WILL MP3 DOWNLOADS ANNIHILATE THE RECORD INDUSTRY? THE EVIDENCE SO FAR

• Published date: 27 April 2004
• Date: 27 April 2004
• Pages: 229-260
• DOI: https://doi.org/10.1016/S1048-4736(04)01507-3
• Author: Stan J. Liebowitz

WILL MP3 DOWNLOADS ANNIHILATE

THE RECORD INDUSTRY? THE

EVIDENCE SO FAR

Stan J. Liebowitz

ABSTRACT

This paper investigates the impact of peer-to-peer networks that promote

the unauthorized downloading of MP3 files exert on the recording industry.

Although Napster was the most famous of these systems, its progeny have

continued to allow millions of music listeners to download music (and other)

files without remuneration to the copyright owners. Economic theory does

not allow us to determine what the impact of such downloading will be. Using

data on the historical sales of prerecordedmusic I examine in detail the recent

decline in recordsales and attempt to gauge the importance of various factors

that have been put forward to explain this decline. My conclusion is that the

evidence is most consistent with a claim that MP3 downloads decrease sales.

Nevertheless, it is unclear whether the damage to the industry will be fatal.

1. INTRODUCTION

After Napster exploded into the public’s consciousness in 1999, concerns with

MP3 downloads, their impact on the recording industry,and the industry’s attempt

to thwart such downloads, have been in the news almost continuously. The

Intellectual Property and Entrepreneurship

Advances in the Study of Entrepreneurship, Innovation and Economic Growth,

Volume15, 229–260

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ISSN: 1048-4736/doi:10.1016/S1048-4736(04)01507-3

229

230 STAN J. LIEBOWITZ

Napster case was only the most public front in a wide ranging battle between the

entertainment industries (movies and records) and the millions of individuals who

were using the Internet to download, without authorization, copyrighted works,

but who otherwise were thought to be the putative customers of these industries.

This fight has spilled over into the political arena. The manifestations were seen

in a bill proposed by Representative Howard Berman from California in 2002

that would have allowed copyright owners to engage with impunity in otherwise

illegal activities “disabling, interfering with, blocking, diverting, or otherwise

impairing” the “unauthorized” distribution of copyrighted items.1The bill did

attempt to restrict these otherwise illegal activities to those that do not “alter,

delete, or otherwise impair the integrity of any computer file or data residing

on the computer of a file trader” but it still amounted to authorizing “hacking”

behavior that is disallowed in other venues.

This is only a small part in a flurry of activities taken by the copyright-based

industries to protect themselves against what they see as online pilfering of their

products. The most recent strategy announced by the recording industry is to

prosecute those making their files available to others over peer-to-peer systems.

As this article is being written, the RIAA is supposedly collecting the names of

hundreds or thousands of users in order to bring suits against them in the next few

months. How this will play out is yet to be seen.

At the center of the current controversy is the fear by the recording industry

that great damage, perhaps even mortal damage, will be done to them if they

do not stop online “trading” of music files, a fear I refer to as the “annihilation

hypothesis.” The movie industry is taking a backseat to the record industry for the

moment because the size of the files needed to view movies make online movie

trading prohibitively time consuming at current connection speeds and because

most users do not yet have the equipment to write DVDs.

As this is all coming to a boil, various possibilities are emerging as potential out-

comes. One outcome would be for the recording industry to beat back the threat of

peer-to-peer systems by engaging sufficiently in successful public prosecutions of

users that the fear of punishment ends this short term experiment in massive copy-

right infringement. A second possibility is that peer-to-peer downloading proves

impossible to prevent by threats of punishment, and an alternative to marketbased

copyright systems arises. Such a system might include a tax on ancillary products,

such as blank CDs, CD burners, or stereo equipment, with the proceeds of the tax

to be distributed based on the number of downloads of individual titles.2A third

alternative would be the rise of digital rights management systems, which would

be an advanced form of copy protection which allows varyingdegrees of use of the

product depending on the price paid by the user. In order for this to work, however,

the copy protection would need to be sufficiently difficultto break that peer-to-peer

Will MP3 Downloads Annihilate the Record Industry 231

files sharing systems would lose their appeal. Finally, another alternative would

be for things to continue down the track that they are on, with peer-to-peer file

sharing proving to be an unpreventable act which reduces the revenues of the

recording industry but not sufficiently so to destroy or alter the industry in any

meaningful way.

Central to any discussion of these hypotheses should be empirical examinations

of the industry. Yet there have been few studies attempting to examine the impact

of MP3 downloads. In the Napster case the recording industry presented evidence

purporting to demonstrate that MP3 downloads were harmful to record sales and

Napster presented evidence purporting to demonstrate that online file-sharing was

beneficial to the record companies.3

As I have explained elsewhere, the evidenceprovided by the recording industry

in the Napster case, in my opinion, failed to support any claim of harm, to say

nothing of supporting the annihilation hypothesis, although the judge nevertheless

ruled against Napster.4I also arguedthat although there was not yet good evidence

to support such harm, there were good economic reasons to believe that online file

sharing would be harmful to the industry.5At that time there was little evidence

of any decline in record sales and I provided rationales as to why the evidence to

support this claim had not yet surfaced.6

Peer-to-peer file sharing, although anathema to the recording industry, is

providing a wonderful natural experiment to economists or anyone else who

might be interested in the impacts of unauthorized copying. The longer it goes on,

the more evidence that can be accumulated on the impact of the copying on the

market for authorized works. The fact that there appear to be actual measurements

of the number of files downloaded provides a metric on the size of the copying

activity that had never existed with any prior copying technologies.7The natural

experiment is still ongoing and results are still coming in. With all the energy and

heat being generated on these topics, however, this seems likea good time to take

stock and examine what we currently know about the impact of MP3 downloading

on record sales.

My conclusions, in a nutshell, are that MP3 downloading does appear to be

causing harm. No other explanations that have been put forward seem to be able

to explain the decline in sales that have occurred since 1999. Still, it is not clear

that the harm will be fatal.

2. BACKGROUND

Records are just a particular category of consumer goods, and not a terribly large

one in terms of revenues. Even so, listening to music is one of the major daily