Piracy Is Not Competition

By Robert VerBruggen
Tuesday, February 28, 2012

In the February 27 issue of National Review, Reihan Salam and Patrick Ruffini argue that Hollywood lobbyists have been more successful than they deserve to be, especially by nearly passing the Stop Online Privacy Act (SOPA). Most of their article’s main points are unobjectionable: SOPA was problematic; the Internet is a wondrous development that should not be overregulated; Hollywood has received unseemly financial favors from various levels of government; and copyright law has been needlessly expanded at the hands of the entertainment industry.

Salam and Ruffini are also correct that the Web has thrown numerous established businesses, from brick-and-mortar retailers to newspapers to the U.S. Postal Service, into turmoil, forcing them to confront highly efficient online competition. They are right, too, that the government should let the market work its magic in these cases. But they are wrong to include the threat Hollywood faces from Internet piracy in this trend.

When brick-and-mortar bookstores complain about the threat they face from Amazon.com, they are complaining that customers will leave them for a superior alternative; when Hollywood complains about piracy, they are complaining that customers have left them for an illegal alternative. They have stopped paying for Hollywood products yet are still consuming them. These are not even remotely similar situations — morally, legally, or economically.

With this distinction in mind, one might find it rather odd for Salam and Ruffini to insist that the solution to piracy is “innovation” rather than law enforcement. By “innovation,” they mean primarily that Hollywood should make it easier and cheaper for customers to buy their content digitally, citing studies indicating that when digital content becomes readily available through legal channels, piracy goes down. But even assuming Hollywood can discourage piracy by cutting prices and offering its content in different ways, since when do we tell crime victims to appease their tormenters?

Moreover, in no other industry do we allow consumers to force prices down by taking products for free whenever they, personally, think the legal versions are too expensive or inconvenient. Any customer may refuse to buy a product that’s undesirable, or even organize a boycott — but then that customer needs to go without the product. Salam and Ruffini provide no justification for singling out industries that sell intellectual property — and little evidence that these industries’ disproportionately young, bratty, and entitled consumers are better equipped than the free market to decide what a “fair” price is for an album or movie that cost thousands or even millions of dollars to create and market. Essentially, they are calling for price controls calibrated to the liking of the Occupy Wall Street crowd.

Salam and Ruffini also note that despite the cratering of sales for easily pirated media — recorded music and home movies, in particular — the entertainment industry as a whole is doing all right by some metrics. But once again, even if this is true, it applies a standard to the entertainment industry that no other sector must suffer under — namely, that it must tolerate violations of its legal rights so long as it remains profitable.

Of course, one may claim that the legal rights themselves are the problem, and should be eliminated or substantially weakened — but Salam and Ruffini take no such position in their piece, at least not explicitly. There are also the matters of how government should prioritize copyright enforcement, and what tradeoff we should strike between enforcing copyright laws and keeping legitimate Internet activity unrestricted. But Congress has for centuries recognized some form of copyright, the Constitution explicitly authorizes the legislature to do so, and even Salam and Ruffini concede that piracy is common and increasing. Thus it would seem that the industry has a strong moral and legal justification to ask the government to enforce copyright law more effectively.

And as regards economics, it doesn’t seem that Salam and Ruffini’s preferred “innovative” solutions hold the key to a diverse and lively, yet convenient and affordable, entertainment industry.

For starters, while making content widely available for low prices does seem to reduce piracy, it hardly eliminates it. In surveys, the number of Americans who reported downloading music illegally decreased by about 40 percent between 2007 and 2010, and even this was partly attributable to a law-enforcement effort (the shutdown of LimeWire, a popular pirate service) rather than improved legal entertainment options. In Sweden, the number of people who pirate music dropped only 25 percent thanks to the appearance of Spotify — which can be thought of as an online music collection to which access is unlimited, so long as users either listen to commercials occasionally or pay a $5–10 monthly subscription fee.

(On a side note, the Swedish survey also indicated that about one-third of Spotify users planned to leave when new limitations for non-paying customers went into effect; these included capping use at ten hours per month and limiting each song to five free plays. These are the people Salam and Ruffini trust to have determined whether entertainment prices are too high.)

And speaking of Spotify, Salam and Ruffini highlight it as the kind of innovation that will rescue the industry from piracy. As Spotify’s own management has noted, many of its users are former pirates, so much of the money it brings in would have been lost otherwise. This is a good way for the company to frame the issue, because there’s not much money to be had.

Spotify’s payment formulas are not public, but various leaks indicate that on average, artists and labels are paid around one-third of one cent every time a user listens to (“streams”) a song. By way of comparison, artists and labels make 70 cents when a song is purchased for 99 cents from iTunes. Thus, a user has to listen to a song on Spotify more than 200 times before earning ad revenue for the artist and label that’s equivalent to a sale.

Seen a different way, when an artist manages to attract a million Spotify listens — no small feat — it brings in just $3,300, and if a given user listens to 20 hours’ worth of four-minute songs in a month, his activity generates just one dollar for artists and labels. Some distributors and labels that have tried Spotify — including my favorite indie heavy-metal label, Century Media — have pulled their music from the service because of the low pay.

Plenty of other labels are still on Spotify, of course. But it’s hard to make the case that Spotify, as an alternative, innovative model, provides reasonable compensation to artists and labels in return for the costs of producing, promoting, and selling recorded music. At best, it can be seen as a loss leader to promote live shows and T-shirt sales — meaning that people like me, who listen to music constantly but rarely interact with bands in other ways, become free riders, thanks to the industry’s attempts to “innovate” its way around a law-enforcement problem.

And, despite not paying artists and labels much, Spotify isn’t making money yet.

Some of the same problems plague a similar innovation in TV and movie distribution, Netflix’s streaming service. As Megan McArdle of The Atlantic has noted, studios initially didn’t mind the low compensation they received from streaming, because streaming was a low percentage of overall consumption and probably cut into Netflix DVD rentals more than actual DVD sales. But as streaming gained ground and threatened other revenues, the low pay became a problem, and Netflix has yet to come up with a solution to attract more studio content. Though the company hiked prices dramatically last year, its streaming service is still lacking when it comes to new movies and recent seasons of TV shows.

Further, while Salam and Ruffini cite statistics indicating that the global entertainment industry is doing A-okay, it’s just as easy to cite evidence that piracy is lowering creative output — as with any complex economic topic, entertainment sales can be analyzed from any angle, and the numbers can say whatever you want them to. Some economists have even purported to prove the laughable thesis that it was just a coincidence that sales imploded at the exact moment when piracy took off.

But piracy does “put pressure on profit margins,” as Salam delicately put it on National Review Online recently. By one estimate, per capita, inflation-adjusted spending on recorded music has fallen 64 percent since its peak in the late 1990s, and is lower today than at any time since at least 1973, despite the fact that every other person you pass on the street is wearing earbuds. The numbers change little when one uses total rather than per capita revenue, and home-video sales are falling as well. It is difficult to tell how much of this is attributable to trends other than piracy — for example, iTunes made it possible to buy individual songs for 99 cents instead of purchasing entire albums — but it seems undeniable that piracy played a major role. That in itself should be troubling to anyone who thinks the profit motive matters — with less profit, presumably, will come less creative output.

And “less creative output” must be measured not only against the entertainment industry as it stood before the Internet — no one is saying we should ban the Web, so such a comparison is meaningless — but also against the entertainment industry today as it would stand with a better anti-piracy regime and the benefits of the Internet. If our failures of copyright enforcement hampered the entertainment industry while the Internet’s sales and marketing potential should have been boosting output, we as a society have lost out.

It’s not possible to measure against a hypothetical world, but one can at least contend that some forms of creative output are in outright decline. As commentator Eduardo Porter noted in the New York Times, while the total number of music-album releases rose between 2005 and 2010, releases of albums that sold at least 1,000 copies — a rather low standard by which to judge whether an artist is making a significant contribution to the world of recorded music — declined about 40 percent. Of course, like Salam and Ruffini’s, Porter’s data are highly debatable — he relies on the Nielsen sales database, which excludes some independent releases and does not count sales of single songs.

The finer points of entertainment economics aside, if widespread and increasingly popular illegal behavior is costing American companies business, and possibly reducing artists’ creative output, it is first and foremost a law-enforcement problem, not an “innovation” problem. It is entirely reasonable for Hollywood to petition the government for better anti-piracy efforts, even if the industry has lobbied for bad legislation in the past.