File Sharing & Music Piracy: How the Internet Is Changing the Tune

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File Sharing & Music Piracy: How the Internet is Changing the Tune

A thesis submitted to the Miami University Honors Program in partial fulfillment of the requirements for University Honors

Andrew Ryan Mott

May, 2004 Oxford, Ohio

ABSTRACT

File Sharing & Music Piracy: How the Internet is Changing the Tune

By Andrew Ryan Mott

This thesis conducts an in depth examination of file sharing via the Internet. According to Stanford University, file sharing is, in definition, “The capability of sharing files among computers on a network.” More specifically, this thesis focuses on the sharing of copyrighted works of music between multiple parties, and the effects that the sharing of music files has had upon the music industry as a whole. Since the late 1990’s, file sharing has become a hotly debated topic among music industry experts and consumers alike, in part due to the decreases in revenue and profits realized by the five major record labels: A & M Universal, Warner Brothers Records, Sony Music, EMI, and Bertelsmann. These record labels contend that their losses in revenue are directly correlated to the widespread dissemination of copyrighted intellectual property via illegal networks created for the purpose of allowing users unlimited access to music at no charge. However, others contend that file sharing is the wave of the future and that the music industry has been slow to catch up with the digital revolution. The ultimate aim of this work is to examine ways in which the music industry can reshape its current business model in order to reverse the trend of downward sloping sales figures. There are five sections to this work, each of which is closely tied to the file sharing debate. The sections are: The Background and History of the Internet, Copyright Law in the United States, File Sharing Networks: The Implications of Napster and MP3.com, Changing the Business Model: The Challenges Facing the Music Industry, and Alternative Viewpoints and Research about File Sharing. Through these sections, one may gain an understanding of the history of file sharing networks, how they have influenced the music industry, and how the industry can adapt in order to create a viable business model for the digital age.

File Sharing & Music Piracy: How the Internet is Changing the Tune

By Andrew Ryan Mott

Approved by:

Dr. Gillian Oakenfull__, Advisor

Dr. Glenn Platt______, Reader

Mr. Todd Bailey______, Reader

Accepted By:

Dr. Carolyn Haynes___, Director, University Honors Program

Acknowledgements

There are many people who have aided me in creating this thesis. I would like to acknowledge my advisor, Dr. Gillian Oakenfull, and both of my readers, Dr. Glenn Platt and Mr. Todd Bailey. Each of them has provided critical insight and knowledge, and without them I would not have been able to successfully complete my thesis work. I would also like to thank Ms. Rachel Vacek for helping me get my thesis started on the right foot, and Mr. Brian Jay Miller of WOXY 97X, who provided me with a wealth of both resources and knowledge.

Last but not least, I would like to thank my Mom and Dad, who patiently listened to me talk about file sharing and how I never thought I would be able to get this thesis completed. Without them, I would never have had anyone to vent my anger to about spending countless hours in front of my computer, researching and writing for this work. Table of Contents

Introduction ...... 10

The Background and History of the Internet . . . . 11 The Beginning: How the Internet Came to Be . . . 11 Intelligence at the Ends: Laying the seed for File Sharing . . 14 Non-Commercial Uses...... 18 The Concept of the Commons . . . . . 18

Copyright Law in the United States of America . . . . 22 A Brief History of Copyright ...... 124 Contributory Infringement, Vicarious Liability and the Doctrine of Fair Use . . . . . 25 The Digital Millennium Copyright Act . . . . 27 Updating Copyright Law for the Digital Age . . . . 28

File Sharing Networks: The Implications of Napster and MP3.com . 31 The MP3 is Unleashed to the Public . . . . . 31 Napster and My.MP3.com: Radical Innovators or Copyright Criminals? 32 The Law Gets Involved: Napster’s Dealings in Court . . 37 The Law Gets Involved: My.MP3.com’s Dealings in Court . . 40 The RIAA Pushes On: Taking the Law to Individual Users . . 42

Changing the Business Model: The Challenges Facing the Music Industry 45 Issues to be Considered in the New Business Model . . . 46 The Digital Music Store: iTunes and Napster 2.0 . . . 49 The Bundling Approach: Making CD’s More Attractive . . 52 An Ongoing Battle ...... 56

Alternative Research and Viewpoints About File Sharing . . 58 A Quantitative Approach to Why the Music Industry is Wrong . 58 Alienated Consumers and Outspoken Artists . . . . 60

Conclusion: File Sharing is the Future . . . . . 62

References ...... 63

Introduction

Throughout time, developments in technology have allowed the fabric of the

global community to become increasingly tighter knit. Phones advocated an increase in

personal communication, flight allowed international travel, and most recently the

Internet has afforded the global community with instant access to virtually any type of information. However, the benefits of new technology inherently possess costs, and the

Internet is of no exception. Music piracy is an issue that has plagued the recording

industry for years, and the development of Internet file sharing programs has magnified

this issue across the globe. In recent years, file sharing has moved to the forefront of the debate over the continually slumping sales of the music industry. File sharing is viewed

as an extremely serious violation of the law by multiple parties, including both the

Recording Industry Association of America, major record labels such as BMG, Universal

and Time Warner, and even the United States Government. Through an examination of

how the Internet was created, United States copyright law, the trials and tribulations of

the early file sharing programs, how the music industry can adapt its business model to

enter the digital age, and alternative viewpoints on file sharing technology, one can gain a

critical understanding of the impact that file sharing has on today’s society. Essentially,

the aim of this thesis is to discuss the history of file sharing, such that one may achieve an

understanding of where the future of the music industry is headed, and how they can

utilize file sharing technology to create a new business model that will thrive in the

digital age. The Background and History of the Internet

“There is one thing that is stronger than all the armies in the world, and that is an idea whose time has come.”

-Victor Hugo, 19th Century playwright and poet

The Beginning: How the Internet Came to Be

Before any type of scholarly discussion of the nature and implications of file sharing can take place, it is of utmost importance that one fully understands the origins and intentions of the Internet as it stands today, and the foundations and ideas upon which the Internet was created. Without the fundamental structure that makes up the Internet, file sharing technology would never have been created. There are three very important concepts that allow the Internet to function as it does. These three concepts are also crucial in that they provide the means by which file sharing can take place. They are: packet switching, end-to-end architecture, and Internet protocols. As we will soon see, it would be impossible for the file sharing phenomenon to have ever begun without these three foundations.

The Internet is, essentially, “a world-wide broadcasting capability, a mechanism for information dissemination, and a medium for collaboration and interaction between individuals and their computers without regard for geographic location.”1 The Internet began in 1969 as a military communications system known as ARPANET.2 ARPANET had a twofold purpose. The first aim was create a system that would aid the government

1 http://www.isoc.org/internet/history/brief.shtml 2 http://www.isoc.org/internet/history/brief.shtml in the sharing of documents and resources in order to facilitate a “secure means by which

secret information could be circulated, a kind of internal electronic postal system.”3 The

second reason was that there was a general fear within the governmental community that

the current communications system that was in use would not be able to withstand any

type of nuclear attack, and that if an attack occurred, all communications systems would

collapse.4 In addition, governmental concerns were not the only forces that drove the shaping of the Internet. Universities, such as UCLA, felt the need to be able to share

their resources with other universities and research facilities in order to make possible a

bicoastal exchange of academic information.5 It was from these three goals and concerns

that the Internet as we know it today was born.

The very first recorded descriptions of the social interactions that could be facilitated by the networking of various “nodes,” or computers, were communicated in

August of 1962, in a series of memos by J.C.R Licklider of the Massachusetts Institute of

Technology (MIT).6 Licklider envisioned a system in which a globally connected set of

computers would allow any end user quick and easy access to any type of information.7

In October of 1962, Licklider became the first person to head the computer research program at the governmental agency known as the United States Advanced Research

Projects Agency (DARPA). At DARPA, Licklider worked alongside a group of men who shared a common goal of developing what would eventually become the Internet.

3 Grahm, 1999, pp. 22 4 http://www.isoc.org/internet/history/brief.shtml 5 http://www.isoc.org/internet/history/brief.shtml 6 http://www.isoc.org/internet/history/brief.shtml 7 http://www.isoc.org/internet/history/brief.shtml Licklider had a vision, but his vision was constrained by the limitations of the telecommunications system as it existed in America in the late 1950’s and early 60’s.

The most current communications technology during the era was the telephone system, owned by AT&T. AT&T’s system was set up on a network composed of

circuits.8 In essence, the telephone system was designed in way that directly linked each

phone call along a single copper wire. Internet researchers saw this system as too

centralized and not able to withstand any type of significant stress that may be put upon

the system, such as a nuclear attack, which was a real and definite threat in the Cold War

era. Internet researchers understood that if only a few of the wires that were used to

connect AT&T’s system were destroyed, the entire telecommunications system could

easily collapse. The answer to this dilemma came in the form of packet switching,

developed by Paul Baran of the Rand Corporation.9 Essentially, Baran looked to create a

system in which a network of computers would rely on packet-switching technology instead of the traditional copper wires. Several important properties underlie the theory

of packet switching. They are: “Sufficient redundancy so that the loss of subsets of links

and nodes would not isolate any of the still-functioning nodes; no central control; signals

would traverse a series of nodes from source to destination, the exact route being

determined by the set of working nodes and links at a particular time; and each node

would contain routing information and could automatically reconfigure that information

within a short time after the loss of a link or node.”10 The first public demonstration of a

8 Lessig, 2001, pp.31 9 Denning, 1989, pp. 530 10 Denning, 1989, pp. 530 network that operated on packet switching technology was organized by Robert Kahn at

the International Conference on Computer Communications in 1972.11 The most significant advantage of packet switching was that any system set up to use packet switch technology would still be able to operate in the event that a part of the system experienced a failure. Thus, the use of packets, instead of the use of circuits, became a

major step along the path towards the networking of computers. In terms of file sharing,

packet switching is important in the sense that music files are transferred from one computer to another in packet form. A song is not transmitted as an entire file, rather, it is divided into many small packets which are broken down, transferred, and then reassembled in order to create an entire music file.

Intelligence at the Ends: Laying the seed for File Sharing

With the advent of packet-switching technology, mere ideas became reality as a feasible system for the connection and communication of multiple computers was created. As the network was designed, a very important construct came into being. This was the idea of “end-to-end” architecture. The end-to-end (e2e) argument says that rather than locating intelligence within the network, all intelligence should be placed at the ends, or client computers. Computers at the “ends” became the “edge” of the networks that were created, and the computers that were located “within” the network were the machines that established the links between all the “edges.”12 The most important aspect

of this setup is that the information and applications that were shared between the

11 http://www.isoc.org/internet/history/brief.shtml 12 Lessig, 2001, pp.34 networked computers was stored on each “end” machine, and not on a central server to which each computer was linked. The central server was merely a “middleman” which assisted in providing the connections. A recent National Research Council (NRC) describes e2e:

“Aimed at simplicity and flexibility, [the end-to-end] argument says that the network should provide a very basic level of service – data transport – and that the intelligence – the information processing needed to provide applications – should be located in or close to the devices attached to the edge [or ends] of the network.”13

End-to-end architecture is important because it allows for unbridled innovation. Without centralized control, innovators with new applications need only to connect their computers to the network and let their applications run.14 The network is completely neutral and does not control how it grows and changes. Therefore, as new and updated applications are developed, users at each and every “end” can adapt to the new technology as it becomes available. According to David Reed, one of the developers of the e2e architecture:

“There were a lot of experiments in those days,” and “we . . . realized that there was very little in common [other] than the way they used the network. There were sort of interesting ways that they used the network differently from application to application. So we felt that we couldn’t presume anything about how networks would be used by applications. Or we wanted to presume as little as possible.”15

13 Lessig, 2001, pp. 35 14 Lessig, 2001, pp.35 15 Lessig, 2001, pp. 39 The idea of e2e architecture is a central aspect of the file sharing phenomenon, and also was a key determinant in the development of the protocols, or “language,” on which the

Internet runs.

E2e allowed multiple computers to connect to one another, but there still existed one fundamental setback: incompatibility. In the late 1980’s, researchers at the

Switzerland based Particle Physics Laboratory CERN (Conseil Européen la Recherche

Nucléaire) began work on a set of protocols, or rules, which would attempt to overcome the incompatibility issues and allow various computers of different makes to communicate seamlessly.16 The man who is credited with the development of these protocols is Time Berners-Lee, a research scientist at CERN. In his book, Weaving The

Web, Berners-Lee states:

“The real world of high-energy physics was one of incompatible networks, disk formats, data formats, and character encoding schemes, which made any attempt to transfer information between computers generally impossible. The computers could simply not communicate with each other.”17

The solution to this problem came in the development of three very important protocols, all developed at CERN by Berners-Lee. They were Uniform Resource Locaters (URL’s),

Hypertext Transfer Protocol (HTTP) and Hyper-Text Markup Language (HTML).

Together, these protocols defined the World Wide Web (WWW). It is important to understand that the WWW and the Internet is not the same thing. The WWW is the set of protocols on which the Internet runs, and includes URL’s, HTTP and HTML. The

16 Berners-Lee, 2000, pp.4 17 Berners’Lee, 2000, pp.35 Internet is the actual physical system that connects the computers throughout the globe,

and includes the hardware and wires that make the Internet run.

So what do all these acronyms mean? Uniform Resource Locators became what we know as web addresses. They represent the address, or space that a given webpage occupies. With the advent of the URL, it no longer became necessary to access information via a long, memorized string of numbers. URLS’s gave way to the web addresses we know today, such as www.napster.com or www.census.gov. HTTP was, in essence, a format negotiator.18 It allowed any computer at the edge of a network to say

what kinds of data formats it could handle, and then allowed servers or other end users to deliver data in one of those formats.19 HTML is a way of representing hypertext. After the URL tells a browser, such as Microsoft Internet Explorer or Netscape Navigator, to

talk HTTP with the server, the client and server have to agree upon the format of the data

that will be shared. If both client and server know the format of the information to be

transferred, then the information can be broken into packets and sent on its way.

However, HTML comes into play when both client and server do not speak the same

language. HTML allows any type of information to be broken down into its coded form,

thus allowing the client computer to see the code and translate it using a language that it

does speak.20 The actual meanings of these various acronyms are not nearly as important

as the functions that they served. These three important protocols, along with a list of

various other protocols, make up what is know as the TCP/IP (Transmission Control

18 Berners-Lee, 2000, pp. 36 19 Berners-Lee, 2000, pp. 36 20 Berners-Lee, 2000 pp. 37 Protocol/Internet Protocol) Suite.21 Together, the protocols that made up the WWW allowed computers at the CERN laboratory to “speak” the same language.

What I have discussed above is by no means an exhaustive history of how the

Internet as we know it today came into existence. What it is, however, is a discourse on the core developments that make the Internet work. The three inventions described; packet switching, e2e, and protocols, are the principal driving forces behind the Internet, and more importantly, they are the vital organs that support file sharing.

Non-Commercial Uses

In its original incarnation, it is imperative to understand that the Internet was not

created for any type of commercial purpose. As described above, the architects of the

Internet saw it only as a means of communication that facilitated in allowing multiple

computers to share important documents. Without a doubt, it would have been

impossible for those who constructed the original Internet to foresee the thousands of different purposes that it would eventually serve. Therefore, the foundations that allow for file sharing were part of the structure that created the Internet as it is today, but were

by no means created with file sharing or any type of commercial activity in mind.

The Concept of the Commons

There exists an important theory underlying all the technical jargon that has been used to describe the structure and design of the Internet as it was originally conceived.

21 http://www.isoc.org/internet/history/brief.shtml This theory is painstakingly outlined in Lawrence Lessig’s work, The Future of Ideas. In

his book, Lessig, a Professor of Law at Stanford Law School and founder of Stanford’s

Center for Internet and Society, puts forth the notion that there are many resources in

society that are held “in common.”22 According to The Oxford English Dictionary,

“commons” are a resource held “in common,” defined as “in joint use or possession, to

be held or enjoyed equally by all persons.”23 Lessig lays out a number of examples of

resources that are held in common, such as the public streets, parks and benches,

Einstein’s theory of relativity, and writings in the public domain. All of these resources

are “free” for anyone to use in the sense that access to the resource is not “conditioned

upon the permission of someone else.”24 Lessig does not use the term “free” in a

monetary sense, and this is an important distinction to note. Lessig’s argument centers on

the idea that the Internet is a “free” form of innovation commons through which creativity

can thrive, and that if too many restrictions are placed upon consumers activity on the

Internet, we risk experiencing a tragedy of the commons through which creativity and

freedom are stifled. It is through the inherent “freeness” that the Internet is allowed to

thrive and grow in ways that cannot always be predicted.

To fully comprehend the theory of the commons as it relates to the Internet, we

must revisit the concept of e2e architecture. End-to-end is what renders the Internet as an

innovation commons. Without any centralized control, users are free to load new

programs and applications onto the network without the permission of any overarching

22 Lessig, 2001, pp. 19 23 Lessig, 2001, pp. 19 24 Lessig, 2001, pp. 20 authority. The system is built in such a way that it is allowed to remain open to any form

of innovation. In the words of the NRC, end-to-end has been “a key to the explosion of

new services and software applications” on the Internet.25 End-to end ensures a “survival

of the fittest” hierarchy, in which the killer programs and applications will flourish, while

those that are inferior will perish as users dispose of them after recognizing their inherent mediocrity.

A commons can also be seen in the code that makes up the Internet. When Tim

Berners-Lee created HTTP and HTML, he designed it so that it was “open.” This meant that any programmer could see the code that was used to build the documents and protocols that governed the Web. When you look at a web page, you can simply click the

“source” button under the “view” menu to see the code that was used to build the web

page. Code is a commons, and the ability for anyone to see how the web is built allows

for innovation. Any end user can view source code, make the changes that they see fit,

and put the new permutation back on the web. Again, e2e allows for an innovation

commons because there is no central authority that decides what is put on the Internet and

what is not allowed.

However, end-to-end architecture is by no means an absolute. In this day and age

of lawsuits and intellectual property concerns, e2e is starting to be seen by many as a

privilege. As Lessig says, “the design of the Internet now need not be its design

tomorrow.”26 The code that defines the network can easily be altered, and in the blink of

25 Lessig, 2001, pp. 40 26 Lessig, 2001, pp. 41 an eye, the tragedy of the commons could occur if the Internet becomes burdened with

new rules and regulations governing its use.

In order to provide a framework for where I would like to go with this thesis, I will provide the thoughts of someone who, on the surface, one would think of as having

no connection to the controversy surrounding file sharing. Senator Orrin Hatch, former chair of the U.S. Judiciary Committee, has written his thoughts on the Internet and file sharing. He wrote:

“If [the digital pipes] through which the new music will be delivered are significantly narrowed by gatekeepers who limit access to or divert fans to preferred content, a unique opportunity will be lost for both the creators of music and their fans. That is why I think it is crucial that policymakers be vigilant in keeping the pipes wide open.”27

Hatch understands what Lessig means by the tragedy of the commons. If the right

to innovation is stifled by private interests, what does this say about our culture today?

As we move along through the rest of file sharing debate, the questions, and hopefully the

answers, surrounding file sharing will become clear. The next step in dissecting the

intricacies of file sharing requires the careful examination of United States copyright

laws. If not for copyright law, both the cultural and legal disputes surrounding file sharing would be non-existent, for it is copyright law that causes file sharing to be an illegal activity.

27 Lessig, 2001, pp.264 Copyright Law in the United States of America

“The Congress shall have Power To . . . promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries . . .”

-U.S. Constitution, Article I, Section 8

The matters surrounding intellectual property and copyright law play a central

role in the debate over file sharing on the Internet. The next step in analyzing the details

of music piracy and file sharing is to take a look at copyright law as it exists in the United

States, the original intent of its creators, and how copyright law has been updated over

the years to reflect changes in technology. In addition, it is essential to examine where

age of easy access to music online.

passed by the United States Congress. According to the Library of Congress, a copyright

is “a form of protection provided by the laws of the United States (title 17, U.S. Code) to

the authors of ‘original works of authorship,’ including literary, dramatic, musical,

artistic, and certain other intellectual works.”28 Section 106 of the 1976 Copyright Act gives the copyright holder the following exclusive rights:

• To reproduce the work • To create derivative works based upon the work, such as translating the work into another language • To distribute copies of the work

28 Library of Congress, 2000 • To perform the work publicly • To display the work publicly29

Copyright protection, under law, begins from the time that the work is created, and the copyright in the work of authorship will immediately become the personal property of the

person who produced the original work.30 In addition, there is a common

misunderstanding that the creator of an original work must register a copyright from the

U.S Copyright Office. This is not true. A copyright on a work of music is secured

automatically when the work is created, and a work is defined as being “created” when it

becomes fixed in a copy or phonorecord for the first time.31 However, if no copyright is

registered, then the author or creator of the work will not have the ability to litigate if

their copyright is violated.

From above, the statutory definition of a phonorecord includes cassette tapes,

CD’s and LP’s. From this definition, we can deduce that when a band or artist creates

their own original music and places it on a medium in order to distribute it to the public,

the band or artist has, in effect, copyrighted their original work. Only they can

reproduce, distribute, perform the work publicly or create derivative works based upon the original work. However, there are very few successful bands out there that create and distribute their creative work completely on their own. The majority of bands have signed contracts with major record labels, through which the band creates the music and

the record label takes on the responsibility of producing and distributing the creative

29 Baase, 1997, pp.167 30 Library of Congress, 2000 31 Library of Congress, 2000 work to the public. Thus, in this commercial arrangement, the music becomes the

intellectual property of the band, since music does not have a tangible form, and the

record label takes control of the privileges granted to the band under copyright law in exchange for paying the band a royalty for the ownership of the copyright. Ultimately, the aim of copyright protection is to maintain a sustainable balance between the rights of

the authors and copyright holders over their creative work and the opportunity for the

public to have the right to access the copyrighted information.32 On the whole,

copyrights are worth millions of dollars to the major record labels. The livelihood of

their business lies in the fact that they own the rights to the artistic work of thousands of

different artists, and without those copyrights, anyone in the world would be allowed to

distribute, perform, or make other types of financial gain from copyrighted music. As we

will see, it is the unauthorized distribution and violation of copyright law by file sharing

networks that is upsetting the way in which the record labels conduct their business.

A Brief History of Copyright

The questions surrounding copyright law and music are by no means new or just emerging in this age of digital technology. According to Larry Starr, professor of music history at the University of Washington in Seattle, “The form [of music] changes, but the issues – who owns the music, what rights pertain to artists, what rights pertain to the companies – these are issues that go way back into the 19th century.”33 The early music

32 Anestopoulou, 2001, pp.321 33 Napoli, 2003 business was dominated by sheet music producers in the late 1800’s and early 1900’s.34

However, the focus shifted to recorded music as technological innovations paved the way for new forms of music distribution; specifically the radio in the 1920’s, cassette recorders in the 1960’s, CD’s in the 1980’s and MP3 players in the late 1990’s.35

Whenever a new form of distribution for creative work is produced, it becomes critical to examine the current copyright law, and make sure that it takes into account any changes that have taken place in technology. In the controversy surrounding file sharing, there is an opinion held by many that the Copyright Act of 1976 is outdated and cannot be logically applied to the cases involved in the file sharing controversy due to the fact that the Internet did not exist in 1976 as it does today.

Contributory Infringement, Vicarious Liability and the Doctrine of Fair Use

Although there are many different concepts and updates that have been made to

U.S. copyright law, there are three that are central to file sharing technology. Two important legal concepts, especially concerning the Internet, must be kept in mind— contributory infringement and vicarious liability. Contributory infringement may be found when a person, with knowledge of the infringing activity, induces, causes, or materially contributes to the infringing activity of another person.36 For example, an

operator of a website may be liable for contributory infringement by knowingly hosting

links to infringing music files.

34 Napoli, 2003 35 Napoli, 2003 36 http://www.riaa.com/issues/copyright/laws.asp Vicarious liability is imposed in the case that a person has the ability to control

the infringing activity and is also receiving a financial benefit from the infringing

activities. Vicarious liability may be imposed even if the person or business is unaware of

the infringing activities. According to the RIAA, “In the case of a site retransmitting

infringing programs, providing direct access to infringing works may show a right and

ability to control the activities of the direct infringer, and receiving revenue from banner

ads or e-commerce on the site may be evidence of a financial benefit.”37 If a person or business is found be liable of contributory or vicarious copyright infringement, the criminal penalties can be exceptionally steep. By definition, criminal penalties are available for intentional acts undertaken for purposes of "commercial advantage" or

"private financial gain." "Private financial gain" includes the possibility of financial loss to the copyright holder as well as traditional "gain" by the defendant.38 If an infringing

activity is found to be for commercial advantage, infringements upon sound recordings

can be punishable by up to five years in prison and $250,000 in fines. Violators can also

be held civilly liable for damages, lost profits, or statutory damages of up to $150,000 per

work infringed.39

The third important aspect of copyright law that relates to file sharing is the

Doctrine of Fair Use. In the United States, under certain circumstances, an alleged violation of the rights of a copyright holder can be defended under the doctrine of “fair use.”40 Sometimes referred to as the “equitable rule of reason,” the fair use doctrine was

37 http://www.riaa.com/issues/copyright/laws.asp 38 http://www.riaa.com/issues/copyright/laws.asp 39 http://www.riaa.com/issues/copyright/laws.asp 40 Landau, 2002, pp. 153 originally created to allow the limited use of portions of copyrighted material for

purposes of criticism and comment, news reporting, scholarship and teaching.41 Over

time, the doctrine of fair use has been expanded to allow for various other uses, including

personal copying for convenience, provided that the copy does not take the place of a

purchased copy from the copyright holder.42 There are four factors that are considered

when conducting a fair use analysis:

1. The purpose and character of the use, including whether such use is of a commercial nature or is for non-profit educational purposes; 2. The nature of the copyrighted work; 3. The amount and substantiality of the portion used in relation to the copyrighted work as a whole; 4. The effect of the use upon the potential market for or value of the copyrighted work.43

In the two file sharing cases that were taken to court in the late 90’s, both defendants,

Napster and My.MP3.com, asserted a defense based on the doctrine of fair use. By definition, the doctrine of fair use allows for a bit more flexibility in relation to

copyrights. However, even with the doctrine of fair use on their sides, many of the early file sharing networks were still found to have overstepped their boundaries.

The Digital Millennium Copyright Act

In addition to the laws regarding contributory infringement, vicarious liability and

the Doctrine of Fair Use, there is one more feature of copyright that has been central to

the file sharing dilemma. It is the Digital Millennium Copyright Act (DMCA), which,

41 Landau, 2002, pp. 153 42 Landau, 2002, pp. 153 43 Landau, 2002, pp. 153 according to the RIAA, represents “the most important overhaul of international

DMCA outlines the responsibilities of Internet Service Providers (ISP’s) in cases of

online infringement. The DMCA forces an Internet Service Provider that is aware of a

works, or the ISP could be liable for damages.45 The DMCA also contains what is known

as a “safe harbor provision.” This provision limits the liability of an ISP in the case that

the ISP has no knowledge of or financial benefit from the infringing activity, provides

proper notification of its policies to all of its subscribers, and sets up an agent to deal with

Napster file sharing network also attempted to use the safe harbor provision of the

DMCA as a defense against charges of contributory and vicarious copyright infringement.47

Updating Copyright Law for the Digital Age

Based upon the issues raised by file sharing, it can be seen that the copyright laws

of the United States have been updated in order to reflect the changes that have taken

place with regarding to the distribution of music. However, methods of music

distribution via the Internet, whether they are legal or illegal, are constantly changing,

and copyright law must keep abreast of the changes. The Internet has created a forum in

44 http://www.riaa.com/issues/copyright/laws.asp 45 http://www.riaa.com/issues/copyright/laws.asp 46 http://www.riaa.com/issues/copyright/laws.asp 47 Anestopoulou, 2001, pp.325 which millions of users are afforded instant access to music, usually at absolutely no cost.

What this represents is a challenge for the artists, the record labels and the government.

There exists an army of millions out there who hold the firm belief that Internet users

should have the right to access any content they want, whether it is protected by

no longer viewed by consumers as having a tangible aspect to it. Gone are the days of

having to leave your home and drive to the local record store in order to purchase your

music. The Internet has created a new business model for the record companies to work

with, and it is essential that copyright law is constantly updated in order to reflect the

latest technological advances. According to Christopher Waterman, dean of the school of

arts and architecture at the University of California at Los Angeles, “Whatever the

[music] industry is going to be, it has to take a different form. This is raising basic

questions about property. Music has been turned into information, and once it is

physically pulled away, not embedded in any material object, you’re in a whole new

world.”48

The above quote illustrates exactly how many in the music industry feel right

now. They have entered a whole new world in which all the old rules of their business

model no longer seem to apply. As evidenced above, even the laws of the United States of America have been forcibly altered to deal with the Internet as a form of commercial distribution. We have now seen how the Internet was forged such that file sharing networks could become a reality, and how copyright law affects both music and the

48 Napoli, 2003 Internet. The next logical step is to examine what happened when the Internet and copyright law clashed soon after the public release of the first mass distributed file sharing networks.

File Sharing Networks: The Implications of Napster and MP3.com

“This is a culture war, between the powers that were and that will be.”

-John Perry Barlow, Grateful Dead lyricist and cyber rights activist

Now that the technical issues surrounding the formation of the Internet and U.S.

frame the facts encircling the Internet based networks that brought both file sharing and

MP3 technology into the lexicon of the general public. The file sharing craze began in

the late 1990’s, as those who were “technologically savvy” caught on to the widespread

dissemination of digital music files for free. As we will see, the file sharing phenomenon

caught on like wildfire as Napster and MP3.com became mainstays within American

popular culture.

The MP3 is Unleashed to the Public

The catalyst of the firestorm surrounding music piracy via the Internet began with

the creation of the MP3 compression software. The term MP3 is short for Moving

Pictures Experts Group (MPEG) Audio Layer 3, and it was developed under the

sponsorship of the International Organization for Standardization and the International

Electrotechnical Commission.49 Essentially, the MP3 software is an algorithm that

compresses a digital music file without significantly degrading the sound clarity of the

original recording. This is done by removing the parts of the audio file that are inaudible

49 Lewine, 2000, pp.50 to human ears.50 The first MP3 codec (compression – decompression) was released for

use on personal computers in 1989, and allowed those who used it to compress their

digital audio files at a ratio of 12:1, meaning a song that had originally been thirty six

megabytes was now only three megabytes.51 Since the size of music files could now be

significantly reduced, the time it took to download them from cyberspace also was

reduced. In addition to its low cost, the reduction in file size helped to make MP3

encoding the most popular method of distributing music over the Internet.52

The late Nineties saw an explosion in the amount of MP3’s and MP3 related

software that was available on the Internet. Web sites offered the necessary software,

digital MP3 players, skins and plug-ins that could be used to access and play MP3 files.

The vast majority of these offerings came completely free of charge. In addition, many websites offered up software programs know as “rippers.” Rippers allow the user to

transform their CD collection into digital MP3 files, which are then stored on the users

hard drive.53 Due to the aforementioned resources that became broadly available on the

Internet, as well as high speed Internet connections, the sharing of MP3 files escalated at

a breakneck pace.

Napster and My.MP3.com: Radical Innovators or Copyright Criminals?

The MP3 format of digital audio gained notoriety in 1999, when the legal issues

surrounding the unauthorized distribution of music came to the forefront with the creation

50 Lessig, 2001, pp. 123 51 Anestopoulou, 2001, pp. 320 52 Anestopoulou, 2001, pp. 320 53 Anestopoulou, 2001, pp. 320 of the file sharing software program known as Napster. Napster was the brainchild of a

19 year old college student by the name of Shawn Fanning.54 In January of 1999,

Fanning, a student at Northeastern University in Boston, released a short set of computer

code that allowed him and his friends to share their collections of digital music with each

other.55 This short code became the backbone of what eventually turned into the

computer software program know as Napster, named as such due to Fanning’s nickname as a child, which he had earned from his “nappy” head of hair. Although Napster was by no means the first program of its type, it was by far the most successful. In its heyday,

Napster boasted more than 58 million users, and at any given time, allowed its users access to some 300 million MP3 files.56

Napster was based on the peer-to-peer (p2p) computing model, a mutation of the

original e2e format, which allows any user access to the hard drive of any other user logged onto the network at the same time. This design was, in essence, a reversion to the

original mechanism of the Internet, when interconnected computers at remote locations were allowed to share data and information.57 Formally, “peer-to-peer is a class of

applications that take advantage of resources – storage, cycles, content, human presence –

available at the edges of the Internet.”58 In order to allow its users access to music,

Napster maintained on its main server a directory and index of the names of millions and

millions of MP3 files. Any user who had downloaded Napster’s free software was not

only granted access to the directory, but was also allowed to make their own files

54 Lewine, 2000, pp. 50 55 Lewine, 2000, pp. 50 56 Lewine, 2000, pp. 50 57 Lewine, 2000, pp. 53 58 Lessig, 2001, pp. 134 available for other users to download. The Napster server acted as a middleman of sorts,

allowing users to see what files were available for download from the other users who

were simultaneously logged onto the main server. The main server did not hold the songs; instead it merely acted as a directory of MP3 file names. If a registered user

wanted to list the available files stored on their personal computer’s hard drive, they

would create a ‘user library’ on their hard drive. After saving their own MP3 files in the

user library, the Napster software would search through the library and verify all of the

files that the user held. If all of the files were in correct MP3 format, the names of those

files would then be uploaded from the user’s hard drive to the Napster servers, while the

actual physical files stayed on the user’s computer.59 Once a user had uploaded their

MP3 collection to the Napster server, those files would become part of a collective

directory of files that were available for sharing during the time the user was logged onto

the network. Something to note about this “collective directory” of filenames is that it

was “fluid;” it tracked the users who were connected in real time, and only displayed file

names that were instantly accessible for sharing.60

In order for a user to download files from another user, Napster included a search

function in its software program. To search the files available for download, a user

needed only to enter the name of the artist or song that was desired. This search string

would then be automatically cross-referenced with the listing of MP3 file names in the

main server’s directory.61 The main server would then compile a list of all the files that

59 Landau, 2002, pp. 152 60 Landau, 2002, pp. 152 61 Landau, 2002, pp.152 were indexed on the server that matched the user’s search string, and would send this list

back to the end user who had entered the original search.

To transfer a copy of the MP3 file that the user wanted to download, the Napster

server would obtain the internet address of the “requesting user” and the internet address

of the “host user” (the user who held the requested MP3 file on their hard drive).62 This information would be used to establish a direct connection between the user holding the copy of the MP3 file and the user that was requesting the MP3 file. Once the computers

were directly connected, the file would be transferred from the host user to the requesting

user.

It is easy to see that Napster was an e2e or p2p network due to the fact that the

information (MP3 files) was stored not on a central server, but at the “edge” (end users)

of the network. Many believe that the reasoning behind the use of a p2p setup was an

attempt to avoid the “copyright police.”63 Basically, if millions upon millions of MP3’s

are stored on a central server, then it becomes highly likely that the authorities will catch

on. In contrast, the p2p system of allowing users to access files directly from the hard

drives of other users makes the stored content harder to locate.64 Instead of holding all of the content in one place, it is spread out over millions of different users, thus making it increasingly difficult, in theory, to find and prosecute those that actually are sharing and downloading MP3 files.65 This concept was quickly proven to be dead wrong, as we will

soon find out.

62 Landau, 2002, pp. 152 63 Lessig, 2001, pp.131 64 Lessig, 2001, pp. 131 65 Lessig, 2001, pp. 131 Despite holding the title of the most widely used and distributed file sharing

software, Napster was not the only major file sharing player in the late 90’s. MP3.com

Inc., founded in 1997 as a subsidiary of a file search website business that went by the name of the Z Company, offered search tools for users of MP3 files and a central server on which artists were encouraged to place their original recordings for promotion and distribution.66 In 2000, MP3.com launched a new service, called My.MP3.com. This

service began after MP3.com purchased approximately 45,000 popular CD’s and

uploaded the files, in MP3 format, onto their central server.67 In order for a user to listen to a certain song, they were first required to prove that they actually owned a hard copy of the CD that contained the song they wished to listen to by inserting the disk into their

CD-ROM drive.68 The My.MP3.com server would verify that the user owned the CD

and then allow that user to hold those tracks on a digital storage space, thus allowing

them to listen to the tracks in any location where Internet access was available.69 In the case that the user did not own the CD, they would be given the chance to purchase it from any online music vendor approved by My.MP3.com. The music vendor would instantly notify My.MP3.com of the purchase, and the user would then be allowed to store those tracks in their “digital locker.”70 My.MP3.com was different from Napster in that it did not allow users to actually download any MP3 files onto their hard drive; rather, it allowed users to stream the audio from the website. In addition, My.MP3.com was not a

p2p service; rather, it kept all of its musical holdings on its own central server.

66 Lewine, 2000, pp. 51 67 Lewine, 2000, pp. 51 68 Anestopoulou, 2001, pp. 321 69 Lewine, 2000, pp. 51 70 Anestopoulou, 2001, pp. 321 The Law gets Involved: Napster’s Dealings in Court

Once Napster cemented itself within the public domain, the Recording Industry

Association of America (RIAA) was quick to cry foul. Suddenly, the traditional rules

relating to capitalism and ownership of intellectual property seemed to change overnight.

Millions of people hooked up, logged on, and realized that music was now free. Napster

made it possible to have literally any song you could possible imagine on your own

personal hard drive within minutes, sometimes seconds. Users amassed enormous

collections of MP3 files, downloading every song that that had ever enjoyed listening to.

Therein lays the problem, according to the Recording Industry Association of America.

The MP3 files that millions of users were downloading for free were all copyrighted by

major record labels, and were the intellectual property of the artists that had created them.

The RIAA and major record labels were quick to file suit against Napster. In December

of 1999, the major record labels came together to sue Napster for contributory and

vicarious copyright infringement.71 The allegations included the charge that Napster intentionally supplied its users with the means to purposely and knowingly violate long- standing copyright laws, and charged Napster with contributory copyright infringement in violation of Sections 106, 115 and 501 of the 1976 Copyright Act.72 In response to the charges, Napster requested summary judgment on the premise that its services were protected under the ‘safe harbor principles’ of Section 512(a) of the Digital Millennium

71 Anestopoulou, 2001, pp. 324 72 Lewine, 2000, pp. 52 73 Anestopoulou, 2001, pp. 324 liability of Internet Service Providers under certain circumstances. Napster lost its bid for

summary judgment based on Judge Marilyn Patel’s interpretation of the DMCA, in which

Judge Patel ruled that Napster was not eligible for protection due to its failure to comply

with the definition of an Internet Service Provider. Judge Patel, of the United States

District Court of the Northern District of California74, found that Napster failed to

“transmit, route or provide connections” to its users, and thus was not eligible for

protection under the DMCA safe harbor principles.75

In the trial court proceedings, Napster presented its defense based on several

previous lawsuits involving either file sharing or new technology, due to the fact that the

United States legal system operates on the principle of “stare decisis;” or the use of past

court decisions in order to provide parameters for current cases.76 The main defense used

by Napster was that its users were protected from copyright infringement under the

Audio Home Recording Act of 1999, which allows noncommercial file sharing.

Napster’s defense also cited RIAA vs. Diamond Multimedia Systems77, in which the court ruled that the copying of MP3 files from a computer’s hard drive to a portable MP3 player was legal.78 Diamond Multimedia Systems was the first company to manufacture a portable MP3 player for noncommercial personal use. In addition, Napster’s defense cited the rulings in Sony Corp. vs. Universal Studios Inc.79 This was a landmark case in

74 Anestopoulou, 2001, pp. 324 75 Anestopoulou, 2001, pp. 324 76 http://www.law.cornell.edu/lexicon/stare_decisis.htm 77 Recording Industry Association of America v. Diamond Multimedia Systems, Inc., 180 F.3d 1072 (9th Cir1999) 78 Anestopoulou, 2001, pp. 325 79 Sony Corp v Universal Studios, 464 US (1984) VCR, which enabled home copying of television programs.80 In Sony Corp. vs.

Universal Studios Inc., the Court found Sony not guilty of contributory copyright

infringement because the VCR had “significant non [copyright] infringing uses,” and that

recording a TV program for the purpose of “time shifting,” or viewing at a later time, was

permissible.81 Napster looked to draw parallels between its ‘New Artist Program’ and the

ruling in the Sony case. Napster argued that its ‘New Artist Program,’ in which music by

new artists was featured for download through permission granted from the artist, amounted to a potential “non-infringing use of importance,” just as the VCR presented a

“non-infringing use of importance” by allowing users to record a TV program for later viewing.82

In a written opinion of the Court issued on August 10th of 2000, Judge Patel found

that the plaintiff record companies had shown a substantial probability of success on the

merits at trial which proved that Napster facilitated contributory and vicarious copyright

infringement and granted an injunction against Napster. Judge Patel rejected the whole

of Napster’s defense. In regards to the defense based upon the decision in RIAA vs.

Diamond Multimedia Systems, Patel ruled that the uploading and downloading of MP3

files between anonymous users facilitated by Napster did not constitute “non-commercial

use.”83 In response to Napster’s reliance on Sony Corp. vs. Universal Studios Inc., Judge

Patel found that Napster’s New Artist Program accounted for such a small portion of the

MP3 traffic on the Napster network that it could not be proven that it constituted an

80 Anestopulou, 2001, pp. 325 81 Anestopoulou, 2001, pp. 325 82 Anestopoulou, 2001, pp. 325 83 Anestopoulou, 2001, pp. 325 important non-infringing use.84 In summation, Judge Patel found that Napster users were

involved in substantial copyright infringement and that Napster did not have the means

by which to control and disable the activities that constituted copyright infringement.85

To the dismay of many a music fan, Judge Patel’s rulings effectively shut down Napster’s

service.

The Law Gets Involved: My.MP3.com’s Dealings in Court

My.MP3.com was also not immune to the long arm of the law. On January 21st,

2000, a group of record companies, led by Universal Music Group’s UMG Recordings

Inc., filed suit against My.MP3.com seeking “injunctive relief and statutory damages of

$150,000 per song infringed.”86 My.MP3.com claimed that it had, in fact, not violated

any type of copyright law due to the fact that they required users to either provide proof

of prior ownership of every song they streamed, or required the user to purchase the CD

if they did not already own it. According to the provisions of Section 106 of the U.S.

right to any type of reproduction of their copyrighted musical recordings, as well as the

exclusive right to authorize any third party to make a reproduction.87 Based upon these

laws, the consortium of record companies pursuing the lawsuit claimed that they had

never granted My.MP3.com any type of permission to make reproductions of their

copyrighted recordings. Therefore, MP3.com’s act of ripping the CD’s into MP3 format,

84 Anestopoulou, 2001, pp. 325 85 Anestopoulou, 2001, pp. 326 86 Anestopoulou, 2001, pp. 322 87 Library of Congress, 2000 as well as the act of storing the MP3’s on their central server, amounted to copyright

infringement under the 1976 Copyright Act.

The defense centered on the idea that the service provided by My.MP3.com was

an innovative technology that allowed users to listen to music that they already owned.

Thus, the use of the streaming and storage technologies made available by My.MP3.com

merely allowed users to exercise their fair use rights. From the Copyright Law in the

United States section of this work, it was noted that the fair use doctrine allowed for

“personal copying for convenience, provided that the copy does not take the place of a purchased copy from the copyright holder.”88 On May 4th of 2000, Judge Jed S. Rakoff

of the District Court of New York issued a written opinion, stating that the unauthorized online distribution of music by My.MP3.com “did not qualify as either storing or making a fair use of copyrighted recordings.”89 Judge Rakoff found that “[The] defendant’s

infringement of plaintiff’s copyright is clear. [MP3.com had] without authorization,

copied [plaintiff’s] recordings onto its computer servers so as to be able to replay the

recordings for its subscribers.”90 91 Judge Rakoff applied the four factors of fair use

analysis in the My.MP3.com proceedings, and found MP3.com to be in violation of all four factors. Rakoff found that the use of the copyrighted works was in fact for commercial purposes, that the nature of the work copied was the “whole of the

88 Landau, 2002, pp. 153 89 Lewine, 2000, pp. 54 90 Anestopoulou, 2001, pp. 323 91 Lewine, 2000, pp. 54 recordings,” and that the defendant had no right to appropriate a further market that

derives from the reproduction of the plaintiff’s copyrighted work.92

Following the issue of this opinion, MP3.com settled with all of the plaintiff record companies except for Universal Music Group, which pursued damages. Universal

originally requested $150,000 per song infringed, but ended up settling for $25,000 per

CD infringed.93

The RIAA Pushes On: Taking the Law to Individual Users

After the major labels and the RIAA tasted success in their cases against Napster

and My.MP3.com, they carried their vigilantism further, bringing lawsuits against

individual users of illegal file sharing technology. The first people to feel the pressure of

the RIAA were students that were found to be operators of “Napster-like internal campus

networks” that were used to illegally distribute millions of copyrighted songs, according

to the RIAA.94 In the formal complaints, filed April 3rd, 2003 in U.S. District Court, the

RIAA alleged that four students at three different universities were operating p2p networks that allowed for widespread copyright infringement. The only difference was that instead of being available to anyone on the Internet, these programs, know as Flatlan,

Phynd and Direct Connect, were only available on specific college’s internal campus local area networks.95 The four students, who attended school at Rensselaer Polytechnic

Institute, Princeton and Michigan Technological University, all faced fines of up to

92 Anestopoulou, 2001, pp. 323 93 Anestopoulou, 2001, pp. 323 94 Holland, 2003, pp. 7 95 Holland 2003, pp. 7 $150,000 per song infringed. Considering the fact that some of these programs facilitated

the movement of up to 80,000 songs a day, the fines were in the billion dollar range.96

By no means did the RIAA expect these students to pony up over a billion dollars, which

would have been impossible. Rather, they were attempting to make a statement to the

public that file sharing is a very serious legal issue, and will be treated as such. In the

end, each of the four students settled with the RIAA for amounts ranging from $12,000 to

$17,500.97 Although the RIAA and major record labels made a point by conducting these lawsuits, it gave them a considerable amount of bad press. Suddenly, people started to become very wary of file sharing. The RIAA loomed like a giant watchdog, boasting that it would find the names of thousands of file sharers and bring them to justice. And it made good on this promise.

In September of 2003, the RIAA forced various Internet Service Providers to hand over the names of customers that were known to be sharing large libraries of MP3 files for others to download. Initially, 261 lawsuits were filed against online music pirates.98 In addition, the RIAA granted amnesty to those who promised to erase their illicit music files and promised never to share copyrighted music again.99 However, the

same people that were sharing files were the music industry’s customer base. The problem was that file sharing had turned them off to paying for music in retail outlets, since music was now available for free. The RIAA and record labels initially believed that the solution to file sharing would be lawsuits. If they could scare people away from

96 Knopper, 2003, pp. 15 97 Knopper, 2003, pp. 15 98 Lohr, 2003, pp.C1 99 Lohr, 2003, pp.C1 file sharing, maybe they could scare them right back into the music retailers. However, lawsuits are not the solution. The answer to the music industry’s woes lies in the development of a new business model, one that takes into account the digital revolution.

The next logical step is to examine the business model of the music industry, such that we may see where there is room for improvement, and what the future may hold for an industry that has proved itself to be sorely out of date. Changing the Business Model: The Challenges Facing the Music Industry

“The person who gets the farthest is generally the one who is willing to do and dare. The surething boat never gets far from shore.”

-Dale Carnegie

Unfortunately for the major record labels, the file sharing phenomenon is a two

front war. We have already examined the legal side, in which record executives are fighting a battle to prosecute those that they see as major threats to their business,

whether they are companies, such as Napster and My.MP3.com, or people, such as those

that were sued for their publicly accessible music libraries. Now we will examine the

other front of the war, in which record labels are fighting to find a way in which to

reconfigure their business model so that it comes into step with the digital revolution.

Obviously, the traditional methods of music distribution, such as selling in retail outlets,

have taken a major hit since the explosion of file-sharing and digital encoding. Major

label sales were down 13.8% in 2003 as compared to 2002.100 In addition, various economic factors have led to the music industry slump. According to Forrester Research, the recent economic recession and surging sales of both DVD’s and video games have led to a substantial decrease in the amount of music purchased through retail outlets.101 Also, the masses have shown what they want through their online behavior. According to

Websense Consultancy, there were 130 unique p2p applications and 89,000 web pages

100 Copeland, 2004, pp. 48 101 Kapica, 2004 devoted to music sharing at the beginning of 2003.102 In light of these factors, the question has essentially become “How do you sell a product that everyone is getting for free”? The answer appears to be radical innovation. The last five years have provided the music industry with a much needed wake up call that has forced them to completely rethink the way they conduct their business, and it has proven that only the innovators will survive.

Issues to be Considered in the New Business Model

The single biggest change that must take place in how the record labels conduct their business is a shift in how they allocate their resources, specifically money. Before the advent of file-sharing, packaging, design, and promotion for each and every CD released represented a substantial investment. However, selling actual products in brick and mortar retail outlets is quickly becoming a thing of the past, as digital music revenues continue to soar. This forces the record labels to rethink whether or not packaging and promotion are as essential as they used to be. Instead, more consideration must be given to the distribution channels, which have moved from a physical channel to a digital channel. This aspect will be examined later via an in depth assessment of the digital music store services. However, there are many other facets that must be considered.

In terms of where money is spent, it would be wise for the music industry to spend some in conducting an objective examination of how the Internet has enabled

102 Jordan, 2003, pp. 6 groups of people to behave.103 The industry must examine usage patterns and purchase

habits in order to effectively understand the tastes and desires of the modern music

consumer. An example of the changing trends in consumer behavior is that unlike movies, video games and Internet surfing, which are foreground activities, music is

increasingly viewed as a background activity.104 Listeners want music that is easily

accessible no matter where they are, and the best way to provide that experience is

through digitization and portability of music. The labels need to find a viable way to

deliver music that can be seamlessly transported and played on different platforms in

different locations.

Another aspect of the old business model that must be reworked is the conception that consumer’s desire increasingly improved audio quality. This is evidenced by the release of multiple different formats of audio in the last ten years, including HDCD’s,

XRCD’s, Minidiscs, and most recently Super Audio CD’s and DVD-Audio.105 In

response to these releases, many consumers asked themselves why they would ever want

to repurchase their music library on a format that, to the average consumer, provided no

discernable increase in audio quality. What the labels failed to realize is that more than

improved quality, consumers want control.106 In short, users want to customize their

listening experience and make their own mixes and compilations, and this is an area in

which major label offerings are sorely lacking. Music fans are increasingly wondering

why they need to spend $12 to $15 for a CD, when all they really want is one or two

103 Jordan, 2003, pp. 10 104 Jordan, 2003, pp. 6 105 Jordan, 2003, pp. 7 106 Jordan, 2003, pp. 10 songs. Many new releases by artists today are fueled by a couple of radio hits, while the

rest of the CD is seen as filler. Users have a strong desire to have complete control over

the content of their music library, and have no wish to pay for songs that they see as

inadequate.

These are just a few of the numerous issues that are forcing the music industry to rethink its business model. The imperative realization that the music industry must face is that the Internet is an ally, not a foe. According to publisher Tim O’Reilly, who has built a successful and technical book business about open source software, “obscurity is a far worse danger to a content business than piracy.”107 If used imaginatively, the Internet could potentially drive music sales to unprecedented heights. The goal of the industry must be to create a perception of value and then charge to deliver it. In doing so, budgets must be refigured to take into account the new business model. One such example is the

Naxos classical label. The label is devoted to its music, yet still sells CD’s at $6 to $8 retail. In order to accomplish this, the label refuses to pay artists large advances, forgoes point-of-sale displays and fancy cover art, and keeps production costs to a minimum.108

This model has worked, as Naxos has taken over anywhere from 15-60% of the classical music sales in various countries.109

Currently, there are two major ways that record labels have shifted their business

practices in order to adopt to the changing marketplace. These two approaches include

the creation of the digital music store and the addition of supplemental materials to

107 Jordan, 2003, pp. 9 108 Jordan, 2003, pp. 11 109 Jordan, 2003, pp. 11 traditional CD packaging, which is used as a tactic to tempt consumers to continue to

purchase traditional CD’s in retail outlets.

The Digital Music Store: iTunes and Napster 2.0

In 2003, digital music sales created $77 million in revenues. According to Jupiter

Research, this number is expected to skyrocket to $1.6 billion by 2006.110 In addition, it is estimated that digital music piracy cost the record labels approximately $700 million in lost CD sales in 2003. With respect to these numbers, it appears that there is unparalleled potential for digital music stores, and the number of entrants to this market has surged in the past couple of years.

One of the first companies to truly embrace the fact that the new face of the record industry would be digital was, in fact, not even a record company. It was Apple

Computers, the makers of personal and business computing products. Apple’s plunge into the digital-music revolution began two years ago with the introduction of the iPod portable MP3 player. Then, in April of 2003, Apple introduced the digital jukebox that was meant to pair up with the iPod, the iTunes Music Store. iTunes was first released for

Macs, and the in October of 2003 for Windows based PC’s. The results have been amazing. As of April 1st, 2004, Apple had registered 50 million songs downloaded at a

cost of 99 cents apiece111, nearly a million and a half iPod’s sold, and aggressive

promotional deals signed with both AOL and Pepsi.112 The man behind the music is the

110 http://www.jupiterresearch.com/xp/jmm/press/2002/pr_011502.html 111 http://www.apple.com/itunes/ 112 Goodell, 2003, pp. 32 CEO of Apple, Steve Jobs, who has been the driving force behind Apple computers since it first introduced the Apple I computer in April of 1976. Jobs is considered by many

Silicon Valley experts to be a literal genius, a man who not only understands the tech business like no other, but is also consistently ahead of the curve.

In an interview in the January 8th, 2004 edition of Rolling Stone magazine, Jobs sat down with columnist Jeff Goodell to discuss the changing face of the music industry.

Jobs was quoted,

“There are a lot of smart people at the music companies. The problem is they’re not technology people . . . When the Internet came along and Napster came along, people in the music business didn’t know what to make of the changes. A lot of these folks didn’t use computers, weren’t on e-mail – didn’t really know what Napster was for a few years.”113

This statement reflects the sentiments of many that are involved in the music industry. Many feel that one of the major setbacks of the record labels is that they are extremely slow to innovate and adapt to new technology. It literally came down to the fact that millions of people were “stealing” copyrighted music before the record labels could see that they were facing something bigger than themselves. Some argue that the record industry could not have foreseen the creation of file sharing networks such as

Napster. However, this argument bears little weight given the fact that thousands of other retailers already offered their products for purchase online before the creation of file sharing networks. So why did it take a legal disaster for the recording industry to see the light? The answer to this is reflected in the ideas put forth by Jobs. The record industry execs were simply stuck in their ways and were extremely slow to catch the “digital

113 Goodell, 2003, pp. 32 train;” whereas savvy consumers were one step ahead of the curve. Thus, the problem for the music industry has become how they can provide a way for people to get the music they crave without breaking the law. According to Jobs,

“Eighty percent of the people stealing music online don’t really want to be thieves. But that is such a compelling way to get music. It’s instant gratification . . . but to tell them they should stop being thieves – without a legal alternative that offers these same benefits – rings hollow. We said, ‘We don’t see how you convince people to stop being thieves unless you can offer them a carrot – not just a stick.’ And the carrot is: we’re going to offer you a better experience . . . and it’s only gonna cost you a dollar a song.”114

Apple is moving full steam ahead into the realm of digital music, and it appears obvious that all the major players in the music business are going to be forced to follow suit. So what does the future of music hold? The business opportunities appear endless as the record labels continually search for innovative ways to guard their profit margins.

While not all forays into the digital marketplace have proven to be as successful as Apple and iTunes, various entrants have embraced the burgeoning distribution model that is the

Internet.

One such entrant is the reincarnation of the original Napster. After Napster lost the lawsuit brought against them by the RIAA, music industry giant Bertelsmann, owner of the BMG music label, purchased the rights to the brand, figuring that it could turn the infamous Napster logo into a cash cow.115 However this endeavor failed for a variety of reasons, the foremost being that only a handful of recording artists would license their music for use on the new pay-for-play download service. After declaring bankruptcy,

Napster was sold off by Bertelsmann to PC software maker Roxio, best know for their

114 Goodell, 2003, pp. 32 115 Burrows, 2004 Easy CD Creator software. Last October, Roxio released Napster 2.0, which Roxio CEO

Christopher Gorog felt had the potential to not only be just as influential as the original

Napster program was, but also compete with Apple’s iTunes. So far, things have not

worked out quite as planned. Since Napster 2.0’s launch in October, Roxio’s stock has fallen from $10.80 a share to $4.48 as of April 20th, 2004.116 Napster 2.0 has also failed

to match up against iTunes, which sells 75% of the 3 million songs legally downloaded each week.117 However, according to Neilsen Soundscan, Napster 2.0 is steadily holding

on to the number two position in relation to iTunes.118 As for the future, executives at

Roxio are looking to form contracts with colleges and universities whereby the Napster

service would be provided to students free of charge, with the university footing the bill.

School’s such as Penn State University and the University of Rochester’s Eastman

School of Music will serve as pilots for this program, which looks to wean students off illegal file sharing.119

Although Napster 2.0 seems poised to create profitable business deals in the

future, it currently is not making any money, and Roxio “doesn’t expect to see profits any

time soon.”120 Various factors explain why the Napster reincarnation is not as lucrative

as once expected. For one, Napster 2.0 offers two services. One is a monthly

subscription, that for $9.99 a month allows users to stream music over their computer.

The problem with this is that the user never actually downloads any music onto a hard

drive, and in turn, never takes ownership of the music so that they can burn it to CD. The

116 Burrows, 2004 117 Burrows, 2004 118 Burrows, 2004 119 Burrows, 2004 120 Burrows, 2004 other service offered by Napster is a download service similar to that of iTunes, in which the user pays 99 cents to have unlimited access to a downloaded song. The problem lies in the fact that Napster has failed to identify themselves as either a streaming service or a download service within a marketplace that is becoming increasingly competitive. If users want to download songs, they will turn to iTunes. In addition, numerous users frown upon the idea of paying a monthly fee for a streaming service that does not allow downloads. Again, Steve Jobs, CEO of Apple, correctly predicted consumer behavior in his Rolling Stone interview. He says, “[Apple] told [the record industry] the music subscription services they were pushing were gonna fail. Here’s why: People don’t want to buy their music as a subscription. They bought 45’s, then they bought LP’s, they bought cassettes, then they bought 8-tracks, then they bought CD’s. They’re going to want to buy downloads.”121 In order to succeed, Napster must define itself by the products it offers instead of offering both streaming and downloads. According to

Business Week Online, Napster’s initial marketing efforts have been misguided, focusing on spots that tout the cat with headphones logo rather than the products and services

Napster 2.0 offers.122

In addition to Apple’s iTunes and Napster 2.0, there are multiple other file sharing networks that offer downloadable music for a fee. Musicmatch and Rhapsody are two services similar to iTunes and Napster 2.0, and websites such as bestbuy.com and even walmart.com offer thousands of different songs for download. However, these services, along with hundreds of other similar offerings, account for only a very small percentage

121 Goodell, 2003, pp. 32 122 Burrows, 2004 of legally downloaded music. iTunes and Napster 2.0 are far and away the two biggest

players in the digital music store arena, with iTunes dwarfing Napster by a considerable

degree.

The Bundling Approach: Making CD’s More Attractive

The second major way in which the record labels have begun to alter their

business model can be seen in the extra materials that are starting to be bundled with

traditional CD’s. Before file sharing, consumers purchased CD’s because it was the only

available option for obtaining ownership of music. As previously discussed, CD sales

have sharply declined in the past few years, in part because those who previously

purchased music no longer felt the need once it became free. In order to entice

consumers to return to purchasing CD’s, many record labels have begun to package their

new releases with bonus materials, including DVD’s, documentaries, bonus songs, playing cards, and interactive CD-ROMS’s.

An example of a record label that has embraced this business approach is TVT

Records, headed by CEO Steve Gottlieb. As major label sales have been steadily declining, TVT increased its sales by 53% between 2002 and 2003, and had revenues approaching $75 million in 2003.123 The reason TVT has been able to survive, according

to Gottlieb, is because “[I] anticipated in the late 1990’s what the digitization of music

was going to do to [my] business – and created a business model that can produce sales

123 Copeland, 2004, pp. 48 even when music is being given away for free.”124 TVT Records continues to thrive

because they focus their efforts on making the purchase of a CD at a retail outlet a better

value proposition than downloading the music for free. This is done by including better packaging, extensive liner notes and artwork, as well as bonus content in the form of special DVD footage, access to online material or bonus tracks.125 The way that Gottlieb

sees it, bundling extra materials with a CD makes the appeal of the artists more personal, and thus creates a desire within the consumer to forge a connection with the artist.

For the time being, the bundling approach seems to be working. In late 2003, the top six spots on Billboards top 200 albums were held by artists that included bonus

materials with their music.126 As more and more record labels have begun to bundle

extra materials with the music, it has become clear that price is no longer a selling point

or point of competition for CDs. Obviously, if a consumer decides to buy a CD, they

have decided to forgo downloading the album, whether they were going to pay for it or

download it for free. The reason they are buying the album is because of the added

materials that become available through the purchase of the actual CD. Peter Fader, a professor of marketing at the University of Pennsylvania’s Wharton School of Business, addresses this in an article in the New York Times. He is quoted, “Labels will survive the downturn better by emphasizing value with add-ons rather than stressing price as a

consumers’ main consideration.”127

124 Copeland, 2004, pp. 48 125 Copeland, 2004, pp. 48 126 Nelson, 2003 127 Nelson, 2003 The task of bringing consumers back to their old purchasing habits does not fall

squarely on the shoulders of the record labels. According to Jerry Goolsby, a marketing

professor who studies the music industry at Loyola University in New Orleans, retailers

share an equal amount of the responsibility.128 Just as many bookstores have turned

themselves into coffeehouses and meeting places, music stores must reinvent themselves

to adapt to changing nature of the music industry and record buying experience. An

example of a store that has done just this is Sonic Boom Records, an independent new and used music chain in the Seattle area. Sonic Boom has succeeded during the industry slump because they have instilled within their outlets a sense of community between customers and employees.129 Sonic Boom is staffed by people who are passionate about music and love to talk to the customers. In addition, the company plays host to a Sonic

Boom Band Night at a local tavern, showcasing employees who perform their own music.

An Ongoing Battle

Obviously, there is no one simple solution to the music industry’s woes. As the digital marketplace continues to expand, new business opportunities pop up at a breakneck pace. One only need open the newspaper on any given day to see that the file sharing controversy is one that continues to make news on a regular basis. In order to thrive, the music industry must listen to its most valuable asset: its customers. The only way through which the music industry will return to where it once was is by realizing that

128 Nelson, 2003 129 Nelson, 2003 many radical changes have taken place, and ultimately, the consumers will determine

where the industry goes in the future.

Interestingly, there are many different sides that share a voice in the debate over

file sharing. So far, an examination of the main stream, highly visible problems and

solutions has been conducted. However, in order to see the whole picture in any

argument, it is always important to examine the opinion of all those who are involved. A

recent study suggests that the record labels have been misrepresenting file sharing all along, and that its effects on the music industry are not nearly as bad as reported. Alternative Viewpoints and Research About File Sharing

“Warning! Buying this CD funds lawsuits against children and families”

-Sticker placed on thousands of CD’s in major retail outlets by activists of pro file sharing website downhillbattle.org

In any heated cultural dispute, there are always two viewpoints that must be

considered. Up to this point, I have examined file sharing from the perspective of the

record labels and music industry, looking at how file sharing has hurt sales and affected

their business model, and how that business model can be changed in order to incorporate

legal file sharing as a means of distribution. However, there are many experts who hold

an entirely different perspective on file sharing, and believe that it has not substantially

affected major label sales. In concluding this thesis, it proves essential to scrutinize these

views, and assess their importance as it relates to the file sharing debate.

A Quantitative Approach to Why the Music Industry is Wrong

On March 29th, 2004, an explosive report was released by two researchers at the

Harvard Business School and the University of North Carolina. The study, conducted by

Associate Professor Felix Oberholzer-Gee of Harvard Business School in Boston and

Professor Koleman Strumpf of the University of North Carolina, Chapel Hill, concluded

that file sharing had no effect on the sale of popular CDs in the second half of 2002.130 It is important to note that the study was the first of its kind in that it uses data from file

130 Harvard Business School, 2004 sharing servers, where the authors directly observed 1.75 million downloads during 17 weeks in the fall of 2002.131 This is in contrast to previous file sharing studies that have been conducted via surveys, which is seen as problematic because it is impossible to judge whether the respondents are answering the survey questions about illegal activity truthfully.

During the study, over three million users shared 500 million files on the Kazaa file sharing network, similar to the original Napster network. The professors found that most people who were sharing files appeared to be individuals who would not have bought the album regardless of their downloading habits. Furthermore, the authors conducted a worst case scenario and found that it would take nearly 5,000 illegal downloads to reduce music industry sales by a single CD.132 If the worst case scenario proved to be true, then industry sales would have declined by 2 million units as a result of illegal file sharing in 2002. However, CD sales actually declined by over 139 million units in this period, pointing to the conclusion that file sharing had only a marginal affect on CD sales.133

The study presents other surprising conclusions on the effect of file sharing as well. For one, the study found that the most popular CD’s actually benefit from file sharing. For the top 25 percent of albums (with sales of more than 600,000 copies) the study found a surprisingly positive effect: 150 downloads increased album sales by one copy.134 This was concluded to be a particularly important finding in that the success of

131 Harvard Business School, 2004 132 Harvard Business School, 2004 133 Harvard Business School, 2004 134 Harvard Business School, 2004 the music industry relies heavily on the sales of the most popular albums. Another one of their findings concluded that file sharers as a whole only download a small selection of songs. In the study, the researchers tracked 680 popular albums, all of which held a spot on a Billboard chart sometime during the fall of 2002. Although the albums studied did well commercially, selling an average of 150,000 copies, over 50 percent of the songs on the albums were never downloaded. Furthermore, 75 percent of the songs were downloaded two times or less, and 90 percent were downloaded fewer than eleven times.135 These findings support my earlier argument that consumers have a strong desire to control the content of their musical library. Customers feel ripped off when they are forced to pay upwards of $15 for a CD, when all they really want is access to one or two songs on the release.

Alienated Consumers and Outspoken Artists

This study is not the only opposing viewpoint to vocalize the idea that file sharing may really may not be hurting the music industry as once believed. A simple web search on Google brings up hundreds of websites that strongly advocate file sharing and point their finger at the music industry as the party that is guilty of being thieves. In an essay entitled Civil Disobedience on the website p2p.net, an anonymous author takes a shot at the music industry. The thoughts of the essay underlie the way that the typical consumer feels in response to the business tactics of the music industry. One section of the essay reads,

135 Harvard Business School, 2004 “On the same record store shelf, stacks of 30 cent blank CDs sit next to the record companies' $16 jewel cases. And if it costs a regular person 30 cents to make a perfect copy on their home computer, imagine how little it costs when you own a factory. Even if you've never burned a CD in your life, you feel like an idiot paying $16 for CD when you know you don't have to anymore. Furthermore, people know a lot more these days about how the music industry works-- at least they understand that not much of the $16 ends up in musician's hands. . . So why does anyone expect fans to pay $16 to an industry that exploits musicians when they have a better option? It comes down to a basic American sense of fairness. People want a fair deal when they buy music and they want to know that they're supporting artists, not executive salaries. That's what makes copying music a principled decision, not a selfish one. It's so simple that for most people it just comes out as "I can't bring myself to pay $16 if I can copy it."136

These sentiments sum up the motives behind file sharing. This is only one example

of the countless tirades against the music industry that plaster hundreds of different

websites. Another site that offers a heretical view of file sharing is downhillbattle.org. On their site, they feature quotes from those who are being sued by the RIAA and major record labels. One quote, from a mother of three reads, “I am

in favor of copyright laws, but this is a little like taking a sledge hammer to an ant on

the sidewalk.”137 The rest of the quotes speak in the same vein, pointing to the music industry as an overreacting behemoth that felt threatened and confused by file sharing technology. In addition, the website features quotes from musical artists who are vocal in their criticism of the music industry. This might seem surprising, given that the record labels claim that the lawsuits are being conducted with the artist’s best interests in mind. David Draiman, of the hard rock band Disturbed, sounds off, saying “This is not rocket science. Instead of spending all this money litigating against kids who are the people they're trying to sell things to in the first place, they

136 http://www.downhillbattle.org/civil.html 137 http://www.downhillbattle.org/defense/details/quotes.shtml have to learn how to effectively use the Internet."138 Other artists weigh in as well.

Internationally recognized DJ Moby is quoted, “File sharing is a reality, and it would

seem that the labels would do well to learn how to incorporate it into their business

models somehow. Record companies suing 12-year-old girls for file sharing is kind

of like horse-and-buggy operators suing Henry Ford."139

The most poignant quote offered on the website comes from Disturbed’s

Draiman, whose bands album is currently double platinum. He says, “"The focus of the industry needs to shift from Soundscan numbers to downloads. It's the way of the

future. You can smell it coming. Stop fighting it, because you can't."140

Conclusion: File Sharing is the Future

The above quote is the point I wish to drive home. File sharing is the way of

the future. Music changes, business changes, people change. That is how the world

works. The music industry is slowly realizing that they are fighting a losing battle,

and that in order to win, they must change the model of their business. The demand

of the consumer’s points in one direction, and that direction is towards the Internet

and file sharing. Hopefully, the music industry and file sharing will soon be able to

coexist in a relationship that proves to be both profitable for the artists and affordable

and convenient for the consumers. Until that point is reached, however, the future of

the music industry still seems uncertain, and only time will tell what the future holds.

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