Steve Gordon, Attorney/Author

How Compulsory License for Internet Might STILL Help Music Industry Woes
Copyright 2009 Steve Gordon

In 2003 I published an article titled “How Compulsory License for Internet Might Help Music Industry Woes” in Entertainment Law & Finance, a newsletter published by the NY Law Journal. Billboard Magazine re-published the article as an op-ed but gave it a new title: “Licensing Could Solve Internet Piracy.” The first title was a much more accurate description of my argument, and I still believe that a compulsory license is the best solution for saving the major record companies, and is in the best interests of the artists, as well as music fans. In fact the circumstances for supporting a compulsory license are even more compelling now than in 2003.

The beginning of my article noted:

Sales of recorded music in the United States and throughout the world have declined for three consecutive years. Three of the five major record companies are now reportedly for sale.

Since 2003, Time-Warner sold off Warner Music, EMI was sold to a group of private investors, Sony Music and BMG merged and then BMG bailed out of the recording business. Income from recorded music has plunged from a peak of approximately 14.5 billion in the U.S. in 1991 to 8 billion today – a precipitous decline of almost 50% in income even without accounting for inflation. Along the way the major labels discarded thousands of employees and dropped scores of artists. Obviously, the record business is in even in worse shape now than six years ago.

The article continued:

The International Federation of the Phonographic Industry blames the situation on CD burning and unauthorized Internet file sharing.

The IFPI was right, the Internet has hurt the record business. But the Internet, by itself, was not the reason for the decline of the record business. One of the primary causes for the industry’s woes can be traced back to the Digital Millennium Copyright Act of 1998 (DMCA). In negotiations surrounding the passage of the Act, the political influence of the recording industry was dwarfed by the money and political influence of the ISPs. Consequently, the labels were forced to concede a “safe harbor” designed to shelter the ISP’s from any liability for carrying P2P sites on their networks. At the same time, the labels failed to make computer manufacturers apply digital rights management restrictions to their hardware. The major labels’ plan to make the manufacturers of digital devices embed code in their gadgets that would prevent people from downloading unauthorized music, The Secure Digital Music Initiative or “SDMI,” was a complete failure because the electronics business, including the parent company for Sony Music, knew that people would buy more PCs, CD burners, and MP3 players if consumers could play and share free music. In fact “free music” is not free at all. In order to download, copy, transport and share “free music” from bit torrent sites, private networks or Russian websites, you need to BUY computers, MP3 players and PAY for subscriptions to high speed Internet providers. The record companies understood this, but were powerless to stop it because the more powerful electronics and ISP industries refused to cooperate and had the economic and political muscle to stonewall even the major labels. As a result the labels attacked the only targets left, the music fans who used this new technology to listen to and collect recorded music. This strategy did not solve the labels’ problems because it did not significantly impede music sharing on the Web. The technology was just too powerful and the electronics and ISP industries made it too easy to share music. The labels themselves recognized this when they announced they would stop their lawsuits against music fans last year.

The Commentary continued with my proposal:

The solution to the music industry’s woes is a federal law providing for a
statutory license that would legalize the sharing of music online while
compensating copyright owners for lost sales. A federal law implementing a
statutory license could legalize the transmission of all recorded music for
purposes of sharing music over the Internet and downloading permanent, portable
copies. Fees would be paid by those directly profiting from file sharing, that is,
the makers of CD burners, including computer manufacturers, and the Internet
service providers (ISPs) whose subscribers already pay in part for access to such
services as Kazaa. As CD sales continued to decline due an ever increasing
number of households acquiring computers and high speed Internet connections,
the amount payable to the fund could be adjusted upwards.

Steve Jobs and Apple have made huge fortunes from selling iPods and iPhones. It has been estimated that less than 10% of music on these devices come from authorized services. Instead, consumers use these devices to copy their own music collections or store music from unauthorized services or pirate sites. Sales of other MP3 players, CD burners, and computers continue unabated. High-speed Internet subscriptions are at an all time high. These segments of the economy, as opposed to the content providers, are doing very well. What is really happening is a redistribution of consumers’ dollars away from the content provides (the labels and artists) to those who facilitate “free” music,” the electronics industry and ISP’s.

The commentary continues with a description of how a statutory license would work.

The contribution of each ISP and computer manufacturer would be determined by
a body designated by the U.S. Copyright Office. The payments would be
delivered to a central administrator on behalf of the labels and the artists. This
fund would be allocated based on downloads of each master as tabulated by
digital rights management technology similar to what the performing rights
societies already use to count the performances of songs on broadcast radio and
TV. The fund administrator would then pay each label and artist on a 50/50 basis,
just as ASCAP and BMI pay songwriters and music publishers. There would also
be a separate fund for music publishing. In fact, the rate for downloading songs is
already subject to a compulsory license of eight [now 9.1] cents per song
under the Copyright Act.

I believe that the principal reason the RIAA and the major record companies have not pushed for this plan, which would force the electronics industry and ISP’s to share the financial rewards of “free music,” is that the labels would be forced to actually share monies for recorded music with the artists. The traditional model is otherwise. Under the standard recording agreement, still in use today, the artists receive only 10% to 15% of the retail price for records sold. After contractual reductions such as packaging (25%), “net sales” (10%) and producer royalties (3% to 5%/), which are all deducted from the artist’s recording royalty, the artist usually winds up with less than 5%. Moreover, they usually don’t even get that because the labels “recoup” advances, recording costs and marketing expenses from recording royalties. As a result, very few artists ever receive a dime of recording royalties. The notion of sharing 50% of income from record sales with the artists is revolutionary, and hard for the labels to accept. But they have to understand that the electronics business and ISP’s are making so much money that if calibrated correctly, there would be more than enough money to go around.

The article also pointed out that a statutory license could cut through a major obstacle in the labels’ capacity to compete in the digital music world. That obstacle has to do with contract restrictions. As I pointed out in the commentary:

Some artist’s contracts do not allow record companies to put the artists’ music
online. As a consultant for one of the major authorized online services, I had to
delete approximately 80% of hip-hop music because sampling agreements
typically do not permit sales via the Internet or as singles of tracks on which
samples are used. Third-party artists who record with other artists often include
the same restrictions. And many major artists who are justifiably afraid that they
will not be adequately compensated by the labels for use of their records online
threaten not to record another album or with some other form of retaliation, even
if they are contractually obliged to allow the labels to use their music in any
media. A statutory license could cut through these knots while guaranteeing fair
compensation to the artists.

These contractual problems continue to have strong negative impact on the record companies’ ability to compete with unauthorized P2P systems. Limewire, Russian websites and the thousands of Bit torrent powered private networks that allow people to share free music are not limited in the amount of music that they allow people to share. They provide access to millions of tracks unavailable on iTunes or other “legit” business models.

The Commentary concludes:

The proponents of a free market would argue that the market is the best device in
establishing a fair price for all private property, including music copyrights.
However, the technological advances created by the Internet have led to what
economists call a “market breakdown” in the recording business. Without a
compromise–such as a compulsory license–between the competing economic
interests (i.e., hardware versus content), everyone will lose.

The crux of my proposal is that a statute legalizing file sharing, in return for a levy on the technologies that make “free music” possible, would help everyone:

• the labels and the artists would be fairly compensated;
• the technology companies would still have the labels around to find, produce and promote music to attract more subscribers to high speed Internet services, and more customers for computers, CD burners, MP3 players and other digital devices; and
• the public would have access to more music without the threat of lawsuits,

Developments since 2003 have only made the argument for a compulsory license as a cure for the recording industry’s woes stronger.

Steve Gordon is an entertainment attorney and author of The Future of the Music Business, and hosts a radio show at that focuses on the revolutionary changes happening in the music business. He recently won a Fulbright Scholarship and delivered a series of lectures on copyright law and the music business at Bocconi University in Milan, Italy.

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