How Bad Is Music File Sharing? – Part 7

In their working paper Curien and Moreau (2005) proposed a model of the music industry under “piracy” in which they took into account quality, variety, as well as price adjustments and showed that P2P file sharing networks could have a positive impact on the music industry as whole (recorded and live music as well as complimentaries such as ringtones). However, record companies bear almost all of the negative effect, whereas artists rather benefit from it, since royalties are often the smallest amount of their income, whereas “piracy” tends to boost live performances.

The authors considered music industry as a monopoly. The industry incurs 3 types of cost: (1) production costs; (2) promotion costs; (3) distribution costs of CDs. Especially the distribution of CDs mainly generate fixed costs, whereas variable costs tend to be zero. The consumer has a “subjective quality” for a given variety of music and a willingness to pay for the preferred music. Two effects have to be considered: First, a positive influence of perceived quality on demand; second, a demand sensitivity to the relevance of supply, as willingness to pay is a decreasing function of the distance between the consumer’s ideal variety and the actual supplied variety. Willingness to pay is measused by Curien/Moreau by the maximal expenditure the consumer is prepared to make for her/his music consumption – buying either CDs or concert tickets as well as ancillary goods. Thus, the consumer’s budget is split between music purchases, concert tickets, and ancillary goods. In addition, the authors also consider a sampling effect of music downloading on concert ticket purchases.

In the following, the authors model the recorded music market, the industry’s as well as artists’ revenues, and deduct a profit maximizing strategy for the music industry’s firms. The following propositions were derived (Curien and Moreau 2005: 13-17):

1. The internalization rate of live-shows has a positive impact on quality, diversity, and profit, whereas the “piracy” rate has a negative impact.
2. “Piracy” systematically leads to lowering CD prices, whereas internalizing part of live music revenue may lead to increasing price, as long as the rate of internalization is low enough. The best strategy for the industry is to augment price together with quality. If, however, the share of concert revenues increases, optimal strategy is then to lower the price of recorded music in order to generate more consumer surplus and more live music revenues.
3. Provided that the live music sector is large enough, the industry is better off with “piracy” and compensating for internalization.
4. As long as the size of the live performance market is lower than that of the recorded market, artists are better off keeping all revenues in a world of “no-piracy”. If the concert sector becomes more important, the artists benefit from sharing some revenue with the industry.
5. In the world of “piracy”, in which the whole music market is displaced towards live music, artists benefit if they share their revenues with the industry.
6. If the live market is large enough, artists always gain from sharing revenues with the industry.
7. If there is initially no “piracy”, the artists have no interest in sharing their revenues at all. When P2P file sharing emerges, the strategic game between artists and record industry leads to an equilibrium, where the industry is worse off than initially and the artists may be better off if the live sector is large enough. In this situation, the firms have an incentive to integrate vertically.
8. If recorded and live music markets are vertically integrated and controlled by majors, profits could be redistributed from artists to the industry.

The authors, therefore, concluded from the model that “(…) record companies should better try to accommodate piracy by exploiting one of its main features: its ability to ensure a large scale diffusion of music at a very low cost” (Curien and Moreau 2005: 20). If they are vertically integrated with the live music sector, the majors could improve their profits by allowing free downloads of music from their webpages, and therefore they should implement a global licence.

 

References

Curien, Nicolas and François Moreau, 2005, The Music Industry in the Digital Era: Towards New Business Frontiers? Working paper, Laboratoire d’Econométrie, Conservatoire National des Arts et Métiers Paris. February 9, 2005.

 

In the next part of the file sharing series two papers – a theoretical and an empirical one – of Martin Peitz and Patrick Waelbroeck will be discussed, which came to different conclusions.