THE LONG TERM FUTURE OF THE RECORDED MUSIC INDUSTRY:

How Will Copyright Law Need to Change

to Accommodate Advancing Technology?

by

Michael J. Lippitz
EES 214A, Prof. Donald Dunn
March 16, 1987

I. Overview

II. An Equilibrium Model of the Music Industry

III. The Social Context of Technological Development in Music

IV. The Economics of Recorded Music and its Production

V. Music Industry Sales Response to the Ascendency of Technology

Figure 1: Recording Industry Unit Sales, 1975-1986
Figure 2: Recording Industry Revenues, 1975-1986
Figure 3: Record, Cassette, CD & Blank Tape Sales, 1975-1986

VI. The Long Term Future of the Recorded Music Industry

(1) The Music Distribution Market
(2) The Music Production Market
(3) Associated Markets

VII. Conclusion: Problems in Getting from Here to There

, 1 • ~

~ Overview

Digital audio: Beethoven's Fifth Symphony captured in fifteen billion

"ones and zeros," a permanent noiseless reproduction of every orchestral
sound. It is seemingly the ultimate in recorded music and a boom to the
recording industry. But the same market demand that pushed audio quality
forward forced high fidelity equipment prices down, encouraging violation
of music copyrights, a possibly significant threat to manufacturers. At
the same time, parallel technological developments in home video, cable
television, and computers are redefining the household entertainment
market.

The purpose of this paper is to speculate where the recorded music

industry will head as these market forces mature. To accomplish this, an
equilibrium model of the United States music industry is proposed in which
"music," "industry," and "technology" interact symbiotically within the
economic, political and social trends in society at large. After examining
the market from the perspective of each component, identifying the
fundamental causes of change and discussing the effectiveness of current
copyright law, the long term technical future of the industry will be
speculated and the resulting markets analyzed with a view towards
anticipating what types of public policy changes will be required.

~ An Equilibrium Model of the Music Industry

In The Crossroads of Business and~, Laurence Shore proposed an

equilibrium model to describe the fundamental components and interactions
necessary for recorded music production. His pictorial representation
appears on the following page, along with his definitions of the components
and explanation of the model. (Please consider it carefully before
continuing.)

Expanding his description of the model, the changes in anyone

components may be thought of as inspired--at least indirectly--by some
social "force." Changes not only for the other components to respond but
may also permanently alter the equilibrium position of the components.

Examined historically, one could broadly claim that industry dominated

music production from the invention of the phonograph (1877) until the late
1950's. The high cost of manufacturing equipment and the relative concen-
tration of technical knowledge supported this dominance. The major
recording companies--no more than half a dozen at any given time--wrote and
produced their own repertoire for hired performers, developed their own
technologies, and marketed their product almost exclusively to a white
middle-class audience. While FM radio, stereophonic sound, television and
other significant technological developments had a profound impact on the
structure of the industry, these technologies mostly served to change the
relative dominance among major companies rather than loosen industry's
control. [1]
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TIME

music

(1) Music--This refers to the cultural form or ... the cultural product
(2) Industry--This component refers to the various business enterprises
involved in the production of music.
(3) Techno1ogy--This includes all the technologies of recording and
reproducing music and musical instruments which are the
result of technological developments.

These components do not interact in isolation. The particular social and

economic context of the larger society is represented by the circle surrounding
these three components. The whole process is not static but evolves over time.
This dimension is indicated by the time arrow in the diagram .

... In order to account for (the) surge and waning of dominance or

influence (among the three components), it is necessary to introduce the notion
of moments of ascendency. This suggests that each of the components has a
particular moment in time when it is dominant in its relationship to one or
both of the other components, in the sense that it exerts a primary influence.
At this moment, the other components are forced to respond.

--The Crossroads of Art and Business. ~ 34-36.

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All this changed in the late 1950's. Due to a variety of social

forces--e.g. the migration of blacks to the north and the post-war baby
boom--rock music exploded onto the music scene. Initially ignored by the
major companies, several of independent producers emerged. By the 1960's,
the introduction of synthesizers and electric guitars changed the funda-
mental nature of music and its production. The Beatles, being one of the
first groups to compose their own music and create their own production
company, were able to control several aspects of production that had
traditionally been the domain of the major recording companies. Other
groups followed their lead and in response recording companies increasingly
used recruiting to obtain repertoire versus developing music in-house. [2]

The ascendency of technology began in the late 1970's and continues

today. As a result of rapid developments in microelectronics, the market
for common home audio components (receivers, amplifiers, turntables and
tape decks) has matured, driving down prices. Unlike previous
technological developments, the dispersion of tape decks could not be
controlled by recording companies. In 1978, digital audio in the form of
the compact disc (CD) promised to set a new standard for sound quality. In
1987, the digital audio tape (DAT) , capable of reproducing the same quality
sound as a CD, will be introduced. The major producers fear that OAT will
further encourage the practice of home taping that began when tape decks
become inexpensive and accessible.

So where will this ascendency of technology take the industry? Are the
major producers' fears founded? If so, what changes in public policy are
appropriate? To approach these questions, it is necessary to look more
carefully at (1) technology in its social context and (2) the economic
facts of the music industry.

III. ~ Social Context of Technological Development in Music

Save for basic research. technological development may be viewed as a

direct response to perceived social needs. But what exactly are these
social "needs?" Since the late 1970's,the re-emergence of the traditional
"American Dream" led many consumers to work harder than ever in an attempt
to "make it." Making it is thought of as having achieved "the good life,"
and in the American psyche, this is typically associated with material
comforts and quality leisure time.

Of course. acquiring material things requires money, and money-making

time must be traded off with leisure time, thus "convenience"--speed,
ease-of-use. and the like--has become an increasingly marketable product
feature. The pursuit of comfort has come to mean insulation from the
"

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difficulties associated with many social environments, e.g. waiting in

line or crowding into a theater. Consumer technology has thus been focused
on making as many things as possible accessible in the comfort of one's own
home and on minimizing the stress of social contacts.

In the music industry, these trends have exhibited themselves in the

growth of the market for "walkman" personal stereos, which serve both as a
convenience due to their portability and as a comfort due to their ability
to "insulate" an individual in crowds. The same insulation effect is true
for automobile stereos, almost a standard feature in today's cars. The
cassette tape, generally easier to manipulate than a record, became the
primary source of prerecorded music in 1983. (Only eight years earlier,
prerecorded cassettes has sold at only one-tenth the pace of records)

Music technology was not the only home entertainment product to

advance in the 1970's. Along with the maturation of the market for common
stereo components other significant products were introduced in the United
States: Cable television, the VCR, and the home computer. Suddenly, the
options for visual home entertainment increased by an order of magnitude,
and the market growth has been dramatic. The music video, an entirely new
medium, was created, pulling in thousands of teenage viewers, the largest
demographical market segment in the industry. Computer video games also
began to compete for the teenager's disposable income. [3]

On the producer side, the increasing quality and decreasing cost of

sound mixing equipment has diminished the control of the major companies.
There are currently some 5000 registered production companies in the United
States. The high capital costs of mass manufacturing, however, has
prevented the rise of small companies in that aspect of the music industry.

IV. ~ Economics 2f Recorded Music and its Production

In a pristine sense, recorded music is completely non-depletable: My

recording and listening has no impact on the value of your recording and
listening. However, it is not "free" in the conventional sense of a public
good because the supply at zero price would not exceed demand. Further-
more, resources are consumed and alternative activities foregone in its
production. Therefore, the salient public policy issue involves regulating
its excludability, a typical free rider problem.

Presently, the balance is set using copyright law, allowing for the
collection of a few cents from every recorded music purchaser. (Obviously,
the transaction costs of negotiating individual contracts would be
prohibitive on a large scale). To mitigate the monopoly position that
would be enjoyed by artists if copyright protection were absolute, the U.S.
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Code known as "compulsory license" allows any manufacturer to produce

copyrighted music as long as a roya1ty--set by the government--is paid to
the owner. Also, the "fair use" provisions written into the copyright law
allow certain non-commercial uses of music without payment of royalties.
When reviewing music copyright law in 1971, for example, the House
Judiciary Committee commented that "it is not the intention of the
Committee to restrain the home recording, from broadcasts or from tapes or
records, of recorded performances where the home recording is for private
use and with no purpose of reproducing or otherwise capitalizing commer-
cially on it." [4] It follows that home taping exclusively for use in
one's own car or wa1kman is not considered to be a violation of copyright.

Royalty payments presently make up almost half of the cost of record

manufacturing. The breakdown for a successful release of a full-length
album is approximately as follows:

Performer's royalty 1.00

Composer's royalty .32
Manufacturing cost .95
Promotional costs ~
PRODUCTION COST $2.80
Manufacturer's profit 1.00
Distributor's profit .50
Retailer's profit 3.68
LIST PRICE ------- $7.98

Total production costs typically run about $250,000 for a full-length

album. Since artists royalties are withheld until production costs have
been recovered, the manufacturer's break-even point is at about 100,000
albums sold. By recording industry estimates, more than 75% of all albums
manufactured lose money; for classical records, the figure is close to 95%!
For major manufacturers, then, big selling albums support those that do not
recover costs. [5]

This low hit-to-re1ease ratio supports a large disparity of earnings

among musicians. The bulk of manufacturers' promotional budgets support
the big sellers, making it exceedingly difficult for a new name to succeed.
In 1976, for example, the average income for members of musicians' unions
was less than $14,000. [6]
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~ Music Industry Sales Response to the Ascendency of Technology

Having examined the general direction of technological development in

the household entertainment market and the economics of recorded music
production, one is in a good position to evaluate market data to assess the
measurable impact of the ascendency of technology. With these data, one
may comment meaningfully on the efficacy of current copyright law and
justify proposals for change.

The recording industry boomed in the 1970's. Annual revenue growth

averaged 15%, peaking at $4.1 billion in 1978, much larger than even movie
industry revenues ($2.7 billion). But industry fortunes changed in 1978.
Revenues dropped to $3.6 billion by 1982 with total volume down 20%. In
the same period, new releases dropped from 4,170 to 2,500. Revenues jumped
to $4.4 billion in 1984 but have remained flat through 1986. [7] The music
industry blames the unenforcabi1ity of copyright law vis-a-vis home taping
for the levelling off of its growth. Current industry estimates of lost
sales in the United States are $750 million per year, 17% of total
revenues. [8] A more careful review of sales statistics and consideration
of broader economic, demographic, and competitive factors suggest
alternative explanations for the industry's retarded growth.

The first thing to note is that total revenue and unit sales
statistics are derived from five sources: LP's (full-length, 33 rpm
records), singles (small, 45 rpm records), prerecorded cassettes, 8-track
cartridges, and compact discs (CD's). In counting unit sales each of these
media are counted equally, even though singles are only one-sixth as long
as the others. It would take fifteen or more singles to fill a blank tape,
compared to only two LP's, so it is arguable whether they contribute much
to home taping. Furthermore, singles are primarily marketed to jukebox
manufacturers, from which it is impossible to tape. Finally, 8-track tapes
are clearly an obsolete technology, thus their sales drop cannot be blamed
on home taping.

All in all, then, when discussing home taping it is only relevant to

consider LP's and cassettes, and CD's. Figures 1 and 2 on the following
pages are graphs of industry unit sales and revenues that compare sales of
all forms of recorded music to sales of just LP's, Cassettes and CD's [9].
Unit sales for these three are flat between 1978 and 1983, while revenues
actually increased steadily, though more slowly than before.

Figure 3, which compares sales of LP's, cassettes, CD's and blank

tapes casts the recording industry's assertions into more doubt. Most
obviously, if home taping was the cause of flat sales in the 1978 to 1983
period, why did industry sales jump in 1984 while blank tape sales con-
tinued to grow? One would expect the opposite effect. Secondly, the chart
clearly reveals the consumer preference shift from LP's to cassettes
discussed earlier. This shift corresponds to a boom in wa1kman sales,
which reached seven million in 1984, almost ten times the number of tape
decks sold. Indeed, every major category of audio/high fidelity equipment
 • I
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FIGURE 1: RECORDING INDUSTRY UNIT SALES

1975-1986
LP + CD +
Cassette All Forms
---
Units (Thousands)
700~----------------------------------------------~

600

500

400

300

200~ ____________ ~ ______________ ~ __ ~ __________ ~~

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986
Year
(1986 figures are industry projections)
 FIGURE 2: RECORDING INDUSTRY REVENUES
1975-1986
LP + CD +
Cassette All Forms
---
$ (millions)
5000~----------------------------------------------~

4000

3000

2000

1000~~ __________ ~ __________ ~ ____________________ ~

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986
Year
(1986 figures are industry projections)
 :

FIGURE 3: RECORD, CASSETTE, CD & BLANK TAPE SALES

1975-1986
LP's Cassettes CD's Blank Tape
--- - -- ••••••••
Units (Thousands)
400~----------------------------------------------~

,..-- ............--
I .•.••
300 I .. •• ••
.,.- ..
I ••••
...
.- ,
•••
-~
.#

•• •• ••
200 ••
•• •• ••
••
•• •• ••
••••
••••
••••
100 ••••
••••
•••••
•••••

____________ __________ ________ __ __

o
~
~
~
~
-
.
~
~
~
1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986

Year
(1986 figures are industry projections)
 -7-

(as measured from manufacturers associations) dropped or remained flat in

the early 1980's with the exception of walkmen, headphones and racked
systems. [10] It therefore stands to reason that a large number of blank
tapes sold were used by record owners to convert their collections to tape,
a perfectly legal endeavor if the tapes are only used personally.

It is illustrative to look at what percentage of home taping is

actually legal. The recording industry's estimated lost sales of $750
million in 1985 corresponds to 94 million LP's or cassettes at $8 a piece.
Since two albums may be taped onto a single blank tape, one could estimate
that 47 million blank tapes were used to tape copyrighted music; but this
represents only 16% of total blank tape sales that year. Therefore, at
least 84% of blank tapes are used for legitimate purposes.

For the up to 16% that are used illegally, it is unclear to what

extent this taping substitutes for legitimate sales. Every person who
receives an illegal recording would not necessarily have purchased the same
recording legitimately at six times the price. If all of these people are
actually acting in accordance with their true demand, at a higher price
they would substitute different goods for the recording. In other words,
all illegal home tapers are not "malicious" free-riders. Indeed, the
increased dispersion of the music no doubt has some positive effect on
legitimate sales.

The above analysis is not intended to condone illegal taping but to

suggest that it likely plays a much smaller part in the current downturn in
the recording industry than the major manufacturers claim. Clearly the
statistics argue against some extreme measures proposed by the industry
that would make all home taping impossible by requiring disabling chips on
tape recorders.

There are several more plausible explanation of flat sales in the

recording industry. One is competition in the broad household
entertainment market. Consider that right after the introduction of
television in 1947, recording industry revenues were flat for seven years,
from 1948 to 1954. [11] Analogously, computer video games alone consumed
$488 million in 1983. Video cassette sales reached $510 million in 1983
and surged to almost $1 billion in 1984. [12] A second relevant factor is
the national economic environment. Before one blames home taping for the
failure of sales to grow, one must take into account that the United States
economy suffered one of its worst recessions since the great depression
between 1980 and 1983. Third, the ascendency of rock music made it the
clear driving force in the record industry; today, popular music sales
account for more than three-quarters of total sales. However, more than
half of popular music listeners are under 30 years old, a segment of the
population that has been shrinking for years. Finally, one could attribute
some flattening of sales to consumer's uncertainty about the future of
recorded music following all of the speculation that following the
introduction of the compact disc. [13] It is important to note that
none of these trends suggest any need for change in current copyright law.
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VI. ~ ~ Term Future of the Recorded Music Industry

The first thing to consider in speculating on the future of recorded

music is what type of technological advancements will be available. The
most promising direction being pursued today is the upgrading of electronic
logic to optical logic. Optical devices would run faster and be able to
carry orders of magnitude more data than their electronic counterparts.
Eventually all wire phone lines will be replaced with optical fiber. As a
result, it will be feasible to use phone lines to support computer
networks.

What does this imply for the music industry? Since it is difficult to
imagine significant improvements in recorded sound quality, consumer demand
will be focused on convenience and price. Convenience can be thought of in
terms of portability and ease of use as before but also in terms of dis-
tribution. Presently, one must drive to a store to purchase recordings,
wait in line, etc., and there is no chance to sample the product except to
hear it on the radio or from a friend's recording. Nor can one economi-
cally purchase only a few selections from a full-length album. (This fact
no doubt provides incentives for home taping--who wants to pay $8 just to
hear a couple of ones favorite songs?). Obviously, it would be very
convenient to be able to sample products and shop at home. Finally, the
high cost of distribution today--recall from the cost breakdown for a
record given in Section IV that more than half of the current list price of
a recording consists of distributor and retailer profit--should also create
market demand for improvements in distribution.

The following analysis considers three markets of the future:

(1) The Music Distribution Market

(2) The Music Production Market
(3) Associated Markets (e.g. hardware and labor)

In each section, both the technical developments and appropriate public

policies will be outlined.

i l l The Music Distribution Market

In the future, distribution will be accomplished over a computer
network. After accessing a recording company's data base, one could select
any desired music and make a tape directly "over the phone" or store to an
optical hard disc. One would then be billed a few cents for each song
recorded to cover royalties. The company could allow users to preview the
first half of any song since taping only half a song would not be valuable
to most people. They could also sell tape jackets, lyrics sheets and other
accessories at the same time for those who wish to pay for them. (These
features add 30% to manufacturing cost today).
 -9-

The opportunity to circumvent copyright law will be even easier in the

advanced computer age. However, the incentive to do so would be small
since it would only saves one a few cents versus several dollars today.
Even in today's market, copyright law appears to be adequate despite
industry claims. It would be appropriate public policy, therefore, to keep
the current copyright law in force to allow for a small collection from
every user. Compulsory license regulations should be kept in order to
allow independent distributors to maintain specialized data bases for
particular consumer groups. Setting the government-regulated royalty
price would thus be the primary public policy concern, although a tax on
blank tape could now be justified since almost all home taping would be
subject to royalty as opposed to only 16% today.

For those without access to a computer terminal, retail outlets would

form to rent computer equipment. Such outlets could also produce and sell
conventional prerecorded tapes for those who do not wish to take time
making personalized copies. No additional regulations would be necessary;
however, new enforcement techniques would need to be developed to catch
pirates since a large business would have sufficient economic incentive to
try to sell several copies of a song while making only one royalty payment.

ill ~ Music Producers' Market

Artists fare well in the world of the future. They receive royalty
payments from all those people who purchased CD's and OAT's legitimately in
the past plus all the non-malicious free-riders. Assuming production costs
continue to drop, less popular artists will be able to sell their wares
more easily since the industry will no longer be dependent on large-scale
manufacturing, the primary exclusionary device today. A new, automated
system of copyright protection, however, will be necessary to prevent
thieves from claiming royalties for works they did not actually create. A
workable way to accomplish this would be to require distributors to check
new music against a government copyright computer, which would need to be
rather sophisticated to catch not only exact copies but also derivative
works.

i l l Associated Markets
On a broad economic scale, the net result of these technological and
public policy changes would be to shift national spending from distribution
to more productive uses (like building computer terminals and laying
optical cable!) Consumers would waste less time circumventing copyright law
since there would no longer be much incentive to do so. Depending on the
storage capacity achieved in hard disc technology, they might largely
replace mechanical tapes. One would instead expect the development of some
kind of cheaper programmable/erasable memory device for use in walkmen or
automobiles. No additional government regulation would be required for
these new industries.
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Conclusion: Problems in Getting From Here to There

The market of the future is significantly more competitive than at

present. Cheaper distribution and the elimination of the fixed cost
excludability of manufacturing today will make consumers and small
producers are the "winners" in such a situation. Large manufacturers,
however, are not "losers" if they adjust appropriately. The current
American business environment, however, seems to value sheer market size
over profits, therefore one would expect manufacturers to be too
short-sighted to shift their capital and labor into other endeavors, even
though this is all they need to do in order to maintain their size (as
corporations, if not as music manufacturers per se) and increase their
profits. They can be expected to continue to assert that technology is
destroying their industry "and costing American jobs" and that therefore
more copyright protection is required. As we have seen, however, illegal
taping is more a symptom of an industry overprotected in the face of broad
competition and economic, demographica1 and technical change than the
reflection of a fundamental failing of copyright law. With only minor
adjustments to copyright law and a few new enforcement procedures, the
industry could thrive in the long term.

Because industry is structurally short-sighted, it would be prudent

for government to enact legislation that will help ease them into the
future. For example, a tax on blank tapes could be used to raise the
revenues necessary to pay for worker retraining and to subsidize the
transaction costs involved in the retirement of capital assets. These are
the only legitimate reasons for raising such a tax. A plain subsidy would
not correct industry short-sightedness but would merely slow progress.
Under such legislation, the industry would become a government liability,
similar to the situation that exists in the tobacco industry today because
the government refuses to legislate progressively.

Unfortunately, such legislation seems unlikely without the passage of

legislation to curb the influence of concentrated wealth on the electoral
process. Otherwise, big money can afford to "purchase" protection from
Congress by funne11ing subsidies back to legislators via the PAC system.
Indeed, the music industry has succeed in introducing some very restrictive
legislation in the 100th Congress. [14] Campaign financing reform,
however, is Senate Bill #2. Let us hope that it passes.
.'.

FOOTNOTES

[1] Laurence Shore, The Crossroads of Business and Music, pp. 73-94.

[2] ~, pp. 94-130.

[3] ~, pp. 140-146.

[4] Sidney Sheme1 and M. William Krasi1ovsky, This Business of Music.

Fifth Edition, p. 144.

[5] Shore, pp. 171-200.

[6] Ibid., p. 172.

[7] Statistics from Sheme1 and personal coversation with Ms. Tanya
Blackwood of Recording Industry Association of America (RIAA), 3/13/87.

[8] RIAA, conversation 3/13/87.

[9] Statistics due to RIAA and 1985 ~ Statistical Abstract, p.

228.

[10] 1985 ~ Statistical Abstract, p. 228.

[11] Shore, pp. 84-85.

[12] 1985 ~ Statistical Abstract, p. 228.

[13] Alex Ben Block, "Digital dream, digital nightmare," Forbes,

November 3, 1986, pp. 205-6.

[14] San Francisco Chronica1, February 28, 1987, p.1.