Copyright Piracy and the Entertainment Industries: Is the Effect Massive or Negligible?

Stephen Carlisle August 13, 2014

On July 26, 2014, a DVD quality copy of The Expendables 3 was leaked online, ¹ three weeks ahead of its scheduled release. ² The best estimates are that it had been downloaded over 2.1 million times, ³ which threatened to take a hefty bite out of the profits of the film. This left Lionsgate scrambling to get a preliminary injunction against various BitTorrent sites. ⁴ Once again, the issue of piracy and its concurrent drain on the profits of entertainment companies is back in the spotlight.

With the advent of Napster in June of 1999, the fortunes of the music industry have plummeted. In 1995 and 1996, global music sales were close to 40 billion dollars annually. ⁵ Last year, global music sales limped in at 15 billion, ⁶ an overall decrease of 62%. The obvious reason would be that this is all due to piracy. Certainly, that’s what the Recording Industry Association of America will tell you, and points to this study from the Institute for Policy Innovation. ⁷ According to this somewhat dated study (2007), the effect of piracy is as follows:

a. As a consequence of global and U.S.-based piracy of sound recordings, the U.S. economy loses $12.5 billion in total output annually. Output includes revenue and related measures of economic performance.

b. As a result of sound recording piracy, the U.S. economy loses 71,060 jobs. Of this amount, 26,860 jobs would have been added in the sound recording industry or in downstream retail industries, while 44,200 jobs would have been added in other U.S. industries.

c. Because of sound recording piracy, U.S. workers lose $2.7 billion in earnings annually. Of this total, $1.1 billion would have been earned by workers in the sound recording industry or in downstream retail industries, while $1.6 billion would have been earned by workers in other U.S. industries.

Yet, there is disagreement about what the real effect of piracy is. Though the argument seems counter-intuitive, some take the position that piracy has little or no effect on the entertainment industries and point to several studies, the most famous of which is this study from 2008, ⁸ which states emphatically that “[t]here is no association between the number of P2P files downloaded and CD album sales.” ⁹ A later study by the same authors, after evaluating other contrary studies, did not cause them to back significantly off their prior analysis. ¹⁰ “Empirical work suggests that no more than 20% of the recent decline in sales is due to sharing [and] [f]ile sharing increases demands for compliments to protected works, for instance, raising the demand for concerts and concert prices.” ¹¹

So how do researchers, particularly those with an expert understanding of economics, come up with such wildly different conclusions? Part of the problem is that, currently, piracy is so pervasive that there is no such thing as a “piracy free zone” that researchers can use for a control group. ¹² For example, one study surveyed 1,500 people in the Netherlands and concluded that those who pirated music bought just as much music as people who did not pirate. ¹³ However, this methodology contains a fundamental error: how much would the “pirates” have bought if piracy was not an option? ¹⁴

Or take the example of a person who pirates material because they consider the price is too high. In the absence of the piracy option, he or she would not have purchased material anyway. So, one can hardly say that this illegal downloading of a CD is a “lost sale.”

Collating all of these various points of view is a recent study by Brett Danaher, Michael D. Smith and Rahul Telang, which has just been published (June 2014) by the National Bureau of Economic Research in the journal Innovation Policy and the Economy. ¹⁵ They have collected 18 distinct studies, the majority of which have been published in peer reviewed journals, on the issue of piracy and its concurrent effect on the entertainment industry. ¹⁶ Of these 18 studies, only 3 found that there was no statistical impact on the entertainment industries. ¹⁷ Of the remaining 15, every one found that piracy has a significant effect on the revenues of the entertainment industry, including one that found that file sharing was the cause for the collapse of record industry sales from 1998 to 2003. ¹⁸

Of some significance, the authors point to a 2013 study in which the adoption in France of the so-called HADOPI anti-piracy legislation resulted in a 20-25% increase in digital music sales. ¹⁹ A similar study tracking the effect of the European Union IPRED directive found “a 27% increase in CD sales and a 48% increase in digital music sales in Sweden.” ²⁰

The majority of the peer reviewed papers all found a clear correlation between file sharing and lost revenue in the entertainment industries. So, of the three that took a contrary position, is there a common denominator that lead them to this conclusion? To my eyes, all three erred in comparing material downloaded via file sharing to the displacement of a physical sale only. In an era where all forms of tangible medium are being displaced by download sales, the real comparison would be either illegal downloads replacing legal digital sales or illegal downloads replacing all forms of content acquisition.

One study made this correlation clear. “[D]igital sales and digital piracy were strongly related while there was no statistical relationship between digital piracy and physical sales.” ²¹ The study also looked at what happened when NBC pulled its content from iTunes in September of 2008. The result was an increase of 11.4% for piracy of NBC content compared against levels of piracy for the other networks. ²²

So now, what is the fate of The Expendables 3? What will the effect be on the box office receipts? A new study concludes that films that leak to the internet before their official release will lose 19% of their box office due to pre-release piracy. ²³ I estimate that the effect will be more significant in that the pirated copy is reportedly very high quality, ²⁴ and not a work print in which various elements are missing.

One caveat with regards to the study. Three out of the four authors are employed by Carnegie Mellon University, which houses the “Initiative for Digital Entertainment Analytics.” This research organization is funded in part by an unrestricted gift paid by the Motion Picture Association of America. This is disclosed by the authors on the title page, and of course it stated that the MPAA has “no editorial control or oversight over the research findings.” ²⁵ So, one should review the study with a heightened sensitivity for institutional bias, just as you should when the Electronic Frontier Foundation takes a position relative to the activities of Google, given their cozy relationship, financial and otherwise. ²⁶

Then there is the “China Conundrum.” Piracy is rampant in China, for both the motion picture sector and for music. “Virtually all music downloads in China [are] unauthorized.” ²⁷ “Piracy rates for optical disc media (CDs, DVDs and VCDs) [are]…at least eighty-five to ninety percent.” ²⁸ Yet China “has skyrocketed to become the second largest film market in the world, with production quantitatively on par with Hollywood.” ²⁹ How did this happen? Once again, this is fodder for those who claim that piracy does not harm intellectual property markets and does not depress the production of new works. ³⁰

Law Professor Eric Priest’s excellent (and thoroughly researched) new article in the Harvard Journal of Law and Technology takes these arguments apart piece by piece. If you’re so inclined to read it, please set aside some time. It is 72 pages long and contains 471 footnotes. But I digress.

Priest rather conclusively demonstrates that the only way that copyright owners are making money in China is through channels in which the copyright owner still has strict control over the delivery of the material. Over 90 percent of the revenues of both the film and music industry are attributable to where the copyright owner has complete control of access to the product. ³¹ In the case of motion pictures, this is theatrical exhibition, where you don’t get to view the movie unless you buy a ticket. ³² In the music industry, the most money is made by the sale of “ring-back” tones, which are delivered to the phone by streaming and not downloading. ³³ The rest of the markets are on “life support” according to China Daily. ³⁴ “China’s total recorded music revenue in 2011 was [less than] that of Thailand – itself a high piracy country with one-twentieth the population of China.” ³⁵ “China currently ranks as the world’s twentieth largest music market with a mere one percent of global revenue.” ³⁶ That’s a rather sobering statistic for a country that has over 1.36 billion people living in it. ³⁷ This is even more sobering considering the world’s number two music market is right next door – in Japan, which accounts for twenty percent of global music sales. ³⁸

And then there’s this not so amusing story:

“China’s most prominent music executive, Song Ke, abruptly quit his job as CEO of the Mainland’s most successful record company in order to launch a Peking duck restaurant. ‘When I make good roast duck,’ Song lamented, ‘people pay and thank me. When I make good music nobody pays me and some even ridicule me’” (internal citations to footnotes omitted). ³⁹

This points to another pernicious effect of piracy, the constant devaluing of artistic works as being something worth paying for.

And then there’s this. A company called Top100.cn started a legitimate online music subscription service in 2006, charging all of $3 a month for unlimited access. ⁴⁰ Finding it could not compete with the pirates offering music for free, it partnered with deep pocketed Google China to launch a 100% free, ad supported music download service. ⁴¹ It went out of business in 2012. ⁴² When Google pulls the plug, that’s a sign of how bad the business really is.

As for the movie industry, Priest points out that “[w]hile the Chinese box office may be booming, it is also a winner-take-all market in which a handful of big budget Hollywood and domestic films dominate box office availability and take the lion’s share of revenue each year.” ⁴³ In round figures, this means that 16% of all movies accounted for 70% of the revenue. ⁴⁴ Only one third of the films made in China saw a domestic release in 2012. ⁴⁵ And remember that box office accounts for 90% of all film revenues in China. In other words, the indie filmmaker is getting squeezed out of the market, because there is no other viable source of revenue due to piracy. ⁴⁶ Not good for a healthy, viable film industry.

This is the point that eludes piracy apologists like the Electronic Frontier Foundation. ⁴⁷ The lack of a viable market for small independent films is crushing free speech. “LBGT filmmakers are often forced to self-finance their works because their films are not viewed as ‘box office winners.’ When unlicensed copies of their films become freely available online, filmmakers lose their ability to monetize their works and ‘their investment can disappear in an instant.’ In this environment, fewer filmmakers will invest in producing a second or even first project and these stories…will cease to be told and this ‘Freedom of Speech’ will be compromised.” ⁴⁸

So, the major content creators are going to give you a steady diet of the tried and true, the bland and the blander. Since box office revenues are the one revenue stream that can be tightly controlled, expect a bunch of safe bets so that box office will be maximized before the losses of piracy start to pile up. Tired of Hollywood remakes of every movie ever made and every TV show ever made? Tired of sequels? Sorry, you’re only going to get more of the same. 21 Jump Street and then 22 Jump Street anyone? Tired of comic book movies? I happen to like them, but since these movies have a built in audience already familiar with the characters and the setting, you’re going to get a lot more of them. Could Pulp Fiction get made today? I doubt it. Even back then, it got turned down by a lot of studios. “TriStar’s objections were comprehensive, encompassing the script’s fundamental structure. “[Co-writer Roger Avary] characterizes the studio’s position: ‘This is the worst thing ever written. It makes no sense. Someone’s dead and then they’re alive. It’s too long, violent, and unfilmable…’” ⁴⁹ By the way, in searching for that quote, one of the top five auto-complete suggestions by Google was “Pulp Fiction Full Movie” and led me to a pirate streaming site.

What to say about the music business? According to this post at The Trichordist, there are 45% fewer working musicians than in 2002 according to the statistics from the U.S. Bureau of Labor Statistics. ⁵⁰ To be fair, as with all things statistical, one can use them to come up with varying numbers to satisfy your hypothetical. ⁵¹

Last year, I settled down at my computer with a $30 iTunes gift card and the year-end issue of Rolling Stone featuring the Top 50 songs of the year. An hour later, I had gone through every song and still had $30 in my iTunes account. So maybe that makes me just another old fogey. On the other hand, where is the next game-changing musician? Who are the Millennials going to say came out with an approach so fresh and so full of talent that it was a musical revolution for their generation? Where is their Eddie Van Halen? Prince? Kurt Cobain? Nowhere that I can see. You’re going to get a lot more pablum from the new Justin Beibers and pre-fab acts like Miley Cyrus, all provided by American Idol, The Voice, The X-Factor and on and on and on. The record labels seemingly have purged their ranks of anything that is not a safe bet. Don’t get me wrong. Ariana Grande can sing like nobody else this side of Mariah Carey, but she got her start on a Nickelodeon TV show. ⁵² By the way, in searching for that citation, one of the top auto-completes suggested by Google was “Ariana Grande MP3” and the first choice was the notorious pirate site MP3skull.com. Out of the top ten results, 8 were links to pirate sites. I would say Ariana has a “Problem.”

My son is 17, and in his prime music consuming years. Sure he’s downloaded (legally) a lot of songs, but when I ask him “What’s new and good?,” he says “Not much. It all sounds the same. I like the classics.” He likes to sing and is active in his school’s a cappella choir. By sharing my iTunes library, he has discovered groups with strong vocal harmonies like Queen, Manhattan Transfer, and genres like doo-wop. That has led him to discover new a cappella groups like Pentatonix. ⁵³ But when I asked him, “Who is the game-changing musician of your era?,” after a long silence, the only name he could come up with is Eminem, whose career is closing in on twenty years in duration. ⁵⁴

What about the computer software industry? Estimates are that “77 percent of the software in China is…pirated.” ⁵⁵ “Microsoft recently reported that in 2011 it generates more revenue in the Netherlands than in China.” ⁵⁶ Think about that for a second. A nation of 17 million ⁵⁷ generates more revenue for Microsoft than a nation of 1.36 billion people. I think with that we can call this whole “piracy doesn’t affect business” for what it is: a “myth” that has been “busted.”

For the final word, I yield the floor back to Professor Priest:

“A copyright system that provides sufficient rewards and autonomy ensures that the most talented creative individuals in society enjoy the economic support and freedom to hone their craft and, in return, spend their professional lives maximizing their creative potential and publicly disseminating the fruits of those efforts. This state of affairs is not only good for creators. It benefits any society that values high quality cultural production and an endless wellspring of high quality works on which to build new works and shared cultural meanings.” ⁵⁸

Preach on, brother Priest, preach on.