Free markets are driven by innovation. But regulation tends to discourage disruptive changes that bring about breakthrough products and services to consumers. The current clash over copyright licensing royalties for webcasting shows a stark contrast between the pro-market approach and the pro-regulatory approach to dynamic markets.
The variety of emerging
technologies and platforms for providing digital music services suggests a marketplace
environment that is innovative and competitive. Webcasting services like
Pandora, Spotify, and iHeartRadio are the market's latest breakthroughs. Yet
digital music content is currently subject to a regulatory regime of forced
access mandates and price controls. Music copyright owners are compelled to
license their content to music service providers, typically subject to
different rates depending on the type of service involved.
When it comes to digital
music content, federal policy has the effect of insulating the status quo from
disruptive changes. But if anything deserves to be disrupted or changed, it's
the current regime of regulatory controls. Transitioning to a free market
framework for music copyright licensing royalties would best unleash the forces
of innovative change, to the benefit of consumers.
On
November 28, the House Subcommittee on Intellectual Property, Competition and
the Internet held a hearing on
webcasting of digital music and copyright licensing royalties. Testimony
focused on rate-setting standards governing royalties that webcasting services
should pay to copyright owners. The
so-called "Internet Radio Fairness Act of 2012" (H.R. 6480/S.3609), which was under discussion at the House
Subcommittee's hearing, would move webcasting from under the "willing
buyer/seller" rate standard to the 801(b) standard that applies to certain
other music services.
Federal
law charges the Copyright Royalty Board to determine "reasonable terms and
rates" for such royalties. The Board applies the "willing
buyer/willing seller" standard to webcasting services. That is, the Board
determines what royalty rates "most clearly represent the rates and terms
that would have been negotiated in the marketplace between a willing buyer and
a willing seller."
However,
the Board applies the different Section 801(b)(1) rate standard to other
services, such as cable and satellite providers. Under the so-called 801(b)
standard, "reasonable terms and rates" are those calculated to: (A)
maximize availability of creative works to the public; (B) afford copyright
holders a fair return and copyright users a fair income under existing economic
conditions; (C) reflect the roles of the copyright holders and users with respect to creative contribution,
technological contribution, capital investment, cost, risk, and contribution to
the opening of new markets; and
(D) "minimize any disruptive impact on the structure of the industries
involved and on generally prevailing industry practices."
This
anti-disruption proviso epitomizes what is wrong with the existing regulatory
regime controlling music copyright royalties. Indeed, this aspect of the Section 801(b) was the
subject of intense debate in House Subcommittee hearing testimony. And it should be a focal point for rolling back and
eventually eliminating the compulsory licensing and rate-setting regime rather
than expanding it.
New
ideas and novel applications of knowledge are what sustain and drive free
markets. That disruption enhances consumer welfare has become so widely
recognized it has all but attained axiomatic status. Disruption is the result of successful investment
and innovation. Unpredictable and rapid
changes in technologies and business models lead to new products and services, overthrowing
old industry patterns. This includes
the dramatic rise of new entrants, creating new demand through supply and overthrowing
complacent incumbents.
The
critical role of disruption in modern markets has also been explained by a myriad
of entrepreneurs and academics. Former Intel CEO Andrew Grove, for example,
popularized the concept of "strategic inflection points" in describing
when the fundamental rules of industry and business operations are dramatically
altered by "10X changes" in competitive forces, technology, or
consumer behavior. In his book, The Innovator's Dilemma, Harvard Business School's Clayton Christensen
brought into sharp focus the role of disruptive innovation in markets,
resulting from changes in business models and technology. For that matter,
House Subcommittee hearing
testimony by SoundExchange President Michael J. Huppe offered several other
examples of leaders in technology markets, including music services, extolling
the benefits of disruptive change in enhancing economic well-being.
Of
course, no one should want regulatory standards to determine the future
direction of market disruption. But neither should regulation seek to forestall
or banish it. As economist Jeffrey Eisenach pointed out in his hearing
testimony, 801(b)'s ratemaking provision grants to users "a de
facto right to perpetual
profitability based on their current business models."
The
existing regulatory regime governing music copyright royalties supplants market
freedom by controlling access to and prices for the primary input for many
music services – that is, digital music content. These problematic aspects of
price controls were the focus of my Perspectives
from FSF Scholars paper, "Putting Music Copyright Policy on a Free Market Footing." Although the willing buyer/seller standard is
intended to mimic market-based prices, like the 801(b) standard it still
involves an onerous displacement of free market mechanisms of adjustment to
changing circumstances. Section 801(b)(1)(D) takes regulatory intrusion a step
further, however, by expressly seeking to impose stasis in pricing.
Moreover, the current
compulsory licensing and ratemaking regulation for digital music content
regulation tends to foster a market environment that is inhospitable to
experimentation and to further waves of innovation. Government-prescribed rules constrain or even
displace the risk-taking and knowledge-based decisions of diverse market
providers. The difficulty is that when
regulation prompts providers to forego promising innovations, the opportunity
costs to consumer welfare are impossible to measure.
Forced
access and rate regulations of digital music are particularly unjustifiable in
light of today's market conditions. Long gone are the days when radio and
cassette tapes were the only ways to access music. CDs and vinyl are still
widely available for music aficionados, along with broadcast radio. But
consumers now have ample choice among cable music services, satellite radio, online
on-demand services, as well as webcasting services relying on ad-based or
subscription models.
House
subcommittee hearing
testimony by Pandora Chairman and CEO Joseph J. Kennedy, raised
understandable complaints about the "lack of a level playing field."
After all, webcasting services are subjected to a different rate standard than
other services, such as cable and satellite. (Commercial radio broadcasters,
for that matter, are exempt from having to pay music copyright royalties at
all.) But these fights regarding fairness and favoritism are an inevitable
by-product of unnecessary over-regulation. In a dynamic market, such as the
market for music content, such disputes are best left for the market to sort
out.
In
the end, the Internet Radio Fairness Act marks a move in the wrong direction. Rather
than readjust rate standards for webcasting, Congress should seek to reduce
regulation in this space for all music services. The ultimate aim of federal
policy for digital music content and copyright licensing royalties should be a
truly free market. That means eventual
elimination of compulsory licensing and ratemaking.
In
the New Year, FSF hopes to continue addressing some of the basic constitutional
and free market principles that should guide any transition to a free market in
digital music content.
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