gave them an determined [REDACTED].101 This YouTube stati-screen agreements a incentive to allow [REDACTED] to pay resulted in a shift of the sound useful benchmark in this proceeding. below-market royalties. Eisenach WDT recording: Musical works ratio to Even in those cases, however, the ¶ 150. The Judges acknowledge Dr. [REDACTED]:1, implying a musical YouTube royalty rates and ratios remain Eisenach’s assertion that this fact could, works TCC percentage of imperfect because other relevant factors on the margin, drive down the royalties [REDACTED]%. See Katz CWRT are not necessarily constant. The Judges paid by [REDACTED] to those labels. ¶¶ 101–104; Herring WRT ¶¶ 28–29). agree that the relatively strong However, the evidence does not bear The Judges reject Dr. Eisenach’s bargaining power of the licensee created that out, because the royalty rates identification of a useful trend in the by the DMCA ‘‘safe harbor’’ provisions, [REDACTED] pays to these labels are shrinking of that ratio (i.e., a growth in distinguishes the YouTube market from comparable to the rates it pays to other the musical works royalty percentage). the market for streaming services. labels that do not have [REDACTED]. Copyright Owners seek to minimize this More particularly, the [REDACTED] lack of comparability by arguing that, 101 Pandora’s status as a purely noninteractive service prior to 2018 does not decrease the contracts with record labels that Dr. although YouTube’s relatively strong relevancy of this benchmark, because: (1) Eisenach reviewed show the same Noninteractive and interactive services both pay [REDACTED], a rate no lower than the 100 If the sound recording royalty rate for performance royalties; (2) noninteractive services interactive streaming is 60%, as discussed infra, historically have not paid mechanical royalties; and rate paid by other interactive streaming this YouTube benchmark equals [REDACTED] × (3) the performance license and the mechanical services. 4/4/17 Tr. 473953 (Eisenach); 0.60 = [REDACTED]%. license are perfect complements. see also, e.g., Trial Ex. 2760 (Digital

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Product Agreement Specific Terms The Judges accept, to some degree, rate. See 4/4/17 Tr. 485152 (Eisenach); between [REDACTED] and Copyright Owners’ argument that ad- 4/5/17 Tr. 5158–61 (Leonard); see also [REDACTED], 2013, supported services are a marketing tool Leonard WRT ¶¶ 55–56. [REDACTED]0005221); Trial Ex. 2765 to identify future subscribers. Until Further, there is a difference in the (Digital Audio Distribution Agreement those subscribers are identified and performance rights royalty rates PROs between [REDACTED] and ‘‘signed,’’ however, they are not charge interactive and noninteractive [REDACTED], July 1, 2013, subscribers. In that sense, ad-supported services that is not captured by Method [REDACTED]0005548). Further, for services may be marketing tools, but #1. See, e.g., In re Petition of Pandora every dollar in royalties a label they do not reduce present royalties Media, Inc., 6 F. Supp. 3d at 330. Had [REDACTED], the label would because the future subscribers have not Dr. Eisenach considered other [REDACTED]. yet been identified. There is no record explanations for the difference between With regard to the specific omission evidence that Spotify’s hard cost saving the All-In sound recording royalty rates of data from Spotify’s ad-supported translates directly into royalty revenue for interactive and noninteractive service, Copyright Owners make lost to Copyright Owners. Apparently, services, he might well have estimated additional arguments. They claim that Copyright Owners argue that their loss a mechanical rate ‘‘[REDACTED]’’ See the ad-supported service does not reflect is in the form of an opportunity cost, Katz CWRT ¶ 122. the actual value of the sound recordings, i.e., losing the opportunity to obtain The Services also note the impact in because that service acts as a funnel to subscription-level royalties from the ad- Method #1 of Dr. Eisenach’s decision to draw listeners to the subscription supported listeners. But if Spotify paid omit [REDACTED] data from his service. Therefore, Copyright Owners subscription-level royalties for all ad- modeling. The Services contend adding maintain, the ad-supported service is supported listeners, it would be paying the [REDACTED] data to Dr. Eisenach’s essentially a loss-leader, with the an implicit marketing cost that effective per play rate for sound difference between the higher effective inefficiently was allocated to the recording results in a per-play rate of per play rates for subscription services [REDACTED]% or so ad-supported $[REDACTED]. See 4/4/17 Tr. 4771–74 and the lower effective per play rates for listeners who, historically, will not (Eisenach). ad-supported services more in the become paid subscribers. Combining the foregoing criticisms, nature of a marketing expense that The use of an ad-supported service as the Services conclude: should not be deducted from Dr. a ‘‘freemium’’ model serves a dual Eisenach’s royalty calculations. See purpose: First, it is an efficient means of If one were to use $[REDACTED] per Eisenach WDT ¶ 148, n.127. marketing—segregating listeners hundred plays for the sound recording rate That analysis, however, omits the fact (which includes the [REDACTED] data) (id. according to WTP—still allowing them at 4771–74), reduce that by 12% as the Board that Spotify’s ad-supported service only to ‘‘experience’’ interactive streaming, did in Web IV for complementary oligopoly [REDACTED]. See Marx WDT ¶ 55, n.77. while, second, simultaneously power, increase the $[REDACTED] per [REDACTED]. These listeners and the providing ad-revenue-based royalties to hundred plays Dr. Eisenach uses for musical revenue they generate are Copyright Owners. If Spotify substituted works performance rights by 60% to account real and reflect the WTP of a large swath advertising as a marketing tool, for the difference in ASCAP rates identified of interactive listeners.102 See Marx WRT Copyright Owners would realize zero by Judge Cote, and then apply Dr. Eisenach’s ¶ 115–16 (‘‘[O]ne aspect of the ad- royalties until the advertising resulted invalid ‘‘valuation ratio’’ of [REDACTED]:1, supported service is to provide an on- in new subscribers.104 the result would be $[REDACTED] per ramp to paid services, it also has hundred plays ($[REDACTED] per play), way another important aspect, namely to d. Analysis of Dr. Eisenach’s Method #1 below the $0.15 per hundred plays rate The Services criticize Dr. Eisenach’s ($.0015 per play) that Dr. Eisenach attempts serve low WTP customers. . . .’’). to validate. Copyright Owners’ economists err in not Method #1 calculation as being based calculating the impact of Copyright upon the incorrect assumption that the SJPFF ¶ 279 (and record citations Owners’ proposal on ad-supported entire difference between interactive therein). services. Ad-supported services and noninteractive rates must be The Judges agree with the Services currently make up [REDACTED] and attributed to the mechanical license that Eisenach’s Method #1 does not [REDACTED]% of all streams in the right. As the Services properly note, provide a useful benchmark in this industry. The Judges agree with there are several reasons, all unrelated proceeding. The absence of interactive Professor Marx that Dr. Eisenach’s to the mechanical right and license, why streaming data from [REDACTED] is a omission of the Spotify data undercuts interactive rates are higher than critical omission. The fact that much of his analysis.103 noninteractive rates for musical works that data relates to [REDACTED] performance rights. Leonard WRT ¶ 55; services [REDACTED] does not justify 102 In the parlance of platform economics, Katz CWRT ¶¶ 117–118; Hubbard removing the data from a market Spotify’s ad-supported service provides a multi- CWRT ¶ 6.4; 4/5/17 Tr. 4972–74 (Katz). analysis; that service is a part of the platform approach, in which listeners, advertisers, market. In fact, Copyright Owners’ sound recording rights holders and musical works Dr. Eisenach’s Method #1 did not holders all combine to obtain revenue based on the account for the presence of the argument proves too much. That is, mutual values each brings to that platform. ephemeral right in licensing their willingness to distinguish and 103 Copyright Owners belatedly propose that if the noninteractive streaming, which isolate the [REDACTED] service and Judges intend to include the Spotify ad-supported accounts for 5% of the noninteractive related data actually underscores the service in the rate structure and rate calculations, they should establish (1) separate rates for ad- need for a differentiated/price supported services that are not incorporated into 104 The provision of a monetarily free-to-the user discriminatory rate structure, such as the calculation of rates set for other services; and service is a reasonable marketing tool, and the the Judges have adopted in this (2) separate terms for an ad-supported service that Judges are loathe to second-guess the business limit the functionality of the service, to avoid model incorporating that marketing approach, proceeding. potential cannibalization of services paying higher especially while it provides royalties to rights The Judges are less sanguine, royalties. COPCL at 106, n.34. This argument is a owners. Also, the Judges do not find it relevant that however, with regard to the Services’ tacit acknowledgement by Copyright Owners that a other interactive streaming services have not argument for a 12% reduction to the segmented market might require a differentiated utilized an ad-supported service. There is no record rate structure, even as they strenuously dispute the evidence regarding why other Services have ceded sound recording rates to reflect the appropriateness of such a structure. that market to Spotify. complementary oligopoly effect arising

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from the ‘‘must have’’ status of the B. Rejection of Services’ 2012-Based The Judges categorically reject this sound recordings in the interactive Proposals argument. The statute is plain in its streaming distribution channel. The requirement that the rates be established 1. Section 115 Benchmark Rates Judges are reluctant to simply import de novo each rate period. A party might the 12% rate reduction from Web IV The Services do not examine in detail feel confident that past is prologue and into other determinations, even though the particular rates within the existing that the parties will agree to roll over that figure was used to adjust from rate structure. Rather, they treat the the extant rates for another period. A interactive streaming rates to rates within that structure as party could be sanguine as to its ability noninteractive streaming rates. The benchmarks, i.e., generally indicative of to make persuasive arguments to keep specific 12% figure was based on record a sufficiently analogous market 105 that the rates unchanged. A party might evidence derived from steering has ‘‘baked-in’’ relevant economic conclude that the mechanical rate is experiments and agreements analyzed considerations in arriving at an such a small proportion of a licensee’s in Web IV. agreement. Dr. Eisenach did not analyze total royalty obligation that its increase The Judges agree with the Services why he chose the levels for the rates and would be unlikely to alter long-term that it is inaccurate in Method #1 to ratios on which he relied as benchmarks business plans. But for sophisticated subtract a performance rate that reflects or consider the subjective commercial entities to claim that they the higher interactive performance rate, understandings of the parties who assumed the rates would remain static rather than the lower noninteractive negotiated his benchmarks. Similarly, is incredible. performance rate. the Services’ economists elected to rely The record indicates that an increase on the 2012 rates as objectively useful e. Analysis of Dr. Eisenach’s Method #2 in the rates might affect different without further inspection.106 interactive streaming services in The Judges find that Dr. Eisenach’s Copyright Owners take the Services to different ways. In particular, there might Method #2 does not contain sufficient task for failing to present evidence of be a dichotomous effect as between industrywide performance royalty and the negotiations that led to the prior essentially pure play streaming services sound recording data to provide a settlements. They argue that, without (such as Spotify and Pandora) and the meaningful analysis for determining a relevant evidence or testimony, the larger new entrants with a wider per-user monthly mechanical works Services cannot provide support for commercial ‘‘ecosystem’’ (such as royalty. The Judges are also troubled by their proposed rates. The Services take Amazon, Apple and Google). As the apparent inconsistent use of Rate a very broad approach in their attempt Spotify’s CFO testified: Court established rates in Method #2, to establish the usefulness of the rate levels within the 2012 benchmark. They The Copyright Owners argue that ‘‘a when Dr. Eisenach had indicated in change in market-wide royalty rates such as other contexts that rates unshackled note that music publishers have this would affect all participants in a similar from Rate Court decisions provide a consistently realized profits under these way,’’ suggesting that the industry as a whole truer indication of market rates. rates, including profits from musical could increase prices without affecting their The Judges understand that Dr. works royalties. Copyright Owners relative price points. Rysman WDT ¶ 94. Eisenach omitted [REDACTED] user counter that mechanical royalties have However, not all Digital Services use the data because of [REDACTED], which is not created a profit for Copyright same business model. For example, several itself a function of its [REDACTED] Owners, and the Services’ assertion of Digital Services are owned by large corporate overall publisher profitability is based parents who can use streaming music as a service. The Judges recognize that ‘‘loss leader’’ to build brand awareness, keep combining [REDACTED] user data with on their lumping of performance users in their broader ecosystem, or promote other interactive streaming services’ royalties together with mechanical other products and/or services. See, e.g., data would significantly change the royalties. Rysman WDT ¶ 29 .... The industry has results, in a manner that Copyright The Services maintain that they relied already seen a few examples of downward Owners find to be anomalous. See on the continuation of the existing rates pressure on prices from this strategy. See CORPFF at 183–184 (noting what in developing their business models. WDT ¶ 50. [REDACTED] See WDT ¶ 73. Copyright Owners describe as ‘‘[t]he For example, Pandora, the latest entrant McCarthy WRT ¶ 38; see Written Direct profound impropriety of ‘‘blending’’ into the interactive streaming market, Testimony of Barry McCarthy, Trial Ex. [REDACTED] rate into Copyright asserts that it based its decision to enter 1060, ¶ 50–51 (McCarthy WDT) Owners’ benchmarking and this market on its assumption that ([REDACTED]); McCarthy WRT ¶ 36 calculations.) However, that seeming mechanical royalty rates would not ([REDACTED]).107 anomaly actually underscores why the increase. Herring WRT ¶ 3. Judges find a differentiated rate 107 As noted elsewhere, the Judges find it highly structure to be appropriate. 105 Here, the ‘‘analogous market’’ is the same as informative that the Services agree to a continuation the target market across all dimensions, except that of the present rates even though: (1) They are all The royalty rates paid by all Services the benchmark is temporally removed from the losing money under these rates; and (2) their should be reflective of the differentiated target, with the rates in the benchmark having been experts suggest much lower rates than the Services WTP of listeners. formed five years ago. propose. While the assertions of ‘‘conservatism’’ 106 This point is not made to be critical of Dr. and reasonableness’’ suggest strategic prudence, the f. Conclusion Eisenach’s approach, but rather to show that the Services’ acquiescence to these rates indicates that Services’ reliance on the 2012 settlement as a year-over-year accounting losses are not of great For the foregoing reasons, the Judges benchmark shares this similar analytical concern—certainly not great enough for the do not adopt Dr. Eisenach’s proposed characteristic, typical and appropriate for the Services to rely on their own experts’ opinions to benchmark rates as the mechanical rates benchmarking method. (The factual wrinkle here is advocate for lower rates. Rather, they seem to be for the upcoming rate period. However, that, hypothetically, the Services could have called locked in a battle for market share, in which the witnesses and presented testimony regarding the single survivor, or the several survivors serving the Judges do find several of the negotiations that led to the 2012 (and 2008) discrete downstream segments, can acquire the benchmark rates implied by his sound settlements, but did not, rendering the 2012 market power sufficient to appropriate a sufficient recording to musical works ratios to be benchmark similar to other benchmarks taken from share of the surplus, as explained in the discussion useful guideposts for identifying the other markets. Mr. Israelite provided some of the Shapley value. That is, the interactive testimony on behalf of Copyright Owners regarding streaming services seemed to be in a Schumpeterian headline percent-of-revenue rate to be those negotiations (as discussed supra), but even competition for the market, not merely in incorporated into the rate structure in that testimony related to the rate structure, rather competition in the market. Given this finding, the the forthcoming rate period. than to the level of the rates themselves. Judges do not find that the year-over-year losses

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The Judges construe this argument as In support of this benchmark, the the sound recording is ultimately sold an iteration of the ‘‘business model’’ Services emphasize that the total [within the] range of price points for argument that they have consistently revenue created by the sale of digital individual tracks in the market ranging rejected. The Judges cannot and will not phonorecord downloads and CDs is from $0.49 to $1.29 and the mechanical set rates to protect any particular essentially commensurate with the penny rate binds regardless of the price streaming service business model. The revenues created through interactive of the track. COPFF ¶ 727 (citing Judges distinguish between: (1) Business streaming, indicative of an equivalent Ramaprasad WDT ¶ 28 & Table 1; 3/20/ models that are necessary reflections of financial importance to publishers when 17 Tr. 1956–58 (Marx)). the fundamental nature of market negotiating rates with licensees in Copyright Owners further attempt to demand, particularly, the varied WTP subparts A and B respectively. See 3/20/ distinguish subpart A from subpart B among listeners; and (2) business 17 Tr. 1845 (Marx) (‘‘downloads, in based on the fact that downstream models that may simply be unable to particular, are comparable to interactive listeners to PDDs and CDs (and any meet dynamic competition. If pure play streaming.’’). Also, although the subpart other physical embodiment of a sound interactive streaming services are unable A rate is the product of a settlement, the recording) become owners of the sound to match the pricing power of Services argue that the rate is a useful recording and the musical work businesses imbued with the self- benchmark because it reflects both the embodied within it, whereas under financing power of a large commercial industry’s sense of the market rate and subpart B the listeners only obtain ecosystem, nothing in section 801(b)(1) the industry’s sense of how the Judges access to the musical works for as long permits, let alone requires, the Judges to would apply the section 801(b)(1) as they remain subscribers or registered protect those pure play interactive considerations to those market rates. 3/ listeners (to a non-subscription service). streaming services from the forces of 15/17 Tr. 1184, 1186 (Leonard); 3/20/17 The Judges find this point to be a horizontal competition. Moreover, any Tr. 1842–43 (Marx). distinction without a sufficient disruption arising from the disparate In opposition, Copyright Owners economic difference. The Judges note impact of a rate increase among argue, for several reasons, that the with favor the testimony of Professor interactive streaming services would not subpart A rates are not proper Leonard, who said of the ‘‘ownership vs. constitute ‘‘disruption’’ under Factor D. benchmarks. First, they emphasize that access’’ distinction that, although it is a Disruption resulting from competition revenue from the sale of PDDs and CDs real legal distinction, it does not reflect would not upend the structure of the has been declining over the past several as fundamental an economic difference industry or generally prevailing years. Second, they note, as the Services as might appear on the surface. Leonard industry practices; rather it would acknowledge, that the parties are not WRT ¶ 27; 3/15/17 Tr. 1098, 1113 influence particular business models. identical; specifically, the licensees in (Leonard). subpart A are record companies whereas 2. The Services’ Subpart A Benchmark The Judges accept Professor Leonard’s in subpart B the licensees are interactive economic analogy. Ownership is in The Services utilize the rate in extant streaming services. See, e.g., 3/15/17 Tr. essence a more comprehensive and subpart A as an additional benchmark 1193 (Leonard). Third, Copyright unconditional form of access. A for the subpart B rates to be determined Owners emphasize that the existing downstream purchaser acquires in this proceeding. Subpart A describes subpart A rate is itself the product of a ownership of the digital or physical the rates record companies pay settlement, rather than a market rate. reproduction of a sound recording and Copyright Owners for the mechanical Fourth, and relatedly, they raise their the embodied musical work for an up- license, i.e., the right to reproduce overarching argument against any front charge (the purchase price). The musical works in digital or physical purported benchmark rate set in ‘‘the purchaser then has unlimited free formats. The particular subpart A shadow’’ of the statutory license, access to that sound recording/musical benchmark rate on which the Services’ because the licensee record companies work going forward. A subscriber to an rely is the existing rate, which the had the option of refusing to settle and interactive streaming service pays an subpart A participants have agreed to to seek instead a potentially lower up-front charge (usually monthly), and continue through the forthcoming rate statutory rate. then likewise has unlimited access to period through settlement.108 Copyright Owners note that the the entire catalog of sound recordings subpart A settlement establishes a per- (and the embodied musical works) for suffered by the Services constitute a serious unit royalty rate of $0.091 per physical each paid period. competitive detriment. Accordingly, in setting or digital download delivery (with effectively competitive rates, the Judges are more In economic terms, each approach concerned with providing the Copyright Owners higher per-unit rates for longer songs), contains the features of a ‘‘two-part with a rate that appropriately compensates them in rendering that rate inapposite as a tariff,’’ where the end user pays a fixed a manner consistent with the relevant and benchmark for the Services’ present access fee (an ‘‘option’’ price, i.e., the persuasive benchmarks, even if the Services may subpart B proposal. See 3/20/17 Tr. incur a somewhat higher level of accounting losses. right to use the owned or accessible Alternately stated, the Judges find that it would be 1960 (Marx). In support of this position, music) and a zero marginal per play highly coincidental (and is unsupported by any Copyright Owners argue that because charge that efficiently corresponds with evidence) that the present rate levels establish in the subpart A rate is expressed as a essence a maximum level of losses the Services the zero physical marginal cost of collectively can sustain, such that a reduction in monetary unit price, Copyright Owners creating another play of the owned or losses is unnecessary but an increase in losses will have eliminated the risk that retailers’ accessible sound recording/musical lead to their demise. downstream pricing decisions will work.109 The salient difference is that 108 The Services did not rely on the settlement affect the Copyright Owners. More the subscriber does not get unlimited that led to the continuation of these rates into the specifically, they note that, ‘‘[u]nder the next rate period as a benchmark. The Services marginal plays for zero additional moved for discovery regarding this most recent subpart A rate structure, the [record charge. The monthly subscription fee is settlement but the Judges denied that motion on the company] (as licensee) pays the same the measure of the marginal cost to the grounds that the new settlement was not a [penny rate] amount in mechanical benchmark on which the Copyright Owners had relied and therefore was not within the scope of royalties regardless of the price at which 109 This point is more general in nature. Any item allowable discovery. See 37 CFR 351.5 (scope of that is ‘‘owned’’ creates value in use because it is discovery limited to materials relevant to the Copyright Owners did not proffer any evidence capable of being accessed, not that it is responding party’s Written Direct Statement). The regarding their most recent settlement. continuously accessed.

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listener who streams. Determination of the sale of one DPD. Marx WDT ¶ 108 Albums’’ analysis. Ramaprasad WDT the allocation of that marginal cost is & n.21 (citing L. Aguiar and J. ¶ 84. Because Apple has advocated for impossible, however, as the Judges Waldfogel, Streaming Reaches Flood a per-stream rate, her conversion was recognize that the subscription fee Stage: Does Spotify Stimulate or Depress expressed on a per-stream basis, at allows for access to a large, Music Sales?, (working paper, National $0.00061 per stream. Professor comprehensive repertoire, whereas Bureau of Economic Research, 2015)); Ramaprasad noted that this rate was not access stemming from the purchase of a Katz WDT ¶ 110 (same). Apple’s only lower than the $0.0015 per stream download, CD, or vinyl record is limited economic expert, Professor Ramaprasad, rate proposed by Copyright Owners, but to the specific sound recording and also relied on the Aguiar/Waldfogel also significantly lower than Apple’s embodied musical work. For this article to support Apple’s benchmark own proposed per-stream rate of reason, there is less access value in the per play proposal. Ramaprasad WDT $0.00091. Ramaprasad WDT ¶ 86. When sale of a download or a CD, compared ¶ 56, n.102.111 Professor Ramaprasad applied the to the access value of a subscription to Professor Marx applied this approach Waldfogel/Aguiar 1:137 ratio, expressed a streaming service, rendering the and formula to Spotify’s revenues. She on a per-play basis, she calculated a rate subpart A rate at best a guideline as to calculated that, given the number of of $0.00066 per stream for interactive the rates below which the subpart B and songs played on Spotify that were streaming, which she noted was even C rates cannot fall.110 longer than five minutes, the per- lower than the per-stream rate of In other respects, the Judges find the recording rate in subpart A is $0.00091 Apple had proposed. subpart A settlement to be somewhat $[REDACTED]. Dividing that per The Judges do not base any recording rate by 137 yields useful. The licensed right in question is conclusions on this ‘‘conversion’’ $[REDACTED] royalty per stream. She identical: The right to reproduce approach. Copyright Owners express then multiplied that per stream musical works for sale into a numerous criticism of the ratio ‘‘equivalent’’ royalty by the total downstream market. Further, the approach, and many of those criticisms, number of streams to estimate a total licensors, i.e., the music publishers and each on its own merit, serve to discredit royalty. Professor Marx then divided the songwriters, are identical. Finally, the the ratio approach. First, the Services total royalty by total revenues. Given the time period is reasonably recent and and Apple simply adopted the All-In approach proposed by the Copyright Owners have not explained equivalence ratios without defining Services, Professor Marx subtracted whether or how the particular market what ‘‘equivalence’’ means. For forces in the subpart A market sectors Spotify’s performance royalty rate of [REDACTED]% of revenue to determine example, the RIAA used the concept to have changed since 2012 to make the identify albums that were sufficiently rate obsolete. The usefulness of the a mechanical royalty rate of [REDACTED]% of revenue using this popular to garner ‘‘gold’’ or ‘‘platinum’’ subpart A rate as a benchmark is awards. That use, absent other evidence, limited, however, because: (1) The approach. Marx WDT ¶ 112, Fig. 22. When she applied the Aguiar/Waldfogel does not indicate that the conversion access value of downstream services is ratio is appropriate for rate-setting greater than the access value of an 137:1 ratio, she identified a musical works All-In royalty rate derived from purposes. See generally Rysman WRT individual purchase of a sound ¶ 96; 3/23/17 Tr. 2775–76 (Ramaprasad). recording/musical work; (2) there is a subpart A of [REDACTED]% of revenue, and a mechanical royalty rate (i.e., after Second, and relatedly, the experts who partial difference in economic risk to relied on the Aguiar/Waldfogel article the licensors between a per-unit royalty subtracting the [REDACTED]% performance rate) of [REDACTED]% of did not verify that the input data that and a royalty based on a percent-of- was used by the authors was revenue (with minima); and (3) the revenue. On behalf of Pandora, Professor Katz appropriate for the purposes for which licensees in the benchmark market are used the same 1:150 conversion ratio as it has been relied upon in this not the same. Professor Marx. He calculated a proceeding. See 3/20/17 Tr. 1945–46 3. The Two Subpart A Benchmarking mechanical rate implied by the subpart (Marx); 3/23/17 Tr. 2789–90 Approaches A rate of [REDACTED]% of revenue, (Ramaprasad). Third, the Aguiar/ Waldfogel article appears not to In their first benchmarking exercise, higher than Professor Marx’s implied rate, but still lower than the existing specifically address two issues that the Services attempt to convert the per- would make the equivalency ratio unit rate in subpart A into a subpart B headline rate of 10.5% in subpart B. Katz WDT ¶ 111. meaningful: (a) What happens to the percent-of-revenue rate. To that end, download behavior of an individual they attempt to identify an equivalency On behalf of Apple, Professor Ramaprasad utilized the same 1:150 who adopts streaming; and (b) how the between a given number of interactive availability of streaming alters the streams and a single play of a purchased ratio, which she adopted from Billboard magazine’s ‘‘Stream Equivalent consumption of a particular song. See DPD. Rysman WRT ¶ 97. Fourth, the experts Professor Marx first applies a 111 Professor Ramaprasad also relied on two other for the Services and Apple ignore that conversion ratio of PDDs to streams of equivalency ratios, the first from Billboard Aguiar and Waldfogel conducted an 1:150, calculated by the RIAA. Second, magazine, and the second from another entity, UK additional analysis described in the she takes note of an academic study Charts Company (UK Charts). However, she same article on which they rely. In that which estimated that marketplace 137 acknowledges that the Billboard ratio combines video streaming royalty data with audio streaming second analysis, the authors compared interactive streams was equivalent to royalty data, which results in an overestimation of the weekly data from Spotify for the the ratio of streams to track sales relative to an period April to December 2013 with 110 The Judges note though that Copyright audio-stream-only analysis. 3/26/17 Tr. 2760–61 Owners’ appropriate reliance on the different access (Ramaprasad). She also acknowledges that UK weekly data from Nielson on digital value in subpart A is an argument relating to the Charts changed its ratio from 100:1 to 150:1 without download sales for the same songs downstream value, confirming that upstream value explanation, rendering uncertain that purported during the same overlapping time demand is a ‘‘derived demand,’’ based on values in industry standard. See COPFF ¶ 683 (and record period. That approach, which Aguiar the downstream market. This argument therefore citations therein). Also, there was no evidence and Waldfogel called their ‘‘matched further undercuts Copyright Owners’ claim that indicating that streaming and download activity in there is an ‘‘inherent value’’ in musical works that the would be comparable to U.S. aggregate sales’’ analysis, yielded a ratio applies in these proceedings. activity. of 43:1, implying a much higher

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mechanical rate for streaming. See was 10.2% in 2015 and 11.3% in 2016. return in the noninteractive space.’’). COPFF ¶¶ 663–64 (and record citations Id. at 1109. Further, the Judges only recently therein). Copyright Owners do not dispute the credited this ‘‘efficient component The Services and Apple offer calculations made by Professor Marx pricing rule’’/opportunity cost approach insufficient evidence to overcome these and Dr. Leonard. However, their general in SDARS III.112 criticisms of their ‘‘equivalence’’ criticisms of the overall concept of using C. Rejection of Apple’s Proposed Rate approach to applying the subpart A subpart A as a benchmark, discussed rates in this proceeding. Accordingly, and rejected below, are equally Apple proposes an All-In per-unit rate the Judges do not rely on these applicable to this second approach. of $0.00091 per play. However, that rate ‘‘equivalence’’ approaches in this The Judges find that the subpart A is premised on two analytical factors determination. benchmark determined by this second that the Judges have rejected in this By contrast, the Services’ second approach is useful—not to establish the proceeding. First, as a single, per-play subpart A benchmarking approach, appropriate benchmark—but to rate, Apple’s proposal fails to reflect the utilized by both Professor Marx and Dr. incorporate into the development of a variable WTP in the market, rendering Leonard, is more straightforward; it does zone of reasonableness of royalty rates it a less efficient upstream royalty rate. not require a conversion of downloads within the rate structure adopted by the Second, Apple’s proposed $0.00091 per- into stream-equivalents. Rather, under Judges in this proceeding. The subpart play rate is derived from the subpart A this approach, Professor Marx simply A rates satisfy important criteria for a conversion ratio approach that the divides the effective per-unit download useful benchmark: The licensors are the Judges rejected in this proceeding. royalty of $.096 by the average retail same in the benchmark and target D. Deriving Royalty Rates From Shapley price of a download, $1.10, to calculate market; the rights licensed are the same Analyses an All-In musical works royalty percent in both markets; the time period of the of [REDACTED]%. Subtracting Spotify’s rates in both markets is proximate; and The Judges look to the Shapley 113 [REDACTED]% performance rate nets a the amount of revenue realized by the analyses utilized by the Professors mechanical works rate of [REDACTED]. licensors in both markets is comparable. Marx and Watt and, to a lesser extent, In similar fashion, given an average CD Additionally, the second approach is the ‘‘Shapley-inspired’’ analysis utilized price of $1.24 per song, she finds that straightforward—simply converting a by Professor Gans, as one means of the All-In musical works rate equals per unit price into a percent of revenue. deriving a reasonable royalty rate (or 114 [REDACTED]%. Subtracting Spotify’s Finally, the Judges take note of a point range of reasonable royalty rates). [REDACTED]% performance rate nets made by Professor Marx: Copyright The Judges defined and described the an ‘‘effective’’ mechanical royalty rate of Owners, like any seller/licensor, would Shapley value in a prior distribution [REDACTED]% under this approach. rationally seek to equalize the rate of proceeding: ‘‘[T]the Shapley value gives Thus, she concludes that the Services’ return from each distribution channel, each player his ‘average marginal proposal in general, and Spotify’s i.e., from licensing rights to sell DPDs/ contribution to the players that precede proposal in particular, are conservative CDs under subpart A and from licensing him,’ where averages are taken with and reasonable, because those proposals interactive streaming services under respect to all potential orders of the provide for substantially higher royalty subpart B. As she explains: players.’’ Distribution of 1998 and 1999 rates than suggested by this subpart A Cable Royalty Funds, 80 FR 13423, benchmark analysis. Marx WDT ¶¶ 113– This principle of equalizing rates of return 13429 (Docket No. 2008–1) (March 13, 114 & Fig. 23. across different platforms has some 2015) (citing U. Rothblum, Dr. Leonard did a similar calculation. similarities with that underlying the approach of W. Baumol and G. Sidak, ‘‘The Combinatorial Representations of the He found that, applying the subpart A Pricing of Inputs Sold to Competitors,’’ .... Shapley Value Based on Average rates expressed as a percentage of They propose an efficient component pricing Relative Payoffs, in The Shapley Value: revenue, interactive streaming services rule whose purpose is to ensure that the Essays in Honor of Lloyd S. Shapley 121 would pay an All-In rate to Copyright bottleneck owner (in our case, the copyright (A. Roth ed. 1988)); see Expert Report of Owners of 8.7% of revenue, based on holder) should get compensation for access Joshua Gans, Trial Ex. 3028, ¶ 64 (Gans the average retail price of digital from all downstream market participants, WDT) (‘‘The Shapley value approach downloads in 2015. Leonard AWDT whether existing or new entrants, that leaves . . . models bargaining processes in a ¶ 42. Dr. Leonard further calculated that, him as well off as he would have been absent free market by considering all the ways entry. expressed as a percentage of payments each party to a bargain would add value to the record labels (rather than total Marx WDT ¶ 104, n.118. by agreeing to the bargain and then downstream revenues) the subpart A The Judges first identified this assigns to each party their average settlement reflects a payment of 14.2% principle in Web IV, through a colloquy contribution to the cooperative of sound recording royalties, when with an economic witness, and it bargain.’’); Marx WDT ¶ 144 (‘‘The idea compared to payments to record labels remains persuasive in this proceeding. of the Shapley value is that each party in 2015. Leonard AWDT ¶ 46. See Web IV, 81 FR at 26344 (Economic should pay according to its average Using updated 2016 data, which expert, Professor Daniel Rubinfeld, contribution to cost or be paid according lowered the DPD retail price to $.99, Dr. acknowledging as ‘‘a fundamental Leonard calculated an ‘‘effective’’ economic process of profit 112 Of course, because copies of musical works percentage royalty rate of 9.6%. 3/15/17 maximization . . . [licensors] would (embodied in copies of sound recordings) are non- Tr. 1108–09 (Leonard). Dr. Leonard then want to make sure that the marginal rivalrous quasi-public goods, licensing a copy to licensees in one platform does not prevent the adjusted this result to make it return that they could get in each sector licensing of another copy to licensees on a different comparable to Google’s proposal, which would be equal, because if the marginal platform. The equalization of returns for such goods seeks a reduction of up to 15% of return was greater in the interactive relates to the elimination of opportunity costs. certain costs incurred to acquire space than the noninteractive . . . you 113 The ‘‘Shapley Analysis’’ or ‘‘Shapley Models’’ revenues. Adjusting for this cost would want to continue to pour are so called based on the work of Nobel Economics Prize winner, Dr. Lloyd S. Shapley. reduction, Dr. Leonard concludes that resources, recordings in this case, into 114 The Judges will revisit the Shapley Analyses the equivalent percent of revenue (after the [interactive] space until that in evaluating factors B and C under section deducting similar costs) in subpart A marginal return was equivalent to the 801(b)(1).

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to its average contribution to value. It recordings as perfect complements, he two categories of necessary embodies a notion of fairness.’’); Written assumes that the musical works complements arrive separately in the Rebuttal Testimony of Richard Watt, licensors would receive the same profit input market under the Shapley Trial Ex. 3034, ¶ 23 (Watt WRT) (‘‘The as the record companies (but not the methodology. 3/20/17 Tr. 1883–84 Shapley model is a game theory model same royalty rate, given their different (Marx). that is ultimately designed to model the costs). Because this is not a Shapley i. Professor Marx’s Baseline Approach outcome in a hypothetical ‘fair’ market ground-up approach, which would environment. It is closely aligned to require estimating the input costs of all Professor Marx noted the undisputed bargaining models, when all bargainers three input providers—the record principle that ‘‘[t]he calculation of the are on an equal footing in the process.’’). companies, the music publishers, and Shapley value depends on the total the interactive streaming services, value created by all the entities together 1. Shapley Models Professor Gans candidly acknowledged and the values created by each possible A Shapley Analysis requires the on cross-examination that he did not subset of entities.’’ Marx WDT ¶ 147. economic modeler to identify perform a full-fledged Shapley Analysis. Equally undisputed is the downstream revenues available for He describes his methodology as a understanding that ‘‘[t]hese values are division among the parties. The ‘‘Shapley-inspired’’ approach. 3/30/17 functions of the associated revenue and economic modeler must also input costs Tr. 4109 (Gans). costs.’’ Id. that each provider must recover out of The surplus to be divided (from downstream revenues, in order to a. Professor Marx’s Shapley Analysis which rates can be derived) is realized identify the residue, i.e., the Shapley Professor Marx testified that, as an at the downstream end of the ‘‘surplus,’’ available for division among initial matter ‘‘[t]he Shapley value distribution chain when revenues are the parties. A Shapley Model is cost- depends upon how [the modeler] received from retail consumers. That based, similar to a public utility-style delineate[s] the entities contributing to surplus can be measured as the profits rate-setting process, which identifies a a particular outcome.’’ Marx WDT ¶ 145. of the downstream streaming services utility’s costs to be recovered before More particularly, Professor Marx (and the alternative services in her determining an appropriate rate of delineated the entities in a manner that model), i.e., their ‘‘revenue minus . . . return.115 In the present case, Copyright she claimed to ‘‘adjust[ ] the model for non-content costs.’’ 116 The total Owners and the Services have applied monopoly power.’’ 3/20/17 Tr. 1862–63 combined value created by the delivery this general approach in different ways, (Marx). She modeled the downstream of the sound recordings through the and each challenges the appropriateness interactive streaming services as a interactive (and substitutional) of the other’s model. combined single service and added to streaming services consists of: (1) The To summarize the differences in their her model other distribution types as aforementioned profits downstream approaches, Professor Marx utilizes a another form of downstream (i.e., service revenue ¥ non-content Shapley Model that purposely alters the distribution to account for the potential cost) minus (2) ‘‘the copyright owners’ actual market structure in order to opportunity cost of interactive non-content costs. Simply put, obtain results that intentionally deviate streaming. By modeling the downstream ‘‘surplus’’ reflects the amount of retail from the market-based distribution of market in this manner, Professor Marx revenue that the input providers can profits. She makes these alterations in artificially, but intentionally, treated the split among themselves after their non- her model to determine rates she Services as a single service, a device to content costs (i.e., the costs they do not identifies as reflecting a ‘‘fair’’ division countervail the allegedly real market simply pay to each other) have been of the surplus (Factor B) and power of the collectives (the music recovered. recompense for the parties’ relative roles publishers and the record companies In her Shapley Analysis, Professor (Factor C). By contrast, Professor Watt’s respectively) that owned the other Marx relied on 2015 data from Warner/ ‘‘correction’’ of Professor Marx’s model inputs. Professor Marx concluded the Chappell for her music publisher non- rejects her alteration of the market publishers’ and record companies’ must content cost data and its ownership- structure. Rather, he maintains that the be offset to establish a fair division of affiliated record company, Warner incorporation of ‘‘all potential orders of the surplus and a fair rate. See 3/20/17 Music Group, for record company non- the players’’ in her model (as in all Tr. 1865, 1907 (Marx). content costs.117 Utilizing the Warner Shapley Models) already eliminates the With regard to the upstream market of cost data and extrapolating to the entire hold-out power of any input provider copyright holders, Professor Marx industry, Professor Marx estimated that who might threaten to walk away from utilized two separate approaches. In her ‘‘Musical Work Copyright Holders’ Total a transaction. self-described ‘‘baseline’’ approach, she Non-Content Costs’’ equaled $424 Professor Gans, like Professor Watt, ‘‘treat[ed] rights holders as one million; and ‘‘Sound Recording does not attempt to alter the market upstream entity, reflecting the broad Copyright Holders’ Total non-content structure. However, Professor Gans overlap in ownership between concedes that he is not attempting to publishers and record labels.’’ Marx 116 Content costs, as opposed to non-content derive Shapley values from a ground–up WDT ¶¶ 146, 162. In her ‘‘alternative’’ costs, are not deducted because the content costs analysis. Rather, Professor Gans takes as approach, she uncoupled the two comprise the surplus to be allocated in terms of royalties paid and residual (if any) that remains a given Dr. Eisenach’s estimation that collectivized copyright holders, with the interactive streaming (and substitute) record companies receive a royalty of grouping the songwriters/publishers, on services. The non-content costs, as discussed infra, $[REDACTED] per play from interactive the one hand, and the recording artists/ must be recovered by each input provider as part streaming services. Since Professor Gans record companies, on the other. Id. The of its Shapley value, because entities must recover costs to the extent their share of revenues allows identifies musical works and sound two purposes of her alternative such recovery. approach were: (1) To separately 117 Professor Marx was limited to the Warner data 115 Unlike in public utility regulation, the allocate surplus and indicate rates for for non-content costs because, among all major Shapley Analysis considers the costs of all input musical works (the subject of this holders of musical works and sound recording providers whose returns will be determined. In copyrights, ‘‘only Warner . . . breaks down its cost traditional public utility rate regulation, the utility proceeding); and (2) to illuminate the by geographic region and by source in enough detail is a monopoly and thus the only provider of a additional ‘‘bargaining power’’ of each to estimate the amounts needed.’’ Marx WDT regulated input. category of copyright holder when these ¶¶ 149–150.

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costs equaled $2.605 billion (more than royalty payments are clearly too high. COPFF ¶ 741. More technically, six times musical works’ copyright Id. ¶ 161.118 Copyright Owners object to Professor holders’ non-content costs). Total Marx’s joinder of the sound recording ii. Professor Marx’s Alternative licensors’ upstream non-content costs and musical works rights holders as a Approach totaled $3.028 billion. Id. ¶ 150, Fig. 26. single upstream entity in her ‘‘baseline’’ Turning to the downstream Professor Marx also performed an model, claiming that combination had distribution outlets, Professor Marx ‘‘alternative’’ Shapley Analysis in which the undisputed effect of lowering identified and relied on Spotify’s 2015 she modeled the upstream market as two Shapley values, and hence royalties, revenue and cost data from for entities: ‘‘a representative copyright available to be divided between the two interactive streaming services; for the holder for musical works and a categories of rights holders. Gans WRT alternative distribution modes, she representative copyright holder for ¶ 21; Watt WRT App. 3 at 2 (in real relied on Pandora’s and Sirius XM’s sound recordings.’’ Id. ¶ 163. In all other world, as opposed to stylized Shapley- revenue and cost data. Id. ¶ 152 & respects, Professor Marx’s methodology world, rights holders would not jointly nn.149–52. Using that data, Professor was the same as in her baseline negotiate with licensees); see also Marx estimated interactive streaming approach. See id. ¶ 199, App. B. COPFF ¶ 742. Further, Professor Gans revenue of $[REDACTED] billion; and Under the alternative approach with questions Professor Marx’s rationale for (2) interactive streaming profit of two owners of collective copyrights her joint negotiation assumption, viz., $[REDACTED]. For the alternative upstream, interactive streaming the overlapping ownership interests of distributors (Pandora and Sirius XM), services’ total royalty payments range record companies and music publishers. she estimated (1) revenues of $8.514 from [REDACTED]% to [REDACTED]% Gans WRT ¶ 21. billion; and (2) profits of $3.576 billion. of service revenue. Id. Sound recording The Judges find this criticism of The total downstream revenue, copyright holders’ total royalty income Professor Marx’s baseline approach to under this alternative approach ranged according to Professor Marx, equaled an be appropriate, in that it was not from [REDACTED]% to [REDACTED]% estimated $10.118 billion. Id. ¶ 153 & necessary to combine the two rights of revenue. Id. Professor Marx explained Fig. 27. holders in a Shapley Analysis. As that this higher range of combined Professor Marx noted some degree of Professor Watt explained in his separate royalties arose from the fact that substitution between interactive criticism, there is no need to collapse splitting the copyright holders into two streaming services and alternative the rights holders into a single creates two ‘‘must-haves’’ providing distribution channels (e.g., non- bargaining entity to eliminate holdout each upstream entity with more ‘‘market interactive and satellite power by the respective rights holders, power and consequently higher payoffs radio). Id. ¶ 154. She opined that ‘‘it is because the ‘‘heart and soul’’ of the than the baseline calculation.’’ Id. ¶ 164, Shapley Model is exclusion of the difficult to determine the exact value of n.153. By splitting the upstream this substitution effect,’’ so she reported holdout value that any input supplier licensors into two categories (record could exploit in an actual bargain. 3/27/ a range of Shapley value calculations companies and songwriters/publishers), that corresponded to ‘‘a range of 17 Tr. 3073 (Watt). He emphasized that, Professor Marx calculated that ‘‘musical because the Shapley Model incorporates possible substitution effects.’’ Id. work copyright holders’ total royalty These data were inputs into Professor all possible ‘‘arrivals’’ of input income as a percentage of revenue suppliers, it eliminates from the Marx’s Shapley algorithm, i.e., assigning ranges from [REDACTED]% to value to each input provider for each valuation and allocation exercise the [REDACTED]%.’’ Id. ¶ 163. By way of effect of an essential input supplier potential order of arrival among these comparison, Spotify actually pays holding out every time or arriving categories of providers to the market. [REDACTED]% of its revenue for simultaneously with another input The multiple values were summed and musical works royalties (i.e., All-In supplier (or apparently creating Cournot averaged as required by the Shapley royalties). Accordingly, Professor Marx Complement inefficiencies). Id. at 3069– methodology to arrive at the ‘‘Shapley concludes that ‘‘[b]ecause this 70. value,’’ which accounts for each entity’s proceeding is about mechanical rates, However, the foregoing criticism does revenues and (non-content) costs under the fairness component of 801(b) factors not pertain to Professor Marx’s second each possible ordering of market- suggests that interactive streaming’s Shapley Model—her ‘‘Alternative’’ arrivals. mechanical rates should be reduced model—in which she maintains the two Based on the foregoing, Professor from their current level.’’ Id. ¶ 161. separate rights holders for musical Marx estimated that the total royalty iii. Copyright Owners’ Criticisms works and sound recordings. Marx WDT payment due from the Services to ¶ 146, n.153; 3/20/17 Tr. 1871–72 Copyright Owners would range from Copyright Owners criticize Professor (Marx). With regard to this Alternative $[REDACTED] million to $[REDACTED] Marx’s model for ‘‘failing to accurately model, Copyright Owners level a more million, depending on varying reflect realities of the market, where general criticism of Professor Marx’s assumptions as to the substitution current observed market rates for sound approach that does pertain to her between interactive services and recording royalties alone are Alternative model (as well as her alternate delivery channels. This range approximately 60% of service revenue. Baseline model). They assert, through of revenues reflected a ‘‘percent of See Watt WRT ¶ 23; Written Rebuttal both Professors Gans and Watt, that revenue’’ paid by interactive streaming Testimony of Joshua Gans, Trial Ex. Professor Marx wrongly distorted the services to all copyright holders 3035, ¶¶ 19, 28 (Gans WRT); see also actual market in yet another manner— (musical works and sound recordings) by assuming the existence of only one ranging from [REDACTED]% to 118 Because her baseline approach combines interactive streaming service—rather [REDACTED]%. Id. ¶¶ 159–160. sound recording and musical works licensors into a single entity, Professor Marx does not break out than the presence of competing Professor Marx then noted that this is separate royalties for musical works performances interactive streaming services. Watt well below the combined royalty rate of or mechanical licenses. However, she recommends WRT ¶¶ 25, 32 n.19, 17; Gans WRT [REDACTED]% Spotify pays for musical that the mechanical rate should be lowered based ¶¶ 55–56; see also COPFF ¶ 755. By this works and sound recording rights, on this finding. Professor Marx does specifically estimate the musical works rate under her change, they argue, Professor Marx indicating that the actual combined Alternative approach. inflated the Shapley surplus attributable

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to the interactive streaming services multiple downstream entities into a and does not disqualify her Shapley compared to the actual proportion they single entity in his Shapley Model in value analysis from further would receive in the market. ‘‘comparison’’ to two upstream rights consideration. According to Professor Gans, this holders. 3/30/17 Tr. 4179 (Gans). Professor Marx’s alternative approach simplified assumption belies the fact Additionally, Professor Watt has yielded a musical works royalty rate of that the market is replete with many authored and published an article (cited between [REDACTED]% and substitutable interactive streaming at Gans WDT ¶ 65, n.36) in which he too [REDACTED]% of service revenue. services, whose competition inter se ‘‘artificially’’ equalized market power 3/20/17 Tr. 1885 (Marx). In that reduces each service’s bargaining between rights holders and licenses alternative model, Professor Marx found power. The problem, he opines, is that (radio stations) in the same manner. See that Spotify’s total royalties for musical to the extent the entities being R. Watt, Fair Copyright Remuneration: works and sound recordings combined combined are substitutes for one The Case of Music Radio, 7, 25, 35 would range from [REDACTED]% to another–such as alternative music (2010) 7 Rev. of Econ. Res. on Copyright [REDACTED]% of total revenue, services–then combining them ignores Issues 21, 25, 35 (2010) (‘‘artificially’’ meaning that payments for sound the effects of competition between them, modeling the ‘‘demand side of the recording rights would be thereby inflating their combined share market as a single unit, rather than approximately [REDACTED]% to of surplus from the joint enterprise (i.e. individual radio stations . . . thereby [REDACTED]% of total revenue. Id. The their Shapley value). Gans WRT ¶ 21. . . . add[ing] (notionally) monopsony ratio of sound recording royalties to Professor Marx does not deny that she power to the demand side’’ to offset the musical works royalties under Professor intentionally elevated the market power monopoly power of the input supplier). Marx’s model is no lower than of the services by combining them in the In essence, the import of this criticism [REDACTED]% to [REDACTED]%, or model as a single agent. However, she is not the faithfulness of Professor [REDACTED]:1. Stated as a percentage explained that she made this adjustment Marx’s testimony to the Shapley Model; of sound recording royalties (i.e., TCC), to offset the concentrated market power rather, it pertains to her decision to musical works royalties would thus be that the rightsholders possess, separate include an adjustment for market power [REDACTED]%.121 and apart from any holdout power, asymmetry that seeks to equalize market b. Professor Gans’s ‘‘Shapley-Inspired which the Shapley ordering algorithm power as between Copyright Owners Approach’’ would address. Thus, Professor Marx and the streaming services. Her explained that her alteration of market adjustment is consistent with testimony On behalf of Copyright Owners, power apparently was designed to by Professor Katz, who cautioned that a Professor Gans presented a model that he described as ‘‘inspired’’ by the address an issue—market power—that Shapley Analysis takes the parties’ Shapley approach, but not per se a the Shapley Analysis does not address. market power as a given, locking-in Shapley Analysis. 3/30/17 Tr. 4109 3/20/17 Tr. 1863 (Marx) (‘‘I want a whatever disparities exist. 4/15/15 Tr. (Gans). At a high level, his Shapley- model that represents a fair outcome in 4992–93 (Katz). the absence of market power, so I am The Judges agree with Professor Watt inspired approach attempted to going to have to be careful about how and find that the Shapley Analysis, determine the ratio of sound recording I construct the model that I am not taking the number of sellers in the royalties to musical works royalties that would prevail in an unconstrained putting in market power into the market as a given, eliminates the ‘‘hold- market. After calculating that ratio, he model.’’).119 out’’ problem that would otherwise estimated what publisher mechanical Professor Gans testified that Professor cause a rate to be unreasonable, in that royalty rates would be in a market Marx’s approach was erroneous because it would fail to reflect effective (or without compulsory licensing by Shapley values are meant to incorporate workable) competition. However, multiplying the benchmark sound market power asymmetries, not to Professor Marx’s Shapley Model also recording rates by this ratio. Gans WDT eliminate them. Gans WRT ¶ 31 attempts to eliminate a separate factor— (Shapley values incorporate market ¶ 63. market power—that she asserts renders Professor Gans began his analysis power asymmetries). However, the a market-based Shapley Analysis Judges note that Professor Gans with two critical assumptions: (1) incompatible with the objectives of Publishers and record companies must acknowledged that in an Australian Factors B and C of section 801(b)(1). The legal proceeding, he too combined have equal Shapley values (i.e., must Judges will consider the appropriateness recover equal profits from total surplus), of Professor Marx’s adjustment for 119 Although at first blush it would seem more because musical compositions and market power in their discussion of sound recording performances are appropriate for Professor Marx to have directly 120 adjusted the copyright holders’ market power by these two factors. For purposes of perfect complements and essential breaking them up into several entities each with deriving a reasonable (and effectively components of the streamed less bargaining power, such an approach would competitive) rate prior to application of performance; 122 and (2) record make Shapley modeling less tractable (by increasing the 801(b)(1) factors, it is sufficient to the number of arrival alternatives in the algorithm), compared with the practicality of equalizing market note that Professor Marx’s adjustment is 121 TCC percentage is the reciprocal of the sound power by inflating the power of the streaming not inconsistent with the traditional recording to musical work royalty ratio, expressed services (by reducing them to a single Shapley Analysis (as both Professors as a percentage. Thus, 1/[redacted] = [redacted] representative agent). For example, in Professor Watt and Gans have acknowledged in (rounded) or [REDACTED]%. Marx’s ‘‘alternative’’ Shapley Model, she models 122 Modeling the market as having two upstream four entities, two upstream (musical works holders their work outside of this proceeding), suppliers of complementary inputs (i.e., a musical and sound recording holders), and two downstream works copyright owner and a sound recordings (the representative single streaming service and a 120 See infra, section VI.B. Although the Judges copyright owner) produces the result that Professor single alternate distribution outlet). With these four find a market power adjustment relevant in a Gans assumed in his analysis: The upstream entities, the number of different arrival orders is 4! section 801(b)(1) Factor B and C analysis, it is not suppliers reap equal profits, though their royalties (factorial), or 24. If Professor Marx instead had a consideration when determining a rate that differ due to differences in their cost structures. broken the musical works copyright holders and the reflects ‘‘effective competition.’’ An effectively Professors Marx, in her ‘‘alternative approach,’’ and sound recording copyright holders respectively into competitive rate need not adjust for market power Watt, in his ‘‘Shapley Model with 3 Streaming two entities, the number of total entities would because such a rate does not include consideration Services, models the market in this way. Marx WDT have increased from 4 to 6. The number of arrival of these two factors or their public utility style ¶ 201 (Figure 33 in Appendix B) (fifth column orders would then have increased from 24 to 720. legislative history antecedents. shows identical Shapley values for both upstream

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company profits from interactive indicated a market-derived musical financial analysts’ projections for the streaming services are used as works per play royalty rate of respective industries to be reasonable. benchmark Shapley values. Gans WDT $[REDACTED] (rounded). Id. ¶ 78, Table Expressed as a percentage of sound ¶ 77. The royalties that result from 3. However, because the musical works recording royalties, Professor Gans’s Professor Gans’s analysis will differ, royalty is comprised of the mechanical 2.5:1 sound recordings to musical works given the different level of costs rate and the performance rate paid to royalty ratio yields a musical works incurred by music publishers and PROs (not to publishers), Professor Gans royalty rate of 40% of TCC. record companies respectively. See had to subtract the performance rate. He c. Professor Watt’s Shapley Analysis Gans WDT ¶¶ 23, 71, 74, 76; Gans WRT determined that the percent of revenues ¶¶ 15–17; see also 3/30/17 Tr. 3989 attributable to mechanical royalties was As a rebuttal witness, Professor Watt (Gans). 81% of the total musical works testified regarding purported defects in Echoing Dr. Eisenach, Professor Gans royalties, under his approach. Thus, he Professor Marx’s Shapley Model. In found these assumptions critical estimated a mechanical royalty rate of addition, he presented alternative because agreements between record $[REDACTED].123 well above the modeling intended to apply an adjusted companies and interactive streaming Copyright Owners’ proposed $0.0015 version of Professor Marx’s Shapley services are freely negotiated, i.e., they statutory per play rate, and thus Model. Professor Watt found that Professor are not set by any regulatory body or confirming the reasonableness of the Marx’s approaches contained several formally subject to an ongoing judicial Copyright Owners’ proposal. Id. ¶ 78. flaws and methodological issues. See consent decree and, accordingly, are On this basis, Professor Gans also 3/27/17 Tr. 3057 (Watt). Accordingly, also not subject to any regulatory or concluded that his Shapley-inspired he, like Professor Gans, attempted to judicial ‘‘shadow’’ that arguably might approach supports the Copyright adjust her modeling in a manner that, in be cast from such governmental Owners’ per-user rate proposal. his opinion, generated ‘‘decent, regulation in the market. Accordingly, Applying the Shapley -based ratio of believable results.’’ Id. at 3058. Professor Gans uses the profits arising 2.5:1 to the benchmark per-user rate from these unregulated market In his Shapley Model adjusting negotiated by the labels of Professor Marx’s analysis, Professor transactions to estimate what the $[REDACTED] per user per month, and mechanical rate for publishers would be Watt found that at least [REDACTED]% after subtracting the value of the of interactive streaming revenue should if they too were also able to freely performance rights royalty, Professor negotiate the rates for the licensing of be allocated to the rights holders (as Gans obtains an equivalent publisher distinguished from a range of their works. See Gans WDT ¶ 75. mechanical rate of $[REDACTED] Professor Gans utilized data from [REDACTED]% to [REDACTED]% of (rounded) per user per month (i.e., projections in a Goldman Sachs analysis total revenues going to rights holders ($[REDACTED]/2.5) × 80%124). Id. ¶ 85. to identify the aggregate profits of the under Professor Marx’s analysis). Of this record companies and the music The Judges do not accept the rates [REDACTED]%, [REDACTED]% should publishers, respectively. See 3/30/17 Tr. derived by Professor Gans’s Shapley- be retained by the musical works 4017 (Gans). Given his assumption that inspired model, because of its copyright holders and [REDACTED]% sound recordings and musical works assumption and use of the should be allocated to record were both ‘‘essential’’ inputs and thus $[REDACTED] per play sound recording companies. Expressed as percentages of able to claim an equal share of the interactive rate. Dr. Eisenach’s revenue, musical works copyright profits, Professor Gans posed the $[REDACTED] per play sound recording owners would receive question: ‘‘[H]ow much revenue do we rate is not supported by the weight of [REDACTED]%125 of total interactive need to hand to the publishers so that the evidence. Moreover, the record streaming revenue while record they end up earning the same profits as company profits are inflated by the companies would receive the labels? Id. at 4018. inefficient rates created through the [REDACTED]%.126 See Watt WRT ¶ 35; He found that, for the music Cournot Complements problem that 3/27/17 Tr. 3083, 3115–16 (Watt).127 publishers to recover their costs and affects the agreements between record The ratio of sound recording to musical achieve profits commensurate with companies and streaming services, as works royalties under Professor Watt’s those of the record companies under his noted by the Services’ experts in this analysis is thus [REDACTED]% to approach, the ratio of sound recording proceeding, and as the Judges noted in [REDACTED]%, or [REDACTED]:1. royalties to musical works royalties Web IV. Expressed as a percentage of sound derived from his Shapley-inspired However, the Judges find the ratio of recording royalties, musical works analysis was 2.5:1 (which attributes sound recording to musical work royalties would be [REDACTED]%. equal profits to both classes of rights royalties that Professor Gans derived holders and acknowledges the higher from his analysis to be informative. 2. Deriving a Royalty Rate costs incurred by record companies Professor Gans computed this ratio Professors Marx, Gans, and Watt compared to music publishers). See based on an assumption of equal reached conclusions that were broadly Gans WDT ¶ 77, Table 3. Shapley values between musical works consistent insofar as they all found that As noted, Professor Gans made a key and sound recording copyright owners. the ratio of sound recording to musical assumption, treating as accurate Dr. The Judges find this assumption to be Eisenach’s calculation of an effective reasonable and confirmed by Professor 125 [REDACTED] (rounded). per play rate for sound recordings of Marx’s Shapley Analysis. The Judges 126 [REDACTED] (rounded). $[REDACTED]. Given those two inputs also find Professor Gans’s reliance on 127 At present, record companies receive (the 2.5:1 ratio and the $[REDACTED] approximately 60% of total interactive streaming revenue, substantially higher than the per play rate) Professor Gans’s approach 123 [redacted] × 0.81 = 0.0025 (rounded). [REDACTED]% calculated by Professor Watt. He 124 Professor Gans multiplies the per play rate by explains that the reason for this difference is clear; providers); Trial Ex. 2619, at 8 (Appendix 3 to Watt 81% but the per user rate by 80%. Compare Gans the mechanical rate is artificially depressed by WRT) (‘‘Since there are only two players in this WDT ¶ 78 with Gans WDT ¶ 85. The rate derived regulation, allowing the sound recording rate (set in game, and each would have veto rights over the by Professor Gans was the 80% figure. Gans WDT an unregulated market) to appropriate a larger share business, the net surplus would be shared equally ¶ 77, Table 3, line 17. This discrepancy has no of the royalties, given the perfect complementarity between them.’’). impact on the relevance of his analysis. of the two rights. Watt WRT ¶ 36.

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works royalty rates should decline. The comparison the actual ratio of sound percent of revenue rates for musical following table summarizes these recording to musical works royalties works and sound recordings. experts ratios, expressed both as ratios paid by Spotify, as well as the ratio and percentages, and includes for implied by the prevailing headline

SOUND RECORDING TO MUSICAL WORKS RATIOS AND TCC PERCENTAGES

Scenario Ratio TCC percentage 128

Watt Shapley Analysis ...... [REDACTED]:1 ...... [REDACTED] Gans Shapley-inspired Analysis ...... [REDACTED]:1 ...... [REDACTED] Marx Shapley Analysis ...... [REDACTED]:1 ...... [REDACTED] Spotify Actual ...... [REDACTED]:1 ...... [REDACTED] Headline Percent of Revenue Rates ...... 5.71:1 ...... 17.5

All of the experts’ ratios are well [REDACTED]% and [REDACTED]% of Even with lower combined royalties, below the current ratio of approximately service revenue, while Professor Watt’s the models also show musical works [REDACTED]:1 for Spotify, and model produces combined royalties of royalties at or above the prevailing approximately 5.71:1 comparing the between [REDACTED]% and headline rate of 10.5%. Mathematically 10.5% headline rate to an average sound [REDACTED]%.129 Even the highest of that is possible only because the models recording rate of approximately 60% of these values is less than [REDACTED]. also yield lower royalties for sound revenue. Accordingly, under their The discrepancy in total royalties recordings at all levels of total royalties. respective Shapley Models, Professors between the models and the real world The following tables show the is explained, in part, by the absence of Marx, Gans, and Watt appear to be in percentage revenue royalty rates for general agreement that the ratio of supranormal complementary oligopoly musical works and sound recordings sound recording to musical works profits in the Shapley Model, and the that are produced by applying the royalties should decline. presence of those profits in the actual Both Professor Marx’s and Professor market. In addition, the total royalties experts’ ratios to the different levels of Watt’s models show lower combined paid in Professor Marx’s model are total royalties. The final column shows royalties being paid by services than are lowered still further by her decision to the rates yielded by applying the ratios currently paid in the marketplace. equalize bargaining power between the to Spotify’s total royalty obligation of Professor Marx’s model produces content providers and services by [REDACTED]%. combined royalties of between modeling the services as a single entity. IMPLIED MUSICAL WORK ROYALTY (% OF REVENUE) BASED ON RATIO AND TOTAL ROYALTIES 130

TCC [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] Expert Ratio % % % % % % %

Watt ...... [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] Gans ...... [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] Marx ...... [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED]

IMPLIED SOUND RECORDING ROYALTY (% OF REVENUE) BASED ON RATIO AND TOTAL ROYALTIES 131

TCC [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] Expert Ratio % % % % % % %

Watt ...... [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] Gans ...... [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] Marx ...... [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED]

Professor Watt explains the mechanical royalties in the United States is Watt WRT ¶ 36.132 significantly below the predicted fair rate, discrepancy between the sound Applying the ratios derived from the recording royalty rates yielded by the and the statutory rate effectively removes the musical works rightsholders from the experts’ models to the higher total Shapley Analysis and the higher rates royalties that prevail in the marketplace that exist in the market: bargaining table with the services. Since this leaves the sound recording rightsholders as would yield musical works royalty rates [The reason] my predicted fraction of the only remaining essential input, higher than the models predict. For revenues for sound recording royalties is bargaining theory tells us that they will example, based on Professor Marx’s significantly less than what is observed in the successfully obtain most of the available lowest estimate of overall royalties of market [is] simple. The statutory rate for surplus. [REDACTED]%, her [REDACTED]:1

128 TCC percentage is the reciprocal of the sound for musical works and sound recordings, and r is 132 More specifically, Professor Watt calculates recording to musical work royalty ratio, expressed the ratio of sound recording to musical work that, for each dollar that the statutory rate holds as a percentage. royalties. down fair market musical works royalties, 129 Professor Watt identified [REDACTED]%—the 131 The royalty rate is computed using the [REDACTED] cents is captured by the record ÷ arithmetic mean of these two numbers—as his formula Rsr = Rt (1 + 1/r) where Rsr is the musical companies (and [REDACTED] cents is captured by preferred figure. work royalty rate, Rt is the combined royalty rate the streaming services). Watt WRT ¶ 23, n.13 & 130 The royalty rate is computed using the for musical works and sound recordings, and r is App. 3. formula Rmw = Rt ÷ (1 + r) where Rmw is the musical the ratio of sound recording to musical work work royalty rate, Rt is the combined royalty rate royalties.

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ratio (or [REDACTED]% TCC sound recordings and what Professor existing [REDACTED]% combined percentage) would yield percent-of- Watt describes as the record companies’ royalty as the Shapley-produced TCC revenue rates for musical works of ability to obtain most of the available percentage yields when applied to the [REDACTED]%.133 Using Spotify as an surplus due to the music publishers’ theoretical combined royalties in the example, however, actual combined absence from the bargaining table. In model. For example, Professor Watt’s royalties for musical works and sound order to derive usable TCC rates from Shapley Analysis produces a recordings are approximately the Shapley Analyses the Judges must [REDACTED]:1 sound recording to [REDACTED]% of revenue. That same address these two issues. musical work ratio, or a [REDACTED]% [REDACTED]:1 ratio would yield a The Judges find that the problem of, TCC percentage. At his preferred percent-of-revenue rate for musical in essence, importing complementary combined royalty rate of works of [REDACTED]%.134 or nearly oligopoly profits into the musical works [REDACTED]%, the implied musical [REDACTED] percentage points higher rate through a TCC percentage can be works rate is [REDACTED]% of revenue. than the model. avoided by reducing the TCC The TCC rate that produces the same This is problematic because the sound percentage. Specifically, the TCC [REDACTED]% of revenue rate under recording rate against which the TCC percentage should be reduced to a level existing conditions would be rate would be applied is inflated both by that produces the same (non- [REDACTED]%.135 These adjusted TCC the existence of complementary complementary-oligopoly) percentage rates are summarized in the following oligopoly conditions in the market for revenue rate when applied to the table.

Adjusted TCC Adjusted TCC Adjusted TCC Adjusted TCC Adjusted TCC using [RE- using [RE- using [RE- using [RE- using [RE- Expert TCC from model DACTED]% com- DACTED]% com- DACTED]% com- DACTED]% com- DACTED]% com- bined royalties bined royalties bined royalties bined royalties bined royalties

Watt ...... [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% Gans ...... [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% Marx ...... [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]%

As to the issue of applying a TCC permanent digital downloads, along market share, they note that there is no percentage to a sound recording royalty with the growth of streaming, is a basis to assume that record companies rate that is artificially high as a result of powerful economic motivation for will head for the exits if their profits musical works rates being held record companies to pursue deals with from streaming drop below current artificially low through regulation, the the Services that ensure the continued levels. At bottom, this concern goes not Judges rely on Professor Watt’s insight survival and growth of the music to the decision whether or not to (demonstrated by his bargaining model) streaming industry. In negotiating those increase the mechanical rate, or to adopt that sound recording royalty rates in the deals both sides will be cognizant of the a particular rate structure, but to the unregulated market will decline in effect on the Services’ content cost of a magnitude of any rate increase, and response to an increase in the decision by this body. measures that should be taken to reduce compulsory license rate for musical In his separate opinion, Judge any disruption the increase might cause works. Strickler expresses concern that ‘‘if to the industry. The Judges take both [T]he reason why the sound recording rate mechanical royalty rates were to concerns into account in this is so very high is because the statutory rate increase to a level that significantly Determination. is very low. And if you increase the statutory reduced the profits of the record The foregoing exercise produced a rate, the bargained sound recording rate will companies from streaming, there is no broad range of potential rates: TCC rates go down. evidence in the record in this ranging from [REDACTED]% to 3/27/17 Tr. 3090 (Watt). Professor proceeding that indicates whether the [REDACTED]%, which correspond to Watt’s bargaining model predicts that record companies would decide to implied percent of revenue rates from the total of musical works and sound maintain the current vertical structure [REDACTED]% to [REDACTED]%. The recordings royalties would stay ‘‘almost of the market and docilely accept such Judges narrow that range by reference to the same’’ in response to an increase in a revenue loss.’’ 137 The Judges the strength of the evidence supporting the statutory royalty. Id. at 3091. acknowledge the concern articulated by the numbers underlying those rates. As must-have suppliers in an Judge Strickler, but note that it applies Professor Watt testified that the data unregulated market, record companies potentially to any rate increase for Professor Marx used in her Shapley are in a position to walk away from musical works that reduces record model was derived from 2015 Spotify negotiations with the Services and, company streaming profits.138 Just as financials and, as a result, understated effectively, put them out of business. the Judges have noted that there is no current downstream revenue. Watt WRT That they have not done so evidence to suggest that the current ¶¶ 37, 43–44. In addition, Professor demonstrates that it is not in their level of short-term losses is the Marx included a number of items as economic interest to do so.136 The maximum that the Services can absorb downstream costs that, in Professor decline in sales of physical copies and in their Shumpeterian competition for Watt’s view, should be excluded from

133 [REDACTED] (rounded). 137 Judge Strickler expresses concern that an sort of disruption the Judges consider under the 134 [REDACTED] increase in the mechanical rate might prompt the fourth 801(b)(1) factor. 135 The target TCC rate is computed using the record companies to create (or acquire) their own 138 The Judges note that Professor Watt’s insight ÷ ¥ formula TCC = 1 ((Rt/Rmw) 1), where Rt is the streaming services, rather than accept a lower applies not only to a Shapley-derived TCC rate, but combined royalty rate in the marketplace royalty rate from the existing Services. It is well- to any rate structure that results in an increase in ([REDACTED]%), and Rmw is the musical work established that it is not the Judges’ role to protect what services pay for musical works. Bargaining royalty rate yielded by the Shapley value analysis. the current players in the industry. Companies— theory instructs that the services and the record 136 The evidence in Web IV revealed that the even major players in the industry—enter and exit record companies’ strategy has been to companies will take into account any increase in ‘‘[REDACTED].’’ Web IV (restricted version) at 63. the market regularly. That market fluidity is not the the statutory royalties that the services must pay.

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the model. Id. ¶¶ 57–59. The net effect allocation of surplus to the upstream In a similar vein, Professor Marx did of understating downstream revenue content providers. Consequently, the not have an opportunity to rebut and overstating downstream costs is to Judges view Professor Marx’s top value Professor Watt’s [REDACTED]:1 sound drive down the amount of surplus for total royalties ([REDACTED]%) to recording to musical work royalty ratio. allocated to the upstream content constitute a lower bound for total Professor Watt derived that ratio using providers. Id. ¶ 42. Although Professor royalties in computing a royalty rate. data from Professor Marx’s model, yet Marx addressed the reasons for her As Professor Watt’s total royalty produced vastly different results. See decision to use 2015 cost and revenue figures were presented as rebuttal Trial Ex. 2619, at 9 (Appendix 3 to Watt data in her model, she did not address testimony, Professor Marx, on behalf of WRT). The reason for this disparity in the effect that her choice had on the services, did not have an outcome was not adequately explored or allocation of surplus, or attempt in any opportunity to rebut them. The Judges explained. The Judges give Professor way to correct for it. See 3/20/17 Tr. give them weight only to the extent of Watt’s [REDACTED]:1 ratio no 1880–81, 1906–08 (Marx). The Judges viewing his lowest figure 139 find that the total royalty values ([REDACTED]%) as an upper bound for weight. produced by Professor Marx’s models total royalties in computing a royalty The Judges are left with the following understate what would be a fair rate. potential royalty rates.

Adjusted TCC Adjusted TCC using [RE- Implied percent of using [RE- Implied percent of Expert TCC from model DACTED]% com- revenue rate using DACTED]% com- revenue rate using bined royalties [REDACTED]% bined royalties [REDACTED]%

Gans ...... [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% Marx ...... [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]%

The Judges find, therefore, that the terms failed to make the distinction the ‘‘buffer’’ copies). The question, zone of reasonable rates ranges from statute requires of the Judges. however, remained unresolved. In [REDACTED]% to [REDACTED]% of Legislative history leading up to the Phonorecords I, the Judges adopted the TCC, or, expressed as equivalent percent enactment of the Digital Performance 2008 Settlement which included ‘‘an of revenue rates, [REDACTED]% to Right in Sound Recording Act of 1995 incidental digital phonorecord delivery’’ [REDACTED]%. Taking into describes incidental DPDs as the in the definition of ‘‘Interactive consideration the totality of the transmission of copies that are made Stream.’’ 74 FR at 4529. After a finding evidence presented in this proceeding, solely to facilitate streaming, i.e., via a of legal error by the Register of 141 the Judges select [REDACTED]% of transmission system ‘‘designed to allow Copyrights (Register), the Judges TCC/[REDACTED]% of revenue as the transmission recipients to hear sound deleted the reference. See 74 FR 6832, recordings substantially at the time of most appropriate rate within that zone 6833 (Feb. 11, 2009). The distinction transmission.’’ See S. Rep. No. 104–138, of reasonableness. did not reappear in the Phonorecords II at 39 (1995). If the recipient does not adoption of the 2012 Settlement. See 78 E. Other Royalty Rates retain those copies for subsequent FR 67938, 67943 (Nov. 13, 2013). playback, then the copies are considered The record in this proceeding is 1. Royalty Rate for Incidental Digital ‘‘incidental deliveries.’’ Id. Copies devoid of factual evidence that demands Phonorecord Deliveries retained for subsequent playback, the rate distinction. The Judges The Act requires the Judges in setting whether ‘‘limited’’ or ‘‘permanent’’ fall conclude, however, that they may, into the category of ‘‘general indeed must, address the distinction as phonorecord mechanical license royalty phonorecord delivery.’’ Id. Further, if a a matter of law. Reviewing the rates and terms to distinguish between transmission system supports retention legislative history, the statutory (i) digital phonorecord deliveries where of digital phonorecords for subsequent language, and the history of study of the the reproduction or distribution of a playback, but the transmission recipient issue by the Copyright Office, the Judges phonorecord is incidental to the chooses not to do so, then the initial conclude that classification of an transmission which constitutes the delivery could be consider incidental. incidental DPD is a function of a digital phonorecord delivery, and (ii) Id. Service’s technological functionality digital phonorecord deliveries in The Copyright Office explored the and, to some extent, an end user’s general. 17 U.S.C. 115(c)(3)(C), (D). The question of identifying incidental DPDs subsequent conduct. extant regulations do not mention in an extended rulemaking In the context of interactive streaming incidental DPDs, but provide that a proceeding.140 During the study of the and similar modes of delivery where limited download is ‘‘a general digital issue, Services identified potentially there is no general DPD, the royalty phonorecord delivery under 17 U.S.C. incidental copies at the service offering rates in this determination covering that 115(c)(3)(C) and (D).’’ 37 CFR 385.11 level (variously called ‘‘server-, root-, mode of delivery are, de facto, the (and incorporated into § 385.21). It encoded-, or cached-’’ copies) as well as royalty rates for the incidental DPDs appears the parties’ 2012 Settlement at the end user level (often called that enable the activity. To the extent

139 By contrast, Professor Marx had ample 140 When it issued an interim rule, the Copyright license with respect to interactive streams.’’ 74 FR opportunity to critique Professor Gans’s report. See Office concluded that in a determination turning at 4539. By way of clarification, the Register noted Marx WRT ¶¶ 73–75. Her criticism focuses on his upon a conclusion of ‘‘when a DPD is an incidental that ‘‘an interactive stream that delivers a decision not to use the Shapley model to determine DPD,’’ the Judges should make that determination reproduction of a sound recording that qualifies as the division of surplus between the downstream ‘‘in the context of a factual inquiry . . . if such a a DPD is, for purposes of the license, an incidental services and the upstream copyright owners. Id. determination proves to be relevant.’’ 73 FR 66173, DPD.’’ Id. (‘‘a stream—whether interactive or non- ¶ 74. She does not challenge the specific ratio of 66179 (Nov. 7, 2008). sound recording to musical works royalties that he 141 The Register noted that the regulation the interactive—may or may not result in a DPD derives from his model and that the Judges use Judges adopted as part of a settlement among the depending on whether all the aforementioned here. parties ‘‘overstates the scope of the section 115 criteria are met.’’).

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any of the configurations covered by the free users to become paying subscribers serve all these objectives adequately but royalty rates set in this determination after the free trial period. When services to differing degrees.’’ Phonorecords entail both incidental and general DPDs, choose to deliver no-cost or non- 1981 Appeal, 662 F.2d at 9. (D.C. Cir. the royalty rate is for all DPDs, revenue bearing offerings qualifying as 1981) (citations omitted). Certain factors incidental or general, that result from promotional, ‘‘free trial,’’ or no-charge require determinations ‘‘of a judgmental the activity.142 locker services, the Services will not or predictive nature,’’ while others call for a broad fairness inquiry. Id. at 8 2. Royalty Rates for Non-Revenue pay mechanical musical works royalties. (citations & quotations omitted). Bearing Service Offerings Neither shall the Services deduct the costs of those service offerings from Accordingly, the Judges are ‘‘free to In the 2012 rates and terms, the service revenue, for purposes of choose’’ within the range of reasonable parties essentially rolled forward the calculating royalties payable on a rates . . . within a ‘zone of rate structure first constructed in the percent of service revenue. reasonableness.’ ’’ Id. at 9 (citations 2008 Settlement. In 2012, the parties omitted). created a separate aggregation of service VI. The Four Itemized Factors in In prior rate determination offerings in a new subpart C 143 to the Section 801(b)(1) proceedings, the Judges have regulations, agreeing to rates and terms The Copyright Act requires that the undertaken the ‘‘reasonableness’’ similar to those to which they agreed in Judges establish ‘‘reasonable’’ rates and analysis followed by consideration of subpart B for interactive streams and terms for the section 115 license. In the four itemized factors. They followed limited digital downloads. Based on the addition, section 801(b)(1) instructs the that approach in this proceeding. The evidence in this record, it appears Judges to set these rates ‘‘to achieve the Judges conclude, however, that their limited offerings, and bundled service following objectives’’: consideration of the four itemized offerings are not different in kind from Factor A: To maximize the availability of section 801(b)(1) factors in this interactive streaming and limited creative works to the public; proceeding also provides further downloads. No party offered compelling Factor B: To afford the copyright owner a support for their findings regarding a evidence to establish the necessity for fair return for his or her creative work and reasonable rate structure and reasonable segregating the current subpart C service the copyright user a fair income under rates. offering configurations from current existing economic conditions; The D.C. Circuit recently reiterated subpart B service offering Factor C: To reflect the relative roles of the the relationship between the 801(b) configurations. copyright owner and the copyright user in standard and market-based rates by In their review of the current and the product made available to the public with contrasting that standard with the proposed rates and terms, however, the respect to relative creative contribution, technological contribution, capital willing buyer/willing-seller standard set Judges see a basis to distinguish investment, cost, risk, and contribution to the forth in 17 U.S.C. 114(f)(2)(B). The court promotional or non-revenue producing opening of new markets for creative noted that the two standards are offerings from revenue-producing expression and media for their distinguishable by the fact that, unlike offerings. In some instances locker communication; and section 114(f)(2)(B), section 801(b)(1) services—particularly purchased Factor D: To minimize any disruptive does not focus on unregulated content locker services—are free to the impact on the structure of the industries marketplace rates. SoundExchange, Inc. user and produce no revenue for the involved and on generally prevailing v. Muzak LLC, 854 F.3d 713, 715 (D.C. Service separate from the purchase price industry practices. Cir. 2017). However, to the extent for the content. In some instances, a 17 U.S.C. 115(c), 801(b)(1).144 market factors may implicitly address service may transmit a sound recording The four itemized factors in section any (or all) of the four itemized factors, embodying a musical work that fits the 801(b)(1) require the Judges to exercise the reasonable, market-based rates may definition of a promotional offering; that ‘‘legislative discretion’’ in making remain unadjusted. If the evidence is, a sound recording that a Record independent policy determinations that suggests that market-based rates fail to Company makes available at no cost to balance the interests of copyright address any (or all) of these four the service and for a limited period. The owners and users.’’ SoundExchange, itemized policy factors, the Judges may Services’ transmissions of those sound Inc. v. Librarian of Cong., 571 F.3d adjust the reasonable, market-based rate recordings are made solely for the 1220, 1224 (D.C. Cir. 2009); see appropriately. See Determination of purpose of promoting a particular sound Recording Indus. Ass’n Am. v. CRT, 662 Rates and Terms ..., 73 FR 4080, recording, an album, or the artist F.2d 1, 8–9 (D.C. Cir. 1981) 4094 (Jan. 24, 2008) (SDARS I) (applying performing the musical work. Record (‘‘Phonorecords 1981 Appeal’’) same factors, holding ‘‘[t]he ultimate companies distributing promotional (analyzing identical factors applied by question is whether it is necessary to recordings bear responsibility, if any predecessor rate-setting body and adjust the result indicated by there be, for the licensing of the holding that statutory policy objectives marketplace evidence in order to embodied musical work. In other of 801(b)(1) ‘‘invite the [Board] to achieve th[e] policy objective[s].’’).145 instances, a Service might offer a free or exercise a legislative discretion in A. Factor A: Maximizing Availability of reduced-price subscription to its determining copyright policy in order to Creative Works to the Public streams, or modified versions of its achieve an equitable division of music subscription-based services, to entice industry profits between the copyright Factor A provides that rates and terms owners and users’’). should be determined to ‘‘maximize the 142 The rates for permanent digital downloads and The four factors ‘‘pull in opposing availability of creative works to the limited downloads set by the parties to the March directions,’’ leading to a ‘‘range of public.’’ 17 U.S.C. 801(b)(1)(A). Of 2017 subpart A settlement do not distinguish particular importance, this provision between incidental DPDs and DPDs in general. The reasonable royalty rates that would Judges deem those rates to cover all DPDs, unambiguously links the upstream rates incidental and general, that result from those modes 144 The 1976 Act applied section 801(b)(1) and its of delivery. four-factor test to new licenses. The lone existing 145 Thus, the Judges reject Copyright Owners’ 143 The so-called subpart C service offerings statutory license carried forward into the 1976 Act argument that the first three itemized section included limited offerings, mixed service bundles, from the 1909 Copyright Act and made subject to 801(b)(1) factors per se reflect the same forces that music bundles, paid locker services, and purchased this standard was the mechanical license at issue shape the rate set in the marketplace. See 4/4/17 Tr. content locker services. in this proceeding. 4589, 4666 (Eisenach).

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and terms that the Judges are setting somewhat restricted, producer surplus still access music in a way that still allows with the downstream market, in which is increased and consumer surplus is some monetization of that provision of that ‘‘the public’’ is listening to sound decreased—with a portion of the overall service. recordings that embody musical works. surplus redistributed to producers/ 3/20/17 Tr. 1894–95 (Marx) (emphasis In the SDARS I Determination, the sellers. Another portion lost as ‘‘a pure added); see Marx WDT ¶ 12 (‘‘An Judges made a general statement, ‘deadweight’ loss . . . the principal economic interpretation of [F]actor A is attributed to an expert economic measure of the allocation of harm’’ that the royalty structure should witness, Dr. Ordover, that ‘‘[w]e agree arising from the exercise of market ‘‘maximize the pie’’ of total producer . . . that ‘voluntary transactions power. Mansfield & Yohe, supra, at 499; and consumer surplus. . . .’’). between buyers and sellers as mediated see Schotter, at 398 (accepted definition Professor Marx contends that the by the market are the most effective way of ‘‘deadweight loss’’ is ‘‘[t]he dollar price discriminatory rate structure is to implement efficient allocations of measure of the loss that society suffers superior to a per play model in societal resources.’ ’’ SDARS I, 73 FR at when units of a good whose marginal maximizing the availability of musical 4094 (quoting from Written Direct social benefits exceed the marginal works to the public: Testimony of Janusz Ordover at 11). social cost of providing them are not However, as the Judges’ present produced because of the profit- The subscription model provides an discussion of the economics of this efficiency benefit because the price of a play maximizing motives of the firm is equal to the marginal cost of roughly 147 market should make plain, they do not involved.’’). zero—a subscriber faces the true marginal agree that such a broad statement As the foregoing definitions imply, cost of playing a song over the internet and captures all the economic realities of the the two surpluses are measured by thus consumes music at the efficient level. market. In fact, Professor Ordover’s full reference to a single equilibrium price. When subscribers face a per-play royalty cost testimony in SDARS I demonstrates that However, when Copyright Owners, like of zero, interactive streaming services have he based his statement on the same any sellers, are able to price the appropriate incentive to encourage music particular aspects of the pricing of discriminate, they enlarge the total listening at the margin. copies of intellectual property (such as value of the combined surpluses, In contrast, if interactive streaming services musical works or sound recordings) that diminish the ‘‘deadweight loss’’ and faced a positive per-play royalty cost, they the Services’ expert witnesses and the would have a diminished incentive to attract appropriate the larger, combined and retain high-use consumers, the very type Judges have identified in this surplus for the producers. See H. of consumers who create the most social proceeding. Varian, Intermediate Microeconomics: A surplus through their listening. They would On behalf of the Services in the Modern Approach 462–63 (2010) (With also have an incentive to discourage music present proceeding, Professor Marx price discrimination, ‘‘[j]ust as in the listening among the high-use consumers they approaches Factor A in a manner that is case of a competitive market, the sum of retain. The higher the level of per-play at once novel (for these proceedings) producer’s and consumer’s surplus is royalties is, the more this incentive might and consistent with fundamental and maximized [but with] the producer . . . affect the behavior of interactive streaming relevant economic principles. getting the entire surplus generated in services. Specifically, she asserts that the market. . . .’’). Id. at ¶¶ 130–131 & n. 135.148 maximization of the availability of Professor Marx marshals these Professor Marx’s analysis is based on musical works (embodied in sound microeconomic principles to explain an understanding that maximizing the recordings) to the public, through why the 2012 Settlement rate structure availability of musical works is a interactive streaming, requires that the tends to incentivize and support the function of incentives to distributors combined ‘‘producer surplus’’ and maximization of musical works and a function of downstream demand. ‘‘consumer surplus’’ be maximized, available to the public under Factor A. She notes, however, that the variable, because that leads to listening by all Marx WDT ¶¶ 119–122, 123–133. As percent-of-revenue rate structure is segments of the public regardless of she testified at the hearing: consistent with agreements in the their WTP. In Professor Marx’s analysis unregulated upstream sound recording ‘‘producer surplus’’ means ‘‘the amount [H]aving different means of price discrimination is going to allow greater market, where record companies license by which the total revenue received by efficiency to be achieved [i]f we have a way sound recordings to these same a firm for units of its product exceeds for low willingness to pay consumers to interactive streaming services. She the total marginal cost. . . .’’ A access music, for example, student discounts, notes: Schotter, Microeconomics: A Modern family discounts or ad-supported streaming, Approach at 389 (2009).146 The where low-willingness-to-pay consumers can Ironically, given the preference of . . . ‘‘consumer’ surplus’’ means ‘‘[t]he Copyright Owners’ economists for market outcomes, . . . they support a proposal that 147 To be clear, this ‘‘harm’’ is not conclusive difference between what the consumer would tend to eliminate [REDACTED] would be willing [and able] to pay and evidence that such static market power is harmful, or even inefficient, on balance, in a dynamic sense. interactive streaming, which the unregulated what the consumer actually has to pay.’’ A monopoly may be more efficient in reducing unit sound recording side of the market has Mansfield & Yohe, at 93. costs because of necessary scale (such as a natural facilitated. [Copyright Owners’] proposal When a perfectly competitive market monopoly) or because of superior production would also completely do away with is in equilibrium (or tending that way) techniques. And again, when marginal production percentage-of-revenue rates that form a key costs (of copies) are essentially zero, exercise of part of unregulated rates negotiated between ‘‘the sum of consumer surplus . . . and market power by copyright owners (including producer surplus . . . is maximized.’’ owners of collectivized repertoires such as record Schotter, at 420. By contrast, if a market companies, music publishers and PROS) can be 148 With regard to Factor A as it relates to is not perfectly competitive because the necessary to induce the production of copyrighted Copyright Owners’ proposal, Professor Marx also sellers have some degree of market goods (such as musical works and sound notes the supply-side ‘‘Cournot Complements’’ recordings), because without production there is problem created by Copyright Owners’ reliance on power, then the level of output is nothing to be copied. But these efficiencies only the unregulated sound recording market. This is a demonstrate why such market power should not be problem because rates in such a ‘‘must have’’ 146 For present purposes, marginal cost includes dissipated, and are not relevant to the narrower unregulated market can be even higher than opportunity cost as well as marginal production issues at hand: how to maximize the availability of monopoly rates, thereby depressing the quantity cost, regarding the marginal cost of distributing goods and to set reasonable rates given the supplied—contrary to a goal of maximizing the copies of the musical works (embodied in otherwise beneficial existence of such market availability of musical works. See 4/7/17 Tr. 5532 interactively streamed sound recordings). power. (Marx).

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music labels and interactive streaming songwriters are their main source of Now, an established songwriter cannot services. income to cover living expenses, mentor young songwriters if he or she wants Marx WRT ¶ 84 (emphasis added). allowing them to dedicate as much of to maintain his living. Veteran songwriters, such as myself, simply do not have time. Beyond Professor Marx’s theoretical their time as possible to songwriting Instead, I spend three to four days a week arguments, Dr. Leonard notes that the instead of having to take other work to with young recording artists who already existing (price-discriminatory) rate make ends meet.’’ Witness Statement of have record deals and need help writing their structure that has existed for two rate Justin Kalifowitz, Trial Ex. 3022, ¶ 15 songs. These recording artists are sometimes periods. He contends there is no (Kalifowitz WDT). If the mechanical very talented songwriters, but it often takes evidence that songwriters as a group royalties from which music publishers the craft and art of the professional writer to have diminished their supply of musical can recoup advances decrease, so too do turn their thoughts into commercial songs. works to the public. In fact, he notes the advances that music publishers are Id. ¶¶ 44–45; see also Witness Statement that the music publishing sector has willing to pay out. ‘‘[I]n the non-digital of Lee Thomas Miller, Trial Ex. 3023, at been profitable throughout the present era, those draws for brand new writers, ¶ 6 (L. Miller WDT) (‘‘Publishers can rate period. 3/15/17 Tr. 1120 (Leonard). it wasn’t uncommon for them to be in simply not afford to ‘develop’ as many Dr. Leonard is correct that there is no the $20,000, $30,000 range when those writers as they once did.’’). evidence in the record that songwriters dollars meant more, 20 years ago. Today To be sure, not all of the diminution as a group have diminished their supply the standard is $12,000.’’ 3/23/17 Tr. of mechanical royalty income has been of musical works to the public. No 2932 (Herbison). a result of the shift from physical participant performed such an empirical The decline in royalties has product and permanent downloads to study. Nevertheless, there is ample, diminished some music publishers’ streaming. Digital piracy, and the uncontroverted testimony that willingness to make or continue unbundling of the album 150 have songwriters have seen a marked decline publishing agreements with songwriters: played significant parts in reducing in mechanical royalty income over the The availability of publishing deals has songwriter income. See 3/23/17 Tr. past two decades, and that this decline significantly decreased. It is alarming that in 2937, 2940–41 (Herbison). It is not has rendered it increasingly difficult for Nashville there are so many fewer within the Judges’ authority to roll back non-performing songwriters (i.e., songwriters than there were just a few years the clock, as it were, and remedy every songwriters with income from ago. Most estimates say that there are less economic force that has diminished songwriting only and not from than one-quarter of the number of songwriters’ income over the past two performing or recording music) to earn professional songwriters than there were just decades. Nevertheless, the Judges find a living practicing their craft. For 10 years ago. Many songwriters in Nashville that the evidence in this proceeding example, Mr. Steve Bogard, a successful who earned a full-time living from royalty supports a conclusion that the existing veteran songwriter from Nashville, payments are no longer signed to publishing deals. rates for mechanical royalties from testified that ‘‘I have written many songs interactive streaming are a contributing that have become hits and continue to Bogard WDT ¶ 41. Diminished factor in the decline in songwriter do so. However, over the past few years, availability of publishing deals means income, and that this decline has led to my income has not reflected my fewer new songwriters entering the fewer songwriters. If this trend continued success because the profession: continues, the availability of quality interactive streaming services are paying Publishers cannot afford to sign as many songs will inevitably decrease.151 a fraction of what I earn from physical songwriters as they did in the past. Music Copyright Owners, principally sales and permanent downloads.’’ publishers typically invested in younger through the rebuttal testimony of Witness Statement of Steve Bogard, writers who might not produce immediate Professor Watt, argue that Professor Trial Ex. 3025, ¶ 32 (Bogard WDT). Lee results and then recouped their money when Marx has made a fundamental error in Thomas Miller, another successful those writers started earning royalties on equating the maximizing of availability Nashville-based songwriter, when asked album cuts. Now, when they do sign writers, of musical works with a maximization to describe the mechanical royalty music publishers increasingly turn to of the sum of the producer and recording artist and producer writers, so they income he earns from on-demand can hedge their bets with a better chance of consumer surplus. Watt WRT ¶ 10. streaming, stated ‘‘[i]t is so insignificant recordings being released. According to Professor Watt, ‘‘A better that we rarely even scroll down and understanding of criterion A is that the look at the line items. . . . [Y]ou look Bogard WDT ¶ 42; see also Witness royalty payments should ensure that a at these numbers of millions of spins Statement of Liz Rose, Trial Ex. 3024, ¶ 20 (Rose WDT) (‘‘we used to sign more and then you look at the tens of dollars 150 Album sales provided songwriters income that they pay.’’ 3/28/17 Tr. 3517–18 songwriters and give them five or six from ‘‘album cuts,’’ i.e., songs that were not hits, but (Miller). years to hone their craft . . . but we provided royalty income from album sales. In the can’t afford to do that anymore’’). current singles market that dominates download Mechanical royalties play a critical sales, hit singles get sold (and provide royalty role in enabling professional Development of those songwriters who income), but lesser-known tracks generally have songwriters to write songs as a full-time are fortunate enough to sign publishing much lower sales and royalties. 3/23/17 Tr. 2938– occupation.149 Professional songwriters deals is also suffering. 40 (Herbison). Similarly, interactive streaming permits listeners to stream individual songs, even have traditionally subsisted on a When I first arrived in Nashville, if they were released as part of an album. ‘‘draw,’’ a periodic advance against experienced and established songwriters Noninteractive streaming of albums is not permitted future mechanical royalties that music would invite young, talented songwriters to without a waiver of the sound recording publishers pay out like a salary. See 3/ write with them. This was a very performance complement. 17 U.S.C. 114(d)(2)(C)(i), 23/17 Tr. 2931 (Herbison). ‘‘In many illuminating experience for the young j(13)(A)). 151 The Judges do not discount the quality of cases, the advances we pay our songwriters and helped them grow into better professionals. It also gave the established existing songs. Indeed, music publishers continue writer new ideas and influences. Today, a to market the ‘‘old standards’’ to young performers. 149 Justin Kalifowitz, founder and CEO of an professional non-performing songwriter The Judges do not measure availability of creative independent music publisher, testified that works by looking at music publishers’ profits or by ‘‘[q]uality songwriting cannot be relegated to a part- cannot simply try to write a great song alone counting recycled songs contributing to those time hobby; it is a calling and a career.’’ Witness or with co-writers who are also professional profits. Maximizing the availability of creative Statement of Justin Kalifowitz, Trial Ex. 3022, ¶ 14 songwriters, then hope that an artist records works includes, if not focuses on, new creative (Kalifowitz WDT). it. works.

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plentiful supply of works is forthcoming offset by a reduction in the up-front By contrast, to equate ‘‘availability’’ into the future. . . .’’ Id. To accomplish subscription price. He suggests that this solely with a higher rate would produce, that end, Professor Watt argues the rates consequence would not necessarily be ultimately, a lower surplus. The Judges should be set to ensure that ‘‘creators deleterious for the streaming service find that Copyright Owners have taken are given the correct incentives to because ‘‘[w]ith the reduction in the a cramped and unrealistic view of continue to create and make available fixed fee (along with the positive per- incentives created by price valuable works.’’ Id. unit price), it becomes entirely possible discrimination. Although a per-unit rate Professor Watt argues that even if the that consumers who were not initially structure with higher royalty rates might rates and rate structure are designed to in the market now find it to be in their have an immediate superficial appeal, maximize consumer and producer interests to join the market, consuming the consequence will most assuredly be surplus, that maximization would not positive amounts of streamed music lower revenues both downstream and inform the Judges as to whether that where previously they consumed none.’’ upstream. result satisfies Factor A. Rather, Id. ¶ 15. The Judges find that the objective of according to Professor Watt In their affirmative case regarding maximizing the availability of musical In effect, a royalty structure is simply a Factor A, Copyright Owners argue that works downstream to the public is way in which producer surplus, once ‘‘availability maximization’’ should be furthered by an upstream rate structure created, is shared between the interactive considered through the lens of the that enhances the ability of the streaming firms and the copyright holders, creators, who seek high rates as a signal interactive streaming services to engage but in and of itself, the structure does not to spur creation and would see low rates in downstream price discrimination determine the size of either producer or as a disincentive. (‘‘down the demand curve,’’ increasing consumer surplus. Consumer surplus and In undertaking a Factor A evaluation, producer surplus are both entirely revenue for both Copyright Owners and the Judges are cognizant of the double the interactive streaming services). determined by the interplay of the demand meaning of ‘‘availability’’ of creative curve for the product in question (here, works in a tiered market such as the In sum, the Judges are persuaded that interactive music streaming) and the way the Professor Marx’s analysis of Factor A is product is priced by the interactive streaming music streaming business at issue in this proceeding. On the one (upstream) consistent with the purpose of that industry to its consumers. That is, regardless statutory objective and sound economic of the structure of the royalty payments, the hand, maximizing availability of ‘‘size of the pie’’ is determined by the creative works might refer to theory. An upstream rate structure unilateral decisions made by interactive encouraging artists to produce more based on monetizing downstream streaming firms about their pricing to prolifically. On the other (downstream) variable WTP will facilitate beneficial consumers. hand, maximizing availability might price discrimination. In turn, that price Watt WRT ¶ 11. refer to encouraging more entry into the discrimination will allow for more Professor Watt also attempts to de- music streaming business to maximize affordable access ‘‘down the demand couple the upstream and downstream options for end-users and, presumably curve,’’ making musical works available rate structures by analogizing interactive expand the overall consumption of to more members of the public. The rate streaming to a retail restaurant offering music. The Judges must weigh the structure determined by the Judges, in of an ‘‘all you can eat buffet.’’ He impact of their rate decisions so as not which both rate prongs monetize concludes that a retailer, such as an to favor one interpretation of availability downstream variable WTP, satisfies interactive streaming service or a buffet of creative works over the other. Factor A. restaurant, can pay for inputs (musical With regard to the downstream Although largely anecdotal and works or food) per-unit while still market, the Judges find that Professor unsupported by sophisticated surveys, charging an up-front access fee ($9.99 Marx’s analysis of how a price studies, or economic theories, the per monthly subscription or $9.99 for a discriminatory model maximizes uncontroverted evidence from buffet meal). By this analogy, Professor availability is correct. Price songwriters and publishers should not Watt purports to demonstrate that discrimination not only serves low WTP go unheeded. That evidence points interactive streaming services do not listeners, but it also indirectly serves strongly to the need to increase royalty require non-unit royalty rates to serve copyright owners, by incentivizing rates to ensure the continued viability of their downstream listeners. Id. ¶ 12. interactive streaming services to songwriting as a profession. The rate Professor Watt asserts that Spotify’s increase the total revenue that price determined by the Judges represents a claim that listeners to it ad-supported discrimination enables. Any seller or 44% increase over the current headline service do not pay a marginal positive licensor would prefer to maximize its rate, and thus satisfies the Factor A price is inaccurate. He notes that revenue, and a rate structure that will objective in this respect as well. listening to advertising that interrupts effect such maximization thus would be B. Factors B and C: Fair Income and the music imposes a time-related/ the best structural inducement. For Returns and Consideration of the annoyance cost that the listeners must purposes of applying Factor A, a rate Parties’ Relative Roles accept.152 This suggests to Professor structure that better increases revenues, Watt that per-unit pricing (at least in a ceteris paribus, should induce more Factor B directs the Judges to set rates non-monetary manner) indeed is production of musical works, a result that ‘‘afford the copyright owner a fair possible downstream. Id. ¶ 13. that Copyright Owners should desire.153 return for his or her creative work and Professor Watt further opines that any the copyright user a fair income under positive marginal cost pricing of songs 153 This point appears to raise a question: How existing economic conditions.’’ Factor by interactive streaming services on could Copyright Owners and their economic C, instructs the Judges to weigh ‘‘the experts argue against a rate structure that inures to subscription plans necessarily would be their benefit as well? The answer is: They do not. relative roles of the copyright owner and As stated supra, they advocate for a rate set under copyright user in the product made 152 The record does not address an assessment of the bargaining room theory, through which available to the public,’’ across several the advertising interruption cost. Advertising in mutually beneficial rate structures can still be dimensions. 17 U.S.C. 801(b)(1)(B), (C). today’s technological environment is often negotiated, but not subject to the ‘‘reasonable rate’’ informative, especially when it is targeted to and itemized factor analysis required by law. In specific listeners, adding some measure of value, those negotiations, as Dr. Eisenach candidly different threat point to use in order to obtain better rather than cost, to the listener. acknowledged, Copyright Owners would have a rates and terms.

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Congress included Factors B and C in ‘‘inspired’’ by the Shapley valuation as a separate analysis), that there is no section 801(b)(1) to establish a legal approach.157 See Marx WDT ¶¶ 11–2 basis to depart from the Judges’ standard for the Judges to use to move (considering ‘‘a ‘fair return’ according to determination of the reasonable rate their determination of new rates for . . . relative contributions (factors B structure and rates as set forth supra. existing licenses beyond a strictly and C)’’ because of the use of ‘‘[a]n C. Factor D: Avoidance of Disruption market-based analysis. In an attempt to economic interpretation of factors B and pass constitutional muster, Congress C . . . a commonly used economic The last itemized factor of section crafted statutory language that approach, the Shapley value, which 801(b)(1) directs the Judges ‘‘to paralleled public utility-style regulatory . . . operationalizes the concept of fair minimize any disruptive impact on the principles.154 According to 1967 return based on relative structure of the industries involved and Congressional testimony, these contributions.’’); Watt WRT ¶ 22 (‘‘I on generally prevailing industry principles were ill-suited for setting agree with Dr. Marx’s assertion that the practices.’’ 17 U.S.C. 801(b)(1)(D). In rates that equitably divided Shapley model is a very appropriate Phonorecords I, 74 FR at 4525, the compensation for the ‘‘relative roles’’ of methodology for finding a rate that Judges reiterated their understanding of licensors and licensees in order to satisfies factors B and C of 801(b); see Factor D, concluding that a rate would provide a ‘‘fair’’ outcome.155 However, also Gans WDT ¶¶ 65 n. 35, 67 (noting need adjustment under Factor D if that as the parties’ economic experts make the Shapley approach provides for a rate clear in their approaches to Factors B ‘‘fair allocation’’ as among input directly produces an adverse impact that is and C in this proceeding, the discipline suppliers to reflect ‘‘the contributions substantial, immediate and irreversible in the of economics has evolved since Mr. made by each party.’’). The Judges short-run because there is insufficient time Nathan criticized as economically concur with this joint analysis. for either [party] to adequately adapt to the impossible any regulatory attempt to The Judges used Shapley analyses to changed circumstance produced by the rate equitably divide creative derive royalty rates in this change and, as a consequence, such adverse contributions.156 Determination, and discussed the impacts threaten the viability of the music In the present proceeding, the parties’ delivery service currently offered to experts’ respective Shapley (or Shapley- consumers under this license. economic experts agreed on the inspired) models in that context.158 To propriety of joint consideration of summarize briefly, Professors Marx, Id. The Judges adopt and apply in this Factors B and C either through a Gans, and Watt’s analyses all produced Determination the same Factor D test. Shapley value analysis or an analysis a lower ratio of sound record to musical Copyright Owners and Apple work royalties than exists under current advocate a complete abandonment of 154 Public utility-style regulation, especially in conditions, implying that a fair the current rate structure. The upshot of 1967 when Congress was working on copyright each proposal is a dramatic swing in reform legislation, was classic rate-of-return allocation of surplus between those two regulation. Essentially, the regulator would groups would be more even than under royalties: Increases under Copyright establish the utility’s costs and determine the rate the current market structure. Professors Owners’ proposal and decreases under charged to customers (or rates charged to different Marx’s and Watt’s Shapley analyses also Apple’s proposal. For all the reasons customers), sufficient to provide the utility with a detailed in this Determination, the reasonable rate of return. See generally Decker, pointed to a lower overall percentage of Modern Economic Regulation at 104 (2014). service revenue being directed to Judges do not adopt either of the per- 155 See Hearing on S. 597, Subcomm. on Patents, copyright royalties than exists under the unit rate structures these parties Trademarks and Copyrights of the S. Committee on current rate structure. Due, in part, to advocate. The Judges decline to make the Judiciary (Mar. 20–21, 1967). her decision to design the model to the requested changes in rate structure 156 Economics experts in the present proceeding not because the structure is different for both Copyright Owners and the Services equalize bargaining power between acknowledge that microeconomic principles (pre- copyright owners and users, Professor and unfamiliar, but because of the Shapley values) do not provide insights as to what Marx’s model produced lower overall dramatic, disruptive effects of the constitutes ‘‘fairness.’’ See, e.g., 3/30/17 Tr. 3991 royalties for copyright owners than proposed per-unit rate structures. (Gans) (‘‘fairness . . . is not a topic that is sitting The Services advocate essentially the in an economics textbook somewhere.’’); 3/20/17 Professor Watt’s model. Tr. 1830 (Marx) (‘‘Fairness is not a notion that has The Judges have determined a rate rate structure that now exists. See SJPFF a unique definition within economics.’’); 1128–29 that is computed based on the highest at 1. The Judges’ proposed rate structure (Leonard) (‘‘economists . . . typically don’t do value of overall royalties predicted by adopts some attributes of the existing ‘fair’ ’’); 4/13/17 Tr. 5919 (Hubbard) (‘‘Economists rate structure, incorporating the aren’t philosophers. I can’t go to the biggest picture Professor Marx’s model and the ratio of meaning of ‘fair’. . . .’’). Rather, economists sound recording to musical work economically reasonable features and attempt to identify ex ante ‘‘fairness’’ by identifying royalties determined by Professor Gans’s abandoning unsupported features that fair processes in the workings of and structure of analysis.159 The Judges find that these unduly fracture and complicate the rate markets, in bargaining, and in the efficiency of structure. outcomes generated by these processes, although rates are consistent with the experts’ their understanding of what constitutes a fair analyses and constitute a fair allocation The record shows that interactive ‘‘process’’ varies. See, e.g. 3/13/17 Tr. 555 (Katz) of revenue between copyright owners streaming services are failing to realize (‘‘[T]he most useful or practical way of thinking an accounting profit under the current about it here was really to focus on whether the and services. The Judges’ analysis with regard to Factors B and C demonstrates structure and nothing the Judges do in process is fair’’ . . . [and] a conception that’s often this proceeding will change the used in economics is that a process is fair if it’s . . . (whether that analysis was undertaken competitive or the outcome of a competitive market. as part of the reasonable rate analysis or Services’ business models to change that A competitive bargaining process is fair. And so circumstance.160 The Services remain in that’s the—the central notion of fairness that I used business and new streaming services here.’’); 3/15/17 Tr. 1129 (Leonard) (‘‘My concept of 157 The Shapley approach, named for Nobel fair . . . and what I think a lot of economists would Memorial Prize winner Dr. Lloyd Shapley, enter the market despite the existence of say is that if you have . . . a negotiation between represents a method for identifying fair outcomes, two parties and there are no . . . constraints such previously unaddressed in microeconomics. 160 It is likely the Services have made and will as holdup . . . and there’s no market power . . . Congress did not apply the Shapley value approach, make business decisions that defer accounting again I hesitate to use the word, so maybe I’ll put perhaps because this methodology, although profits. The Judges’ approach offers no criticism of it in quotes, would be fair.); Eisenach WDT ¶ 24 (‘‘a developed in 1953, was not yet widespread in the the Services’ business decisions; rather, the Judges rate set at the fair market value by definition economic literature in 1967. attempt to assure a structure that permits the provides fair returns and incomes to both the 158 See supra, section V.D.1. Services’ competitive tactics without penalizing the licensee and licensor.’’) 159 See supra, section V.D.2. creators of the works they exploit.

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chronic accounting losses. The Services’ acknowledged problem of a lack of Copyright Owners would run the very inability to become profitable will scale, would constitute an unwarranted real risk of preventing the services from persist based on the record, under subsidy to these services at the expense surviving the ‘‘short-run,’’ threatening existing competitive conditions. As Mr. of Copyright Owners.161 the type of disruption Factor D is Pakman testified: [N]o current music Although the Services have indicated intended to prevent. their ability to withstand short-term subscription service—including While the reasonable rate determined losses as they compete for scale/market marquee brands like Pandora, Spotify by the Judges does not present the same and Rhapsody—can ever be profitable, share, the record also indicates that there is a limit to such losses, however risk of disruption as the rates sought by even if they execute perfectly. . . .’’ imprecise and unknown, beyond which the Copyright Owners, it does represent Testimony of David B. Pakman, Trial services will be unable to attract capital a not insubstantial increase of Ex. 696, ¶ 23 n.5 (citation omitted) and survive until the long run market approximately 44% over the current (Pakman WDT). Although Mr. Pakman de´nouement. As Dr. Leonard testified, headline rate. In order to mitigate the blames the lack of profitability (in part) ‘‘[REDACTED] is relevant and suggests risk of short-term market disruption, on the level of mechanical royalties, the [REDACTED].’’ Leonard AWDT ¶ 101 and to afford the services sufficient Judges find, based on the Services’ own n.151. This testimony reflects the well- opportunity ‘‘to adequately adapt to the acknowledgement, that the lack of understood principle that ‘‘[t]here is no changed circumstance produced by the profitability is a function of a lack of specific time period . . . that separates rate change,’’ the Judges will phase in scale (which is another way of the short run from the long run.’’ R. the new rate in equal annual increments indicating that market share is divided Pindyck & D. Rubinfeld, over the rate period. Thus, the rates for among too many competing interactive Microeconomics at 190 (6th ed. 2005). the 2018–2022 rate period shall be the streaming services). Id. Lowering Thus, although the Services appear able greater of the percent of revenue and mechanical royalties to provide the to withstand current rates, a rate percent of TCC rates in the following Services profitability, in the face of the increase of the magnitude sought by table:

2018 2019 2020 2021 2022

Percent of Revenue ...... 11.4 12.3 13.3 14.2 15.1 Percent of TCC ...... 22.0 23.1 24.1 25.2 26.2

The Judges’ rate structure continues to Register retained authority to regulate downloads and ringtones, the so-called produce an All-In rate, from which the ‘‘notice of intention to obtain the section ‘‘subpart A’’ configurations. portion for the mechanical rights is 115 license and requirements regarding With the Judges’ determination to derived. The two rights are perfect monthly payment and monthly and change section 115 rate structures and complements. Without sufficient annual statements of account. . . .’’ See to realign service offerings for rate evidence to establish independent Final Order, Division of Authority purposes, the regulatory terms must respective values, any attempt to Between the Copyright Royalty Judges likewise change. Further, beginning in segregate the two could result in and the Register of Copyrights under 2013–14 with the Web IV determination, disruptive unintended consequences. In Section 115 Statutory License, 73 FR the Judges launched an initiative to the rate structure the Judges adopt, they 48396, 48397 (Aug. 19, 2008) (Register’s simplify copyright royalty regulations, attempt to ensure that no one of the Rulemaking Opinion). In adopting by eliminating duplication and, to the myriad licenses required for the public terms, the Judges may adopt ‘‘additional extent possible, using plain English. The to enjoy broadcast music swallows up terms ‘necessary to effectively regulations codifying the terms of the payment for any other license. implement the statutory license.’ ’’ Id. at present determination are no exception. To standardize the part 385 regulations, VII. Terms 48398. In this Determination the Judges’ cleave to the division of authority the Judges begin with a reorganization Before enactment of the Copyright that consolidates all regulations of between them and the Register, Royalty and Distribution Reform Act of general application in a new subpart A. declining to adopt terms any of the 2004, the Register held exclusive In this Determination, it is not the authority to set terms for use of the participants proposed that might Judges’ intention to change the agreed section 115 compulsory license(s). In impinge on the Register’s authority. terms for extant subpart A. The Judges the 2004 Act, Congress gave the Judges The extant regulations for the section do, however, move some of the agreed authority to set ‘‘reasonable rates and 115 license have developed over time. subpart A regulations to the new terms of royalty payments’’ for section Participants in prior proceedings crafted subpart A regulations of general 115 licenses, as well as terms the regulations to codify the structure application. Further, given the changes establishing ‘‘requirements by which and terms of their settlements. The most in rate structures effected by this copyright owners may receive recent regulatory amendment occurred determination, the Judges now include reasonable notice of the use of their in November 2017, when record labels Music Bundle configurations in the works under . . . section [115], and and Copyright Owners negotiated a same regulatory category as the under which records of such use shall settlement relating to the use of musical constituent parts of the music bundle, be kept and made available. . . . ’’ See works embodied in physical viz., physical phonorecords, permanent 17 U.S.C. 115(c)(3)(D), 801(b)(1). The phonorecords, permanent digital digital downloads, and ringtones.

161 Copyright Owners argue that the services Spotify’s CFO, Mr. McCarthy notes, Sirius and XM percentage of revenue as they grew their subscriber could attempt to cut their non-content costs in (the pre-merger predecessors to Sirius XM) ‘‘nearly base. . . . Their costs declined as they achieved order to remain sustainable. They suggest that the bankrupted themselves and merged in order to scale.’’ Id. Once again, the necessity of scale services emulate Sirius XM, which successfully survive.’’ McCarthy WRT ¶ 42. Moreover, not only remains paramount. reduced its non-content costs as a percent of were Sirius XM’s content costs lower as a percent revenue. See Rysman WDT ¶¶ 98–100. However, as of revenue, but also its ‘‘costs declined as a

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Regulations specific to physical ¶ 83. The rationale offered by the demand. See Ghose WDT ¶¶ 54, 60. Mr. phonorecords, PDDs, and ringtones Services is that discounts for a family Vogel, testifying for Spotify asserted that adopted by agreement together with group or for a student build the ultimate counting streams of under 30 seconds regulations specific to Music Bundles customer base, by orienting the affords a substantial windfall to will now appear in subpart B. discounted service users to their Copyright Owners. Written Rebuttal New subpart C includes all streaming particular formatting and increasing Testimony of Paul Vogel, Trial Ex. 1068, service offerings that are revenue user comfort and convenience. Id. ¶ ¶ 39–40 (Vogel WRT). Pandora and bearing, including offerings that the Copyright Owners urge the Judges to Spotify join in the request to add a 30- Services market at discounted prices, require the Services to pay the same second threshold to the definition of such as annual subscriptions, family royalty rate for discounted offerings as ‘‘Play.’’ Apple contends that the time plans, or student plans. Regulations for they pay for full-price subscription threshold is a feature of [REDACTED]. promotional streams and service offerings. Apple PFF ¶ 240. Copyright Owners offerings for which the Licensee Relying on their rationale for choosing argue against the proposal arguing that receives no consideration and that are a percent-of-revenue rate structure the definition for section 115 should free to the end-user are contained in rather than a per-unit rate structure, the align with that adopted for subpart D. Judges recognize that the Services are, to noninteractive streaming licenses under some extent, focusing more on growth of section 114. A. Definitions market share than growth of revenue. The Judges’ rate structure in this But the Judges also recognize that 1. Service Revenue proceeding does not stand on a per-play marketing reduced rate subscriptions to base. Nonetheless, the section 115 Participants in the present proceeding families and students is aimed at regulations must clarify that allocation disagree on the definition of Service monetizing a segment of the market of mechanical royalties is based on the Revenue to be used in setting a base for with a low WTP (or ability to pay) that relative number of plays of a Copyright application of the percent of revenue might not otherwise subscribe at all. Owners’ works. Copyright Owners prong in the greater-of rate structure. The Services, as they work toward advocate for a per-unit rate structure Copyright Owners’ proposed per-unit profitability, are likely to continue to that reflects demand. The Judges cannot rate structure obviates the need for a market aggressively to users with the find that a partial play of a work Service Revenue definition; WTP full subscription prices and to signifies consumer demand; in fact, a consequently it does not include one. monetize other users in hopes of getting skip-though might indicate just the Pandora seeks an express exclusion of them into the ‘‘funnel’’ for full-price opposite consumer conclusion. The revenue from a Services’ products subscriptions. outside the purview of the section 115 Judges adopt the definition of ‘‘Play’’ license, e.g., Pandora’s linked concert 2. Fraudulent Streams that exempts streams of under 30 ticket sales app, TicketFly. Pandora PFF Apple, Google, Pandora, and Spotify seconds for tracks that are, in their 84. Pandora also seeks to expand the seek inclusion of a definition of entirety longer than 30 seconds. current deduction from gross revenues ‘‘fraudulent streams’’ in the section 115 4. Pass-Through Licenses for the costs associated with producing regulations to avoid royalty payments advertising revenue by permitting a for them. Google proposes defining a The extant regulations provide similar deduction for such costs of fraudulent stream in terms of the origin alternative measures in the calculus for doing business as credit card fees, app of the request with an alternative finding the greater-of all-in royalty pool store fees, and carrier service billings. quantitative limitation. See Google Inc.’s or, in some instances, the measure of the Id. PFF 85; see Herring WDT ¶ 63. Amended Proposed Rates and Terms at lesser-of prong to be used to determine Interestingly, Amazon joins in this 3. Spotify combines the two criteria. See the greater-of royalty pool. The request even though Amazon Spotify’s PFF/PCL at 115. Apple revised difference is in the percent-of-TCC [REDACTED]. See Amazon PFF ¶ 107 its original quantitative definition to a depending on whether the record (and record citations therein). reasonableness determination delegated company’s licenses are ‘‘pass-through’’ For the Judges, it is almost axiomatic to the Service. See Apple Inc. Proposed or not. The parties offered minimal that revenues from product offerings Rates and Terms at 2. evidence on the topic. Pandora unrelated to the section 115 license In light of technological developments proposed to eliminate the distinction as should not be included in the revenue that permit non-human streaming of ‘‘unnecessary.’’ Pandora PFF ¶ 79. base for calculation of section 115 sound recordings for purposes other Pandora’s conclusion is consistent with royalties. On the other hand, the section than consumer listening, the Judges Professor Eisenach’s observation that 115 revenues should not be diminished concur that these non-consumer streams the pass-through rate is rarely used. by such costs of doing business as should not be counted in determining Eisenach WDT ¶ 82 n.67. paying app store and carrier service fees the allocation of royalties. Accordingly, The Judges find the separate pass- and commissions or credit card fees. a definition of Fraudulent Stream is through TCC rate is unnecessary and The Judges will retain the cost-of- appropriate. The Judges conclude that decline to include one in the revenue-production deduction for the definition should establish a regulations. marketing to create advertising revenue quantitative measure, removing the but decline to deduct other subjective determinations of the various B. Offerings administrative costs from the revenue Services from the equation. 1. Limited Downloads and Interactive base. Streaming Amazon and Pandora also ask for 3. Royalty-Bearing Streams adjustments to per-subscriber Apple led the Services in asking for The Judges do not alter definitions calculations to accommodate a definition of ‘‘Play’’ that eliminates identifying Limited Downloads and discounted service offerings, such as from any per-play calculation a stream Interactive Streaming, as the settling discounted annual subscriptions, family lasting fewer than 30 seconds. Apple parties defined those service offerings in plans, and student accounts. See, e.g., contends including these partial plays the 2012 Settlement. The Judges do, Amazon PCL ¶¶ 36–39; Pandora PFF are not indicative of true consumer however, add other offering

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configurations to those configurations to extent Services offered a purchased 6. Unremunerated Offerings enlarge the rate category. content locker service, the evidence was No party in this proceeding offered that those Services are exiting the arena. 2. Mixed Bundles evidence or argument against For example, Apple described its continuing the zero royalty rate for In the current regulations based on Purchased Content Locker Service as a promotional streams, as they are defined the 2012 Settlement, mixed service non-remunerative service that it is in the regulations. The Judges accept the bundles regulated in current subpart C phasing out and no longer marketing. agreed definition in the extant and are differentiated from music See, e.g., Apple PCL 52. regulations, with substantial editing to bundles in the same subpart. Compare For Purchased Content Locker eliminate unnecessary complexity, and 37 CFR 385.21 (definition of ‘‘mixed Services that do not generate revenue adopt the agreed zero rate for service bundle’’) with id. (definition of for the Service, no royalty should promotional streams. ‘‘music bundle’’).162 The rate structures accrue. For Paid Locker Services, a In addition, the Judges include in the for the two bundle types, with one Service receives subscription new subpart D regulations other exception, and the rates for the two 163 payments and subscription revenues offerings for which a Service receives no bundle types are identical. The for those offerings are part of the service remuneration. Free trial subscriptions difference between the bundle revenue to which the percent-of-revenue and purchased content locker services calculations occurs at the final step, calculation applies. that are free to the user and not allocation of the payable royalty pool. associated with any revenue (such as For mixed service bundles, the payable 5. Family and Student Plans advertising revenue) bear a royalty rate royalty pool is allocated to musical The Judges adopt here a greater-of rate of zero. works rightsholders on the basis of structure that measures a percent of relative number of plays. For music service revenue against a percent of C. Reporting and Auditing bundles, which include up to three TCC. The basic rate calculations are Among the areas open to the Judges service configurations, the payable straightforward. The Judges also adopt a for rulemaking are notice and royalty pool is subdivided by Mechanical Floor for Offerings that recordkeeping, to the extent the Judges configuration (CD, PDD, ringtone) and currently have a Mechanical Floor find it necessary to augment the the per-play allocation is calculated for alternative. In the present proceeding, Register’s reporting rules. The Judges’ each configuration separately. the Judges adopt a Mechanical Floor for regulations must be supported by record Copyright Owners proposed certain configurations. For purposes of evidence and may include guidance on combining regulations for mixed bundle determining that minimum rate, should how payments are made and when, offerings with the regulations for their the need ever arise, the parties ask for accounting practices, audits, and component parts. The Judges conclude clarification regarding subscriber acceptable deductions from royalties. that the differences in kind between counts. See Register’s Rulemaking Opinion at mixed offerings including streaming and The Services presented evidence of 48398. With respect to the section 115 a mixed music offering including only three subscription variations: licenses, the Register’s regulations currently regulated configurations are Discounted annual subscriptions, family address licensees’ Notice of Intent to sufficient to separate them. Mixed subscriptions, and student obtain a section 115 license, details of bundles will be subject to the streaming subscriptions. A discounted annual the licensees’ monthly payments, and rate structure, with allocation allowed subscription is no different from any specifications for licensees’ monthly based on the relative values of music subscription for purposes of calculating and annual Statements of Account. Id. streaming and any other bundled the per-subscriber minimum mechanical at 48397. offering. rate. In the present proceeding, the parties’ 3. Music Bundles As an example, Spotify proposed, proposed terms by and large described albeit for a different purpose in a rate structures and calculations of The Judges now include Music different rate structure, that family Bundles with the regulations adopted payable rates. Given the rate structure accounts be treated as 1.5 subscribers the Judges adopt, many of the parties’ for physical phonorecords, permanent per month and student accounts be downloads, and ringtones—the three proposed terms are inapplicable. Some treated as .5 subscriber per month. See, participants did propose rule changes potential components of a ‘‘music e.g., Spotify Second Amended Proposed bundle.’’ Each separate offering within that are appropriate even with the new Rates and Terms at 16. Copyright rate structure and that would the bundled configuration shall be Owners’ rate proposal is based not on subject to the rate agreed by the parties appropriately augment the Register’s subscribers, but on end users, which rules. In some instances, however, the that proposed the subpart A settlement, they define to include any person who as applicable to that component part. parties’ regulatory proposals are streams at least one play during an proffered as part of their legal argument 4. Lockers accounting period, apparently without but are not supported by factual regard to that user’s subscription status. In the existing regulations, Paid evidence in the record. For purposes of calculating a Locker Services and Purchased Content The Judges include in the part 385 Mechanical Floor rate, the Judges adopt Locker Services are both royalty-bearing regulations provisions that augment the the Services’ proposal, in the form configurations. In the present part 210 statement of information articulated by Spotify. Family accounts proceeding, the only evidence regarding Services must record and retain with are to be counted as 1.5 subscribers and locker services was expository. To the regard to promotional and trial student accounts are to be counted as .5 streaming offerings. The Judges decline subscriber. 162 ‘‘Mixed service bundles’’ are a product to adopt other changes to part 210 package that includes music access together with a requested by Spotify. The Judges will non-music product, such as Internet services. A 163 The Judges heard no testimony regarding ad- forward those change requests to the ‘‘music bundle’’ refers to packaging different music supported locker services, but to the extent they access configurations in a single music sale for a exist, the conclusions for subscription paid locker Register of Copyrights for such single price, such as authorizing a PDD with the services apply equally to ad-supported locker consideration as the Register deems purchase of a CD. services. appropriate.

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D. Late Fees application and applies to all section continued development. The rates and 115 royalties. terms established in this Final The Act expressly authorizes the Determination shall supplant existing E. Part 210 Regulations Judges to include in a determination rates and terms effective as of January 1, ‘‘terms with respect to late The Register’s rules are codified in 2018. payment . . .’’ provided the late part 210 of 37 CFR. The Judges decline The Register of Copyrights may payment terms in no way interfere with to adopt proposed changes that review the Judges’ Determination for other rights or remedies of copyright encroach on the settled part 210 legal error in resolving a material issue holders. 17 U.S.C. 801(c)(7). In the regulations. The Judges defer to the of substantive copyright law. The extant regulations, only subpart A Copyright Office for terms that are the Librarian shall cause the Judges’ contains a provision for late fees. The responsibility of and under the Determination, and any correction Judges did not previously include late authority of the Register of Copyrights. thereto by the Register, to be published fee provisions in prior subparts B and C VIII. Conclusion in the Federal Register no later than the because the settling parties did not conclusion of the 60-day review period. include those provisions. In the present The section 115 phonorecords license proceeding, Copyright Owners asked the Suzanne M. Barnett, has a long history. Application of the Chief Copyright Royalty Judge. Judges to adopt late fee provisions for license has changed significantly as the all royalty payments. Copyright Owners methods of musical works delivery have Jesse M. Feder, contend that adding the late fee evolved.164 While the current market, Copyright Royalty Judge. provision to all section 115 royalties increasingly dominated by digital Dated: November 5, 2018 simply ‘‘clarifies’’ the intention of the streaming, cannot be characterized as DISSENTING OPINION OF parties that settled on rates and terms in immature, it cannot either be COPYRIGHT ROYALTY JUDGE DAVID 2012. characterized as stable. R. STRICKLER The Judges cannot divine the Determination of royalty rates and intentions or missed opportunities of terms for the section 115 license is I respectfully dissent from the parties not before them. On the other complex and arduous, and reasonable Majority Opinion, for the reasons set hand, the Judges are aware that section people can differ as to the best forth below. 115 establishes a royalty due date and approach—as evidenced by the issuance II. The Majority Opinion Lacks an assigns to the Register of Copyrights of a dissenting opinion in this Adequate Basis in the Record authority to develop regulations proceeding. Judge Strickler’s dissent detailing payment procedures. See 17 follows this majority opinion and the A. The Rate Structure Adopted by the U.S.C. 115(c)(5). Rate terms under other regulatory terms codifying the Majority was not proposed during the sections of the Act require licensees to Determination are set out below this Proceeding. pay a late fee, if warranted. The Judges SUPPLEMENTARY INFORMATION section. The Majority Opinion establishes an see no reason for Copyright Owners to In this market, with the evidence all-in rate and rate structure for receive late fees for ‘‘subpart A’’ before them, the Judges have attempted performances and mechanical activities, but forego late fees for other to establish royalty rates and terms that reproductions, equal to the greater of the licensed activities. A late fee provision compensate songwriters and music percent of total service revenue and is now included in the subpart publishers and offer to licensees Total Content Cost (TCC), as set forth in containing regulations of general appropriate returns and incentives for the following table:

2018 2019 2020 2021 2022 (percent) (percent) (percent) (percent) (percent)

Percent of Revenue ...... 11.4 12.3 13.3 14.2 15.1 Percent of TCC 165 ...... 22.0 23.1 24.1 25.2 26.2

See Majority Opinion, supra at 1.166 Fact and Conclusions of Law (GPFF). proposed by any party during the The Majority does not deny that this See GPFF ¶ 4.167 (However, the majority hearing is critical. The gravamen of this rate structure was never proposed by expressly asserts that, although they proceeding was the issue of how to any party during the proceeding. In fact, selected this rate structure after combine different proposed rate prongs this rate structure was only proposed consideration of Google’s post-hearing (and discard others) in order to establish after the hearing, when the record had amended rate proposal, they ‘‘did not a rate structure that meets the statutory already been closed. More particularly, rely’’ on Google’s post-hearing proposal. requirements that the structure be this rate structure was proposed post- Majority Opinion at 37 n.39) ‘‘reasonable’’ and that it address the four hearing by Google, Inc. (Google) in an The fact that the two prongs in this itemized statutory objectives. See 17 amended rate proposal, which Google rate structure were not combined as the U.S.C. 801(b)(1). The majority has supported in its Proposed Findings of only two parts of a rate structure selected two rates that, although parts of

164 Passage of the Hatch-Goodlatte Music 165 ‘‘TCC’’ is shorthand for ‘‘Total Content Cost,’’ 167 However, Google proposed rates that were Modernization Act (MMA) introduces further the cryptic industry terminology used to measure well below the rates adopted by the majority. See changes in the administration of the section 115 royalties paid by interactive streaming services to GPFF ¶ 4 (proposing the greater of 10.5 percent of license. Under the MMA, the Register and the music publishers for musical works, as a percent of service revenue or 15 percent of TCC). In the event Judges are required to make sweeping changes to these services’ payment to record companies for these rates are deemed too low by the Judges (as has applicable regulations. Rather than attempt to adapt sound recording licenses. the regulations the Judges adopt based on the record occurred), Google requests that the Judges abandon before them in this proceeding, the Judges will 166 As this Dissent was initially written, the this structure and adopt instead the 2012 rate engage in a notice and comment rulemaking Majority Opinion was not final and therefore the structure, because that structure ‘‘still adhere[s] to procedure to conform all affected regulations to the page citations had been left blank. Page numbers are the Sec. 801(b) factors by setting sustainable, fair provisions of the MMA. now included. rates that would not disrupt the industry.’’ Id. ¶ 8.

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other proposals made during the rate proposals presented at the hearing Accordingly, whenever the record proceeding, were never combined in and create a new combination that no companies demand and obtain a higher this manner during the hearing. Because party had presented. I do not think the sound recording royalty rate, under the it is the combination of rates that is majority can overcome this problem by majority’s rate structure, the services’ crucial, the majority erred by plucking relying on the fact that the two elements section 115 mechanical royalty rate two rates from the record, combining of the majority’s new rate structure must increase as well.169 them post-hearing, and then wrongly appeared in different rate proposals, Although it proposed such a declaring that this ‘‘mash-up’’ was because, again, the key issue in this structure, Google candidly identified actually based on the record. proceeding was how to establish a rate this exact risk arising from an uncapped Copyright Owners filed a post-hearing structure that combined various rate TCC. Specifically, Google submission that calls these matters to prongs. acknowledged: the Judges’ attention, in connection with This shock to the parties is not Having no cap on TCC . . . leaves the Google’s identical rate structure speculative, and the inappropriateness services exposed to the labels’ market power, contained in its amended rate proposal of using an amended rate proposal to and would warrant close watching if adopted submitted after the record had inject untested rate structures was .... closed.168 Copyright Owners’ Reply to clearly articulated by Copyright Owners’ Google PFF ¶ 73 (emphasis added). But Google’s Proposed Findings of Fact and counsel at oral argument. As counsel obvious and crucial questions arise: Conclusions of Law (CORPFF-Google). explained: Who would do the ‘‘watching’’? When In their submission, Copyright Owners [Google] decided it would be a good idea would such watching occur? Congress correctly noted the absence of an to give you something simple. . . . I agree directed the Judges to be the evidentiary record to support the that they are allowed to change their ‘‘watchers,’’ and Congress instructed combination of a percent-of-revenue rate proposal, but when I talk about the inability that the ‘‘watching’’ should occur only and a TCC rate. See CORPFF-Google at to address all the depth, no one has been able through rate proceedings, scheduled at p. 2 (‘‘Google’s new proposal is not only to analyze it. They haven’t run numbers, right? There are no forecasts for this specified intervals. The majority has not unsupported by any evidence, it is adequately addressed Google’s candid divorced from the evidence in the proposal. [N]o one has been able to test out what this proposal would do. So that’s why warning as to the risk of an uncapped record [and] neither Dr. Leonard I say it is difficult to address it all because TCC, to the extent it has even addressed [Google’s expert witness] nor any other we weren’t given an opportunity to have our the issue at all. expert opined on the new proposal, let experts test out the structure. The injury to the services from the alone provide a basis for assessing its 6/7/17 Tr. 6275–76 (Copyright Owners’ majority’s uncapped TCC rate structure reasonableness.’’). As a substantive Closing Argument). is easily demonstrated. For example, as matter, Copyright Owners describe this The majority’s error in creating and discussed infra, the unregulated sound mix-and-match rate structure as a adopting its own rate structure recording royalty rate charged to Frankenstein’s Monster. Id. at pp. 2, 17. (identical in structure to Google’s post- interactive streaming now ranges from Using a different analogy, they argue hearing structure) has created a real risk approximately [REDACTED] % TO that this jury rigged rate structure is of economic harm that the parties were [REDACTED] % of total service revenue. nothing more than an unlitigated, post- not able to address at the hearing. As With a TCC of 26.2% (the majority’s hearing selection of one rate from discussed below, this risk of harm TCC rate in 2022) the TCC prong would ‘‘Column A’’ and another from ‘‘Column extends not only to Copyright Owners, equal as much as [REDACTED] % (i.e., B.’’ Id. at p. 15. [REDACTED]). However, if the Because this particular rate structure but also to the interactive streaming unregulated record companies was not proffered at the hearing, the services, a fact acknowledged by Google, demanded 70% of revenue as sound parties had no ability to mount a the proponent of this rate structure, as recording royalty payments, the challenge to it during the proceeding. explained below. mechanical rate would then rise to The statute and the Judges’ regulations B. The Majority Opinion Causes Injury 18.34% (i.e., .70 × .262). This would be set forth in detail how the parties must to Licensees and Licensors a [REDACTED] % increase in the present evidence, testimony and 1. Injury to Licensees (the Services) mechanical rate, arising from the arguments. See 17 U.S.C. 803(b)(6); 37 exercise of the absolute discretion and CFR 351.1 through 351.15. At the The crucial aspect of the majority’s self-interest of the record companies. hearing in this proceeding (as in all rate rate structure, absent from any rate Moreover, the total royalty cost to the proceedings), the parties submitted proposal presented at the hearing, is the service paying these royalties would be detailed written testimonies, engaged in use of an uncapped TCC prong in a [REDACTED] %, leaving the service extensive direct and cross-examination greater of rate structure. Because the with only [REDACTED] % of revenue to of witnesses, including expert economic TCC prong will be triggered when it is greater than the percent-of-revenue fund the rest of its operations. witnesses, who supported and attacked It is important to distinguish the TCC prong, the mechanical royalty rate will the rate proposals made a part of the rate in the 2012 benchmark, advocated be determined by reference to whatever record. It must come as quite a shock in this Dissent, with the TCC rate in the rate has been established by the record when, after all that testimony, evidence Majority Opinion. Under the 2012 companies for sound recording and analysis has been presented, the benchmark, the TCC is capped in a royalties. However, it is undisputed that majority decides to ignore the parties’ ‘‘lesser of’’ prong, such that, if the prong the record companies, by statutory in which the TCC is set forth should be 168 A party is entitled to ‘‘revise its . . . requested design, have the unfettered legal ability rate at any time during the proceeding up to, and to set their sound recording royalty including, the filing of the proposed findings of fact 169 Tying the section 115 mechanical license and conclusions of law.’’ 37 CFR 351.4(b)(3). rates, allowing them to exercise their royalty to another rate is analogous to what a However, nothing in the regulations permits the economic power to demand rates that country does when it adopts a ‘‘currency board,’’ amendment to create a new rate structure that was embody their ‘‘complementary giving up its own sovereignty over the value of its not supported by the evidence at the hearing. oligopoly’’ status, as previously currency by tying it to the value of another Otherwise, a party could subvert the entire currency. Here, the majority has relinquished its adversarial process by inserting a new proposal described by the Judges. See Web IV, 81 ‘‘sovereignty’’ over the setting of rates over the five after the record had closed. FR 26316, 26333–34 (May 2, 2016). year rate term, 2018–2022.

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triggered, it generally cannot exceed a 2. Injury to Licensors (Copyright The notion that Google’s TCC prong will specified per-subscriber rate, thus Owners) provide protection from revenue gaming, deferral and displacement, and other revenue placing a limit on the reliance on the The Majority Opinion’s rate structure effect of the record companies’ market prong problems is unsupported and would jeopardize Copyright Owners as speculative. Relying on just the TCC to solve power. See, e.g., 37 CFR 385.13(a)(2) well, as they note in their post-hearing those admitted problems leaves the and (3). This has been a tradeoff the filing in response to Google. In that Copyright Owners’ protection from such services have been willing to accept, reply, Copyright Owners take note of the problems entirely outside the statute .... because they have agreed to settlements new risks—unaddressed at the [REDACTED] are what protects the Copyright in 2008 and again in 2012 incorporating hearing—that they would face under Owners from price-slashing by the services. this constrained use of TCC. However, such a structure: What is left unanswered . . . is . . . how can they never accepted a complete deferral it be reasonable to ask the Judges to set a rate to the sound recording rate as an —record companies could acquire the that does not itself provide for a fair return streaming services, and then set low uncapped measure of the mechanical . . . but simply puts the Copyright Owners’ internal sound recording royalty rates fair return in the hands of the labels to rate for all tiers of service. (transfer prices) that would amount to negotiate terms that will adequately protect The majority apparently responds to ‘‘sweetheart’’ deals intended to diminish the publishers and songwriters as well? The this problem of record company the royalties paid to Copyright Owners; labels do not have a mandate to ensure that influence and market power with a —services could start their own record the Services provide a fair return to the figurative shrug. First, the majority companies, and then engage in the same Copyright Owners, and cannot be directed to concedes that Google’s expressed transfer pricing/’’sweetheart’’ deals that ensure such. Indeed, labels may not have the concern is ‘‘true,’’ but irrelevant, include low sound recording royalties; same incentives as songwriters and because the record companies could put —record companies could grant sound publishers to negotiate such protections in recording licenses in exchange for equity their deals. To wit, a label could make an the services out of business with high interests in services (short of outright rates at any time, even without the agreement with a service that includes only acquisition) and then agree to accept lower a revenue prong in exchange for equity or imposition of the TCC prong. Majority royalty rates than would exist in the some other consideration that it may never Opinion, supra at 35 n. 75. But this absence of the equity payments, thus include in the applicable revenue subject to point ignores the fact that, at present, reducing mechanical license royalties. the TCC. . . . [W]hat if Google purchased one the record companies do not have to be CORPFF-Google at pp. 2–3, 24, 40, 44. or more record labels and did not have to pay concerned with a reduction of their Also of great importance to Copyright any label royalties? Or what if Spotify chose royalties because of the linking of those Owners, a rate structure limited to a to avail itself of the compulsory license to royalties to the mechanical license percent of revenue or a TCC rate does create its own master recordings embodying royalties. That is new and, as explained musical works—which it is already doing nothing to protect Copyright Owners [COPFF ¶ 396]—and chose to compensate infra, the record companies may decide from the potential displacement, itself for its use of the master recordings on to keep their rates high despite the deferment, bundling or attribution a sweetheart basis (or not at all)? Or what if increase in mechanical rates, or decide indeterminacy of a revenue-based one or more labels decided to enter the it is in their interest to avoid a reduction structure. That is, even a TCC prong is interactive streaming market and did not in royalty revenue by creating a a revenue-based prong, but under that have to pay themselves royalties? In each completely different paradigm for prong the task of calculating ‘‘revenue’’ case, the Copyright Owners’ protection—the streaming, by which the record is delegated to the record companies, protection that the Services admit the companies move the streaming service Copyright Owners need and is provided by over whom the Judges have no control. the TCC—would be gone. in-house and effectively destroy the Google claims that its proposed existing services. Is this speculative? Of structure (and, by extension, the CORPFF-Google at 39–41 (emphasis in course it is, but that is precisely the majority’s structure) does protect against original). problem. As Copyright Owners’ counsel the problems that can arise under a I cannot improve upon Copyright stated in closing argument, and as revenue-based royalty. GPFF ¶¶ 67, 72 Owners’ statement of the problems they Google intimated in its post-hearing (‘‘Because record labels will always face from an uncapped TCC rate prong filing, the potential impact of the record protect their own interest, this prong in a greater of structure. companies’ responses to such a rate ensures that, through that process, they The majority however dismisses this structure, given their market power, also protect the interest of Copyright argument, stating (as noted supra) that needed to be tested at the hearing, Owners .... Today, Copyright they do not rely on ‘‘Google’s revised which, of course, it was not. Owners still recognize the virtue of the rate proposal.’’ Majority Opinion at 37 Then, in what may reasonably be TCC structure in protecting their n.39. However, that response misses the characterized as a combination of interest . . . .’’). point: Google’s argument is the same as naivete´ and wishful thinking, the However, Copyright Owners rightly the majority’s argument with regard to majority notes that the parties simply note that they obtain no legal protection rate structure. Because one is deficient ‘‘must . . . trust in the rational self- under such a TCC prong. In making this as a consequence of not having been not interest of the market participants.’’ Id. argument regarding displacement and presented and tested at the hearing— at 36 n.75. But Congress delegated the deferral of revenue, Copyright Owners failing to afford the parties the ability to authority to set mechanical royalty rates lay out comprehensively all the cross-examine witnesses and present a to the Judges and, as noted in both the problems inherent in an uncapped TC rebuttal case—then the other is deficient Majority Opinion and this Dissent, the prong set in a greater of rate structure, as well. section 801(b)(1) standards and such as adopted in the majority opinion: C. The Majority Misunderstands the objectives are not to be determined Record simply by reference to the market, let an equal regulatory (or deregulatory) footing. alone by a referral to a market actor However, that is the role of Congress, not the The majority pins its novel rate economically adverse to the parties in Judges, and the Judges cannot fix the disparity in structure not on any party’s proposals, 170 the regulatory structure by simply ceding to the but rather on the direct mechanical this proceeding. record companies the power to set mechanical royalty rates (And even if the Judges could license agreements entered into 170 It may be the case that sound recording rights accomplish this, they certainly could not do so [REDACTED] and a single license and the musical works rights should be placed on absent a record, and after the record had closed). entered into by a non-participant and

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peripheral licensee, Microsoft.171 See the application of the Shapley value effect and, the ratio of sound recording Majority Opinion, supra, at 34. approaches modeled by experts for the royalties to musical works royalties However, the majority recognizes that services and for Copyright Owners. theoretically then should fall, with the many other interactive streaming To summarize,173 the Shapley models fall in the ratio arising from a significant agreements with music publishers estimate a ‘‘surplus’’ of revenue from reduction in sound recording royalties contain different rate structures, downstream revenues, after all the non- and an increase in musical works rates. including the rate structure consistent content costs of the market participants But theory must meet reality. As I with the 2012 benchmark. Id. are recovered, that is available to be note in greater detail infra in connection But the majority’s rationale for relying distributed among the services and the with my own analysis of the Shapley on the [REDACTED] (and Microsoft) input providers, i.e., the record approach, no witness could state agreements to support its rate structure companies (who provide the sound whether this see-saw effect would is bewildering. The majority, relying on recordings) and the music publishers occur, and there were no witnesses from the testimony of Dr. Leonard, writes that (who provide the music works). The the record companies who testified that the ‘‘marketplace supports a number of division of that surplus is determined the record companies would impotently rate structures and that no single by an algorithm that measures and acquiesce to a significant loss in structure or element of a structure is averages the value of each party’s royalties to accommodate the diversion indispensable.’’ Id. at 34. The majority’s contribution to the creation of the of a huge economic surplus away from reliance on this point is bewildering surplus, over all possible arrival them and to the Copyright Owners.176 because it (rightly) praises a market with sequences in the marketplace. I am unwilling to adopt the multiple rate structures as support for As the majority correctly notes, the hypothetically plausible idea of a see- its adoption of a single rate structure. parties’ Shapley value models all saw effect impacting the division of this This makes no sense. predict that the ratio of sound recording surplus, when there is simply no Moreover, the ‘‘marketplace’’ of royalties to musical works royalties evidence that such an adjustment would which the majority speaks so should decrease from current levels. occur. Given the $1.604 billion in approvingly is not an unregulated However, the majority is merely interactive streaming revenue reported market. Rather, it is a ‘‘marketplace’’ assuming that the sound recording rates by RIAA, I cannot merely assume that that has flourished for a decade, as will adjust downward. They base their the record companies would acquiesce discussed infra in this Dissent, while the assumption on the testimony of to a substantial reduction in royalty 2012 benchmark (and its fundamentally Professor Watt, who identified what revenue, rather than seek some other identical economic antecedent, the 2008 another economic witness (Professor market structure in which to protect this rate structure) were in place. It is this Katz, for Pandora) described as the ‘‘see- revenue, such as, for example, regulated ‘‘marketplace,’’ with its multi- saw’’ effect. Simply put, this effect resurrecting the idea of establishing or tiered rate structure, that has enabled arises from the assumption that the otherwise integrating their own creation of the multiplicity of rates that interactive streaming services must be streaming services. The Services’ the majority lauds. Unwittingly the permitted to retain enough revenue to experts, and Apple’s expert, testified majority has adopted the perverse survive,174 but, beyond that, the that any purported see-saw effect was notion that ‘‘no good deed goes suppliers of the two ‘‘must have’’ inputs indeterminate with regard to its impact unpunished,’’ by relying on the benefits can negotiate in a free market to share on the interactive streaming services. of the 2012 benchmark as a basis to equally the remainder of the surplus See 4/5/17 Tr. 4944–45 (Katz) eliminate it! Perhaps the more generated by downstream revenue. (acknowledging the possibility that a appropriate adage to follow should be: (They receive different percentages of mechanical royalty rate increase would ‘‘If it ain’t broke, don’t fix it.’’ 172 total revenue because, although their affect sound recording royalties in the share of the Shapley surplus is equal, D. The Majority Makes the Heroic future but not immediately, and that they have different non-content Assumption that the Major Record there is no reliable estimate of the size costs).175 of any such adjustment); 4/7/17 Tr. Companies will Docilely Accept In this see-saw paradigm, the present Millions of Dollars in Lost Revenue, by 5515–5516(Marx) ((stating that there ratio of sound recording: musical works would ‘‘[m]aybe [there would] be some Agreeing to Accept Lower Sound royalties is too high at present, Recording Royalties adjustment on the sound recording side according to the Shapley valuations, .... [H]ow those negotiations play The majority is sanguine as to the because the mechanical royalty has been out, I think it’s complicated and hard to impact of the uncapped TCC prong rate set under section 115 at too low a rate, guess’’); 4/5/17 Tr. 5704–05 (Ghose) in its proposed rate structure, because it allowing the record companies to (‘‘[I]t’s quite likely that the streaming has confidence that the major record appropriate the remainder of the service will want to maintain their companies will recognize that they have surplus, i.e., more than the percentage royalties and their revenues at the no choice but to decrease their royalty suggested by the Shapley approach. current levels. And so, you know, to me rates and reduce their revenues by According to the majority and the it seems like an extreme statement that millions of dollars, in order to subsidize Shapley experts, applying the Shapley the entire increase in publisher profits the section 115 royalty rate increases values would eliminate this regulatory will come at the expense of the adopted in the Majority Opinion. The streaming services.’’). And, to repeat, complacency of the majority is based on 173 The Shapley value approach is described in more detail, infra. Copyright Owners own Shapley value 171 There is no record evidence that Microsoft 174 I will return to this crucial assumption expert, Professor Gans, suggests that the continues to operate an interactive streaming presently. service. 175 Another Shapley value expert for Copyright 176 The record companies would have to accept 172 I note that Google’s economic expert, Dr. Owners, Professor Gans, does not concede that the substantial losses in royalty income. According to Leonard, did not testify in support of the rate ‘‘see-saw’’ effect will occur. Rather, he testified that the RIAA, interactive streaming revenues for 2015 structure for which the majority and Google have the services might simply raise downstream prices totaled $1.604 billion. See Marx WDT ¶ 153 & App. advocated for the first time post-hearing. In fact, he or pay the higher royalties out of higher profits B.1.b (citing RIAA figures). The extent of this opined that the 2012 rate structure (without the (which to date do not exist). Gans WRT ¶ 32. This assumed loss by record companies, absent any Mechanical Floor) was the best rate structure for the opinion only underscores the tenuous nature of the evidence, makes the assumption of the see-saw 2018–2022 rate period. see-saw hypothesis. effect completely unreasonable.

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burden will fall on the services, not the evidence as to the potential III. The Majority Opinion is Legally record companies. consequences of such a draconian Erroneous To convince itself of the unlikelihood reallocation of revenue. Accordingly, I A. The Majority has not ‘‘Determined’’ of such results, the majority notes that, cannot agree with a rate structure that Statutory Rates as a matter of economic theory, given implicitly depends on the voluntary Pursuant to 17 U.S.C. 801(b)(1), the the present interactive streaming market reduction in royalty income of by an structure, the record companies already Judges have the duty to make a unregulated input provider to whom the determination’’ of rates that are have the economic power to put majority has ceded control over the streaming services out of business, ‘‘reasonable’’ and that are calculated to statutory rates. because the market in which record achieve four itemized sets of objectives. companies and interactive streaming E. The Majority Denigrates the Parties’ The majority’s two-pronged rate services negotiate is unregulated. Ten- Year Rate Structure as a ‘‘Rube- proposal fails to discharge this duty. Indeed, the record companies’ strategy Goldberg-esque’’ Device. Rather, the majority has adopted a rate has been to ‘[REDACTED].’’ Web IV, structure that is indeterminate, allowing supra, at 63 (restricted version). The majority disparages the parties’ the record companies, especially the But the static nature of this ten year rate structure, spanning two major record companies with ‘‘must assumption is not reasonable in this settlements, as ‘‘Rube-Goldberg-esque.’’ have’’ repertoires, to set the mechanical context. It may be reasonable to assume, Moreover, the majority characterizes the rates that are paid under section 115. given the royalty revenue allocations existing structure as ‘‘impenetrable.’’ Merely setting the ratio between now present in the interactive streaming That is a remarkable statement, given sound recording royalty rates and market, that the record companies that the parties have operated under the mechanical royalty rates is not the same would continue to find it in their self- structure for a decade—clearly they as actually making a ‘‘determination’’ setting the rates. As noted in Section I, interest to maintain the existence of know how to penetrate the language and supra, pegging the regulated mechanical interactive streaming services. However, understand its meaning. It may be true, if mechanical royalty rates were to royalty rate to the unregulated sound as discussed in more detail infra, that increase significantly, there is no recording royalty rate through the some songwriters and others may find evidence in the record in this ‘‘greater of’’ uncapped TCC prong leaves proceeding that indicates whether the the calculation of their royalties to be the statutory mechanical rate record companies would decide to difficult to understand. However, the indeterminate. Nothing in section maintain the current vertical structure creative artists can utilize the services of 801(b)(1) permits the setting of an of the market and docilely accept such their agents—the NMPA and others—to indeterminate rate that becomes a revenue loss. For example, they could answer any questions that may arise. It determined only when an unregulated create their own streaming services seems close to hubris for any jurist to private party sets its own rates.178 (perhaps learning the lessons from the dismiss a decade-long voluntary rate B. The Majority Decision Unlawfully failed Pressplay and MusicNet attempts structure, one that the parties have Delegates to Private Entities, of the past). Or, they could adopt what extended by agreement, as Unrepresented in this Proceeding (the Professor Gans suggests, maintain the ‘‘impenetrable,’’ merely because the Record Companies), the Ability to Set sound recording royalty rates, thereby jurist finds the structure too difficult to the Section 115 Royalty Rates hastening a more immediate exit of understand. The majority’s adoption of an streaming services from the market, or The majority also indicates that it has reduce their potential for success, uncapped TC C prong in a greater of the power to make certain that the making them ripe for acquisition by structure constitutes an improper regulations it adopts are sufficiently record companies at distress prices.177 delegation of a statutory duty to the In any event, from an evidentiary simple and understandable. Such a record companies, who are private perspective, there is no reason why the common sense point cannot be entities. However, the majority has not Judges should either indulge in or disputed, but it is misapplied here. cited any authority supporting such a dismiss such speculation. There is Again, the proof of the pudding is in the private delegation, nor has it suggested absolutely no evidence that such a eating, so to speak; the parties have that its uncapped TCC presents an issue significant shift in royalty distribution operated under the existing rate regarding the delegation of duties. would occur, nor is there sufficient structure for a prolonged period, belying The Supreme Court and the D.C. any concern that the Judges should Circuit have established a ‘‘private 177 The majority dismisses the risk of the adopt regulations that are simpler, and nondelegation doctrine,’’ which destruction of the present market structure as not reject those that are more complicated. prohibits the delegation of statutory the type of disruption that the Judges may consider. duties to private entities. Carter v. Majority Opinion at 74 n.137. However, the Moreover, as noted infra (in response to majority finds that it must implement its 44% rate the same ‘‘complexity’’ argument made Carter Coal Co., 298 U.S. 238 (1936); increase incrementally over five years, because a by Copyright Owners), the issue of Ass’n of Am. R.R.s v. U.S. Dep’t of more sudden implementation would be disruptive Transp., 721 F.3d 666, 675 (D.C. Cir. under the statutory standard. It seems apparent that regulatory complexity is not a factor or objective in the rate-setting process 2013), vacated and remanded sub nom. establishing a rate structure that cedes control to the Dep’t of Transp. v. Ass’n of Am. R.Rs., record companies who can increase the mechanical under section 801(b)(1). Thus, if the rate at will is at least as disruptive to the industry. 2012 rate structure otherwise is best Moreover, the disruption is not merely to one 178 This point needs to be distinguished from the business, but rather to every service and every suited to effectuate the statutory case where the parties voluntarily agree to service business model now in operation. (Recall objectives as compared with the other recognize the perfect complementarity between that even Google, who claims to support this rate alternatives, there is no basis for the inputs, such as in the ‘‘All-In’’ context, and deduct structure, acknowledges that the services are subject the cost of the perfectly complementary to abuse from the record companies’ market power, complexity of the structure to override performance right when calculating the mechanical and Google puzzlingly calls on ‘‘someone’’ to the specific application of the express license. In the ‘‘All-In’’ case, the parties’ prior ‘‘watch’’ the situation.) Moreover, as Copyright statutory factors. agreement is part and parcel of the useful 2012 Owners point out, as discussed supra, even they benchmark adopted in this Dissent, and the face significant risk from this structure. Indeed, this licensors are essentially the same underlying rate structure is an ‘‘equal opportunity disrupter.’’ entities.

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135 S.Ct. (2015) (Railroad v. DOT). In public agency is an expression of There is a better approach. As set Railroad v. DOT, the D.C. Circuit struck legislative intent as to how a statute forth in full infra, I have presented an down a statute that explicitly delegated should be applied. See K. Brown, Public Alternative Dissenting Determination. regulatory authority to Amtrak, Law and Private Lawmakers, 93 Wash. ALTERNATE DISSENTING allegedly a private entity, to develop U. L. Rev. 616, 655–57 (2016). DETERMINATION standards to evaluate passenger service However, when an agency in turn quality. Id. at 673–677. The Association delegates its powers to private entities, IV. INTRODUCTION of American Railroads had challenged such as the record companies, these The Copyright Royalty Judges (Judges) the delegation of authority to Amtrak, rationales disappear. With regard to the commenced the captioned proceeding to claiming it was a private entity and that first rationale, technical expertise, the set royalty rates and terms to license the the holding in Carter Coal precluded the record companies certainly have copyrights of songwriters and delegation of such authority to a private expertise in the area of music royalty publishers in musical works made and entity. The D.C. Circuit agreed that this rate-setting. However, that expertise is distributed as physical phonorecords, express grant of authority by Congress to married to an intention—indeed, a digital downloads, and on-demand fiduciary obligation—that they seek to a private entity was unconstitutional digital streams during the rate period maximize their own profit, even if that under the private nondelegation January 1, 2018, through December 31, 179 maximization ‘‘conflict[s] with the doctrine. Id. 2022. See 81 FR 255 (Jan. 5, 2016). If Congress cannot expressly delegate legislative mandates of Congress,’’ such Below, I set forth my alternative statutory and regulatory power to a as the standards set forth in section analysis, rate structure and rates, in the private entity, then, a fortiori, a 801(b)(1). See id. at 655. As for the form of a comprehensive alternative subordinate administrative agency, the second rationale, private entities, such determination. Copyright Royalty Board, cannot (or at as the record companies in this context, least should not) be able to implicitly ‘‘are not beholden to the democratic V. ALTERNATIVE DETERMINATION delegate statutory and regulatory process,’’ and the public therefore ‘‘has OF RATE STRUCTURE AND RATES authority to private entities. Yet in this no legal mechanism’’ to hold them In this alternative determination, I case, the majority has implicitly made accountable. Thus, the second Chevron would establish the section 115 royalty such a subdelegation, yoking the rationale is inapplicable. See id. at 657. rate structure, and rates, for the period mechanical royalty rates paid by Finally, with regard to the third basis for 2018 through 2022, by adopting the interactive streaming services to the Chevron deference, legislative intent, 2012 settlement as the appropriate rates set by record companies, an private entities do not have the interest benchmark, thereby maintaining the unregulated sector of the music in filling in the interstices of ambiguous same structure and rates as now exist industry. Thus as explained supra, the statutory authority by ascertaining the under the current regulations. My level of rates can rise at the unfettered public interest. See id. at 658. Indeed, as decision in this regard is based on a discretion of the record companies, to corporations, their duty is to their comparative analysis of that benchmark the detriment of the streaming services, shareholders, which, to state the and other benchmarks, and a and the measurement of royalties can obvious, is not the same as the public consideration of other record evidence lead to the diminution of the royalty interest expressed in section 801(b)(1). submitted by the parties, as fully set base, to the injury of Copyright Owners, In the present case, the private delegation is even more problematic. forth herein. through the record companies’ unbound Additionally, had the record evidence right to define ‘‘revenue’’ and to The record companies to whom implicit not included the 2012 rate structure and compartmentalize consideration (e.g., rate-setting authority has been delegated rates as a designated benchmark, I through equity instead of royalties).180 are not in any sense neutral. In relation Not only does the private delegation to the interactive streaming services, the nonetheless would have established for of section 115 rate-setting authority via record companies are licensors, seeking the 2018–2022 period the same rate the pegging of that rate to the payment from the interactive streaming structure and rates as now exist, unregulated sound recording royalty services. In relation to Copyright pursuant to the Judges’ authority to rate appear to violate the private non- Owners, they are competitors for royalty adopt the existing rates and rate delegation doctrine, it also appears to be revenue, in the sense that both the structure when they find that those inconsistent with the Judges’ expansive record companies and music publishers prevailing provisions better satisfy the powers under Chevron U.S.A. Inc. v. are input providers who compete for the statutory standards than any other Nat’l Resources Defense Council, 467 downstream revenue generated by the proposed structures and rates properly U.S. 837 (1984). Under the Chevron interactive streaming services. It is hard discernible from the record evidence. doctrine, courts defer to administrative to imagine that the Majority Opinion Music Choice v. Copyright Royalty Bd., agencies for three broad reasons: First, would (or should) be afforded Chevron 774 F.3d 1000, 1009 (D.C. Cir. 2014). the agencies are presumed to have deference, when the structure it creates A. Background technical expertise. Second, as arms of smacks too much of the fox guarding not the government, they are politically one but two henhouses. 1. Statute and Regulations accountable. Third, an express Of course, a full evaluation of these The Copyright Act (Act) establishes a delegation of authority by Congress to a legal issues, by the parties and the compulsory license for use of musical Judges, was skirted, because no party works in the making and distribution of 179 The Supreme Court vacated and remanded the proposed during the hearing a rate phonorecords. 17 U.S.C. 115. case, after granting certiorari, holding that Amtrak structure with an uncapped TCC. If this Phonorecords licenses now include was not in fact a private entity. structure had been proposed, the parties physical and digital sound recordings 180 The majority’s concern for ‘‘transparency,’’ expressed as a criticism of the parties’ workable ten would most certainly have fully briefed embodying the protected musical works year rate structure, disappears in connection with the issue in their proposed Conclusions as well as digital sound recordings that it delegation of rate-setting to the record companies. of Law and Reply Proposed Conclusions may be streamed on demand by a The definition of revenue, the handling of bundled of Law. Alas, they were not given that products and the exclusion of certain consideration listener. from royalties will remain opaque to the Judges and opportunity, and the majority has acted The Section 115 compulsory license, to Copyright Owners. without the aid of the parties’ input. created in 1909, reflected Congress’s

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attempt to balance the exclusive rights revisions to the Copyright Act retained musical work in a purchased telephone of owners of copyrighted musical works the then extant royalty fee of 2.75¢ per ringtone. Subpart B regulations govern with the public’s interest in accessing phonorecord (or 0.5¢ per minute of licenses for interactive streaming and protected works. In 1897, Congress playing time or fraction thereof, limited downloads. Subpart C extended copyright protection for the whichever amount was larger). regulations govern limited offerings, benefit of rightsholders to the However, the 1976 revision also created mixed bundles, music bundles, paid performance of their musical a new entity, the Copyright Royalty locker services, and purchased content compositions. Act of Jan. 6, 1897, 54th Tribunal (CRT), to conduct periodic locker services. Cong., 2d Sess. Ch. 4, 29 Stat. 481 proceedings to adjust the rate.182 2. Prior Proceedings (1897). However, at the dawn of the In 1995, Congress passed the Digital 20th century, the standardization and Performance Right in Sound Recordings In 1980, the CRT conducted the first commercialization of a prior Act (DPRA), Public Law No. 104–39, contested proceeding to set rates for the technological advance roiled the 109 Stat. 336, extending the mechanical Section 115 compulsory license. The musical works markets. That period saw license to ‘‘digital phonorecord CRT increased the then-existing rate by the expansion of the manufacture and deliveries’’ (DPDs) (emphasis added), more than 45%, from 2.75¢ rate per sale of piano rolls—a system of which the statute defines as each phonorecord to 4¢ per phonorecord. 45 perforated notations that could be used individual delivery of a phonorecord by FR 63 (Jan. 2, 1980).183 By 1986, the in conjunction with ‘‘player pianos’’—to digital transmission of a sound CRT had increased the mechanical rate play music automatically. recording which results in a specifically to the greater of 5¢ per musical work or The copyright implications of this identifiable reproduction by or for any .95¢ per minute of playing time or commercial advancement were transmission recipient of a phonorecord fraction thereof. 46 FR 66267 (Dec. 23, adjudicated in a 1908 Supreme Court of that sound recording, regardless of 1981); see also 37 CFR 255.3(a)–(c). The decision, White-Smith Music Publishing whether the digital transmission is also next adjustment of the Section 115 rates Co. v. Apollo Co., 209 U.S. 1 (1908). a public performance of the sound was scheduled to begin in 1987. That decision held that piano rolls did recording or any nondramatic musical However, the parties entered into a not embody a system of notation that work embodied therein. 17 U.S.C. settlement that the CRT adopted, setting could be read and therefore were not 115(d). Accordingly, the license now the rate at 5.25¢ per track beginning on ‘‘copies’’ of musical works within the covers DPDs, in addition to physical January 1, 1988, and established a meaning of the existing copyright laws, copies, such as compact discs (CDs), schedule of rate increases generally but rather were merely parts of devices vinyl records and cassette tapes. based on positive limited percentage for mechanically performing the music. A proceeding to determine reasonable changes in the Consumer Price Index Id. at 17. Thus, the owners of otherwise royalty rates and terms for the section every two years over the next 10 years. copyright-protected musical works 115 mechanical license is commenced See 52 FR 22637 (June 15, 1987). The lacked such protection vis-a`-vis piano by the Judges on the schedule provided rate increased until 1996, when the rate rolls. by 17 U.S.C. 803(b)(1)(A)(i)(V). was set at the greater of 6.95¢ per track In reaction to that decision, Congress Although a contested hearing may or 1.3¢ per minute of playing time or expanded the rights of musical works ultimately be necessary, the Act strongly fraction thereof. See 37 CFR 255.3(d)– copyright owners to include the right to encourages negotiated settlements (h). make ‘‘mechanical’’ reproductions, such among interested parties. See 17 U.S.C. The rates set by the CRT pursuant to as piano rolls, that embody musical 115(c)(3)(E)(i) (‘‘License agreements the 1987 settlement were set to expire works. However, Congress made that voluntarily negotiated at any time on December 31, 1997. The Librarian of right subject to a compulsory license between one or more copyright owners Congress announced a negotiation because of concern about monopolistic . . . and one or more persons entitled period for owners and users of the control of the piano roll market by the to obtain a compulsory license . . . section 115 license in late 1996, during makers of piano rolls (and another shall be given effect in lieu of any which the parties reached a settlement burgeoning invention, phonorecords). determination . . . .’’); 17 U.S.C. regarding rates for a ten-year period to 184 17 U.S.C. 1 (1909); see also H.R. Rep. 803(b)(3) (requiring a ‘‘Voluntary end in 2008. Under the settlement, No. 60–2222, at 9 (1909).181 Negotiation Period’’); 17 U.S.C. (ultimately adopted by the Librarian), Specifically, under the 1909 legislation, 803(b)(6)(C)(x) (requiring a settlement the rate for physical phonorecords was upon payment of a royalty rate of 2¢ per conference prior to a hearing). set at 7.1¢ per track beginning on ‘‘mechanical,’’ any person was As currently configured, the January 1, 1998, and a schedule was applicable regulations are divided into permitted to manufacture and distribute established for fixed rate increases every three subparts. Subpart A regulations a reproduction of a musical work. two years over the next 10-year period Congress revised the mechanical govern licenses for reproductions of with the rate beginning on January 1, license in its broader 1976 revision of musical works (1) in physical form 2006, being the larger of 9.1¢ per track the copyright laws. Among the various (vinyl albums, compact discs, and other or 1.75¢ per minute of playing time or changes relating to the phonorecords physical recordings), (2) in digital form fraction thereof. See 37 CFR 255.3(i)– license, Congress directed licensees to when the consumer purchases a (m); see also 63 FR 7288 (Feb. 13, 1998). provide copyright owners with a pre-use permanent digital copy (download) of written ‘‘notice of intention,’’ in order to the phonorecord, and (3) inclusion of a 183 The United States Court of Appeals for the District of Columbia Circuit affirmed the CRT. obtain the Section 115 license. The 1976 182 See H.R. Rep. No. 94–1476 at 111 (1976); 17 Recording Industry Ass’n. of America v. Copyright U.S.C. chapter 8 (1978). In 1993, Congress abolished Royalty Tribunal, 662 F.2d 1 (D.C. Cir. 1981) (1981 181 Because of this history, and the fading the CRT and replaced it with copyright arbitration Phonorecords Appeal) (remanded on other importance of mechanical piano rolls, this license royalty panels (CARPs). Copyright Royalty Tribunal grounds). is often referred to as the ‘‘phonorecords’’ license, Reform Act of 1993, Public Law No. 103–198, 107 184 The Librarian initiated the 1976 proceeding but still also remains identified, synonymously, as Stat. 2304. In turn, Congress abolished the CARP during the period after the termination of the CRT the ‘‘mechanical’’ license. In point of fact, vinyl system and replaced it with proceedings before the and the inception of the CRB, a time during which records, CDs, tapes and any other physical Copyright Royalty Judges. Copyright Royalty and controversies regarding royalty rates and terms were reproductions would still constitute ‘‘mechanical’’ Distribution Reform Act of 2004, Public Law No. referred to privately retained arbitrators under the reproductions. 108–419, 118 Stat. 2341. CARP program,

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The rates adopted for DPDs for the 10- bundles, music bundles, paid locker Judges of a partial settlement with year period were the same as those set services and purchased content locker regard to rates and terms for physical for physical phonorecords, and the rates services.’’ Adjustment of Determination phonorecords, permanent digital for incidental DPDs were deferred until of Compulsory License Rates for downloads, and ringtones—the services the next scheduled rate proceeding. See Mechanical and Digital Phonorecords, covered by the extant regulations found 37 CFR 255.5, 255.6; see also 64 FR 78 FR 67938 (Nov. 13, 2013) in subpart A of part 385. The Judges 6221 (Feb. 9, 1999). (Phonorecords II). Once again, the published notice of the partial In 2006, with expiration of the settling parties included the trade settlement 190 and accepted and previous settlement term nearing, the associations for the licensors and considered comments from interested Judges commenced a proceeding to licensees, NMPA and DiMA, parties.191 adjust the mechanical rates under respectively. Mirchandani WDT ¶ 59. On October 28, 2016, NMPA, section 115. On January 26, 2009, they The present section 115 proceeding Nashville Songwriters Association issued a Determination, effective March thus is the third since the Judges were International (NSAI), and Sony Music 1, 2009. In that Determination, the given jurisdiction under the Copyright Entertainment (SME) filed a Motion to Judges noted that the parties had settled Royalty and Distribution Reform Act of Adopt Settlement Industry-Wide. The their dispute regarding rates and terms 2004.186 In the Phonorecords II motion asserted that SME, NMPA, and for conditional downloads, interactive settlement, the parties agreed that any NSAI had resolved the issue raised by streaming and incidental digital future rate determination for subparts B SME in response to the original notice. phonorecord deliveries (i.e., rates in the and C configurations presented to the The Judges evaluated the remaining new subpart B). Mechanical and Digital Judges would be a de novo rate objection to the settlement filed by Phonorecord Delivery Rate determination. See 37 CFR 385.17, George Johnson dba GEO Music Group Determination, 74 FR 4510, 4514 (Jan. 385.26 (2016). However, they did not (GEO) and found that GEO had not 26, 2009) (Phonorecords I). The parties agree that the existing rate structure or established that the settlement who negotiated the settlement included rates could not be considered as the agreement ‘‘does not provide a 187 the NMPA and DiMA, the trade bases for future rate determinations. reasonable basis for setting statutory association representing its member B. The Present Proceeding rates and terms.’’ See 17 U.S.C. streaming services. Testimony of Rishi 801(b)(7)(A)(iii). As a part of the second In response to the Judges’ notice Mirchandani, Trial Ex. 1, ¶ 59 settlement, Sony withdrew from this regarding the present proceeding, 21 (Mirchandani WDT). proceeding. The Judges published the entities filed Petitions to Participate.188 With regard to the subpart A rates, the agreed subpart A regulations as a Final The participants engaged in negotiations Judges in Phonorecords I rejected the Rule on March 28, 2017.192 and discovery. On June 15, 2016, some parties’ proffered benchmark evidence, of the participants 189 notified the During the course of the proceeding, and instead adopted the existing rates the Judges dismissed some participants and rate structure, holding as follows: 186 Pub. L. No. 108–419, 118 Stat. 2341. and other participants withdrew. Based on the evidence before us, we 187 The Phonorecords I settlement agreement Remaining participants at the time of conclude that no single benchmark offered in contained a clause stating that ‘‘[s]uch royalty rates the hearing were NMPA and NSAI, evidence is wholly satisfactory with respect shall not be cited, relied upon, or proffered as representing songwriters and publisher to all of the products for which we must set evidence or otherwise used in the Proceeding,’’ copyright owners (collectively where ‘‘the Proceeding’’ was a defined term rates. . . . [W]e are not persuaded that the meaning Phonorecords I. Trial Ex. 6013, Copyright Owners), and GEO, the pro se . . . existing rate . . . now in effect for Phonorecords I Agreement at Sec. 3. By contrast, songwriter/copyright owner. Licensees nearly three years is . . . inappropriate. the Phonorecords II settlement agreement did not of the copyrights appearing at the contain such a clause that would preclude reliance Phonorecords I at 4522 (emphasis on the evidentiary value of the Phonorecords II hearing were Amazon Digital Services, added). royalty rates. See Trial Ex. 6014, Phonorecords II LLC (Amazon), Apple Inc. (Apple), Thus, in the first (and only) litigated Agreement at Sec. 5.5 (including a full-integration Google, Inc. (Google), Pandora Media, section 115 proceeding before the clause of the Phonorecords II wrapper agreement). Inc. (Pandora), and Spotify USA Inc. I find this distinction important, because it Judges, they adopted the existing rates demonstrates that the parties to the 2012 settlement (Spotify) (collectively referred to as the and structure for the subsequent rate understood the evidentiary value of the Services). period, rather than rates and a structure Phonorecords II settlement in the next section 115 Beginning on March 8, 2017, the that were proposed by the parties, proceeding, i.e., this proceeding. Judges conducted a twenty-one day 188 Initial Participants were: Amazon Digital hearing that concluded on April 13, because the Judges were concerned that Services, LLC (Amazon); Apple, Inc. (Apple); the parties’ proposals would not be Broadcast Music, Inc. (BMI); American Society of 2017. During the course of the hearing, appropriate for all of the products at Composers, Authors and Publishers (ASCAP); the Judges heard oral testimony from 37 issue.185 David Powell; Deezer S.A. (Deezer); Digital Media witnesses,193 and admitted over 1,100 Association (DiMA); Gear Publishing Company exhibits. The participants submitted In 2013, the Judges adopted a (Gear); George Johnson d/b/a/GEO Music Group settlement that carried forward the (GEO); Google, Inc. (Google); Music Reports, Inc. existing rates and added a new subpart, (MRI); Pandora Media, Inc. (Pandora); Recording 190 See 81 FR 48371 (Jul. 25, 2016). subpart C, which, as noted supra, covers Industry Association of America, Inc. (RIAA); 191 Three parties filed comments. American Rhapsody International Inc.; SoundCloud Limited; Association of Independent Music (A2IM), Sony several newly regulated categories— Spotify USA Inc.; ‘‘Copyright Owners’’ comprised Music Entertainment (Sony), and George Johnson ‘‘limited offerings, mixed service of National Music Publishers Association (NMPA), dba GEO Music Group (GEO). A2IM urged adoption The Harry Fox Agency (HFA), Nashville of the settlement and Sony approved of all but one 185 That is, the Judges in Phonorecords I Songwriters Association International (NSAI), provision of the settlement. GEO objected to the recognized that the existing rate structure and rates Church Music Publishers Association (CMPA), settlement. were sufficient to cover all products at issue, a Songwriters of North America (SONA), Omnifone 192 See 82 FR 15297 (Mar. 28, 2017). result that this Dissent likewise would accomplish. Group Limited; and publishers filing jointly, 193 By stipulation of the participants, the Judges But, a fortiori, in the present case this result is also Universal Music Group (UMG), Sony Music also accepted and considered written testimony backed by an evidentiary record supporting the Entertainment (SME), Warner Music Group (WMG). from six additional witnesses who did not appear. continuation of the existing structure and rates, 189 The settling parties were: NMPA, NSAI, HFA, Amazon designated and other participants because the present regulatory structure has been UMG, and WMG. As part of the settlement counterdesignated testimony from the presented by the Services as a benchmark, rather agreement, UMG and WMG withdrew from further Phonorecords I proceeding, which was admitted as than as a default position. participation in this proceeding. Exhibits 321 and 322.

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Proposed Findings of Fact (PFF) and providers, such as Spotify and several functionalities: (1) Music Store; Proposed Conclusions of Law (PCL) on Pandora.195 Others, such as Amazon, (2) a cloud-based locker service; (3) an May 12, 2017, and Replies to those Apple Music, and Google Play Music, on-demand digital music streaming filings on May 26, 2017. On June 7, are part of wider economic service; and (4) a Section 114 compliant 2017, counsel for the parties made their ‘‘ecosystems,’’ in which a music service non-interactive digital radio service (in closing arguments. is one part of a multi-product, multi- the U.S.). Written Direct Testimony of Under 37 CFR 351.4(b)(3), a service aggregation of activities, Zahavah Levine, Trial Ex. 692, ¶ 43 participant may amend its rate proposal including some that are also related to (Levine WDT). at any time up to and including the time the provision of a retail distribution The largest services entered direct it files proposed findings and channel for music. For example, agreements with publishers to license conclusions.194 In this proceeding, Amazon is a multi-faceted internet retail their musical works. The terms of those Copyright Owners, Google, Pandora and business. Amazon offers a buyers’ licensing agreements varied. For Spotify each filed an amended rate program for an annual fee (Amazon example, Apple agreed to [REDACTED] proposal with its filing of a PFF and Prime) that affords loyalty benefits to with the major publishers that includes PCOL. members, such as free or reduced rate a minimum [REDACTED]. Expert Report The parties delivered closing shipping or faster delivery on the of Jeffrey A. Eisenach, Ph.D. ¶¶ 84–92 arguments on June 7, 2017. products it markets. For its music (Eisenach WDT). In these agreements, C. Overview of the Licensing Parties service, Amazon bundles interactive [REDACTED]. Id. ¶ 87 n.79. streaming at no additional cost with its Google’s practice is to [REDACTED]. 1. The Licensees: The Streaming Prime Membership, [REDACTED].196 In Levine WDT ¶¶ 51–52.200 Services addition to the Prime Music service, There is conflicting evidence about Many diverse enterprises have Amazon’s U.S.-based business also whether the market for streaming launched new music streaming services includes an online store to purchase services is faring poorly financially or to meet growing consumer demand for CDS and vinyl records, a digital performing about the same as other streaming. Currently, there are at least download store, a purchased content emerging industries. See, e.g., Timmins 31 music streaming services available locker service, Amazon Music WRT ¶¶ 16–17; Levine WDT ¶ 16 from 20 identifiable providers. Some of Unlimited (a full-catalog subscription (‘‘streaming music services generally the well-known of these include: music service), and Amazon Music remain unprofitable businesses’’ with Amazon, Apple, Google (and its recently Unlimited for Echo (a full-catalog content acquisition costs (primarily acquired YouTube), Deezer (partnered subscription service available through a music royalties) being ‘‘the biggest with Cricket/AT&T), iHeartRadio, single Wi-Fi enabled Amazon Echo barrier to profitability.’’) For example, Napster, Pandora, SoundCloud, Spotify, device).197 In launching Prime Music, Spotify, one of the largest pure-play and Tidal (partnered with Sprint). Amazon relied on the Section 115 streaming services, has reportedly Written Rebuttal Testimony of Jim license as it did for Amazon Music [REDACTED]. Katz WDT ¶ 65. Timmins, Trial Ex. 3036, ¶ 20 (Timmins Unlimited and Amazon Music Nevertheless, some estimates place WRT). Most of the companies entering Unlimited for Echo.198 Spotify’s market value at more than $8 the on-demand streaming music market Google describes its Google Play billion, suggesting perhaps, investors’ have done so recently. Id. ¶ 21. In the offerings as its ‘‘one-stop-shop’’ for the expectation of future profits. Expert last five years, new entrants to the purchase of Android apps. The Google Report of Marc Rysman, Ph.D. ¶ 150 market have initiated at least five Play Store allows users to browse, (Rysman WDT).201 interactive streaming services, joining purchase, and download content, including music. Google Play Music is 2. The Licensors: Publishers and Spotify which launched in the United Songwriters States in 2011. Id. ¶ 22. Google Play’s entire suite of music By one estimate, as of 2016 there were services. Google Play Music, launched The four largest publishers—Sony/ [REDACTED] million United States on- in 2011, is bundled with the YouTube ATV ([REDACTED] percent), Warner/ demand subscribers: Spotify accounted Red video service subscription.199 See Chappell ([REDACTED] percent), for [REDACTED] million, [REDACTED] Expert Report of Jui Ramaprasad Universal Music Publishing Group Apple Music (4 million), Rhapsody and November 1, 2016 at Table 2, and ¶ 62, (UMPG) ([REDACTED] percent), and Tidal (2 million each), and all others n.105 (Ramaprasad WDT). It includes Kobalt Music Publishing ([REDACTED] accounting for the remaining 4 million. percent)—collectively accounted for just Written Testimony of Michael L. Katz 195 Until late 2016, Pandora operated as a over 73 percent of the top 100 radio noninteractive streaming service, arguably not songs tracked by Billboard as of the (On behalf of Pandora Media, Inc.) ¶ 34, subject to the compulsory license for mechanical Table 1 (Katz WDT). According to royalties, but Pandora recently began offering more second quarter in 2016. Katz WDT ¶ 46. Spotify, as of June 2016, it had interactive features, including a full on-demand In addition, there are several other approximately [REDACTED] million tier. Introductory Memorandum to the Written significant publishers, including BMG Direct Statement of Pandora Media, Inc. at 1–2; and Songs Music Publishing, and many monthly average users (MAU) in the Written Direct Testimony of Christopher Phillips at United States, of which [REDACTED] 8 (Phillips WDT). thousands of smaller music publishers million were subscribers, with 196 Amazon Prime is a $99- per-year service that and self-publishing songwriters. Id. apparently [REDACTED] million users offers Amazon customers access to a bundle of Songwriters have three primary services including free two-day shipping, video of Spotify’s ad-supported service. sources of ongoing royalty income, streaming, photo storage and e-books, in addition to which they generally share with music Written Direct Testimony of Barry Prime Music. Expert Report of Glenn Hubbard, McCarthy (On behalf of Spotify USA November 1, 2016 at 15 (Hubbard WDT). publishers: mechanical royalties, Inc.) ¶ 6 (McCarthy WDT). 197 Mirchandani WDT at 5. Some of the services that offer music 198 3/15/17 Tr. 1315–16 (Mirchandani). 200 According to Ms. Levine, labels historically 199 Google’s experience with music licensing have not passed through mechanical rights to streaming are pure-play music dates at least far back as 2006, when it acquired subscription services so the lower percentages are YouTube. Levine WDT at 3. Google’s music services irrelevant. Levine WDT at n.5. 194 Nothing in § 351.4 permits the Judges to credit were part of Google’s Android Division but were 201 The implications of the different perspectives an amended rate proposal that is not adequately recently combined within the YouTube business on industry profit and losses are considered infra supported by the record evidence. unit. Id. at 3–4. in this Dissent.

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synchronization (‘‘synch’’) royalties, Conclusions of Law ¶¶ 271, 283 establish rates that are mathematically and performance royalties.202 See Katz (SJPFF).) precise, given the nature of the statutory WDT ¶ 41; Copyright and the Music Total publishing revenue declined by task and the controlling legal Marketplace: A Report of the Register of [REDACTED] percent between 2013 and precedents. Nat’l Cable Television Ass’n Copyrights at 69 (Feb. 2015) (Register’s 2014, but then increased by v. Copyright Royalty Tribunal, 724 F.2d Report).203 Songwriters who are also [REDACTED] percent between 2014 and 176, 182 (D.C. Cir. 1983) (‘‘Ratemaking recording artists receive a share of 2015. Katz WDT ¶ 58. The largest generally is an intensely practical revenues from their record labels for the publishers, Sony/ATV, UMPG, and affair.... The Tribunal’s work fixing of the musical work in a sound Warner Chappell, [REDACTED], earning particularly, in both ratemaking and recording. Sound recording royalties a combined $[REDACTED] million from royalty distribution, necessarily include those from the sale of physical U.S. publishing operations for that year. involves estimates and approximations. and digital albums and singles, sound Id. ¶ 59. There has never been any pretense that recording synchronization, and digital the CRT’s rulings rest on precise D. The Rate-Setting Standards in performances. Id. Recording artists can mathematical calculations; it suffices Section 801(b)(1) also derive income from live that they lie within a ‘zone of performances, sale of merchandise, and 1. The Legal Basis for the Four Itemized reasonableness.’ ’’) (citations omitted). other sources. Id. at 69–70. Objectives The Judges also have discretion as to The shift in consumption from The Copyright Act requires that the whether and how they choose to physical sales to streaming coincided Judges establish ‘‘reasonable’’ rates and integrate their application of the with a reallocation of publisher revenue terms for the Section 115 license. In ‘‘reasonable rate’’ standard with their sources. In 2012, 30% of U.S. publisher addition, section 801(b)(1) instructs the analysis of the four itemized factors in revenues came from performance Judges to set these rates ‘‘to achieve the section 801(b)(1). They may: (1) royalties and 36% from mechanical following objectives’’: establish a ‘‘reasonable rate’’ as an royalties, with the rest coming from initial step, and then apply the four synch royalties and other sources. See Factor A: To maximize the availability of itemized factors; or (2) integrate their creative works to the public; Register’s Report at 70. By 2014, 52% of Factor B: To afford the copyright owner a analysis of the four itemized factors into music publisher revenues came from fair return for his or her creative work and a single ‘‘reasonable rate’’ approach— performance royalties, while 23% came the copyright user a fair income under even beginning that approach with a from mechanical royalties, with the existing economic conditions; consideration of the four factors. remainder coming from synch royalties Factor C: To reflect the relative roles of the Compare Recording Industry Ass’n of and other sources. Id at 71, n.344. By copyright owner and the copyright user in America, Inc. v. Librarian of Congress, one estimate, mechanical license the product made available to the public with 176 F.3d 528, 533 (D.C. Cir. 1999) revenues from interactive streaming respect to relative creative contribution, (approving of the latter approach) with technological contribution, capital services accounted for only investment, cost, risk, and contribution to the Phonorecords I (applying the former [REDACTED] percent of total music opening of new markets for creative approach, explaining that ‘‘the issue at publishing revenues in 2015. Katz WDT expression and media for their hand in analyzing the section 801(b) ¶ 42. communication; and factors is whether these [four] policy It is noteworthy that the shift from Factor D: To minimize any disruptive objectives weigh in favor of divergence mechanical royalties to performance impact on the structure of the industries from the results indicated by the royalties coincided with the shift from involved and on generally prevailing benchmark marketplace evidence.’’) 73 sales of phonorecords, DPDs, and CDS, industry practices. FR at 4094 (Jan. 24, 2008) (quoting for which no performance royalty is 17 U.S.C. 115(c) and 17 U.S.C. SDARS I).205 required, to the use of interactive 801(b)(1).204 In the 1981 Phonorecords Appeal, the 2. The Economic Basis for the Four streaming, for which a performance Itemized Objectives royalty and a mechanical royalty are D.C. Circuit noted the interplay among both required. Further (as discussed these four objectives: The legal and regulatory process of more fully infra), the latter is reduced [T]he statutory factors pull in opposing setting statutory royalty rates and terms pursuant to an ‘‘All-In’’ formula that directions, and reconciliation of these has long been informed by economics. reflects the perfect complementarity of objectives is committed to the Tribunal as See, e.g., W. Blaisdell, Study No. 6, The the performance and mechanical part of its mandate to determine Economic Aspects of the Compulsory licenses (i.e., neither license has any ‘‘reasonable’’ ‘ royalty rates .... [T]he License, U.S. Senate Subcommittee on Tribunal was not told which factors should Patents, Trademarks and Copyrights value to an interactive streaming service receive higher priorities. To the extent that without the other). Additionally, (October 1958) (Senate Study). This is the statutory objectives determine a range of certainly true with regard to the noninteractive streaming pays only a reasonable royalty rates that would serve all performance royalty but no mechanical these objectives adequately but to differing establishment of the standards set forth royalty, providing a further basis for degrees, the Tribunal is free to choose among in section 801(b)(1). The legislative mechanical royalties to be a smaller those rates, and courts are without authority history in the long build-up to the percentage of the publishers’ total to set aside the particular rate chosen by the adoption of these standards is revenues, assuming growth in Tribunal if it lies within a ‘‘zone of highlighted by dueling economic reasonableness.’’ noninteractive streaming. See Services’ Joint Proposed Findings of Fact and Id. at 9. 205 In the present proceeding, the parties’ When applying the foregoing arguments combine both approaches. For example, as discussed infra, the issue of ‘‘rate structure’’ is 202 Another revenue source is folio licenses, standards, the Judges are not required to analyzed by the parties as a marketplace issue, lyrics, and musical notations in written form. Katz which places it in the analytical ‘‘reasonable rate’’ WDT at 31. 204 The 1976 Act applied section 801(b)(1) and its box, and also as a Factor B and Factor C issue, 203 References to the Register’s Report are four-factor test to new licenses. The mechanical affecting the analysis of ‘‘fair’’ return and income incorporated herein to provide background license at issue in this proceeding is the lone and the ‘‘relative roles’’ of the parties. Thus, in this information. This Dissent is not based on factual existing statutory license carried forward into the Dissent, I shall also on occasion apply the same information or opinion contained therein, as that 1976 Act from the 1909 Copyright Act and made analyses to certain ‘‘reasonable rate’’ and ‘‘itemized document is not record evidence in this proceeding. subject to the 801(b)(1) standards. factor’’ issues.

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positions taken in Congressional statutory ratemaking,’’ including a rate range [with] a higher ceiling so that testimony in 1967 by the licensors, ‘‘that insures the party against whom it more bargaining can take place,’’ which through the NMPA and its economic is imposed a reasonable return on . . . would ‘‘permit competitive bargaining witness, Robert R. Nathan, and by the investment’’ and ‘‘that divides the . . . .’’ Senate Hearing at 384, 421. In licensees, the RIAA, through their rewards for the respective creative fact, Mr. Nathan and the NMPA were counsel, Thurman Arnold, Esq., a well- contributions of the record producers quite specific as to how the rate-setter known advocate of strong antitrust [as licensees] and the copyright owners should determine the range for enforcement. See Hearing on S. 597, . . . equitably between them.’’ Id. at bargaining under this theory: ‘‘[T]he rate Subcomm. on Patents, Trademarks and 469. should be high enough to allow and Copyrights of the S. Committee on the Mr. Nathan criticized this approach encourage private negotiation, but not Judiciary (Mar. 20–21, 1967) (Senate on two fronts. First, he argued that the so high as to make the compulsory Hearing). ‘‘personal service’’ nature of the licensing provision meaningless . . . .’’ Mr. Nathan expressed incredulity that songwriting and publishing industry Id. at 417. the songwriting industry would even be precluded application of a ‘‘reasonable Before the Senate Judiciary subject to a compulsory mechanical rate of return’’ requirement for the Committee, the RIAA’s attorney, Mr. licensing scheme. Id. at 382.206 Mr. setting of the compulsory royalty Arnold, asserted that incorporating the Nathan did not see any basis for treating rate.207 Second, with regard to the bargaining room theory into the new this license differently than how ‘‘we division of the ‘‘rewards’’ proposed in statute would flaunt the purpose of a generally function under competitive Mr. Arnold’s testimony, Mr. Nathan compulsory license: marketplace bargaining arrangements stated that ‘‘I have never in all my [T]o set a statutory rate so high as to promote whereby most entities in our economy experience encountered this novel negotiations by a record manufacturer and a bargain for that which goes into the concept of dividing rewards for creative publisher below that statutory rate violates creation of goods and services and also contributions as a meaningful and and contradicts the very purpose of imposing bargain the price for which those goods relevant standard of ratemaking.’’ Id. at the compulsory license on the music and services are sold.’’ Id. 1093–94. publisher. Thus, in his 1967 testimony, Mr. This 1967 dispute was never resolved. Senate Hearing at 468. Nathan advocated that Congress Rather, the issue languished until 1980, The bargaining room theory would eliminate the compulsory license and when, Congress abandoned the permit different pairings of licensors the statutory rate. Importantly for the statutorily-fixed rate and substituted a and licensees to enter into agreements at present proceeding, he specifically regulatory rate-setting process. varying rates below the statutory rate. urged Congress (if it did not eliminate However, the post-1967 legislative Indeed, a CBS Records witness before the compulsory license) to resist history did not elucidate how rates set the Senate Judiciary Committee replacing the fixed statutory fee with a under the new statutory standard were acknowledged that ‘‘[a] higher ceiling regulatory standard to be implemented to be related (if at all) to marketplace would permit wider variation in royalty by a quasi-adjudicatory body, as one rates, either as a matter of law or a rates....’’ Id. at 417 (emphasis might regulate a public utility. He matter of economic policy. F. Greenman added). Further, Mr. Nathan explained explained to Congress: ‘‘[O]ne might ask & A. Deutsch, The Copyright Royalty this commercial desire for a variety of . . . whether the music publishing Tribunal and the Statutory Mechanical rates in somewhat more formal industry has any characteristics of a Royalty: History and Prospect, 1 economic terms: ‘‘[A] prudent public utility. I submit . . . that there is Cardozo Arts & Ent. L.J. 1, 53, 59 businessman . . . merely wants to price nothing in the music publishing (1982).208 his goods on the apparent willingness of industry which gives [it] the 3. The ‘‘Bargaining Room’’ Rate-Setting the consumer to pay.’’ Id. at 419 characteristics or the elements of a (emphasis added). public utility . . . .’’ Id. at 383. Mr. Theory Under Section 801(b)(1) Nathan noted what he understood to be a. The Bargaining Room Theory in The House Judiciary Committee adopted the bargaining room theory in its report: a key distinction: Unlike traditional Historical Context The committee is setting a statutory rate at public utilities like ‘‘railroad systems’’ A corollary to the debate regarding the the high end of a range within which the or ‘‘streetcar lines,’’ the songwriting and standard to be established in section parties can negotiate, now and in the future, publishing industry is ‘‘a creative and 801(b)(1) was another dispute: whether for actual payment of a rate that reflects non-standardized area,’’ and market values at the time, but one that is not the statutory rates and terms should be so high as to make it economically ‘‘[m]onopoly and public utility aspects set pursuant to what was coined the are just not prevalent in this industry.’’ impractical for record producers [as ‘‘bargaining room theory’’ of rate-setting. licensees] to invoke the compulsory license Id. This theory was summarized by Mr. The opposing position of the if negotiations fail. Nathan: When setting a statutory or licensees, expressed by Mr. Arnold on H.R. Rep. at 21. regulatory rate, the rate-setter should behalf of the RIAA, contained the seeds Despite movement in the House, in allow for ‘‘opening up of the bargaining of the standard ultimately adopted in the event, the language in section section 801(b)(1). As Mr. Arnold 801(b)(1) as enacted did not address the 207 The Judges note that this unique ‘‘personal bargaining room theory, but rather set testified, the statute should include, service’’ aspect of the business is less economically inter alia, ‘‘accepted standards of significant when, as is typical, published songs are forth the aforementioned requirement collected and owned by large publishing firms, and for the establishment of ‘‘reasonable’’ 206 This overarching criticism of the existence of such firms each price their repertoires jointly rates and for the achievement of the statutory license was echoed in the present through blanket licenses. objectives set forth in Factors A through 208 proceeding by NMPA’s President, David Israelite. 3/ The standards apparently were adopted to D. As two attorneys who were involved 29/17 Tr. 3677 (acknowledging that he ‘‘always ensure the constitutionality of the delegation of disapproved of the compulsory licensing system, rate-setting by Congress to an administrative body. in the process of crafting section ever since [he] knew about it.) (Israelite); see also See SDARS I, 73 FR at 4082 (citing Hearings on H.R. 801(b)(1) wrote in their exhaustive Witness Statement of David M. Israelite ¶ 55 2223 before the Subcomm. on Courts, Civil history of the process: (Israelite WDT) (‘‘I feel it is important . . . to Liberties, and the Administration of Justice of the express my view that [the compulsory license] is no House Comm. on the Judiciary, 94th Cong., 1922 The most significant elements of the longer necessary . . . .’’). (1975)). statutory criteria may be what they omit.

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They do not include any explicit mention of under which copyright users must try to Moreover, as noted supra, the Judges are the standard . . . adopted by the House make private deals [is] inconsistent with required to consider not only the Judiciary Committee in 1967 that the Section 801(b)(1) . . .’’). In further reasonableness of the rates, but also how statutory rate should be at the high end of a support of their argument in favor of the the four itemized factors listed in range within which the parties can negotiate bargaining room theory, Copyright . . . for an actual payment of a rate that section 801(b)(1) bear on the reflects market values and . . . not so high Owners emphasize the inability of the reasonableness of the rates, i.e., the . . . as to make it economically impractical Judges (or anyone) to identify present maximization of the public for record producers to invoke the market rates precisely, let alone over the ‘‘availability’’ of musical works, ‘‘fair’’ compulsory license if negotiations fail. five year rate period. Proposed return, ‘‘fair’’ income and ‘‘minimize[d] Conclusions of Law of Copyright Owners Greenman & Deutsch, supra, at 59. . . . disruptive impact.’’ These are not In 1981, the CRT ruled that, as a ¶ 89 (COPCOL) (‘‘the compulsory factors necessarily implicated or fully matter of law, the language in section license set by the Judges cannot possibly addressed by a market-based analysis. If contemplate every single business 801(b)(1) precluded the use the the Judges were to adopt wholesale the model that may develop in the ensuing bargaining room approach to rate- bargaining room theory, they would time.’’). Their reasoning is a reprise of setting. Adjustment of Royalty Payable eliminate the value of those extra- the original argument for the bargaining under Compulsory License for Making market factors. Finally, as Dr. Eisenach room theory: If the statutory rate is set and Distributing Phonorecords, 46 FR conceded, adoption of the bargaining below market rates, then the parties will 10466, 10478 (1981). On appeal, the room theory would alter the parties’ never negotiate upward toward the D.C. Circuit affirmed the CRT’s decision respective ‘‘threat points’’ (a/k/a market rates, because the licensees will to eschew this approach. 1981 ‘‘disagreement points’’) in the ‘‘Nash always prefer to invoke the right to use Phonorecords Appeal, supra. However, context,’’ increasing Copyright Owners’ the licensed work at the below-market the D.C. Circuit’s affirmance was not bargaining power as compared with the statutory rates. However, if the Judges non-application of the bargaining room based on the CRT’s conclusion that the set the statutory rate above what they ‘‘bargaining room’’ approach was approach. 4/4/17 Tr. 4846–47 find to be market rates, different 209 impermissible as a matter of law. (Eisenach). licensees who each have a maximum In addition, an application of the Rather, the appellate court held that the willingness to pay (WTP) below such a CRT had exercised its lawful statutory bargaining room theory would be statutory rate would seek to negotiate inconsistent with another purpose of discretion—in the form of a policy lower rates with the licensors. In determination—to reject the use of the statutory licensing—the minimization of response to such requests to negotiate, transaction costs. If each interactive ‘‘bargaining room’’ approach. Id. at 37. according to this argument, Copyright With regard to the legal question as to streaming service were required to Owners would respond by negotiating negotiate separately with each music whether the ‘‘bargaining room’’ theory various lower rates for those licensees, could be applied by the rate-setter, the publisher, the process would diminish provided lower rates were also in the the transaction cost savings, which is an D.C. Circuit held that ‘‘the statutory self-interest of Copyright Owners. 4/3/ criteria . . . do not explicitly address important reason for statutory licensing. 17 Tr. 4431 (Rysman). See 4/6/17 Tr. 5233 (Leonard) (‘‘the the bargaining room question, and that I find, as a matter of policy, that the dispute can only be resolved through point of having this kind of compulsory bargaining room theory is not applicable licensing setting is to reduce the [CRT’s] articulation of principles to the setting of rates in the present case. that flesh out the statutory notions of transactions cost and to . . . prevent the Rather, I agree with the policy decision exercise of market power and prevent ‘reasonable’ rates and ‘fair’ returns.’’ Id. in Phonorecords I that the rate setting at 36. As the authors of the historical disruption in the marketplace.’’); 4/13/ policies made explicit in section 17 Tr. 5901 (Hubbard) (most listeners article noted, this appellate ruling 801(b)(1) are best discharged if the preserved for future litigants the right to demonstrate low WTP such that ‘‘notion Judges identify rate structures and rates of negotiation with [that] entire long tail advocate for a policy change to allow for that reflect the standards set forth in the an implementation of the ‘‘bargaining is a lot of transactions costs . . . which statutory provision. Indeed, if the Judges would seem to me to be at odds with the room’’ approach under section were to supplant the statutory factors 801(b) factors.... [I]t . . . would seem 801(b)(1). Greenman & Deutsch, supra, with a theory leading to rates to subvert the very purpose of this at 64. Those ‘‘future litigants’’ have intentionally designed to substitute hearing to just suggest wholesale private arrived in this proceeding. discretionary bargaining, the parties renegotiation.’’). b. The Bargaining Room Theory in the would essentially be returned to a On balance, based on the foregoing, I Present Proceeding purely market-based rate-setting do not accept and will not apply the approach. See 3/21/17 Tr. 2194 In the present case, the parties bargaining room theory to establish (Hubbard) (adoption of the ‘‘bargaining either the rate structure or the zone of disagree on the issue of whether the room theory’’ would ‘‘extensively’’ shift reasonable rates. Judges should apply the bargaining bargaining power to the Copyright room theory of rate-setting in this Owners); see also 3/13/17 Tr. 569 (Katz) E. The Present Rate Structure and Rates determination. Compare Copyright (‘‘the statutory proceeding . . . ‘‘help[s] Subpart B sets forth mechanical Owners’ Reply to Services’ Joint offset the possible asymmetries’’ in royalty rates in connection with the Proposed Findings of Fact and bargaining power). delivery and offering of interactive Conclusions of Law at 146 (CORPFF–JS) Notably, section 801(b)(1) does not streams and/or limited downloads. (‘‘Copyright Owners . . . contend that require the Judges even to attempt to set . . . [the] bargaining room theory [is a] market rates, or to use market rates to 209 A ‘‘threat point’’ or ‘‘disagreement point’’ is a quite permissible consideration[ ] under establish ‘‘reasonable’’ rates under the concept from bargaining (game) theory (specifically, 801(b)(1) analysis . . .’’) with Services’ statute. Music Choice, 774 F.3d, supra, in the Nash bargaining model) representing the Joint Reply to the Copyright Owners’ at 1010. (‘‘Copyright Act permits, but value point at which a party will walk away from negotiations—thereby affecting the value of the Proposed Findings of Fact and does not require, the Judges to use ultimate bargain. See SDARS II, 74 FR 23054, Conclusions of Law at 28 (SJRPFF–CO) market rates to help determine 23056–57 (April 7, 2017) (summarizing the Nash (‘‘[a] rate creating ‘bargaining room’ reasonable rates’’) (emphasis added). model).

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There are three product distinctions —lesser of 21% of service payments for (i) Mixed Service Bundle: 11.35% of within the subpart B rate structure: sound recording rights and $0.80 per service revenue. (a) Nonportable vs. Portable Services subscriber per month. (ii) Music Bundles: 11.35% of service (b) Unbundled vs. Bundled Services (iv) Bundled Subscription Services: revenue. (c) Subscription vs. Ad-Supported Services —21% of service payments for sound (iii) Limited Offering: 10.5% of 37 CFR 385.13. recording rights. service revenue. Copyright Owners provide a helpful (v) Free Non-Subscription/Ad- (iv) Paid Locker Service: 12% of and more specific summary of these Supported Services: incremental service revenue. categories: —22% of service payments for sound (v) Purchased Content Locker: 12% of (a) ‘‘standalone non-portable recording rights. service revenue. subscription—streaming only’’ services (i.e., 2. Subtract Applicable Performance and tethered to a computer); Royalties [the ‘‘All-In’’ Calculation] (i.e., (b) ‘‘standalone non-portable subtract from the result in the previous b. The applicable ‘‘All-In’’ minimum, subscription—mixed’’ (i.e., both streaming step the ‘‘total amount of royalties for also based on the type of service: and limited download) services; (c) ‘‘standalone portable’’ subscription public performance of musical works (i) Mixed Service Bundle: 21% of streaming and limited download services that has been or will be expensed service payments for sound recording (i.e., accessible on mobile or other Internet- pursuant to public performance licenses rights. enabled devices); in connection with uses of musical (ii) Music Bundles: 21% of service (d) ‘‘bundled subscription services’’ which works through such offering.’’) payments for sound recording rights. are streaming and limited download services 3. Compare the maximum of the result bundled with another product or service; and from the previous steps and the (iii) Limited Offering: 21% of service (e) ‘‘free [to the end user] nonsubscription/ following mechanical-only per payments for sound recording rights ad-supported services.’’ subscriber royalty floors based on the (subject to a further minimum payment of $0.18 per subscriber per month). Copyright Owners’ Written Direct type of service: 212 Statement, Proposed Rates and Terms at (a) Standalone Non-Portable (iv) Paid Locker Service: 20.65% of B–3 (Copyright Owners’ Proposal) Subscription, Streaming Only: $0.15 per service payments for sound recording (quoting 37 CFR 385.13). subscriber per month. rights (subject to a further minimum More granularly, the present subpart (b) Standalone Non-Portable payment of $0.17 per subscriber per B rate structure and rates and for Subscription, Mixed Use: $0.30 per month). interactive streaming and limited subscriber per month. (v) Purchased Content Locker: 22% of downloads, as agreed to by the parties (c) Standalone Portable Subscription, any incremental service payments to in their 2012 settlement, are set forth in Mixed Use: $0.50 per subscriber per record companies for sound recording full at 37 CFR 385.12 and 385.13, and month. rights (above the otherwise applicable are summarized below: 210 (d) Bundled Subscription Services: payments for permanent digital 1. Calculate the ‘‘All-In’’ Publishing $0.25 per active subscriber per month. downloads and ringtones). Royalty for the Service Offering (e) Free Non-Subscription/Ad- 2. Subtract Applicable Performance a. maximum of 10.5% of service Supported Services: Not Applicable.213 Royalties revenue and the following minimum Subpart C of part 385 sets forth the Subtract from the result in the royalties based on the type of service: royalty structure and rates for licensing previous step the ‘‘total amount of (i) Standalone Non-Portable mechanical rights for five categories: royalties for public performance of Subscription, Streaming Only: limited offerings, mixed service musical works that has been or will be bundles, music bundles, paid locker —lesser of 22% of service payments for expensed pursuant to public 211 services, and purchased content locker performance licenses in connection sound recording rights and $0.50 services. The present subpart C rate per subscriber per month. with uses of musical works through structure, established consensually in such subpart C offering.’’ 214 (ii) Standalone Non-Portable the 2012 settlement, are set forth at 37 At the time of the hearing, the Subscription, Mixed Use: CFR 385.20 through 385.26. As services paid the following subpart B succinctly summarized by Dr. Leonard —lesser of 21% of service payments for mechanical rates: 215 sound recording rights and $0.50 per (see Leonard AWDT ¶ 26), the structure subscriber per month. and rates are as follows: 214 As under subpart B, collected royalties under 1. Calculate the ‘‘All-In’’ Publishing (iii) Standalone Portable Subscription, subpart C are allocated on a per play basis. The Royalty for the Service Offering Services, and Apple, do not propose a change in Mixed Use: a. Maximum of the applicable this regard. Copyright Owners, given their proposal percentage of service revenue based on that subpart C be eliminated, would utilize the 210 This summary is set forth in the Amended subpart B allocation methodology for the service Expert Witness Statement of Dr. Gregory Leonard, the type of service: offerings now in subpart C. Google’s economic expert witness. See Amended 215 Pandora had not begun its interactive Expert Witness Statement of Dr. Gregory K. Leonard 212 This is the so-called ‘‘Mechanical Floor’’ rate, streaming service at the time of the hearing. ¶ 25 (Leonard AWDT). I find Dr. Leonard’s format discussed infra. However, since November 2015, Pandora asserts to be particularly useful, but I note that all the 213 The regulations also describe how the royalty that it has entered into direct licenses with parties clearly and consistently summarized the revenue collected shall be allocated among musical thousands of music publishers that cover the existing rate structure. See also, e.g., Israelite WDT works that had been played on the interactive mechanical rights that are at issue in this ¶ 28. streaming services. That allocation is made on a per proceeding. Written Direct Testimony of Michael 211 To be clear, these alternative percentages play basis, and, under the parties’ proposals in this Herring ¶ 49 (Herring WDT). See, e.g., PAN Dir. Exs. reflect percent of payments to record companies for proceeding, that general allocation principle would 6–7. Many of those deals bundle interactive sound recording rights, unregulated and set in the remain unchanged. Compare Copyright Owners’ streaming (for which mechanical and performance market, not the percent of revenue received by the Proposal at B–14–15 with, e.g., Second Amended rights are required) and noninteractive streaming interactive streaming services. That is, these are the Proposed Rates and Terms of Spotify USA Inc. at (for which, arguably, no mechanical license is so-called ‘‘TCC’’ rates. 12–13 (Spotify’s Proposal). required). Katz WDT ¶ 105.

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Licensee/service Rate prong Rate Reg or direct contract Source

Amazon Unlimited for Echo [REDACTED] ...... $[REDACTED] ...... § [REDACTED] ...... Brost WDT,216 Ex. 18 (HX 20). Amazon Prime ...... [REDACTED] ...... $[REDACTED] ...... § [REDACTED] ...... Marx 217 WRT ¶ 40. Apple Music ...... Not Applicable ...... [REDACTED] ...... Direct contracts ...... Wheeler 218 WDT ¶¶ 10, 12; HX 1432, HX 1434, HX 1435. [REDACTED] ...... [REDACTED] ...... [REDACTED] ...... [REDACTED] ...... Leonard AWDT ¶ 52 et seq. Spotify/Ad-Supported ...... [REDACTED] ...... [REDACTED] ...... § [REDACTED] ...... Marx WDT 219 ¶ 83. § [REDACTED] ...... Spotify Subscription ...... [REDACTED] ...... $[REDACTED] ...... § [REDACTED] ...... Marx WDT ¶ 76.

F. The Economic Framework for understood that there is typically a reproduce. . . .’’); Marx WDT ¶ 117 Analyzing the Rate Structure Issues positive correlation between price and (‘‘the marginal costs of providing rights The parties’ proposals are based on quantity (causing the well-known to a particular musical work and varying explicit and implicit upward slope of a supply curve). See, streaming it to the consumer are assumptions regarding the economic e.g., C. Byun, The Economics of the effectively zero); Written Rebuttal principles that underlie the licensing of Popular Music Industry at 74 (2016) Testimony of Richard Watt (Ph.D.) (On musical works. During the hearing, the (‘‘The firm’s supply curve is upward behalf of the NMPA and the NSAI) ¶ 44 parties have urged the Judges to apply sloping, since the relationship between n.48 (Watt WRT) (considering reliable certain economic principles, often price and quantity supplied by the firm Professor Marx’s conclusion that ‘‘[a] imploring the Judges to recognize that is positive.’’) This positive correlation is marginal cost of zero is a close the consequence of several factors. the economic underpinnings of their approximation of true costs of Among those factors is the increasing arguments can be found in the teachings delivery.’’); Expert Rebuttal Report of marginal physical cost of inputs of a generic introductory ‘‘Economics Glenn Hubbard, February 15, 2017 required to create the product. Marx 101’’ course. See, e.g., 3/8/17 Tr. 133 ¶ 4.20 (Hubbard WRT) (‘‘copyrighted WDT ¶ 38 n.39 (‘‘ ‘Marginal cost’ is (Copyright Owners’ Opening music work . . . has zero marginal defined as the increase in total cost Statement); 3/14/17 Tr. 920 (Herring); 4/ production costs’’); Rebuttal Expert resulting from an additional unit of 13/17 Tr. 5917 (Lane). I generally agree Witness Statement of Dr. Gregory K. output.’’). The marginal cost of inputs that, particularly with regard to the rate Leonard ¶¶ 6, 95 (Leonard WRT) generally increases because, inter alia, structure, it is helpful to ‘‘begin at the (acknowledging ‘‘the zero marginal cost inputs are scarce and a seller must pay beginning’’—i.e., with basic economic of a stream’’); Corrected Written more for each unit of an input as it Testimony of Michael L. Katz (On behalf principles—so that the subsequent becomes more scarce, or if additional analyses are grounded in some basic of Pandora Media, Inc.) ¶ 26 (Katz units are less productive. See Krugman CWRT) (‘‘The creation and distribution concepts. & Wells, Microeconomics at 312–13 (2d Basic economic theory teaches that of musical works has . . . zero or near- ed. 2009). Additionally, input sellers zero marginal costs.’’); 3/30/17 Tr. supply and demand determine an must consider the opportunity cost of equilibrium market price. See, e.g., W. 4085–40866, (Gans) (agreeing that the supplying an input to a particular buyer, ‘‘marginal physical cost’’ of ‘‘additional Nicholson & C. Snyder, Microeconomic i.e., any revenue foregone by selling that Theory at 10 (10th ed. 2008) (‘‘[D]emand electronic versions of sound recordings scarce input to that particular buyer . . . embody[ing] musical works is and supply interact to determine the rather than to another buyer who was equilibrium price and the quantity that zero); see generally W. Landes, willing to pay a higher price. See E. Copyright in R. Towse, A Handbook of will be traded in the market.’’); see also Mansfield & G. Yohe, Microeconomics at Final Rule and Order, Determination of Cultural Economics at 100 (2d ed. 2011) 242 (11th ed. 2004) (‘‘opportunity cost’’ (‘‘[T]he cost of reproducing the Reasonable Rates and Terms for the of an input is ‘‘the value of that input Digital Performance of Sound [copyrighted] work that additional users if it were employed in its most valuable can be added at a negligible or even zero Recordings, Docket No. 96–5 CARP alternative use.’’). DSTRA, 63 FR 25394, 25404 (May 8, cost.’’) So, there is an important basic In this proceeding, the products being distinction between the marginal 1998) (‘‘CARP PSS 1998’’) (noting that licensed by Copyright Owners to the ‘‘price [is] set in the marketplace physical costs associated with creating interactive streaming services for additional units of ordinary private according to the laws of supply and distribution are collections (repertoires) goods and additional digital copies of demand. . . .’’); Eisenach WDT ¶ 34 of additional copies of a song embodied songs/sound recordings. (‘‘the interplay between supply and in a sound recording—not the original With regard to demand, there is a demand results in a market price.’’) or first copy of the song or the sound negative correlation between price and With regard to the supply of an recording. The marginal physical cost of quantity (causing the equally well- ‘‘ordinary private good’’ in a perfectly such additional digital copies of a 220 known downward slope of a demand competitive market, it is well musical work embodied in a sound curve). See, e.g., Krugman & Wells, recording is essentially zero. See 216 supra, at 63–64. This negative Written Direct Testimony of Kelly Brost. Written Rebuttal Testimony of Marc 217 correlation is also the consequence of Written Rebuttal Testimony of Leslie M. Marx. Rysman, Ph.D. ¶ 71 (Rysman WRT) 218 Written Direct Testimony of Rob Wheeler. several factors. For present purposes, (‘‘Intellectual property commonly may 219 Written Direct Testimony of Leslie M. Marx. two factors are pertinent. First, a buyer’s have little to no marginal costs to 220 A ‘‘private good is ‘‘one that is both demand is a function of the benefit the excludable and rival in consumption,’’ i.e., the supplier can prevent non-payers from consuming P. Krugman & R. Wells, Microeconomics at pp. G– buyer realizes from acquiring the good— the good, and each unit of the good cannot be 2, G–7 (2d ed. 2009). The distinction between a what economists term ‘‘utility.’’ Second, consumed by more than one person simultaneously. private good and a public good is discussed infra. buyers’ ability to satisfy their desire for

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utility is constrained by their ability to buyers whose WTP was equal to the derived from the [downstream] firm’s pay—what economists call a ‘‘budget lower price as the demand curve output choice.’’).224 constraint.’’ To simplify somewhat, the descends, i.e., whose WTP was less than In perfectly competitive markets for point where a buyer’s utility and ability higher prices along the demand curve. ordinary private goods, prices tend to pay intersect represents a point on By contrast, an upward shift of the toward an ‘‘equilibrium’’ price where the buyer’s demand curve, indicating entire demand curve can be the there is an intersection between his or her ‘‘Willingness to Pay’’ consequence of several factors, quantity demanded (on the demand (WTP).221 See Byun, supra at 26–27 (The including a reduction in the price of a curve) and the quantity supplied (on the demand curve represents a mapping of competing (substitute) good and a supply curve). In that market, the all such points, reflecting both (1) the change in consumer tastes. To reiterate, positive price equals both marginal cost and marginal benefit.225 That price ‘‘intuitive’’ idea that the more expensive this distinction between an increase in would allow for a reasonable estimation a good, the greater its ‘‘budget’’ impact, quantity demanded and an increase in lowering the quantity demanded; and of a per unit price that economists demand is of particular importance in (2) diminishing marginal ‘‘utility,’’ as would be able to identify, in terms of this proceeding, as will be evident as I reflected in the buyer’s willingness to economic efficiency, as a fair market pay [(WTP)] for additional units of the compare and contrast the parties’ price. See, e.g., G. Niels, H. Jenkins & J. good); see also Pindyck & Rubinfeld, economic arguments. See Krugman & Kavanagh, Economics for Competition supra, at 83, 140 (‘‘[P]references and Wells, supra, at 66–67 (‘‘[W]hen you’re Lawyers ¶ 1.4.7 (2d ed. 2016) (The budget constraints . . . determine how doing economic analysis, it’s important ‘‘equilibrium price’’ reflects ‘‘allocative individual consumers choose how much to make the distinction between changes efficiency’’ on the demand side and of each good to buy . . . choos[ing] in the quantity demanded, which ‘‘productive efficiency’’ on the supply goods to maximize the satisfaction they involve movements along a demand side.’’); Nicholson & Snyder, supra at can achieve, given the limited budget curve, and shifts of the demand 469–72 (‘‘[P]erfectly competitive available to them.’’ . . . [C]onsumers’ curve.’’). markets lead to efficiency in the demand curves for a commodity can be It is also important—especially in this relationship between production derived from information about their proceeding—to distinguish markets [supply] and preferences 226 tastes . . . and from their budget vertically. There are two markets [demand]. . . .’’) 222 This snapshot of a perfectly constraints.’’). The market demand implicated in this proceeding. There is competitive market for an ordinary curve for an ordinary private good is the the upstream market for the sale and private good is described in the typical horizontal sum of all quantities purchase of inputs, here, licenses for the demanded at each price reflected in the ‘‘Economics 101’’ course. However, collected copies (entire repertoires) of because (as noted supra) the marginal demand curves of all potential buyers. musical works embodied in the Byun, supra, at 27; Pindyck & Rubinfeld, physical cost of supplying an additional streamed sound recordings. There is supra, at 141.223 copy of a song/sound recording is Importantly for the present also the downstream market for the sale essentially zero, at least one key proceeding, changes along the demand and purchase of the final product, condition for efficient per-unit pricing curve (i.e., changes in quantity comprised of both (1) the right to listen does not exist. A price above zero would demanded in response to changes in to a given sound recording/musical not reflect allocative efficiency, because price) must be distinguished from work; and (2) an ‘‘option’’ value,’’ i.e., price must equal marginal cost to create changes in demand, i.e., shifts of the a right to access a large repertoire of such efficiency. However, at a price of entire demand curve representing a sound recordings/musical works. The zero—that is, equal to marginal cost—no different quantity demanded at each dynamics of these two markets are supplier would have an economic price. A movement ‘‘down the demand different, yet they are economically incentive to incur the cost of producing curve’’ would reflect an increase in new intertwined. They are economically the original version of the musical work. different in certain obvious ways, in that As one scholar has summarized: 221 Thus, it is important to keep in mind that the upstream market consists of There is a conflict between the competing WTP incorporates ‘‘Ability To Pay,’’ when licensors and licensees whereas the goals of ensuring access to intellectual evaluating the distinctions among the interactive downstream market is comprised of streaming services’ various tier offerings and the 224 issue of price discrimination. See C. Sunstein, streaming services and listeners Importantly, this economic interdependency Willingness to Pay vs. Welfare, 1 Harv. L. & Pol. (subscribers or users) with the markets exists as a matter of law as well as economics in Rev. 303, 310 (2007) (noting the ‘‘need to make a this proceeding. Section 801(b)(1)(A) explicitly exhibiting different degrees of (inter makes the link between the upstream and distinction . . . between WTP and ability to pay downstream markets relevant to the setting of .... When . . . people show a low WTP, it may alia) competition, market power, upstream rates in this proceeding, by instructing the be because their ability to pay is low [b]ut their low homogeneity and preferences among the Judges to set upstream rates that ‘‘maximize the WTP does not demonstrate that they would gain participants in each market. However, availability of creative works to the public,’’ i.e., to little in terms of welfare from receiving the relevant they are interdependent as well, because the downstream listeners. good.’’) (emphasis in original). 225 If the market is imperfect, i.e., if the seller has 222 When discussing consumer demand, the upstream demand of the interactive streaming services for musical works some market power, then the positive price will economists often leave implicit the distinction exceed marginal cost. between the budget constraint, which reveals an (and the sound recordings in which they 226 There are other particular requirements that ability (or inability) to pay, and the WTP, by are embodied)—known as ‘‘factors’’ of must be satisfied for a market to be perfectly combining both in the WTP phrase. In this Dissent, production or ‘‘inputs’’—is derived from competitive such that the resulting price reflects I shall use the WTP phrase in its combined form, these fair market efficiencies. See Mansfield & unless distinction is of some importance in this the downstream demand of listeners to Yohe, supra at 290–91 (Perfect competition proceeding. and users of the interactive streaming requires: (1) Homogeneous products across sellers; 223 These two aspects of demand are reflected in services. This interdependency causes (2) no seller or buyer is so large as to affect the the present proceeding by the services’ attempts to product price (i.e., all participants are price-takers design a ‘‘range of products’’ with different ‘‘price upstream demand to be characterized as rather than price-makers; (3) all resources are points’’ (reflecting consumers’ varying budget ‘‘derived demand.’’ See Krugman & completely mobile across markets, i.e., they can constraint/WTP) and ‘‘features to accommodate Wells, supra, at 511 (‘‘[D]emand in a freely enter or exit the market); and (4) all market preferences’’ (reflecting differences in utility). See, factor market is . . . derived demand participants (consumers, producers and input e.g., Phillips WDT 16 (describing Pandora’s design suppliers) have ‘‘perfect knowledge’’ of all relevant of its new interactive streaming offerings). . . . [t]hat is, demand for the factor is information.

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property at a price equal to marginal cost and are understood not to be ‘‘private’’ (downstream) delivery), through the providing incentives for the production of goods as in the simple model sketched major record companies (and a information. Finding the balance between supra, but rather are ‘‘quasi- public constellation of smaller publishers). access and incentives arising from the free goods.’’ A ‘‘public good’’ has two These collective activities are highly access and exclusive rights norms is concentrated among only a few such characterized as the static/dynamic dilemma characteristics. First, it has a zero or the short-run/long-run dilemma. marginal production cost (formally, they publishers. As noted supra, the four are ‘‘non-rivalrous in consumption,’’ largest publishers—Sony/ATV D. Barnes, The Incentive/Access because consumption of one unit does ([REDACTED] percent), Warner/ Tradeoff, 9 Nw. J. Tech. & Intell. Prop. not prevent another unit from being Chappell ([REDACTED] percent), 96, 96 (2010). consumed). Second, the provider of the Universal Music Publishing Group The distinction between normal public good cannot prevent (UMPG) ([REDACTED] percent), and private goods and intellectual property consumption of the good by non-payers Kobalt Music Publishing ([REDACTED] applies specifically in the markets for (formally, ‘‘non-excludability’’). See percent)—collectively accounted for just musical works and sound recordings. As Nicholson & Snyder, supra, at 679. A over 73 percent of the top 100 radio a Canadian scholar recently explained: ‘‘quasi-public good’’ (sometimes called songs tracked by Billboard 229 as of the For normal goods and services, the optimal an ‘‘impure public good’’ or a ‘‘mixed second quarter in 2016. Katz WDT ¶ 46. level of consumption is generally considered good’’) possesses only one of these two The collective nature of the principal to be the level achieved when the price of the public goods characteristics. See, e.g., G. music publishers is further made clear good is equal to its marginal production from the testimony of their witnesses in cost.... This level corresponds to what Dosi & J. Stiglitz, The Role of economists call a first-best optimum, which Intellectual Property Rights in the this proceeding. See Witness Statement requires that fixed costs be covered one way Development Process, with Some of Peter Brodsky ¶ 5 (Brodsky WDT) or another. A competitive market is generally Lessons from Developed Countries: An (Sony/ATV Music Publishing owns and the preferred mechanism for defining and Introduction at 6, Inst. of Economics, administers ‘‘the largest catalog of achieving an optimal level of production and Laboratory of Economics and musical compositions in the world, with consumption for normal goods. Management, Working Paper 2013/23 over [REDACTED] songs written by With information goods or assets, the (Nov. 2013) (defining a quasi-public [REDACTED] of songwriters’’); Witness problem is somewhat more difficult since the good as one where either ‘‘it is . . . hard Statement of David Kokakis ¶ 10 same unit . . . think of a musical work or (Kokakis WDT) (UMPG owns and sound recording . . . can be listened to and to exclude others’’ or, ‘‘even if it were enjoyed many times by many different users possible, it is inefficient to do so.’’). In administers [REDACTED] or consumers now and in the future as the market at issue in this proceeding, compositions); Witness Statement of consumption does not destroy or alter the one person’s accessing of a streamed Gregg Barron ¶ 5 (BMG owns and unit in question. copy of sound recording (and the administers [REDACTED] M. Boyer, The Competitive Market musical work embodied within it) on an compositions); Witness Statement of Value of Copyright in Music: A Digital interactive streaming service is not in Annette Yocum ¶ 8 (Warner/Chappell Gordian Knot, Toulouse School of rivalry with another person’s listening owns and administers [REDACTED] 230 Economics Working Paper at 18 (Sept. to a copy of the same sound recording/ compositions). The mechanical license thus is in the 2017) (emphasis added).227 song (i.e., one person’s listening does Economists have analyzed and not cause a marginal increase in nature of a blanket license modeled this conundrum, utilizing physical cost to the licensors),228 but the (notwithstanding that the interactive approaches beyond those in a basic licensors can exclude any person from streaming service must first serve a ‘‘Economics 101’’ classroom. See P. listening who does not subscribe to or Notice of Intention (NOI) on the Samuelson, Aspects of Public register with the interactive streaming copyright owner in order to utilize the Expenditure Theories, 40 The Rev. of service. When piracy is uncontrolled, statutory mechanical license in Econ. & Statistics, 332, 336 (1958) copies of sound recordings (and the connection with each individual song). (when attempting to price additional musical works embodied therein) 17 U.S.C. 115(b); 37 CFR 201.18). Much copies of public goods with marginal resemble pure public goods. When of the economic value of a collection of costs approximating zero ‘‘the easy piracy is reduced, these reproductions millions of copyrights within one formulas of classical economics no are more in the nature of quasi-public publishing umbrella lies in the longer light our way.’’). goods, because they are still not economizing on transaction costs— Copies of intellectual property goods, rivalrous in consumption. allowing large entities to administer the including especially electronic copies, An additional complexity: The copyrights. See generally S. Besen, S. products supplied in the market Kirby and S. Salop, An Economic 227 This point highlights a particular distinction (upstream and downstream) in this Analysis of Copyright Collectives, 78 between private goods and products with public proceeding are not simply individual Va.L.Rev. 383 (1992); R. Watt, Copyright good characteristics (discussed infra), upending the copies of discrete musical works. Collectives: Some Basic Economic ‘‘economic efficiency’’ principles of for private Theory, reprinted in R. Watt (ed.), goods markets taught in an ‘‘Economics 101’’ class. Rather, the product is the collection of See C. Yoo, Copyright and Public Good Economics: repertoires of musical works, A Misunderstood Relation,’’ 155 U. Pa .L. Rev. 635, collectivized (through ownership, 229 This Billboard measure tracks songs played on 638 (2007) (There is ‘‘an interesting inversion of the administration and distribution) by the AM–FM terrestrial radio broadcasters, which are conditions for the efficient allocation of private not required to license the works or the sound goods. For private goods, consumers pay the same music publishers and, in final recordings they play. price and signal the different valuations that they 230 The sound recording market is also highly place on the good by purchasing different 228 This non-rival aspect of streamed music is not concentrated. See Marx WDT ¶ 149 (‘‘The three quantities. For pure public goods, consumers only a theoretical underpinning of the interactive major labels, Sony Music Entertainment, Inc., consume the same quantity of production and markets, but also is the crucial basis for the Warner Music Group, and Universal Music Group signal the intensity of preferences by their services’ plans (discussed infra) to achieve ‘‘scale’’ (‘UMG’), account for roughly 65% of US recording willingness to pay different prices.’’). This principle and, ultimately, profitability, as discussed infra. See industry revenue.’’). Also, the performance rights is particularly applicable in response to the generally J. Haskel & S. Westlake, Capitalism collectives are highly concentrated, with ASCAP argument that economic efficiency is fostered by without Capital at 66 (2017) (‘‘From an economic and BMI representing over 90% of the songs per-unit pricing in the market at issue in this point of view, scalability derives from . . . what available for licensing in the United States. See proceeding. economists call ‘non-rivalry.’ ’’). Register’s Report at 20.

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Handbook on the Economics of collective sets the royalty rate to be paid One analytical approach to the issues Copyright at 168–170 (2014).231 by a distribution channel to provide raised by the economics of copyrights However, along with the efficiencies such downstream access, in order to involves the application of concepts of collective ownership comes the maximize profits, it must: (1) Consider from the sub-field of ‘‘welfare market power of the collective. As has potential royalty revenue from the economics.’’ As one of Copyright been noted: various distribution channels; (2) Owners’ economist-experts noted, the In so much as copyright law establishes a determine whether these distribution pricing issue raised in this proceeding . . . monopoly of each copyright holder in channels/licensees serve overlapping invokes principles from the branch of his or her own item of intellectual property, downstream listeners; (3) minimize this sub-discipline. 3/27/17 Tr. 3032 copyright collectives imply an even larger opportunity costs by attempting to (Watt) (defining ‘‘welfare economics’’ monopoly situation for entire specific types equalize (on the margin) royalty revenue informally as ‘‘what economists use of intellectual property in general. Exactly paid by such overlapping licensees; (4) when we talk about efficiency and we how this monopoly power affects social refuse licenses to distributor categories talk about producer/consumer surplus welfare is a natural point of discussion.... that would ‘‘cannibalize’’ higher royalty and things like that.’’) 234; see also [T]here are social costs involved when a revenues from other distribution Pindyck & Rubinfeld, supra, at 590 natural monopoly 232 is run by only one firm, since that firm will not sell its output at the channels; and (5) identify the (defining ‘‘welfare economics as the socially optimal price, but rather at the pure distribution channels that provide ‘‘normative evaluation of markets and profit maximizing price. It is for this reason access to listeners who would not economic policy.’’). A core principle of that most natural monopolies are subject to otherwise pay for a higher-priced welfare economics, and thus of heavy regulation.... The administration distribution channel because of their economics writ large, is the ‘‘theory of and marketing of intellectual property has low WTP (i.e., distribution channels and the second best.’’ 235 Simply stated—and many aspects of a natural monopoly.... listeners that do not cause in a manner applicable here—the theory The fact that unregulated copyright ‘‘substitution’’ or ‘‘cannibalization’’). provides: ‘‘When it is not possible to collectives do not achieve a social optimum For the category of services that fall in obtain the most desirable economic establishes strong theoretical foundations for number (5) above, licensors would outcome in a situation—marginal cost arguing that such collectives should be negotiate a royalty without regard to regulated. pricing in this case—society has to opportunity cost (i.e., without fear of compromise and accept the next most R. Watt, Copyright and Economic ‘‘substitution’’ or ‘‘cannibalization’’), desirable outcome.’’ A. Schotter, Theory: Friends or Foes at 163, 190 because no such opportunity costs Microeconomics: A Modern Approach at (2000); see also C. Handke, The would be present. Compare Expert 427–428 (2009) (emphasis added).236 It Economics of Collective Copyright Report of Joshua Gans on Behalf of is accurate to state that the Judges’ Management at 9, reprinted in Watt, Copyright Owners ¶ 50 (Gans WDT) practical task in this case is to Handbook of the Economics of (‘‘The opportunity cost of licensing determine a rate structure and rates that Copyright, supra (entities controlling a musical works to a given interactive are economically ‘‘second best’’ in this collection of copyrights are natural streaming service depends on the economic context and satisfy the legal monopolies). royalty income lost as a result of doing requirements of section 801(b)(1). Thus, the ‘‘product’’ that is licensed so. There are numerous potential Because the theory of the second best to interactive streaming services can be sources of that lost royalty income, by its very nature does not provide for modeled not merely as the individual including lost revenue from another a single ‘‘first best’’ outcome, it provides musical work or sound recording, but interactive streaming service (that may ammunition for all economic experts in also as access to copies of a large pay higher rates), as well as lost this proceeding to use to take pot shots repertoire of songs. Such access can be physical sales, downloads and radio/ at the models and proposals put forth by offered through various delivery webcasting revenue.’’) with Hubbard their adversaries. If no alternative is channels, such as interactive streaming, WRT ¶ 4.3 (‘‘a songwriter’s opportunity ‘‘first best,’’ then each suffers from some noninteractive streaming and satellite cost of licensing to a service that is both imperfection or market distortion radio. market expanding and that does not compared with the unattainable ‘‘first At this point of analysis, therefore, the ‘‘cannibalize’’ users from other services best’’ outcome in a perfectly competitive concept of ‘‘opportunity cost’’ is of is relatively low.’’). market. But because the ‘‘first best’ particular importance.233 When a Thus, the simple ‘‘Economics 101’’ solution is unattainable, levying such model—which suggests a simple single criticisms is akin to shooting fish in a 231 The economic concept of a collective per-unit price—is not applicable. (‘‘We barrel. organization is broader than the more common and The salient criticisms, and the narrow conception of ‘‘collection societies’’ as are not in Kansas anymore,’’ or, to limited to PROs. See A. Katz, Copyright Collectives: repeat Professor Samuelson’s elegant difficult task for this tribunal, involve Good Solution, But for Which Problem, at 2, n.7, phraseology, ‘‘the easy formulas of reprinted in R. Dreyfuss & D. Zimmerman (eds.) classical economics no longer light our 234 It should be noted that Professor Watt Working Within the Boundaries of Intellectual decidedly rejects the applicability of welfare Property Law (2010) (‘‘The term ‘copyright way.’’). Accordingly, to analyze the economics as a tool with regard to Factor A of collectives’ encompasses various types of parties’ proposed rate structures, the section 801(b)(1)—unless ‘‘availability’’ were to be organizations, with different mandates, structures, Judges must consider economic models equated with ‘‘use’’ of copyrighted musical works. forms of governance and regulatory oversight.’’). informed by the economic principles See id. at 3033. 232 When large publishing houses or major record that reflect these market realities. 235 The ‘‘Theory of the Second Best’’ was labels control large swaths of the market, and their originally developed more than sixty years ago. See products are ‘‘must haves,’’ they are Fortunately, the Judges hardly are R. G. Lipsey and K. Lancaster, The General Theory ‘‘complementary oligopolists’’ rather than operating in a vacuum, either in a of Second Best, 24 Rev. Econ. Stud. 11 (1956–1957). monopolists, a difference that leads to supranormal theoretical or practical sense, given the 236 As Professor Marx notes, the first theorem of pricing and greater inefficiencies than arise from testimony provided by the economic welfare economics provides ‘‘that the allocation of monopoly. See Web IV, 81 FR 26316, 26348 (May resources is efficient in a general equilibrium with 2, 2016). witnesses in this proceeding. perfect competition, and in a perfectly competitive 233 To repeat, the ‘‘opportunity cost’’ of using an market, price equals firms’ marginal cost. Marx input is the foregone value of the most highly- ‘‘opportunity cost’’ as the ‘‘[c]ost associated with WDT ¶ 116 n.129 (citing B. Douglas Bernheim and valued alternative use of that input. See generally opportunities that are foregone when a firm’s Michael D. Whinston, Microeconomics 561–62, Pindyck & Rubinfeld, supra, at 689 (defining resources are not put to their best alternative use.’’). 601–02).

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weighing various ‘‘second best’’ The Judges have utilized a price generally 1 A. Kahn, The Economics of alternatives, as presented through—and discriminatory approach previously to Regulation 198 (1970) (‘‘The decision limited by—the record, to identify the reflect a segmented marketplace. In Web about what kinds of modifications rate structure that better satisfies the IV, the Judges set three different per second-best considerations recommend statutory criteria, as construed by the play royalty rates for sound recording can be made only by looking at the facts D.C. Circuit and prior applicable licenses for noninteractive services in each individual case. No set of determinations and decisions by the pursuant to section 114; one rate for ad- economic principles can substitute for Judges, their predecessors, the Librarian supported services; a higher rate for the use of judgment in their and the Register. See 17 U.S.C. subscription services; and a lower rate application.’’). In the present context, 803(a)(1). for educational broadcasters. See Web that judgment is informed through the At the theoretical extremes are two IV, supra, 81 FR at 26346, 26405, adjudicatory process that places the unacceptable approaches to rate-setting: Likewise, in the rate court, the royalty economic experts of the licensors and (1) setting price equal to the marginal rate paid to songwriters for licensees in an adversarial proceeding, physical cost of copying, which is zero; performances on noninteractive services revealing the strengths and weaknesses and (2) setting price on a per unit basis is lower than the rate paid for of their approaches, through direct and that exceeds marginal physical cost. In performances on interactive services. rebuttal written testimony, direct and the chasm between these two See In re Pandora Media, 6 F.Supp.2d cross-examination, and inquiries from inadequate approaches exist many 317, 360 (S.D.N.Y. 2014), aff’d sub nom the Judges.238 alternative rate structures with varying Pandora Media, Inc. v. ASCAP, 785 F.3d I consider these various approaches in rates for various segments of the market. 73 (2d Cir. 2015) (setting noninteractive the context of the foregoing economic In general terms, these alternative rate- performance royalties paid by principles. setting structures are forms of ‘‘price noninteractive services below the rate discrimination,’’ which, in the broadest by interactive services, and noting that G. The Parties’ Proposals sense, means simply a departure from a ‘‘[i]f there was one principle regarding 1. The Services (i.e., excluding Apple) single, per-unit price. See, e.g., H. rate structure on which the parties The Services propose respective rates Varian, Intermediate Microeconomics: A agreed at trial it was that the rate for and rate structures that—while varying Modern Approach 462 (2010) (defining customized radio should be set below in their particulars—share a number of ‘‘price discrimination’’ as’’[s]elling the rate for on-demand interactive common elements. Broadly, the Services different units of output at different services.’’). propose a rate structure that in the main prices’’). For example, rates based on a Perfect price discrimination (i.e., continues the current rate structure. percent-of-revenue (even without any ‘‘first-degree’’ price discrimination) is More particularly, the Services’ alternative rate prongs) are themselves a essentially not possible. (For example, a proposals share the following core blunt form of price discrimination. J. senior discount may be afforded to a elements: Cirace, CBS v. ASCAP: An Economic millionaire who has a WTP, based in Analysis of a Political Problem, 47 Ford. part on income, far above the price (1) the rate should continue be set as an Rev. 277, 288 (1978) (‘‘A license fee imputed in his or her senior discount.) ‘‘All-In’’ rate for musical works licenses, i.e., a mechanical rate that permits all services to based upon a percentage of gross See generally Nicholson & Snyder, deduct royalties paid to the same rights revenue is discriminatory in that it supra, at 505 (‘‘First-degree price holders and their agents for performing grants the same number of rights to discrimination poses a considerable rights; different licensees for different total information burden for the monopoly— (2) the rate should continue to be dollar amounts, depending upon their it must know the demand function for structured as a percentage of revenue, subject ability to pay [and] [t]he effectiveness of each potential buyer.’’). However, the to certain minima; and price discrimination is significantly existence of any imperfection, whether (3) the ‘‘All-In’’ headline rates should enhanced by the all-or-nothing blanket in a price discriminatory royalty or any continue, with the subpart B headline rate maintained at 10.5% of revenue. license.’’); W.R. Johnson, Creative royalty, is not indicative of the Pricing in Markets for Intellectual unacceptability of the price structure as However, the Services propose that the Property, 2 Rev. Econ. Rsch. Copyrt. an appropriate benchmark or statutory ‘‘Mechanical Floor’’ in the existing rate Issues 39, 40–41 (2005) (identifying rate structure. Rather, such structure be discontinued. revenue sharing licenses as a form of imperfections must be weighed against The principle additional and differing price discrimination).237 the imperfections in any other proffered particulars of the rate structures pricing structure. Thus, when a proposed by each Service are set forth 237 Even in the case of an ordinary private good regulator is tasked with rate-setting, the below. with increasing marginal costs, sellers will prefer to process inescapably requires the use of a. Amazon price discriminate, increasing the ‘‘producer informed judgment in order to consider surplus’’ and shrinking the ‘‘consumer surplus,’’ if In its May 11, 2017 ‘‘Proposed Rates they can identify the WTP of different segments of the competing benefits and costs of any the demand curve and can avoid after-market proposed rate structures and levels. See and Terms’’ (Amazon Proposal), arbitrage (i.e., avoiding low WTP buyers re-selling Amazon proposes that the rate structure to higher WTP buyers and thus depriving sellers of find it rational to attempt to use price as currently set forth in the applicable the benefits of price discrimination). See Nicholson discrimination whenever it becomes apparent that regulations should rollover into the & Snyder, supra, at 503 (‘‘whether a price marginal sales at lower prices to low WTP buyers 2018–2022 rate period, except as discrimination strategy is feasible depends crucially will at least cover some fixed costs. See W. Baumol, on the inability of buyers of the good to practice Regulation Misread by Misread Theory: Perfect otherwise proposed by Amazon. arbitrage.’’). Further, sellers of cultural goods Competition and Competition-Imposed Price Amazon Proposal at 1. In that regard, generally use price discrimination when they have Discrimination at 6 (2005) (‘‘[U]nder competitive the following elements comprise the excess supply and temporally-limited demand. See conditions the firm will normally be forced to adopt core structure of Amazon’s proposed W. Baumol, Applied Welfare Economics, in R. discriminatory pricing wherever . . . feasible.... Towse, A Handbook of Cultural Economics at 26 [U]niform pricing is not to be taken as the normal (1st ed. 2003) (noting that for theatres ‘‘[s]olvency characteristic of equilibrium of the competitive 238 Thus, in contrast with the Majority Opinion, generally requires price discrimination,’’ thereby firm.’’). Thus, the ‘‘general’’ per-unit pricing this Dissent does not attempt to arbitrarily select avoiding the economic loss arising from ‘‘half- presented in Economics 101 may not be quite so disparate elements from the record to create, post- empty theatres’’). Moreover, even sellers of all sorts ubiquitous, placing any per-unit pricing proposal in hearing, a rate structure that was not subject to this of goods, and even in a competitive market, will this proceeding on even more tenuous grounds. adversarial process.

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rate structure that would constitute bundle in accordance with GAAP for • For all licensed activity, the changes in the current regulations: the provision of music bundles under ‘‘mechanical-only’’ royalty floor should be removed, i.e., removed from • subpart C, where the record company is The per subscriber minimum and/or §§ 385.12(b)(3)(ii) and 385.13(a)(1) & (3) for: subscriber-based royalty floors for a ‘‘family the licensee. Google Amended Proposal (a) standalone non-portable subscription- account’’ should equal 150% of the per at 33–34. Additionally, Google proposed streaming only; and (b) standalone portable subscriber minimum and/or subscriber-based a new royalty of 15% ‘‘of the applicable subscriptions service. royalty floor for an individual account. consideration expensed by the service, • A broadening of the present ‘‘not to • A student subscription account discount if any . . . incremental to the applicable exceed 15%’’ reduction of ‘‘Service of 50% should be included in the regulations consideration expensed for the right to Revenues’’ in § 385.11 to reflect, in toto, an to the per subscriber minimum and exclusion of the actual costs attributable to subscriber-based royalty floor that would make the relevant permanent digital downloads and ringtones.’’ Id. at 34.243 ‘‘obtaining’’ revenue, ‘‘including [but not otherwise apply under the current expressly limited to] credit card regulations. However, Google is in favor of the commissions, app store commissions similar • A discount for annual subscriptions general elements of the Services’ payment process charges, and actual carrier equal to 16.67% of the minimum royalty rate proposal, set forth supra, if the Judges billing cost.’’ (or rates) and subscriber-based royalty floor were to: (a) reject its amended proposal (or floors) that would otherwise apply under 2. Apple in toto, see Google’s Proposed Findings § 385.13. Apple proposed that the Services pay • A 15% discount to the minimum royalty of Fact and Conclusions of Law ¶8 rate (or rates) and subscriber-based royalty (Google PFF); or (b) adopt Google’s or $0.00091 for each non-fraudulent floor (or floors) to reflect a service’s actual amended proposal but incorporate a stream of a copyrighted musical work ‘‘app store’’ and carrier billing costs, not to TCC rate greater than the 15% proposed lasting 30 seconds or more. Apple Inc. exceed 15% for each. by Google. See id. ¶ 47. Proposed Rates and Terms (as amended) Amazon Proposal at 1–2. at 3–4. Apple proposed defining a use c. Pandora as any play of a sound recording or a b. Google In its May 11, 2017 ‘‘Proposed Rates copyrighted work lasting 30 seconds or As noted supra, in its May 11, 2017 and Terms (As Amended)’’ (Pandora more. Additionally, Apple proposed an ‘‘Amended Proposed Rates and Terms’’ Amended Proposal),244 Pandora seeks exemption for a ‘‘fraudulent stream,’’ (Google Amended Proposal),239 Google the following changes from the current which it proposes be defined as ‘‘a proposes a rate structure that combines regulations: stream that a service reasonably and in certain elements, eliminates other good-faith determines to be fraudulent.’’ • Elimination of the alternative elements and uses specific rates, Id. at 2. computation of subminimums I and II now For paid locker services, Apple together in a combination that was not in § 385.13 and in § 385.23 (for subparts B presented at the hearing.240 and C respectively) ‘‘in cases in which the proposes a $0.17 per subscriber fee, also Specifically, the Google Amended record company is the Section 115 licensee.’’ as a component of an ‘‘All-In’’ musical Proposal set forth a rate structure that • A broadening of the present ‘‘not to works royalty rate that would include ‘‘eliminat[es] . . . different service exceed 15%’’ reduction of ‘‘Service the ‘‘Subpart C’’ royalty, the mechanical categories’’ and replaces them with ‘‘a Revenues’’ in § 385.11 to reflect, in toto, an royalty, and the public performance single, greater-of rate structure between exclusion of costs attributable to ‘‘obtaining’’ royalty. Id. at 7–8. For purchased 10.5% of net service revenue and an revenue, ‘‘including [but not expressly content locker services, Apple proposes limited to] credit card commissions, app a zero royalty fee. Id. at 7. uncapped 15-percent TCC component.’’ store commissions, and similar payment 241 Id. at 1. Similar to one of Amazon’s process charges.’’ 245 3. Copyright Owners proposals, Google also seeks a discount • A discount on minimum royalties for The Copyright Owners proposed that in rates for ‘‘carrier billing costs’’ and student plans ‘‘not to exceed 50%’’ off ‘‘app store commissions,’’ plus ‘‘credit minimum royalty rates set forth in § 385.13. the Judges adopt a unitary greater-of rate card commissions’’ and ‘‘‘similar structure for all interactive streaming Id. at 1, 7. payment process charges,’’ all not to and limited downloads that are d. Spotify currently covered by Subparts B and exceed 15%. Id. at 6 (for subpart B); 26 246 (for subpart C).242 C. Copyright Owners’ Amended Google also proposed a new rate of In its May 11, 2017 ‘‘Second Proposed Rates and Terms, at 3 (May 11, 13% of the record company’s total Amended Proposed Rates and Terms’’ 2017) (Copyright Owners’ Amended wholesale revenue from the music (Spotify’s Second Amended Proposal), Proposal). The proposal was structured Spotify seeks the following changes as the greater of a usage charge and a 239 The Google Amended Proposal amended its from the current regulations: per-user charge. Specifically, each original proposal filed on November 1, 2016. Google month the licensee would pay the originally proposed a subpart B rate structure that 243 Google’s proposed single 10.5% TCC rate does greater of (a) a per-play fee ($0.0015) generally followed the existing structure. Google not include the ‘‘Mechanical-Only Floor’’ that multiplied by the number of interactive Written Direct Statement, Introductory Pandora and Spotify expressly seek to eliminate. Memorandum at 3 (Nov. 1, 2016). The ‘‘Mechanical-Only’’ Floor, found in 37 CFR streams or limited downloads during 247 240 Google’s post-hearing proposal appears to 385.15, ensures that music publishers and the month and (b) a per-end user fee have been an impetus for the majority to invent its songwriters will receive no less than a fixed per- own post-hearing structure of rates, albeit different subscriber amount of between $0.25 and $0.50, 246 The Copyright Owners’ rate proposal would in its particulars even from Google’s post-hearing regardless of the amount that remains after apply the subpart A rates to so-called ‘‘music proposal. deduction of musical works performance royalties bundles’’ (‘‘offerings of two or more Subpart A 241 As noted supra, ‘‘TCC’’ is an industry acronym from the ‘‘All-In’’ rate. products to end users as part of one transaction’’) for ‘‘Total Content Cost.’’ 244 The Pandora Amended Proposal superseded which are currently covered by subpart C. Id. at 3 242 Google describes this proposed change as a its original proposal filed on November 1, 2016, by nn. 2 & 4. change in the definition of ‘‘Service Revenue,’’ adding definitions (for ‘‘fraudulent streams’’ and 247 Copyright Owners’ original proposal defined unlike Amazon, which described its proposed 15% ‘‘play’’) that do not directly relate to the royalty ‘‘end user’’ as any person who ‘‘had access’’ to a discount as a change in rates. The difference is rates. See Pandora Media, Inc.’s Proposed Findings standalone music service. Id. at 8–9. However, mathematically irrelevant, and, for the sake of of Fact and Conclusions of Law Appx. C (Pandora Copyright Owners narrowed their proposed completeness and consistency, these 15% discount PFFCOL). definition of ‘‘end user’’ to include any person who proposals are treated here as proposed changes in 245 Pandora does not expressly describe this (a) pays a fee for access to a standalone music rates. change as a change in rates per se. Continued

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($1.06) multiplied by the number of end because of this complexity, publishers See, e.g., Israelite WDT at 10; ¶¶ 29(B), users during the month. Id. at 8. The and songwriters cannot easily verify the 30, 31(C); Brodsky WDT ¶ 68 At the license fee would be for mechanical accuracy of data the services input hearing, NMPA’s president, Mr. Israelite rights only, and would not be offset by when calculating royalty payments. See explained how he construes the any performance royalties that the Brodsky WDT ¶ 76; Ghose WDT ¶¶ 80, ‘‘inherent value’’ of a musical work: licensee paid for the same activity (i.e., 81, 82; Ramaprasad WDT ¶¶ 4, 38, 42– ‘‘[W]homever owns an individual the existing ‘‘All-In’’ aspect of the rate 44; Rysman WDT ¶ 57; 3/23/17 Tr. 2865 copyright is the one to define it. I think structure would be eliminated). Id. (Ghose); 3/22/17 Tr. 2477–78 (Dorn). that would be the most appropriate Beyond the issue of complexity, definition of it. What someone is willing H. The Structure of the Rates for the Copyright Owners and Apple argue that to license it for would be that inherent Forthcoming Rate Period interactive streaming services do not value to that owner. That would be my 1. Per-Play or Percent of Revenue (with need the present upstream rate structure view.... That would be the market Minima) in order to adopt any particular value.’’ 3/29/17 Tr. 3707 (Israelite). downstream business model. Rather, a. Copyright Owners’/Apple’s Argument Copyright Owners and Apple assert that b. The Services’ Arguments in for a Per-Unit Rate 248 a per-play structure would establish a Opposition to a Per-Play Rate Structure Copyright Owners and Apple level of equality in the royalty rates The Services make several arguments emphasize that a per play royalty rate across these services, without regard to in opposition to the use of a proposed structure, as compared with a percent of business models, and the services could per-play royalty rate. The overarching revenue-based structure, provides price downstream in whatever manner theme of these arguments is that an transparency and simplicity in reporting they choose. But regardless of the inflexible ‘‘one size fits all’’ rate to songwriters and publishers, because downstream pricing structure, structure would be ‘‘bad for services, it requires only one metric besides the songwriters and publishers would be consumers, and the copyright owners rate itself—the number of plays, making paid on the same transparent, fixed alike.’’ Services’ Joint Proposed Findings it much easier to calculate and report, amount—without advantaging any one of Fact and Conclusions of Law at p. 89 and for songwriter/licensors to business model over another. See, e.g., (SJPFF). understand. See, e.g., Rysman WDT 3/23/17 Tr. 2849, 2863 (Ghose) First, they argue that an upstream per- ¶ 56; Wheeler WDT ¶ 19; Expert Report Thus, Copyright Owners and Apple play rate would not align with the of Anindya Ghose November 1, 2016 maintain that a royalty based on the downstream demand for ‘‘all-you-can- ¶¶ 83–84 (Ghose WDT); Ramaprasad number of plays aligns the eat’’ streaming services. As Professor WDT ¶ 41; Brodsky WDT ¶ 76; 3/22/17 compensation paid to the creators of the Marx testified, a per stream fee Tr. 2476–78 (Dorn); 3/22/17 Tr. 2855–56 content with the actual demand for and introduces a number of distortions and (Ghose). Relatedly, Copyright Owners consumption of their content. Ghose inefficiencies, encouraging a capping of argue that a transparent metric tied to WDT ¶ 84; Rysman WDT ¶¶ 9, 58; downstream plays and reduces actual usage is superior because, under Testimony of David Dorn ¶ 33 (Dorn incentives for services to meet the the alternative percent-of-revenue WDT). demand of consumers ‘‘who are going to approach, services can manipulate Copyright Owners further argue that stream a lot of music.’’ Marx WDT revenue through bundling, discounting, the present rate structure’s failure to ¶¶ 130–131. In this vein, Pandora’s then and accounting techniques. Licensors measure royalties based on per play president, Michael Herring, noted that a also note that licensees’ might defer consumption is counterintuitive, per-play consumption-based model service revenues and emphasize because it permits a decreasing effective where the revenue is fixed per user increasing market share rather than per play rate even as the quantity of creates uncertainty and volatility profits. Rysman WDT ¶¶ 43–45. songs that listeners ‘‘consume’’ via around prospective margins, and the Copyright Owners and Apple contrast interactive streaming is increasing. uncertainty discourages investment and their proposed per play approaches with Israelite WDT ¶ 39. Copyright Owners hampers profitability. 3/14/17 Tr. 894– the current rate structure, which they note, for example, that listening to 95 (Herring). Mr. Herring notes that this characterize as cumbersome and [REDACTED] increased from a general economic problem that occurs convoluted. They emphasize that under [REDACTED] streams in July 2014 to when a retail subscription business has the current rate structure, the services [REDACTED] streams in December fixed subscription revenues per must perform a series of different greater 2016, a fifteen-fold increase in the customer but costs that are variable and of and lesser of calculations, depending number of streams. Hubbard WRT, Ex. unpredictable because the downstream on a service’s business model, to 1; id. at WRT ¶ 2.22; 4/13/17 Tr. 5971– quantity of units accessed are determine which prong of the rate 72 (Hubbard). However, themselves variable and unpredictable. structure is operative. Proposed contemporaneously [REDACTED] Written Rebuttal Testimony of Michael Findings of Fact of Copyright Owners mechanical royalty payments to the Herring ¶ 17 (Herring WRT); 3/14/17 Tr. ¶ 16 (COPFF) (and record citation Copyright Owners only increased 894–98 (Herring). See also Mirchandani therein). Copyright Owners assert that [REDACTED]. (Hubbard WRT ¶ 3.9; 4/ WDT ¶ 39 (one-size-fits-all rate is not 13/17 Tr. 5971–73 (Hubbard). The ‘‘offering agnostic’’ as Copyright Owners service offering licensed activity during the relevant upshot, Copyright Owners assert, is that, claim, but rather is ‘‘offering accounting period, or (b) makes at least one play of as streaming consumption increased determinative.’’) licensed activity during the relevant accounting dramatically from 2014 to 2016, the Second, the Services argue that there period. This would apparently have the effect of, for effective per stream mechanical is no ‘‘revealed preference’’ in the example, excluding as an ‘‘end user’’ any Amazon Prime member or listener to Spotify’s ad-supported royalties paid by [REDACTED] to marketplace for musical works and service who did not listen to any song in the Copyright Owners decreased from sound recordings for a per-play royalty, accounting period. Copyright Owners’ Amended [REDACTED]to [REDACTED]. 4/13/17 as opposed to a percent of revenue Proposal at 8. Tr. 5972–73 (Hubbard). royalty (with minima). In particular, 248 Copyright Owners’ per-unit proposal contains two prongs in a greater-of structure. The first is a Finally, Copyright Owners assert that they point out that mechanical royalties per-play prong, and the second is a per-user prong. a per-unit rate is appropriate because a have never been set on a per play basis. The greater-of proposal is considered infra. musical work has an ‘‘inherent value.’’ See Herring WRT ¶ 19. The Services

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also point to the direct licenses 2. An Issue within the Per-Unit Importantly, Apple argues from the interactive services regularly enter into Approach: Copyright Owners’ record evidence that Professor Ghose’s with music publishers, PROs and record ‘‘Greater-Of’’ Rate Proposal example is representative, because companies—[REDACTED]. SJPFF services monthly streams have ¶¶ 174–75 (and record citations Copyright Owners propose a ‘‘greater historically been less than 707. More therein). They acknowledge that some of of’’ per-unit structure, whereby the granularly, relying on data in Dr. royalty would equal the greater of the agreements with record companies Leonard’s written rebuttal testimony, $.0015 per play and $1.06 per-end user contain alternative per-user prongs, Apple contends that the annual per month. In support of this approach, id.¶ 175, but they note that this is weighted average number of streams Copyright Owners assert that it consistent with the existing rate per-month per-user across current establishes a value for each copy that is Subpart B and Subpart C services has structure which already contains a per independent of the services’ business always been below [REDACTED] in each subscriber minima, but not a per play models and pricing strategies. Rysman year from 2012 to 2016. See Leonard prong. Further, the Services note that WDT ¶ 89. They argue that the greater WRT Ex. 3b. More particularly, the [REDACTED]. See 3/23/17 Tr. 2857 of structure is not any more complicated number of monthly per user streams for (Ghose); see also 3/22/17 Tr. 2479 than a per play rate alone—and much each of those five years was (Dorn) (Apple paying [REDACTED] rate less complicated than the 2012 rate [REDACTED] (in 2012), [REDACTED] under direct licenses with publishers). structure—because adding a per-user (in 2013), [REDACTED] (in 2014), Third, the Services discount the royalty rate to the structure requires [REDACTED] (in 2015) and argument that Copyright Owners’ only one additional metric for royalty [REDACTED] (in 2016). Id. proposed rate structure is superior to calculation—the number of users. Additionally, the average number of the present rate structure because the Brodsky WDT ¶ 76. Copyright Owners streams per-month per-user has latter is too complicated or also assert that their greater-of structure exceeded 707 (which would trigger the cumbersome. They characterize this is a usage-based approach, aligned with per play prong) [REDACTED] according criticism as ‘‘overblown,’’ and further the value of the licensed copies because to the service-by-service data. Id. (Deezer averaged [REDACTED] streams take note that the detailed nature of the each rate tier is tied to a ‘‘particular in 2014 and Tidal averaged structure is designed to ameliorate any use,’’ as it couples rates with usage and [REDACTED] streams in 2016. Id.) problems associated with the use or consumption. CORPFF–JS at p. 22. Finally, Copyright Owners note that in Apple argues that this historical data calculation of a revenue-based headline music licensing agreements it is not indicates that the services would rate, by the inclusion of per subscriber uncommon to find royalty rates set in a consistently pay more than the $0.0015 and TCC minima. SJPFF ¶ 174. They greater of formula that includes a per per play rate. See Apple Inc.’s Findings further note that section 801(b)(1) does user and a per play prong (as well a of Fact and Conclusions of Law ¶ F284 not list as a criteria or objective that the percent-of-revenue prong). See (Apple PFF).249 rates must be simple or easy for CORPFF–JS at p. 97 (and record According to Apple, even Copyright songwriters to understand, or otherwise citations therein). Owners’ own expert, using different ‘‘transparent.’’ Services’ Joint Reply to data, found that [REDACTED] services The services (i.e., including Apple) Apple Inc.’s Findings of Fact and he reviewed would have been required assert that the greater-of aspect of Conclusions of Law at 34, 36 (SJRPFF– to pay under the per-user prong in Copyright Owners’ rate proposal would A). Thus, they argue, the Judges cannot December 2015, if the Copyright lead to absurd and inequitable results, Owners’ proposal had been in effect. jettison an otherwise appropriate rate well above the rates established under structure because some unquantified Rysman WRT ¶ 87, Table 1. In like Copyright Owners’ per-play rate prong. fashion, Professor Rysman’s data for segment of the songwriting community This point is explained in detail by might be uncertain as to how their December 2014 data indicated that Professor Ghose, one of Apple’s [REDACTED] services would have been royalties were computed. economic expert witnesses. Professor required to pay under the per-user Finally, separate from these Ghose explains that under Copyright prong. Id. at Table 2. arguments against per-play rate Owners’ greater of structure, interactive Professor Ghose expands the proposals, the Services note a vexing streaming services would pay under the hypothetical scenarios in an attempt to problem related to Apple’s specific per-user prong if the average number of proposal: How to convert the typical monthly streams per user was less than 249 This analysis also underscores the inaccuracy 707. 4/12/17 Tr. 5686–5687 (Ghose). of Copyright Owners’ claim that each stream of a percent-of-revenue performance royalty musical work has ‘‘inherent value.’’ See, e.g., into a per play rate in order to subtract Thus, such a service would be required Israelite WDT ¶ 39 (It ‘‘makes no sense’’ if ‘‘[e]ach it from Apple’s proposed per play to pay the $1.06 per user rather than service effectively pays to the publisher and mechanical rate, so as to calculate the $0.0015 per stream. Id. at 5687. As an songwriter a different per-play royalty.’’) But in example, Professor Ghose used a reality, Copyright Owners understand that each ‘‘All-In’’ rate? (This problem is musical work also contributes to a different value— hypothetical scenario in which a service irrelevant to Copyright Owners’ access value (what economists call ‘‘option had one user who listened to 300 value’’)—when the musical works are collectivized proposal, because they propose the streams in a given month. Under and offered through an interactive streaming elimination of the ‘‘All-In’’ provision in Copyright Owners’ $0.0015 per play service, resulting in different effective per play rates the rate structure.) The Services note paid by services if the per user prong is triggered. prong, the service would pay $ 0.0015 To explain this inconsistency, Copyright Owners that Apple Music’s Senior Director, × 300, equal to $.45 in royalties. Under note the existence of a second ‘‘inherent value’’— David Dorn, was unable to explain how its per user prong, the service would the access or option value noted above—not created this calculation would be made. See 3/ by the songwriter in his or her composition—but pay a royalty of $1.06 for the one user, rather created by the publisher to provide a separate 22/17 Tr. 2508–09 (Dorn). Thus, the which is an effective per play rate of value for the user—who inherently values access to Services assert that Apple’s proposal 1.06 ÷ 300, which equals effectively $ a full repertoire. But these two purportedly would introduce ‘‘more complexity, not 0.0035 per play, more than two times ‘‘inherent’’ values are inconsistent (which is why there are two prongs in the proposal) and, given the less.’’ SJRPFF–A at 34. the $0.0015 rate under the stated per heterogeneity of listeners, neither value is play prong. 4/12 Tr. 5687 (Ghose). homogeneous throughout the market.

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demonstrate what he considers to be the of approach, as depicted in his chart, absurdity of Copyright Owners’ greater- reproduced below:

Copyright Owners do not dispute stream is zero, so it is economically are high revenues and a small number of these analyses. Rather, they make two inefficient to marry a per play fee to a plays, and if there are low revenues and a points. First, they claim that the binding per user fee in a greater of approach. Cf. large number of plays. Only if there are low nature of the per user prong is not Leonard 3/15/17 Tr. 1122–23 (Leonard) revenues and a small number of plays does the user benefit. By contrast, either a per-play problematic, because the [REDACTED]. (efficient pricing would utilize an up- or a percentage-of-revenue tariff, with or See Copyright Owners’ Reply to Apple’s front fee and a zero per play fee without a minimum fee, allocates risk Proposed Findings of Fact and thereafter). between [licensors] and the users more Conclusions of Law at 104 (CORPFF–A). None of the parties presented any evenly. economic or policy analysis of such a I find this argument to be a non- Copyright Board of Canada, Statement ‘‘greater-of’’ formula aside from its sequitur, because sound recording rates of Royalties . . . Re:Sound Tariff 8— witnesses’ own testimonies. Further, I in this context certainly have no bearing Non-interactive and Semi-interactive did not identify any such academic or on the present issue, and Copyright Webcasts 2009–2012, Decision of the industry analyses of this ‘‘greater-of’’ Owners also do not indicate which Board at 27–28 (May 16, 2014). prong would otherwise apply in those approach. However, the Copyright I recognize that the 2012 rate structure sound recording licenses. In fact, a Board of Canada has criticized this type also contains a greater-of formula. review of the citations in CORPFF–A at of rate structure in the following Importantly, though, the alternative 104 reveals that [REDACTED]. See manner, which I find persuasive: prong is not a per play prong, avoiding COPFF ¶ ¶ 72, 91–92, 95. [A] ‘‘greater-of’’ tariff [i.e., rate] would not the unfairness identified in the Second, as noted supra, Copyright be fair and equitable, because it would Canadian Judges’ opinion. Also, the Owners attempt to support what appear provide an undue advantage to [licensors] on 2012 greater-of structure was a to be absurd effective per play rates by two counts. To be fair and equitable, a tariff negotiated bargain, indicating a should neither overcompensate nor explaining that the per user rates reflect undercompensate rights owners. If set revealed preference among all potential the value of access to the repertoires, as correctly, neither a per-play rate nor a alternatives. Moreover, the alternative to opposed to the value of an individual percentage-of-revenue rate will tend to do so, the percent-of-revenue prong is itself a stream—again, what economists refer to to the extent that each captures a (different) ‘‘lesser-of’’ formulation, dampening the as an ‘‘option price. See CORPFF–A at measure of usage. On the other hand, a tariff impact of the ‘‘greater-’’of’’ structure. 104–105 (and citations therein). I agree set at the greater of those two rates is hedged Thus, the 2012 rate structure has the that this access or option value is real. in favor of the collective. It may prevent effect of moderating the negative impact However, when such a value is inserted undercompensation if a service has low of a greater of formulation such as into a greater-of rate formula—where the revenues; it does not prevent proposed by Copyright Owners by overcompensation in the case of a high- access value is supplanted by the per revenue service that uses few sound keeping rates, calculated on either play value, and vice versa– the pricing recordings. A greater-of formulation also prong, on bases and at levels the parties resembles a game of ‘‘heads I win, tails burdens users with an unfair share of risks. agreed were acceptable. you lose.’’ Moreover, as noted supra, the [Licensors] benefit[ ] if there are high In sum and as explained supra, many marginal physical cost of an additional revenues and a large number of plays, if there economic trade-offs must be weighed in

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establishing pricing in this second-best what I would tend to do with any agreement, covering the current rate scenario. Some rate structures tend to benchmark. I am using it as a period and serving as a template for balance the several factors and thus are benchmark to avoid having to model current agreements. See Katz WDT ¶¶ 6, reasonable, whereas others may tend to things and build it from the ground 71; 3/13/17 Tr. 608–09 (Katz); Leonard favor one side of the transaction over up.’’) (emphasis added). AWDT ¶ 47 et seq. (noting that ‘‘existing the other and do not meet the standard The Services’ experts opine that, for a agreements’’ regularly track the section of reasonableness. Copyright Owners’ number of reasons, the 2012 rate 115 provisions); 3/15/17 Tr. 1082 greater-of approach represents such a structure is not only a benchmark, but (Leonard). As noted by Amazon’s Head one-sided structure, and accordingly I also that it is a highly appropriate of Content Acquisition, Mr. would reject this structure. benchmark. First, they note that the Mirchandani, the 2012 rate structure has 2012 rate structure embodies been demonstrated to be ‘‘workable,’’ 3. The Services’ Argument for a characteristics that the Judges have even if ‘‘imperfect.’’ Mirchandani WDT Percent-of-Revenue Structure (with consistently identified as part and ¶ 7. Minima) parcel of an appropriate benchmark. The Services’ experts further a. The Services’ General Benchmark That is, the 2012 rate structure applies emphasize that the structure of current Returning to the issue of per-unit to: (a) the same rights; (b) the same uses; rates satisfactorily reflects the economic pricing vs. percent-of-revenue pricing and (c) the same types of market market conditions in which the (with minima), the Services propose a participants. See 3/15/17 Tr. 1082–83 mechanical license for interactive rate structure for Subparts B and C that (Leonard); 3/13/17 Tr. 551, 566–7 streaming is used. See 4/13/17 Tr. 5943 generally follows the structure set forth (Katz). (Hubbard) (acknowledging a ‘‘love’’ of in the existing regulations adopted after Additionally, because the 2012 rate competitive markets, and recognizing the Judges approved the parties’ 2012 structure was the product of a that there are supply and demand settlement.250 The Services emphasize settlement between and among market considerations in this market that that they are not simply advocating that participants, the Services maintain that require the more flexible pricing the basics of the 2012 rate structure it reflects market forces, including an structure generally provided in the current regulations). (I understand should be preserved merely because implicit consensus as to the effects of Professor Hubbard’s reference to the there is a benefit in preserving the status the structure on piracy and potential particularities of ‘‘this market’’ to relate quo. See 3/13/17 Tr. 564 (Katz) (relying substitution across platforms. See 3/13/ to the quasi-public good nature of the on the 2012 structure as an excellent 17 Tr. 580, 722 (Katz). More broadly, copies of musical works/sound benchmark, ‘‘not because it’s the status they argue that because the 2012 rate recordings, as discussed in this Dissent, quo.’’). structure was agreed to by market Rather, the Services, through their participants who had assumedly supra.) The Services’ experts candidly economic experts, put forth the 2012 weighed the costs and benefits of their acknowledge that the rate structure they rate structure (sans Mechanical Floor) agreement, it therefore demonstrates the advocate is not necessarily the ‘‘best’’ as an appropriate benchmark—for the ‘‘revealed preferences’’ of these approach to pricing in this market. See Judges to weigh, consider, adjust (if economic actors. See 3/15/17 Tr. 1095 (Leonard); see also Leonard AWDT ¶ 74 4/7/17 Tr. 5574–6 (Marx); see also appropriate) and apply or reject—as Mirchandani WDT, supra. Rather, the they would with any proffered (direct license agreements that track the regulatory rate structure are further Services’ link the fact that the marginal benchmark. See SJRPFF–CO at pp. 803– physical cost of streaming is zero to the 04 (and case law and record citations evidence of a ‘‘revealed preference’’ for that structure). need for a flexible rate structure such as therein). The Services note that now exists. Professor Hubbard links the considering the current rate structure as Another Service expert notes that— because the Services have different tiers zero marginal physical cost a benchmark (rather than as a mere characteristic to the setting of royalty attempt to preserve aspects of the status of listeners paying at different levels— their economic incentives are aligned rates by noting that, because ‘‘[t]he quo) is instructive because it allows for marginal production cost at issue here an identification of market value by with Copyright Owners—to avoid substitution of their higher priced is—is zero.... it’s not clear why it’s analogy—through the examination of a not better to bring new customers into services by their lower priced services comparable circumstance, rather than the market on which royalties would be (i.e., to avoid opportunity costs). Thus, requiring the experts and the Judges to paid and, of course, zero marginal cost the incentives that existed when the build a theoretical model from the incurred.’’ 4/13/17 Tr. 5917–18 2012 rate structure was first ‘‘ground up’’ to represent the industry at (Hubbard). See also Marx WDT ¶ 97 implemented remain in effect. See 3/21/ issue, and without requiring the Judges (‘‘Setting the price of marginal 17 Tr. 2192 (Hubbard) (testifying that to substitute their analysis and downstream listening at its marginal there continues to be a ‘‘substantial judgment as to why terms were cost of zero induces more music heterogeneity on the consume side of included within the benchmarks. See 3/ consumption and variety than per-song the market.’’).251 13/17 Tr. 691–2 (Katz) (‘‘[My overall Finally, the Services or per-album pricing.’’). I understand approach has been just ask the question assert that the 2012 benchmark is this testimony to be consistent with the [if] we take this as a benchmark . . . [i]s relevant and helpful because, although economic point, discussed supra, that, it reasonable to take the [2012] it was entered into five years ago, it is in the ‘‘second-best world’’ created by structure? .... [I]n trying to rely on nonetheless a relatively recent the characteristics of this market, no one the benchmark, I am trying to say, okay, can claim that any given rate structure well, the industry decided this, let me 251 Professor Hubbard further notes that he identified no empirical evidence in the record of is the ‘‘best.’’ ask, is it working overall? . . . ’’ [T]hat’s any opportunity costs incurred by Copyright Professor Katz notes that the existing Owners as a consequence of the extant rate rate structure captures important 250 Except when they do not. As noted supra, the structure, and that the survey results obtained by specific aspects of the economics of the Services seek the elimination of the ‘‘Mechanical the Klein Survey support his claim that Floor,’’ a significant departure from the existing substitution/cannibalization is not a material interactive streaming market, structure. I discuss that issue elsewhere in this economic factor. 4/13/17 Tr. 5918 (Hubbard). This accounting for: (1) the variable WTP Dissent. issue is discussed in greater detail infra. among listeners; and (2) the corollary

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variable demand for streaming services. 1176 (Leonard) (noting that More particularly, Professor See 313/17 Tr. 586–87 (Katz); see also notwithstanding the changes and Zmijewski testified that: Marx WRT ¶ 239 et seq.; 4/7/17 Tr. 5568 growth in the streaming marketplace 1. Total revenues reported by the NMPA (Marx) (noting that the present structure over the current rate period, the for NMPA members from all royalty serves differentiated products offered to underlying economic structure of the sources 255 [REDACTED] from approximately customer segments with a variety of marketplace—that made a percent-of- $ [REDACTED] in 2014 to $ [REDACTED] in preferences and WTP). In more formal revenue based royalty appropriate—has 2015, a [REDACTED] in royalty revenue. Id. economic terms, Professor Katz notes not changed). ¶ 41. that the present structure enhances The Services’ experts further assert 2. The [REDACTED] in (1) above includes variable pricing that allows streaming that the multiple pricing structures an [REDACTED] in mechanical royalties from streaming from $ [REDACTED] in 2014 to $ services ‘‘to work[][their]way down the necessary to satisfy the WTP and the [REDACTED] in 2015, a [REDACTED] in demand curve,’’ i.e., to engage in price differentiated quality preferences of royalty revenue derived from the mechanical discrimination that expands the market, downstream listeners relate directly to license. Id. providing increased revenue to the the upstream rate structure to be 3. The [REDACTED] in (1) above includes Copyright Owners as well as the established in this proceeding. For an [REDACTED] in performance royalties Services. 3/13/17 Tr. 701 (Katz).252 I example, Professor Marx opines that the from streaming from 4 [REDACTED] in 2014 understand this testimony to be appropriate upstream rate structure is to $ [REDACTED] in 2015, a [REDACTED]. consistent with the economic point, derived from the characteristics of Id. made supra, that a price discriminatory 4. Mechanical royalty revenue for the sale downstream demand. 3/20/17 Tr. 1967 of downloads and physical phonorecords rate structure is appropriate in markets (Marx) (agreeing that the rate structure [REDACTED] in 2014 to $ [REDACTED] in with zero marginal physical cost, upstream should be derived from the 2015 (a [REDACTED] of $ [REDACTED]), varying WTP and the absence of need to exploit the willingness to pay of while the combination of mechanical and arbitrage. various users downstream via a performance royalty revenue royalty from Professor Hubbard attempts to capture percentage of revenue because streaming [REDACTED] from $ [REDACTED] the interrelationship between the downstream listeners have varying in 2014 to $ [REDACTED] (an [REDACTED] economics of this market and the willingness to pay that should be of $ [REDACTED]). Thus, the [REDACTED] in existing rate structure as follows: exploited for the mutual benefit of royalty revenue from streaming outstripped the [REDACTED] from the sale of downloads [F]rom an economic perspective, you can copyright licensees and licensors). and physical phonorecords by $ think of this market and this industry as Professor Marx further acknowledged [REDACTED]. Id. ¶ 38.256 being composed of different customer that this upstream:downstream Moving to a comparison of revenue segments by tastes and preferences and consonance in rate structures represents growth to streaming growth, Professor willingness to pay. And so no rate structure an application of the concept of can really work without understanding that, Hubbard dismisses as economically and no business model can really work ‘‘derived demand,’’ whereby the ‘‘meaningless’’ the argument that without understanding that. demand upstream for inputs is Copyright Owners have suffered relative [I]n terms of rate structures, the dependent upon the demand for the economic injury under the current rate Phonorecords II framework from the previous final product downstream. Id. Moreover, structure simply because the increase in proceeding does offer a benchmark to start Dr. Leonard notes that ‘‘the downstream their revenues from interactive because it provides for differences in distinct company is going to have a lot more streaming has been proportionately less product categories in terms of music service information about . . . the business, offerings, pricing possibilities, and so on. than the growth in the number of And it has encouraged a very diverse digital about what makes sense,’’ 4/6/17 Tr. interactive streams—leading music offering set from actual competitors. 5238 (Leonard). mathematically—to a lower implicit or The Services also note that the 3/21/17 Tr. 2175–76 (Hubbard).253 effective per stream royalty rate. 4/13/17 existing rate structure has produced Tr. 5971–73 (Hubbard). That is, there is Moreover, Professor Hubbard perceives generally positive practical a link between the existing rate no evidence that, if the price of the consequences in the marketplace. Their services available to these low to zero structure and the ‘‘growth in the number joint accounting expert, Professor Mark of consumers, number of streams, entry, WTP listeners had been increased, they Zmijewski, testified that the decrease in would have paid the higher price, rather the number of companies providing the publishing royalties from the sale of streaming services, and the identity of than declined to utilize a royalty- product under Subpart A since 2014 has bearing interactive streaming service. In the companies providing those services been offset by an increase in music . . . .’’ 4/13/17 Tr. 5978 (Hubbard); see fact, the only survey evidence in the publisher royalties (mechanical + record (the Klein Survey, discussed also Hubbard WDT ¶ 4.7 performance royalties) over the same 254 infra) suggests that listeners to ([REDACTED]). See also 3/15/17 Tr. period. Expert Report of Mark E. Zmijewski February 15, 2017 ¶¶ 38, 40 255 252 A Copyright Owner economic expert, All royalty sources include mechanical Professor Rysman, acknowledges that—under the (Zmijewski WRT); 4/12/17 Tr. 5783 royalties from physical phonorecords, digital current rate regime—revenues may be increasing (Zmijewski); see also 4/13/17 Tr. 5897 downloads and streaming; performance royalties because of movements ‘‘down the demand curve’’ (Hubbard) (‘‘the evidence that I from streaming and non-streaming; and synchronization. Zmijewski WRT ¶ 41. (i.e., changes in quantity demanded in response to reviewed suggests that the copyright lower prices), rather than because of—or in addition holders have actually benefitted from 256 By contrast, looking only at mechanical to—an outward shift of the demand curve (i.e., an royalty revenue, for the sale of digital downloads increase in demand at every price). 4/3/17 Tr. this structure . . . .’’). and physical phonorecords mechanical royalty 4373–74 (Rysman). revenue [REDACTED] from $ [REDACTED] in 2014 253 Professor Hubbard’s point that the variety of does not compete by offering a low-cost service. to $ [REDACTED] (as noted in (4) above, whereas business models in the industry is a consequence Eisenach WDT ¶¶ 49–50. However, Tidal’s offering mechanical royalty from streaming [REDACTED] of the various customer characteristics is of a higher priced subscription service that provides from $ [REDACTED] in 2014 to $ [REDACTED] in noteworthy as a distinguishing counterpoint to the enhanced features such as hi-fidelity sound quality 2015. Thus, the $ [REDACTED] in mechanical simple cliche´ that the Judges should be ‘‘business actually proves the point that Professor Hubbard royalty revenue from streaming [REDACTED] in model neutral.’’ 3/21/17 Tr. 2175–76 (Hubbard). and the other Service economists are making: There mechanical royalty revenue from the sale of digital 254 The Copyright Owners sought to rebut is a segmentation of demand across product and physical phonorecords. This comparison is the Professor Hubbard’s argument by confronting him characteristic and WTP that permits differential metric from Professor Zmijewski’s analysis that with the offerings of Tidal, a streaming service that pricing in this industry. Copyright Owners assert is most relevant.

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streaming services have a highly elastic the marketplace appears to be August 2016, Spotify had [REDACTED] demand, i.e., they are highly sensitive to functioning (in the sense that publishers million average monthly users on its ad- price increases. I understand Professor are earning profits and new and existing supported service, compared with Hubbard’s point to be highlighting the interactive streaming services continue [REDACTED] million subscribers to its distinction, also discussed in the to operate despite accounting losses), subscription service. Marx WDT ¶ 49 economics overview, supra, between an these revenue-measurement issues are n.62 & Fig. 7; Hubbard WDT ¶ 3.14 and ‘‘increase in demand’’ and an ‘‘increase being adequately handled by the Ex. 4 ([REDACTED]. Accordingly, the in quantity demanded.’’ alternative rate prong, even if an altered treatment of such services in the rate On the licensee (interactive streaming second prong might work better. Id. at structure is of particular importance. service) side of the ledger, Professor 738; 4/5/17 Tr. 5055–57 (Katz) (also The majority of the listeners to the ad- Katz identifies the entry of new noting that ‘‘ecosystem’’ entities in the supported format use Spotify’s ad- interactive streaming services (including mold of Amazon, Apple and Google, supported service, although there are Pandora) and new investment in such as Yahoo, were in the marketplace other such services available in the existing interactive streaming services when the existing rate structure was market, including SoundCloud and during the present rate period as formulated). In similar fashion, Dr. Deezer. See COPFF ¶ 341 (and record evidence that the present rate structure Leonard opined that the 2012 rate citations therein). (The arguments is ‘‘working.’’ 3/13/17 Tr. 667 (Katz). In structure created a number of ‘‘buckets’’ regarding the appropriate rate structure fact, he notes the ubiquity of percentage- to deal with problems of this sort. 3/15/ pertaining to ‘‘free to the user’’ services of-revenue based royalty structures in 17 Tr. 1227–28 (Leonard). overlaps to an extent with the argument the music industry, indicating (as a More broadly, the Services’ position regarding ad-supported services, and I matter of revealed preference) the regarding the use of the two prongs and consider them jointly.) practicality of such a revenue-based their alternate rates to ameliorate the The Services assert that they offer ad- royalty system. See 3/13/17 Tr. 766–67 revenue-measurement problems is supported or other free-to-the-user (Katz); see also 4/5/17 Tr. 5166–67 summed up by Professor Katz as interactive streaming tiers to meet the (Leonard) (‘‘[I]n the area of intellectual follows: demand of a large cohort of the listening property licensing . . . percentage-of- population that does not have a positive revenue is not exactly surprising. In [T]he primary reason [for the two rate prongs] . . . is because of the measurement WTP for streamed music. [REDACTED]. fact, I would say it is probably the most issues that can come up when having 3/21/17 Tr. 2179–83 (Hubbard); see also common approach that you see as a royalties based on a . . . percentage of Marx WDT ¶¶ 53–54; Katz WDT ¶ 86. general matter.... [N]arrowing into revenues because there can be issues about [REDACTED]. 4/13/17 Tr. 5906 the area we’re talking about here of how to appropriately assign revenues to a (Hubbard) (‘‘[REDACTED]’’) see also 4/ interactive streaming, it is pretty service. And so I think the minim[a] can play 5/17 Tr. 5231 (Leonard) (‘‘the funneling common here, too. . . .’’). an important role when those—you know, is itself a mechanism to separate out the In sum, given ‘‘how the industry has when those measurement problems are people who really value music and want performed’’ under the current rate severe, you can turn to the minimum instead.... [W]hat I have in mind, right, is to just be able to listen to what they structure, the Services conclude that it want to listen to, versus people who is therefore appropriate to continue that that what would happen if you could imagine an entrepreneur coming along and . . . are not willing to pay that amount basic structure going forward. 3/13/17 saying we want to have a service and have of money . . . .’’). In this regard, Tr. 565 (Katz). some incredibly low price and not a very Spotify most aggressively markets itself The Services’ economic experts do good monetization model, where a copyright as an ‘‘up-seller’’—providing its ad- not ignore the fact that there may be owner would say—in an effectively supported service as a funnel to convert revenue attribution problems when competitive market, would say, wait a low WTP listeners into subscribers. interactive streaming is combined with minute, I don’t want to license to you on Spotify’s strategy, as explained by its in- those terms. It’s—I just think the possibility other products or services. They house economist, is as follows: acknowledge that, even absent any of getting a return is so low, I’m not going wrongful intent with regard to the to do it, even though you, as an entrepreneur, One of Spotify’s key beliefs in its identification and measurement of are willing to try this. I as the copyright commercial strategy is that moving someone owner want some sort of, you know, return from piracy to a legal music service needs to revenue, attribution of revenue across on it. And that’s what the minimum also be frictionless—otherwise, they won’t come. product/service lines of various services helps to do. Often a Spotify user’s journey begins in our can be difficult and imprecise. See, e.g., free-to-users ad-supported tier, and upgrades 4/5/17 Tr. 5000 (Katz) (the problem of 3/13/17 Tr. 599 (Katz.); see also 3/20/17 to a paid (or premium) subscription as he or measuring revenue is ‘‘certainly a factor Tr. 1900–01 (Marx) (minima protect she becomes more familiar with the that goes into thinking about against revenue measurement enhanced paid-only features through trial reasonableness.’’).257 problems); 4/7/17 Tr. 5584 (Marx) promotions and/or marketing efforts.... However, Professor Katz testified that (noting that the statutory minima play This presents a ‘‘you help me today and I’ll help you tomorrow’’ licensing proposition: as the existing rate structure agreed to by ‘‘two roles’’—protecting the Copyright Owners from ‘‘revenue rightsholders allow Spotify to use their the parties accommodates these content, Spotify in turn helps rightsholders, bundling, deferral and displacement mismeasurement’’ by creating the by first taking users from free options that issues via the use of a second rate prong ‘‘greater of’’ prong, ’’ but incorporating pay little to no royalties—such as piracy, or that would be triggered if the royalty the per subscriber rate prong in the even AM/FM radio—to an ad-supported revenue resulting from the headline rate ‘‘lesser of’’ component to protect the service that generates higher royalties, and of 10.5% of streaming revenue fell services from ‘‘manipulation of the then further taking these users to a paid service .... below the royalty revenue generated by sound recording royalties’’ on which the that second prong. Katz WDT ¶¶ 82–83; TCC prong is calculated). Written Direct Testimony of Will Page 3/13/17 Tr. 670 (Katz). Moreover, Another particular issue raised by the (On behalf of Spotify USA Inc.) (Page Professor Katz concluded that, because existing structure relates to the WDT) ¶¶ 13–14. significant percentage of listeners to Mr. Page notes the success of Spotify 257 This Dissent considers the specific deferral interactive streaming services that are in growing the overall ‘‘royalty pie’’ in and displacement arguments in more detail infra. ‘‘free’’ to the user. For example, as of its home country of Sweden, where

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‘‘[w]hat wasn’t understood [in 2009], offering an ad supported service, terms in a settlement, the elements of but is appreciated now, is that the vast Copyright Owners would realize zero the rate structure do not reflect the majority of the adult population in all royalties until such self-advertising structure the market would set, but key markets spends zero on music. resulted in new subscribers.) 259 rather reflect only the parties’ own Spotify’s core commercial proposition With regard to the tangible economic prediction of how the Judges would rule was to grow the business by growing the benefits of such downstream products to in the absence of a settlement. See 4/4/ average revenue per person across the the upstream Copyright Owners, 17 Tr. 4591 (Eisenach). entire population, not by holding onto Professor Marx notes that an ad- Second, Copyright Owners dismiss a shrinking minority of people buying supported service is in the nature of a any relevancy in the fact that they albums or PDDs.’’ Id. ¶ 24. multi-party ‘‘platform,’’ creating an agreed in the 2012 settlement to To avoid substitution (i.e., intersection among streaming services, maintain virtually unchanged the cannibalization) that would reduce listeners and advertisers. 3/21/17 Tr. Subpart B rate structure and rates set revenues to the services and the 2013 (Marx). This is why she forth in the 2008 settlement. They claim rightsholders alike, the services emphasizes, as did Mr. Page, supra, that that this essential status quo was differentiate such ‘‘funneling’’ products ‘‘Spotify’s ad-supported service is maintained because there had been only by intentionally structuring them as monetizing . . . low-willingness-to-pay a two-year window between the inferior in quality compared to listeners better than [REDACTED], Phonorecords I settlement and the subscription tiers, for example by terrestrial radio, and, of course, piracy.’’ commencement of proceedings in interspersing songs with ads (as in the 4/7/17 Tr. 5503 (Marx); see also Marx Phonorecords II, and that no meaningful Spotify ‘‘free’’ tier) and by offering a WRT at 14, Fig. 7 (comparing ‘‘musical market changes occurred in that short more limited repertoire of songs (as with works royalties per user-hour across time period. However, the Services Amazon Prime Music). As Professor these alternatives). dispute the substantive assertion that Hubbard explains, ‘‘free-to-the listener’’ Professor Marx also noted that it is there was no significant market tiers must be inferior in some manner of inappropriate to consider the royalty development by the time of quality in order to sort out listeners who rates paid by higher-priced interactive Phonorecords II. Written Rebuttal have a WTP sufficient to pay for the streaming services, such as Tidal, as Statement of Zahavah Levine (On behalf higher-priced (i.e., subscription) tier. He evidence supporting a finding that ad- of Google, Inc.) ¶¶ 5–6 (Levine WRT); 3/ elucidates this point by analogizing to supported or other ‘‘free to the listener’’ 8/17 Tr. 171–172; 270–272 (Levine). the discriminatory pricing of airline services pay too little in royalties. She Numerous services, including the more seating, whereby different classes of notes that the ad-supported and other recent large new entrants, had already seating combine varying amenity ‘‘free to the listener’’ tiers represent the entered the market, with some realizing packages with higher prices (i.e., first exploitation of the low WTP segment of significant subscriber numbers. Id. at class, business class and coach). the demand curve, whereas other 155–157 (Levine). Ms. Levine further Hubbard WDT ¶ 3.15.258 services seek to exploit the higher end testified that the Subpart B rates could The use of an ad-supported service as of the demand curve. For example, and not reasonably be construed as a ‘‘freemium’’ model thus serves a dual as noted supra, Tidal offers a $20 per ‘‘experimental’’ during the purpose: First, it is an efficient means of month subscription tier that can Phonorecords II negotiations, and by the marketing—segregating listeners generate higher royalties, but does so by time of the Phonorecords II settlement, according to WTP—allowing them to offering a differentiated product of other significant market changes had ‘‘experience’’ interactive streaming, higher quality via a premium high- occurred in the music delivery market. while, second, still providing royalties to fidelity. 3/21/17 Tr. 5601–02 (Marx). Id. ¶ 5. For example, she notes that Copyright Owners. (If Spotify Rhapsody had already been in the substituted self-advertising in other 4. Copyright Owners’ Argument against market for approximately ten years and media as a marketing tool instead of the 2012 Percent-of-Revenue Structure had approximately one million paying (with Minima) and Judicial Analysis of listeners. Id. ¶¶ 5–6. 258 Professor Hubbard’s example parallels the that Argument Third, Copyright Owners assert that insight of the 19th century French economist, Jules [REDACTED]. Rebuttal Witness Dupuit, one of the first economists to explain the a. The Allegedly Limited Evidentiary economics of price discrimination. Dupuit Value of Settlement Rates Statement of David M. Israelite ¶ 28 examined the pricing of several classes of seating (Israelite WRT); 3/29/17 Tr. 3649–3652 on railway carriages. As he noted: ‘‘[A] good many Copyright Owners criticize the (Israelite). However, the Services . . . travelers in third class, travel[ ] without a roof relevancy of the 2012 settlement-based respond by noting that there is no over the carriage, on poorly upholstered seats .... rate structure. First, they note that, as It would cost very little . . . to put some meters of evidence to support Mr. Israelite’s leather and kilos of horse-hair [on the seats], and testimony regarding the [REDACTED]. it is beyond greed to withhold them. It is not 259 The interactive streaming of music is an And, notwithstanding his testimony ‘‘experiential’’ good. See Byun, supra, at 23 (‘‘Music because of the several thousand francs which they regarding [REDACTED], the Services would have to spend to cover the third class is a specific type of good, known as an experiential wagons or to upholster the benches that a particular good, meaning that it must be experienced or note that the NMPA incurred the railway has uncovered carriages and wooden sampled before the customer can assess . . . quality expense of a year-long negotiation with benches; it would happily sacrifice this for the sake . . . and . . . utility.’’) Thus, the provision of a the Services to seek higher rates, create of its popularity. Its goal is to stop the traveler who monetarily ‘‘free-to-the user’’ service is a reasonable new service categories in Subpart C, and can pay for the second class trip from going third marketing tool, and the Judges are loath to second- class. It hurts the poor not because it wants them guess the business model incorporating that changes to the TCC calculations. Id. at to personally suffer, but to scare the rich. The marketing approach, especially after it has proven 159, 161–164; 3/29/17 Tr. 3856 comfort in third class is deliberately reduced to successful while still providing royalties to rights (Israelite). dissuade travelers who are ready to pay for higher owners. See Page WDT ¶ 27 (Spotify’s freemium Fourth, Copyright Owners assert, levels of comfort from traveling at the cheaper model monetizes through subscriptions more fares.’’ Jules Dupuit, De l.infuence des pe´ages sur successfully than the sale of downloads and CDs, assuming arguendo that the current rate l’utilite´ des voies de communication, Annales des as well as terrestrial radio and, of course, piracy). structure can be used for benchmarking Ponts et Chausse´es, 17, me´moires et documents 207 Also, the Judges do not find it relevant that many purposes, that the Services have not (1849), quoted in T. Randolph Beard & Robert B. other interactive streaming services have not presented competent evidence or Ekelund, Jr., Quality Choice and Price utilized an ad-supported service, absent record Discrimination: A Note on Dupuit’s Conjecture, 57 evidence as to why they have ceded that significant testimony as to the intentions of the So. Econ. J. 1155, 1156–57 (1991). market (and marketing) niche principally to Spotify. settling parties who had negotiated the

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2012 settlement, or, for that matter, the negotiations, that he directly negotiated this rate structure was renewed, 2008 settlement that preceded it. with Mr. Israelite and the general consumer adoption of streaming was Specifically, Copyright Owners claim counsel for the NMPA, negotiations that obvious, contrary to Copyright Owners’ that the witnesses who were called by led to the parties’ agreement essentially allegations. Levine WRT ¶ 5. The the Services to testify in this regard did to maintain the Subpart B structure and Services also assert that numerous not negotiate directly with the to create what became the new Subpart services, including those backed by Copyright Owners in connection with C rate structure. Id. at 11; see also 3/9/ large companies, such as Yahoo and these settlements. 3/29/17 Tr. 3621–22 17 Tr. 325–27 (Parness). Microsoft, had already entered the (Israelite). More particularly, the two Ms. Levine testified that in the market, and some of those services had Services’ witnesses who provided Phonorecords II negotiations, Copyright achieved significant subscriber testimony in this regard, Adam Parness Owners sought an increase in the numbers. 3/8/17 Tr. 155:14–157:12 and Zahavah Levine, acknowledged Subpart B rates, the services refused, (Levine); see also Parness WDT ¶ 12. they had no direct involvement in the and Copyright Owners ultimately c. Alleged Displacement and Deferral of Phonorecords I negotiations, and Ms. withdrew that demand. Levine WRT ¶ 2. Revenue Levine did not engage in direct The implication from this testimony is negotiations with regard to the that the stability of the rate structure is Copyright Owners criticize the 2012 Phonorecords II settlement either. 3/9/ not indicative of the absence of rate structure because its reliance on a 17 Tr. 339–40 (Parness); 3/29/17 Tr. negotiations, but, at least according to revenue-based structure creates 3885–86 (Israelite); see also Israelite Ms. Levine, that rate structure stability problems regarding the measurement of WRT ¶ 14 (indicating that Ms. Levine was a by-product of the negotiating revenue. Specifically, Copyright Owners had left Real Networks in 2006, before process. allege that services can displace revenue properly attributable to streaming and her former subordinate was negotiating b. The Settlement Rates are allocate it to other products within the the 2008 settlement). Anachronistic However, the evidence indicates that owners’ broader economic ‘‘ecosystem.’’ Ms. Levine and Mr. Parness were On behalf of Copyright Owners, Mr. Also, they allege that services can and involved in the contemporaneous Israelite described their willingness to do defer revenue from the present into internal discussions of negotiation continue the 2008 rate structure through the future, foregoing present profits in strategy on behalf of the Services, which 2017 (ten years in total) as reflective of order to grow their customer base to makes their testimony relevant as to the their understanding that the interactive achieve a market share that allows for intentions of the Services involved in streaming market was still not long-term profits.261 See Rysman WDT those earlier negotiations. More ‘‘mature,’’ Israelite WDT ¶ 108; WRT ¶ 13. particularly, Ms. Levine was employed ¶ 26, and thus the ten year rate structure The problems associated with revenue by Google/You Tube when the 2012 remained ‘‘experimental.’’ Israelite WDT measurement and attribution arise in settlement was negotiated and finalized. ¶ ¶ 81, 103; Israelite WRT ¶ ¶ 4, 19, 26, various contexts. First, the Services may At that time, Google was a member of 32. This issue is discussed in more focus on long-term profit or revenue DiMA, the trade association detail infra.260 maximization, thereby possibly representing the interests of actual and More particularly, Copyright Owners deferring shorter-term profits through potential interactive streaming services. maintain that the current rate structure temporarily lower downstream pricing See Phonorecords II, DiMA Petition to was ‘‘experimental’’ because there had (i.e., revenue deferral) in a manner that Participate. Thus, Ms. Levine was been no data to evaluate the interactive suppresses revenue over that shorter- competent to give testimony as to the streaming business, and Copyright term. Second, the services may use parties’ positions in the negotiations. Owners lacked knowledge as to the music as a ‘‘loss leader,’’ displacing Mr. Parness testified, at the time of future development of the interactive streaming revenue and encouraging the Phonorecords I settlement, he was market. Israelite WDT ¶¶ 33, 81, 95); consumers to enter into the so-called Director of Musical Licensing for Israelite WRT ¶¶ 4, 17, 18, 19, 29; 3/29/ economic ‘‘ecosystem’’ of the streaming RealNetworks, Inc., an interactive 17 Tr. 3631–32, 3754, 3764–65 services, especially the multi-product/ streaming service and a member of (Israelite); see also COPFF ¶ 421 (and service firms in this proceeding— DiMA, its bargaining representative. In record citations therein). Amazon, Apple and Google—within Whether experimental or otherwise, that capacity, Mr. Parness was ‘‘actively which consumers can be exposed to [REDACTED]. Id. at 3636–38. involved’’ on behalf of Real Networks. other goods and services available for Written Direct Testimony of Adam In response, the Services assert that there is no record evidence, beyond Mr. purchase. Third, the interactive Parness (on behalf of Pandora Media, streaming services may obscure royalty- Inc.) ¶ 5 (Parness WDT). Mr. Parness Israelite’s testimony, that the existing rate structure was, or remains, based streaming revenue by offering understood that the important aspects of product bundles that include their the Phonorecords I negotiations and experimental. They further note (as referenced supra) that by 2012, when music services with other goods and settlement were: (1) an agreement that services, rendering it difficult to parse noninteractive services did not need a out the bundled revenue as between the mechanical license; (2) the interactive 260 In an attempt to dig deeper into why Copyright Owners agreed to particulars in the royalty-bearing revenue (from the mechanical license would be calculated settlements regarding the TCC prong, the Judges interactive service) and the revenue on an ‘‘All-In’’ basis; (3) the rate would asked Dr. Eisenach if Copyright Owners had attributable to the other items in the be structured as a percent-on-revenue provided him with information regarding the 2012 bundle. with certain minima; and the headline settlement. He responded by stating that ‘‘[w]hen I’ve asked the question, I’ve found people chuckle i. Deferral rate would be 10.5%. Parness WDT ¶ 7. . . . when I ask the question, people say: ‘Nobody He noted that the rate minima were really knows.’ .... Someone may know, but that’s With regard to revenue deferral, included at the behest of Copyright what I’ve been told.’’ 4/4/17 Tr. 4611 (Eisenach). I Copyright Owners argue that the Owners, who were concerned that a am perplexed by the response provided to Dr. Eisenach, because the history of the present rates services’ focus on future growth, not purely revenue-based rate might result would seem to be of great relevance, ascertainable in too little revenue. Id. ¶ 8. Mr. Parness and not subject to being laughed off when a party’s 261 This strategy is referred to as ‘‘scaling,’’ and further testified, with regard to the 2012 own expert seeks such information. is discussed in more detail infra.

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current revenues. See [REDACTED] zero. This is the success-through- precisely the bargain struck between ([REDACTED]). By way of example, scalability discussed infra. See generally Copyright Owners and services in 2008 Copyright Owners highlight a particular Haskel & Westlake, supra, at 65–66 and 2012, and that has been ongoing aspect of [REDACTED] business model: (profitability through scaling is through the present day. [REDACTED]. Id. at 2168–69 enhanced by the use of inputs with zero Are there even better ways to address ([REDACTED]). The economic upshot of marginal costs). this issue? Perhaps, but by the very such a focus on the long-run rather than It appears that the nature of the nature of this adversarial proceeding, on present revenues, according to downstream interactive streaming the Judges cannot identify the Copyright Owners, has caused revenues market, and its reliance on scaling for theoretically optimal manner by which to grow annually by only 31% from success, results necessarily in a the revenue deferral phenomenon 2013 to 2014, and by only 34% from competition for the market rather than should be addressed. Rather, the choices 2014 to 2015, even as the number of simply competition in the market. This before the Judges are stark: the per-unit streams over these two periods has is the form of dynamic competition pricing proposals submitted by grown by 63% and 101% respectively. known as Schumpeterian competition Copyright Owners and Apple, and the Ghose WDT ¶ 74. (named after the economist Joseph tiered rate structure now in existence The Services respond by noting that Schumpeter). Such competition and generally (but not uniformly) Copyright Owners did not conduct an emphasizes the importance of the presented by the Services as the empirical analysis to confirm the extent dynamic creation of new markets and appropriate benchmark.262 As discussed to which to which interactive streaming ‘‘new demand curves,’’ recognizing that infra, I have identified the 2012 rate services actually engage in revenue short-term profit or revenue structure as the best benchmark from deferral, and that their expert was maximization may be inconsistent with among these proposals. The revenue therefore compelled to qualify his rational competition for the market. deferral phenomenon indicates the need conclusions by conceding only that That is, this form of competition for Copyright Owners to protect such revenue deferral ‘‘may’’ occur. See recognizes that businesses and investors themselves, but it does not indicate that, 4/3/17 Tr. 4344–43, 4347, 4349 do not simply seek out commercial on balance, the issue is better resolved (Rysman). Additionally, the Services activities that will merely earn returns by the unacceptable per unit pricing assert that the primary industry pricing available elsewhere in the economy, but proposals submitted in this proceeding. model—$9.99 per month for unlimited rather seek out longer-term supranormal Accordingly, I do not find the revenue access—has existed since the early profits, investing in businesses that deferral issue to be a sufficient basis to 2000’s, belying Copyright Owners’ appear able to satisfy consumer demand reject the 2012 benchmark in favor of assertion that there has been a change in and capture large swaths of market Copyright Owners’ or Apple’s per-unit pricing in the current rate period share—a dynamic and enduring process rate proposals.263 intended to build market share. See that creates and ultimately destroys ii. Displacement through Bundling Levine WRT ¶ 6 (describing how various business entities and markets in Rhapsody ‘‘pioneered’’ the subscription the process (which Schumpeter coined Copyright Owners argue that services on-demand model in the early 2000’s as ‘‘creative destruction.’’) See J. Sidak also displace revenue by engaging in and how the $9.99 model was adopted & D. Teese, Dynamic Competition in ‘‘cross-selling’’ by which they sell by, e.g., MOG, and ). Antitrust Law, 5J. Comp. L. & Econ.5, access to musical works/sound [REDACTED] 581 (2009). Indeed, Amazon’s economic recordings through the bundling of that The Services also argue that Copyright expert witness, Professor Hubbard, Owners misunderstand the services’ acknowledged that ‘‘[t]he music 262 As I note in this Dissent, there is no sufficient emphasis on [REDACTED]. However, as evidence to allow the Judges to mold their unique industry exemplifies this process’’ of rate structure, and the majority has erred in its noted supra, the Services do Schumpeterian ‘‘creative destruction.’’ attempt to do so. acknowledge that they focus broadly on Hubbard WDT ¶ 2.1 & n. 1. 263 Looked at from a different perspective, this [REDACTED]. Id. at 2082, 2141 Of course, when royalties are paid as issue pits the music publishing business model ([REDACTED]). a percent of current revenue, the input against the interactive streaming business model. The Services also disagree with Music publishers must maximize revenues (subject supplier, i.e., Copyright Owners in the to any cost constraints) over some time horizon, and Copyright Owners’ assertion that present case, are likewise deferring their argument in this proceeding indicates that [REDACTED], 4/7/2017 Tr. 5498 (Marx); some revenue to a later time period (and they seek to maximize royalty revenue over the 3/21/17 Tr. 2169 (McCarthy); and also assuming some risk as to the short-run, so that current songwriters receive [REDACTED]. 4/6/2017 Tr. 5327 royalties based on current revenue that is not ultimate existence of that future deferred because of the interactive streaming (Vogel). Thus, the business model, they revenue). One way the input supplier services’ long-term business model. See Rysman argue, is reflective of the fundamental can avoid this impact is to refuse to WDT ¶ 50. The music publishers could instead pay structure of market demand, rather than accept a percent of revenue form of royalties to songwriters based (at least in part) on an index of several years of revenue to be consistent evidence of revenue deferment. payment and move to a fixed per-unit with the long-term business models of the I find that the record indicates that input price. This is what Copyright interactive streaming entities. See Leonard WRT the services do seek to engage to some Owners seek in this proceeding, subject ¶ 60 (noting that advances from publishers to extent in revenue deferral in order to to a bargaining room approach by which songwriters are examples of such a long-run ‘‘smoothing’’ of royalty revenues). Or, as Copyright promote their long-term growth strategy. they could switch back to the old Owners urge, the Judges could require the A long-term strategy that emphasizes approach (or any other approach) interactive streaming services to abandon the scale over current revenue can be through purely market-based revenue-based royalty structure (with protective rational, especially when a critical input negotiations, but free from the statutory alternate prongs and floors) and to accept inefficient per-unit rates, thereby compromising their is a quasi-public good—because growth standards of section 801(b)(1). However, downstream businesses. In keeping with the Judges’ in market share and revenues is not another way in which the input supplier long-standing position, I believe the Judges should matched by a commensurate increase in can mitigate the effect of such revenue remain business model neutral, and decline to favor the cost of such inputs, whose marginal deferrals is to establish a pricing one challenged business model over another. structure that provides alternate rate Instead, I would adopt the 2012 rate structure that cost of production (reproduction, embodies a negotiated compromise by the parties actually, because they are copies of prongs and floors, below which the that has adequately addressed this revenue deferral sound recordings/musical works) is royalty revenue cannot fall. This is issue.

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access with other goods or services, flows in the opposite direction.’’ Levine revenue realized if each item was sold allocating too much revenue to the non- WRT ¶¶ 8–9. at its separate or undiscounted price. music portion of the bundle, rather than With regard to Pandora, Copyright See SDARS I Underpayment Ruling at attributing the correct amount to the Owners note that it has expanded 18–19. The parties in the present music service and thus, to the revenue beyond its ‘‘pureplay’’ origins by proceeding do not so much dispute this base. Written Rebuttal Testimony of acquiring Ticketfly, a fan-to-fan live point as they argue whether the bundles Christopher C. Barry, CPA, CFF (on concert ticket exchange business. 3/9/17 discounts and alleged displacements behalf of Copyright Owners) ¶ 7. Tr. 408–410 (Phillips). According to tend, on balance, to increase the Copyright Owners argue that the Copyright Owners, in the future, revenue base (by adding new services manipulate revenue Pandora may generate revenue from this subscribers) or to decrease the revenue calculations in their favor, allegedly ancillary business—revenue that base (by reducing per subscriber defining revenue in opportunistic ways. arguably should be included as ‘‘service revenue). I agree with Copyright Owners See Rysman WDT ¶ 44; Rysman WRT revenue’’ in a revenue based rate that the services may be using bundling ¶ 15; Ghose WDT ¶¶ 62–81. They structure. Rysman WRT ¶ 34. However, and associated discounts in a manner maintain that they cannot discern such Pandora notes that Ticketfly is a small that is inconsistent with short-run manipulation and opportunism as it operation relative to Pandora’s overall maximization of revenues, or even occurs, because the booking of revenue business and, as Copyright Owners profits, but they may also be growing among lines of business is ‘‘opaque to acknowledge, any use by Pandora of the revenue base. publishers’’—especially in comparison resources it obtained through streaming The import of this dispute in the to the identification of the number of music to benefit Ticketfly would be present case is how the presence of consumers or the number of streams. realized in the future, making such a bundling and discounting bears, Rysman WDT ¶ 43; Rysman WRT ¶ 15; link speculative at this time. Moreover, initially, on the rate structure and, then, Ghose WDT ¶¶ 80–81. Pandora argues that, if and when on the rates within that structure. With regard to the rate structure, the rate In response, the Services assert there Pandora may drive incremental attendance at concerts and other live prongs in the 2012 benchmark that the is no evidentiary support for this overall events through Ticketfly, music Services are urging the Judges to adopt and conclusory assertion. JSRPFF at p. publishers and songwriters would deal with these revenue measurement 308. In connection with the assertion of benefit directly from such attendance. and attribution issues by the use of a displacement-through-bundling, both See Herring WRT ¶ 34. greater-of rate structure, whereby—if the parties examine—essentially as an [REDACTED]. It has announced an revenue-based royalty is lower than the emblematic case study—Amazon’s offering of a subscription together with other prong (typically a per-subscriber, pricing of interactive music in a bundle a subscription to The New York Times, a TCC prong or the Mechanical Floor)— with one of its products. That study is i.e., a separate entity offering a separate then one of the latter prongs becomes addressed below. product. According to Copyright applicable. By contrast, Copyright Amazon Products and Pricing: A Case Owners, Rysman WRT ¶ 36. However, Owners’ proposal provides for a greater- Study [REDACTED]. SJRPFF at p. 868. of per unit/per-user royalty that does Finally, with regard to Apple, not contain any features pertaining to [REDACTED] Copyright Owners note that the various bundling. As between these two Survey Results music and other services and products alternatives, I find that the 2012 rate are available through Apple, including structure is clearly more consonant with [REDACTED]. 264 iTunes download purchases, Beats the marketplace reality of varying WTP, Other Potential Displacements from music service and, of course, Apple’s through the use of price discrimination Bundling ubiquitous non-music products. See through bundling and, indeed, has COPFF ¶¶ 523–527. Although Copyright accommodated such bundling for a With regard to other bundled offerings Owners do not identify any specific decade. that Copyright Owners claim to bundling or product-to-product I acknowledge Copyright Owners’ improperly diminish revenue and hence displacement, they note more broadly argument that the bundling they the royalty base, the evidence is more that ‘‘Apple’s interactive streaming anticipated may well have been of a descriptive than statistical. With regard service can operate as a gateway into the different nature (e.g., bundling to Google Play Music, Copyright Owners iTunes ecosystem, which Apple uses to interactive streaming with cell phone or point to evidence suggesting that Google sell , apps, and other products.’’ internet service) when they agreed to ‘‘leverages its music business to drive Kokakis WDT ¶ 60. the bundle provisions in the 2012 revenue elsewhere within its settlement, and that they had not enterprise.’’ COPFF ¶ 482A et seq. (and Findings Regarding Displacement, contemplated the myriad ways in which record citations therein). Google, in Discounts and Bundling bundling would occur going forward, response, argues that this argument is I find the parties’ back-and-forth on especially with the entry of large multi- preposterous because ‘‘Google’s other these bundling, discounting and product ‘‘ecosystem’’ firms such as products already reach literally displacement issues (absent a separate Amazon, Apple and Google. However, hundreds of millions of people in the analysis of any given bundle/discount, what that possible difference between U.S. [and] [t]he idea that Google is such as presented by Amazon with anticipated and actual bundling intentionally driving down the price of regard to the bundled $7.99 price for indicates to me is that, hypothetically, Google Play Music in order to ‘‘grow a Echo for Prime members) to be perhaps a different bundling structure, base of customers’’ who will then be indeterminate—and for good reason. As or different rates within the structure, more likely to use Search or Gmail or the Judges have found previously, all might be more appropriate than the Google Maps simply strains such bundling, and associated 2012 rate structure in this regard. But credulity. .... The value proposition discounts, constitute forms of price the Judges cannot deal in hypothetical discrimination, whereby a seller can rate structures and rates: Copyright 264 With regard to this topic, see the discussion increase total revenues for the bundle Owners (and Apple) did not propose of ‘‘cannibalization,’’ infra. and through a discount beyond the such an alternative structure; instead, so

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to speak, they threw out the baby with that Copyright Owners have not royalties under subpart A) with the bath water, rejecting any price presented any evidence that would revenues from interactive streaming discriminatory rate structure (and support the claim that declining (that generate mechanical royalties bundling is a form of price physical and download sales have been under subparts B and C, and discrimination)—proposing instead to caused by increases in interactive performance royalties) is inconsistent replace such a structure with a non- streaming. Thus, in the absence of such with Copyright Owners’ (persuasive) discriminatory rate that fails to address evidence, the Services argue that argument, discussed infra, that there is the varying WTP among listeners from Copyright Owners have merely assumed no sufficient evidence to correlate which upstream demand by the causation from correlation. See JSRPFF listening across purchases and interactive streaming services is at p. 380 (and record citations therein). streaming services. The Services derived. In fact, they point to the testimony of correctly note that the sale of a In these proceedings, the Judges are NMPA’s own witness, Bart Herbison, download or a CD (or a vinyl record) bound by the parties’ proposals, unless Executive Director of Copyright Owner allows the purchaser to ‘‘access’’ that there are record facts that permit the participant NSAI. Mr. Herbison testified purchase an indefinite number of times, Judges to mold a rate structure or rates that he did not ‘‘blam[e] the loss of whereas access through a streaming that vary from the proposals.265 Here, songwriters on streaming,’’ service likewise allows for listening (to with regard to the impact of bundling acknowledging that piracy and various songs) for an indeterminate and other price discriminatory elements disaggregation of the album were major number of times. In this regard, of the rate structure, the choices are problems for songwriters prior to the Copyright Owners’ proposed per-unit stark. Only the 2012 benchmark popularity of streaming, and therefore, royalty rate for streaming is simply not proposed by the Services addresses overall, he was ‘‘not ascribing any large consistent with pricing per unit sold these issues, and in a manner that has percentage of [lower mechanical under subpart B, because the items existed in the market for a decade.266 royalties] to streaming.’’ 3/23/17 Tr. purchased are themselves inconsistent 2940–41, 2945, 2955–56 (Herbison). d. Cannibalization in nature—as Copyright Owners (again, Moreover, not only do the Services persuasively) argue in opposition to the Copyright Owners assert that the note the absence of proof that these use of commercial and academic Services’ benchmarking approach fails changes were caused by interactive conversion ratios to correlate the to account for the ‘‘cannibalization’’ of streaming, they note that the changes number of times a consumer listens to digital download and physical sales, can just as easily be attributed to a song in the purchased product and through listeners’ substitution of changing ‘‘consumer preferences,’’ for streaming spheres. interactive streaming for the purchase of which the interactive streaming services digital downloads and physical should not be penalized. See 3/21/17 Tr. e. The ‘‘Shadow’’ of the Statutory products, mainly CDs. In support of this 2227–28 (Hubbard) (such changes do License argument, Copyright Owners point to not reflect cannibalization, but rather Copyright Owners assert that any the contemporaneous increase in how the industry has evolved to satisfy benchmark, including the Services’ interactive streaming and the decrease ‘‘contemporary consumers’ preferences’’ proffered benchmarks, based on rates set in the sales of digital downloads and and to ‘‘respond to consumer for a compulsory license, are inherently CDs. They note that the sale of digital demand.’’). suspect, because they are distorted by albums and digital tracks decreased by I find that there is no sufficient the so-called ‘‘shadow’’ of the statutory 9.4% and 12.5%, respectively from 2013 evidence to indicate that interactive license. This is a recurring criticism. to 2014, and by an additional 2.9% and streaming has caused the decline of the See, e.g., Web IV 81 FR at 26329–31. 12.5%, respectively, from 2014 to 2015. sale of physical and digital sound More particularly, Copyright Owners See Israelite WDT ¶ 70; Ex. 2773 (2014 recordings. Moreover, even assuming argue: ‘‘The royalty rate contained in Nielsen Report), at 2; Ex. 2780 (2015 arguendo any sales of digital downloads virtually any agreement made by a Nielsen Report), at 7, 8. Thus, they and physical product was caused by the music publisher or songwriter with a argue that the royalty structure (and listeners’ preference for interactive license for rights subject to the rates) must account for this substitution streaming, the effect of such a compulsory license will be depressed by effect through an increase in the phenomenon on songwriter royalties is the availability of the compulsory royalties on interactive streaming. See unclear. Record companies, as licensees, license.’’ COPFF ¶ 708 (and record COPFF ¶¶ 575–586 (and record citations pay royalties to music publishers, under citations therein). In summary, this therein). subpart A, for the musical works alleged shadow purportedly diminishes The Services do not dispute these embodied by record companies in the value of a rate that was formed by statistics. However, the Services argue digital downloads and physical product. private actors who negotiated while Assuming a portion of that royalty understanding that either party could 265 As noted supra, the Judges may also find that revenue is lost (‘‘cannibalized’’) by refuse to consummate a contract and the existing rate structure and rates are appropriate, if the benchmarks proffered by all the parties are interactive streaming, the services that instead participate in a proceeding insufficient. See Music Choice, supra. Thus, the utilize the musical works in those before the Judges to establish a rate. 2012 rate structure would have been an appropriate streams pay both a mechanical royalty Thus, neither side can utilize any structure for the forthcoming rate period even if it and a performance royalty in exchange bargaining power to threaten to actually had not been affirmatively advocated as a benchmark by the Services. for the licenses to use the musical ‘‘walk away’’ from negotiations and 266 I note an important difference between the works. There is insufficient evidence in refuse to enter into a license. In that bundling issue in the SDARS context and that issue the record to conclude that, on balance, sense, therefore, any bargain they struck here. For the SDARS, the issue was how to measure there is a net substitution effect that would be subject to the so-called revenue where only a pure revenue-based rate structure exists, and the Judges noted the difficulty results in lower royalties paid for ‘‘shadow’’ of the regulatory proceeding. in assigning value to different elements of the musical works. The argument that the shadow taints bundle. Here, the 2012 benchmark (the parties’ Further, I agree with the Services that the use of statutory rates, and direct agreement) addresses this indeterminacy by Copyright Owners’ attempt to compare agreements otherwise subject to the adopting alternative royalty prongs, which, as noted in the text, supra, is one way to resolve the sales of downloads and physical statutory license is undercut, however, indeterminacy problem. product (which generate mechanical by section 115 of the Copyright Act,

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which provides that in addition to the differentiation).267 In the present case, can exceed even monopoly-level rates. objectives set forth in section 801(b)(1), because Copyright Owners’ and Apple’s Second, when such negotiations are in establishing such rates and terms, the proposals are structured as per-unit conducted with all the parties at the Copyright Royalty Judges may consider rates, they suffer from deficiencies that figurative table (including perhaps trade rates and terms under voluntary license dwarf any alleged problems associated associations), no single party, whether agreements described in subparagraphs by the alleged shadow of the 2012 licensor or licensee, has (B) and (C). 17 U.S.C. 115(c)(3)(D). The statutory benchmark; that is, assuming disproportionate market power in the two subparagraphs referenced therein, arguendo that the shadow on balance is negotiations. subparagraphs (B) and (C), respectively, problematic rather than beneficial. I agree with Professor Katz that refer to agreements on ‘‘the terms and In the present proceeding, the parties settlement agreements reached in the rates of royalty payments under this weigh-in on the shadow issue with shadow are useful. Because the statutory section’’ by ‘‘persons entitled to obtain several, more particular, arguments. proceeding is the backstop, the power of a compulsory license under [17 U.S.C. Copyright Owners emphasize that the any entity simply to refuse to strike a 115](a)(1)]; and ‘‘licenses’’ covering purpose of their benchmarking deal except on its own unilateral terms ‘‘digital phonorecord deliveries.’’ Id. approach is to avoid the distortions of is effectively negated. Thus, such Thus, it is beyond dispute that Congress the shadow, by utilizing the unregulated settlement agreements tend to eliminate has authorized the Judges, in their sound recording agreements between complementary oligopoly inefficiencies, discretion, to consider such agreements labels and interactive streaming services and provide guidance as to an as evidence, irrespective of—or perhaps and then applying a ratio of sound effectively competitive rate. Indeed, this because of—the shadow cast by the recording: musical works royalties, (the argument is consistent with the Judges’ compulsory license. latter also in unregulated contexts), to ‘‘shadow’’ analysis in Web IV, supra, at Additionally, as noted supra, the develop a benchmark wholly free of the 26330–31 (noting the counterbalancing Judges may consider the existing shadow cast by the statute. 4/4/17 Tr. effect of the statutory license in statutory rates themselves as evidence of 4191 (Eisenach) (‘‘[T]he underlying establishing effectively competitive the appropriate rate for the forthcoming problem with looking at an agreement rates). Further, when such settlement rate period, even when those rates were negotiated under the shadow of a agreements are industrywide, they tend not the product of a settlement. Indeed, license [is that][i]t shifts bargaining to eliminate disproportionate market the Judges may consider existing rates power from the compelled party to the power, and the resulting rates thus may as the starting point and the end point uncompelled party by the very nature of be evidence of a rate that is fair and thus of their analysis. Music Choice, supra, the exercise.’’). consonant with Factor B of section The Services’ experts discount the 774 F.3d at 1012 (the Judges may ‘‘use[ ] 801(b)(1). (This issue is discussed in foregoing shadow criticism. Indeed, the prevailing rate as the starting point further detail in connection with the what Copyright Owners considered of their Section 801(b) analysis’’ and Factors B and C analysis, infra.) vice, the Services laud as virtue. That is, may ultimately find that ‘‘the prevailing Although Copyright Owners are the shift in bargaining power is rate was reasonable given the Section theoretically correct in noting that some precisely what makes any shadow effect 801(b) factors.’’). licenses might have otherwise been of the statutory license tolerable. negotiated at rates higher than the Of course, the fact that the Copyright Professor Katz points out that rates set settlement rate that was affected by the Act and the D.C. Circuit grant the Judges voluntarily by the parties in a settlement shadow, that is simply the tradeoff that statutory authority to consider and rely under the ‘‘shadow’’ provide two the statutory scheme makes in its on statutory rates and related settlement important benefits. 3/13/17 Tr. 661 identification of settlement rates as agreements as evidence does not (Katz). First, with a statutory rate-setting evidentiary benchmarks. That is, such a instruct the Judges as to how much proceeding as a backstop, large licensors theoretical problem needs to be weighed weight to afford such agreements. The cannot credibly threaten to ‘‘hold out’’ against the salutary aspects of exercise of that judicial discretion and ‘‘walk away’’ from the negotiations settlement rate structures and rates, remains with the Judges. without an agreement, thereby negating discussed supra. I find that the benefits But with regard to the particular issue their ability to use their ‘‘must have’’ of the settlement process, in this of the so-called shadow of the statutory status as a cudgel to obtain rates that proceeding, easily outweigh the loss of rate, there is no reason to find such any hypothetical deals that may have benchmark agreements per se inferior to 267 The Judges note that one of the two been reached above the settlement rates, benchmarking methods relied upon by Copyright especially because, in the absence of the other marketplace benchmark Owners subtracts the statutory rate set in Web III agreements that may be unaffected by for noninteractive streaming from a royalty rate shadow, rates higher than the settlement the shadow, because those other derived from the unregulated market for sound rate would be a function, in part, of the benchmarks may be subject to their own recording licenses between labels and interactive Copyright Owners’ complementary streaming services. This would seem to violate the oligopoly and other market power, imperfections and incompatibilities Copyright Owners’ own assertion that statutorily set with the target market. Thus, the Judges rates are tainted by a regulatory shadow and thus which compulsory statutory licensing must not only consider (i) the cannot be used to establish reasonable rates. has been designed to mitigate. importance, vel non, of any potential However, Copyright Owners’ expert testified that, Although I recognize the market- in his opinion, the Judges in Web III accurately based value of a benchmark agreement ‘‘shadow-based’’ differences between identified the market rate for noninteractive the regulated benchmark market and an streaming, so that rate could be utilized as if it were reached under the shadow of the unregulated market that might impact set in the market. 4/4/17 Tr. 4643 (Eisenach). This statutory license, (indeed, economic the probative value of the former, but assertion proves too much. If one expert on behalf actors’ settlement agreements are part of a party may equate a rate set by the Judges with and parcel of the market 268 also (ii) how those differences (if any) the market rate, why cannot the Judges, or any other ), I cannot compare to the differences (if any) party’s expert, do the same with regard to a between the unregulated market and the different statutory rate? The end result of such an 268 For example, the Judges regularly assume in target market (e.g., differences based on approach takes us back to the point the Judges made a benchmarking approach that the contracting at the outset in this section: any rate set by the parties have ‘‘baked-in’’ the values of discrete items complementary oligopoly power, Judges or influenced by the Judges’ rate-setting in their agreement. See, e.g., Web IV, supra, at bargaining constraints and product process must be considered on its own merits. 26366.

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defer to any implicit ‘‘mindreading’’ by settlement, some members of the Subscription, Mixed Use services contracting parties as to the Judges’ streaming community expressed a view covered under Subpart B.’’)).269 application of the all the non-market that the value of any mechanical right Finally in this regard, the services elements of section 801(b)(1). Rather, implicated by interactive streaming is assert that the Judges have made similar the Judges have a duty to independently essentially zero, because the Copyright determinations for analogous sets of apply the itemized factors listed in the Owners are already compensated rights in other proceedings. For statute. Accordingly, I reject the idea through performance payments to the instance, they note that the Judges that rates and terms reached through a PROs. 3/29/17 Tr. 3645–47 (Israelite). effectively set an ‘‘All-In’’ licensing rate for reproductions of sound recordings settlement must be understood to According to Apple, the absence of any and performances of sound recordings supersede—or can be assumed to separate value in the mechanical rate embody—the Judges’ application of the under 17 U.S.C. 112 and 114. The (when separated from the performance services analogize the relationship of statutory elements set forth in section rate) is underscored by the fact that 801(b)(1). However, if on further the performance right and the interactive streaming is the only analysis, the Judges find that provisions mechanical right, on the one hand, with distribution channel that pays both a arising from an agreement in fact do the sound recording ephemeral right reflect the statutory principles set forth performance royalty and a mechanical and the sound recording performance in section 801(b)(1), then the Judges royalty. Rebuttal Testimony of David right on the other, characterizing both may adopt the provisions of that Dorn ¶ 10 (Dorn WRT). pairs of rights as ‘‘perfect settlement in toto, again, if those Thus, according to the services, a complements.’’ See SJPFFCOL ¶ 114 provisions are superior to the evidence determining factor in the 2008 (citing Web IV, 81 FR at 26397–98 submitted in support of alternative rates settlement was Copyright Owners’ (discussing bundling of Secs. 112 and and terms. agreement to a deduction of 114 rights and noting that licensees performance fees, via the acceptance of ‘‘would be agnostic with respect to the 5. The ‘‘All-In’’ Rate Structure and the allocation of those rates to the Section an ‘‘All-In’’ rate. 3/8/17 Tr. 298–301 ‘‘Mechanical Floor’’ 112 and 114 license holders.’’). (Parness); Parness WDT ¶ 7; 3/8/17 Tr. a. The ‘‘All-In’’ Rate Structure Separately, as noted supra, Apple 170–71 (Levine) (explaining benefits of concurs with the adoption of an ‘‘All- The current mechanical royalty rate is ‘‘All-In’’ rate structure). In fact, for the In’’ rate in the forthcoming rate period. calculated as a so-called ‘‘All-In’’ rate. services, according to one of its According to Apple, the Judges should Simply put, the last step when witnesses, the ‘‘All-In’’ nature of the rate adopt an ‘‘All-In’’ rate for interactive calculating the mechanical rate is to was a determining factor in the parties streaming because (1) mechanical and subtract from the intermediate figure the reaching a settlement. 3/8/17 Tr. 300– performance royalties are rate paid by the interactive streaming 301 (Parness). complementary rights that must be services to performing rights Accordingly, the services argue that considered together in order to prevent organizations (PROs) for the ‘‘public this ‘‘All-In’’ rate structure is consistent exorbitant costs; (2) the current statute performance’’ right. All five services uses an ‘‘All-In’’ rate; (3) ‘‘All-In’’ rates (i.e., including Apple) urge the Judges to with the parties’ expectations in settling Phonorecords I and II. See SJPFF ¶ 112. provide greater predictability for establish a statutory rate structure for businesses; and (4) recent fragmentation Additionally, the Services point out that the forthcoming rate period that and uncertainty with respect to many direct licenses between musical contains this ‘‘All-In’’ feature, whereas performance licenses threaten to Copyright Owners request that the rate works copyright owners and streaming exacerbate the problems of high costs for the forthcoming rate period be set services incorporate the ‘‘All-In’’ feature and uncertainty already present in the without regard to the royalty rate paid of the existing section 115 license. See industry.’’ APFF ¶ 138 et seq. (and by the services to the PROs for the JSPFFCOL ¶¶ 143–145 (and record record citations therein). As a policy performance rights. I examine the citations therein). The services also matter, Apple maintains that an ‘‘All- parties’ arguments seriatim below. emphasize that the Copyright Owners’ In’’ rate helps maintain royalties at an recent settlement of the Subpart A i. The Services’ Position (including economically efficient level because it rates—approved by the Judges—implies Apple’s Position) sets a single value for all of the rights an ‘‘All-In’’ feature. Specifically, one of that interactive streaming services must According to the services, a key the services’ expert economic witnesses, obtain from publishers and songwriters. aspect of the 2008 and 2012 settlements Dr. Leonard, testified that, expressed as See 3/23/17 Tr. (Ramaprasad) 2667- was that the rates paid by services for a percentage of payments to the record 2669, 2670 (a mechanical-only rate mechanical royalties would allow for a labels (not as a percentage of total could cause ‘‘exorbitant’’ rates, but an deduction of expenses for public streaming service revenue), the subpart ‘‘All-In’’ rate would not); Expert performance royalties, i.e., the top-line A settlement reflects a payment of Rebuttal Report of Professor Jui rate paid under the Section 115 license 15.8% of ‘‘All-In’’ sound recording Ramaprasad February 15, 2017 ¶ 13 would be ‘‘All-In’’ from the services’ royalties in 2006, and of 14.2% of ‘‘All- (Ramaprasad WRT) (a mechanical-only point of view. Levine WDT ¶ 35; Parness In’’ sound recording royalties, when royalty could lead to ‘‘unreasonably WDT ¶ 7; 3/8/17 Tr. 298–99 (Parness). high combined royalties for publishers compared to payments to record labels In this regard, a Google fact witness, and songwriters’’); see also Leonard in 2015. Leonard AWDT ¶ 46 (noting Zahavah Levine, testified that as far AWDT ¶ 58; Katz WDT ¶ 94; Herring back as 2001, the streaming services that ‘‘these ratios are lower than the WDT ¶ 59. Accordingly, Apple asserts wanted to avoid what she described as current ratios of musical works-to-sound that, by adoption of an ‘‘All-In’’ rate, the a ‘‘double dip’’ problem, whereby a recordings royalties contained in streaming services avoid two separate service might need to conduct separate Section 385, Subparts B and C (e.g., negotiations with PROs and with music musical works royalties are between 269 Of course, the subpart A rates are implicitly publishers in order to obtain usable 17.36% and 21% of the service payment ‘‘All-In’’ because record companies do not pay to record companies for sound performance royalties. I consider further, infra, the musical works license rights. 3/8/17 Tr. evidentiary value of the subpart A settlement and 147–148 (Levine). In fact, prior to recordings for Standalone Portable rates.

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negotiations for the performance right also raise the specter of future this proceeding and is not subject to the and the mechanical right—ensuring that ‘‘withdrawals’’ by music publishers Section 115 license. See COPCOL ¶ 314 these two complementary rights are from one or more PROs. As Apple notes, (citing 17 U.S.C. 106, 115, 201(d); Ex. considered in tandem, with the cost of in the past few years, publishers have 920 at 16; 2 Nimmer on Copyright Sec. one impacting the cost of the other. See taken steps to effectuate such 8.04[B] (‘‘[T]he compulsory license does Dorn WRT ¶ 15; see also 3/13/17 Tr. withdrawals, especially from PROs that not convey the right to publicly perform 587–588 (Katz); 3/15/17 Tr. 1191–1192 are governed by consent decrees. Dorn the nondramatic musical work (Leonard); Herring WDT ¶ 59. WRT ¶ 18; Ramaprasad WRT ¶¶ 13, 63; contained in the phonorecords made Further in this regard, Apple Parness WDT ¶ 17; Katz WDT ¶ 91. under that license. Similarly, a grant of maintains, if a full mechanical-only rate Apple points to the example of one large performing rights does not, in itself, were adopted in lieu of an ‘‘All-In’’ rate, publisher, UMPG, which moved a confer the right to make phonorecords interactive streaming services would portion of its catalog from ASCAP, a of the work.’’)). need to pay for mechanical rights PRO governed by a consent decree, to Copyright Owners further note that pursuant to the statute and then engage SESAC, which is not. 3/27/17 Tr. 3207 performance royalties are set in in an entirely separate negotiation for (Kokakis). Apple also notes that UMPG negotiations between licensors and the performance right. Dorn WRT also fully withdrew from BMI for a brief licensees, subject to challenge in a ‘‘rate ¶¶ 14–15; Ramaprasad WRT ¶ 13. This period in June 2014. 3/27/17 Tr. 3204 court’’ proceeding, and conclude that could lead to an undeserved windfall (Kokakis). Moreover, Apple maintains the Judges cannot set an ‘‘All-In’’ rate for publishers and songwriters as, after that, even when publishers have not because they have ‘‘not been vested this negotiation, total royalty payments actually withdrawn, ‘‘[s]everal with the authority to set rates for that interactive streaming services pay publishers of significant commercial performance rights because they are not for musical works could be importance have threatened [to covered by Section 115.’’ COPCOL exponentially higher than whatever withdraw entirely from ASCAP and ¶ 315.272 mechanical-only rate the Judges adopt. BMI].’’ 3/9/17 Tr. 376–81(Parness); see Copyright Owners also argue in this Dorn WRT ¶¶ 14–15; Ramaprasad WRT also Parness WDT ¶ 17; 3/27/17 Tr. regard that the services have not ¶ 13. Apple avers that this would be 3206 (Kokakis) (UMPG executive provided evidence in this proceeding to unfair—because the royalty payments confirming that he and the services justify and support an ‘‘All-In’’ rate, are all made to the same entities, i.e., the ‘‘had discussed at times the possibility such as evidence showing the rates and publishers and songwriters. Dorn WRT of Universal withdrawing’’ fully from a terms in existing performance licenses; ¶¶ 15–16; see also Herring WDT ¶ 59.270 PRO); 3/28/17 Tr. 3310–3313 (Kokakis) the duration of such licenses; As noted supra, Apple, consistent ([REDACTED]). Apple maintains that benchmarks for performance rights with the other Services, argues that the these events and threats of withdrawal licenses; and the impact of interactive ‘‘All-In’’ rate structure is particularly create uncertainty in the performance streaming on other sources of important because of relatively recent rights marketplace and portend a performance income, including non- industry developments. Specifically, potential increase in performance interactive streaming, terrestrial radio Apple takes note of the recent royalty costs for interactive streaming, and satellite radio income. Further, ‘‘fragmentation’’ 271 and uncertainty in which could not be ameliorated in the Copyright Owners point out that the performance rights licensing that the absence of an ‘‘All-In’’ rate. See PROs and/or all music publishers are all services all claim to threaten an Ramaprasad WRT ¶ 63 (the only certain necessary parties for any such exacerbation of the existing uncertainty result of publishers withdrawing is that determination, but they were not over royalty costs. See Dorn WRT performance royalties ‘‘will increase’’); proffered by the services. See COPCOL ¶¶ 17–18; Ramaprasad WRT ¶¶ 13, 63; 3/8/17 Tr. 256–57, 262–63(Levine); 3/ ¶ 319. Parness WDT ¶¶ 16–20; Katz WDT 13/17 Tr. 602–04 (Katz) (fragmentation For these reasons, Copyright Owners ¶¶ 87–94; Tr. 3/13/17 Tr. 602–604 leads to higher performance rights decry as mere ‘‘sophistry’’ the services’ (Katz). Apple notes that this problem costs). argument that they are not asking the may be exacerbated because of the Judges to set performance rates, but ii. Copyright Owners’ Position rather only to ‘‘set’’ a ‘‘mechanical’’ rate emergence of a fourth PRO, Global Regarding an ‘‘All-In’’ Royalty Rate Music Rights (GMR), in addition to that permits them to deduct what they ASCAP and BMI, as well as SESAC Copyright Owners initial argument is pay as a performance royalty. More which (like GMR, and unlike ASCP and jurisdictional in nature; they emphasize particularly, they argue that this BMI) is not subject to a consent decree that this is a proceeding to set rates and approach, if adopted, would leave the and rate court review (as discussed terms for the Section 115 compulsory mechanical rate indeterminate, subject infra). Parness WDT ¶ 18; Katz WDT mechanical license to make and to whatever is decided in negotiations ¶ 91. See 3/9/17 Tr. 382–83 (Parness); 3/ distribute phonorecords, not to perform or judicial action regarding the 13/17 Tr. (Katz) 602–604. works. 17 U.S.C. 115, 801(b)(1). More mechanical rate. See COPCOL ¶ 320. In addition to the problems created by particularly, they note that, whereas the Indeed, Copyright Owners note, under potential fragmentation, the services Section 115 compulsory license the Services’ ‘‘All-In’’ proposal, the explicitly applies solely to ‘‘the mechanical rate could be zero (if 270 Pandora and Google separately make the same exclusive rights provided by clauses (1) performance royalties are agreed to or arguments as Apple in this regard. See Pandora and (3) of section 106, to make and to set by the rate courts at a rate that is PFFCOL ¶¶ 35–36 (and record citations therein); distribute phonorecords of [nondramatic Google PFF ¶ 29 (and record citations therein). musical] works,’’ it does apply to the 272 Copyright Owners note that performance 271 ‘‘Fragmentation’’ refers to the existence of exclusive right provided by clause (4) to royalties are set directly in negotiations between more than one owner of copyrights to a musical licensors and licensees, but if the either of the two work, requiring an interactive streaming service to perform the work publicly. 17 U.S.C. largest PROs (ASCAP and BMI) and licensees are engage in a costly and uncertain attempt to locate 106, 115. Thus, Copyright Owners unable to enter into consensual agreements, they each owner and provide it with a separate Notice argue, the public performance right rates are set in a federal court action in the of Intent and to bear the risk of a potential provided by 17 U.S.C. 106(4) is an Southern District of New York (before a designated infringement action if one or more copyright ‘‘rate court’’ judge), pursuant to existing Consent owners is not located. SJPFF ¶¶ 162–63 (and record entirely separate and divisible right Decrees. See COPCOL ¶ 316; Register’s Report at 20, citations therein). from the mechanical right at issue in 34, 37, 41.

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greater than or equal to the ‘‘All-In’’ rate Thomas Kelly ¶ 66; Witness Statement b. The ‘‘Mechanical Floor’’ proposed by the Services here)—and, of Michael Sammis ¶ 27; Yocum WDT i. Copyright Owners’ Position they argue, ‘‘a mechanical royalty rate of ¶ 23; Israelite WDT ¶ 71 (all asserting zero ‘‘is anything but reasonable.’’ that combining mechanical royalties Copyright Owners urge the Judges to COPCOL ¶ 322. and performance income in a single retain the Mechanical Floor.275 They In an evidentiary attack, Copyright ‘‘All-In’’ payment will diminish emphasize that the Mechanical Floor Owners demonstrate that the only payments to songwriters, and will establishes a minimum value protecting percipient witness who engaged directly negatively impact the publishers’ ability the mechanical right, in that it cannot be in the 2008 negotiations involving the to recoup advances, which will, in turn, reduced by subtracting the performance ‘‘All-In’’ rate (or any other matter) was royalty as occurs under the ‘‘All-In’’ negatively impact the size and number the NMPA president, David Israelite, rate. See Israelite WRT ¶¶ 19–22, 29, 81; of future advances). and that, by contrast, the services’ two 3/29/17 Tr. 3632, 3634–3636, 3638, witnesses, Mr. Parness and Ms. Levine, Copyright Owners further assert that 3754, 3764–3765 (Israelite); 3/8/17 Tr. did not participate directly in those the Services’ claim that increasing 259 (Levine). negotiations. See CORPFF–JS at 58. ‘‘fractionalization’’ of licenses justifies They also note that the revenue Thus, Copyright Owners assert that the an ‘‘All-In’’ rate is a red herring. displacement and deferral problems services cannot credibly argue based on Specifically, they argue that there has they allege to exist under a percentage what the negotiating parties actually always been fractional licensing of of revenue ‘‘do not exist’’ with the intended with regard to, inter alia, the performance rights by the PROs, Mechanical Floor because that rate is ‘‘All-In’’ rate.273 because there typically are multiple expressed on a per subscriber basis. Copyright Owners also take aim at the songwriters and publishers with COPFF ¶¶ 639–40. [REDACTED]. In this services’ argument that it matters not ownership rights in a song and they may regard, Copyright Owners maintain that whether they pay royalties designated as not all be affiliated with the same PRO, the Services’ desire to eliminate the ‘‘performance’’ or ‘‘mechanical,’’ and there is no legal basis on which any Mechanical Floor is nothing other than because the same rights owners are also a ‘‘thinly veiled effort to sharply reduce receiving performance royalties. one PRO has the right to license rights that it does not have. Israelite WRT the already unfairly low mechanical According to Copyright Owners, this royalties.’’ COPFF ¶ 644. The import of argument: (1) ignores the fact that the ¶¶ 65–66; 3/29/17 Tr. 3662–63 (Israelite); HX–327; 3/9/17 Tr. 372–73 the Mechanical Floor is underscored by Copyright Act creates separate and Dr. Eisenach who testifies that, in 2015, distinct mechanical and performance (Parness). Moreover, they claim that, contrary to the Services’ assertions, the [REDACTED]. Written Rebuttal rights, and made only the former subject Testimony of Jeffrey A. Eisenach, Ph.D. presence of GMR has not altered the to compulsory licensing under Section ¶ 115 (Eisenach WRT). 115; (2) ignores the fact that the rates for extent of fragmentation in any manner, the use of those two rights, to the extent let alone increased the degree of Copyright Owners further argue that the Mechanical Floor is necessary to not agreed, are set in different fragmentation in the marketplace. In preserve a source of royalty revenue for jurisdictions; and (3) ignores the particular, Copyright Owners point out disruption that would be caused by the payment of advances to songwriters that the Services admitted that GMR and the funding of recoupments of prior eliminating mechanical royalties— represents fewer than 100 songwriters disruptions arising from (a) the fact that advances paid by publishers to and has a meager market share of songwriters. COPFF ¶ 640 (and record mechanical royalties are the most roughly 3 percent of the performance significant source of recoupment of citations therein). They also point out market. 3/9/17 Tr. 365–67 (Parness); see that songwriters benefit more from advances to songwriters; and (b) also Israelite WRT ¶ 59. Copyright songwriters receive a greater share of publishing agreements than from Owners also note that the Services mechanical royalties than they do of agreements with PROs, because, under presented no evidence either that there performance royalties (both because of current publishing agreements, the standard splits in songwriter has been an increase in performance songwriters typically receive 75% or agreements and the fact that rates in licenses issued by GMR, or, more of mechanical income whereas the performance income, unlike mechanical more generally, of any actual or PRO’s split performance income 50/50 income, is diminished by PRO potential impact of this alleged between publishers and songwriters. Id. commissions). COPCOL ¶ 323; COPFF ‘‘fragmentation’’ of the performance Finally, Copyright Owners note that the ¶ 640.274 See also Witness Statement of rights marketplace on their interactive PROs charge songwriters a fee, further streaming businesses. 3/9/17 Tr. 381 reducing the value of the performance 273 Copyright Owners take this argument one step (Parness). income relative to income. Id. further—maintaining that consequently the Services ‘‘have presented no competent evidence that an Next, Copyright Owners note that the ii. The Services’ and Apple’s ‘‘All-In’’ rate structure ‘‘is consistent with the issue of publisher withdrawals from Arguments for Eliminating the parties’ expectations in settling Phonorecords I and PROs—if it ever was a justification for Mechanical Floor II.’’ CORSJPCL ¶ 112. It is difficult to conclude that this fundamental rate structure, agreed to in two an ‘‘All-In’’ rate—has been overtaken by Despite their trumpeting of the 2012 separate settlements between the parties, was not events. Specifically, they note that the settlement as an appropriate benchmark, consonant with their ‘‘expectations.’’ ASCAP and BMI rate courts in the the Services (and Apple, which does not 274 Copyright Owners note that, in Phonorecords Southern District of New York, the I, Judge Sledge voiced a similar sentiment from the rely on the 2012 structure) propose the bench, referring to consideration of the performance Second Circuit and the Department of elimination from that benchmark of the royalty as a ‘‘waste of time.’’ COPFF ¶ 597 (and Justice have determined that partial Mechanical Floor in the forthcoming record citations therein). The Judges are not bound withdrawals by publishers are not by any prior statement by a Judge that is not a part of a prior determination. Moreover, the Judges note permitted. Ex. 876, at 4; Israelite WRT 275 The Mechanical Floor refers to the step in the that they are not in this proceeding ‘‘setting’’ the ¶¶ 62–63, citing In re Pandora Media, rate calculation after the ‘‘All-In’’ rate has been performance royalty rate, but rather considering Inc., supra, 1. calculated. If that calculation would result in a whether that royalty payment should be a dollar royalty payment below the stated Mechanical deduction in the formula for calculating the Floor rate, then the Mechanical Floor rate would mechanical license. bind.

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rate period. In support of this position, c. Findings Regarding the ‘‘All-In’’ Rate an acknowledgment that the royalties they make the following arguments: and the Mechanical Floor for licenses which are perfectly • When negotiating both the Phonorecords I find that the ‘‘All-In’’ rate is a complementary can be calculated in a I and Phonorecords II settlements, the necessary and proper element of the manner that reduces one royalty to services acquiesced to the Copyright Owners’ 2012 benchmark, and must remain in reflect another royalty i.e., the sound insistence that this Mechanical Floor be the rate structure for the forthcoming recording license is reduced by the included in the rate structure, because the rate period. As an initial matter, I reject value of the ephemeral license. See Web services believed that the Mechanical Floor Copyright Owners’ argument that the IV, 81 FR, supra, at 26398 (‘‘The Judges was ‘‘illusory,’’ i.e., that it was ‘‘highly ‘‘All-In’’ feature is unlawful because the . . . find that the minimum fee for the unlikely to ever be triggered . . . .’’ SJPFF Judges do not regulate performance [s]ection 112 license should be ¶¶ 127, 160 (and record citations therein). subsumed under the minimum fee for See also Apple PFF ¶¶ 85, 165 (arguing that rates. The ‘‘All-In’’ feature does not the Mechanical Floor in the current rate constitute a regulation of the the [s]ection 114 license, 5% of which structure adds uncertainty and leads to performance rate, but rather represents shall be allocable to the [s]ection 112 services paying ‘‘windfall’’ royalties to the a cost exclusion (or deduction) from the license holders, with the remaining 95% Copyright Owners well above the ‘‘All-In’’ mechanical rate. I recognize, as do the allocated to the [s]ection 114 license amount); Google PCOL ¶ 22 (asserting that parties, that the royalties otherwise due holders.’’). Of particular importance for the triggering of the Mechanical Floor in under a revenue-based format may this Dissent is the fact that the some circumstances has been caused by exclude certain costs. See 73 CFR subsuming of the section 112 ephemeral Copyright Owners leveraging market power). 385.11(Definition of ‘‘Service Revenue,’’ license fee within the section 114 In this regard, the Services assert that the paragraph (3) therein).276 license was done at the behest of the parties who negotiated the Phonorecords parties, and in fact dates back to the settlements did not expect a Mechanical The exclusion of performance Floor to bind, due to longstanding, stable royalties in the ‘‘All-In’’ calculation is parties’ agreement as to that issue since public performance rates. 3/8/17 Tr. 309 also necessary, because—as all parties Web I. See Web IV, supra, 81 FR at (Parness); Parness WDT ¶¶ 9, 21; Levine and economists agree—mechanical 26396–97 (‘‘The current $500 minimum WDT ¶ 35; 3/8/17 Tr. 254:24–256:8 (Levine). rights and performance rights are perfect fee for commercial webcasters has been • Past and potential future fragmentation complements. That is, each right is in force for more than a dozen years, of the licensing of public performance rights, worthless without the other. See and has been voluntarily re-adopted by threatened withdrawals by music publishers generally, Varian, supra, at 40 (‘‘Perfect licensors and licensees.’’).277 from PROs and the advent of new PROs, all complements are goods that are always However, the performance license and combine to increase the likelihood that the consumed together in fixed proportions the mechanical license, while Mechanical Floor will be triggered. Katz WDT ¶¶ 87, 91. . . . A nice example is that of right and overlapping in important respects, do • Because mechanical rights and public left shoes.... Having only one out of not overlap in all respects. performance rights are ‘‘perfect a pair of shoes doesn’t do the consumer Consequently, I find that, for several complements’’ from the perspective of an a bit of good.’’). reasons, the Mechanical Floor now in interactive streaming service, there is no Accordingly, if the mechanical rate the regulations should also be included economic rationale for setting the two rates was set in this proceeding without a in the rate structure for the forthcoming separately from one another. Id. ¶ 88. See credit for the performance rate, the rate period. also Leonard AWDT ¶¶ 56, 82–83 (relying on perfect complementarity of the two First, the fact that the performance the ‘‘perfect complements’’ argument to licenses would be ignored, and the right and the mechanical right are advocate for an elimination of the interactive streaming services would necessary complements to the licensees Mechanical Floor). Marx WDT ¶¶ 135, 165 pay two times for the same economic (‘‘Economic efficiency would be improved by does not end the inquiry. As Copyright removing the $0.50 per-subscriber fee floor right—the right to stream the musical Owners point out, the mechanical from the paid subscriber mechanical royalty work embodied in the sound recording. royalties are used by the publishers in formula’’ and ‘‘[REDACTED]’’). Further, as the Services note, there is a part to fund advances to songwriters, • [REDACTED] Id. substantial overlap not only in the and their subsequent recoupment, thus • Triggering of the Mechanical Floor songwriters who receive royalties from providing an important source of would not reflect an increase in the value of both licenses, but also in the entities liquidity to songwriters, pending the performance rights or mechanical rights, but that negotiate these rates on their behalf. later payment of royalties. If the ‘‘All- rather would reflect the ability of copyright Thus, it is appropriate to continue to In’’ rate substantially reduces or fully holders to exert market power over recognize the economic and bargaining- eliminates the mechanical portion of the interactive services in the form of supra- entity overlaps by continuing to exclude competitive performance rights license fees. calculation, the pool of funds available Id. 94. the performance rate through the ‘‘All- for advances and recoupments would be • A Mechanical Floor defeats the benefits In’’ rate structure. In this regard, I agree reduced. of an ‘‘All-In’’ rate. Apple PFF ¶¶ 164–167. with the Services and Apple that the Thus, the Services’ argument that the (and record citations therein). Judges’ treatment of the ephemeral mechanical right has no standalone • It is incorrect that Copyright Owners license as embodied within the sound value, while sufficient to support an ‘‘had no control over’’ public performance recording license in combined section ‘‘All-In’’ rate, is incomplete and, to an rates. The Services note that the same 112 and 114 proceedings is implicitly extent, self-serving, with regard to the publishers that are members of the NMPA board, controlling its policy and strategy, are Mechanical Floor issue. To the music 276 I recognize that the reduction of the publishers and songwriters, the also member of the board of ASCAP, the mechanical rate interim calculation by the amount largest PRO. SJRPFF–CO at p. 284 (citing In of the performance rate in ‘‘Step 2’’ (see re Pandora Media, Inc., 6 F. Supp. 3d 317, § 385.12(b)(2)), acts as an exclusion from royalties 277 The consensual nature of the handling of these 341 (S.D.N.Y 2014) (describing how rather than a deduction from revenue (by analogy, perfect complements in Webcasting proceedings representatives of UMPG, Sony/ATV, and just as a tax credit is a subtraction from taxes, underscores the difference between the whereas a tax deduction is a subtraction from appropriateness of adopting an ‘‘All-In’’ rate that BMG all work with each other as ASCAP income). However, there is no statutory or has been the subject of long-standing agreement in board members and work with David Israelite regulatory impediment that prohibits this exclusion this proceeding (ten years) and the of the NMPA). from royalties. Also, it is noteworthy that the costs inappropriateness of the majority’s binding of the that are excluded under current § 385.12(b)(2) are parties in this proceeding to the rates of another [REDACTED] all costs over which the Judges have no authority. perfect complement, the sound recording rate.

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mechanical right does have a separate Second, although the services assert ASCAP and BMI); and (4) some value, in the funding of songwriters, a that they had dismissed the triggering of fractional (a/k/a fragmented) licensing value not provided by the performance the Mechanical Floor as ‘‘illusory,’’ that has always been present in the market. royalty. It is essentially a source of dismissal was demonstrably incorrect, See CORPFF–JS at pp. 87–90 (and royalty revenue that has been as evidenced by the large number and record citations therein). designated and created through an arm’s percent of service-months in which the Fifth, I reject a further complaint, length negotiation, by which songwriter Mechanical Floor has been triggered. advances and recoupments can be Moreover, [REDACTED]. Marx WDT [REDACTED], that the Mechanical Floor funded. The fact that this pool or source ¶ 76. More generally, the Mechanical is perverse, because lower retail pricing of revenue arises from the payment by Floor provides a form of insurance to that diminishes revenues will increase services for the mechanical right that is Copyright Owners that the mechanical the likelihood that the Mechanical Floor a perfect complement (from their royalty will not be reduced or will bite. I see this too as a feature of perspective) to the performance right is eliminated if services trigger that rate this floor—not a bug. As Pandora’s not the point; Copyright Owners have a alternative because of relatively high witness, Mr. Parness, explained (see 3/ right to the benefit of the 2012 performance rates. 9/17 Tr. 354 (Parness)), the Mechanical bargain 278 that identified a floor below Third, I am unpersuaded by the Floor was made part of the ongoing which their source of advances/ Services’ argument that the sole reason settlement terms expressly because recoupment funds would not fall. By the Mechanical Floor has been triggered Copyright Owners were fearful that analogy, the cost of any publisher input, is because the performance royalty rate retail pricing would be too low and not just the cost of providing liquidity has increased significantly ‘‘to levels not generate decreased royalties under other to songwriters, such as, for example, the foreseen when the Mechanical Floor prongs. cost of heating the buildings in which was negotiated.’’ SJRPFF–CO at pp. songwriters toil, has no direct, 411–12. I find that criticism puzzling; Finally, I do not agree with the standalone value to the services, yet no the purpose of the Mechanical Floor is assertion that the presence of the one would assert that the licensors are to limit the extent to which the Mechanical Floor rate ‘‘defeats the not entitled to a pool of royalty revenue performance royalty rate would benefits’’ of an ‘‘All-In’’ rate. To be sure, sufficient to recover their heating costs. diminish the mechanical rate through the Mechanical Floor limits the value of Liquidity funding for songwriters is a the ‘‘All-In’’ approach. Thus, the the effective cost reduction embodied in necessity, just as heat is a necessity— services are asserting that the essential the ‘‘All-In’’ rate, but that limitation and the complementary nature of the nature of the Mechanical Floor is a bug, does not defeat the ‘‘All-In’’ rate. This rights to the Services is of no relevance when in fact it is a defining feature— critique actually underscores a broader in that regard. (In fact, providing again, a form of rate insurance for which infirmity in the services’ arguments in financial liquidity to songwriters, like the music publishers/songwriters opposition to a continuation of the providing them with a heated building, bargained, and to which the services Mechanical Floor. They maintain that of course indirectly does benefit the acquiesced, when agreeing to the 2008 the 2012 settlement, carrying forward services, because songwriters who are and 2012 settlements. essentially the structure of the 2008 financially illiquid or physically frozen Fourth, I do not find that the potential settlement, has worked satisfactorily for from lack of heat, are equally unable to for further fragmentation of musical licensors and licensees alike. I agree, write the musical works that the works licenses and publisher 279 finding that the present rate structure services must play.) withdrawals is a sufficient reason to should be continued. However, the In recognition of the importance of consider eliminating the Mechanical Services, contrary to their basic advances to songwriters, Professor Katz Floor. Copyright Owners have argument, seek to disrupt the status quo speculates that the problem of convincingly argued that: (1) Services that they otherwise recommend, in recouping advances could be solved by have offered no evidence that the transferring some of the advancements introduction of the new PRO, GMR, will order to obtain a better bargain than from the music publishers to the PROs. have any impact on the performance contained in that benchmark. To put the 3/13/17 Tr. 607 (Katz). However, I am royalty rate; (2) partial withdrawals are point colloquially, the Services cannot loath to join in speculation that parties not permitted by the rate court, the have their cake and eat it too. over whom the Judges have no Second Circuit or the Department of 6. Findings Regarding the Rate jurisdiction will voluntarily change the Justice; (3) there is no evidence of Structure conduct of their businesses, and then increasing performance rates (and the bootstrap those speculative predictions rate courts can ensure ‘‘reasonable’’ Based on the foregoing, and as to support their rulings.280 rates charged by the two largest PROs, detailed further below, I conclude that the 2012 rate structure constitutes a 278 I note that the majority maintains the saw’’ assertion regarding an assumed willingness by Mechanical Floor. However, the Mechanical Floor usable objective benchmark in this record companies to agree to a decrease in sound 281 was part of the trade-off of consideration within the recording royalties in response to an increase in proceeding. Based on the foregoing, I 2012 benchmark settlement. It is inconsistent for mechanical royalties, as discussed infra. Also, the reject the per-unit rate structure the majority to maintain this vestige of the 2012 point in the accompanying text should be advocated by Copyright Owners. I also benchmark while rejecting its other aspects, in favor contrasted with the basis for adoption of an ‘‘All- reject the services’ proposal to eliminate of the post-hearing rate structure they have created. In’’ rate: The industry over which the Judges have This yet another example of how the majority’s rate jurisdiction in this proceeding for ten years has the Mechanical Floor. structure—to borrow from Copyright Owners’ operated under a rate structure (which I find to be analogy—picks provisions from columns A, B . . . a useful benchmark), that incorporates the ‘‘All-In’’ and now C, when inventing its post-hearing adjustment to account for the performance royalties. 281 structure. Thus, the Mechanical Floor and the ‘‘All-In’’ I note once again that, separate and apart from 279 From a more technical economic perspective, structure are both parts of the 2012 benchmark, its usefulness as a benchmark in this proceeding, all productive upstream inputs benefit downstream revealing the parties’ longstanding willingness and the existing rate structure can also constitute a re-sellers. ability to operate under an overall structure in reasonable rate that the Judges may adopt, 280 This is the same principle that leaves me which performance royalties are subject only to a particularly in the absence of any contrary reluctant to rely on speculation inherent in the limited deduction in the calculation of the probative record evidence. See Music Choice, supra, Majority Opinion and in Copyright Owners’ ‘‘see- mechanical royalty. 774 F.3d at 1010.

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7. The 2012 Benchmark, in its Entirety, shall constitute evidence of market end.... [I]f the Copyright Owners’ is a More Useful Benchmark than a Per- rates. Therefore, I cannot simply proposal were adopted, [the services] Unit Rate Structure or the Services’ disregard the settlement rates as would have the ability to negotiate Modified Version of the 2012 immaterial evidence. See 17 U.S.C. direct agreements with publishers.’’) Benchmark 115(c)(3)(D). Of course (as noted supra), (emphasis and underscore added). I further find that the discriminatory the Judges may give whatever weight Professor Rysman, echoed Dr. rate structure in the 2012 benchmark they think is proper to such evidence, Eisenach in this regard, when renders it a more useful benchmark than without running afoul of any statutory discussing the potential impact on the per-unit proposals set forth by duty. As explained in further detail Spotify of Copyright Owners’ proposed Copyright Owners and Apple. Although below, for a number of reasons, I not substantial rate increase: the 2012 rate structure is not necessarily only find this benchmark useful, I also [REDACTED] the best structure that could have been accord substantial weight to this benchmark. 4/3/17 Tr. 4390, 4431 (Rysman) designed, it possesses the characteristics (emphasis added). of a useful and beneficial benchmark. In First, the record indicates that that regard, I take note of the four classic Copyright Owners have demonstrated Thus, I find there to be no real dispute characteristics of an appropriate (albeit tacitly) their understanding that, as to the need for an upstream benchmark, as identified by the federal if the Judges did not set a price discriminatory rate structure. To borrow rate court: discriminatory rate structure to reflect from a classic story, I perceive that the the varying WTP, Copyright Owners parties are not in disagreement as to In choosing a benchmark and determining what kind of rate structure is needed in how it should be adjusted, a rate court must would have to invent it. This finding is apparent from a careful reading of their the market, but are rather ‘‘haggling over determine [1] the degree of comparability of 283 the negotiating parties to the parties advocacy for the adoption of a the price.’’ Perhaps more contending in the rate proceeding, [2] the bargaining room approach to rate- importantly, the parties appear to be in comparability of the rights in question, and setting. That approach is explicitly disagreement as to who and what shall [3] the similarity of the economic premised on the idea that Copyright be in control of the setting of rates, the circumstances affecting the earlier Owners would offer to enter into Judges and the statute on the one hand, negotiators and the current litigants, as well multiple and different price or Copyright Owners and the as [4] the degree to which the assertedly discriminatory agreements with various unregulated market on the other. The analogous market under examination reflects answer is—as it must be according to an adequate degree of competition to justify services, if the high statutory rate set reliance on agreements that it has spawned. under the bargaining room theory is too statute—that it is the Judges who set the rates. They are instructed by statute and In re Pandora Media, supra, at 354. high for some services to operate. This point is made clear by the testimony of guided by precedent to set a reasonable The 2012 benchmark meets these rate and to consider several itemized criteria. First, it pertains to the same Professor Rysman and Dr. Eisenach. See, e.g. 4/3/17 Tr. 4390, 4431 (Rysman) factors, not to cede that authority to any rights at issue in this proceeding. 284 (lauding the bargaining room approach market participant. Further, as Second, the licensors (music publishers) Professor Katz testified, the statutory and licensees (interactive streaming as reflecting the ‘‘economical element of price discrimination . . . the [licensor] license, and negotiations undertaken services) categories are comparable (if under the so-called shadow of that not identical).282 Third, the economic is picking its prices carefully.’’) (emphasis added). license, incorporate a countervailing circumstances are sufficiently similar power that allows the streaming services and the same in crucial respects, i.e., the The following colloquy between the Judges a more equal bargaining position. ongoing differentiated nature of this and Dr. Eisenach is also instructive: 3/13/17 Tr. 577 (Katz). Under the marketplace and the zero marginal [THE JUDGES] bargaining room approach, that salutary physical cost of the licensed copies, (as Are you familiar with the concept of the aspect of the statutory scheme would be discussed supra). Fourth, the 2012 bargaining theory of rate setting . . . [t]he eliminated. benchmark it reflects a rate structure idea that rate setters, such as this Board, Second, and related to the prior point, with an adequate degree of competition should set rates that are higher than the I find the 2012 rate structure to be a very because, as explained in connection market rate for certain users because they can useful benchmark because it embodies a then, as you are testifying to now, can with the discussion of the shadow price discriminatory rate structure that effects, it is a rate free of complementary bargain with the licensors for lower rates to use a bargaining concept in the setting of reflects the downstream market’s oligopoly effects and of an imbalance in rates? segmentation by WTP. Although market power. Further with regard to [DR. EISENACH] Copyright Owners correctly argue that this fourth point, the parties have been discriminatory upstream rates are not operating over the past ten years under So as you have just stated it, I think that required in order to accommodate this basic rate structure, with profits is consistent with my testimony in this matter, which is that the compulsory license downstream price discrimination, they accruing to the licensors and admittedly serves as a back-stop. It is a guaranteed cap do not provide a sufficient counter- tolerable losses for the licensees. on what anyone would have to pay. The argument to the Services’ point that the More particularly, I re-emphasize that, ability to negotiate mutually beneficial upstream rate should also be price as a matter of law, section 115 bargains below that cap is there for all of the discriminatory in order to incentivize, specifically provides that settlements parties. And the incentives to do so are there as well. 283 The provenance of the story in which the 282 Copyright Owners assert that the different 4/4/17 Tr. 4845 (Eisenach) (emphasis quoted phrase is the punch line is uncertain, and identities of the licensees, particularly the market has been variously attributed to, inter alios, George entry of Amazon, Apple and Google, and their and underscore added); see also id. at Bernard Shaw, Winston Churchill, Groucho Marx, bundling and discounting of interactive streaming, 4843–44 (‘‘one thing that I took into Mark Twain, W.C. Fields, and Bertrand Russell. diminish the comparability of the 2012 benchmark. account in considering . . . higher 284 This point underscores a defect in the Majority The Services note that even prior to the entry of mechanical rates . . . is the ability of Opinion. Under its provisions, participants in a these three entities, similar multiproduct firms were streaming services to negotiate direct neighboring market, the record companies in the licensees—including Yahoo and Microsoft. I sound recording market, who license their own discuss the bundling and discounting issues deals with the publishers.... We’re perfect complement, will have economic control elsewhere in this Dissent. looking here at an upper and not a lower over the mechanical royalty rate, via the TCC prong.

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rather than jeopardize, the downstream segmented downstream demand, ‘‘greater of’’ structure’’ with a ‘‘lesser of’’ licensees’ satisfaction of the varying making an upstream discriminatory rate prong). 287 WTP among listeners. Absent such a structure more efficient, even if not Fifth, I rely on the 2012 rate structure structure, the services are more likely to necessary. I find that, in a second-best as an objective benchmark. Thus, the face the vexing problem of essentially world such as the interactive streaming absence of more direct testimony fixed revenues and variable costs, under industry, a consonance between regarding what went through the minds the ‘‘all-you-can-eat’’ model demanded upstream and downstream pricing of the negotiators of the 2008 and the by listeners. Although Copyright structures enhances efficiency.286 2012 settlement does not diminish the Owners may well be correct in their objective value of this benchmark. I do argument that an upstream Fourth, Copyright Owners argument not place dispositive weight on the discriminatory rate structure can be that the 2012 benchmark, with its subjective reasons why the parties may accomplished without resort to a attendant multi-pronged rate structure, have entered into the prior settlements. revenue-based rate structure (that is, for is inconsistent with the idea that a I view the terms of the 2012 settlement example, via different per-play rates), musical work has (or should have) a as potential objective benchmark neither Copyright Owners nor Apple single ‘‘inherent’’ value, see, e.g., information. See, e.g., 3/13/17 Tr. 550– proposed such an alternative Israelite WDT at 10; ¶ ¶ 29(B), 30, 31(C); 51, 566 (Katz) (acknowledging his lack discriminatory rate or provided Brodsky WDT ¶ 68, is actually of knowledge as to why the parties evidence by which the Judges could inconsistent with Copyright Owners’ negotiated specific provisions of the mold such rates (as they did in Web IV). own proposed rate structure. That is, 2012 settlement, but noting that Third, I find insufficient evidence to Copyright Owners’ proposal, that the objectively the results of the settlement support Copyright Owners’ assertion statutory rate automatically should shift demonstrate the satisfactory that the market in 2012 was not yet from a per-play rate to a per-user rate if performances of the market). Further, ‘‘mature’’—compared with the market at the latter leads to greater royalties, both Professor Katz and another present—and that the 2012 rate belies their fealty to the ‘‘inherent Services’ expert, Professor Hubbard, structure was thus ‘‘experimental.’’ At a value’’ argument. Rather, their greater-of noted that the current rate structure high level, all markets are not ‘‘mature,’’ approach demonstrates their eagerness remains valuable, not based on their in the sense that they are dynamic and to jettison this concept if another consideration of the parties’ subjective thus subject to change, making all rate measurement tool (the per user rate) understandings at the time of structures ‘‘temporary,’’ if not could result in greater revenue. That is, settlement, but rather because the ‘‘experimental.’’ Moreover, the ongoing Copyright Owners’ proposal seeks to market has not since changed in a creative destruction in the streaming accommodate two separate values manner that would create a basis to industry has only reinforced the fact (value-in-use and access (option) value, depart from a multiple-rate upstream that, even since 2012, the interactive while denying that other marketplace rate structure. Katz WDT ¶ 80 (‘‘My streaming services market is still not yet values can exist, even if they reflect analysis has identified no changes in ‘‘mature.’’ See. e.g., Written Direct industry conditions since then [2012] Testimony of Paul Joyce (on behalf of varying WTP and varying ability-to- pay). that would require changing the Google Inc.) ¶ 17 (Joyce WDT) fundamental structure of the percentage- (describing Google Play Music as I recognize that the 2012 benchmark of-revenue prong.’’); 4/13/17 Tr. 5977– ‘‘nascent compared to other participants is also a greater-of approach, but it 78 (Hubbard) (changes in the market are 285 in the streaming music market.’’) blends into that approach a ‘‘lesser of’’ ‘‘not uncorrelated with the structure However, even if Copyright Owners’ approach (per subscriber or TCC) within that was in place’’ in 2012). In this maturity/experimental argument had one of the ‘‘greater of’’ prongs. Thus, regard, it bears emphasis that Dr. merit, it does not supersede the there is no real fundamental dispute Eisenach, quite properly, relied on convincing economic logic that a price between Copyright Owners and the several potential benchmarks for his rate discriminatory rate structure remains Services as to whether rates may be analysis, without attempting to examine appropriate, because the economic disconnected from unit pricing. Rather, the parties who negotiated those fundamentals endure. The cost of the question is whether the disconnect benchmark agreements. He too was producing an additional copy of a will be made to benefit only Copyright treating potential benchmarks in an musical work remains zero. A market Owners (in a manner that would cause objective manner, consistent with my segmented by WTP is efficiently served substantial negative impact to Services, understanding of the long-standing through price discrimination. Upstream (as detailed in Professor Ghose’s rebuttal method of using benchmarks for the demand for licenses is a derived testimony, discussed supra), or will be setting of rates. demand, see 3/20/17 Tr. 1967–68 structured to reflect the parties’ Sixth, I do not credit the arguments by (Marx), and thus a function of the historical and ongoing bargain that Copyright Owners and Apple (and by softens and balances the impact of a the majority) that the present rate 285 In this regard, it is noteworthy that another of Copyright Owners’ expert economic witnesses— greater-of structure. See 4/7/17 Tr. 5584 structure is complex. If some expressly echoing a prior licensor expert in (Marx) (noting that Copyright Owners’ songwriters find their royalty statements Phonorecords I—opines that the present interactive ‘‘greater-of’’ proposal lacks the balance confusing, that is a real concern that streaming market is ‘‘unlike a mature business.’’ See in the 2012 structure that combines a should be resolved. However, one of the Watt WRT ¶ 40 (‘‘Interactive streaming of music is a relatively new enterprise, made of some relatively benefits of a collective, be it the new companies and companies new to the space.’’). 286 Of course, as explained supra, all second-best publishers themselves, or, the NMPA, Although Professor Watt was making this point for markets are inefficient in the static sense. Thus, the NSAI or a PRO, is that these the purpose of explaining how to identify revenues under the bargaining room approach that Copyright collectives have the expertise and and costs for inclusion in a Shapley value analysis Owners endorse, they would exchange one (discussed infra), unlike ‘‘Schrodinger’s Cat,’’ the ‘‘inefficiency’’ (percent of revenue pricing) with resources to identify and explain how interactive streaming market cannot be two another (unit pricing above marginal cost) and then contradictory things at once, simultaneously seek to negotiate away the latter inefficiency, 287 Again, it bears emphasis that the 2012 ‘‘mature’’ for the purpose of avoiding a outside the ‘‘reasonable rate’’ requirement and benchmark provides Copyright Owners with an discriminatory rate structure and ‘‘not mature’’ for without regard to itemized statutory factors in access (option) value prong, in the form of a per- Shapley purposes. section 801(b)(1). subscriber rate.

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royalties are computed and distributed. benchmark for the forthcoming rate benchmark agreements could be There is no good reason why the rate period. utilized. Id. More particularly, Dr. structure that is consonant with the Eisenach posited that there may be a 1. The Copyright Owners’ Benchmark parties’ ten year history and with the relationship—a ratio—between the Rates relevant economic model should be sound recording royalty rate and the sacrificed on the slender argument that a. Overview of Approach musical works royalty rate. To that end, ‘‘simpler is better than complicated.’’ I Copyright Owners identified potential he ‘‘examine[d] a variety of markets in agree that, ceteris paribus, the rate rates through an analysis undertaken by which sound recording and musical structure should be simple but, as one of their economic experts, Dr. works rights are both required in order Albert Einstein is credited with saying: Eisenach, of several benchmarks, and of to ascertain the relative value of the two ‘‘Everything should be made as simple relationships between musical works rights as actually reflected in the as possible, but no simpler.’’ The 2012 and sound recording royalties that he marketplace.’’ Id. (emphasis added). 288 Through this examination, Dr. rate structure meets this criterion. identified in various markets. He began Eisenach concluded that these proposed Accordingly, for the reasons set forth by noting that ‘‘an economically valid benchmarks ‘‘establish upper and lower in this Section III of the Dissent, I find approach for assessing the value of bounds for the relative value of sound the 2012 rate structure, in its entirety, to intellectual property rights which are recording and musical works rights . . . be the appropriate benchmark for the subject to compulsory licenses is to estimate[d] to be between 1:1 and rate structure in the forthcoming period. examine market-based valuations of 4.76:1.’’ Id. To make these ratios more reasonably comparable benchmark I. THE PARTIES’ PROPOSED RATES instructive, I note that the inverse of rights—that is, fair market valuations these ratios (e.g., 1:4.76 instead of Establishing a rate structure resolves determined by voluntary negotiations.’’ 4.76:1) can be expressed as a percentage. only one aspect of the overall rate Eisenach WDT ¶ 8 (emphasis added). In determination. The next issue to decide Thus, the ratio of 1:4.76 is equivalent to selecting potential benchmarks, Dr. a statement that musical works royalties is whether the rates within the 2012 Eisenach identified what he understood benchmark are appropriate, whether equal 21% of sound recording royalties to be key characteristics that would in agreements struck in the purported they need to be changed and, if so, make a benchmark useful: whether the record provides a basis for benchmark market. More obviously, the ‘‘[U]nderlying market factors . . . ; the 1:1 ratio means that, in agreements identifying different rates. Unlike the term or time period covered by the majority, I hew to the record, and do not within that purported benchmark agreements; factors affecting the relative market, musical works royalties equal attempt to divine from the record brand bargaining power of the parties; and new post-hearing rates (or rate 100% of sound recording rates. By differences in the services being converting the ratios into percentages, it structures) that were never presented by offered.’’ Id. ¶ 80. the parties, and thus never subjected to becomes apparent that the high end of Dr. Eisenach found useful the license Dr. Eisenach’s benchmark range is examination by the parties’ counsel and terms for the sound recording rights economists. almost five times as large as the low end utilized by interactive streaming of the range. Copyright Owners have identified per services, because they are negotiated play and per user rates in their rate freely between record companies and b. Economic Relationship between proposal. Although I have rejected that the interactive streaming services. Id. Sound Recording and Musical Works rate structure, I review Copyright These rates made attractive inputs for Rights Owners’ evidence regarding the setting his analysis because they: (1) relate to Dr. Eisenach testified that ‘‘[f]or music of such rates. If that evidence is the same composite good—the sound users that require both sound recording informative, and if the record permits, I recording that also embodied the rights and musical works rights, the two would attempt to convert Copyright musical work; and (2) the interactive sets of rights can be thought of in Owners’ per-unit rate proposal into a streaming service licensees were the economic terms, as perfect complements percent of revenue rate with appropriate same licensees as in this proceeding. in production: Without both inputs, minima, consistent with the 2012 Thus, to an important degree, Dr. output is zero.’’ Id. ¶ 76 (emphasis benchmark rate structure. Eisenach found these agreements to added). Dr. Eisenach also notes that, On the other side of the ledger, possess characteristics similar to those ‘‘for interactive streaming services, the several of the Services’ expert in the mechanical license market at two categories of rights [sound economists have asserted that, although issue in this proceeding. Moreover, Dr. recordings and musical works] are the 2012 benchmark sets forth a Eisenach found that ‘‘[d]ata on the further divided into a reproduction generally appropriate rate structure, and royalties paid under these licenses are license [i.e., the mechanical license] and that the rates have been acceptable to available and allow . . . estimat[ion of] a performance license. . . .’’ Id. (Thus, the Services, the rates within that the rates actually paid by the the mechanical license and the structure are in fact too high and should [interactive] streaming services to the performance license likewise are perfect be reduced for the forthcoming rate labels for sound recordings on both a complements with each other and with period. Accordingly, I also examine per-play and a per-user basis.’’ Id. the sound recording license.) those lower rates to determine if they However, as Dr. Eisenach noted, these Dr. Eisenach acknowledges that ‘‘[t]he should be incorporated into the 20212 benchmark agreements related to a relative value of sound recording [to] different right—the right to a license of musical works licenses may depend on 288 I note that Copyright Owners not only sound recordings—not the right to a variety of factors, and traditionally the voluntarily agreed to this multi-tiered rate structure relationship has differed across different in 2008, they were the parties who had proposed license musical works broadly, or to the this structure, and they then ratified its usefulness mechanical license more specifically. types of services and situations.’’ Id. by adopting it anew in the 2012 settlement. Thus, as with any benchmark that does ¶ 78. Dr. Eisenach eschewed Moreover, Copyright Owners agreed to a similar not match-up with the target market in unnecessary ‘‘assumptions, tiered structure for the new subpart C rates in that complexities and uncertainties 2012 settlement. These facts belie the assertion that all respects, Dr. Eisenach examined how Copyright Owners found this rate structure to be too the rates set forth in the sound associated with theoretical debates’’ as confusing. recording: interactive streaming to why the particular existing market

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ratios existed. Id. ¶ 79. Rather, instead of by the current Section 115 compulsory rates and/or the prospect of a future rate ‘‘put[ting] forward a general theory of license . . . represent an upper bound proceeding. 4/4/17 Tr. 4591 (Eisenach) relative valuation,’’ he found it on the relative market valuations of the (‘‘The underlying problem with looking ‘‘sufficient . . . to assume that the sound recording and musical works at an agreement negotiated under the relative values of the two rights should rights.’’ Id. ¶ 92 (emphasis added). (As shadow of a license’’ is that [i]t shifts be stable across similar or identical an ‘‘upper bound,’’ these ratios would bargaining power from the compelled market contexts.’’ Id. represent the lower bound of the party to the uncompelled party by the very nature of the exercise.’’).293 c. Dr. Eisenach’s Potential Benchmarks reciprocal percentage of the value musical works rights relative to sound Given these limitations, Dr. Eisenach Dr. Eisenach considered a variety of recording rights, again, 21% and 22%.) concluded, as he did with regard to the benchmark categories in which the The 21% and 22% TCC rates within actual section 115 rates licenses, that licensee was obligated to acquire section 115 identified by Dr. Eisenach ‘‘[i]n my opinion, the evidence licenses for musical works and licenses imply certain approximate percent-of- presented . . . indicates that the relative for sound recordings. His selection and revenue rates, i.e., percent of total valuation ratios implied by the . . . consideration of each category of service revenue (not percent of sound negotiations under [the statutory] benchmark markets are itemized below. recording revenue). For example, if the shadow—ranging from 4.2:1 [23.8%%] i. The Current Section 115 Statutory sound recording royalty rate for to 4.76:1[21%]—represent an upper Rates interactive streaming is [REDACTED] bound on the relative market valuations %,292 then, using these section 115 TCC of the sound recording and musical The current statutory rate structure figures, the implied musical work works rights.’’ Eisenach WDT ¶ 92 contains several alternate rates royalty rate would be calculated as (emphasis added). explicitly calculated as a percentage of [REDACTED][ %, or [REDACTED] %. To payments made by interactive streaming iii. Synchronization Agreements take the low end of the range, if the services to the record companies for Synchronization (Synch) Agreements sound recording royalty rate is sound recording rights. As noted supra, are license contracts between audio- [REDACTED] % then, applying these such rates are identified in the industry video producers, such as movie and TCC figures, the implied musical work as the ‘‘TCC’’ rates, the acronym for television producers, with, respectively, royalty rate would be calculated as ‘‘Total Content Cost.’’ Id. ¶ 82. In the music publishers and record companies, [REDACTED] %, or [REDACTED] %. Subpart B category, the TCC is 22% for allowing for the use, respectively, of the Again, because Dr. Eisenach opines that ad-supported services and 21% for musical works and the sound recordings these are upper bounds on the relative portable subscriptions. Id.; see also 37 in ‘‘timed synchronization’’ with the market valuations,’’ that is the CFR 385.13(b)(2) and (c)(2).289 These movie or television episode. See equivalent of opining that they percentage figures correspond to sound generally D. Passman, All you Need to represent the lower bound of a recording: musical works royalty ratios Know about the Music Business 265 (9th percentage-based royalty calculated via of 4.55:1 and 4.76:1, respectively. ed. 2015). Dr. Eisenach found these this ratio approach. Dr. Eisenach notes that these statutory Synch Agreements to be a mixed bag in rates were not set by the Judges ii. Direct Licenses between Parties terms of their value as a benchmark. On pursuant to a contested hearing, but Potentially Subject to a Section 115 the one hand, he recognized that the rather (as noted supra) reflect two Compulsory License licenses they conveyed ‘‘do not apply to consecutive settlements (spanning Dr. Eisenach also examined direct music streaming services as such’’ but, approximately a decade), first in 2008 agreements between record companies on the other hand, they ‘‘are negotiated and again in 2012. Id. ¶ 83. Dr. Eisenach and interactive streaming services that completely outside the shadow of the discounts the value of these settlement contain rates for sound recordings and 293 Again, I discussed the issue of the ‘‘shadow’’ rates for three reasons. First, he notes mechanical royalties, respectively. See, that they were established prior to the of the statutory license supra. Suffice it to note here e.g., id. ¶ ¶ at 84–91. In such cases, the that the ‘‘shadow’’ of the statutory license does not ‘‘marketplace success’’ of Spotify in the ‘‘shift’’ bargaining power so much as it eliminates 290 ratio of sound recording:musical works interactive streaming industry. royalties ranged tightly between 4.2:1 to unequal bargaining power. Although the interactive services have the legal right to refuse to license at Second, he notes that the settlements, 4.76:1, closely tracking the regulatory although voluntary, ‘‘were negotiated rates set by the Judges (the legal compulsion ratios implicit in the section 115 TCC. operates only on the licensors), such refusal of the under the full shadow of the services to obtain licenses would shut them out of 291 Id. ¶ 92. (The 4.2:1 ratio equates to a compulsory license.’’ Third, he finds TCC rate of 23.8%, and the 4.76:1 ratio the interactive streaming market in which they have that, although the settlement made substantial investments (unless they equates to a mechanical rate of 21%.) attempted to engage in piracy which certainly incorporates rate prongs based on a According to Dr. Eisenach, the percent of sound recording rates (the would be quickly shut down). So, it would be similarity of these direct contract rate absurd for the services not to license at rates set in TCC prongs), those provisions are part ratios to the statutory ratios reflects the a section 115 proceeding. And, if they did so refuse, of a ‘‘lesser of’’ segment of the rate Copyright Owners could then attempt to move the ‘‘shadow of the statutory license,’’ by listeners of the erstwhile interactive streaming structure, and thus capped by which direct negotiations between alternative per subscriber rates. Id. & service to other distribution channels such as parties regarding rights that are subject purchased downloads and physical products, n.70. Thus, Dr. Eisenach concludes: ‘‘In to a statutory license are influenced by which they claim are sufficiently profitable for them and, they claim, have been cannibalized by my opinion, the evidence . . . indicates the presence of statutory compulsory that the relative valuation ratios implied interactive streaming. Or, as Copyright Owners indicate (as discussed supra), under the bargaining 292 [REDACTED]; 4/7/2017 Tr. 5509 (Marx) room approach, if the statutory rate was set too high 289 Lower percentages apply if the record (indicating most recent sound recording royalty for some services, Copyright Owners could companies’ revenue includes revenue to be ‘‘passed payments equaled [REDACTED] % of revenue); negotiate lower rates, free of the statutory through’’ by them to pay mechanical license Marx WDT ¶ 62 (‘‘In 2015, Spotify paid ‘‘reasonableness’’ requirement, without regard to royalties. However, according to Dr. Eisenach, such [REDACTED] % of its US gross revenue for sound the four itemized objective in section 801(b)(1), and ‘‘pass throughs’’ are not typical. Id. ¶ 82 n.67. recording royalties based on its negotiated rates with the complementary oligopoly power to ‘‘hold 290 Spotify was launched in the United States in with record labels summarizing Spotify’s rates out’’ and ‘‘walk away, or to threaten to do so, to the summer of 2011. 3/20/17 Tr.1778 (Page). under various agreements); see generally SJPFF ¶ 87 obtain a higher rate than would be set under the 291 I discuss the ‘‘shadow’’ argument supra. ([REDACTED]). statute.

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compulsory license. . . . ’’ Id. ¶ 93. Dr. record companies, Dr. Eisenach filed that these agreements provided Eisenach notes, from his review of other (with the Judges’ approval) ‘‘significant insight into the relative testimony and an industry treatise, that Supplemental Written Rebuttal value of the sound recording and these freely negotiated market Testimony (SWRT) addressing these musical works rights in this agreements grant the musical agreements. In that testimony, Dr. proceeding.’’ Id. (emphasis added). composition royalty payments equal to Eisenach examined [REDACTED]. Dr. Eisenach compared the musical the corresponding royalty paid for the Eisenach SWRT ¶ 6, and n. 5. Dr. works rates in these ‘‘Opt-Out’’ sound recording,’’ id. ¶ ¶ 94–95 & nn.87, Eisenach identified nine of these agreements with the sound recording 88, which is the equivalent of a 1:1 licenses specifically in his SWRT, and royalty rates paid by Pandora, which he sound recording:musical works ratio.294 noted that YouTube paid to obtained from the revenue disclosures Dr. Eisenach finds this 1:1 [REDACTED]—which Dr. Eisenach in Pandora’s Form 10K filed with the relationship to be important benchmark found to be the comparable YouTube SEC that provided royalties (‘‘Content evidence, concluding as follows: category—whereas [REDACTED]. Id. Costs’’) as a percent of revenue, and he The synch and micro-sync examples confirm and Table 1 therein. also relied on data contained in prior that in circumstances in which licensees As Dr. Eisenach accurately calculated, rate court decisions. Eisenach WDT require both sound recording and musical the [REDACTED] revenue split reflects a ¶ 125 & Table 6. With this data, he composition copyrights in order to offer their ratio of [REDACTED], (a musical works calculated that the ratio of sound service, and where that service is not entitled rate equal to [REDACTED] % of the recording: musical works royalties in to a compulsory license for either right, the sound recording rate), whereas the existing agreements was [REDACTED] sound recording rights and the musical [REDACTED] revenue split reflects a for 2018, i.e., the musical works rate composition rights are in many cases equally ratio of [REDACTED] (a musical works equaled [REDACTED]% of sound valued, that is, the ratio of the two values is 1:1. rate equal to [REDACTED] % of the recording royalties. This [REDACTED]% sound recording rate).295 ratio would correspond to a mechanical Id. ¶ 98. rate of [REDACTED]%, assuming, v. The Pandora ‘‘Opt-Out’’ Deals iv. YouTube Agreements arguendo, the sound recording rate is Dr. Eisenach also examined certain [REDACTED]%, or [REDACTED]% if the Dr. Eisenach also examined licenses direct licensing agreements entered into sound recording rate is [REDACTED]%. between: (1) YouTube (owned by between Pandora and major music Dr. Eisenach also made a forecast, by Google) and record companies; and (2) publishers covering the period from which he linked the passage of time to YouTube and music publishers, to 2012 through 2018, to determine an assumption that, after the rate court determine their potential usefulness as whether they constituted useful proceedings concluded, the parties, benchmarks. [REDACTED]. For these benchmarks in this proceeding. Id. without any further legal uncertainty, reasons, Dr. Eisenach concluded that for ¶ 103. Pandora had negotiated these would permanently be ‘‘permitted to purposes of assessing the relative value direct agreements with major publishers negotiate freely outside of the control of of the sound recording and musical for musical works rights after certain the rate courts.’’ He made this works rights, the YouTube agreements publishers had decided to ‘‘opt-out,’’ estimation and forecast through a represent reasonably comparable i.e., to withdraw their digital music temporal linear regression, extrapolating benchmarks. Id. performance rights from PROs, and from the prior [REDACTED] in these In his original Written Direct asserted the right to negotiate directly Pandora ‘‘opt out’’ musical works rates. Testimony, Dr. Eisenach relied upon with a digital streaming service. As Dr. See Eisenach WDT ¶ 129. Dr. Eisenach’s seven agreements between YouTube and Eisenach acknowledges, the music linear regression further [REDACTED] several music publishers pertaining to publishers’ legal right to withdraw these the ratio to [REDACTED], which would [REDACTED]. Id. ¶ 101 n.93. rights remained uncertain during an be equivalent to [REDACTED] the [REDACTED]. However, with regard to extended period. Pandora thus musical works rate, as a percentage of the revenue received by the record negotiated several such ‘‘Opt-Out’’ sound recording royalties, from the companies, Dr. Eisenach could only Agreements with an understanding that [REDACTED]% noted above for actual speculate based on public reports as to the rates contained in those direct agreements in force in 2018 to the percent of revenue received by the agreements might not be subject to rate [REDACTED]%. almost a [REDACTED] record companies for the sound court review. based on the extrapolation alone. Id. recordings embedded in the posted Given this unique circumstance, and ¶ ¶ 104; 128 & Table 8, Fig. 13. (This YouTube videos. Id. ¶ 102. Thus, he was given that the markets and parties [REDACTED]% ratio would correspond unable to make an informed argument involved in the Pandora Opt-Out to a musical works rate of in his original written testimony agreements are somewhat comparable to [REDACTED]%. assuming the sound regarding the ratio of sound recording the markets and parties at issue in this 296 recording rate is [REDACTED]% and royalties:music publisher royalties in proceeding, Dr. Eisenach concluded [REDACTED]% if the sound recording his YouTube [REDACTED]. rate was [REDACTED]%.) However, after the Judges compelled 295 Although Dr. Eisenach does not emphasize the Google to produce in discovery copies following point, the actual percentages of revenue d. Dr. Eisenach’s Two Methods for reflect that musical works royalties constitute only Estimating the Mechanical Rate of the YouTube agreements with the [REDACTED]% of total revenues in these YouTube agreements, [REDACTED]. Also, these data indicate Having calculated these five 294 Dr. Eisenach finds this 1:1 ratio to be present that YouTube, as licensee, retains [REDACTED]% to benchmarks, Dr. Eisenach applied them in the two types of Synch Agreements he identified. [REDACTED]% of the total revenue attributable to One version represents an agreement relating to a these benchmark agreements, [REDACTED]. in two separate methods to estimate the specific musical work and sound recording 296 Pandora was only a noninteractive service at mechanical rate to be adopted in this combination. The other version, a ‘‘Micro-Synch’’ that time, and only paid the performance right proceeding. Agreement, which he describes as ‘‘essentially royalty, not the mechanical right royalty, for the ‘blanket’ synch licenses, in that the license grants right to use musical works. Because the parties i. Method #1 the right to synchronize not just one particular song agree that the performance right and the mechanical . . . but any song in the publisher’s catalog (or a right are perfect complements, Pandora’s payments Dr. Eisenach’s Method #1 for significant portion thereof). . . .’’ Eisenach WDT for the performance right are relevant and estimating the mechanical rate is based ¶ 96. probative. on the following premises:

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1.The sound recording royalty paid by 5.The mechanical rate implied by this calculated by Dr. Eisenach was interactive streaming services is difference in sound recording rates must $[REDACTED] ([REDACTED]). Id. Table unregulated and thus negotiated in the be ‘‘adjust[ed] for the relative value of 11. marketplace. Eisenach WDT ¶ 16. sound recordings [to] musical works’’ Dr. Eisenach estimated the rate paid 2.The sound recording royalty paid by (as discussed supra). Id. ¶ 140. by noninteractive services for sound noninteractive services is regulated, but Dr. Eisenach combines these steps recordings at $0.0020 per play, or $0.20 Dr, Eisenach find the royalties set by the and expresses his Method #1 in the form per 100 plays. He made this estimate by Judges in Web III to reflect a market rate. of the following algebraic equation: taking note of the various rates paid in 4/4/17 Tr. 4643 (Eisenach); see also MRMW = (SRIS¥SRNIS)/RVSR/MW, 2015 pursuant to the Judges’ Web III Eisenach WDT ¶ 136 and n.123. where Determination and pursuant to the pureplay rates paid under an earlier 3. The interactive streaming services MR = Mechanical Rate for Musical Works require a mechanical license (the license MW settlement. Id. ¶ 136 & n.123. However, SRIS = Sound Recording Rate for Interactive at issue in this proceeding), whereas the Streaming (All In) he candidly acknowledged that he noninteractive services are not required SRNIS = Sound Recording Rate for Non- found it ‘‘not possible to know the to obtain a mechanical licenses. Interactive Streaming (Performance average amount paid by non-interactive 4. According to Dr. Eisenach, the Only) webcasters,’’ and he acknowledged that difference between the rates paid by RVSR/MW = Relative Value of Sound the subsequent Web IV Determination interactive services and noninteractive Recording to Musical Works Rights. had superseded those noninteractive services for their respective sound Eisenach WDT ¶ 140. sound recording rates. Id. at n. 123. recording licenses equals the value of Dr. Eisenach determined the per play His final inputs, discussed supra, are the remaining license, i.e., the rate paid by interactive services by the several benchmark ratios of sound mechanical license. Id. ¶ 137 (‘‘[T]he identifying certain services, but recording: musical works royalties in difference between these two rights is [REDACTED], and ‘‘tally[ing] the total the markets that he had selected. akin to a ‘mechanical’ right for sound payments . . . and divid[ing] by the After Dr. Eisenach inserted the recordings, directly paralleling the total number of interactive streams the foregoing data into the algebraic mechanical right for musical works in service reports.’’ Id. ¶ 148. The average expression set forth above, he presented this proceeding.’’). sound recording per play royalty his data in the following tabular form:

MUSICAL WORKS MECHANICAL PER 100 PLAYS RATE CALCULATION [Method 1]

(1) (2) (3) (4) (5)

SRIS per 100 SRNIS per 100 Difference RVSR/MW MRMW per 100 [REDACTED] ...... $0.20 [REDACTED] ...... 1:1 ...... [REDACTED] [REDACTED] ...... 0.20 [REDACTED] ...... [REDACTED] ...... [REDACTED] [REDACTED] ...... 0.20 [REDACTED] ...... [REDACTED] ...... [REDACTED] [REDACTED] ...... 0.20 [REDACTED] ...... [REDACTED] ...... [REDACTED] [REDACTED] ...... 0.20 [REDACTED] ...... 4.76:1 ...... [REDACTED]

See id. Table 12.297 Thus, applying market-derived mechanical royalty. His other variables are as defined and his five potential benchmark ratios, Dr. Method #2 ‘‘derive[s] an all-in musical described in Method #1. Eisenach determined that the works value based on the relative value mechanical works royalty rate to be set of sound recordings to musical works Id. in this proceeding ranged from and then remove[s] the amount of Dr. Eisenach calculates PRMW, as an $[REDACTED] per play to public performance rights paid for average of $[REDACTED] per 100 plays $[REDACTED] per play (dividing the musical works, leaving just the for the licensees that he included in his figure in column (5) by 100 to reduce mechanical-only rate.’’ Id. ¶ 142. The data analysis. Id. ¶ 156, Table 13. the rate from ‘‘per 100’’ to ‘‘per play’’). algebraic expression for Method #2 is as Applying all the inputs across the follows: ii. Method #2 various benchmark ratios, the results MRMW = (SRIS/RVSR/MW)¥PRMW, from Dr. Eisenach’s Method #2 can also Dr. Eisenach describes his Method #2 where PRMW is the public performance be depicted in tabular form, as set forth as an alternative method of deriving a royalty rate for musical works, and the below:

MUSICAL WORKS MECHANICAL PER 100 PLAYS RATE CALCULATION [Method 2]

(1) (2) (3) = (2) 298 × (1) (4) (5)

SRIS RVSR/MW Ratio Adj. (Avg.) PRMW MRMW

[REDACTED] ...... 1:1 ...... [REDACTED] ...... [REDACTED] ...... [REDACTED] [REDACTED] ...... [REDACTED] ...... [REDACTED] ...... [REDACTED] ...... [REDACTED] [REDACTED] ...... [REDACTED] ...... [REDACTED] ...... [REDACTED] ...... [REDACTED] [REDACTED] ...... [REDACTED] ...... [REDACTED] ...... [REDACTED] ...... [REDACTED]

297 Dr. Eisenach testified that [REDACTED].

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MUSICAL WORKS MECHANICAL PER 100 PLAYS RATE CALCULATION—Continued [Method 2]

(1) (2) (3) = (2) 298 × (1) (4) (5)

SRIS RVSR/MW Ratio Adj. (Avg.) PRMW MRMW

[REDACTED] ...... 4.76:1 ...... [REDACTED] ...... [REDACTED] ...... [REDACTED]

See id., Table 14. approach—relying on empirics over interactive services embeds within his In sum, after applying all of his abstract theory, viz., assuming that a analysis the inefficiently high rates that potential benchmarks in both of his tightly clustered set of ratios across arise in that unregulated market through methods, Dr. Eisenach opined that ‘‘the several markets and discerning a central the complementary oligopoly structure YouTube and Pandora [Opt Out] tendency from among them—could aid of the sound recording industry and the agreements represent the most in the identification of the statutory Cournot Complements inefficiencies comparable and reliable benchmarks, rates. (As noted supra, Dr. Eisenach that arise in such a market. See Katz implying ratios of [REDACTED] and eschewed unnecessary ‘‘assumptions, CWRT ¶ 56; Marx WRT ¶ ¶ 137–141. I [REDACTED], respectively, with a mid- complexities and uncertainties agree with this criticism. Indeed, the point of [REDACTED].’’ Id. ¶ 130 (I note associated with theoretical debates’’ as Judges explained at length in Web IV that converting these end-points and to why the particular existing market how the complementary oligopoly mid-point of his range to TCC ratios existed. Id. ¶ 79.) In this regard, I nature of the sound recording market percentages results in a range from understand that Dr. Eisenach was compromises the value of rates set [REDACTED]% to [REDACTED]% and a following a well-acknowledged therein as useful benchmarks for a mid-point of [REDACTED]%.) 299 principle of economic analysis, market that is ‘‘effectively 300 e. Criticisms and Analysis of Dr. articulated by the Nobel laureate competitive.’’ In Web IV, the Judges Eisenach’s Benchmark Methods economist Milton Friedman, who were provided with evidence of the famously eschewed excessive theorizing ability of noninteractive services to steer i. Dr. Eisenach’s Ratio of Sound that failed to match the predictive some performances toward recordings Recordings: Musical Works power of empirical analysis. See M. licensed by record companies that Dr. Eisenach’s attempt to identify Friedman, The Methodology of Positive agreed to lower rates in exchange for comparable benchmarks and Economics, reprinted in D. Hausman, increased plays. Here, the Judges were corresponding ratios of sound recording The Philosophy of Economics at 145, not presented with such evidence, likely rates to musical works rates appears to 148–149 (3d ed. 2008). because an interactive streaming service me to be a reasonable first step in However, the data available to Dr. needs to play any particular song seeking to identify usable benchmarks. Eisenach did not demonstrate a whenever the listener seeks to access That is, I find his basic conceptual sufficient cluster of similar ratios to that song (that is the essence of an establish a predictive ratio across the interactive service compared with a 298 The ratio in column (2) is converted into its data set. That is, the problem does not noninteractive service). Thus, the Judges reciprocal percentage and the percentage is lie in the analysis, but rather in the have no direct evidence sufficient to multiplied by the corresponding figure in column implications from the data regarding apply a discount on the interactive (1). For example, in the third row, the [REDACTED] ratio equals [REDACTED]%. When $[REDACTED] is ratios of sound recording royalties to sound recording rate to adjust that multiplied by [REDACTED], the product is musical works royalties. The Services potential benchmark in order to fashion $[REDACTED] (rounded). make this very criticism, noting the an effectively competitive rate.301 299 Dr. Eisenach found these results to confirm the instability of the ratio across the several reasonableness of Copyright Owners’ per play rate markets in which Dr. Eisenach 300 In Web IV, the Judges noted that, even in the proposal. However, because I reject a per-play rate willing buyer/willing seller context of 17 U.S.C. structure, that point is not relevant to my Dissent. identified potential benchmarks. See 114(f)(2(B), all relevant authority required that I further note that Dr. Eisenach also calculates a per SJRPFF–CO at 182 (and record citations those rates be reasonable, that is, they must reflect user rate, using his Method #2. As he explains, therein). Apple finds that the wide ‘‘this is accomplished by calculating all-in a market that is ‘‘effectively competitive’’ (i.e., publisher royalties on a per user basis and range of ratios is unsurprising, because ‘‘workably’’ competitive, the economic analog to subtracting the average effective per-user Dr. Eisenach’s benchmarks do not relate ‘‘effectively’’ competitive.). See Web IV, supra, at performance royalties to publishers, leaving an to the same products and same uses of 26331–34 (noting the legal bases for an equivalence appropriate rate for mechanical royalties.’’ Id. ¶ 159. the two rights. Indeed, Apple’s between effectively competitive and reasonable He finds that the sound recording rate per user is rates). (However, the rates in this proceeding are $[REDACTED] (the per user analog to [REDACTED] [REDACTED], confirming, according to further subject to potential adjustment by per 100 plays in his per play analysis). Applying Apple, that there is no fundamental application of the four itemized factors in section the same ratios and utilizing similar market data as market ratio that can be applied in this 801(b)(1).). As the Judges noted in Web IV, ‘‘[a]n in his per play approach, Dr. Eisenach concludes effectively competitive market is one in which proceeding. Dorn WRT ¶ ¶ 6, 24, 28–29. supercompetitive prices or below-market prices that a ‘‘mechanical rate of between $[REDACTED] To be sure, this point does not go and $[REDACTED] per user reflects the range of cannot be extracted by sellers or buyers . . . .’’ Id. relative values for sound recordings and musical unnoticed by Dr. Eisenach, who focuses at 26331 (citation omitted). Because Dr. Eisenach’s works . . . .’’ Id. ¶ 165. Finally, he notes that, at more on the royalty ratios arising from approach intentionally incorporates sound the [REDACTED] ratio (his mid-point of the two potential benchmarks in the middle recording market-based royalty rates into his ratios, YouTube and Pandora benchmarks), the those rates and the ratios in which they are inputs ‘‘mechanical only’’ rate would be $[REDACTED] per of his range—the Pandora ‘‘Opt-Out’’ must be reduced to eliminate the supercompetitive user (even greater than the $1.06 per user rate agreements and the YouTube effect of complementary oligopoly that is proposed by Copyright Owners.) Id. Because I do Agreements, discussed infra. inconsistent with effective competition. not agree that Copyright Owners’ per-user proposal The Services assert an additional and 301 Dr. Eisenach suggests that the entry of large is appropriate (for the reasons discussed supra), this fundamental criticism of Dr. Eisenach’s ‘‘ecosystem’’ firms, Amazon, Apple and Google into asserted confirmation of the reasonableness of the interactive streaming market has tended to add Copyright Owners’ per-user proposal is unhelpful approach. They note that his use of ‘‘bargaining power’’ to the licensee side of the in the context of this Dissent. sound recording royalties paid by Continued

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Thus, the sound recording royalties benchmark as a representation of a rate synchronization differs in important relied upon by Dr. Eisenach likely are that the licensors have agreed to accept, economic respects from streaming); too high and would need to be adjusted given the provisions of section 115. Hubbard WRT ¶ ¶ 6.31–6.32 (testifying to reflect reasonable rates derived from on various ‘‘economic characteristics of Direct Licenses a market that is effectively competitive. synch licenses, that render the ratio However, because there is no record The Services disagree with Dr. between sound recording royalties and evidence in this proceeding allowing for Eisenach’s minimization of the musical works royalties different an estimate of the adjustment, I can find relevance of this benchmark category. between synch and interactive only that Dr. Eisenach’s ratios are too They argue that the direct licenses streaming services’’); Marx WRT high to the extent they incorporate the between interactive services and music ¶ ¶ 148–151 (‘‘Synch royalty rates are a royalty rates derived from the sound publishers ‘‘are by far the most directly poor benchmark for streaming royalty recording market. apposite benchmarks used in Dr. rates’’). Indeed, even Dr. Eisenach Eisenach’s analysis,’’ because they, like acknowledged that, at best, the low ratio ii. Dr. Eisenach’s Specific Benchmarks the section 115 rates and terms in the synch licenses indicates an Section 115 Benchmark themselves, possess the characteristics unusually high musical works royalty The Services assert that Dr. Eisenach’s of a useful benchmark in that they are: rate among his collection of calculation of a section 115 ‘‘valuation (1) voluntary; (2) concern the same benchmarks. 4/4/17 Tr. 4671, 4799 ratio’’ of 4.76:1 is incomplete, because licensors/publisher; (3) negotiated in the (Eisenach); Eisenach WDT App. A–9. he limited this statutory ratio to the same market; and (4) pertain to the same In a prior proceeding, the Judges 21% and 22% TCC prongs. They note rights. See Katz WDT ¶ ¶ 97–113; rejected the synch license benchmark as that under the percentage-of-revenue Leonard AWDT ¶ ¶ 51–76. useful ‘‘[b]ecause of the large degree of prong of section 115 (10.5%), this I find that direct licenses that meet its incomparability.’’ See Phonorecords statutorily-derived ratio would have the foregoing criteria are at as least as I, 74 FR at 4519. I find that nothing in ranged between 5:1 and 6:1, see 4/5/17 useful as the section 115 benchmark the present record supports a departure Tr. 5152 (Leonard), implying a musical itself, provided those licenses do not from that prior finding. The lack of works rate equal to only 16.67% to 20% include additional rights whose values comparability remains present because of sound recording royalty rates. I agree have not been adequately isolated from the synchronization market differs in that Dr. Eisenach’s statutory the particular mechanical license at important economic respects from the benchmarks would have been more issue in this proceeding.302 The so- streaming market. See Leonard WRT comprehensive if he had included the called ‘‘shadow’’ of section 115 provides ¶ 39. Because synch rights pertain to ‘‘valuation ratios’’ derived from this a default rate for the licensing parties, media such as music used in films or in headline prong of the present royalty so direct licenses that deviate in some television episodes,303 the historically rate structure. However, the Services’ manner from the rates in the statutory equal valuation of publishing rights and focus on that lower implied TCC fails to license reveal a preference for other sound recording rights arises from the recognize the greater-of rate structure rates and terms that, at least marginally, particular conditions faced in those (with a lesser-of second prong) to which are below the statutory rate. (If in the industries. Id. Movie and television the parties agree. The purpose of the direct negotiations the licensors insisted producers may have a certain musical explicit TCC levels was that they could on rates above the statutory rates, a work in mind as a good fit for a trigger if greater than the 10.5% rate and licensee would simply reject the particular scene in the film. Id. the implicit TCC that could be derived demand and default to the statutory However, these producers have the from that rate. Accordingly, I find that rate.) Thus, as the services note, these option of making their own sound the fact that the existing rate structure, benchmarks are useful, because ‘‘these recording of that musical work, and for on which the Services rely in this agreements . . . were voluntarily this reason, ‘‘cover’’ songs are quite proceeding, includes the potential use entered both in 2008 and 2012, by the common in films. Id.; see also Marx of the 21% and 22% prongs, very same publishers in the same WRT ¶ 149 (‘‘Both film and television demonstrates the usefulness of this markets and for the same rights . . . .’’ production companies have the option SJPFF ¶ 261 (and record citations of recording their own versions of songs, market, obviating any concern over undue licensor therein). More generally, as described rather than paying royalties to use a pre- power. Eisenach WRT ¶ 77. However, as indicated supra, I find that the so-called recorded song. .... This option gives by the Shapley value analyses of Copyright Owners’ the users of synch rights, such as movie other economic expert witnesses, Professors Gans ‘‘shadow’’ of the statutory license on a and Watt, bargaining power is a function of how benchmark not only does not disqualify producers, more bargaining power many participants exist on one side of the market that benchmark as useful evidence, but relative to the labels than would be the versus the other. See Gans WRT ¶ 55 (noting, rather serves to eliminate licensor ‘‘hold case with streaming services.’’). Thus, without making any exception for these large the contribution to value of the sound entities, that ‘‘[s]ervices are substitutes for one out’’ power, making the resulting rate another, providing rightsholders with a wide array more reasonable and more reflective of recording is less vis-a`-vis the musical of choices in their licensing decisions [and] this an effectively competitive rate work in the synch market. Leonard WRT competition reduces individual services’ bargaining ¶ 39. power.’’); Watt WRT ¶ 25 (‘‘[T]he different Synchronization Licenses Additionally, in the case of interactive streaming companies—Spotify, Apple Music, Rhapsody/Napster, Google Play Music, The Services also take issue with Dr. synchronization rights, the marketplace Amazon, etc.—do all compete (and rather fiercely) Eisenach’s inclusion of synchronization for sound recording rights is more among themselves, offering very (perhaps perfectly) licenses in his collection of benchmarks. competitive than other music licensing substitutable services.’’). That is, despite the overall contexts because individual sound size of Apple, Amazon and Google, in a market See, e.g., Leonard WRT ¶ ¶ 37–40 transaction, all licensors providing complementary (testifying that synchronization licenses ‘‘must have’’ inputs will have a bargaining are not comparable for interactive 303 The Copyright Owners also rely on blanket advantage, and they can refuse to license even to (‘‘microsynch’’) licenses by which publishers grant these large entities if the latter insist on too low a streaming licenses because their entire catalogs for use in synchronized audio- royalty, licensing instead to other interactive video productions, and they also rely on synch streaming services who can satisfy downstream 302 See the discussion infra regarding the licenses for mobile and video game applications. market demand. In this regard, there is no evidence importance of this qualifier in connection with The Judges’ critique of synch licenses as that [REDACTED]. Pandora’s Direct Licenses. benchmarks is equally applicable to these licenses.

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recordings (and thus the musical works I agree with the Services in this agreements resulted in a shift of the within them) compete against one regard. [REDACTED].304 sound recording: musical works ratio to another for inclusion in the final Under the [REDACTED] contract [REDACTED], implying a musical works product (e.g., a movie or television provisions (i.e., the [REDACTED] TCC percentage of [REDACTED]%. See episode). By contrast, in the interactive provisions) governing YouTube’s Katz CWRT ¶ ¶ 101–104; Herring WRT streaming market, services must build a agreements with [REDACTED]. See ¶ ¶ 28–29. catalog of sound recordings and their Professor Katz’s Supplemental Written I reject Dr. Eisenach’s identification of included musical works, so that many Rebuttal (Katz SWRT) ¶ ¶ 13(b) n.26 and a trend in the [REDACTED]. His change works can be streamed to listeners. Id. 13(e) n. 29 (and contracts referenced in the ratio to [REDACTED] was driven That is, in the interactive streaming therein). [REDACTED], the sound by expectations regarding the likelihood market, the sound recordings (and their recording copyright owner receives a of an uncertain change in the legal embodied musical works) are ‘‘must royalty of [REDACTED]% of revenue, landscape regarding publisher have’’ complements, not in competition compared with the [REDACTED] withdrawals from performing rights organizations. However, changes in with each other. However, in the synch received by music publishers. Id. such uncertainties are not well-captured market the potential sound recordings of ¶ ¶ 13(h) n. 32 and (k) n.35 (and by mapping them over a time horizon. any given musical work identified by contracts referenced therein). Moreover, as the Services note, and as the movie or television producer is a Thus, under the [REDACTED] deals, Dr. Eisenach concurs, even assuming substitute good, in competition with any the royalty ratio is [REDACTED], which equals 4.76:1. In turn, that ratio implies arguendo such a change in relative other existing or future cover sound uncertainty could be captured in a recording of the same musical work for a TCC musical works rate of [REDACTED]%. Under the [REDACTED] regression, other regression forms, such inclusion in the movie or television as a quadratic form, could have been show. deals, the royalty ratio is [REDACTED], which equals [REDACTED], which used to demonstrate not a [REDACTED], YouTube Agreements implies a TCC musical works rate of but rather a return of the ratio to its [REDACTED]%. I find that these ratios prior level (an equally plausible future I agree with Copyright Owners that and implied percentages derived from event). See 4/5/17 Tr. 495963 (Katz); YouTube is a competitor vis-a-vis the YouTube’s [REDACTED] royalty rates to Katz CWRT ¶ ¶ 104–107, Table 1,F; interactive streaming services. Indeed, be usable benchmarks in this 4/4/17 Tr. 4807–08 (Eisenach) (noting the Services acknowledge this point. proceeding. his linear form of regression was not [REDACTED]. Page WDT ¶ ¶ 47, 53, 55; ‘‘material’’). see also (Eisenach) WRT ¶ 59. In like Pandora ‘‘Opt-Out’’ Agreements Moreover, the assumption behind Dr. fashion, Professor Marx testified that Together with his YouTube Eisenach’s regression was not borne out. [REDACTED]. Marx WDT ¶ 44 n.54. benchmark, Dr. Eisenach finds the In 2015, the Second Circuit Court of Accordingly, at least one form of Pandora ‘‘Opt-Out’’ agreements to be the Appeals affirmed a 2014 decision by the YouTube Agreement would likely be most useful among the several potential Southern District of New York, somewhat comparable to the interactive benchmarks he examined. I agree with prohibiting such partial withdrawals. In streaming market. Dr. Eisenach that the Pandora ‘‘Opt- re Pandora Media, Inc. v. ASCAP, 785 F.3d 73, 77–78 (2d Cir. 2015), aff’g In re As noted supra, Dr. Eisenach selected Out’’ agreements have a degree of comparability sufficient to render them Pandora Media, 6 F. Supp. 3d 317, 322 for input into his ratio the YouTube (S.D.N.Y. 2014). Subsequently, in agreements and rates pertaining to usable as benchmarks. However, I do not agree with Dr. August, 2016, the Department of Justice [REDACTED]. See SJRPFF–CO at 187– issued a statement announcing that, 89 (and record citations therein). Eisenach’s attempt to extrapolate into the future from the actual rates in those consistent with these judicial decisions, I agree that the inclusion of a video Opt-Out Agreements. Rather, I find that it would not permit such partial component in the YouTube product the [REDACTED] ratio that Dr. Eisenach withdrawals under the existing consent renders less useful as a benchmark the identified for the year 2018 derived decrees. See Eisenach WDT ¶ 114 & n. agreements relating to ‘‘User Videos from existing agreements is the most 109 therein. In fact, as indicated supra, with Commercial Sound Recordings.’’ useful benchmark derived from the there were actual Pandora ‘‘Opt-Out’’ Further, as Dr. Eisenach acknowledges, ‘‘Opt-Out’’ data. See Eisenach WDT agreements that set rates through 2018 these YouTube audio/video ¶ 104. The Services concur with Dr. that established a sound combinations also provide for Eisenach with regard to the existence of recording:musical works ratio of synchronization rights, see Eisenach this [REDACTED] ratio, and they further [REDACTED], that Dr. Eisenach chose to disregard in favor of his extrapolated WDT ¶ 100, and this addition of yet note that Pandora’s most recent direct lower ratio. See Katz CWRT ¶ 103; another right in the licenses further license agreements during the ‘‘Opt- Herring WRT ¶ 28. muddies the comparability of a Out’’ period with the publishers (who YouTube benchmark. control many of the works underlying iii. Dr. Eisenach’s Per Play Sound The Services further maintain that— sound recordings performed by Recording Rate assuming arguendo any YouTube Pandora) provide that publisher I also have difficulty relying on the licenses are appropriate benchmarks— royalties will be determined as data set which Dr. Eisenach developed Dr. Eisenach should have relied on a [REDACTED].305 Specifically, these for his estimation of a $[REDACTED] different category of YouTube licenses per play sound recording royalty rate, to 304 for his benchmark analysis. Specifically, I take note of Dr. Eisenach’s criticism of the which he applied the several benchmark [REDACTED] publishing rates as constrained by the they maintain that the more appropriate ‘‘shadow’’ of the section 115 license. However, as ratios. The principal problems with this YouTube benchmark ratio would explained elsewhere in this Dissent, I find the compare the contractual provisions ‘‘shadow’’ of the section 115 statutory license to be of this benchmark, because: (1) noninteractive and between YouTube and publishers, and beneficial in establishing rates that reflect the interactive services both pay performance royalties; YouTube and record companies, for workings of an effectively competitive market. (2) noninteractive services do not pay mechanical 305 Pandora’s status as a purely noninteractive royalties; and (3) the performance license and the [REDACTED]. service prior to 2018 does not impact the relevancy mechanical license are perfect complements.

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data is that it covered a non-random they generate, are real and reflect the yet been identified. By using ad- sample of only approximately 15% of WTP of a large swath of interactive supported services, Spotify certainly all interactive plays, excluding in listeners.306 See Marx WRT ¶ 115–16 & does avoid hard marketing costs that particular plays on [REDACTED] ad- Fig. 9 (‘‘While I agree that one aspect of would be incurred through, for example, supported services and Apple’s the ad-supported service is to provide paid advertising to convince non- interactive streaming service. Inclusion an on-ramp to paid services, it also has subscribers to subscribe. However, there of [REDACTED] would have another important aspect, namely to is no record evidence that this hard cost [REDACTED] his per play rate from serve low WTP customers .... saving translates directly into lost $[REDACTED] to $[REDACTED] Copyright Owners’ economists err in not royalty revenue to Copyright Owners. (Inclusion of [REDACTED] would have calculating the impact of the Copyright Apparently, Copyright Owners argue [REDACTED] the $[REDACTED] Owners’ proposal on ad-supported that their loss is in the form of an estimate to $[REDACTED].) SJRPFF–CO services. Ad-supported services opportunity cost, losing the opportunity at 158–59 (and record citations therein). currently make up [REDACTED] in the to obtain subscription-level royalties Dr. Eisenach explained that he industry.’’) I agree with this point, and from the ad-supported listeners. But if restricted his data sample purposefully. I therefore agree with the Services that Spotify paid subscription-level royalties He decided to omit several sound Copyright Owners erred in their for all ad-supported listeners, it would recording labels because they decision to exclude Spotify data from be paying an implicit marketing cost [REDACTED], which he asserted their analyses.307 that inefficiently was wasted on the [REDACTED]. Eisenach WDT ¶ 150. I I also disagree with Copyright [REDACTED].308 acknowledge Dr. Eisenach’s assertion Owners’ suggestion that the ad- In this regard, it is important to that this fact could have an impact, on supported service deprives them of remember that, as discussed supra, the margin, of driving [REDACTED] the higher royalties from subscribers. music is an ‘‘experiential’’ good. See royalties paid by [REDACTED] to those Although ad-supported services identify Byun, supra, at 23. Thus, provision of a labels. However, the evidence does not future subscribers, until those monetarily ‘‘free-to-the user’’ service is bear that out, because [REDACTED]. subscribers are identified, they are not a reasonable marketing tool, and the More particularly, the [REDACTED] subscribers. In that sense, ad-supported Judges are loath to second-guess the contract with record labels that Dr. services indeed are marketing tools, but business model incorporating that Eisenach reviewed show [REDACTED]. they do not reduce present royalties marketing approach, especially after it 4/4/17 Tr. 4739–53 (Eisenach); see also, because the future subscribers have not has proven successful while still e.g. Trial Ex. 2760 ([REDACTED]); Trial providing royalties to rights owners. See Ex. 2765 ([REDACTED]). [REDACTED]. 306 In the parlance of platform economics, and as Page WDT ¶ 27 (Spotify’s freemium With regard to Dr. Eisenach’s specific noted supra, Spotify’s ad-supported service model monetizes through subscriptions omission of data from Spotify’s ad- provides a multi-platform approach, in which listeners, advertisers, sound recording rights more successfully than the sale of supported service, Copyright Owners holders and musical works holders all combine to downloads and CDs, as well as make additional arguments. They claim obtain revenue based on the mutual values each terrestrial radio and, of course, piracy). that the ad-supported service does not brings to that platform. See 3/21/17 Tr. 2013 (Marx). reflect the actual value of the sound 307 Copyright Owners belatedly propose that—if d. Service’s Criticisms and Judicial the Judges intend to include the Spotify ad- Analysis of Dr. Eisenach’s Method #1 recordings, because that tier acts as a supported service in the rate structure and rate funnel to draw listeners to the calculations—that they establish (1) separate rates The Services criticize Dr. Eisenach’s subscription service. Therefore, for ad-supported services that are not incorporated Method #1 calculation as being based Copyright Owners maintain, the ad- into the calculation of rates set for other services; and (2) separate terms for an ad-supported service upon the incorrect assumption that the supported service is essentially a loss- that limit the functionality of such a service to entire difference between interactive leader, with the difference between the avoid potential cannibalization of services paying and noninteractive rates must be higher effective per play rates for higher royalties. COPCOL ¶ 228 & n.34. This attributed to the mechanical license subscription services and the lower argument is a tacit acknowledgement by Copyright Owners that a segmented market may require a right. As the Services properly note, effective per play rates for the ad- differentiated rate structure (even as they there are several reasons, all unrelated supported services more in the nature of strenuously dispute the appropriateness of such a to the mechanical right and license, why a marketing expense that should not be structure). Such a post-hearing argument is ‘‘too interactive rates are higher than deducted from Dr. Eisenach’s royalty little, too late.’’ If Copyright Owners wanted to noninteractive rates for musical works calculations. See Eisenach WDT ¶ 148 argue in the alternative in this manner, they needed to do so during the hearing, and support their performance rights. Leonard WRT ¶ 55; n.127. arguments for limited ad-supported functionality Katz CWRT ¶ ¶ 117–118; Hubbard WRT However, that analysis omits several and segmented rates with testimony and evidence. ¶ 6.4; 4/5/17 Tr. 4972–74 (Katz). First, important facts. First, as Mr. McCarthy, As I noted supra, the Judges ‘choices were limited Dr. Eisenach’s Method #1 did not Spotify’s CFO testified, [REDACTED]. to the rate structures proffered by the parties, or reasonably suggested by the evidence; a different account for the presence of the 3/21/17 Tr. 2058–59 (McCarthy) structure, if proffered or suggested by the evidence, ephemeral right in licensing ([REDACTED]). Second, he notes that might have been preferable, but it had to be noninteractive streaming (discussed [REDACTED]% of Spotify’s paid supported by record evidence. In any event, the rate supra), which accounts for 5% of the subscribers in the United States were structure I adopt in this Dissent does not simply average Spotify’s lower effective per-unit rate into noninteractive rate. 4/4/17 Tr. 4851–52 previously such engaged users of the ad- an overall rate, because the I am adopting a (Eisenach); see also 4/5/17 Tr. 5159– supported service. McCarthy WRT ¶ 22; differentiated rate structure that continues to treat 5161 (Leonard) (discussing how Dr. see also 3/21/17 Tr. 2059 (McCarthy). the ad-supported market segment separately, Eisenach’s analysis does not consider Third, Mr. McCarthy testified that the reflecting the presence of a market segment with a lower WTP. Startlingly, the majority adopts this ad-supported tier [REDACTED]. See reasoning wholesale in the Majority Opinion, 308 Another alternative marketing approach 3/21/17 Tr. 2059 (McCarthy) foreclosing Copyright Owners’ argument. So, would be the offering of free trial subscriptions. ([REDACTED]). although the majority agrees that Copyright Owners However, there was no testimony as to whether free Notwithstanding the marketing value could not propose a new rate structure post-hearing, trials would better monetize listening than the the majority gives itself a free pass to do the same, freemium model used by Spotify. In fact, Spotify’s of the freemium model, it must be even though the harm to the parties is identical in CFO, Mr. McCarthy testified that, [REDACTED]. remembered that [REDACTED]. These either case—they are deprived of the opportunity to 3/21/17 Tr. 2113–2115 (McCarthy). See also COPFF listeners, and the advertising revenue challenge the post-hearing creation. ¶ 369.

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the ephemeral right); Leonard WRT and related data in this manner only specifically, the Services assert that Dr. ¶ ¶ 55–56. Second, there is a difference underscores the need for a Eisenach’s willingness to use the rate in the performance rights royalty rates differentiated/price discriminatory rate courts’ performance rates is inconsistent charged by PROs to interactive and structure, such as proposed by this with his broader claim that musical noninteractive services that is not Dissent. works rates have been artificially captured by Method #1. See, e.g., In re Also, I agree that Dr. Eisenach’s reduced below market rates. For Petition of Pandora Media, Inc., 6 F. analysis imports the complementary example, when identifying benchmarks, Supp. 3d at 330 (ASCAP charges oligopoly power of the sound recording Dr. Eisenach relies on the non-rate court different royalty rates for performance companies. Although (as also noted performance rights paid by Pandora in rights depending on whether the service supra) I do not think that the Judges the Opt-Out agreements precisely is non-interactive or interactive). Had could simply import the 12% steering because they represent, in his opinion, Dr. Eisenach considered these factors, adjustment from Web IV to calculate market-based rates untainted by the he might well have estimated a this effect (because the 12% was a depressing effects of the rate court. See mechanical rate significantly less than function of evidence specific to that Eisenach WDT ¶ ¶ 106–110, 4/4/17 Tr. the rates he derived, even using his proceeding), it is clear that any 4805, 4821–23. (Eisenach). According to ‘‘valuation ratios.’’ See Katz CWRT benchmark approach should adjust the Services, to be consistent, Dr. ¶ 122. downward a rate inflated by the Eisenach should have increased the rate The Services also note the impact in presence of complementary oligopoly in court levels to reflect what he Method #1 of Dr. Eisenach’s decision to the benchmark market. understood to be market rates. Such [REDACTED] from his modeling. As the And to reiterate, although the Services consistency, they assert, would make Services note, adding [REDACTED] to utilize Dr. Eisenach’s [REDACTED] ratio the subtracted rate in the Method #2 Dr. Eisenach’s effective per play rate for (implying a TCC of [REDACTED]%) to formula larger, and the difference— sound recording results in a per rate of illustrate the impact of their other which is Dr. Eisenach’s mechanical $[REDACTED]. See 4/4/17 Tr. 4771–74 criticisms, I find that ratio to be much rate—smaller. (Eisenach). Further, the Services note lower than what can reasonably be Finally, the Services criticize Dr. that, by introducing the unregulated gleaned from Dr. Eisenach’s Eisenach’s Method #2 calculations sound recording rates in his ratio, Dr. benchmarks. As indicate supra, the because they exclude not only Eisenach has imported the most usable benchmark information significant sound recording data, but complementary oligopoly (Cournot from Dr. Eisenach’s approach are the also the performance royalty data for Complements) power associated with YouTube [REDACTED] ratio, and the Amazon, Apple, Google, and Spotify. those rates, as noted in Web IV. See Katz Pandora ‘‘Opt-Out’’ ratio from actual Accordingly, Method #2 accounts for CWRT ¶ 56; Marx WRT ¶ ¶ 137, 141. agreements, which imply a TCC only 13 percent of total interactive Combining all of the foregoing between [REDACTED]% and service revenues in 2015. See Katz criticisms, the Services conclude as [REDACTED]%. CWRT ¶ 124. I agree with the Services that Method follows: e. Services’ Criticisms and Judicial #2 does not contain sufficient Analysis of Dr. Eisenach’s Method #2 If one were to use $[REDACTED] per industrywide performance royalty and hundred plays for the sound recording rate The Services criticize Dr. Eisenach’s sound recording data to provide a ([REDACTED]) (id. at 4771:10–4774:5), Method #2 principally for the same meaningful analysis for determining a reduce that by 12% as the Board did in Web reason they criticize his Method #1, viz., per-user monthly mechanical works IV for complementary oligopoly power, his use of a ratio that embodies increase the $0.20 per hundred plays Dr. royalty. I am also troubled by the Eisenach uses for musical works performance inapposite sound recording data. They apparent inconsistent use of rate court rights by 60% to account for the difference also emphasize the import of his established rates in Method #2, when in ASCAP rates identified by Judge Cote [in decision to omit Spotify’s sound Dr. Eisenach had indicated in other the rate court], and then apply Dr. Eisenach’s recording data from his Method #2 contexts that rates unshackled from rate invalid ‘‘valuation ratio’’ of [REDACTED], the calculations. At the hearing, Dr. court decisions provide a truer result would be $[REDACTED] per hundred Eisenach acknowledged the significance indication of market rates. plays [$[REDACTED] per play], way below impact of this omission, but he More broadly, I understand that Dr. the $0.15 per hundred plays rate [$0.0015 per defended the omission as virtue rather Eisenach omitted [REDACTED] because play] that Dr. Eisenach attempts to validate. than vice, because of the starkly of [REDACTED], which is [REDACTED]. SJPFF ¶ 279 (and record citations different manner in which Spotify I recognize that combining [REDACTED] therein). Thus, the foregoing criticisms monetizes its ad-supported service. He user data with other interactive would reduce Copyright Owners’ testified that, had he incorporated all of streaming services’ data [REDACTED]. benchmark by 80%. Spotify’s sound recording data in See CORPFF–JS at pp. 183–184 (noting I agree with the Services that Method estimating a current industrywide what Copyright owners describe as #1 does not provide a useful benchmark monthly per user charge, he would have ‘‘[t]he profound impropriety of in this proceeding. As noted supra, and calculated a monthly per user sound [REDACTED] into Copyright Owners’ most importantly, the absence of recording rate of $[REDACTED] per benchmarking and calculations.) interactive streaming data from Spotify month, rather than the $[REDACTED] Once again, though, that seeming is a critical omission. The fact that rate he determined when excluding anomaly actually underscores why I much of that data relates to ad- [REDACTED] data. 4/4/17 Tr. 4825–28 find the differentiated rate structure in supported services with a limited (Eisenach). the 2012 benchmark to be appropriate. functionality does not justify removing In addition, the Services assert that The royalty rates paid by all services that data from a market analysis, Method #2 is faulty because of Dr. should be reflective of the differentiated because that service is a part of the Eisenach’s use of the rate court WTP of their listeners (for the reasons market. In fact, Copyright Owners performance royalty rates that he discussed supra). That is, the same argument proves too much. That is, subtracts from his ratio-derived musical reason why Dr. Eisenach elected not to their willingness to distinguish and works rate to identify an implied lump Spotify with other services in his isolate the Spotify ad-supported service mechanical works rate. More calculations incorporated into Copyright

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Owners’ ‘‘one size fits all’’ rate elect to rely on the 2012 rates as period; a party could be sanguine as to structure. Indeed, the anomalous nature objectively useful evidence of the its ability to make persuasive arguments of Spotify’s monetization of the parties’ revealed preferences.310 as to why the rates should remain downstream market underscores why Copyright Owners disagree with this unchanged; a party might even conclude ‘‘one size does not fit all,’’ and why the use of the 2012 rate structure. As with that the mechanical rate is such a small 2012 rate structure therefore is regard to the structure of the rates, they proportion of the total royalty obligation preferable (and why Copyright Owners take the Services to task for failing to that its increase would be unlikely to made the post-hearing argument for a present evidence of the negotiations that alter long-term business plans. But for separate rate structure, with separate led to the prior settlements, including sophisticated commercial entities to terms, for ad-supported services, as the present 2012 benchmark. They argue claim that they simply assumed the that, without such supporting evidence discussed supra). rates would roll over without the or testimony, the Services cannot possibility of adjustment strikes me as f. Conclusion provide support for their proposed rates. For the reasons set forth above, I See CORPFF–JS at p. 61 (noting the lack so absurd and reckless as to raise would not adopt Dr. Eisenach’s of evidence for the ‘‘computations for serious doubts about the credibility of proposed benchmark rates as the different types of potential services’’ in that position. mechanical rates for the upcoming rate the 20212 benchmark). At least one of the Services, Spotify, period. However, as explained supra, I The Services take a broad approach in further suggests that the present rates find that the actual Pandora Opt-Out their attempt to support the usefulness should not be increased because an Agreements, the [REDACTED] YouTube of the rate levels within the 2012 increase in the rates might affect Agreements [REDACTED] rates provide benchmark. They note that music different interactive streaming services useful benchmark information (albeit publishers have consistently realized in different ways. In particular, there not the same information that Dr. profits under these rates, including might be a dichotomous effect as Eisenach identifies as useful from those profits from musical works royalties. between essentially pure play streaming agreements). Thus, usable ratios from However, Copyright Owners note that services (such as Spotify and Pandora) Dr. Eisenach’s analysis consist of the mechanical royalties have not created a and the larger new entrants with a wider [REDACTED] and [REDACTED] ratios profit for Copyright Owners, and the commercial ‘‘ecosystem’’ (such as derived from the YouTube [REDACTED] Services’ assertion of overall publisher Amazon, Apple and Google). As agreements and the [REDACTED] ratio profitability is based on their lumping of Spotify’s CFO testified: derived from the Pandora Opt-Out performance royalties together with Agreements. These ratios, respectively performance royalties. As I have noted The Copyright Owners argue that ‘‘a convert to percentages (i.e., a TCC supra, in considering Professor change in market-wide royalty rates such as percentages) of [REDACTED]%, Zmijewski’s analysis, the combination this would affect all participants in a similar [REDACTED]%, and {REDACTED]%. of mechanical and performance way,’’ suggesting that the industry as a whole Also useful are the 21%-22% TCC royalties earned by the music publishers could increase prices without affecting their values in the existing rate structure, is the more important metric, because: relative price points. Rysman WDT ¶ 94. which, as Dr. Eisenach indicated, (1) performance and mechanical [REDACTED]. See, e.g., Rysman WDT ¶ 29 [REDACTED]. See Eisenach WDT royalties are perfect complements; and .... [REDACTED]. ¶ ¶ 84–92. (2) the mechanical royalty has been calculated in an ‘‘All-In’’ fashion, McCarthy WRT ¶ 38 (emphasis 2. The Services’ Benchmark Rates 309 subtracting the performance royalty added); see also McCarthy WDT ¶ ¶ 50– a. The Present Section 115 Rates from the mechanical royalty, which of 51 ([REDACTED]); McCarthy WRT ¶ 36 ([REDACTED]). The Services do not examine in detail course has the effect of inflating the the particular rates within the existing performance royalty portion relative to I construe this argument as an rate structure. Rather, they treat the the mechanical royalty portion. iteration of the ‘‘business model’’ rates within that structure as The Services also maintain that they argument that the Judges have benchmarks are generally treated— relied on the continuation of the rates consistently rejected, viz., that the considerations in arriving at an that now exist to develop their business Judges will not set rates in order to agreement. Thus, just as Dr. Eisenach models. For example, Pandora, the latest protect any particular streaming service did not analyze why the rates and ratios entrant into the interactive streaming business model. Final Rule and Order, on which he relied as benchmarks were market, asserts that its decision to enter Digital Performance Right in Sound set at the levels he identified, or this market was based on its assumption Recordings and Ephemeral Recordings, that there would be no increase in the consider the subjective understandings 72 FR 24084, 24088 n.8 (May 1, 2007) mechanical royalty rates. Herring WRT of the parties who negotiated his (Web II). That is, I distinguish between: benchmarks, the Services’ economists ¶ 3. I categorically reject this argument. The applicable regulations provide that (1) business models that are necessary reflections of the fundamental nature of 309 The following analysis does not address the ‘‘[i]n any future proceedings the royalty direct deals entered into by Pandora, cited by rates payable for a compulsory license market demand, particularly, the varied Professor Katz in his testimony. He candidly shall be established de novo.’’ 37 CFR WTP among listeners; and (2) business acknowledged that the probative value of these models that may simply be unable to agreements was weakened by the fact that they 385.17; see also 37 CFR 385.26 (same). included rates for other tiers of service, including A party may feel confident that past is meet dynamic competition within the noninteractive service, and he had not given prologue and the parties will agree to market or a given market segment. If consideration to how the bargaining and setting of roll over the extant rates for another pure play interactive streaming services each rate in each tier might be interrelated. See Katz are unable to match the pricing power WDT ¶ 105 (‘‘The simultaneous agreement with respect to multiple services can cloud the 310 This point is not made to be critical of Dr. of businesses imbued with the self- interpretation of any given number in a contract Eisenach’s approach, but rather to show that the financing power of a large commercial because the rates are negotiated as a package.’’). I Services’ reliance on the 2012 settlement as a ecosystem, nothing in section 801(b)(1) agree with Professor Katz and, for this reason, I benchmark shares this similar analytical place no weight on those direct Pandora characteristic, typical and appropriate for the permits—let alone requires—that the agreements. benchmarking method in general. Judges protect those pure play

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interactive streaming services from the has been declining over the past several 1098, 1113 (Leonard) (‘‘in the case of a forces of horizontal competition.311 years. See COPFF ¶ ¶ 196, 583, 611, 736 PDD, and streaming, in both cases On balance, I do not find that the (and record citations therein). Second, you’re getting—it’s really about on- Services’ status quo and business model they note that, as the Services demand listening .... I think it’s . . . arguments for maintaining the section acknowledge, the parties are not a very, very useful benchmark.’’). 115 rates are themselves persuasive identical; specifically, the licensees in I disagree with Dr. Leonard, and agree reasons to maintain those rates. If those Subpart A are the record companies with Copyright Owners that the rates should be maintained, support for whereas in Subpart B the licensees are ‘‘ownership vs. access’’ dichotomy such a result would need to be found the interactive streaming services. See, diminished the usefulness of the elsewhere in the record. e.g., 3/15/17 Tr. 1193 (Leonard). Third, subpart A rate as a benchmark. Although Dr. Leonard is correct in b. The Services’ Subpart A Benchmark they emphasize that the existing Subpart A rate is itself the product of a noting that ownership is in essence a The Services propose the rate set forth settlement, rather than a market rate. more comprehensive and unconditional in Subpart A as a benchmark for the More importantly, Copyright Owners form of access, a downstream purchaser Subpart B rates to be determined in this also note that the subpart A settlement acquires ownership of only the digital or proceeding. As noted supra, Subpart A establishes a per-unit royalty rate of physical embodiment of a sound reflects the rates paid by record $.091 per physical or digital download recording (and the embodied musical companies, as licensees, to Copyright delivery (with higher per-unit rates for work) in exchange for an up-front Owners for the mechanical license, i.e., longer songs), rendering that rate charge (the purchase price), and then the right to reproduce musical works in inapposite as a benchmark for the has unlimited free access to that single digital or physical formats. The Services’ present subpart B proposal. In sound recording/musical work going particular Subpart A benchmark rate on support of the conclusion that this forward. By contrast, a subscriber to an which the Services’ rely is the existing makes for an inapposite comparison, interactive streaming service pays an rate, which the Subpart A participants Copyright Owners argue that because up-front charge (usually monthly), and have also agreed to continue through the the subpart A rate is expressed as a then likewise has unlimited access to forthcoming rate period through the monetary unit price, the Copyright the entire catalog of sound recordings settlement noted supra. Owners have eliminated the risk that (and the embodied musical works) for In support of this benchmark, the the retailers’ downstream pricing each such period. Services emphasize that the total decisions will impact Copyright Thus, the dissimilarities between the revenue created by the sale of digital Owners. More specifically, they note products regulated in subpart A and phonorecord downloads and CDs is that, ‘‘[u]nder the Subpart A rate subpart B outweigh their similarities. essentially commensurate with the structure, the label (as licensee) pays the An interactive streaming service revenues created through interactive same [penny rate] amount in provides an access (option) value to streaming, indicative of an equivalent mechanical royalties regardless of the entire repertoires of music. A purchased financial importance to publishers when price at which the sound recording is download or CD provides unlimited negotiating rates when negotiating rates ultimately sold [within the] range of access for only a single sound with licensees in Subparts A and B price points for individual tracks in the recording/musical work. respectively. See 3/20/17 Tr. 1845 market ranging from $0.49 to $1.29 and In other respects, though, I recognize (Marx) (‘‘downloads, in particular, are the mechanical penny rate binds that the subpart A market and comparable to interactive streaming.’’). regardless of the price of the track. settlement are somewhat comparable to Also, although the Subpart A rate is the COPFF ¶ 727 (citing Ramaprasad WDT the subpart B market. The licensed right product of a settlement, the Services ¶ 28 & Table 1). in question is identical—the right to argue that the rate is a useful benchmark Of equal importance, Copyright license copies of musical works for because it reflects both the industry’s Owners distinguish Subpart A from listening in a downstream market. sense of the market rate and the Subpart B based on the fact that Further, the licensors—i.e., the music industry’s sense of the how the Judges downstream listeners to DPDs and CDs publishers and songwriters—are would apply the section 801(b)(1) (and any other physical embodiment of identical.312 Finally, the time period is considerations to those market rates. a sound recording) become owners of reasonably recent, and the Copyright 3/15/17 Tr. 1184, 1186 (Leonard); the sound recording and the musical Owners have not explained whether or 3/20/17 Tr. 1842–43 (Marx). work embodied within it, whereas how the particular market forces in the In opposition, Copyright Owners under Subpart B the listeners only Subpart A market sectors have changed argue, for several reasons, that the obtain access to these songs and musical since 2012 to make the rate obsolete. Subpart A rates are not proper works for as long as they remain Notwithstanding these similarities benchmarks. First, they emphasize that subscribers or registered listeners (to a though, I find that the facially different revenue from the sale of DPRs and CDs non-subscription service). access value in subpart A constitutes a In reply to this argument, Dr. Leonard, fatal flaw in its usefulness as a 311 Moreover, any disruption arising from the asserted that the legal ‘‘ownership vs. benchmark in this proceeding. However, disparate impact of a rate increase among access’’ distinction does not reflect as interactive streaming services would not constitute the Services, and Apple, have presented ‘‘disruption’’ under Factor D of section 801(b)(1), fundamental an economic difference as because such disruption would not impact the might appear on the surface. Leonard 312 However, the licensees in the benchmark structure of the industry or generally prevailing WRT ¶ 27 (‘‘[T]here are certain market are not the same. Moreover, as Copyright industry practices, but rather would impact conceptual similarities between Owners note, there is an important economic particular business models. The irrelevancy, for difference in the identities of the licensees. In disruption purposes, of a rate increase under the streaming and a download.’’). Having subpart A, the licensees are record companies, who existing structure must be distinguished from a rate paid for a track download, a user can use the licensed musical works as inputs to create increase caused, as in the Majority Opinion, by a listen to it as often as desired without a new product, the sound recording. In subpart B, radical change in the rate structure that cedes further charge. Similarly, having paid the interactive streaming services use the musical control of rates to private third-parties, i.e., the work through their use of the finished product (the record companies, who have economic interests the subscription fee, a streaming user sound recording). This basic difference suggests adverse to both the services and Copyright Owners, can listen to a track as often as desired that the different values are a consequence of a as discussed supra. without further charge’’); 3/15/17 Tr. difference in kind.

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evidence which they assert provides of streams, 150, yielding a value for the ¶ 96. Second, and relatedly, the experts two different ways of rendering subpart per-play total streaming royalty of who relied on the Aguiar/Waldfogel A rates compatible. Accordingly, I $[REDACTED]. Id. ¶ ¶ 109–110. The article did not verify that the input data consider those approaches below. resulting per-play royalty rate for the used by the authors was appropriate for sum of mechanical and performance the purposes for which it has been c. The Services’ and Apple’s Subpart A royalty translates to [REDACTED]% of relied upon in this proceeding. See Benchmarking Approaches Spotify’s revenue. Id. ¶ 111. Subtracting 3/20/17 Tr. 1945–46 (Marx); 3/23/17 Tr. To convert the per-unit rate in subpart out the performance royalty of 2789–90 (Ramaprasad). Third, the A into a subpart B percent-of-revenue [REDACTED]% as in an ‘‘All-In’’ Aguiar/Waldfogel article appears not to rate, the Services and Apple identify calculation, she derived a mechanical specifically address two issues that several alleged third-party conversion royalty rate equivalent from Subpart A would make an equivalency ratio ratios between a given number of of approximately [REDACTED]% to meaningful: (a) what happens to the interactive streams and a single play of [REDACTED]% of revenue. Id. ¶ 112, download behavior of an individual a purchased DPD that they allege are Fig. 22. who adopts streaming; and (b) how the applicable in this proceeding. Professor Marx engaged in the same availability of streaming alters the Professor Marx first applies a calculation methodology when applying consumption of a particular song. See conversion ratio of PDDs to streams of the 1:137 conversion ratio from the Rysman WRT ¶ 97. Fourth, the experts 1:150, which she noted had been Aguiar/Waldfogel article, and she for the Services and Apple ignore that established by the RIAA. Second, she determined a percent-of-revenue royalty Aguiar and Waldfogel conducted an (as well as Professor Katz) takes note of for Spotify of [REDACTED]% (‘‘All-In’’), additional analysis described in the an academic study which estimated higher than the [REDACTED]% when same article on which they rely. In that that, in the marketplace, 137 interactive applying the 1:150 conversion ratio. Id. second analysis, the authors compared streams was equivalent to the sale of ¶ 111 n.123. the weekly data from Spotify for the one DPD. Marx WDT ¶ 108 & n.21 On behalf of Pandora, Professor Katz period April to December 2013 with (citing L. Aguiar and J. Waldfogel, used the same 1:150 conversion ratio as weekly data from Nielson on digital Streaming Reaches Flood Stage: Does Professor Marx. He calculated a download sales for the same exact songs Spotify Stimulate or Depress Music mechanical rate implied by the subpart during the same overlapping time Sales? (working paper, National Bureau A rate of 4.25%, higher than Professor period. That approach, which Aguiar of Economic Research, 2015)); Katz Marx’s implied rate, but still lower than and Waldfogel called their ‘‘matched WDT ¶ 110 (same). Apple’s economic the existing headline rate of 10.5% in aggregate sales’’ analysis, yielded a ratio expert, Professor Ramaprasad, also subpart B. Katz WDT ¶ 111. On behalf of 1:43, implying a much higher relied on the Aguiar/Waldfogel article to of Apple, Professor Ramaprasad utilizes mechanical rate for streaming. See support Apple’s benchmark per play the 1:150 ratio, which she adopted from COPFF ¶ ¶ 663–64 (and record citations proposal. Ramaprasad WDT ¶ 56, Billboard magazine’s ‘‘Stream therein). n.102.313 Equivalent Albums’’ approach. The Services and Apple offer no To apply the 1:150 conversion ratio, Ramaprasad WDT ¶ 84. Because Apple sufficient evidence to overcome these Professor Marx first calculated the has advocated for a per stream rate, her criticisms of their ‘‘equivalence’’ subpart A mechanical license fee as the conversion was expressed on a per approach for applying the Subpart A weighted average of the PDD/CD stream basis, at $0.00061 per stream. rates in this proceeding. Accordingly, I mechanical license fee for songs five Professor Ramaprasad noted that this do not rely on such ‘‘equivalence’ minutes or less and songs greater than rate was not only lower than the approaches in this determination. five minutes: $[REDACTED] per copy $0.0015 per stream rate proposed by By contrast, the Services’ second for the former and $[REDACTED] per Copyright Owners, but also significantly Subpart A benchmarking approach, minute or a fraction thereof lower than Apple’s own proposed per- utilized by both Professor Marx and Dr. (conservatively assuming that songs stream rate of $0.00091. Ramaprasad Leonard, is more straightforward, and longer than five minutes have an WDT ¶ 86. When Professor Ramaprasad does not require a conversion of average length of eight minutes). Based applied the Waldfogel/Aguiar 1:137 downloads into stream-equivalents. on this assumption, she estimated a ratio, expressed on a per-play basis, she Rather, under this approach, Professor PDD/CD mechanical license fee of calculated a rate of $0.00066 per-stream Marx simply divides the effective per- $[REDACTED] per song. Marx WDT for interactive streaming, which she unit download royalty of $[REDACTED] ¶ 108. Next, Professor Marx obtained a noted also was even lower than the per- by the average retail price of a per-play streaming royalty equivalent by stream rate of $0.00091 Apple had download, $1.10, to calculate an ‘‘All- dividing the $[REDACTED] per song proposed. In’’ musical works royalty percent of amount (derived supra) by the number I do not place any weight on this [REDACTED]%. Subtracting Spotify’s ‘‘conversion’’ approach. Copyright [REDACTED]% performance rate nets a 313 Professor Ramaprasad also relied on two other Owners levy numerous criticisms of the mechanical works rate of equivalency ratios, the first from Billboard ratio approach, and those criticisms, [REDACTED]%. In similar fashion, magazine, and the second from another entity, UK each on its own merit, serve to discredit given an average CD price of $1.24 per Charts Company (UK Charts). However, she acknowledges that the Billboard ratio combines the ratio approach. First, the Services song, she finds that the ‘‘All-In’’ musical video streaming royalty data with audio streaming and Apple simply adopted the works rate equals [REDACTED]%. royalty data, which results in an overestimation of equivalence ratios without defining Subtracting Spotify’s [REDACTED]% the ratio of streams to track sales relative to an what ‘‘equivalence’’ means. For performance rate nets an ‘‘effective’’ audio-stream-only analysis. 3/23/17 Tr. 2760–61 (Ramaprasad). She also acknowledges that UK example, the RIAA used the concept to mechanical royalty rate of Charts changed its ratio from 1:100 to 1:150 without identify albums that were sufficiently [REDACTED]% under this approach. explanation, rendering uncertain that purported popular to garner ‘‘gold’’ or ‘‘platinum’’ Thus, she concludes that the Services’ industry standard. See COPFF ¶ 683 (and record awards. That use, absent other evidence, proposal in general, and Spotify’s citations therein). Also, there was no evidence indicating that streaming and download activity in does not indicate that the conversion proposal in particular, are conservative the United Kingdom would be comparable to U.S. ratio is appropriate for rate-setting and reasonable, because those proposals activity. purposes. See generally Rysman WRT provide for substantially higher royalty

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rates than suggested by this subpart A from all downstream market participants, [REDACTED]% to [REDACTED]%, this benchmark analysis. Marx WDT whether existing or new entrants, that leaves TCC reflects a royalty equal to an ¶ ¶ 113–114 & Fig. 23. him as well off as he would have been absent effective percent of total 314 revenue Dr. Leonard did a similar calculation. entry. equal to [REDACTED]% to He found that, applying the subpart A Marx WDT ¶ 104, n.118. The Judges [REDACTED]%. rates, expressed as a percentage of first identified this principle in Web IV, Second, the YouTube agreements revenue, interactive streaming services through a colloquy with an economic with music publishers identified by Dr. would pay an ‘‘All-In’’ rate to Copyright witness. See Web IV, 81 FR at 26344 Eisenach—that relate to [REDACTED]. Owners of 8.7% of revenue, based on (SoundExchange’s economic expert, That [REDACTED]% royalty is a the average retail price of digital Professor Daniel Rubinfeld, denominator in the ratio concept downloads in 2015. Leonard AWDT acknowledging that, generally, utilized by Dr. Eisenach,315 and the ¶ 42. Dr. Leonard further calculated that, licensors, as ‘‘a fundamental economic numerator is the [REDACTED] sound expressed as a percentage of payments process of profit maximization . . . recording royalty paid to the record to the record labels (rather than total would want to make sure that the companies. As explained supra, downstream revenues) the subpart A marginal return that they could get in YouTube has agreed to pay settlement reflects a payment of 14.2% each sector would be equal, because if [REDACTED], and has agreed to pay of ‘‘All-In’’ sound recording royalties, the marginal return was greater in the [REDACTED]. The [REDACTED] ratio when compared to payments to record interactive space than the reduces to [REDACTED], implying a labels in 2015. Leonard AWDT ¶ 46. noninteractive . . . you would want to TCC ([REDACTED]) of [REDACTED]%. Using updated 2016 data, which continue to pour resources, recordings The [REDACTED] ratio reduces to lowered the DPD retail price to $.99, Dr. in this case, into the [interactive] space [REDACTED], implying a TCC Leonard calculates an ‘‘effective’’ until that marginal return was ([REDACTED]) of [REDACTED]%. percentage royalty rate of 9.6%. 3/15/17 equivalent to the return in the Third, I look at the effective rates paid Tr. 1108–09 (Leonard). Dr. Leonard then noninteractive space.’’). by Spotify, the largest interactive adjusts this result to make it comparable However, that argument is dependent streaming service in terms of in terms of to Google’s proposal, which seeks a 15% upon a usable conversion ratio to the number of subscriber-months and reduction of up to 15% in certain costs equalize access value per unit. Professor the number of plays. See Marx WRT incurred to acquire revenues. Adjusting Marx does not explain how, absent such ¶ ¶ 37–38 & Figs. 8 & 9. Under the for this cost reduction, Dr. Leonard conversions, it would be possible to current rate structure, as noted supra, concludes that the equivalent percent of equalize rates of return across platforms. [REDACTED] 316 [REDACTED]. revenue (after deducting similar costs) Accordingly, I find that the principle of Continuing with a consideration of in Subpart A is 10.2% in 2015 and ‘‘equalized returns’’ relied upon by Spotify’s rates paid under the existing 11.3% in 2016. Id. at 1109. Professor Marx cannot be applied. rate structure, [REDACTED]. [REDACTED]. The average rate is Copyright Owners do not dispute the 3. Apple’s Proposed Rate calculations made by Professor Marx relevant in this proceeding because, as and Dr. Leonard in these regards. Apple proposes a per-play rate of discussed supra, Spotify’s two tiers are However, they emphasize that this $0.00091 per unit. However, that rate is interrelated, in that the ‘‘freemium’’ approach nonetheless is not useful premised on two analytical factors that model construes ad-supported listeners because it fails to fails even to attempt I have rejected, as discussed supra. as a pool of potential converts to the to explain the significant differences in First, as a single, per-play rate, it fails subscription tier, even as they generate access value between the purchase of a to reflect the variable WTP in the (indirectly) advertising revenue that download or CD, on the one hand, and market, rendering it a less efficient converts to royalties for the Copyright a subscription to (or free use of) an upstream royalty rate. Second, Apple’s Owners under the TCC prong. Fourth, leaving the Spotify rates, I interactive streaming service, on the proposed $0.00091 rate is derived from note that direct deals identified in the other. That is, whereas the Services and the subpart A conversion ratio approach record reflect rates in the present Apples’ first approach is deficient that I have rejected, for the reasons regulations (as Dr. Eisenach noted, because its conversion ratios are not discussed supra. I incorporate herein albeit he minimized the importance of applicable, Services’ second approach my analysis rejecting a per-unit those direct agreements). Also, the fails because it simply bypasses approach, and my analysis rejecting the direct agreements contain additional altogether the problem of access value subpart A conversion ratio approach. terms that make them relatively differences. 4. Findings Regarding the Reasonable Finally, I take note of a point made by uncertain benchmarks. For example, Rate (before consideration of the four although Google’s direct deals include Professor Marx, that Copyright Owners, itemized factors) like any seller/licensor, would rates that reflect the statutory rate— rationally seek to equalize the rate of There are several rates, as discussed 314 In the context of this section, ‘‘total’’ revenue return from each distribution channel supra, that I find to be supported by sufficient evidence to be relevant to the is intended to distinguish from the percent of i.e., from licensing rights to sell DPDs/ royalties paid by interactive streaming services to CDs under subpart A and from licensing setting of rates in the present record companies as sound recording royalties (i.e., to interactive streaming services under proceeding. TCC). First, Dr. Eisenach’s Pandora Opt-Out 315 subpart B. As she explains: To repeat for the sake of clarity, Dr. Eisenach Agreement benchmarks, as contained in does not rely on the ‘‘static image’’ agreements for This principle of equalizing rates of return those agreements (i.e., without his ultimate opinion. But the text accompanying this footnote expresses how the ‘‘static image’’ rate across different platforms has some extrapolation), reflect a ratio of similarities with that underlying the is being applied based on Dr. Eisenach’s ratio [REDACTED] of sound approach. approach of W. Baumol and G. Sidak, ‘‘The 316 Pricing of Inputs Sold to Competitors,’’ .... recordings:musical works in a The record in some places records this figure comparable benchmark setting. This as [REDACTED]% and [REDACTED]%. I They propose an efficient component pricing understand these differences reflect rounding of rule whose purpose is to ensure that the ratio, as noted supra, translates to a TCC figures and some discrepancy as to the time period bottleneck owner (in our case, the copyright percent of [REDACTED]%. With sound covered. In any event, these differences do not holder) should get compensation for access recording royalty rates of approximately impact my findings.

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[REDACTED]. Leonard AWDT ¶ ¶ 53– to consider, challenge and rebut at the popularity of lockers. 3/8/17 Tr. 159– 54.317 Also, its direct deals omit the hearing. What the Judges cannot do is 160 (Levine); 3/16/17 Tr. 1458–1461 Mechanical Floor, id., which, as noted attempt to cobble together elements of (Mirchandani) ([REDACTED]); supra, [REDACTED]. different proposals (the majority’s Mirchandani WDT ¶ 33 ([REDACTED]), [REDACTED] pays [REDACTED] ‘‘Frankenstein’s Monster’’ approach, as Copyright Owners further note that this royalties equal to [REDACTED] for its characterized by Copyright Owners) fall in popularity is reflected in the fact bundled subscription services which, without evidence as to how those that neither Spotify nor Pandora offers after subtracting an [REDACTED]% combined elements would impact the either a purchased content or a paid performance royalty, equals a industry and its participants. locker service. They note that Apple, mechanical royalty of [REDACTED] % which at one time offered a paid locker VI. SUBPART C: APPLYING THE 2012 of [REDACTED]. Leonard AWDT ¶ 64. service, has abandoned that product, but BENCHMARK [REDACTED]. still offers a purchased content locker Apple pays [REDACTED]. Wheeler The parties’ negotiations in service (perhaps a function of its market WDT ¶ 10. [REDACTED]. See Eisenach Phonorecords II that culminated in the share of previous listener purchases of WDT ¶ 10 (‘‘[A]s a matter of economics 2012 settlement focused more intensely digital downloads from its iTunes the Section 115 license operates as a on the rates that would apply to new Store). 3/22/17 Tr. 2523 (Dorn). ceiling but not a floor on Section 115 service types, including cloud locker Copyright Owners also note that the royalties.’’). services, that would ultimately be Services’ subpart C arguments suffer Based on the foregoing evidence embodied in subpart C of 37 CFR part from the same defect as their subpart B regarding rates, I find that the existing 385. Parness WDT ¶ 13; Levine WDT arguments: they have not provided any rate structure is generating effective ¶ ¶ 38–39; Israelite WDT ¶ ¶ 28–30. In evidence explaining the basis for any of percent-of-revenue rates in the manner fact, the subpart C negotiations that the rates or terms contained in . . . in which it was intended. The 10.5% created five new service categories were subpart C .... of the statute. headline rate is exceeded by the rates quite protracted, the subject of a CORPFF–JS at p.2. paid by [REDACTED], even as the negotiation over more than one year. In opposition, the Services argue that effective per play rates that generate 3/29/17 Tr. 3652–55 (Israelite). Copyright Owners do not point to any those percentages are lower. The rates Moreover, in this protracted give-and- evidence to show that locker services actually paid and the rates under the take, the NMPA rejected some categories have completely ‘‘disappeared.’’ Rather, 2012 benchmark are also consistent proposed by the services, while others they note that Apple and Amazon with the benchmark rates arising from were accepted and became part of continue to offer locker services. Joyce the benchmark analyses undertaken by subpart C. Id. at 3654- 56. WDT ¶ 5; Mirchandani WDT ¶ ¶ 16–17. Dr. Eisenach that I find to be sufficiently In setting these rates—rather than In this regard, Apple notes that each comparable, particularly with regard to developing a new royalty structure for service in this proceeding that sells the TCC prong. The clustering of the these service types—the parties downloads also offers locker services. effective percent of revenue rates in this ultimately agreed on a structure for See 3/22/17 Tr. 2523–25 (Dorn); regard indicates that the price subpart C that resembled the subpart B Ramaprasad WDT, Table 3. The Services discriminatory aspects of the existing structure, adopting a headline also note that Copyright Owners are structure allow for the growth of percentage of revenue royalty rate and seeking rates for subpart C products that revenue, as the interactive streaming per-subscriber and TCC minima. are substantially higher than present services ‘‘exploit the demand curve’’ by Parness WDT ¶ 14; see also 37 CFR rates. See Joyce WDT ¶ 19. offering tiers of service that appeal to 385.22. As with the bundling More generally, the Services urge the the budget constraints and the negotiations relating to subpart B, the Judges to use the subpart C rate preferences of the segmented parties negotiated and created a bundled structure as the benchmark for rates in marketplace. The fact that a wide array service category under subpart C (with the forthcoming period for the same of products with different certain adjustments to the definition of reasons as they urge the use of the characteristics at different price points ‘‘revenue.’’) 3/8/17 Tr. 161–64 (Levine); subpart B benchmarks a an appropriate has monetized usage, such that some 37 CFR 385.21. Not only are these benchmark. That is, the 2012 subpart C effective actual rates exceed the 10.5% provisions the default statutory terms, benchmarks were negotiated by the ‘‘headline’’ rate, is testament to the but publishers and service also same parties, covering the same rights mutual benefits of the existing rates. incorporate these rates and terms in over a relatively contemporaneous As noted supra, this finding does not their direct licenses. See Leonard period, and the economic circumstances mean that there might not be better AWDT ¶ ¶ 54, 58, 67, 69. are sufficiently similar. Amazon ways to monetize demand, and I do not Copyright Owners now urge the characterizes the ‘‘[t]he existing . . . suggest that the record permits me (or elimination of these subpart C Subpart C service categories and rate the majority) to identify appropriate provisions. They note that, although the structures [as] represent[ing] the rates with mathematical precision. Services had been very interested in collective efforts of industry However, as the D.C. Circuit has held, locker services (a large focus of subpart participants . . ., including [a] and as noted supra, our rate-setting is an C) during the 2012 negotiations, locker proceeding[] before the [Judges] which intensely practical affair, and services have decreased in popularity were resolved by a negotiated settlement mathematical precision is not possible. and significance, and have largely agreement among the participants many Nat’l Cable Television Ass’n, 724 F.2d at disappeared. They explain this of whom are also participants in this 182. Moreover, the Judges are phenomenon as linked to the transition proceeding.’’ Mirchandani WDT ¶ ¶ 58– constrained: We must choose among the by listeners from ownership to access 62. Moreover, several of the listed rates and structures proposed by the models, rendering functionally services already provided (or had plans parties, or reasonably ascertainable from unimportant a listener’s access to his or to provide) subpart C services in 2012, the evidence, through an evidentiary her own libraries as stored in a cloud underscoring the relevance of the process that the parties were permitted locker. In fact, Copyright Owners point negotiated settlement. See 3/18/17 Tr. out that the Services’ own witnesses 157–158 (Levine) (discussing Google’s 317 [REDACTED]. have acknowledged this decrease in the plans to launch a . . . locker service in

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the period of Phonorecords II understanding of the different use the findings identifying the reasonable negotiations); Mirchandani WDT ¶ 16 values implicated by subpart B and the rate structure and rates. (discussing launch of Amazon locker locker services identified in subpart A. The Relationship of the Four service in mid-2012). C.318 The Services also criticize the Itemized Factors to the Market Rate application of Copyright Owners’ VII. THE FOUR ITEMIZED FACTORS The D.C. Circuit recently reiterated greater-of approach in the subpart C IN SECTION 801(b) the relationship between the 801(b) context as absurd. They claim that The four itemized factors set forth in standard and market-based rates by under Copyright Owners’ proposal, section 801(b)(1) require the Judges to contrasting that standard with the licensors would receive $0.091 for each exercise ‘‘legislative discretion’’ in willing buyer/willing-seller standard set download of a copy from a purchased making independent policy forth in 17 U.S.C. 114(f)(2)(B). The court content locker, and at least $1.06 per- determinations that balance the interests noted that the two standards are month for each month that a listener of copyright owners and users.’’ distinguishable by the fact that, unlike facilitates a copy in order to accesses the SoundExchange, Inc. v. Librarian of section 114(f)(2)(B), section 801(b)(1) track via that locker, because. This Cong., 571 F.3d 1220, 1224 (DC Cir. does not focus in the same manner as would be absurd, according to the 2009); see also RIAA v. CRT, 662 F.2d rates that would be set in a marketplace. Services, because the separate copy is 1, 8–9 (D.C. Cir. 1981) (analyzing SoundExchange, Inc. v. Muzak LLC, 854 the basis for the royalty payments that identical factors applied by predecessor F.3d 713, 715 (D.C. Cir. 2017). However, to the extent that market Copyright Owners had already received rate-setting body and holding that the factors may implicitly address any (or when the listener originally purchased statutory policy objectives of 801(b)(1) the product. Mirchandani WRT ¶ 47. all) of the four itemized factors, the ‘‘invite the [Board] to exercise a reasonable, market-based rates may Adding to this criticism, Apple legislative discretion in determining emphasizes that Copyright Owners fail remain unadjusted, And, if the evidence copyright policy in order to achieve an suggest that the market-based rates fail to mention that: (1) all purchased equitable division of music industry content locker services are free by to account for any (or all) of these four profits between the copyright owners itemized factors, the Judges will adjust definition, pursuant 37 CFR 385.21; and and users’’). (2) some locker service streams originate the reasonable, market-based rate from private copies of songs that are not The four factors ‘‘pull in opposing appropriately. See SDARS I, supra at streamed content from a central service directions,’’ leading to a ‘‘range of 4094 (applying the same itemized (see 3/13/17 Tr. 829–830 (Joyce). reasonable royalty rates that would factors and holding that ‘‘[t]he ultimate On balance, I find that the subpart C serve all these objectives adequately but question is whether it is necessary to rate structure has the same attributes of to differing degrees.’’ Recording Indus. adjust the result indicated by a useful benchmark as does the subpart Ass’n of Am. v. Copyright Royalty marketplace evidence in order to B rate structure. The categories of Tribunal, 662 F.2d 1, 9 (D.C. Cir. 1981) achieve th[e] policy objective.’’).319 (‘‘Phonorecords 1981 Appeal’’) parties were the same, the rights are the B. Factor A: Maximizing the same and the agreement is relatively (citations omitted). Certain factors require determinations ‘‘of a judgmental Availability of Creative Works to the contemporaneous. I do not find that the Public lack of popularity of the subpart C or predictive nature,’’ while others call configurations cuts against the use of for a broad fairness inquiry. Id. at 8 1. Introduction the 2012 rate structure as a benchmark. (citations & quotations omitted). Factor A provides that rates and terms If the subpart C categories wither in the Accordingly, the Judges are ‘‘free to should be determined to ‘‘maximize the marketplace, the impact of this rate choose’’ within the range of reasonable availability of creative works to the structure will be of little importance. rates . . . within a ‘zone of public.’’ 17 U.S.C. 801(b)(1)(A). Of But if these lockers, bundles and other reasonableness.’ ’’ Id. at 9 (citations particular importance, this provision offerings grow in popularity, the relative omitted). unambiguously links the upstream rates strength of this benchmark will be Further, as explained at note 205 (and and terms that the Judges are setting preferable to the ‘‘greater of’’ the accompanying text) supra, the with the downstream market, in which formulation proposed by Copyright ‘‘reasonableness’’ analysis can be ‘‘the public’’ is listening to sound Owners. undertaken as an initial step, followed recordings that embody musical works. In that regard, Copyright Owners’ rate by consideration of the four itemized In a prior Determination, the Judges structure proposal for subpart C factors, or the four-factor analysis can be made a general statement, attributed to (identical to its proposal for subpart B) undertaken as part of the an expert economic witness, Dr. Janusz is rejected for the same reasons as it was ‘‘reasonableness’’ analysis. I have Ordover, in SDARS I, that ‘‘[w]e agree rejected for subpart B, and those followed what I understand to be the with Dr. Ordover that ‘voluntary criticisms are incorporated into this more conventional approach in transactions between buyers and sellers section. Further, locker services are proceedings applying the section as mediated by the market are the most distinguishable from other products. 801(b)(1) standards by essentially effective way to implement efficient Musical works embodied in the sound undertaking the former approach. allocations of societal resources.’ recordings that have already been However, my following consideration of purchased have a value that is reflected the four itemized section 801(b)(1) 319 Thus, the Judges reject Copyright Owners’ in the sale through another distribution factors also provides further support for argument that the first three itemized section channel. It would be anomalous to 801(b)(1) factors per se reflect the same forces that shape the rate set in the marketplace. See 4/4/17 Tr. apply the same rate structure to the right 318 Once again, separate and apart from the 4589, 4666 (Eisenach). The Services also challenge of a service to obtain a copy so that the usefulness of the 2012 benchmark structure and Dr. Eisenach’s assertion that he believes that the downstream customer could store or rates as benchmark evidence, the existing rate first three itemized factors reflect market forces, access that which he or she already structure and rates, which embody the 2012 based on his prior writings and testimony, a charge settlement, serve as a default rate structure and set that he persuasively denies. Compare SJRCOPFF at owns. I find that the parties’ prior arm’s of rates, because the other evidence in the record p.5 with 4/4/17 Tr. 4676–79 (Eisenach). I find this length negotiations of the subpart C does not support an alternative approach. See Music dustup to be irrelevant to their objective analysis of structure better reflects their Choice, supra. the itemized 801(b)(1) factors.

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Ordover WDT at 11.’’ SDARS I, 73 FR 2. The Services’ Position As the foregoing definitions imply, at 4094. However, as the discussion of the two surpluses may be measured by the economics of this market, supra, On behalf of the Services, Professor reference to a single equilibrium price. should make plain, I do not agree that Marx approaches Factor A in a manner However, when sellers are able to price such a broad statement captures all the that is at once novel (for these discriminate, they enlarge the total economic realities of the market. In fact, proceedings) yet consistent with value of the combined surpluses, Professor Ordover’s full testimony in fundamental and relevant economic diminish the ‘‘deadweight loss’’ and SDARS I clearly demonstrates that he principles. Specifically, she asserts that appropriate for themselves the larger, fully appreciates the particular aspects maximization of the availability of combined surplus. See Varian, supra at of the economics of the markets at issue, musical works (embodied in sound 465 (With price discrimination, ‘‘[j]ust including the aspects relevant to Factor recordings) to the public, through as in the case of a competitive market, A. More fully, Professor Ordover interactive streaming, requires that the the sum of producer’s and consumer’s testified as follows in SDARS I: 320 combined ‘‘producer surplus’’ and surplus is maximized [but with] the ‘‘consumer surplus’’ be maximized, Unimpeded market transactions promote producer . . . getting the entire surplus economic efficiency and lead to supply and because that leads to listening by all generated in the market. . . .’’). In fact, demand decisions that maximize society’s segments of the public regardless of price discrimination is ubiquitous in the economic welfare. [I]n the special case of their WTP. To understand Professor marketplace. See Baumol, Regulation markets for sound recordings and other Marx’s analysis, the economic Misread by Misread Theory, supra. intellectual property . . . the incremental terminology on which she relies needs cost of serving any single user is very low a brief explanation. Professor Marx marshals these relative to the initial cost of creation, and use microeconomic principles, Marx WDT by any single user does not diminish the The ‘‘producer surplus’’ is ‘‘the ¶ ¶ 119–122, to explain why the 2012 availability of the content to others. . . . [T]o amount by which the total revenue rate structure tends to incentivize and account for these differences, pricing in these received by a firm for units of its support the maximization of musical markets should be based on the underlying product exceeds the total marginal cost. value of the product to the buyer. works available to the public under . . .’’ A Schotter, Microeconomics: A Factor A. Id. ¶ ¶ 123–133. As she ... Modern Approach at 389 (2009). The The solutions to this policy problem focus testified: ‘‘consumer’ surplus’’ is ‘‘[t]he difference on an oft-noted tension in the pricing of [H]aving different means of price intellectual property between static and between what the consumer would be willing [and able] to pay and what the discrimination is going to allow greater dynamic efficiency. . . . [E]conomists have efficiency to be achieved [i]f we have a way . . . a clear answer . . . provided by so consumer actually has to pay.’’ for low willingness to pay consumers to called second-best . . . pricing.’’ . . . The Mansfield & Yohe, supra, at 93. When access music, for example, student discounts, rule is that those customers—be they final a perfectly competitive market is in family discounts or ad-supported streaming, users or intermediate customers (such as the equilibrium (or tending that way) ‘‘the where low-willingness-to-pay consumers can SDARS, for example)—whose demand for the still access music in a way that still allows product (content) is inelastic should pay a sum of consumer surplus . . . and higher markup above the marginal cost of producer surplus . . . is maximized.’’ some monetization of that provision of that serving them, and those whose demands are Schotter, supra, at 420. By contrast, if a service. elastic should pay a lower markup. . . . market is not perfectly competitive 3/20/17 Tr. 1894–95 (Marx) (emphasis Since elasticity of demand is related to because the sellers have some degree of added). See also Marx WDT ¶ 12 (‘‘An ‘‘willingness to pay’’ [WTP] [so] users or market power, and the level of output is economic interpretation of [F]actor A is usages with a high [WTP] . . . should be somewhat restricted, producer surplus required to contribute the most (per unit of that the royalty structure should increases relative to consumer surplus— usage). . . . [T]his principle assures that the ‘‘maximize the pie’’ of total producer with a portion of the overall surplus greatest number of consumers will be able to and consumer surplus. . . .’’). benefit from use of a product .... [‘‘V]alue- redistributed to producers/sellers. based pricing’’ . . . provides the correct Another portion is lost as ‘‘a pure More granularly, Professor Marx incentives for producers of content insofar as ‘deadweight’ loss . . . the principal explained why the price discriminatory it ensures that overall revenues from all measure of the allocation of harm’’ rate structure is superior to a per play sources recoup the costs of creating the arising from the exercise of market model in maximizing the availability of content in the first place. power. Mansfield & Yohe, supra, at 499. musical works to the public: Ordover WDT at 4, 16–18 (emphasis See also Schotter, supra, at 398 (setting The subscription model provides an added). Professor Ordover then noted forth the accepted definition of efficiency benefit because the price of a play the same upstream/downstream link ‘‘deadweight loss’’ as ‘‘[t]he dollar is equal to the marginal cost of roughly that I have identified in this proceeding: measure of the loss that society suffers zero—a subscriber faces the true marginal [I]t is important to note that demand for when units of a good whose marginal cost of playing a song over the internet and music content by the SDARS [or any social benefits exceed the marginal thus consumes music at the efficient level. distribution channel] is a ‘‘derived demand’’ social cost of providing them are not When subscribers face a per-play royalty cost in the sense that it flows from consumers’ produced because of the profit- of zero, interactive streaming services have demand for the service as a distribution the appropriate incentive to encourage music maximizing motives of the firm listening at the margin. channel for music. . . . [T]he SDARS’ [or any involved.’’).322 distribution channel’s] [WTP] content owner In contrast, if interactive streaming services is inextricably linked to consumers’ [WTP] faced a positive per-play royalty cost, they for the . . . service .... found ‘‘highly informative’’ the ‘‘survey data and would have a diminished incentive to attract results’’ obtained by a testifying survey expert, id. 321 and retain high-use consumers, the very type Id. at 18–19 (emphasis added). at 23—just as I find informative the results of the of consumers who create the most social Klein Survey. surplus through their listening. They would 322 320 I recount Professor Ordover’s testimony to To be clear, this static ‘‘harm’’ is hardly also have an incentive to discourage music provide the context for the snapshot of his conclusive evidence that such market power is listening among the high-use consumers they testimony excerpted and relied on in SDARS I. I do actually harmful, or even inefficient, on balance, in not rely on Professor Ordover’s testimony in a dynamic sense. A monopoly may be more retain. The higher the level of per-play deciding any factual issues in this proceeding. efficient in reducing unit costs because of, inter royalties is, the more this incentive might 321 To estimate the different values (elasticities) alia, necessary scale (such as a natural monopoly) affect the behavior of interactive streaming within a distribution channel, Professor Ordover or because of superior production techniques. services.

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Id. ¶ ¶ 130–131 and n.135 (emphasis royalty payments should ensure that a is informative, especially when it is added) 323 plentiful supply of works is forthcoming targeted to specific listeners, it is not Although Professor Marx’s analysis is into the future. . . .’’ Id. To accomplish clear from the record that such based on an understanding that that end, Professor Watt argues the rates ‘‘interruptions’’ would constitute a pure maximizing the availability of musical should be set so as to ensure that cost. See Phillips WDT ¶ 33 (noting the works is a function of incentives to ‘‘creators are given the correct ability of streaming services to ‘‘deliver distributors and a function of incentives to continue to create and extremely targeted advertising to downstream demand characteristics, she make available valuable works.’’ Id. particular audiences.’’)). notes that the variable, percent-of-rate Further, Professor Watt argues that Further, Professor Watt opines that based rate structure is consistent with even if the rates and rate structure are any positive marginal cost pricing of agreements in the unregulated upstream designed to maximize the consumer and songs by interactive streaming services market, where record companies license producer surplus, such maximization on subscription plans necessarily would sound recordings to these same would not inform the Judges as to be offset by a reduction in the up-front interactive streaming services. In that whether that result satisfies Factor A. subscription price. He further suggests regard, she notes: Rather, according to Professor Watt: that this consequence would not Ironically, given the preference of . . . In effect, a royalty structure is simply a necessarily be deleterious for the Copyright Owners’ economists for market way in which producer surplus, once streaming service because ‘‘[w]ith the outcomes in this context, they support a created, is shared between the interactive reduction in the fixed fee (along with proposal that would tend to [REDACTED], streaming firms and the copyright holders, the positive per-unit price), it becomes which the unregulated sound recording side but in and of itself, the structure does not entirely possible that consumers who of the market has facilitated. Their proposal determine the size of either producer or were not initially in the market now would also completely do away with consumer surplus. Consumer surplus and producer surplus are both entirely find it to be in their interests to join the percentage-of-revenue rates that form a key market, consuming positive amounts of part of unregulated rates negotiated between determined by the interplay of the demand music labels and interactive streaming curve for the product in question (here, streamed music where previously they services. interactive music streaming) and the way the consumed none.’’ Id. ¶ 15. product is priced by the interactive streaming In their affirmative case regarding Marx WRT ¶ 84 (emphasis added). industry to its consumers. That is, regardless Factor A, Copyright Owners argue that Beyond these theoretical arguments, of the structure of the royalty payments, the ‘‘availability maximization’’ should be Dr. Leonard notes that this is the basic ‘‘size of the pie’’ is determined by the considered through the lens of the unilateral decisions made by interactive rate structure that has existed for two creators, who seek high rates as a signal rate periods, and there is no evidence streaming firms about their pricing to consumers. to spur creation, and would see low that the songwriters as a group have rates as a disincentive. In particular, diminished their supply of musical Watt WRT ¶ 11. Professor Watt also attempts to de- another of Copyright Owners’ expert works to the public. In fact, he notes economic witnesses, Professor Rysman, that the music publishing sector has couple the upstream and downstream rate structures by analogizing interactive testified, in colloquy with the Judges, been profitable throughout the present that the importance of price-signaling rate period. 3/15/17 Tr. 1120 (Leonard). streaming to a retail restaurant offering of an ‘‘all you can eat buffet.’’ There, was so paramount that even a I understand this point—particularly in hypothetical outlandish royalty would the context of Factor A—to indicate that restaurants pay a positive per unit price for inputs of food offered at the buffet, induce creators to maximize there has been and will continue to be availability: a growing supply of musical works yet still—according to Professor Watt— available to the public, because charge a single price for unlimited THE JUDGES: So if all the available music profitability is a market signal for the access to the buffet. (Professor Watt does was available on streaming services and the not provide any evidence of how buffet subscription price was $10,000 a month, that entry of new resources and supply. See would be equally available as it would on an generally Varian, supra at 416 (‘‘[I]f a restaurants in fact make pricing ad-supported service? firm is making profits we would expect decisions.) Thus, he concludes that a PROFESSOR RYSMAN: That’s how I read entry to occur.’’). retailer, such as an interactive streaming availability.... I think that would raise service or a buffet restaurant, can pay questions in the other factors, but as I read 3. Copyright Owners’ Position for inputs (musical works or food) per- availability, that would still satisfy Copyright Owners, principally unit while still charging an up-front availability. through the rebuttal testimony of access fee ($9.99 per monthly 4/3/17 Tr. 4397 (Rysman). Professor Watt, argue that Professor subscription or $9.99 for a buffet meal). Marx has made a fundamental error in By this analogy, Professor Watt purports 4. Analysis and Findings equating the maximizing of availability to demonstrate that interactive For several reasons, I find that of musical works with a maximization streaming services do not require non- Professor Marx’s analysis of how a price of the sum of the producer and unit royalty rates to serve their discriminatory model maximizes consumer surplus. Watt WRT ¶ 10. downstream listeners. Id. ¶ 12. availability is correct. According to Professor Watt: ‘‘A better Professor Watt further notes that First, the rationale for price understanding of criterion A is that the Spotify is not accurate when it claims discrimination is two-fold; not only that listeners to its ad-supported service does it serve low WTP listeners, but it 323 With regard to Factor A as it relates to do not pay a marginal positive price. He also serves copyright owners, by Copyright Owners’ proposal, Professor Hubbard notes that listening to advertising that incentivizing interactive streaming also notes the supply-side ‘‘Cournot Complements’’ problem created by Copyright Owners’ reliance on interrupts the music imposes a time- services to increase the total revenue the unregulated sound recording market. This is a related/annoyance cost that the listeners that the price discriminating licensor problem because rates in such a ‘‘must have’’ must accept. This suggests to Professor can obtain. Any seller or licensor would unregulated market can be even higher than Watt that per-unit pricing (at least in a prefer to maximize its revenue, and a monopoly rates, thereby depressing the quantity supplied—contrary to a goal of maximizing the non-monetary manner) indeed is rate structure that will effect such availability of musical works. See 4/7/17 Tr. 5532 possible downstream. Id. ¶ 13. maximization thus would be the best (Hubbard). (However, to the extent the advertising structural inducement. Moreover, for

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purposes of applying Factor A, a rate rate might have an immediate more difficult, because (as noted by structure that better increases revenues, superficial appeal, if the consequence Professor Marx and Professor Ordover in ceteris paribus, would induce more will be lower revenues, the high per- SDARS I) upstream demand is derived production of musical works, a result play rate would reveal itself as a form from downstream demand. that Copyright Owners should desire.324 of fool’s gold.327 To be clear, I do agree with Professor Second, and by contrast, it would be Third, I find that the objective of Watt that percent-of-revenue pricing is less profitable simply to equate maximizing the availability of musical not necessary to facilitate price ‘‘availability’’ with a higher rate. As works downstream to the public is discrimination downstream. Indeed, in noted supra, any product that is priced furthered by an upstream rate structure Web IV, the Judges adopted multi-tier beyond the WTP of a significant portion that contains price discriminatory upstream per-play pricing, not percent- of the public is unavailable to that characteristics that enhance the ability of-revenue pricing, to reflect variable segment. In this regard, Copyright of the interactive streaming services to WTP downstream. But here, Copyright Owners have taken a cramped and engage in downstream price Owners have not proposed multiple-tier unrealistic view of such incentives. In discrimination (‘‘down the demand per unit pricing, and nothing in the particular, I disagree with Professor curve,’’ increasing revenue for both record indicates how the Judges could Rysman’s assertion that even a $10,000 Copyright Owners and the interactive mold Copyright Owners’ per- play rate per month subscription price would streaming services). That is, as into multiple, discriminatory rates. The increase ‘‘availability.’’ I find that he recognized by both Professor Marx in only rate structure proposed in this misapprehends the nature of a price this proceeding—and Professor Ordover proceeding that promotes such signal. If the price is so high as to in SDARS I—upstream pricing is a efficiencies is the existing rate structure. eliminate or reduce total revenue to function of derived demand, and should Because the Judges remain subject to creators, in no way will higher rates be ‘‘value-based,’’ i.e., discriminating (and bounded by) the evidence adduced simply induce the supply of creative among the different values placed on at the hearing, they have before them works over time.325 Indeed, even streamed music by different segments of only one rate structure that promotes monopolists do not seek the highest listeners. and reflects the downstream market’s price possible, but rather seek to Fourth, I find that Professors Watt and need for price discrimination to maximize profits. See Mansfield & Marx are talking past each other promote the availability of musical Yohe, supra, at 362–63 (‘‘Monopolies regarding price discrimination. works to the public.328 maximize profits by producing where Professor Watt argues that a percent-of- In this regard, Pandora notes the marginal cost equals marginal revenue based upstream royalty challenges of operating a business that revenue.’’). Thus, even monopolists— structure is not necessary in order for has fixed revenues per customer but who have the most market power—are the streaming services to price variable cost. Herring WRT ¶ 17. constrained in their pricing by the discriminate downstream. However, I Copyright Owners did not provide demand curve and the marginal revenue understand Professor Marx to be sufficient evidence that their proposed it creates.326 Although a higher royalty asserting not that a percent-of-revenue per unit royalty rate would better royalty structure is a necessary accommodate such risks. Instead, as 324 This point appears to raise a question: How condition for downstream price noted supra, Copyright Owners rely on could Copyright Owners and their economic discrimination, but rather that some an analogy; Professor Watt’s comparison experts argue against a rate structure that inures to form of price discrimination is of the streaming industry to the buffet their benefit as well? The answer is: They do not. appropriate, and that a discriminatory As stated supra, they advocate for a rate set under restaurant industry, in which he the bargaining room theory, through which percent-of-revenue royalty structure will assumed input suppliers did not charge mutually beneficial rate structures can still be better align the upstream and based on a percent of revenue. However, negotiated, but not subject to the ‘‘reasonable rate’’ downstream incentives, thus Professor Watt admitted that his and itemized factor analysis required by law. In maximizing the availability of musical those negotiations, as Dr. Eisenach candidly testimony in this regard was ‘‘pure acknowledged, Copyright Owners would have a works downstream. A single upstream observation,’’ and that he has never different threat point to use in order to obtain better price for musical works would tend to consulted for a buffet restaurant and has rates and terms. 4/4/17 Tr.4845–46 (Eisenach). make price discrimination downstream never performed any economic analysis 325 This point is reminiscent of an old joke from of the business strategies of buffet the era of the Great Depression. A poor boy is how much information firms have about rivals, and restaurants. 3/27/17 Tr. 3173–74 (Watt). selling Apples on the street corner for a price of $1 how often firms interact with each other in the million per apple. A man approaches and asks the market.’’) In similar fashion, Professor Watt I note one particular difference between boy: ‘‘How many apples do you expect to sell at that acknowledged the presence of a supply curve in a foodstuff input to a buffet restaurant price?’’ To which the boy responds: ‘‘Well, I only competitive markets but declined to conclude that and a musical stream input to an have to sell one!’’ one exists in the markets at issue here. 3/27/17 Tr. interactive service: the foodstuff is a 326 On a technical economic level, perhaps 3035–36 ([JUDGES]: ‘‘Is there a supply curve in the beyond the material in a prototypical ‘‘Economics market?’’ [PROFESSOR WATT]: ‘‘[T]hat’s a hard private good, rivalrous in consumption, 101’’ course, a party with market power, whether question to answer. . . . [C]learly . . . economic i.e., with a positive marginal cost, a monopolist or otherwise, is not subject to a supply theory points to certain markets where there is no whereas the copy of the musical work curve, because a supply curve depicts how much supply curve, per se, and other markets in which supply would be forthcoming at given prices, there would be. Like a perfectly competitive market, is non-rivalrous, i.e., with a zero whereas a firm with any pricing power can it’s acceptable that there’s a supply curve. . . . influence both price and quantity. See Krugman & [O]once you get into non-perfectly competitive 328 More particularly, in Web IV, the Judges set Wells, supra, at 368 (‘‘[M]onopolists don’t have output markets . . . it becomes really debatable.’’). multiple per-stream noninteractive royalty rates on supply curves . . . [A] monopolist . . . does not 327 And, again, Copyright Owners are not a per-play basis, differentiating among subscription take the price as a given; it chooses a profit economic naifs. Once more, the bargaining room services, ad-supported services and educational maximizing quantity, taking into account its own approach is relevant, in connection with the webcasters. These decisions were based on the ability to influence the price.’’). Oligopolists act foregoing price discrimination analysis. A licensor Judges’ understanding of the evidence at the similarly, but their influence on price is who could segment the market via WTP could hearing. If the parties had presented the Judges with complicated by their predictions of, and reactions exploit the demand curve and increase revenues evidence in this proceeding that would have to, the pricing and production decisions of their above the revenues available in a single-price permitted them to fashion price-discriminatory per- oligopolistic competitors. See Nicholson & Snyder, market. Copyright Owners appear to understand play or per user rates, those would have been an supra, at 521 (‘‘[I]n an oligopoly . . . prices depend this point—acknowledging they would bargain options for consideration. However, there was on how aggressively firms compete, which in turn with licensees if the single-price rate set by the insufficient evidence to permit me to depart from depends on which strategic variables firms choose, Judges was too high. the parties’ proposals in that regard.

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marginal production cost. Because this is economically logical, the services are indicates it is a rate structure (among all difference is a critical aspect of the the market actors who interact with the ‘‘second best’’ economic options) economics of intellectual property, listeners and are in the better position that has aligned well the characteristics Copyright Owners’ failure to explore to gauge consumer demand. It would be of both the upstream and downstream this distinction precludes judicial inappropriate to rely on the opinion of markets in a manner that increases the reliance on their proffered analogy. Copyright Owners’ expert as to what is availability of musical works ‘‘down the Fifth, I find that Professors Watt and theoretically possible if the business demand curve.’’ And once again, I note Marx are also talking past each other model was changed, or the impact of that Copyright Owners and their experts with regard to the usefulness of the that change on the availability of are not in the business of attempting to consumer surplus/producer surplus musical works. Indeed, Professor Watt market interactive streaming services in approach. Professor Watt claims that the could testify only that if the interactive the downstream market, so their development of the surplus is relevant streaming services attempted to pass ‘‘advice’’ as to the beneficial use of only to determine how the surplus will through to listeners a per-unit royalty listening caps, overages and tiered be split, as noted supra. See Watt WRT via a per-unit downstream charge, it subscriptions is simply speculative. See ¶ 11. Professor Marx takes issue with the would become ‘‘possible’’ that [REDACTED]. assertion that the rate structure does not consumers who were not initially in the In sum, I am persuaded that Professor determine the size of either producer or market would be induced by the lower Marx’s analysis of Factor A is consistent consumer surplus. I understand subscription price to join the market, with the purpose of that statutory Professor Marx’s point to be that a preferring the combination of the lower objective and sound economic theory. royalty structure that efficiently subscription price and the positive per An upstream rate structure that contains incentivizes price discrimination will play rate to a higher subscription price multiple royalties reflective of and enlarge the producer surplus by and a lower per play rate. Watt WRT derived by downstream variable WTP appropriating consumer surplus and ¶ 15. However, the net effect of such a will facilitate beneficial price eliminating deadweight loss,329 change is simply speculative. What can discrimination. In turn, such price resulting in more surplus that can then be said with some assurance is that such discrimination allows for access to be be allocated between the licensors and a change would impose a positive afforded ‘‘down the demand curve,’’ licensees. Indeed, a close reading of marginal cost on the listener for a making musical works available to more Professor Watt’s testimony is not product (the copy of streamed music) members of the public. Accordingly, I inconsistent with this understanding. that has a zero production cost, which would not make any adjustment He testified that the rate structure ‘‘in is inconsistent with static allocative pursuant to Factor A.332 and of itself’’ does not determine the efficiency. Also, if the services could C. Factors B and C: Fair Income and size of the producer surplus. Rather, he obtain more revenue by lowering the Returns and Consideration of the testified that producer (and consumer) subscription price and charging a per- Parties’ Relative Roles surplus are ‘‘entirely determined by the play rate, there is nothing in the record interplay of the [downstream] demand to explain why they have not engaged Factor B directs the Judges to set rates curve and the way the product is priced in such a strategy on a widespread that ‘‘afford the copyright owner a fair [downstream].’’ Id. But Professor Marx’s basis.331 return for his or her creative work and point is that (1) upstream price Seventh, although I acknowledge that, the copyright user a fair income under discrimination makes downstream price in response to per-play pricing, the existing economic conditions.’’ Factor C instructs the Judges to weigh ‘‘the discrimination more efficient; and (2) services could implement downstream downstream price discrimination (a) usage restrictions, such as listening caps, usage-based tiers and overage 332 The Majority Opinion finds that its significant increases the producer surplus (by increase in rates is necessary to provide sufficient appropriating consumer surplus and charges (see Rysman WRT 75) such income to songwriters and, thereby incentivize eliminating the ‘‘deadweight loss); and steps would not align with the price songwriting which will make more musical works (b) increases the quantity of musical discriminatory model that would best ‘‘available’’ to the public. In this regard, the serve a listening market with a variable majority has made the same mistake as Professor works listened to downstream, i.e., that Rysman, confusing higher prices with increased are available to the public at prices WTP. Again, a price discriminatory revenues. The majority has collapsed the existing approximating their WTP. She does not upstream rate structure is appropriate price discriminatory rate structure into a single not because it is either necessary or the greater-of structure, based on two revenue prongs. state that the rate structure ‘‘in and of (which I acknowledge to be a ‘‘blunt’’ price itself’’ will impact the consumer only way in which this market can be structured, but rather because the record discriminatory tool, compared with the richer price surplus; in fact, her point is that the rate discrimination in the 2012 rate structure that has structure interacts with the demand worked successfully).The majority’s approach fails 331 Professor Watt notes that Spotify has engaged to address two problems: (1) what is the evidence curve, via price discrimination, to affect in a non-monetary version of this strategy, offering as to the elasticity of demand that makes them the size of the producer surplus.330 an ad-supported service with no up-front confidence that their 44% increase in rates will Sixth, I am unpersuaded by Professor subscription price but a non-monetary ‘‘fee’’ in the bring forth additional revenue to songwriters? (That Watt’s argument that a positive per-play form of burdensome advertising. Watt WRT ¶ 15. is, what would be the corresponding decrease in However, as noted supra, it is not necessarily quantity demanded?); and (2) with the TCC rate charge levied downstream would likely correct to equate listening to advertising with a uncapped, how can the majority conclude that necessitate a lower subscription price monetary cost, because some advertising is sound recording companies will not seek to that would maximize availability of valuable, especially more targeted advertising (why preserve their share of royalties even as mechanical music to the public. Although the point else would advertisers pay to advertise?) and non- royalties rise under the majority’s approach, leading monetary costs may be quite de minimis for an to a spiraling of royalties and a reduction of overall appreciable segment of the public. In any event, the quantity demanded that offsets the rate increases? 329 And shift some consumer surplus to the business of identifying consumer preferences in (This second problem is a reprise of my broader producers, which is the point of price order to establish the appropriate mix of up-front criticism of the majority’s assumption that the discrimination from the perspective of the seller. fees and per-play ‘‘costs’’ is the specialized business sound recording companies will docilely accept a 330 Indeed, the enhancement of efficiency and the activity of the interactive streaming services, so any ‘‘Shapley Surrender’’ (to coin a phrase) and accept increase in profits (with the attendant signal to change in rate structure that is premised on an the transfer of tens of millions of dollars of royalties producers) is at the essence of price discrimination. assumption that market demand and the from them to music publishers/songwriters, rather See Nicholson & Snyder, supra, at 507 (when availability of musical works can be equally or than attempt to preserve their revenues and take sellers’ price discrimination leads to an increase in better served via a different rate structure needs to that preservation out of the hides of the services, total output it is ‘‘allocatively superior’’). be supported by additional record evidence. Copyright Owners, or both.

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relative roles of the copyright owner and The parties’ economic experts have 1. The Parties’ Shapley Value Evidence copyright user in the product made addressed the Factor B and C issues and Testimony available to the public,’’ across several through either a Shapley value analysis a. Shapley Values dimensions.333 or an analysis ‘‘inspired’’ by the Shapley 336 A Shapley value approach requires As explained supra, Factor B, and, valuation approach. The Judges defined and described the Shapley the economic modeler to identify implicitly, Factor C, were included in downstream revenues available for section 801(b)(1) to establish a legal value in a prior distribution proceeding: ‘‘[T]the Shapley value gives each player division among the parties. The standard that would pass constitutional economic modeler must also input each muster, yet the statutory language his ‘average marginal contribution to the players that precede him,’ where provider’s costs, which each must paralleled public utility-style regulatory recover out of downstream revenues, in 334 averages are taken with respect to all principles. According to Mr. Nathan order to identify the residue, i.e., the in his 1967 congressional testimony, potential orders of the players.’’ Distribution of 1998 and 1999 Cable Shapley ‘‘surplus,’’ available for these principles were ill-suited for division among the parties. As such, the setting rates that ‘‘equitably divided Royalty Funds, 80 FR 13423, 13429 (Docket No. 2008–1) (March 13, 2015) Shapley approach is cost-based, in the compensation for the ‘‘relative roles’’ of same general manner as a public utility- licensors and licensees in order to (citing U. Rothblum, Combinatorial Representations of the Shapley Value style rate-setting process identifies a provide a ‘‘fair’’ outcome.335 However, Based on Average Relative Payoffs, in utility’s costs that must be recovered as the parties’ economic experts make The Shapley Value: Essays in Honor of before an appropriate rate of return can clear in their approaches to Factors B 338 Lloyd S. Shapley 121 (A. Roth ed. be set. In the present case, Copyright and C, economics has evolved since Mr. 1988)).337 See also Gans WDT ¶ 64 (‘‘The Owners and the Services have applied Nathan’s 1967 testimony in which he Shapley value approach . . . models this general approach in different ways, criticized as economically impossible bargaining processes in a free market by and each challenges the appropriateness any regulatory attempt to equitably considering all the ways each party to of the other’s model. divide creative contributions. a bargain would add value by agreeing To summarize the differences in their to the bargain and then assigns to each approaches, Professor Marx utilizes a 333 These dimensions are: ‘‘creative contribution, party their average contribution to the Shapley value approach that purposely technological contribution, capital investment, cost, alters the actual market structure in risk, and contribution to the opening of new cooperative bargain.’’); Marx WDT ¶ 144 markets for creative expression and media for their (‘‘The idea of the Shapley value is that order to obtain results that intentionally communication.’’ Id. each party should pay according to its deviate from the market-based 334 Public utility-style regulation—especially in average contribution to cost or be paid distribution of profits—in order to 1967 when Mr. Nathan was testifying—was classic according to its average contribution to determine rates she identifies as ‘‘rate-of-return’’ regulation. Essentially, the reflecting a ‘‘fair’’ division of the regulator would identify the utility’s costs, value. It embodies a notion of determine the value of invested capital, ascertain an fairness.’’); Watt WRT ¶ 23 (‘‘The surplus (Factor B) and recompense for appropriate rate of return on such capital, and, Shapley model is a game theory model the parties’ relative roles (Factor C). then, establish the rate (or rates) charged to that is ultimately designed to model the By contrast, Professor Watt’s customers (or to different customers), in order to ‘‘correction’’ of Professor Marx’s model provide the utility with revenue that covers its costs outcome in a hypothetical ‘‘fair’’ market and provides a ‘‘reasonable rate of return.’’ See environment. It is closely aligned to rejects her alteration of the market generally C. Decker, Modern Economic Regulation bargaining models, when all bargainers structure to achieve such a result. at 104 (2014). are on an equal footing in the process.’’). Rather, he maintains that the 335 The economic experts for Copyright Owners In the parties’ direct cases, on behalf incorporation of ‘‘all potential orders of and the Services acknowledge that microeconomic the players’’ in her model—as in all principles (pre-Shapley values) do not provide of the Services, Professor Marx insights as to what constitutes ‘‘fairness.’’ See, e.g., constructed a Shapley model. On behalf Shapley models—already adjusts for the 3/30/17 Tr. 3991 (Gans) (‘‘fairness . . . is not a of Copyright Owners, Professor Gans hold-out power of any input provider topic that is sitting in an economics textbook developed what he described as a who might threaten to walk away from somewhere.’’); 3/20/17 Tr. 1830 (Marx) (‘‘Fairness a transaction. is not a notion that has a unique definition within ‘‘Shapley-inspired’’ approach. In economics.’’); 1128–29 (Leonard) (‘‘economists . . . rebuttal to Professor Marx’s Shapley Professor Gans, like Professor Watt, typically don’t do ‘fair’ ’’); 4/13/17 Tr. 5919 value model, Copyright Owners, does not attempt to alter the market (Hubbard) (Economists aren’t philosophers. I can’t through the testimony of Professor Watt, structure. However, Professor Gans also go to the biggest picture meaning of ‘‘fair’’. . . .). does not attempt to construct Shapley Rather, economists attempt to identify ex ante criticized Professor Marx’s analysis, and ‘‘fairness’’ by identifying fair processes in the made adjustments to her model. values from the ground up. Rather, he workings of and structure of markets and takes as a given Dr. Eisenach’s bargaining, and in the efficiency of outcomes 336 Dr. Lloyd Shapley won a Nobel Memorial estimation that record companies generated by these processes, although their Prize in economics for this work. The Shapley receive a royalty of $[REDACTED] per understanding of what constitutes a fair ‘‘process’’ approach represents a method for identifying fair play from interactive streaming services. varies. See, e.g. 3/13/17 Tr. 555 (Katz) (‘‘[T]he most outcomes, previously unaddressed in useful or practical way of thinking about it here was microeconomics. Mr. Nathan did not reference the Because Professor Gans identifies really to focus on whether the process is fair’’ . . . potential use of the Shapley value approach in his musical works and sound recordings as [and] a conception that’s often used in economics 1967 testimony, perhaps because this methodology, perfect complements, he assumes that is that a process is fair if it’s . . . competitive or although developed by Lloyd Shapley in 1953, was the outcome of a competitive market. A competitive not yet widespread in the economic literature. the musical works licensors would bargaining process is fair. And so that’s the—the 337 The parties’ economic expert witnesses find receive the same profit as the record central notion of fairness that I used here.’’); 3/15/ that these Factors B and C are properly considered companies (but not the same royalty 17 Tr. 1129 (Leonard) (‘‘My concept of fair . . . and jointly in the present proceeding, and I agree. See rate, given their different costs). Because what I think a lot of economists would say is that Marx WDT ¶ ¶ 11–2 (the Shapley value . . . this is not a Shapley value ground-up if you have . . . a negotiation between two parties operationalizes the concept of fair return based on and there are no . . . constraints such as holdup relative contributions.’’); Watt WRT ¶ 22 (‘‘the . . . and there’s no market power . . . again I Shapley model is a very appropriate methodology 338 Unlike in public utility regulation, the hesitate to use the word, so maybe I’ll put it in for finding a rate that satisfies factors B and C of Shapley value method considers the costs of all quotes, would be [‘]fair[’].’’); Eisenach WDT ¶ 24 (‘‘a 801(b)’’); see also Gans WDT ¶ ¶ 65 n. 35, 67 (noting input providers whose returns will be determined. rate set at the fair market value by definition the Shapley approach provides for a ‘‘fair In traditional public utility rate regulation, the provides fair returns and incomes to both the allocation’’ as among input suppliers to reflect ‘‘the utility is a monopoly and thus the only provider of licensee and licensor.’’) contributions made by each party.’’) a regulated service.

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approach (which would entail were: (1) to separately allocate surplus copyrights ‘‘only Warner . . . breaks estimating the input costs of all three and indicate rates for musical works down its cost by geographic region and input providers—the record companies, (the subject of this proceeding); and (2) by source in enough detail to estimate the music publishers and the interactive to illuminate the additional ‘‘bargaining the amounts needed.’’ Marx WDT streaming services—Professor Gans power’’ of each category of copyright ¶ ¶ 149–50. Utilizing this Warner cost candidly acknowledged on cross- holder when these two categories of data and extrapolating to the entire examination that he did not perform a necessary complements arrive industry, Professor Marx estimated that full-fledged Shapley value analysis; separately in the input market under the ‘‘Musical Work Copyright Holders’ Total hence he describes his methodology as Shapley methodology. 3/20/17 Tr. Non-Content Costs’’ equaled $424 a ‘‘Shapley-inspired’’ approach. 3/30/17 1883–84 (Marx). Each of Professor million; and ‘‘Sound Recording Tr. 4109 (Gans) ([Q]: ‘‘[Y]ou do, is it fair Marx’s Shapley value approached is Copyright Holders’ Total non-content to say, a Shapley-inspired analysis, if it considered in more detail infra. costs equaled $2.605 billion (more than wasn’t a Shapley model?’’ [PROFESSOR six times copyright Holders’ non- GANS]: ‘‘That’s fair enough.’’). i. Professor Marx’s Baseline Approach content costs), summing to total Professor Marx noted the undisputed upstream non-content costs of $3.028 b. Professor Marx’s Shapley Value billion. Id. ¶ 150, Fig. 26. Approach principle that ‘‘[t]he calculation of the Shapley value depends on the total Turning to the downstream Professor Marx testified that, as an value created by all the entities together distribution outlets, Professor Marx initial matter ‘‘[t]he Shapley value and the values created by each possible identified and relied on Spotify’s 2015 depends upon how [the modeler] subset of entities.’’ Marx WDT ¶ 147. revenue and cost data from for delineate[s] the entities contributing to Equally undisputed is the interactive streaming services, and for a particular outcome.’’ Marx WDT ¶ 145. understanding that ‘‘[t]hese values are the alternative distribution modes, she More particularly, Professor Marx functions of the associated revenue and relied on Pandora’s and Sirius XM’s delineated the entities in a manner that costs.’’ Id. revenue and cost data. Id. ¶ 152 and was ‘‘not putting in market power into The surplus to be divided (from nn.149–152. Using that data, Professor the model.’’ 3/20/17 Tr. 1862–63 (Marx). which rates can be derived) is realized Marx estimated interactive streaming That is, she modeled the downstream at the downstream end of the revenue of $[REDACTED]; and (2) interactive streaming services as a distribution chain when revenues are interactive streaming profit of combined single service (and she added received from retail consumers. That $[REDACTED]. For the alternative to her model ‘‘other distribution types surplus can be measured as the profits distributors (Pandora and Sirius XM), as another form of downstream of the downstream streaming services she estimated (1) revenues of $8.514 distribution to account for the potential (and the alternative services in her billion; and (2) profits of $3.576 billion. opportunity cost (‘‘cannibalization’’) of model), i.e., their ‘‘revenue minus . . . The total downstream revenue, interactive streaming). By modeling the non-content costs.’’ 339 The total according to Professor Marx, equaled an downstream market in this manner, combined value created by the delivery estimated $10.118 billion. Id. ¶ 153 & Professor Marx artificially—but of the sound recordings through the Fig. 27. intentionally—treated the multiple interactive (and substitutional) Professor Marx noted that there would interactive streaming services as a single streaming services consists of: (1) the be some degree of substitution between service, a treatment used as a device (or aforementioned profits downstream interactive streaming services and artifact) to countervail the allegedly real (i.e., service revenue ¥ non-content alternative distribution channels (e.g., market power of the collectives (the cost) minus (2) ‘‘the copyright owners’ non-interactive internet radio and music publishers and the record satellite radio). Id. ¶ 154. She opined non-content costs. Simply put, companies respectively) that owned the that ‘‘it is difficult to determine the ‘‘surplus’’ reflects the amount of retail other inputs—a market power that exact value of this substitution effect,’’ revenue that the input providers can Professor Marx concluded must be so she reported a range of Shapley value split among themselves after their non- removed (i.e., offset) to establish a fair calculations that corresponded to ‘‘a content costs (i.e., the costs they do not division of the surplus and a fair rate. range of possible substitution effects.’’ simply pay to each other) have been See 3/20/17 Tr. 1865, 1907 (Marx) Id. recovered. (‘‘[M]y goal is to model a fair market, These data were all inputs into the where there [are] no obvious Thus, any Shapley value calculation Shapley algorithm, i.e., assigning value asymmetries in market power upstream requires data to estimate costs and to each input provider for each potential versus down. So I viewed it as revenues. In her Shapley analysis, order of arrival among these categories appropriate to view interactive Professor Marx relied on 2015 data from of providers to the market. The multiple streaming as one player.’’). Warner/Chappell for her music values were summed and averaged as With regard to the upstream market of publisher non-content cost data and its required by the Shapley methodology to copyright holders, Professor Marx ownership-affiliated record company, arrive at the ‘‘Shapley value,’’ which as utilized two separate approaches. In her Warner Music Group, for record explained supra, accounts for each self-described ‘‘baseline’’ approach, she company non-content costs. She was entity’s revenues and (non-content) ‘‘treat[ed] rights holders as one limited to this data set for non-content costs under each possible ordering of upstream entity, reflecting the broad costs because among all major holders market-arrivals. overlap in ownership between of musical works and sound recording Based on the foregoing, Professor publishers and record labels.’’ Marx Marx estimated that the total royalty 339 Content costs, as opposed to non-content WDT ¶ ¶ 146, 162. In her ‘‘alternative’’ costs, are not deducted because the content costs payment due from the interactive approach, she ungrouped the two comprise the surplus to be allocated in terms of streaming services to the Copyright collectivized copyright holders—the royalties paid and residual (if any) that remains Owners would range from songwriters/publishers, on the one with the interactive streaming (and substitute) $[REDACTED] to $[REDACTED], based services. The non-content costs, as discussed infra, hand, and the recording artists/record must be recovered by each input provider as part on varying assumptions as to the companies, on the other. Id. The two of its Shapley value, because entities must recover substitution between interactive purposes of her alternative approach costs. services and substitute delivery

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channels. This range of dollar-based revenue for musical works royalties (i.e., Id. at 3058–59. He emphasizes that, revenues reflected a ‘‘percentage of ‘‘All-In’’ royalties). Accordingly, because the Shapley approach revenue’’ paid by interactive streaming Professor Marx concludes that incorporates all possible ‘‘arrivals’’ of services to all copyright holders ‘‘[b]ecause this proceeding is about input suppliers, it eliminates from the (musical works and sound recordings) mechanical rates, the fairness valuation and allocation exercise the ranging from [REDACTED]% to component of 801(b) factors suggests effect of an essential input supplier [REDACTED]%. Id. ¶ ¶ 159–160. that interactive streaming’s mechanical holding out every time or arriving Professor Marx then noted that this is rates should be reduced from their simultaneously with another input well below the combined royalty rate of current level.’’ Id. ¶ 161. supplier (or apparently creating Cournot [REDACTED]% paid by Spotify for Complement inefficiencies). Id. at 3069– iii. Discussion of Professor Marx’s musical works and sound recording 70. Shapley Value Approach and the rights, indicating that the actual However, the foregoing criticism does Criticisms of the Copyright Owners’ combined royalty payments are clearly not pertain to Professor Marx’s second Witnesses too high. Id. ¶ 161.340 Shapley value model—her ‘‘Alternative’’ model—in which she ii. Professor Marx’s Alternative Copyright Owners criticize Professor Marx’s model for ‘‘failing to accurately maintains the two separate rightsholders Approach for musical works and sound reflect realities of the market, where recordings. Marx WDT ¶ 146, n.153; 3/ As noted supra, Professor Marx also current observed market rates for sound 20/17 Tr. 1871–72 (Marx). With regard performed an ‘‘alternative’’ Shapley recording royalties alone are to this Alternative model, Copyright value in which (as opposed to her approximately [REDACTED]% of Owners level a more general criticism of baseline approach) she modeled the service revenue. See Watt WRT ¶ 23; Professor Marx’s approach that does upstream market as two entities: ‘‘a Written Rebuttal Testimony of Joshua pertain to this model (as well as her representative copyright holder for Gans on Behalf of Copyright Owners Baseline model). They assert, through musical works and a representative ¶ ¶ 19, 28 (Gans WRT); see also COPFF both Professors Gans and Watt, that copyright holder for sound recordings.’’ ¶ 741. More technically, Copyright Id. ¶ 163. (That change enlarged the Professor Marx wrongly distorted the Owners object to Professor Marx’s actual market in yet another manner— number of ‘‘arrival’’ orderings to 24 joinder of the sound recording and (four factorial) but, in all other respects, by assuming the existence of only one musical works rightsholders as a single interactive streaming service—rather Professor Marx’s methodology was the upstream entity in her ‘‘baseline’’ same as her methodology in her initial than the presence of competing model, which had the undisputed effect interactive streaming services. Watt approach. See id. ¶ 199, App. B). of lowering Shapley values, and hence Under this alternative approach with WRT ¶ ¶ 25, 32 n.19, 17; Gans WRT royalties, available to be divided ¶ ¶ 55–56; see also COPFF ¶ 755. By this two owners of collective copyrights between the two categories of upstream (musical works owners and change, they argue, Professor Marx rightsholders. Gans WRT ¶ 21; Watt inflated the Shapley surplus attributable sound recording owners), interactive WRT App. 3 at 2) (noting that in the real streaming’s total royalty payments range to the interactive streaming services world, as opposed to the stylized compared to the actual proportion they from [REDACTED]% to [REDACTED]% Shapley-world, the institutional of streaming revenue. Id. (Sound would receive in the market. structure is such that the two would not According to Professor Gans, this recording copyright holders’ total jointly negotiate with licensees); see also royalty income under this alternative simplified assumption belies the fact COPFF ¶ 742. Even more particularly, that the market is replete with many approach ranged from [REDACTED]% to Professor Gans questions Professor [REDACTED]% of revenue. Id. Professor substitutable interactive streaming Marx’s rationale for her joint negotiation services, whose competition inter se Marx explained that this higher range of assumption, viz., the’ overlapping reduces each service’s bargaining combined royalties (as a percentage) in ownership interests of record companies power. The problem, he opines, is that her alternative approach arose from the and music publishers. Gans WRT ¶ 21. to the extent the entities being fact that splitting the copyright holders combined are substitutes for one into two creates two ‘‘must-haves’’ I find this criticism of Professor another—such as alternative music providing each upstream entity with Marx’s baseline approach to be services—then combining them ignores more ‘‘market power and consequently appropriate, in that it was not necessary the effects of competition between them, higher payoffs than the baseline to combine the two rightsholders in a thereby inflating their combined share calculation.’’ Id. ¶ 164, n.153. By Shapley analysis. As Professor Watt of surplus from the joint enterprise (i.e. splitting the upstream licensors into two explained in his separate criticism, there is no need to collapse the their Shapley value). Gans WRT ¶ 21. categories (record companies and Professor Marx does not deny that she musical works licensors), Professor rightsholders into a single bargaining entity to eliminate holdout power by the intentionally elevated the market power Marx calculated that ‘‘musical work of the services by combining them in the copyright holders’ total royalty income respective rightsholders, because the ‘‘heart and soul’’ of the Shapley value model as a single represent agent. as a percentage of revenue ranges from However, as noted supra, she explained [REDACTED]% to [REDACTED]%.’’ Id. excludes the holdout value that any input supplier could exploit in an actual that she made this adjustment to offset ¶ 163. By way of comparison, Spotify the concentrated market power that the actually pays [REDACTED]% of its bargain. 3/27/17 Tr. 3073 (Watt). More particularly, Professor Watt explains: rightsholders possess—separate and apart from any holdout power they 340 Because her baseline approach combines The model . . . allows us to capture a sound recording and musical works licensors into might have (which, as noted by player’s necessity [and] bargaining power, Professor Watt, is addressed by the a single entity, Professor Marx does not break out including vetoes, holdouts, everything . . . separate royalties for musical works or mechanical that’s actually in the market. It allows us to Shapley ordering algorithm). Thus, her licenses. However, she recommends that the alteration of market power apparently mechanical rate should be lowered based on this import all of that into a model that generates finding. Professor Marx does specifically estimate a fair reflection upon each player of what was designed to address an issue— the musical works rate under her Alternative they actually do without any abuse of . . . market power—that the Shapley value approach, as discussed infra. any power that they may have. approach does not address. 3/20/17 Tr.

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1863 (Marx) (‘‘I want a model that decision to include within her ‘‘fair In the present case, the issue of represents a fair outcome in the absence income/return’’ and ‘‘relative market power, as it relates to the of market power, so I am going to have contribution’’ analysis of Factors B and fairness of the rates and their reflection to be careful about how I construct the C an adjustment for market power of the parties’ relative roles and model that I am not putting in market asymmetry that seeks to equalize market contributions, pertains in large measure power into the model.’’). power as between Copyright Owners to the power of the rightsholders Although at first blush it would seem and the streaming services. In this derived from their status as collectives. more appropriate for Professor Marx to regard, her adjustment is consistent As noted supra, music publishing is have directly adjusted the copyright with testimony by Professor Katz, who highly concentrated among a few large holders’ market power by breaking them cautioned that the Shapley value publishers. (As also noted supra, the up into several entities each with less approach takes the parties’ market major record companies likewise bargaining power, such an approach power as a given, locking-in whatever control significant percentages of the would have made Shapley modeling disparities exist. 4/15/15 Tr. 4992–93 market.) These large entities provide the less tractable (by increasing the number (Katz). efficiencies of a collective, performing of arrival alternatives in the algorithm), I agree with Professor Watt and find the salutary service of minimizing compared with the practicality of that the Shapley value approach licensing transaction costs. However, a equalizing market power by inflating the inherently eliminates the ‘‘hold-out’’ by-product of collectives is the power of the streaming services (by problem that would otherwise cause a concentration of pricing power. This is reducing them to a single representative rate to be unreasonable, in that it would why, for example, the performing rights agent).341 fail to reflect effective (or workable) societies, ASCAP and BMI, operate Professor Gans testified that competition. However, Professor Marx’s under consent decrees that limit their (regardless of how Professor Marx Shapley value approach attempts to receipt of royalty rates reflective of their sought to equalize market power) her eliminate a separate factor—market market power. See R. Epstein, Antitrust approach was erroneous because power—that she asserts renders a Consent Decrees at 31(2007) (noting that Shapley values are meant to incorporate market-based Shapley approach a collective representing numerous market power asymmetries, not to incompatible with the objectives of musical works can be understood as ‘‘all eliminate them. Gans WRT ¶ 31 (noting Factors Band C of section 801(b)(1). potential competitors in the market Shapley values incorporate market Strictly speaking, this issue does not banded together . . . who will sell their power asymmetries). However, I note raise the question of which approach is goods—at above-competitive prices.’’). Professor Marx’s adjustment for that Professor Gans acknowledged that more consistent with the traditional market power, like Professor Watt’s in an Australian legal proceeding, he too Shapley value approach, but rather, as adjustment as noted in his article (and combined multiple downstream entities Professor Marx noted, whether the like Professor Gans’s adjustment in his into a single entity in his Shapley value modeler should equalize market power Shapley approach in the approach in ‘‘comparison’’ to two in this particular context in order to aforementioned Australian proceeding), upstream rightsholders. 3/30/17 Tr. satisfy these two statutory objectives. ameliorates this collective pricing 4179 (Gans). Additionally, Professor See also 3/27/17 Tr. 3126–27 (Watt) power. In that sense, the adjustment Watt has authored and published an (indicating that a market rate ‘‘might renders the Shapley value more article (cited at Gans WDT ¶ 65, n.36) in reflect’’ both existing market power and representative of ‘‘fairness’’ and which he too ‘‘artificially’’ equalized ‘‘abuse of monopoly power,’’ the latter market power between rightsholders ‘‘relative contributions.’’ In the process, in the form of ‘‘hold-out’’ behavior, but the baby is not thrown out with the and licenses (radio stations) in the same the Shapley Value approach will manner. See R. Watt, Fair Copyright bathwater, so to speak, because the eliminate the ‘‘abuse of monopoly lower transaction costs achieved by the Remuneration: The Case of Music power.’’).342 Radio, 7, 25, 35 (2010) 7 Rev. of Econ. collectives are inputs in the Shapley model, thereby enlarging the surplus Res. on Copyright Issues 21, 25, 35 342 At the hearing, Professor Watt was confronted (2010) (‘‘artificially’’ modeling the on cross-examination with his published article available for sharing among all input ‘‘demand side of the market as a single stating that the Shapley value eliminates ‘‘market suppliers. (That is, if the songwriters unit, rather than individual radio power.’’ As the foregoing analysis indicates, though, were disaggregated (‘‘uncollectivized’’) the Shapley value incorporates whatever market and required to bargain separately with stations . . . thereby . . . add[ing] power exists (unless otherwise adjusted). Professor (notionally) monopsony power to the Watt testified that his language in this regard was each interactive streaming service, demand side’’ to offset the monopoly ‘‘poorly worded’’ and that he intended to state that transaction costs would be higher, if not power of the input supplier). the Shapley value eliminates the ‘‘abuse of market disabling.) power,’’ by which he meant the ability of ‘‘must Professor Marx’s adjustment thus In essence, the import of this criticism have’’ suppliers to ‘‘hold out’’ and refuse (or is actually not about the faithfulness of threaten to refuse) to negotiate. 3/27/17 Tr. 3131– mitigates the collective market power of Professor Marx’s approach to the 33, 3148 (Watt). The Judges find, considering the music publishers, yet retains the lower Shapley Value model. Rather, the totality of Professor Watt’s testimony and writings, transaction costs incurred by that he indeed intended to refer to ‘‘abuse of market rightsholders. In this approach, I detect salience of this critique pertains to her power’’ in his prior writing. This seems clear because he has consistently expressed the opinion a clear and modern echo of the ‘‘public 341 For example, in Professor Marx’s ‘‘alternative’’ that the Shapley value does prevent the exploitation utility’’ rate regulation history that was Shapley model, she models four entities, two of complementary oligopoly (must have/hold out) the foundation for Factors B and C of upstream (musical works holders and sound power, through its inclusion of all ‘‘arrival section 801(b)(1). The goal of such rate recording holders), and two downstream (the orderings’’ in its algorithm. However, his writings representative single streaming service and a single (like Professor Gans’s prior work with which he was regulation has been to maintain the alternate distribution outlet). With these four confronted on cross-examination) demonstrate that efficient cost structure of the utility (i.e., entities, the number of different arrival orders is 4!, the Shapley value approach may be applied by its low average costs), while or 24. If Professor Marx instead had broken the adjusting the number of licensors or licensees to ameliorating the ability of sellers to use musical works copyright holders and the sound change any existing market power disparities. This recording copyright holders respectively into two is fully consistent with Professor Marx’s testimony their concentrated market power to earn entities, the number of total entities would have that the extent of market power remains a choice increased from 4 to 6. The number of arrival orders for the Shapley modeler, and Professor Katz’s adjustment simply takes as given any disparity in would then have increased from 24 to 720. testimony that a Shapley value that makes no such market power that actually exists.

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supranormal profits. See Decker, supra, value modeling. See 3/13/17 Tr. 577 no apparent imbalance of market power (public utility rate of return regulation (Katz) (‘‘I think of the shadow as in the negotiating process (such as the is intended to allow the regulated entity balancing the bargaining power between imbalance that Professor Marx to recover its costs and a ‘‘fair rate of the two parties.’’); Katz CWRT 136, attempted to eliminate by equalizing the return’’). Professor Marx’s market power n.236 (‘‘there are market forces that number of Shapley-participants on each adjustment provides a form of market promote the achievement of the side of the bargain). In this regard, in power mitigation, while still statutory objectives in private Web III (on remand), the Judges also incorporating the higher surplus agreements, such as the 2012 found that these settlement emanating from the more efficient cost Settlement, when the parties are equally agreements—with the ‘‘shadow’’ of a structure of collectivized licenses.343 matched (it was an industry-wide statutory license looming over the negotiations—avoided the same market iv. Application of Professor Marx’s negotiation) and the negotiations are power imbalance that Professor Marx Shapley Value Analysis in this conducted in the shadow of a pending seeks to eliminate in her Shapley Proceeding rate-setting proceeding that can be expected to set reasonable rates in the modeling equalizing the number of Consideration of whether to apply event that the private parties do not licensors and interactive streaming Professor Marx’s Shapley value model reach agreement.’’). Accordingly, any services. Specifically, in Web III (on requires the placement of her modeling attempt by me to use Professor Marx’s remand), the Judges held: in the proper context of other evidence Shapley modeling approach, after I have [T]he NAB, which negotiated on behalf of in this proceeding. More particularly, accepted the appropriateness of the a group of broadcasters, enjoyed a degree of her Shapley value methodology must be present rate structure and rates as bargaining power on the buyers’ side during compared with the process that led to benchmarks, would constitute an its negotiations with SoundExchange. .... the creation of the 2012 rate structure. inappropriate form of double-counting. [S]uch added market power on the buyer side This comparison demonstrates that the The Judges came to a similar tends to mitigate, if not fully offset, Judges should not make any adjustment additional leverage that SoundExchange analytical conclusion with regard to might bring to the negotiations. . . . The to the reasonable rates they have analogous private agreements in Web III determined in this proceeding through question of competition is not confined to an (on remand), where they adopted as examination of the seller’s side of the market an application of the Shapley value alone. Rather, it is concerned with whether 344 benchmarks two settlements between analyses. SoundExchange (as the negotiating and market prices can be unduly influenced by The 2012 rate structure (for subparts settling agent for the record company sellers’ power or buyers’ power in the B and C) was the product of an licensors), and respectively, the market. industrywide negotiation, with the National Association of Broadcasters Id. Thus, the Judges have previously music publishers represented by the (NAB) and Sirius XM. Determination of recognized that a negotiated agreement NMPA and the interactive streaming Royalty Rates for Digital Performance between industrywide representatives— services represented by DiMA, their Right in Sound Recordings and when a failure to agree will trigger a respective trade associations, continuing Ephemeral Recordings, 79 FR 23102 statutory rate proceeding—will: (1) the 2008 industrywide settlement rate (Apr. 25, 2014). There (although ameliorate the complementary structure for subpart B. (Although oligopolists’ ‘‘abuse of power’’ arising individual entities also participated, the Shapley values were not in evidence), the Judges found that from the threat to withhold a ‘‘must settlement was industrywide.) When have’’ license; and (2) reflect such a settlement occurs, it contains the SoundExchange, as a collective, would countervailing licensee power that same benefits with regard to the internalize the impact of the complementary neutralizes the monopoly power of a avoidance of the ‘‘hold-out’’ effect and nature of the repertoires on industry revenue and thus seek to maximize that overall licensor-collective. the equalizing of bargaining power as Web III, as a prior determination by produced by Professor Marx’s Shapley revenue. This would result in lower overall rates compared to the situation in which the this body, thus underscores the individual record companies negotiated 343 redundancy of a Shapley value To be clear, although I find such a market separately. . . . 345 346 power adjustment a relevant consideration in a adjustment in such a context. section 801(b)(1) Factor B and C analysis, it is not The . . . power of SoundExchange was Further, absent any valid reason to the a consideration when determining only a rate that compromised by the fact that the NAB . . . contrary, the Judges have a statutory reflects ‘‘effective competition.’’ An effectively could have chosen instead to be subject to competitive rate need not adjust for such market the rates to be set by the Judges . . . which 345 power, because such a rate (as also set under the would be free of any potential cartel effects— Of course, the parties in the present willing buyer/willing seller standard of 17 U.S.C. proceeding could not know in advance that the rather than voluntarily agree to pay above- Judges would determine a rate structure 14(f)(2)(B)) does not include consideration of these market rates. two factors or their public utility style legislative incorporating these principles, and their Shapley history antecedents. Alternately stated, the Shapley Id. at 23114 (emphasis added). In those analyses thus were proffered given that uncertainty. 346 value approach, without any adjustments for market settlements, the licensees likely were Professors Watt and Gans also criticize power, eliminates only the complementary Professor Marx’s selection of data as inputs in her oligopoly (‘‘must have’’) effect, through its use of all represented by, respectively, a trade Shapley model. In fact, Professor Gans testified that ‘‘arrival orderings,’’ indicating the outcome of an association (NAB), and the entire his re-working of Professor Marx’s model through effectively competitive market, but does not licensee-side of the relevant market the use of different data alone accounted for the necessarily address the Factor B and C objectives. (Sirius XM). Thus, the Judges have bulk of his increase (‘‘the lion’s share’’) of the 344 Professor Marx estimated a Shapley-derived surplus attributable to rights holders. However, in rate of [REDACTED]% to [REDACTED]%. Marx previously acknowledged a similar his written testimony, he did not separately WDT ¶ 163 & App. B. This rate range brackets the removal of the ‘‘abuse of market power’’ quantify the impact of Professor Marx’s attempts to ‘‘headline’’ 10.5% rate in the 2012 benchmark but (arising from complementarity) as in a equalize market power by reducing the number of is [REDACTED] pursuant to the 2012 benchmark Shapley value analysis, when the streaming services. 3/30/17 Tr. 4057, 4119 (Gans). structure. However, I note that Professor Marx Because I find that Professor Marx’s Shapley value testified that the mechanical rate she derived in her licensors are jointly represented in model would be redundant given the rate structure Alternate Shapley approach was not intended to be negotiations by a common agent. analysis undertaken, for the reasons stated in the precise, but rather indicative of a range and Further, because the 2012 settlement text, supra, these data input disputes are moot. Of direction for the Judges to consider. 4/7/17 Tr. 5576 was industrywide, with both sides course, if one were to apply the Shapley values in (Marx) (the Factor B and C Shapley Value analysis this proceeding (as the majority does), each party’s points in the ‘‘direction’’ of rates ‘‘moving slightly represented by (inter alia) their criticisms of the sufficiency of the other’s data sets lower’’ within the existing rate structure). respective trade associations; there was would need to be carefully scrutinized.

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duty to act in accordance with their In light of his decision to assume this mechanical royalty rate of prior determinations. 17 U.S.C. equality in upstream Shapley values, $[REDACTED] (rounded) (i.e., 803(a)(1).347 Professor Gans also coined the phrase [REDACTED] × [REDACTED]), Gans ‘‘top-down’’ approach to describe his WDT ¶ 78, confirming, in his opinion, c. Professor Gans’s ‘‘Shapley-Inspired approach, as distinguished from the reasonableness of Copyright Approach’’ Professor Marx’s approach which— Owners’ proposed $0.0015 statutory per On behalf of Copyright Owners, again coining a phrase—he labeled a play rate. Professor Gans presented a model that ’‘‘bottom-up’’ approach. Gans WDT ¶ 77. On this basis, Professor Gans also he described as ‘‘inspired’’ by the Moreover, as Professor Gans noted, an concluded that his Shapley-inspired Shapley value approach, and thus not important distinction between the two approach supports the Copyright per se a Shapley value approach. 3/30/ approaches is that the bottom-up Owners’ per-user rate proposal. 17 Tr. 4109 (Gans). At a high level, his approach was ‘‘really an exercise . . . in Applying the Shapley value based ratio Shapley-inspired approach attempted to modeling the royalty rate as the result of 2.5 to 1 to the benchmark per-user determine the ratio of sound recording of a hypothetical bargain [whereas] [t]he rate negotiated by the labels of royalties to musical works royalties that top-down approach was to actually %[REDACTED] per user per month, and would prevail in an unconstrained calculate this [b]enchmark I was after subtracting the value of the market. After calculating that ratio, he worried about. Is this price [i.e., the performance rights royalty, Professor estimated what publisher mechanical Copyright Owner’s proposed rate] too Gans obtained an equivalent publisher royalty rates would be in a market high or not?’’ 3/30/17 Tr. 4013–14 mechanical rate of $[REDACTED] without compulsory licensing by (Gans). (rounded) per user per month. (i.e., multiplying the benchmark sound Professor Gans utilized data from ([REDACTED]/2.5) × 80%).348 Gans recording rates by this ratio. Gans WDT projections in a Goldman Sachs analysis WDT ¶ 85. ¶ 63. to identify the aggregate profits of the record companies and the music i. Services’ Criticisms and Dissent’s Professor Gans begins his analysis by publishers, respectively. 3/30/17 Tr. Analysis of Professor Gans’s Approach making two critical assumptions: (1) 4017 (Gans). Given his assumption that I do not credit Professor Gans’s publishers and record companies must sound recordings and musical works Shapley-inspired model, because of its have equal Shapley values (i.e., they were both ‘‘essential’’ inputs and thus assumption and use of the must each recover from total surplus able to claim an equal share of the $[REDACTED] per play sound recording equal profits), because musical profits, Professor Gans posed the interactive rate. As found supra, Dr. compositions and sound recording question: ‘‘[H]ow much revenue do we Eisenach’s $[REDACTED] per play performances are perfect complements need to hand to the publishers so that sound recording rate is not supported by and essential components of the they end up earning the same profits as the weight of the evidence. Therefore, streamed performance; and (2) the label the labels?’’ Id. at 4018. Professor Gans’s Shapley-inspired profits from interactive streaming He found that, for the music analysis is unpersuasive for that reason services are used as benchmark Shapley publishers to recover their costs and alone. More particularly, the record values. Gans WDT ¶ 77. The royalties achieve profits commensurate with company profits are inflated by the that result will differ, given the different those of the record companies under his inefficient rates created through the level of costs incurred by music ‘‘top down’’ approach, the ratio of Cournot Complements ‘‘hold out’’ publishers and record companies sound recording royalties to musical problem that impacts the agreements respectively. Gans WDT ¶ ¶ 23, 71, 74, works royalties derived from his between record companies and 76; Gans WRT ¶ ¶ 15–17; see also 3/30/ Shapley-inspired analysis was 2.5:1. streaming services, as noted by the 17 Tr. 3989 (Gans). (which attributes equal profits to both Services’ experts in this proceeding, and Echoing Dr. Eisenach, Professor Gans classes of rights holders and as the Judges noted in Web IV. found these assumptions critical acknowledges the higher costs incurred Professor Gans’s model is also because agreements between record by record companies compared to music troubling because it begs two broad companies and interactive streaming publishers). Gans WDT ¶ 77, Table 3. questions: (1) whether the model services are freely negotiated, i.e., they As noted, Professor Gans made a key produces a ‘‘reasonable’’ rate as required are not set by any regulatory body or assumption, treating as accurate Dr. by Sec. 801(b)(1); and (2) whether the formally subject to an ongoing judicial Eisenach’s calculation of an effective model produces a rate that also consent decree and, accordingly, are per play rate for sound recordings of adequately satisfies Factors B and C of also not subject to any regulatory or $[REDACTED]. Given those two inputs section 801(b)(1). He testified as follows judicial ‘‘shadow’’ that arguably might (the 2.5:1 ratio and the $[REDACTED] as to why he understands a Shapley- be cast from such governmental per play rate), Professor Gans’s based methodology generally will regulation in the market. Professor Gans approach indicated a market-derived provide an economic approach that therefore uses the profits arising from musical works royalty rate of satisfies the objectives of section these unregulated market transactions to $[REDACTED] (rounded). Id. ¶ 78, Table 801(b)(1): estimate what the mechanical rate for 3. However, because the musical works publishers would be if they too were royalty is comprised of the mechanical [O]ne of the reasons why the Shapley analysis is useful is because these regulations also able to freely negotiate the rates for rate and the performance rate paid to have a fairness objective. I wasn’t the only the licensing of their works. Gans WDT PROs (not to publishers), this one—every economist I think you’ve asked ¶ 75. $[REDACTED] rate needed to be about what they meant by fairness. It’s—it’s adjusted down. Accordingly, he not a topic that is sitting in an economic 347 If the Judges had considered the impact of the subtracted the performance rate and Shapley value analyses in the context of setting a determined that the percent of revenues 348 Professor Gans multiplies the per play rate by reasonable rate—rather than as a separate attributable to mechanical royalties was 81% but the per user rate by 80%. Compare Gans consideration under Factors B and C—they would WDT ¶ 78 with Gans WDT ¶ 85. The rate derived have reached the same result, given the 81% of the total musical works by Professor Gans was the 80% figure. Gans WDT countervailing power that exists between the royalties, under his Shapley-inspired ¶ 77, Table 3, line 17. This discrepancy does not settling parties. approach. Thus, he estimated a impact the relevance of his analysis or my findings.

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textbook somewhere. But the way in which, publishers. As explained supra with Radio, 7 Rev. Econ. Rsch Copyright. you know, I viewed it turned out to be regard to Professor Marx’s model and Issues at 21, 27 (2010).349 similar to others in that it means that if you the critiques thereto, a model that does Finally, one of the assumptions contribute something of economic value that not address the market power is very similar to what somebody else does behind Professor Gans’s approach is that in terms of economic value, you should be asymmetries of the parties (as Professor musical works are as indispensable as expecting them to get the same out of it in Gans expressly acknowledges his model sound recordings for purposes of a terms of what they get to take home. does not) thus fails to address the Shapley value approach. However, that Tr. 3/30/17 3991 (Gans). Thus, if (as Dr. concepts of fairness and relative roles/ assumption is subject to challenge. More Eisenach opines), there is an identity contributions required by Factors B and particularly, I find merit in a further between a market rate and a reasonable C. Thus, while Professor Marx’s analysis critique made by Dr. Leonard. He (effectively competitive) rate that takes is redundant of the market power questioned the underlying assumption into account Factors B and C of section adjustments reflected in the 2012 that musical works are ‘‘essential 801(b)(1), then Professor Gans’s settlement, Professor Gans’s Shapley- inputs,’’ or ‘‘must haves,’’ in the same Shapley-inspired analysis would be inspired approach omits such way in which sound recordings are useful (absent any other defects). adjustments. essential inputs/’’must haves.’’ Conversely, if there is no identity I also agree with Professor Marx’s As he explained, at the time a between a purely market-based rate and further criticism that Professor Gans’s recording artist and a record company a reasonable (effectively competitive) Shapley-inspired model is lacking in decide upon which song to record, they rate that explicitly takes into account certain other important respects. have numerous songs from which to Factors B and C, then Professor Gans’s Perhaps most importantly, he choose. No one song therefore is model is not helpful in applying those intentionally omits the streaming essential at the time in which the statutory factors. services from his model, because he is recording artist and the record company I find that Professor Gans’s model interested only in equating Copyright must select the song. (The essentiality of fails to incorporate sufficiently the Owners’ profits with those of the record the song may exist, as Copyright Owners reasonableness requirements and the companies. Professor Gans did not note, in those instances when the ‘‘fairness’’ and ‘‘relative roles’’ elements provide any convincing evidence to songwriter himself or herself is of of section 801(b)(1). As explained supra, explain why the Judges should rely on sufficient acclaim and notoriety.). It is the concept of a ‘‘reasonable’’ rate a model that omits from consideration only after a song has been incorporated reflects a market rate that is not the very licensees who would be paying into a recording that it has become distorted by a lack of effective the royalties pursuant to a rate the essential. As Dr. Leonard notes, this competition. Here again, a key model is intended to confirm. (I point is analogous to the problem of assumption made by Professor Gans, by understand this omission by Professor ‘‘hold up’’ in the setting of royalties for his own admission, is that the Gans to be one reason why he described patented inputs within a larger complex $[REDACTED] per play rate estimated his model a ‘‘top-down,’’ Shapley device. At an early stage of production, by Dr. Eisenach satisfies the statutory ‘‘inspired’’ approach, as opposed to a the device manufacturer has the requirement of reasonableness. But, as full-fledged Shapley value model.). opportunity to select among several discussed supra, Dr. Eisenach’s Consequently, Professor Gans’s results competing patented inputs, but once calculation of the $[REDACTED] per provide for the streaming services to pay one of them is selected, its uniqueness play rate sound recording rate reflects total royalties (sound recording and allows the owner of the input to the unregulated ‘‘must have’’ hold out musical works) greater than their total demand a disproportionate share of the power of the record companies. Thus, revenue, leading to losses despite their revenue in royalties, because, ex post Professor Gans’s Shapley-inspired undisputed contribution to the total selection, it has become ‘‘essential.’’ approach has imported the record surplus available for distribution. Marx However, ex ante selection, it was not companies’ ‘‘must have’’ hold out WRT ¶ 184 (Professor Gans’s Shapley- ‘‘essential.’’ Thus, the existing spread power, and therefore inserted the inspired calculation of a per-play between musical works royalties and ‘‘abuse of power’’ that Professor Watt musical works royalty rate of $0.0031, sound recording royalties, according to rightly identified as necessarily combined with the existing sound Dr. Leonard, may reflect this excluded from a full-fledged Shapley recording royalty rate, would cause phenomenon, rather than simply an value approach. Although Professor Spotify to pay [REDACTED]% of its artificial regulatory diminution in the Gans chose to describe his approach by revenue in royalties). mechanical royalty rate. 4/5/17 Tr. coining the phrases ‘‘Shapley-inspired’’ Professor Gans apparently explains 5185–87 (Leonard). and a ‘‘‘top-down’ Shapley,’’ I find his away these losses by the fact that the borrowing of the Shapley moniker in Services have been engaging in below d. Professor Watt’s Shapley Approach this context to be somewhat Orwellian, market pricing to increase market share and the ‘‘See-Saw’’ Effect and such pricing shows up in their and find his approach to be too As noted supra, Professor Watt lower revenues. I address that issue dissimilar from a full-fledged Shapley appeared solely as a rebuttal witness. In elsewhere in this Determination. approach to be of assistance in that capacity, he testified as to However, to the extent Professor Gans is establishing a reasonable (effectively purported defects in Professor Marx’s correct in this regard, it shows the limits competitive) rate. See 3/30/17 Tr. 4107– Shapley modeling. In addition, he of a Shapley-inspired approach that, by 09 (Gans) (acknowledging that the top presented alternative modeling intended down/bottom up dichotomy is of his definition, treats accounting costs and revenue inputs as relevant parameters. own making and that the original work 349 Further in that regard, it is important to Because I do not apply the Shapley by Dr. Shapley ‘‘is closer to a bottom- approaches to adjust the rates or to determine up approach’’). note ‘‘[t]hat the main problem with the reasonableness, the parties’ attacks on the Professor Gans’s Shapley-inspired Shapley approach . . . a particularly usefulness of the other’s data sets are moot. approach also does not attempt to pressing problem [is] that of data However, as noted supra, to the extent the Majority availability.’’ R. Watt, Fair Copyright Opinion applies any of the Shapley approaches, it eliminate any other market power that needed to address and resolve the issues of data may be possessed by the music Remuneration: The Case of Music reliability.

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to apply an adjusted version of Professor [REDACTED] should be retained by the bargaining theory tells us that they will Marx’s Shapley value model. Musical Works copyright holders, which successfully obtain most of the available Professor Watt agreed that the equals [REDACTED]% (i.e., surplus. Shapley model is extremely well-suited [REDACTED]) of total interactive to address Factors B and C within streaming revenue. As these Watt WRT ¶ 36.352 Professor Watt section 801(b)(1). 3/27/17 Tr. 3057 calculations imply, the record opines that, because the mechanical rate (Watt). He characterizes the Shapley companies would receive should rise, the sound recording rate model as an approach ‘‘for analyzing [REDACTED]% ([REDACTED]) of the therefore should fall—a phenomenon complex strategic behavior in a very [REDACTED]% of interactive streaming the parties have summarized as a ‘‘see- simple way.’’ Id. at 3058. However, he revenues allocated to the rightsholders. saw’’ effect. See, e.g., 4/5//17 Tr. 5079– found that Professor Marx’s approaches Thus, the record companies would 80:10 (Katz).353 contained several flaws and receive [REDACTED]% of total However, no witness explained how methodological issues. Id. at 3057. interactive streaming revenues this seesaw effect would occur, and Accordingly, he, like Professor Gans, ([REDACTED]). Watt WRT ¶ 35; 3/27/17 there were no witnesses from the record attempted to adjust her modeling in a Tr. 3083, 3115–16 (Watt).351 companies who testified that the record manner that, in his opinion, generated Professor Watt’s ratio of 37.9%:29.1% companies would impotently acquiesce ‘‘decent, believable results.’’ Id. at 3058. equals 1.3:1, whereas Professor Marx’s to a significant loss in royalties to Professor Watt criticized Professor ratio (given the range she estimated) is accommodate the diversion of a huge Marx’s alternative Shapley model, in [REDACTED], a ratio of [REDACTED]. economic surplus away from them and which she treated sound recording and Moreover, both of their ratios are well to the Copyright Owners.354 Indeed, musical works as being owned by two below the current ratio of approximately when the Judges inquired of Professor distinct entities. 3/20/17 Tr. 1885 [REDACTED] for Spotify, and Watt how such an adjustment might (Marx). In that alternative model, approximately [REDACTED] comparing occur, given existing contractual rates Professor Marx found that Spotify’s total the 10.5% headline rate to an average between the Services and record royalties for musical works and sound sound recording rate of approximately companies, he acknowledged that he recordings combined would range from [REDACTED]% of revenue. had not thought of that problem until he {REDACTED]% to [REDACTED]% of Accordingly, under their Shapley value was questioned by the Judges at the total royalties. Id.350 That total indicated models, Professors Watt and Marx hearing, and he acknowledged that the a payment of approximately appear to be in general agreement that timing of any adjustment might be [REDACTED]% to [REDACTED]% of the ratio of sound recording:musical disruptive. 3/27/17 Tr. 3091–92 total revenue for sound recording works royalties should decline. (Watt).355 royalties. Although she understood that However, Professor Watt’s model Spotify actually pays [REDACTED]% of indicates that this ratio reduction 352 More specifically, Professor Watt calculates its revenue in total for these royalties should occur via a significant increase that, for each dollar that the statutory rate holds (see id. at 1860–61), she was not in musical works royalties and an even down fair market musical works royalties, 95 cents concerned by the difference, or by the greater precipitous decline in the sound is captured by the record companies (and 5 cents reduction of royalties paid to record recording royalties set in an unregulated is captured by the streaming services). Watt WRT companies under her alternative market. On the other hand, Professor ¶ 23, n.13 & App. 3. 353 Shapley model, because she ‘‘wasn’t Marx’s model indicates that the ratio Although it is noteworthy that Professor Gans does not anticipate such an effect, and instead trying to construct a model of the should narrow essentially through a speculates that the Services might simply pay the market as it is,’’ but rather . . . a model dramatic reduction in sound recording same sound recording royalty rate and the higher that represents the allocation of surplus royalties and an essentially stable mechanical rate out of existing profits or through in a way that is fair and respects the musical works rate. an increase in downstream prices. Gans WRT ¶ 32. The Judges find no evidence to support the relative contributions of the parties’’. Id. Professor Watt explains that the cause speculation that the Services could engage in such at 188. of the dramatically lower sound substantial adjustments in the market. In his Shapley modeling adjusting recording rates in his Shapley model is 354 According to the RIAA, interactive streaming Professor Marx’s analysis, Professor the existing regulation of musical works revenues for 2015 totaled $1.604 billion. See Marx Watt reached conclusions that were rates. Specifically, he opines: WDT ¶ 153 & App. B.1.b (citing RIAA figures). The broadly consistent with her finding that assumption that the see-saw effect would induce [The reason] my predicted fraction of record companies to surrender a significant amount the ratio of sound recording:musical revenues for sound recording royalties is of this revenue (which has been growing year-over- works royalty rates should decline. significantly less than what is observed in the year as streaming becomes more popular), absent Specifically, Professor Watt found that market [is] simple. The statutory rate for any evidence, makes the assumption of the see-saw at least [REDACTED]% of interactive mechanical royalties in the United States is effect speculative and unreasonable. 355 streaming revenue should be allocated significantly below the predicted fair rate, Copyright Owners argue that Professor Watt (as a non-lawyer) did not appreciate that contracts to the rightsholders, and, of this and the statutory rate effectively removes the musical works rightsholders from the between record companies and interactive bargaining table with the services. Since this streaming services could be renegotiated at any time 350 Under her baseline Shapley value model, upon mutual agreement of those parties. See Professor Marx estimated combined royalty leaves the sound recording rightsholders as CORPFF–JS at 221–22 (and citations therein). While payments equaling [REDACTED]% to the only remaining essential input, this legal point of course is correct, it does not [REDACTED]% of total Spotify revenue. Id. at 1888. address the economic uncertainty as to whether the She could not break that range down into musical 351 At present, record companies receive record companies would be willing to renegotiate works and sound recording royalties because her approximately 55% to 60% of total interactive rates in a manner by which they concede a loss of baseline model treated both types of royalties as if streaming revenue, substantially higher than the royalty revenue as indicated by Professor Watt’s they were paid to a single rightsholder. 37.9% calculated by Professor Watt. anticipated see-saw effect.

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I am loath to adopt the hypothetically you know, to me it seems like an threaten their viability. As noted supra, plausible idea of a ‘‘see-saw’’ effect extreme statement that the entire such year-over-year accounting losses impacting the division of this surplus, increase in publisher profits will come are consistent with a long-run when there is simply no evidence that at the expense of the streaming competition for the market, during such an adjustment would occur.356 services.’’). which losses can be endured as a cost Given at least $[REDACTED] in In any event, from an evidentiary of doing business. Indeed, the services interactive streaming revenue, if the perspective, there is no need to indulge remain in business despite the existence record companies were to passively in such speculation. There is absolutely of chronic losses. In that regard, a accept a reduction of royalties from no evidence that such a significant shift financial expert engaged jointly by the approximately [REDACTED]% of that in royalty distribution would occur, nor Services testified that he was ‘‘not aware revenue, $[REDACTED], to Professor is there sufficient evidence as to the of a single standalone digital music Watt’s proposed 37.9%, i.e., to potential consequences of such a service that has sustained profitability $[REDACTED], they would lose draconian reallocation of revenue. to date,’’ Testimony of David B. Pakman (assuming no further growth in In sum, my analysis of the Shapley ¶ 23 (Pakman WDT), yet that lack of streaming) approximately approaches with regard to the elements sustained profitability has not $[REDACTED] annually, or of Factors B and C demonstrates materially diminished the ranks of $[REDACTED] over five years. The (whether that analysis was undertaken interactive streaming services nor Judges cannot merely assume that the as part of the ‘‘reasonable rate’’ analysis dampened competition from new record companies would ‘‘go quietly or as a separate ‘‘factor’’ analysis) that entrants into the market. into that good night,’’ rather than seek there is no basis to apply those elements Moreover, the record indicates that some other market structure in which to to adjust the reasonable rates as set forth the services are not as concerned with protect this revenue, such as, for in the 2012 benchmark. short-term rates as they are with long- example, resurrecting the idea of term market share, or what the services D. Factor D establishing or otherwise integrating call ‘‘scaling,’’ in their Schumpeterian their own streaming services. The The last itemized factor of section competition for the market. This point Services’ experts, and Apple’s expert, 801(b)(1), Factor D, directs the Judges was made clearly by [REDACTED] testified that any purported see-saw ‘‘to minimize any disruptive impact on (emphasis added). Of course, effect was indeterminate with regard to the structure of the industries involved [REDACTED]. Katz CWRT ¶ 204. its impact on the interactive streaming and on generally prevailing industry The point is well-recognized by services. See 4/5/17 Tr. 4944–45 (Katz) practices.’’ 17 U.S.C. 801(b)(1)(D). In Google as well. See Joyce WDT ¶ 20 (acknowledging the possibility that a Phonorecords I, 74 FR at 4525, the ([REDACTED]) (emphasis added). This mechanical royalty rate increase would Judges reiterated their understanding of acknowledgement was echoed by one of affect sound recording royalties in the Factor D, concluding that a rate would Copyright Owners’ economic expert future but not immediately, and that need adjustment under Factor D if that witnesses, who explained that the there is no reliable estimate of the size rate services’ competitive posture was of any such adjustment); 4/7/17 Tr. directly produces an adverse impact that is typical of internet-based entities that 5515–5516(Marx) ([REDACTED]); 4/5/17 substantial, immediate and irreversible in the accept short-term losses to build Tr. 5704–05 (Ghose) (‘‘[I]t’s quite likely short-run because there is insufficient time economies of scale through, for that the streaming service will want to for either [party] to adequately adapt to the example, investing in customer loyalty. maintain their royalties and their changed circumstance produced by the rate Rysman WDT ¶ 32. revenues at the current levels. And so, change and, as a consequence, such adverse Moreover, another expert economic impacts threaten the viability of the music witness for the Services, Dr. Leonard, delivery service currently offered to 356 As a matter of economic theory, given the candidly acknowledged that ‘‘[a]n present interactive streaming market structure, the consumers under this license. argument may be made that the services record companies already have the economic power Id. I adopt and apply in this expect to be profitable eventually, to put streaming services out of business, because Determination the same Factor D test as otherwise they would go out of business the market in which record companies and interactive streaming services negotiate is set forth above. and Spotify, for example, would not unregulated. So, I recognize that—given the present The Services are advocating broadly have positive market value.’’ Leonard interactive streaming market structure—the record for essentially the same rate structure AWDT 101, n.153. Likewise, Pandora companies apparently find it in their self-interest to that now exists, except for the notes that it can ‘‘achieve the growth it maintain the presence of interactive licensees. Indeed, the evidence in Web IV revealed that the elimination of the Mechanical Floor. projects . . . under a continuation of record companies’ strategy has been to See SJPFF at 1. My proposed rate existing rates and terms . . . .’’ ‘‘[REDACTED].’’ Web IV, supra, at 63 (restricted structure is consistent with that Pandora’s Introductory Rebuttal version). However, if mechanical royalty rates were position, except that I would maintain Memorandum at 3 (emphasis added). to increase to a level that significantly reduced the profits of the record companies from streaming, the Mechanical Floor. I would also This inability of the services to there is no evidence in the record in this proceeding maintain the existing rates. Because this become profitable will persist based on that indicates whether the record companies would result would continue the existing the record, under existing competitive decide to maintain the current vertical structure of structure and rates, neither the services conditions. As Mr. Pakman testified: the market and docilely accept such a revenue loss. For example, they could create their own streaming nor Copyright Owners can reasonably [N]o current music subscription services (perhaps learning the lessons from the complain of disruption under the service—including marquee brands like failed Pressplay and MusicNet attempts of the past). standard quoted above. Indeed, a Pandora, Spotify and Rhapsody—can Or, they could maintain the sound recording royalty continuation of the present rate ever be profitable, even if they execute rates, thereby hastening a more immediate exit of streaming services from the market. Although such structure and rates reflects constancy perfectly . . . .’’ Pakman WDT 23 n.5 an acceleration of exit might be the consequence in rather than disruption. (citation omitted). Although Mr. an unregulated market (fostering Schumpeterian More particularly, the fact that Pakman blames the lack of profitability competition for the holy grail of market scale), such interactive streaming services are failing (in part) on the level of mechanical a change would not only be inconsistent with affording the services a fair income, but also would to realize an accounting profit under royalties, id., I find, based on the clearly be disruptive pursuant to Factor D of section this structure does not demonstrate that Services’ own acknowledgement, that 801(b)(1). the rate structure proposed would the lack of profitability is a function of

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a lack of scale (which is another way of the services in quite unchartered waters that those two rights are—without indicating that market share is divided regarding the disruptive impact of that dispute—perfect complements, means among too many competing interactive increase. The majority actually that the profitability of Copyright streaming services). In fact, Mr. Pakman recognizes that the increase is so Owners must be viewed economically himself recognizes the importance of draconian that it cannot be in the context of royalties realized from scale to long-run profitability. Pakman implemented immediately. See Majority both rights (especially given the ‘‘All- WDT ¶ 26 n.11 (‘‘Scale is a magic word Opinion, supra. Instead, the majority In’’ aspect of the mechanical royalty). for so many cloud-based companies and leaches the increase into the rates year- Indeed, Copyright Owners’ principal services. . . . It may be that Spotify will by-year, as if one can simply assume complaint is that, although their gain some power over the royalties it that the disruptive impact of such a rate mechanical royalty revenue has pays once it has a critical mass of increase is ameliorated in this manner. increased, it has not increased as fast as customers . . . .’’). Pakman WDT ¶ 26 Without a record to consider the impact the increase in the number of musical n.11 (emphasis added). of that rate increase, the majority may works streamed via sound recordings Given the paramount importance of simply be substituting a slow bleed for performed on interactive services. scaling to the long-term success of a fatal blow.359 However, as noted, supra, the record interactive streaming, lowering With regard to the Mechanical Floor, reflects that the increase in streams is mechanical royalties in this I do not find that the continuation of itself a function of the price proceeding—simply to mitigate or this element of the existing rate discriminatory rate structure that prevent shorter-term losses by structure would be disruptive under the incentivizes downstream services that interactive streaming services—would applicable standard. As discussed can move ‘‘down the demand curve’’ constitute an unwarranted subsidy to supra, the risks of fractionalized and offer streaming services to listeners these services at the expense of licenses and publisher withdrawals with a low WTP. 3/13/17 Tr. 701 (Katz). Copyright Owners.357 have receded, belying any reasonable Such a structure will produce an Also, although the services have assertion that such events are on the increase in royalties, even as it may indicated their ability to withstand ‘‘immediate’’ horizon. Further, given produce a lower effective royalty per short-term losses as they compete for that musical works royalties are a stream but, as Professor Hubbard scale/market share, the record also fraction of the total royalties paid by explained, that comparison misses the indicates that there is a limit to such interactive streaming services, the salient economic point. 4/13/17 Tr. losses—however imprecise and triggering of the Mechanical Floor 5971–73 (Hubbard). unknown—beyond which services will would be unlikely to ‘‘threaten the Further, the current rate structure has be unable to attract capital and survive viability’’ of the interactive market.’’ allowed for rates to exceed the 10.5% until the long run market de´nouement. Further, because the Mechanical Floor headline rate. For example, In this regard, Mr. Joyce noted that, was a bargained-for feature of the [REDACTED]. Accord, 3/29/17 Tr. 3637 [REDACTED], at some point benchmark structure on which the (Israelite (‘‘I don’t even think we [REDACTED]. Joyce WDT ¶ 18. As Dr. Services rely, and because that thought of them as minima. We thought Leonard testified, ‘‘[REDACTED].’’ provision protects the funds available to of them as alternate rates. And we Leonard AWDT ¶ 101 n.151. This provide liquidity to songwriters in the would get the greatest of three different testimony reflects the well-understood form of advances, removal of the rates.’’). In this regard, the existing principle that ‘‘[t]here is no specific Mechanical Floor would more likely ‘‘greater of’’ structure incorporates the benefits that the Copyright Board of time period . . . that separates the short disrupt ‘‘prevailing industry practices.’’ run from the long run.’’ R. Pindyck & D. Canada identified (as discussed supra) The continuation of the Mechanical Rubinfeld, Microeconomics at 190 (6th as tilted in favor of rights holders, Floor avoids that disruption. ed. 2005). Thus, although the services With regard to the impact on although the existing structure, appear able to withstand current rates, Copyright Owners, I find that the established via settlement, ameliorates a rate increase of the magnitude sought adoption of a rate structure based on the that impact by providing a ‘‘lesser-of’’ by Copyright Owners would run the 2012 benchmark would not be approach in the second rate prong.) In sum, I find no evidentiary basis to very real risk of preventing the services disruptive under the standard quoted from surviving the ‘‘short-run,’’ support a Factor D adjustment to the above. The record indicates that music threatening the type of disruption Factor rates I have otherwise proposed in this publishers have been profitable while D is intended to prevent.358 Dissent. Moreover, the 44% rate increase this standard has been in effect, and that Because I have rejected Copyright adopted by the majority likewise places interactive streaming has contributed to Owners’ rate proposal, the potential that profitability. Although that disruptive impact of their proposal is profitability is generated by a 357 In this regard, Copyright Owners argue that moot, given my decision to consider the the services could attempt to cut their non-content combination of mechanical and ‘‘reasonable’’ rate structure and rate costs in order to remain sustainable. They suggest performance royalties paid by issues before considering the four that the services emulate Sirius XM, which interactive streaming services, the fact successfully reduced its non-content costs as a itemized factor of section 801(b)(1). percent of revenue. See Rysman WDT ¶ ¶ 98–100. 359 However, if I had incorporated this However, as Spotify’s CFO, Mr. McCarthy notes, Of course, it is possible that the majority may disruption consideration within the Sirius and XM (the pre-merger predecessors to be correct that rolling out this rate increase over five Sirius XM) ‘‘nearly bankrupted themselves and years will ameliorate its disruptive impact. But it ‘‘reasonable rate’’ analysis, my finding merged in order to survive.’’ McCarthy WRT ¶ 42. is equally possible that the rate and structure would be the same, i.e., that Copyright Moreover, not only were Sirius XM’s content costs remain disruptive even when introduced in this Owners’ rate proposal would be lower as a percent of revenue, but also its ‘‘costs extended manner. The salient point, again, is that declined as a percentage of revenue as they grew the fact this rate structure and these rates were unreasonable because it would be their subscriber base. .... Their costs declined as adopted post-hearing with the absence of a record disruptive under the Factor D standards. they achieved scale.’’ Id. Once again, the necessity to support them makes the analysis too speculative. That disruptive effect is captured by of scale remains paramount. The parties deserve an opportunity, and are entitled the following summary of the rate 358 That is, the potentially profitable long-run cost to one under the statute, to challenge the rates and changes for the several services if curve, from scaling, may never be attainable if the rate structure, whether as inconsistent with Factor interactive streaming services remain on perpetual D or as inconsistent with any other requisite set Copyright Owners’ proposal were to be loss-inducing short-run cost curves. forth in section 801(b)(1). implemented:

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FIGURE 3—IMPACT OF COPYRIGHT OWNERS’ PROPOSAL ON SPOTIFY’S ROYALTIES [In thousands except percentages, 2H2015–1H2016]

[REDACTED]

FIGURE 4—ESTIMATED IMPACT OF THE COPYRIGHT OWNERS’ PROPOSAL ON OTHER STREAMING SERVICES, 2015

Current Copyright Owner’s proposal Impact of Copyright Owners’ proposal Service name Mechanical Musical works Mechanical Musical works % increase in % increase in royalties royalties royalties royalties mechanical musical works royalties royalties

Google ...... [REDACTED] .... [REDACTED] .... [REDACTED] .... [REDACTED] .... [REDACTED] .... [REDACTED] Amazon Prime ...... [REDACTED] .... [REDACTED] .... [REDACTED] .... [REDACTED] .... [REDACTED] .... [REDACTED] Rhapsody ...... $7,323,476 ...... $10,253,216 ..... $11,230,793 ..... $14,160,533 ..... 53% ...... 38% Apple Music ...... [REDACTED] .... [REDACTED] .... [REDACTED] .... [REDACTED] .... [REDACTED] .... [REDACTED] TIDAL ...... $755,522 ...... $1,754,546 ...... $1,600,723 ...... $2,599,747 ...... 112% ...... 48% Deezer ...... $438,412 ...... $563,412 ...... $822,541 ...... $947,540 ...... 88% ...... 68% Other ...... $4,478,824 ...... $11,255,046 ..... $16,709,012 ..... $23,485,234 ..... 273% ...... 109% Average ...... $5,277,869 ...... $8,311,074 ...... $16,098,189 ..... $19,131,394 ..... 194% ...... 109%

Marx WRT at 8–9. [REDACTED] it paid during that period 4/4/17 Tr. 4647–49 (Eisenach). These increases are on an order of under existing rates. Id. ¶ ¶ 8, 9. I find these three points inapposite magnitude that indicates to me that Apple also claims that Copyright with regard to the issue of whether such increase would clearly implicate Owners’ proposal would lead to a Copyright Owners’ proposed rate the applicable disruption standard. shutdown of one of its services. structure and rate increase would Specifically, Apple asserts that it would minimize disruption. Simply put, The knock-on effects of this proposal not continue to offer its purchased Copyright Owners’ proposed changes would be disruptive under the content locker service if it were subject are not yet in existence, so any evidence applicable standard. Pandora indicates to Copyright Owners’ per-user proposal of changes that have occurred it would have little choice but to and that Apple would never offer a paid previously cannot reflect the potential eliminate its limited offering Pandora content locker again if the Copyright impact of Copyright Owners’ proposals. Plus product. See Herring WRT ¶ 10. Owners’ rates were in place. 3/22/17 Tr. Of particular note, Copyright Owners’ Under Copyright Owners’ proposed per 2526 (Dorn). proposal would eliminate the ‘‘All-In’’ user rate, it would pay [REDACTED] the Copyright Owners argue that the feature of the mechanical rate, resulting amount it now pays for both mechanical services could ameliorate any disruptive in the disruption from ‘‘double- and performance royalties, and royalties impact from these rates by estimating counting’’ the value of perfect would be even higher on the other the number of plays per user, raising complements that the ‘‘All-In’’ feature is prong—based on the number of songs rates and/or limiting functionality (e.g., designed to avoid. played, Herring WRT ¶ 7, even though by capping listening). See Rysman WRT And again, I return to Copyright the overwhelming majority of streams ¶ 75. However, there is no sufficient Owners’ endorsement of the bargaining on Pandora Plus are noninteractive and evidence in the record that the services room theory and their concomitant do not implicate the mechanical right. could engage in such modifications and acknowledgement that they might well See Herring WRT ¶ 16. Mr. Herring estimations in order to offset the engage in bargaining, by which they further testified that, under Copyright draconian rate increases that would would agree to lower rates to Owners’ proposal, [REDACTED]. result from Copyright Owners’ proposal. accommodate different services catering Consequently, he notes that Pandora Copyright Owners argue that the to differing listener segments. That would lack any resources to invest in its current status of the interactive argument at least implicitly burgeoning interactive streaming service streaming market indicates that neither acknowledges that Copyright Owners’ offerings. Herring WDT ¶ 58. their proposed rate structure nor their ‘‘one-size-fits-all’’ rate is a misnomer, [REDACTED]. Marx WRT ¶ 16 & Fig. proposed higher rates would be and that their proposal is designed to 1. disruptive pursuant to Factor D or the handle potential disruptive impacts Judges’ application of that factor. In that In similar fashion, Google claims that through negotiation that were not regard, Copyright Owners make three Copyright Owners’ rate proposal would subject to an application of any of the points with regard to ongoing market [REDACTED] rates it pays for interactive section 801(b)(1) factors. developments: streaming on its Google Play Music In sum, even if I had integrated my service. More particularly, if Google had 1. Ongoing entry of new interactive disruption analysis into my reasonable paid Copyright Owners’ proposed rates streaming services indicates that the market rate analysis (as opposed to treating it from June 2013 to June 2016, is healthy and expanding; separately), I would have rejected 2. The entry in particular of large entities Copyright Owners’ rate structure and [REDACTED], Leonard WRT ¶ 9. On with comprehensive product ‘‘ecosysems’’ dollar terms, Google estimates that it (i.e., Amazon, Apple and Google) specifically rate proposal as inconsistent with Factor would have paid $[REDACTED] for demonstrates the opportunity for profitable D. musical works rights under Copyright interactive streaming; and I also find that Apple’s per play rate Owners’ proposal, compared with 3. [REDACTED]. structure would be disruptive,

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essentially for the same reason that Subpart C—Interactive Streaming, Limited Affiliate means an entity controlling, Copyright Owners’ proposed structure Downloads, Limited Offerings, Mixed controlled by, or under common control would be disruptive. For example, Service Bundles, Bundled Subscription with another entity, except that an Apple’s proposed per-play rate would Offerings, Locker Services, and Other affiliate of a record company shall not Delivery Configurations increase Spotify’s royalty payments on include a Copyright Owner to the extent its ad-supported service to 385.20 Scope. it is engaging in business as to musical [REDACTED]% of revenue, threatening 385.21 Royalty rates and calculations. works. 385.22 Royalty floors for specific types of Bundled Subscription Offering means the continuation of that service—the offerings. only one to provide a monetarily free a Subscription Offering providing service. See Written Rebuttal Testimony Subpart D—Promotional and Free-to-the- Licensed Activity consisting of Streams of Paul Vogel (on behalf of Spotify USA User Offerings or Limited Downloads that is made Inc.) ¶ 48. In this regard, the senior 385.30 Scope. available to End Users with one or more director of Apple Music, David Dorn, 385.31 Royalty rates. other products or services (including indicated in colloquy with the Judges, Authority: 17 U.S.C. 115, 801(b)(1), products or services subject to other that [REDACTED]. See 3/22/17 Tr. 2538 804(b)(4). subparts) as part of a single transaction (Dorn) ([REDACTED]). Of course, the ad- without pricing for the subscription supported Spotify service, and the PART 385—RATES AND TERMS FOR service providing Licensed Activity [REDACTED], for example, are designed USE OF NONDRAMATIC MUSICAL separate from the product(s) or to [REDACTED], so Apple’s proposed WORKS IN THE MAKING AND service(s) with which it is made rate structure and rates would DISTRIBUTING OF PHYSICAL AND available (e.g., a case in which a user disincentivize such distribution DIGITAL PHONORECORDS can buy a portable device and one-year channels, impeding the ‘‘future’’ listener access to a subscription service conversion Mr. Dorn anticipates. Subpart A—Regulations of General providing Licensed Activity for a single Moreover, such low WTP listeners on an Application price), ad-supported or other free-to-the- § 385.1 General. Copyright Owner(s) are nondramatic musical works copyright owners who listener service generate royalties that (a) Scope. This part establishes rates are entitled to royalty payments made would otherwise not be paid. See and terms of royalty payments for the under this part pursuant to the Written Rebuttal Testimony of Will Page use of nondramatic musical works in compulsory license under 17 U.S.C. (On behalf of Spotify USA Inc.) ¶ 48 making and distributing of physical and 115. ([REDACTED]); see also 4/7/17 Tr. 5503 digital phonorecords in accordance with (Marx) ([REDACTED]). Digital Phonorecord Delivery or DPD the provisions of 17 U.S.C. 115. This has the same meaning as in 17 U.S.C. 4. Conclusion subpart contains regulations of general 115(d). application to the making and End User means each unique person For the foregoing reasons, I distributing of phonorecords subject to that: respectfully dissent. the section 115 license. (1) Pays a subscription fee for an Issue Date: November 5, 2018. (b) Legal compliance. Licensees Offering during the relevant Accounting David R. Strickler, relying on the compulsory license Period; or detailed in 17 U.S.C. 115 shall comply Copyright Royalty Judge. (2) Makes at least one Play during the with the requirements of that section, relevant Accounting Period. List of Subjects in 37 CFR Part 385 the rates and terms of this part, and any Family Plan means a discounted other applicable regulations. This part subscription to be shared by two or Copyright, Phonorecords, Recordings. describes rates and terms for the more family members for a single Final Regulations compulsory license only. subscription price. (c) Interpretation. This part is Free Trial Offering means a ■ For the reasons set forth in the intended only to set rates and terms for subscription to a Service’s transmissions preamble, the Copyright Royalty Judges situations in which the exclusive rights of sound recordings embodying musical revise 37 CFR part 385 to read as of a Copyright Owner are implicated works when: follows. and a compulsory license pursuant to 17 (1) Neither the Service, the Record U.S.C. 115 is obtained. Neither the part Company, the Copyright Owner, nor any PART 385—RATES AND TERMS FOR nor the act of obtaining a license under person or entity acting on behalf of or USE OF NONDRAMATIC MUSICAL 17 U.S.C. 115 is intended to express or in lieu of any of them receives any WORKS IN THE MAKING AND imply any conclusion as to the monetary consideration for the Offering; DISTRIBUTING OF PHYSICAL AND circumstances in which a user must (2) The free usage does not exceed 30 DIGITAL PHONORECORDS obtain a compulsory license pursuant to consecutive days per subscriber per 17 U.S.C. 115. two-year period; Subpart A—Regulations of General (d) Relationship to voluntary (3) In connection with the Offering, Application agreements. The rates and terms of any the Service is operating with Sec. license agreements entered into by appropriate musical license authority 385.1 General. Copyright Owners and Licensees and complies with the recordkeeping 385.2 Definitions. relating to use of musical works within requirements in § 385.4; 385.3 Late payments. the scope of those license agreements (4) Upon receipt by the Service of 385.4 Recordkeeping for promotional or written notice from the Copyright free trial non-royalty-bearing uses. shall apply in lieu of the rates and terms of this part. Owner or its agent stating in good faith Subpart B—Physical Phonorecord that the Service is in a material manner Deliveries, Permanent Digital Downloads, § 385.2 Definitions. operating without appropriate license Ringtones, and Music Bundles Accounting Period means the monthly authority from the Copyright Owner 385.10 Scope. period specified in 17 U.S.C. 115(c)(5) under 17 U.S.C. 115, the Service shall 385.11 Royalty rates. and any related regulations. within 5 business days cease

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transmission of the sound recording network connection, reauthorizes use transaction without pricing for the embodying that musical work and for another time period not to exceed music services or music products withdraw it from the repertoire one month), or in the case of a separate from the whole Offering. available as part of a Free Trial Offering; subscription plan, a period of time Music Bundle means two or more of (5) The Free Trial Offering is made following the end of the applicable physical phonorecords, Permanent available to the End User free of any subscription no longer than a Digital Downloads or Ringtones charge; and subscription renewal period or three delivered as part of one transaction (e.g., (6) The Service offers the End User months, whichever is shorter; or download plus ringtone, CD plus periodically during the free usage an (2) A number of times not to exceed downloads). In the case of Music opportunity to subscribe to a non-free 12 (unless the Licensee, in lieu of Bundles containing one or more Offering of the Service. retransmitting the same sound recording physical phonorecords, the Service GAAP means U.S. Generally Accepted as another Limited Download, must sell the physical phonorecord Accounting Principles in effect at the separately and upon specific request of component of the Music Bundle under relevant time, except that if the U.S. the End User made through a live a single catalog number, and the Securities and Exchange Commission network connection, reauthorizes use of musical works embodied in the Digital permits or requires entities with another series of 12 or fewer plays), or Phonorecord Delivery configurations in securities that are publicly traded in the in the case of a subscription the Music Bundle must be the same as, U.S. to employ International Financial transmission, 12 times after the end of or a subset of, the musical works Reporting Standards in lieu of Generally the applicable subscription. embodied in the physical phonorecords; Accepted Accounting Principles, then Limited Offering means a subscription provided that when the Music Bundle that entity may employ International plan providing Interactive Streams or contains a set of Digital Phonorecord Financial Reporting Standards as Limited Downloads for which— Deliveries sold by the same Record ‘‘GAAP’’ for purposes of this subpart. (1) An End User cannot choose to Company under substantially the same Interactive Stream means a Stream, listen to a particular sound recording title as the physical phonorecord (e.g., a where the performance of the sound (i.e., the Service does not provide corresponding digital album), the recording by means of the Stream is not Interactive Streams of individual Service may include in the same bundle exempt from the sound recording recordings that are on-demand, and up to 5 sound recordings of musical performance royalty under 17 U.S.C. Limited Downloads are rendered only as works that are included in the stand- 114(d)(1) and does not in itself, or as a part of programs rather than as alone version of the set of digital result of a program in which it is individual recordings that are on- phonorecord deliveries but not included included, qualify for statutory licensing demand); or on the physical phonorecord. In under 17 U.S.C. 114(d)(2). (2) The particular sound recordings addition, the Service must permanently Licensee means any entity availing available to the End User over a period part with possession of the physical itself of the compulsory license under of time are substantially limited relative phonorecord or phonorecords it sells as 17 U.S.C. 115 to use copyrighted to Services in the marketplace providing part of the Music Bundle. In the case of musical works in the making or access to a comprehensive catalog of Music Bundles composed solely of distributing of physical or digital recordings (e.g., a product limited to a digital phonorecord deliveries, the phonorecords. particular genre or permitting number of digital phonorecord Licensed Activity, as the term is used Interactive Streaming only from a deliveries in either configuration cannot in subpart B of this part, means delivery monthly playlist consisting of a limited exceed 20, and the musical works of musical works, under voluntary or set of recordings). embodied in each configuration in the statutory license, via physical Locker Service means an Offering Music Bundle must be the same as, or phonorecords and Digital Phonorecord providing digital access to sound a subset of, the musical works embodied Deliveries in connection with recordings of musical works in the form in the configuration containing the most Permanent Digital Downloads, of Interactive Streams, Permanent musical works. Ringtones, and Music Bundles; and, as Digital Downloads, Restricted Offering means a Service’s the term is used in subparts C and D of Downloads or Ringtones where the engagement in Licensed Activity this part, means delivery of musical Service has reasonably determined that covered by subparts C and D of this part. works, under voluntary or statutory the End User has purchased or is Paid Locker Service means a Locker license, via Digital Phonorecord otherwise in possession of the subject Service for which the End User pays a Deliveries in connection with phonorecords of the applicable sound fee to the Service. Interactive Streams, Limited recording prior to the End User’s first Performance Royalty means the Downloads, Limited Offerings, mixed request to use the sound recording via license fee payable for the right to Bundles, and Locker Services. the Locker Service. The term Locker perform publicly musical works in any Limited Download means a Service does not mean any part of a of the forms covered by subparts C and transmission of a sound recording Service’s products otherwise meeting D this part. embodying a musical work to an End this definition, but as to which the Permanent Digital Download or PDD User of a digital phonorecord under 17 Service has not obtained a section 115 means a Digital Phonorecord Delivery in U.S.C. 115(c)(3)(C) and (D) that results license. a form that the End User may retain on in a Digital Phonorecord Delivery of that Mixed Service Bundle means one or a permanent basis and replay at any sound recording that is only accessible more of Permanent Digital Downloads, time. for listening for— Ringtones, Locker Services, or Limited Play means an Interactive Stream, or (1) An amount of time not to exceed Offerings a Service delivers to End play of a Limited Download, lasting 30 one month from the time of the Users together with one or more non- seconds or more and, if a track lasts in transmission (unless the Licensee, in music services (e.g., internet access its entirety under 30 seconds, an lieu of retransmitting the same sound service, mobile phone service) or non- Interactive Stream or play of a Limited recording as another limited download, music products (e.g., a telephone Download of the entire duration of the separately and upon specific request of device) of more than token value and track. A Play excludes an Interactive the End User made through a live provided to users as part of one Stream or play of a Limited Download

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that has not been initiated or requested works in the form of Permanent Digital content directly relating to the Offering by a human user. If a single End User Downloads or Ringtones at the time of (e.g., an image of the artist, information plays the same track more than 50 purchase, or subsequently have digital about the artist or album, reviews, straight times, all plays after play 50 access to the purchased sound credits, and music player controls) shall be deemed not to have been recordings of musical works in the form comprises 75% or more of the space on initiated or requested by a human user. of Interactive Streams, additional that display, excluding any space Promotional Offering means a digital Permanent Digital Downloads, occupied by advertising. An Offering is transmission of a sound recording, in Restricted Downloads, or Ringtones. directly available to End Users from a the form of an Interactive Stream or (1) A qualifying seller for purposes of page if End Users can receive sound Limited Download, embodying a this definition is the entity operating the recordings of musical works (in most musical work, the primary purpose of Service, including affiliates, cases this will be the page on which the which is to promote the sale or other predecessors, or successors in interest, Limited Download or Interactive Stream paid use of that sound recording or to or— takes place). promote the artist performing on that (i) In the case of Permanent Digital Restricted Download means a Digital sound recording and not to promote or Downloads or Ringtones, a seller having Phonorecord Delivery in a form that suggest promotion or endorsement of a legitimate connection to the locker cannot be retained and replayed on a any other good or service and: service provider pursuant to one or permanent basis. The term Restricted (1) A Record Company is lawfully more written agreements (including that Download includes a Limited distributing the sound recording the Purchased Content Locker Service Download. through established retail channels or, if and Permanent Digital Downloads or Ringtone means a phonorecord of a the sound recording is not yet released, Ringtones are offered through the same part of a musical work distributed as a the Record Company has a good faith third party); or Digital Phonorecord Delivery in a format intention to lawfully distribute the (ii) In the case of physical to be made resident on a sound recording or a different version of phonorecords: telecommunications device for use to the sound recording embodying the (A) The seller of the physical announce the reception of an incoming same musical work; phonorecord has an agreement with the telephone call or other communication (2) For Interactive Streaming or Purchased Content Locker Service or message or to alert the receiver to the Limited Downloads, the Record provider establishing an integrated offer fact that there is a communication or Company requires a writing signed by that creates a consumer experience message. an authorized representative of the commensurate with having the same Service means that entity governed by Service representing that the Service is Service both sell the physical subparts C and D of this part, which operating with appropriate musical phonorecord and offer the integrated might or might not be the Licensee, that works license authority and that the locker service; or with respect to the section 115 license: Service is in compliance with the (B) The Service has an agreement with (1) Contracts with or has a direct recordkeeping requirements of § 385.4; the entity offering the Purchased relationship with End Users or (3) For Interactive Streaming of Content Locker Service establishing an otherwise controls the content made segments of sound recordings not integrated offer that creates a consumer available to End Users; exceeding 90 seconds, the Record experience commensurate with having (2) Is able to report fully on Service Company delivers or authorizes delivery the same Service both sell the physical Revenue from the provision of musical of the segments for promotional phonorecord and offer the integrated works embodied in phonorecords to the purposes and neither the Service nor the locker service. public, and to the extent applicable, Record Company creates or uses a (2) [Reserved] verify Service Revenue through an segment of a sound recording in Record Company means a person or audit; and violation of 17 U.S.C. 106(2) or entity that: (3) Is able to report fully on its usage 115(a)(2); (1) Is a copyright owner of a sound of musical works, or procure such (4) The Promotional Offering is made recording embodying a musical work; reporting and, to the extent applicable, available to an End User free of any (2) In the case of a sound recording of verify usage through an audit. charge; and a musical work fixed before February Service Revenue. (1) Subject to (5) The Service provides to the End 15, 1972, has rights to the sound paragraphs (2) through (5) of this User at the same time as the recording, under the common law or definition and subject to GAAP, Service Promotional Offering stream an statutes of any State, that are equivalent Revenue shall mean: opportunity to purchase the sound to the rights of a copyright owner of a (i) All revenue from End Users recording or the Service periodically sound recording of a musical work recognized by a Service for the offers End Users the opportunity to under title 17, United States Code; provision of any Offering; subscribe to a paid Offering of the (3) Is an exclusive Licensee of the (ii) All revenue recognized by a Service. rights to reproduce and distribute a Service by way of sponsorship and Purchased Content Locker Service sound recording of a musical work; or commissions as a result of the inclusion means a Locker Service made available (4) Performs the functions of of third-party ‘‘in-stream’’ or ‘‘in- to End User purchasers of Permanent marketing and authorizing the download’’ advertising as part of any Digital Downloads, Ringtones, or distribution of a sound recording of a Offering, i.e., advertising placed physical phonorecords at no musical work under its own label, under immediately at the start or end of, or incremental charge above the otherwise the authority of the Copyright Owner of during the actual delivery of, a musical applicable purchase price of the PDDs, the sound recording. work, by way of Interactive Streaming or Ringtones, or physical phonorecords Relevant Page means an electronic Limited Downloads; and acquired from a qualifying seller. With display (for example, a web page or (iii) All revenue recognized by the a Purchased Content Locker Service, an screen) from which a Service’s Offering Service, including by way of End User may receive one or more consisting of Streams or Limited sponsorship and commissions, as a additional phonorecords of the Downloads is directly available to End result of the placement of third-party purchased sound recordings of musical Users, but only when the Offering and advertising on a Relevant Page of the

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Service or on any page that directly a live network connection to the advances, barter or any other monetary follows a Relevant Page leading up to transmitting service, substantially at the and/or nonmonetary consideration, and including the Limited Download or time of transmission, except to the whether that consideration is conveyed Interactive Stream of a musical work; extent that the sound recording remains via a single agreement, multiple provided that, in case more than one accessible for future listening from a agreements and/or agreements that do Offering is available to End Users from Streaming Cache Reproduction; not themselves authorize the Licensed a Relevant Page, any advertising (2) Using technology that is designed Activity but nevertheless provide revenue shall be allocated between or such that the sound recording does not consideration for the identified rights to among the Services on the basis of the remain accessible for future listening, undertake the Licensed Activity, and relative amounts of the page they except to the extent that the sound including any value given to an affiliate occupy. recording remains accessible for future of a record company for the rights to (2) Service Revenue shall: listening from a Streaming Cache undertake the Licensed Activity. Value (i) Include revenue recognized by the Reproduction; and given to a Copyright Owner of musical Service, or by any associate, affiliate, (3) That is subject to licensing as a works that is controlling, controlled by, agent, or representative of the Service in public performance of the musical work. or under common control with a Record lieu of its being recognized by the Streaming Cache Reproduction means Company for rights to undertake the Service; and a reproduction of a sound recording Licensed Activity shall not be (ii) Include the value of any barter or embodying a musical work made on a considered value given to the Record other nonmonetary consideration; and computer or other receiving device by a Company. Notwithstanding the (iii) Except as expressly detailed in Service solely for the purpose of foregoing, applicable consideration shall this part, not be subject to any other permitting an End User who has not include in-kind promotional deduction or set-off other than refunds previously received a Stream of that consideration given to a Record to End Users for Offerings that the End sound recording to play the sound Company (or affiliate thereof) that is Users were unable to use because of recording again from local storage on used to promote the sale or paid use of technical faults in the Offering or other the computer or other device rather than sound recordings embodying musical bona fide refunds or credits issued to by means of a transmission; provided works or the paid use of music services End Users in the ordinary course of that the End User is only able to do so through which sound recordings while maintaining a live network business. embodying musical works are available connection to the Service, and the (3) Service Revenue shall exclude where the in-kind promotional reproduction is encrypted or otherwise revenue derived by the Service solely in consideration is given in connection protected consistent with prevailing connection with activities other than with a use that qualifies for licensing industry standards to prevent it from Offering(s), whereas advertising or under 17 U.S.C. 115. sponsorship revenue derived in being played in any other manner or on connection with any Offering(s) shall be any device other than the computer or § 385.3 Late payments. treated as provided in paragraphs (2) other device on which it was originally A Licensee shall pay a late fee of 1.5% and (4) of this definition. made. per month, or the highest lawful rate, (4) For purposes of paragraph (1) of Student Plan means a discounted whichever is lower, for any payment this definition, advertising or Subscription to an Offering available on owed to a Copyright Owner and sponsorship revenue shall be reduced a limited basis to students. remaining unpaid after the due date by the actual cost of obtaining that Subscription means an Offering for established in 17 U.S.C. 115(c)(5) and revenue, not to exceed 15%. which End Users are required to pay a detailed in part 210 of this title. Late (5) In instances in which a Service fee to have access to the Offering for fees shall accrue from the due date until provides an Offering to End Users as defined subscription periods of 3 years the Copyright Owner receives payment. part of the same transaction with one or or less (in contrast to, for example, a more other products or services that are service where the basic charge to users § 385.4 Recordkeeping for promotional or not Licensed Activities, then the is a payment per download or per play), free trial non-royalty-bearing uses. revenue from End Users deemed to be whether the End User makes payment (a) General. A Licensee transmitting a recognized by the Service for the for access to the Offering on a sound recording embodying a musical Offering for the purpose of paragraph (1) standalone basis or as part of a Bundle work subject to section 115 and subparts of this definition shall be the lesser of with one or more other products or C and D of this part and claiming a the revenue recognized from End Users services. Promotional or Free Trial zero royalty for the bundle and the aggregate Total Cost of Content or TCC means rate shall keep complete and accurate standalone published prices for End the total amount expensed by a Service contemporaneous written records of Users for each of the component(s) of or any of its affiliates in accordance making or authorizing Interactive the bundle that are Licensed Activities; with GAAP for rights to make Streams or Limited Downloads, provided that, if there is no standalone interactive streams or limited including the sound recordings and published price for a component of the downloads of a musical work embodied musical works involved, the artists, the bundle, then the Service shall use the in a sound recording through the release dates of the sound recordings, a average standalone published price for Service for the accounting period, brief statement of the promotional End Users for the most closely which amount shall equal the activities authorized, the identity of the comparable product or service in the applicable consideration for those rights Offering or Offerings for which the zero- U.S. or, if more than one comparable at the time the applicable consideration rate is authorized (including the internet exists, the average of standalone prices is properly recognized as an expense address if applicable), and the beginning for comparables. under GAAP. As used in this definition, and end date of each zero rate Offering. Stream means the digital transmission ‘‘applicable consideration’’ means (b) Retention of records. A Service of a sound recording of a musical work anything of value given for the claiming zero rates shall maintain the to an End User— identified rights to undertake the records required by this section for no (1) To allow the End User to listen to Licensed Activity, including, without less time than the Service maintains the sound recording, while maintaining limitation, ownership equity, monetary records of royalty-bearing uses

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involving the same types of Offerings in the royalty rate payable for each work Purchased Content Locker Services the ordinary course of business, but in embodied in the phonorecord or PDD provided through subscription and no event for fewer than five years from shall be either 9.1 cents or 1.75 cents nonsubscription digital music Services the conclusion of the zero rate Offerings per minute of playing time or fraction in accordance with the provisions of 17 to which they pertain. thereof, whichever amount is larger. U.S.C. 115, exclusive of Offerings (c) Availability of records. If a (b) Ringtones. For every Ringtone the subject to subpart D of this part. Copyright Owner or agent requests Licensee makes and distributes or information concerning zero rate authorizes to be made and distributed, § 385.21 Royalty rates and calculations. Offerings, the Licensee shall respond to the royalty rate payable for each work (a) Applicable royalty. Licensees that the request within an agreed, reasonable embodied therein shall be 24 cents. engage in Licensed Activity covered by time. (c) Music Bundles. For a Music this subpart pursuant to 17 U.S.C. 115 Bundle, the royalty rate for each shall pay royalties therefor that are Subpart B—Physical Phonorecord element of the Music Bundle shall be calculated as provided in this section, Deliveries, Permanent Digital the rate required under paragraph (a) or subject to the royalty floors for specific Downloads, Ringtones, and Music (b) of this section, as appropriate. types of services described in § 385.22. Bundles Subpart C—Interactive Streaming, (b) Rate calculation. Royalty § 385.10 Scope. Limited Downloads, Limited Offerings, payments for Licensed Activity in this This subpart establishes rates and Mixed Service Bundles, Bundled subpart shall be calculated as provided terms of royalty payments for making Subscription Offerings, Locker in paragraph (b) of this section. If a and distributing phonorecords, Services, and Other Delivery Service includes different Offerings, including by means of Digital Configurations royalties must be calculated separately Phonorecord Deliveries, in accordance with respect to each Offering taking into with the provisions of 17 U.S.C. 115. § 385.20 Scope. consideration Service Revenue and This subpart establishes rates and expenses associated with each Offering. § 385.11 Royalty rates. terms of royalty payments for Interactive (1) Step 1: Calculate the all-In royalty (a) Physical phonorecord deliveries Streams and Limited Downloads of for the Offering. For each Accounting and Permanent Digital Downloads. For musical works, and other reproductions Period, the all-in royalty shall be the every physical phonorecord and or distributions of musical works greater of the applicable percent of Permanent Digital Download the through Limited Offerings, Mixed Service Revenue and the applicable Licensee makes and distributes or Service Bundles, Bundled Subscription percent of TCC set forth in the following authorizes to be made and distributed, Offerings, Paid Locker Services, and table.

TABLE 1 TO PARAGRAPH (b)(1)—2018–2022 ALL-IN ROYALTY RATES

2018 2019 2020 2021 2022 Royalty year (%) (%) (%) (%) (%)

Percent of Revenue ...... 11.4 12.3 13.3 14.2 15.1 Percent of TCC ...... 22.0 23.1 24.1 25.2 26.2

(2) Step 2: Subtract applicable relation to all uses of musical works for distribution of each musical work used Performance Royalties. From the which the Service pays Performance by the Service by virtue of its Licensed amount determined in step 1 in Royalties for the Accounting Period. Activity through a particular Offering paragraph (b)(1) of this section, for each The Service shall make this allocation during the Accounting Period. To Offering of the Service, subtract the total on the basis of Plays of musical works determine this amount, the Service must amount of Performance Royalty that the or, where per-play information is allocate the result determined in step 3 Service has expensed or will expense unavailable because of bona fide in paragraph (b)(3) of this section to pursuant to public performance licenses technical limitations as described in each musical work used through the in connection with uses of musical step 3 in paragraph (b)(3) of this section, Offering. The allocation shall be works through that Offering during the using the same alternative methodology accomplished by dividing the payable Accounting Period that constitute as provided in step 4 in paragraph (b)(4) royalty pool determined in step 3 for the Licensed Activity. Although this of this section. Offering by the total number of Plays of (3) Step 3: Determine the payable amount may be the total of the Service’s all musical works through the Offering royalty pool. The payable royalty pool is payments for that Offering for the during the Accounting Period (other the amount payable for the reproduction Accounting Period, it will be less than than Plays subject to subpart D of this and distribution of all musical works the total of the Performance Royalties if part) to yield a per-Play allocation, and used by the Service by virtue of its the Service is also engaging in public Licensed Activity for a particular multiplying that result by the number of performance of musical works that does Offering during the Accounting Period. Plays of each musical work (other than not constitute Licensed Activity. In the This amount is the greater of: Plays subject to subpart D of this part)) case in which the Service is also (i) The result determined in step 2 in through the Offering during the engaging in the public performance of paragraph (b)(2) of this section; and Accounting Period. For purposes of musical works that does not constitute (ii) The royalty floor (if any) resulting determining the per-work royalty Licensed Activity, the amount to be from the calculations described in allocation in all calculations under step subtracted for Performance Royalties § 385.22. 4 in this paragraph (b)(4) only (i.e., after shall be the amount allocable to (4) Step 4: Calculate the per-work the payable royalty pool has been Licensed Activity uses through the royalty allocation. This is the amount determined), for sound recordings of relevant Offering as determined in payable for the reproduction and musical works with a playing time of

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over 5 minutes, each Play shall be (1) Standalone non-portable Period and the specified number of counted as provided in paragraph (c) of Subscription—streaming only. Except as cents per subscriber (or active this section. Notwithstanding the provided in paragraph (a)(4) of this subscriber, as the case may be) shall be foregoing, if the Service is not capable section, in the case of a Subscription used as the subscriber-based component of tracking Play information because of Offering through which an End User can of the royalty floor for the Accounting bona fide limitations of the available listen to sound recordings only in the Period. A Family Plan shall be treated technology for Offerings of that nature form of Interactive Streams and only as 1.5 subscribers per month, prorated or of devices useable with the Offering, from a non-portable device to which in the case of a Family Plan the per-work royalty allocation may those Streams are originally transmitted Subscription in effect for only part of a instead be accomplished in a manner while the device has a live network calendar month. A Student Plan shall be consistent with the methodology used connection, the royalty floor is the treated as 0.50 subscribers per month, by the Service for making royalty aggregate amount of 15 cents per prorated in the case of a Student Plan payment allocations for the use of subscriber per month. End User who subscribed for only part individual sound recordings. (2) Standalone non-portable of a calendar month. (c) Overtime adjustment. For purposes Subscription—mixed. Except as of the calculations in step 4 in provided in paragraph (a)(4) of this Subpart D—Promotional and Free-to- paragraph (b)(4) of this section only, for section, in the case of a Subscription the-User Offerings sound recordings of musical works with Offering through which an End User can § 385.30 Scope. a playing time of over 5 minutes, adjust listen to sound recordings either in the the number of Plays as follows. form of Interactive Streams or Limited This subpart establishes rates and (1) 5:01 to 6:00 minutes—Each play = Downloads but only from a non-portable terms of royalty payments for 1.2 plays. device to which those Streams or Promotional Offerings, Free Trial (2) 6:01 to 7:00 minutes—Each play = Limited Downloads are originally Offerings, and Certain Purchased 1.4 plays. transmitted, the royalty floor for use in Content Locker Services provided by (3) 7:01 to 8:00 minutes—Each play = step 3 of § 385.21(b)(3)(ii) is the subscription and nonsubscription 1.6 plays. aggregate amount of 30 cents per digital music Services in accordance (4) 8:01 to 9:00 minutes—Each play = subscriber per month. with the provisions of 17 U.S.C. 115. 1.8 plays. (3) Standalone portable Subscription (5) 9:01 to 10:00 minutes—Each play Offering. Except as provided in § 385.31 Royalty rates. = 2.0 plays. paragraph (a)(4) of this section, in the (a) Promotional Offerings. For (6) For playing times of greater than case of a Subscription Offering through Promotional Offerings of audio-only 10 minutes, continue to add 0.2 plays which an End User can listen to sound Interactive Streaming and Limited for each additional minute or fraction recordings in the form of Interactive Downloads of sound recordings thereof. Streams or Limited Downloads from a embodying musical works that the (d) Accounting. The calculations portable device, the royalty floor for use Record Company authorizes royalty-free in step 3 of § 385.21(b)(3)(ii) is the required by paragraph (b) of this section to the Service, the royalty rate is zero. shall be made in good faith and on the aggregate amount of 50 cents per basis of the best knowledge, subscriber per month. (b) Free Trial Offerings. For Free Trial information, and belief of the Licensee (4) Bundled Subscription Offerings. In Offerings for which the Service receives at the time payment is due, and subject the case of a Bundled Subscription no monetary consideration, the royalty to the additional accounting and Offering, the royalty floor for use in step rate is zero. certification requirements of 17 U.S.C. 3 of § 385.21(b)(3)(ii) is the royalty floor (c) Certain Purchased Content Locker 115(c)(5) and part 210 of this title. that would apply to the music Services. For every Purchased Content Without limitation, a Licensee’s component of the bundle if it were Locker Service for which the Service statements of account shall set forth offered on a standalone basis for each receives no monetary consideration, the each step of its calculations with End User who has made at least one royalty rate is zero. Play of a licensed work during that sufficient information to allow the (d) Unauthorized use. If a Copyright month (each such End User to be Copyright Owner to assess the accuracy Owner or agent of the Copyright Owner considered an ‘‘active subscriber’’). and manner in which the Licensee sends written notice to a Licensee determined the payable royalty pool and (b) Computation of royalty rates. For purposes of paragraph (a) of this section, stating in good faith that a particular per-play allocations (including Offering subject to this subpart differs in information sufficient to demonstrate to determine the royalty floor, as applicable to any particular Offering, a material manner from the terms whether and how a royalty floor governing that Offering, the Licensee pursuant to § 385.22 does or does not the total number of subscriber-months for the Accounting Period, shall be must within 5 business days cease apply) and, for each Offering the Streaming or otherwise making Licensee reports, also indicate the type calculated by taking all End Users who were subscribers for complete calendar available that Copyright Owner’s of Licensed Activity involved and the musical works and shall withdraw from number of Plays of each musical work months, prorating in the case of End Users who were subscribers for only the identified Offering any End User’s (including an indication of any overtime access to the subject musical work. adjustment applied) that is the basis of part of a calendar month, and deducting the per-work royalty allocation being on a prorated basis for End Users Dated: December 18, 2018. paid. covered by an Offering subject to Suzanne M. Barnett, subpart D of this part, except in the case Chief Copyright Royalty Judge. § 385.22 Royalty floors for specific types of a Bundled Subscription Offering, Approved by: of offerings. subscriber-months shall be determined (a) In general. The following royalty with respect to active subscribers as Carla D. Hayden, floors for use in step 3 of defined in paragraph (a)(4) of this Librarian of Congress. § 385.21(b)(3)(ii) shall apply to the section. The product of the total number [FR Doc. 2019–00249 Filed 2–4–19; 8:45 am] respective types of Offerings. of subscriber-months for the Accounting BILLING CODE 1410–72–P

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