Dynamic analysis of an institutional conflict: copyright owners against online file sharing.

Author:Pavlov, Oleg V.
 
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Online music-sharing networks have been used by millions of people since they first appeared in 1999 (Leuf 2002; Associated Press 2004). The popularity of peer-to-peer (P2P) technology and the low-cost music distribution channel it created threaten the dominant position of a small number of large firms in the commercial music industry (Alexander 2002). Threatened by the possible restructuring of the entire industry in five to ten years (BBC 2002; Mann 2003), the dominant players responded with a fierce campaign against online copying. They oppose music-sharing networks on the grounds that the networks facilitate mass copyright infringement and erode industry's profits. This type of institutional response orchestrated by the incumbent economic players has precedents. Eighteenth century publishers in Great Britain resisted the emergence of public circulating Libraries (Roehl and Varian 2000), and Hollywood studios perceived video technology when it first appeared in the late 1970s as a threat to their movie revenues (Roehl and Varian 2000; Alexander 2002).

According to the Recording Industry Association of America (RIAA), which represents music copyright owners, online file sharing causes a significant decline in CD sales and erodes the financial incentives for the production of new material (RIAA 2003). Several research studies, however, suggest that online file sharing may not have a negative effect on the music market (Alexander 2002). In a widely publicized study, Felix Oberholzer and Koleman Strumpf (2004) compared directly observed data on CD sales and downloading. They concluded that "downloads have an effect on sales which is statistically indistinguishable from zero." The authors explained the result by noting that "most [P2P] users ... would not have bought the album even in the absence of file sharing." Contrary to the RIAA claims, file-sharing networks may have also increased the supply of music--the networks brought visibility to many "non-marketable" artists that could not use distribution channels controlled by the profit-seeking commercial music establishment (Gallaway and Kinnear 2001).

The commercial music industry pursues an offensive strategy comprising litigation, lobbying, and self-help (Yu 2003). Often testing the boundaries of legal and regulatory systems, the war against file swapping set off sharp and sagacious debates on the nature of intellectual property, the role of the copyright law, and fundamental notions of citizenry such as freedom of speech (Lessig 2001; Goldstein 2003; Green 2003; Amy Harmon and John Schwartz, "Music File Sharers Keep Sharing," The New York Times, September 19, 2003). Since institutions invariably affect the economy (North 1992), the outcomes of the polemics in courts will have considerable pecuniary consequences for the recording industry and the entire economy. New laws and new interpretations of old laws may cause new industries that are attempting to grow on the platform of peer-to-peer technology to flourish or decline (for examples see Non 2000 and Elkin 2002). But it is still not clear to what extent the recording industry can control the recalcitrant music networks (France and Grover 2003). Some analysts predict that peer-to-peer networks will ebb under pressure from the music industry, while other experts prophesize a continuous rise in popularity (BBC 2002). There also have been warnings that the true danger to the existence of file-sharing networks is not the belligerence of the music industry but the prevalence of free riding on P2P networks (Adar and Huberman 2000; Alexander 2002).

With this article I hope to add to the understanding of the institutional conflict within the commercial music industry. The framework for our analysis is rooted in the descriptive pattern modeling approach of institutional economics (Wilber and Harrison 1978). However, acting on a proposition that the traditionally narrative analysis of institutional economics may be buttressed by formal methods (North 1992; Hodgson 1998), I use the approach of institutional dynamics (Radzicki 1988, 1990a; Radzicki and Seville 1993) to build a resource-based model of a peer-to-peer community. Then in a series of computer experiments with the model I simulate actions applied by the copyright holders against file sharing. The experiments reveal that the internal feedback structure of a peer-to-peer system renders it extremely resilient to outside disturbances. Experiments also suggest that institutional measures are likely to differ in their effectiveness.

I proceed by describing the institution of the commercial music industry. Then I explain actions that copyright owners have tried or may undertake against online file sharing. Subsequently, I develop a formal model of a representative peer-to-peer network that is then tested against a reference year. I devote one section to a series of experiments that examine the consequences of four policies inspired by litigation and self-help approaches. I offer a brief summary of findings and conclusions in the last section.

The Institution of the Commercial Music Industry

An institution is operationally characterized by the presence of (1) participants, (2) rules that govern activities within the institution, and (3) folk views that explain and justify actions within the institution (Neale 1987). Rules and folk views are constraints that define an institution, and they may be formal, such as copyright law, common law, and government regulations, and informal, such as conventions and socially accepted or self-imposed norms of behavior (North 1992). The commercial music industry has all the characteristics of an institution, as I describe in this section.

Participants

Participants of the commercial music industry are legion and, among others, include artists, recording studios, agents, customers, trade publications, disk jockeys, and many more (Dolfsma 2002; France and Grover 2003). Since an organization is a particular form of an institution created for a purposeful coordination of activities (Hodgson 1998, 180), some of these players are institutions in their own right. New participants emerge and old ones wane as the importance of players changes over time. Dolfsma 2002 offers an account of an institutional transformation that led to the disappearance of a music "presenter" and its replacement by a "disk jockey." Players also merge as the recording industry undergoes consolidations. Unlike in the early days when there were no national music conglomerates (Gallaway and Kinnear 2001), the industry is currently dominated by five major international corporations, commonly referred to as "The Big Five": Vivendi's Universal Music Group, AOL Time Warner's Warner Music Group, Sony Music Entertainment, Bertelsman's BMG, and EMI Group. In a recent account these companies controlled 75 percent of worldwide music sales (Anna Wilde Mathews, "Record Labels Send Messages to Warn Music File Sharers," The Wall Street Journal, April 30, 2003, B.6).

Players may appear and gain prominence due to novel technologies. For example, the introduction of the point-of-sale retail information systems in the 1980s led to the invention of a new music popularity chart. Adoption of the chart in 1991 by the leading trade publication Billboard transformed the industry by boosting positions of a small number of record companies, allowing greater segmentation of the music market, giving prominence to country music, and negatively impacting albums from some independent labels (Anand and Peterson 2000). Similarly, music-sharing communities owe their existence to the novel peer-to-peer technology.

Rules

Observing that institutions do not exist in isolation (Neale 1987), institutional economists have long recognized the inseparable amalgamation of legal and economic activity in the market world (e.g., Medema 1992); the alliance has been dubbed a legal-economic nexus (Samuels 1989). Soon after its formation in the 1880s, the music industry secured the extension of the copyright law to music (Anand and Peterson 2000). By constituting what is property and establishing ownership rights, the legal system since then has defined the structure of the music industry (Samuels 1989; Coase 1992, 717) and protected copyright owners against piracy (Lister 1998).

Folk Views

People use folk views to "justify the activities or explain why they are going on, how they are related, what is thought important and what unimportant in the patterns of regularity" (Neale 1987). The wide adoption of music-swapping technology showed that the public at large does not see music sharing as a criminal act, even though the recording industry believes that using peer-to-peer networks is akin to stealing (Amy Harmon and John Schwartz, "Music File Sharers Keep Sharing," The New York Times, September 19, 2003). This perception of legitimacy of music sharing comes from the underlying socio-cultural values of a society (Dolfsma 2002)--a great number of Internet users perceive online music as a free public good. The origins of this view may come from two facts: (1) music has been available as a free public good for years through the radio media (Gallaway and Kinnear 2001; Amy Harmon and John Schwartz, "Music File Sharers Keep Sharing," The New York Times, September 19, 2003), and (2) content on the Internet for the most part is free (Gallaway and Kinnear 2001). Moreover, "institutions constitute the arenas in which people try to accomplish their aims" (Neale 1987). Thus when faced with a choice of distribution channels they choose the least costly and most convenient one. As Gallaway and Kinnear succinctly put it, talking about P2P networks: "In the commercial milieu, one does not expect rational individuals to reject the option which offers lower prices, lower transactions costs, and better variety" (2002).

Attitudes toward the new technology among artists are less uniform. Many of them disapprove of...

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