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Costing the alternatives to Apple Pepsi DRM

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Analysis Imagine a world where music and movies could be freely exchanged online, where artists are recompensed and the labels don't lose a cent, and where 12-year old girls need not fear harboring an MP3 of their favorite TV show theme tune on their PC.

All that could be yours for less than the price of a subscription to Napster: for less than $6 a month. Harvard University Professor Terry Fisher has completed the first comprehensive examination of various alternative models and the one we outline here offers such tantalizing social benefits, that even the most jaded sceptic ought to pay attention. Professor Fisher belongs to the school of forensic sceptics rather than the school of wide-eyed techno-utopians, and he's spent three years trying to make the sums add up. We think it's worth a look, and we think you ought to take a look too. (To make his task even more difficult, Fisher's license model also takes on the additional onerous task of compensating Hollywood, too).

How does it work? Let's look at the sums: what level of compensation do the labels, studios and artists need to make it worthwhile?

Fisher actually lays his philosophical armory down for us to inspect at a very early stage, and it's thus. Economies have had a lot of trouble with public goods that are 'nonrivalrous' - if you use it you're not depriving someone from access - and 'nonexcludable' - it's actually hard to make them exclusive. Examples of the latter include roads, defense, and culture. It's a real danger that if no one pays, then nothing gets done: the roads crumble, the country becomes vulnerable, and aspiring pop stars give up their dreams of one day snorting cocaine from an expensive prostitute's thighs.

But our flippant illustration of the final example is not entirely accidental. Many artists forsake fame for fame's sake - but the beauty of alternative reward models is that there's no disincentive for them to become popular, either. To cite an example, when we've discussed flat fees before, someone usually writes in with some anguish to complain how this would only reward Michael Jackson for being popular. But what's wrong with that? There was a time when he was very popular, and deservedly so.

So let's start at an accountant's year zero.

Calculating lost revenue

In the year 2000, the record labels earned $7 billion on retail sales of $13 billion. For the sake of argument, let's assume that in the first year 20 per cent of retail sales were lost to unlimited copying. That's $1.4 billion, although they'd save $210 million in manufacturing costs, and approximately $145 million in mechanical royalties. That brings the compensation to $1.045 billion for the recordings royalties and $138 million for songwriters, plus an amount for lost radio-related royalties.

For the movie industry, calculating the potential loss is extremely difficult. Firstly it's hard to estimate how much the industry earns now from DVD and VCR sales and rentals, and cable and satellite deals. And it's even harder to gauge the loss from file swapping. Even with the advent of Bitorrent, downloads are slow, and few have the patience or resources to find value in them compared to the availability on offer at plentiful late night retail outlets. Fisher reckons five per cent, rather than twenty per cent for the music business, of a $10 billion industry, or $479 million.

So combined, that's $1.677 billion to keep the RIAA and the MPAA happy.

But of course that's not all it would cost: the model requires an organization to calculate and distribute the royalties, performing the duties of ASCAP or BMI today. ASCAP reported that its 1998 administrative overhead was 16 per cent, so Fisher generously estimates 20 per cent. (It's pretty generous, as we'll see, because the digital overheads may actually be much lower). This takes - and bear with us, because it also generously throws in a 10 per cent charge for inflation between 2000 and 2004 - the net result to $2.306 billion.

So who pays?

Raising the money

If it was implemented as a regressive poll tax, with 87 million household filing IRS returns, each household would pay a mere $27 extra a year: a little over $2 a month, or 51 cents a week. That's half the price of a single iTunes Music Store song.

That's the most efficient way, with the lowest overheads.

However, any kind of income tax increase is obviously a hard sell, especially in God and Gubbment-fearing America. And there are many sound objections. Why should the poor subsidize the rich? Why, notes Fisher (who clearly must remember the culture wars of the early 1990s), should a proportion of the population which finds the entertainment products blasphemous be asked to subsidize their creators? And why should Net-free households want to subsidize the broadband users who are actually taking advantage of the system?

Fisher then exhaustively discusses four other options: taxing the playback devices and/or burners, levies on the physical media, levies on the delivery service, such as Kazaa, or on the Internet access point (your ISP). The latter is by far the largest: spending on broadband in the US in 2004 is estimated to be $16.4 billion. By contrast, blank media sales generate $2 billion in revenue. In total, these four categories gross $20.248 billion. And so to get our $2.3 billion to compensate artists, studios and labels would require an 11 per cent hike.

But what if it fell entirely on broadband users? Some might find the figure surprising: excluding all of the other penny taxes we've just mentioned, the cost will be $6 per broadband user per month. Um, is that all? Well, actually, yes it is.

So what do consumers gain from suddenly being able to exchange music? It's perhaps the most delicious question that's ever been asked - and there are so many advantages to the free exchange of culture that we may have forgotten what they are.

Fisher puts it thus:

"Consumers would pay less for more entertainment.

Artists would be fairly compensated. The set of artists who made their creations available to the world at large – and consequently the range of entertainment products available to consumers – would increase.

Musicians would be less dependent on record companies, and film makers would be less dependent on studios, for the distribution of their creations.

Both consumers and artists would enjoy greater freedom to modify and redistribute audio and video recordings. Although the prices of consumer electronic equipment and broadband access would increase somewhat, demand for them would rise, thus benefiting the suppliers of those goods and services. Finally, society at large would benefit from a sharp reduction in litigation and other transaction costs."

Is that enough? Well, there are two other benefits Professor Fisher doesn’t list. The high street music chainstore would find itself in competition with informal music distribution points - such as concert venues, clubs or coffee shops. Given the availability of cheap wireless playback hardware (phones or Bluepods) every café or laundrette could become a 'record store'.

The stores that survive would of necessity focus on their expertise and social relationships. It's hard to see what would draw customers into a Virgin chainstore, but it's easy to see an Aquarius Records (a feted specialist store in San Francisco's Mission district continuing to draw a loyal following). Social spaces could be transformed. Nor does Fisher attempt to calculate the demand for Internet infrastructure which might result, with potentially huge macroeconomic benefits.

Divvying up the pot

So what's the fairest way to divide the revenues? Professor Fisher points out that only a representative sample is required: the model need not involve Big Brother surveillance and aggregation of every song played. TV advertising buyers trust a system already: Neilsen's ratings are calculated from only a few thousand households. And in any case, it's doubtful any agency could afford the IT infrastructure required to aggregate such a vast data warehouse. However Fisher has a technical proposal which could simplify auditing enormously. He suggests that digital media carries embedded watermarks which would not restrict the playback of the song but would help auditors.

Fisher says that the "ballot stuffing" is the biggest technical hurdle.

"You can never eliminate but you can minimize the ballot stuffing problem," he tells us. "This most promising solution is an automated sampling system that counts the frequency members of the sample play a song all the way through. It's possible for artists to inflate the figure somewhat, to persuade family members to leave computers on 24x7, but that static is tolerable."

The most significant disincentive to ballot stuffing is the model itself: most people would simply want the model to work. Unlike the current situation, where there's a monetary advantage to be gained by breaking the system.

As for cross-border 'leakage' - Fisher says it is troubling from a fairness standpoint and this could limit its political appeal. "But it could work internationally especially when compared to a regime that leaks like crazy - the regime currently using illicit P2P."

The simple idea is very powerful. Fisher identifies four constituencies necessary to accept the model: consumers, artists, device manufacturers and finally the intermediaries: the studios and labels. The model has huge advantages for three of the four. And what incentives, we asked, would the labels and studios have?

After hearing his presentations, Fisher says industry is intrigued but hardly feels impelled to jump. The biggest 'carrot' is that it would see its revenues guaranteed at 2000 levels. If it believes its own rhetoric, that could be a very powerful incentive indeed.

Aside from a fringe of partisans, consumers are likely to embrace it enthuasiastically. Several months into the infancy of DRM-locked music sales, the online stores are dwarfed by the quantity of peer to peer file swapping, which is again on the rise. Consumers will likely face two futures.

In one, the music industry succeeds in locking music sales through DRM restrictions on MP3s, and equally restricted CDs. It's then at liberty to 'reinvent' itself, introducing such multi-sales opportunities we outlined here, and that Ross Anderson suggested in his TCPA FAQ: one-time plays, songs that only play on your birthday, graduated pricing models that charge a 'premium' for higher bit rates. Our favorite has already been suggested by the RIAA's Cary Sherman: a locked iPod full of all the music you'll ever need, which you can pay and unlock at your leisure. (It's deliciously illustrative of the lobby group, which has made the cynical, and not entirely false calculation that most of the people in the world have the same record collection. Or one that varies only by such sufficient degrees that it can apply the logic of the battery farm.)

The other comes at a price, but a predictable and low price, and promises to see high street and the economy rejuvenated. That isn't a hard choice for consumers to make, but it will need to be fought against entrenched lobbyists. Our thanks to Professor Fisher for his exhaustive research in making our choices clear. ®

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Professor William W. Fisher

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