Music piracy: A case of “The Rich Get Richer and the Poor Get Poorer”

https://doi.org/10.1016/j.infoecopol.2012.01.002Get rights and content

Abstract

There is evidence that music piracy has differential effects on artists depending on their popularity. We present a model of music piracy with endogenous copying costs: consumers’ costs of illegal downloads increase with the scarcity of a recording and are therefore negatively related to the number of originals sold. Allowing for a second source of revenues apart from record sales, we show that piracy can hurt some artists while benefiting others. Under plausible assumptions, piracy is beneficial to the most popular artists. However, this does not carry over to less popular artists, who are often harmed by piracy. We conclude that piracy tends to reduce musical variety.

Highlights

► We present a model of music piracy with endogenous copying costs. ► Copying costs decrease as the number of originals sold increases. ► The sales of stars’ music suffer more from piracy than those of smaller artists. ► Yet piracy can increase the recognition of an artist’s music. ► Stars, but not smaller artists, offset sales losses with recognition-related income.

Introduction

Information goods, defined broadly by Shapiro and Varian (1999, p. 3) as “anything that can be digitized,” have the particular property that they can be copied virtually without quality degradation. This makes them vulnerable to copyright infringement. Music is the information good that suffers most severely from the violation of intellectual property rights. Piracy of music has been rampant since the emergence of Internet-based file sharing networks in the late 1990s. The music industry claims that this kind of private, noncommercial piracy is threatening the creation of music at large. Musicians themselves seem to be divided over whether file sharing is good or bad, as a survey of American musicians and songwriters by the Pew Institute (2004) has shown. Pop star Robbie Williams has been quoted as saying that piracy is “great.”1 According to a recent survey by the Dutch Ministry of Justice (Weda et al., 2011), only 28% of the 4000 interviewed artists believe file-sharing financially harms them. The Featured Artists Coalition, the British Academy of Songwriters, Composers and Authors, and the Music Producers Guild, (whose members include Elton John, Tom Jones, Paul McCartney, and Radiohead’s guitarist Ed O’Brian) wrote a joint statement opposing the British legislation against file-sharing. Nonetheless, many governments take a tough stance against peer-to-peer (P2P) file-sharing. In this context, studying the impact of file-sharing on artists’ profits and welfare is not only academically but also policy relevant.

P2P file-sharing is the predominant form of music piracy in the digital era. Because of their improved design, modern P2P technologies (e.g., the popular BitTorrent) amplify the effects of piracy. Traditional forms of piracy cannot reach a broad audience, and first-generation P2P platforms suffer from congestion as the demand for a file increases. By contrast, second-generation P2P platforms are able to maintain high levels of performance even in the face of strong demand. Another important feature of P2P file-sharing is that the availability of a file and the time it takes to download it, which together determine the cost of copying for consumers, depend on the number of initial seeds. Recordings that register a larger number of legal sales usually generate a greater number of initial seeds, implying that the cost of downloading is endogenous and negatively related to record sales.

At a theoretical level, the basic trade-off policymakers are facing in designing copyright legislation is between under-utilization and under-production of intellectual property (Romer, 2002). Since information goods are largely non-rival, efficient consumption requires all consumers with a willingness-to-pay exceeding the (small) cost of reproduction to have access to the good. Therefore, at least in the short run, consumers almost always benefit from the availability of copies. The presence of high fixed costs, however, means that producers would make a loss if they set the price at marginal cost (i.e., reproduction cost). Copyright confers some market power to the producer and makes market provision possible. Unauthorized reproduction erodes the producer’s market power, and therefore his incentive to create, leading to a problem of underprovision. In the basic models, piracy is harmful to producers, which entails negative long run repercussions also for consumers due to reduced incentives to create (Johnson, 1985, Belleflamme, 2003, Yoon, 2002, Bae and Choi, 2006).

There are several reasons why there may actually be less of a conflict between consumptive efficiency and incentives for producers than this discussion suggests. It may be profitable to allow some piracy when producers can indirectly appropriate the consumers’ rent from copying by charging a higher price (Liebowitz, 1985). A second case is the presence of positive network effects on the demand side. If a consumer’s valuation depends on how many others are consuming the good, piracy allows the monopolist to take advantage of network effects while maintaining a high price and extracting surplus from high-valuation consumers (Conner and Rumelt, 1991, Takeyama, 1994, Shy and Thisse, 1999). A third case is sampling: with experience goods (e.g., music) and heterogeneous tastes, consumers do not know beforehand whether they like a product. File sharing enables consumers to try out new musical genres and artists, which may under some conditions increase demand (Peitz and Waelbroeck, 2006b).2

In a contribution specifically dealing with the music industry, Gayer and Shy (2006) point to a possible conflict between artists and publishers as to the desirability of piracy. The argument is based on the observation that record sales are not the only source of income for artists, who have a number of other sources (e.g., live concerts). While publishers may be harmed by piracy, artists may benefit from the increased recognition of their music that piracy brings about. The notion that piracy may increase concert revenues also has some empirical support (Oberholzer-Gee and Strumpf, 2010, Mortimer et al., 2012).

From an empirical point of view, file sharing can provide insights regarding the impact of unauthorized copying (in particular for testing the different hypotheses put forward by the theoretical literature). So far, there is only limited support for a positive effect of piracy on demand. On the contrary, most empirical studies indicate that the record industry is being harmed (Hui and Png, 2003, Peitz and Waelbroeck, 2004, Zentner, 2006, Rob and Waldfogel, 2006, Liebowitz, 2008, Waldfogel, 2010). For example, Rob and Waldfogel, 2006, Waldfogel, 2010 both estimate that the sales displacement produced by illegal downloading (the marginal effect of illegal downloads on sales) is between −0.15 and −0.3. One exception is the investigation by Oberholzer-Gee and Strumpf (2007), who find that piracy has no statistically discernible effect on album sales. Apart from this controversial result, one interesting point raised by their work is that the impact of piracy may vary across artists: some may gain while others may lose.

In this paper, we present a model that accounts for differential effects of piracy depending on the artist’s popularity. We start from the simple framework of a monopolist selling to a continuum of consumers who self-select according to their willingness to pay. The general self-selection setup of the model draws on Yoon (2002). We assume that the artist sells a single recording and is characterized by an exogenously given level of popularity that reflects both his ability and the appeal of the musical genre he produces. The originality of the model resides in the assumption of endogenous copying costs. From the literature in computer science (see, e.g., Qiu and Srikant, 2004, we know that the BitTorrent technology is not subject to congestion. That is, the number of simultaneous downloaders has no effect on the time it takes to download a file. One of the main reasons is that downloaders simultaneously upload file parts they have already received. Download times do, however, depend on the extent to which legal copies are uploaded to the network. Therefore, we assume that the consumers’ cost of downloading is decreasing in the artist’s sales of originals. This is consistent with the common idea that, on average, it is much more time-consuming to find and download a recording from a little known artist than a very popular song, which in equilibrium indeed turns out to be the case. Following Gayer and Shy (2006), we also introduce an alternative source of revenue for artists (which can be thought of as a proxy for live performances, merchandizing, participation in TV shows, etc.). Together with differences in download costs, these side revenues can explain why some artists may be in favor of piracy while others oppose it.

Gayer and Shy (2006), who model a conflict of interest between artists and labels, leave the decision of how to price the CD solely to the record company, which is assumed to ignore the artist’s interest in setting the price. The artist gets a share of the label’s profit. By contrast, we consider only a single entity which maximizes its total profits taking into account all the artist’s revenues. This can be seen as a special case of Gayer and Shy’s approach where the entire profits go to the artist and the artist takes the pricing decision. Alternatively, it can be interpreted as a situation where the artist and the label bargain over the conditions of the contract, including the price of the recording, prior to entering into a business relationship. In that case, they will agree on the price that maximizes joint surplus, and then distribute the surplus (according to their respective bargaining power) through a fixed upfront payment.

Alcalá and González-Maestre (2010) also study artists that differ in popularity. They use an overlapping-generations model to endogenize the number of stars. They incorporate promotion costs that can be reduced by using piracy as a promotion device. We disregard the promotion component that adds, as the authors show, an incentive to allow piracy, and we focus instead on another transmission channel: the presence of endogenous copying costs. That is, we allow the costs that consumers incur when downloading a song from a file-sharing network to vary across artists depending on their record sales.

Intuitively, we would expect the assumption that downloading costs decrease with sales of originals to result in a smaller effect of piracy on less popular artists, while popular artists should be more strongly affected. However, this effect might be counterbalanced by the fact that opportunities to make money out of alternative sources increase with “stardom.” Piracy, by expanding the user base of a recording, leads to higher revenues from these other sources. If a popular artist’s music is both more demanded and easier to download and is therefore copied more, we should expect that popular artists – while losing more in terms of record sales – also benefit more from the increased dissemination of their recordings than less popular artists. In the formal analysis that follows, we examine the relative strength of these two effects and investigate which conditions determine the impact of piracy on different artists.

Our results confirm the finding obtained in a different setting by Gayer and Shy (2006) according to which artists can be better off with piracy than without it if side revenues are important. But this applies in an unrestricted way only to the more popular artists. The less popular artists may still be worse off under piracy even if side revenues are large. If downloading costs are not high enough to shield less popular artists from piracy, so that their music still faces the threat of being pirated but not to the extent needed to reach a sufficient level of side revenues, piracy reduces their profit. From a welfare perspective, this means that piracy dampens their incentives to create music and may therefore be detrimental for musical variety.

The remainder of this paper is structured as follows. Section 2 introduces the model. In Section 3, we derive the artists’ pricing decision. In Section 4, we examine the welfare effects of piracy, the emphasis being on long-term incentives to create new music. Section 5 concludes.

Section snippets

Model setup

We consider a market in which an artist, characterized by a popularity parameter α  [0, 1], is a monopolist. For an artist of type α, there is a mass α of consumers having unit demand for the artist’s recording. We interpret α as a measure of how many people like his music.

Pricing of originals

In this section, we study the artist’s pricing decision. We start by deriving the optimal price of a recording in the absence of piracy. Then, we examine how the artist adjusts his behavior in the presence of a file-sharing network on which consumers can exchange illegal copies of the recording. Finally, we illustrate some of the insights of the model through a numerical example.

Short-term welfare

To evaluate the effect of piracy on short-term welfare, we need to compute the total surplus (net consumer surplus plus profit) under the assumption that the artist has entered the market. There are several problems with this methodology. First, it may not be very meaningful to calculate surplus in the current model. In the partial equilibrium setting of the model, the source of the side revenues is not explicitly modeled; in a way, side revenues fall like manna from heaven. In reality,

Conclusion

The digital era has brought about significant changes for the music industry. With recordings being available in digital format, copies can be made cheaply and virtually without quality degradation. Modern file-sharing technologies perform well even when large numbers of consumers simultaneously want to download the same file. Moreover, digital media markets are global in nature, increasing the returns that accrue to the most popular artists.

We have presented a model of music piracy with

Acknowledgments

We are grateful, for insightful comments and suggestions, to the editors of this Special Issue, Lapo Filistrucchi, Lisa George and Catherine Tucker, and to two anonymous referees. For their help and comments, we also thank Ascensión Andina-Díaz, Helmuth Cremer, Philippe De Donder, Vivien Massot, Dongyu Qiu, and Sebastian Schuett. Part of this research was conducted while Amedeo Piolatto was visiting the CentER for Research in Economics and Business (CentER) at Tilburg University, whose

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