Martin Peitz from the University of Mannheim and Patrick Waelbroeck from the Ecole nationale supérieure des télécommunications in Paris focus in several articles on the impact of file sharing on music record sales. In a 2004 article in the Review of Economic Research on Copyright Issues they provided empirical evidence that music downloading have caused a worldwide reduction in music sales of about 20%. In contrast, they argue on the basis of a theoretical model in a 2006 article in the International Journal of Industrial Organization – based on 2005-working paper – that due to the sampling effect the record labels do not necessarily suffer from file sharing activities. How the come to these different conclusions can be read here.
The article “The Effect of Internet Piracy on Music Sales” (Peitz and Waelbroeck 2004a) is based on a working paper (Peitz and Waelbroeck 2004b) with the same title. For this study, Peitz and Waelbroeck used data from the IFPI world report of 2003 for 16 countries, which represent 90% of the world market value. The number of downloads were obtained from IPSOS-REID market research. The cross-section analysis showed, “(…) that music downloading could have caused a 20% reduction in music sales worldwide between 1998-2002” (Peitz and Waelbroeck 2004: 78). However, the analysis also revealed “(…) that other factors than music downloads on file-sharing networks are likely to be responsible for the decline in music sales in 2003” (Peitz and Waelbroeck 2004: 78.).
In the regression model, music sales given in total units of recorded music (singles, LPs, music cassettes, and CDs) is the dependent variable. The explanatory variables are gross national product (GNP in US$) and the number of downloads reported by IPSOS-REID as a proxy for Internet music “piracy”. Although the number of downloads does not reflect the intensity of downloading activity, the authors consider this variable as a good proxy. In addition, broadband penetration, digital media player penetration, DVD player penetration as well as the penetration of CD-R burning devices were also tested as independent variables.
The estimation results indicated that income (GNP growth) has a strong positive effect on CD purchases. In contrast, the number of downloads as proxy for Internet music “piracy” has a negative effect on CD purchases. “The implied loss of CD sales due to MP3 downloads is -20% for the period 1998-2002” (Peitz and Waelbroeck 2004: 75). To obtain this effect, the authors multiplied the estimated coefficient by the sample average number of downloaders as a percentage of the number of Internet users. This gives only a crude estimate of the effect as the authors admitted, but they consider it a good reference value.
The estimantion results also indicate that broadband penetration has a higher negative impact on record sales than the number of downloads from P2P file sharing networks. However, the authors did not believe that broadband penetration is a good proxy for “piracy”. Also the penetration rate of digital media players has a negative impact on music sales, whereas DVD penetration and the penetration rate of CD-R burning devices does not add much to the explanatory power of the model (Peitz and Waelbroeck 2004: 76).
Although the study shows a clear negative impact of P2P file sharing on record sales, the authors admitted that it ignored other explanatory factors; therefore, more micro-studies are needed.
Peitz/Waelbroeck (2006) presented a multi-product monopoly model in which prodcts are located on the Salop circle and in which consumers regard orginals superior to copies. The model showed that the emergence of P2P file sharing networks leads to higher profits if there is suffient taste heterogeneity and product diversity. In addition, if variable demand is added to the model, file sharing can lead to lower prices, higher unit sales, and higher profits (Peitz and Waelbroeck 2006: 908).
The model assumes that the products are located with an equal distance from each other in respect of product differentiation. Therefore, the labels would always charge the same price across all products. Since the marginal costs of production are zero, the profits are equal to revenues. Further, it is assumed that consumers do not have any information without downloading and therefore buy at random. They are faced with a two-stage decision process: (1) Either downloading or not; if they download, consumers learn more about their preferred music; (2) Either buying one unit (e.g. a CD) or not.
In the following, Peitz/Waelbroeck analyzed the market when downloading is not possible and when downloading is possible. In comparison, the model indicates “(…) that a firm can obtain higher profits if downloading is possible” (Peitz and Waelbroeck 2006: 911). This holds only true “(…) if there is sufficient taste heterogeneity (…) and sufficient product diversity” (Peitz and Waelbroeck 2006: 912). However, the results do not alter if variable demand is considered.
Thus, the authors concluded: “Do music labels necessarily suffer from downloading on P2P networks? Our analysis shows that the answer is ‘no’. In our model, profits increase for a certain set of parameters because consumers can make more informed purchasing decisions because of sampling and are willing to spend for the original although they could consume the download for free” (Peitz and Waelbroeck 2006: 912).
Peitz, Martin and Patrick Waelbroeck, 2006, “Why the Music Industry May Gain From Free Downloading – The role of Sampling.” International Journal of Industrial Organization, Vol. 24 (2006): pp. 907-913.
In part 9 of the ongoing series I will summarize the results of Alejandro Zentner’s article “Measuring the Effect of File Sharing on Music Purchases”.