What Filesharing Studies Really Say: Part 19 – Biggest Threat to the Recording Industry? The Recording Industry

this is part 19 of the re-publication of my meta-analysis on what filesharing studies really say.

[Originally published on ZeroPaid on May of 2012.]

This is it. We’ve reached the end of our long series of what the file-sharing studies are really saying. This series started out strong and is going to end strong. The last study we will be looking at in this review looks in to file-sharing and wound up concluding that the biggest threat to the recording industry isn’t really the people who are downloading their material, but rather, the recoding industry itself.

If the recording industry has sustained heavy wounds in the battle against file-sharing, could they be mostly self-inflicted wounds? Many critics of the industry have said in numerous times that some of the recording industries actions was merely an exercise of shooting themselves in the foot. I would argue that the argument that recording industry is shooting themselves in the foot has become a cliche these days. For those who have said this for years, we know that there is a study to back these arguments up too.

The study is called “The Music Market in the Age of Download”. It was published in 2007 by the Italian journal “Fondazione Eni Enrico Mattei”.

A portion of the summary of this study lays out what the study was hoping to find:

In this paper I present a theoretical model, that investigates the consequences of the appearance of a pirate low quality good (typically a mp3 file) in the music market. In this paper I propose a model of sampling, consider the possibility that the firm modifies its business entering into the low quality segment and investigate the supposed conflict between the recording company, whose profit depends on the CD sold, and the artist, whose profits depend in part on the live performance, the demand of which can increase for the positive externality due to the illegal download of music.

This is yet another study that points out that there is a positive force for music sales thanks to file-sharing.

The study begins with a review of events of file-sharing in Italy. One note of interest was the following:

In 1999 the term file sharing itself was unknown to most people; in 2001 Michael Greene, then president of the National Academy of Recording Arts and Sciences, declared “The most insidious virus in our midst is the illegal downloading of music on the Net”

You could go for several paragraphs citing quotes from various entertainment industries throughout the years decrying certain kinds of technology that later wound up being common place (and the industry ultimately profited off of finally adopting the technology). This kind of quote is nothing really new, but does add to that long list of quotes from entertainment people decrying technology.

The study decided to break the research down in two parts, describing it all like this:

Surprisingly the increasing economic theoretical literature that in last years has analyzed the file-sharing and piracy problem, has ignored how the strategy and the profit of the forms can change, if the monopolist itself enters the low quality market. The second part of this paper fills this gap, investigating whether the form can react the piracy entering in the new market, and when this strategy can increase the form profits compared both with a no-copying world and the case it decides not to enter the new market.

The study went on to review, like numerous other studies before, previous cases of file-sharing and related history. It also reviewed the market of entertainment in the Italian market from 1995 – 2005. It then reviewed number of internet users and broadband penetration in Italy.

Next, the study starts playing with various mathematical models. The first model presumed a no-copying world:

In this section I propose a theoretical model of file-sharing piracy. Although the market I refer to is the music market, such model is generalizable and able to explain the consequences of the appearance of a pirate substitute of different quality in any market where an original good produced under copyright protection.

Next, it looked at a model that presumed copying does exist:

The no-copying assumption reflects the technological constrains existing in the music market until the mid 90s. Such constrains have been dramatically removed by the vast diffusion of re-production technologies (such as cd recorders), peer-to-peer distribution software on the internet and, in the case of the recording industry, mp3 music files.

The next calculation involved the following:

From now on we assume that there are always buyers both of the original good (the cd) , and the copy (the mp3 file)9. In such a case two marginal consumers exists: the consumer i indifferent between the cd and the mp3 file, and the consumer j indifferent between the mp3 file and nothing.

After that, the study looked at the world of sampling:

The entrance in the market of a competitor producing an illegal substitute good, violating the copyright, causes a decrease of the profits of the firm, that is directly proportional to the substitutability between the original good and the copy ([character that can’t be copied]).

Nevertheless file-sharing advocates sustain that the profit or recording companies might not decrease, but even increase, because file-sharing would be used just to sample between artists. According to them, after such a sampling the consumers would purchase the favorite cds, and the market might be enlarged. In the next paragraph I analyze such an hypothesis, proposing a model of sampling.

So, the study then proposed another mathematical model with a sampling effect in place:

In the previous paragraph I have considered a simple monopoly pricing problem with piracy. In this section I propose a theoretical model of sampling extending the analysis to an intertemporal framework with two periods in order to point out under which conditions the sample effect, i.e. the supposed increase in the demand of the music market due to the possibility to test music with the mp3 files, do matter for the strategy and the pro¯ts of the recording industry.

After the calculations were done, the study made the following findings:

According to my model, in the music market the file-sharing does not seem to guarantee a positive externality on the demand of cds big enough to compensate the substitution effect due to the mp3 files. Sample effect should increase the sales more than the existence of a free substitute decrease, and this seems to be improbable.

Such a situation might realize just with binding assumptions on the value of the parameters, or for some class of artist, for example the beginners, who might be advantaged by an increase in the fans, more than the lose in the sale damaged them. Moreover most of the pro¯ts of the beginners come from the live performance, rather than cd sales, hence the positive externality should be enlarged and the sample effect could plays a central role.

Nevertheless, in a world hyperconnected where anyone can be himself producer, recording companies and more in general publisher of any digital good, have to re-think their role and their business: in order not going bankrupt firms have to modify their strategy.

The study then commented on the major recording industry reacting to piracy at the beginning of the decade, describing it as, at best, hysterical. Nevertheless, the study did look at the music industry entering the market and suggests that there are ways of doing so (again, lots of math involved here).

I think what this study is finding here fits with some of the general wisdom I’ve heard from time to time around music and file-sharing. While it is possible for file-sharing to negatively impact an artist even with the sampling effect taken into account, those artists that are negatively impacted are generally the ones at the very top of the chain of popularity. One way of looking at this is that it has an equalizing effect in the music business for all artists – unknown artists have a better chance at being known while top artists might have some form of decline in their bottom line. So, it’s good news for the music industries version of the 99.9%.

The study makes a number of conclusions including the following:

In a digital world, where a good can reach the consumer without the intermediation of a publisher, there is little purpose for the traditional recording industry, nevertheless I show that the annihilation condition often cried out by the firms, i.e. a scenario where the pirated sector collapse going bankrupt, is never the equilibrium of the market, since the ¯rm can always enter itself the substitute segment producing a good (for example selling itself mp3 files), that is of higher quality with respect to the one presents in the market.

Finally I have investigated the relation between artists and recording company, the two main subjects on the supply side of the music industry, in this paper I show that the file sharing can undermine their contrast.

Further research should invest the complementarity between the digital good sector and other markets: if, on the one hand, the piracy has decreased the dimension of the music market, on the other hand industries that sold the machines used by the pirates have increased their business, and for example the market of the MP3 players has been invented from nothing. Probably the “big enemy” of the recording industry is not the final consumers, that occasionally can act as a pirate, but the industries that are cannibalizing music market profits.

I, for one, do agree with a lot of what the study is saying – especially the point that the music industry may be its own worst enemy. Since I follow these types of activity, I can see it on a somewhat regular basis where the major companies may have done more harm than good on themselves.

This is it! The last of our long-running series of what file-sharing studies really say! In the next segment of this series, we hope to put together some notes and post sources where one may find these studies more directly as well as provide a list of links to each part for easy bookmarking. We hope you were able to get something out of this series – or, at the very least, enjoyed it. As usual, feedback is always welcome and we appreciate any linking to this or any other story here. Feel free to share to the world!

Drew Wilson on Twitter: @icecube85 and Google+.

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