Debate on Downloading

Tuesday, February 08, 2005 | 09:37 AM

My friend Cody Willard is a hedge fund manager, focused on telecom and technology. He and I had an interesting public debate yesterday, on P2P, downloading and the music industry.

This was originally published on the (subscription only) RealMoney.com, but is reproduced here with permission. It got enough positive feedback that I thought Big Picture readers might find it intriguing. For your reading pleasure, Me vs. Cody. Enjoy!

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Cody WIllard  :   Piracy Steals Music Companies' Thunder
2/7/2005 1:23 PM EST

The effects of piracy on the economy and the world are just getting started. Music company EMI told investors today that it would miss sales projections for the year by about 9%. Trading in England, the stock took a huge hit on the news, wiping out billions of dollars of value.

Music content sales such as records, tapes and CDs have long trended with the broader economies. With global economies steadily growing the last couple of years, the music business should have been on fire. Alas, that is not the case, and the single biggest reason is piracy.

 

Guide PicksCody WIllard (Cont.):  Piracy Steals Music Companies' Thunder
 
Initially, the Recording Industry Association of America (RIAA) spent a long time with its head in the sand as the nefarious iteration of Napster (as opposed to today's legal iteration of Napster) began to undermine the entire industry's model. Then, about five or six years ago, the industry decided that it should fight the peer-to-peer (P2P) technologies like Napster that were enabling mass sharing of pirated copies of music. Napster's model was indeed illegal and eventually shut down. However, in a clear victory for both technology and freedom itself, the newer versions of P2P software aren't illegal because they simply enable people to freely trade data files without actually keeping track of what those files are.

It's not even really a fine line in my mind: If the technology provider, such as Napster, is knowingly assisting in the trading of files by keeping a centralized command of what files are being traded, it's illegal. But technology that simply enables blind trading of files isn't. After all, if Gnutella is liable for the illegal activities that users of its software partake in, shouldn't it follow that Microsoft (MSFT:Nasdaq - commentary - research) and Intel (INTC:Nasdaq - commentary - research) are, too? Heck, so is the power company and the telephone company. And the vendor of the glass in the monitor. Where does it stop?

Let's be clear, though: It's illegal -- and flat-out immoral -- to mass-trade copyrighted material. We all accept that stealing a CD from our local record store is wrong. So, too, is it wrong to steal the content in an MP3 file. Nothing drives me crazier than the hypocrites who say they favor free markets, but who rationalize the theft of music content. Free markets by their nature entail property rights, and music content is a form of property according to our law system. If you're illegally downloading music, stop now!

Likewise, I often hear and read the argument that illegal MP3 downloading actually drives sales. Even if that were true (which, as EMI's and the overall music industry's sales trends obviously show, is decidedly not), that doesn't make it your right to violate the rights of the content's owners. If they, in a free-will choice, decide that it makes financial sense for them to allow their music to be distributed in MP3 form for free, then go crazy and download. But that's simply not the case.

Other shills for content theft like to point to the parallels between the VCR and P2P. Certainly there are similarities, such as the content providers fighting against a technology that is enabling copying of their content. The piracy advocates like to point out what a boon VCR and eventually DVDs ended up becoming to the content owners. Those technologies absolutely did end up generating all kinds of sales of content in the form of video sales and rentals, and I would have blasted the industry for trying to shut down a technology enabler (such as I am doing here, blasting the industry for fighting the legal P2P network enablers), which they clearly didn't have the right to do. But just as making an MP3 copy of CDs that you have purchased isn't illegal today, it also wasn't illegal for people to record television shows. Those recorders didn't enable the mass distribution of that copied content, and that's where the parallels end.

The recording industry is in big trouble because a lot of folks have decided that content rights are meaningless. I applaud the industry for going after those stealing its wares -- whether it's a 12-year-old honor student or a grandmother of eight, who the media like to portray as the "victims" of these lawsuits. Simply put, theft is theft and the industry has a right to pursue those who are stealing it, regardless of age or social status.

I certainly hope there are unforeseen revenue streams that will arise out of the P2P networks that enable this mass theft and wealth destroyer that we are seeing play out before our eyes, embodied in EMI's blowup today. Music is the first to feel this squeeze, but you can rest assured that all content owners will be affected by these thefts in mass. Television and movie studios are next. Books, magazines, news -- all content will eventually be affected by this mass theft movement, and it's going to be ugly for these owners like Time Warner (TWX:NYSE - commentary - research), Sony (SNE:NYSE - commentary - research) and others unless the very ownership laws that our quasi-capitalistic economy is based on are enforced.

(On another note, how about we all work on vilifying this theft in a grass roots-type movement, too?)

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Barry Ritholtz:    A lot More to Copyright than Meets the Eye
2/7/2005 4:00 PM EST

You know, for two guys who are good friends, Cody and I disagree on a lot of things ... what the Unemployment Rate actually means, significant P2P issues and RIAA litigation are but a few areas where we are far, far apart. While there are plenty of issues in which we are sympatico, the music industry is certainly not one of them.

It's a complex issue, and people tend to grossly oversimplify it.

Cody doesn't address the issue of the near infinite extensions of copyright, a constitutionally unwarranted legislative act, a corruption of the framers' intent, and a large corporate giveaway at the public's expense.

There are many more issues -- why didn't the music industry explore digital distribution a decade ago? The short answer is that its retail distributors vehemently objected to it. So it did nothing, despite its clientele clamoring for a digital distribution channel. The marketplace hates a vacuum, so up popped Napster, Scour, Kazaa, Donkey, Bit Torrent and the rest.

While I don't condone file-sharing (I do use it to check out songs before buying CDs), I believe it is the industry's own fault. File-sharing came about due to horrible business management and decision-making by the industry. Consider for a moment that legitimate downloadable music wasn't truly available until less than two years ago. That's truly astounding.

Further, I believe the RIAA made a mistake selecting a show-horse approach -- making peer-to-peer its top priority. What it should have focused on, in my humble opinion, was counterfeiting. This would have been more of a workhorse strategy. According to the Industry's own studies 35% of all physical CDs are illegal copies. That's where I would have put the focus, had I been running the RIAA. Of course, that sort of enforcement is a long, hard slog, involving a lot of police work, private investigations and grind-'em-out type of IP enforcement. Not a lot of photo ops or headlines when you bust two guys in a garage in Singapore or a small Russian mobster.

Further, the industry was complicit in the 1996 telecommunications reform act, which enabled firms like Clear Channel (CCU:NYSE) to consolidate the industry and catch short-term profits -- but at the expense of their longer-term health. (For more on this, see Radio's Wounded Business Model)

People turned to P2P as a replacement for radio.

This is before we even get to the issue of price fixing scandal, which the industry gets caught doing on what seems like a regular basis. It recently paid a large fine as a settlement for its illegal behavior -- and even got caught cheating on that.

Then there's the larger issue of DRM, abusive copyright enforcement and more crimping innovation in the technology industry. There's an article on this very subject in today's New York Times, but I first addressed this issue here back in 2000.

There's a lot more to this issue than meets the eye.

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CW:  Barry and Downloading
2/7/2005 4:14 PM EST

Barry, you bring up some good points. However, I would first call attention to your saying that you don't "condone" file-sharing but that you do use it. I'm not sure how you rationalize utilizing something you don't condone.

On the same note, theft is theft. And you don't legally (or morally, IMHO) have the right to download songs you might or will or won't pay for in the future. The owners of that content assuredly have not contractually agreed to your stealing their content, even if you plan to pay for it later. Maybe you can go to your local record store and try that approach -- just sneak the CD out and come back later to pay for it.

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BR:    Condone This
2/7/2005 5:01 PM EST

I drink alcohol, eat fried foods and drive too fast. But I do not condone those activities by others.

Further, you are assuming that all P2P MP3s are illegal -- and that's a false statement. I believe the reason the major labels are against P2P is that it eliminates the need for a middleman -- them! The term is disintermediation. And the P2P networks threaten the labels. In one possible digital future, artists will sell their music to listeners directly.

iTunes offers a partial solution to the problem of not hearing new music on the radio by allowing you to hear 15 or 30 seconds of a song before you buy it. But that's not really a satisfactory solution.

Lastly, definition of theft is incorrect. Theft requires an intent to convert someone else's private property into your own, depriving them of the quiet enjoyment of it. If you think I am guilty of anything, it's probably an unlicensed use -- not theft. This is a civil and not a criminal offense.

Sorry, but that's the lawyer in me being precise with legal terminology.

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CW:  Parallels and Convolutions
2/7/2005 5:19 PM EST

Barry, I think you must be saying that you neither condone nor condemn illegal downloading by others. I think it's important that we do condemn theft of property.

To your point about downloading not always being illegal, I am certainly not assuming that is the case. I myself have written and recorded dozens of songs and could easily make them available for free. That would be my own choice as sole owner of that content -- I'm not exactly signed by EMI (yet, LOL). But the mass of P2P downloaders most assuredly have no idea if they're downloading legal content or not, and the mass of copyrighted material being downloaded is indeed being downloaded illegally.

iTunes is likely a new middleman, in this disintermediation. Again, most assuredly that is the case, as I've said repeatedly in these pages.

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An Overview of the Music Industry's Problems
2/8/2005 4:09 PM EST

I expect we will be continuing this debate in the months to come . . .

 

In response to Cody's missive, I felt an obligation to set the clarify the matter a bit -- set the record straight, so to speak. I would rather engage in intelligent discussion than allow this discussion to devolve further (J'accuse!). Since this is an investor site, rather than one dedicated to moral evaluations, let's explore some questions that are of great significance to investors in the Music/Technology/Radio complex of companies that are so affected by these issues:

1. Sales in every type of "Old Media" have suffered as consumers discovered newer forms of digital entertainment. Primetime television viewing is down, ratings for many sports events are significantly off, Movie theatre attendance is lower, Newspaper circulation has declined, magazine sales have slowed, radio station listenership is way down, and of course, CD sales are lower.

On the other hand, DVD sales have been booming, VideoGames sales continue to set new records, the internet keeps growing exponentially, Blogs are stealing the thunder from print, Radio execs are panicking - not over satellite radio, but over Apple's iPod, which has become the new radio.

2. The music industry fought against legal downloadable music for years. They eventually acquiesced to Apple's (AAPL) desire to make music easily downloadable in their iTunes Music Store, but this was only after years and years of ignoring obvious market demand. Those intervening years allowed a thriving P2P mindset to develop. 

Question: Which rocket scientists were responsible for this grievous error in business judgment? Have they been fired yet? If not, why?

3. There was an opportunity to co-opt Napster (NAPS) before it was litigated into non-existence, only to be subsequently purchased in bankruptcy for its brand name. That was an historic missed opportunity. Was this ever explored by industry execs? Shall we just instead chalk up yet another business poor decision to the same brain trust?

4. The music industry's love affair with insipid boy bands certainly hurt sales. A parade of mediocre talent - some who can barely sing, others who can't even be bothered to fake it - also led to weakened sales. I wonder: How much of the industry's problems merely reflect their poor judgment and an inability to gauge what the public wants to hear?

5. The music industry has heavily lobbied Congress for favorable legislation. In addition to the RIAA, an umbrella organization representing the major labels, they also employ a variety of full time lobbyists. What was their position on the 1996 Telecommunications reform act, which allowed the consolidation of radio station ownership. Do they lobby for or against it? Did they even know about it, or foresee the possible impact it might have ?

Further, did anyone in the industry ever consider the impact of this consolidation on music sales? Have they investigated or commissioned any studies into what the impact of stations such as Clearchannel Communications (CCU) or Infinity, (now part of Viacom - VIA) buying up lots of smaller chains had on sales, play-lists, etc.?

6. We have been seeing significant increase in DVD sales at the expense of CDs. How have the major labels moved to exploit this trend, and to what degree are they cannibalizing their own sales? Does the rise of new media provide an opportunity for management to throw the blame to a suitable scapegoat?

7. CD sales also fell when the economy went into a recession; They started to recover once the recession ended. Is there something I don't understand about the music industry - namely, why they believe they are exempt from the Business cycle?

8. When the industry cut their prices, they saw sales rise. Yet we continue to see a reluctance to allow open competition in the market place. Suggested retail prices still thrives, the same few CDs seem to be on sale at different stores each week. That's something which at least implies some limited coordinated discounting.

Question: Why won't the big music labels allow the market place to determine pricing?

9. Maybe its because they are unrepentant Price Fixers. Lets not forget that nearly all of the big labels signed a consent decree (an admission of guilt and a big settlement) for illegal price-fixing.

To be blunt, I find it laughable that this group has claimed the moral high ground, when these habitual anti-trust violators clearly have dirty hands.

10. Some studies have suggested that the Nielsen ratings on CD sales consistently undercount sales. Indeed, one wag went so far as to declare that RIAA accounting practices a leading cause of declining music sales.

Are sales off as much as advertising, or are the labels pulling yet another fast one?

 

That's 10. I could go on and on with this, but I think by this point, you get the idea. The issues surrounding P2P and downloading are far more complex than the "Oh, woe is us industry" makes it appear. I cannot help but think that many of the music industry's problems are largely of their own making, as well as part of a larger trend away from older media.

 

CW:  Call Illegal Downloading What It Is: Theft
2/8/05 1:53 PM ET

I really created a firestorm of dialogue both here on the site and in my emails with my commentary about piracy yesterday. Though I think most readers followed these points, I did get several questions and comments from emailers who seemed to miss them:

1. I wouldn't even begin to think that RIAA is somehow battling for private ownership rights in some grand manner for the benefit of our economy and nation. I think they are totally, 100% wrong for going after most of the surviving P2P technology providers. I think they are totally, 100% right for going after people who are stealing their music content property. I think it's important for all content providers to be protected from thieves, just as I think it's important for shop owners, homeowners, lawnmower owners and anyone else to be protected from thieves.

2. I seriously doubt the lawsuits will have much long-term effectiveness in stopping the theft. But they have certainly had some near-term impact, as I know the kids I work with think twice and have slowed down their illegal downloading activities.

3. It's irrelevant if the RIAA did or didn't react quickly enough to the downloading phenomenon. Just because they have or haven't figured out how to offer their products in an economic manner off the Internet doesn't mean that they can now freely be looted.

4. To Barry's point about downloading music before purchasing it, one emailer asked what's wrong with that -- after all, consumers try out cars, tennis rackets and golf clubs before purchasing them. Hey, again, it's totally 100% kosher if the seller is willing to allow you to try out the music. But the sellers in this case aren't willing to do that. You don't like it? Don't buy it! If you wanted to try out a lawnmower and the dealer wouldn't let you, would that give you the right to steal it first, try it out and return it in perfect condition? Didn't think so.

5. One emailer wrote to say that correlation isn't causation. Fair point. It's possible that all this theft of music isn't what's actually keeping the music business under wraps in a strong economy. That still doesn't make it right to steal, and it doesn't mean that a mass move to piracy won't undermine all kinds of content business models, from TV and movie studios, to books, to this Web site.

6. Finally, if you're downloading this stuff illegally, you are a thief, plain and simple. Quit trying to rationalize your actions and get over it. Just stop stealing. Long before this stuff became mainstream controversial, I never did and never will download content illegally. Ain't gonna happen.

There are a couple possible ways to play this ongoing and escalating battle of piracy and content. Macrovision (MVSN:Nasdaq) is rolling out a product that will search P2P networks for any illegally traded songs and kill them. I'm doing more homework on that.

Then, of course, there's Apple (AAPL:Nasdaq) with its iTunes store, which is likely to become the largest (legal) distributor of music over the next few years. Audible (ADBL:Nasdaq), Napster (NAPS:Nasdaq) and RealNetworks (RNWK:Nasdaq) are also potential plays on the legal distribution of music over the Internet. Of course, these distributors of legal, protected music are likely to have ongoing battles with pirates too.

Tuesday, February 08, 2005 | 09:37 AM | Permalink | Comments (29) | TrackBack (2)
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» Ritholtz on the RIAA and P2P from BusinessPundit
Barry Ritholtz has posted a transcript of an excellent debate he had with a hedge fund manager about P2P and the RIAA. It's long, but worth the read, so check it out.... [Read More]

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A debate between two friends of differing opinions on the music downloading issue. One of them's skivvies are bit too tight, if you ask me . . . The Big Picture: Debate on Downloading And as someone pointed out on in the Interesting People list (I'm... [Read More]

Tracked on Feb 13, 2005 1:10:33 AM

Comments

Gentlemen...your arguments are for nothing more than filling blog space or realmoney conversation space.

I will tell you right up front that I cannot remember the name of the tech company...but they do exist as per a segment on the original but now dead techtv. The company tracks all peer to peer file shares. Worldwide. If you download one song 100 times...or one time...the software logs this as one download. They don't take anything...just track the actuall mp3 files being swapped world wide. An example of the power of this idea was shown on tech tv. They demoed two separate songs. Each song was ranked by the number of downloads. Then they compared other downloads of songs by the same artist. They showed two examples. The first was an artist with one very popular song...but the remaining downloads were next to nothing. In other words...a one hit wonder. The second example was the complete opposite. One very popular download followed by five or six other popular downloads for the same artist. This artist was labelled a group.

Now what do you think they do with that info?

They sell it. To radio stations and the RIAA. Why? Come on. Surely you can figure the rest out.

The one hit wonders are sent rather quickly to the download sites while the "groups" are identified as someone that is worthy of the cost of putting together a cd and distributing it. Why? Because, regardless of what they say...there is money in cd's.

Gentlement, please...move on. You are being played...along with everyone else, on this issue of the "costs" of downloading. If anything...there is a shift underway of the business models of the content owner/distributor. The ones that have figured it out won't admit it and bitch. The ones who haven't figured out won't admit and bitch. You guys pick up on this and give the bitchers a platform. To bad. Maybe if we just stopped talking about it we would wake up one morning and finally be living the reality of entertainment distribution.

Pay as you go.

Period.

Paul.

Posted by: pf | Feb 8, 2005 11:21:30 AM

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