Music Advocacy Journal Issue #7: Technical Treatise on Record Piracy – Part 6, The Impact of Piracy

In Part 1 “Yin and Yang”, I laid out the critical questions surrounding music piracy and shared a true story that exhibited a polarized point of view on the topic. We talked about how MYnstrel approached the problem of music retail from a neutral position – concerning ourselves with all of the competing interests of different parties, and digging up the facts.

In Part 2 “Where Does Your CD Money Go?”, I shared some of our analysis that was generated in our music retail Business Process Engineering activities. The key question was simple:

  • Where does your money go when you purchase a CD?

It’s important to know where the money for a CD goes to understand how piracy impacts the workers responsible for getting the album from the artist’s mind and into your hands.

In Part 3 “Stratification & Levies”, I continued answering the line of inquiry we began in Part 2. Who exactly is responsible for getting a great-sounding recorded piece of music in your hands? What do they get paid for their labor from that CD sale? What does an artist actually make?

In Part 4 “Writers & Hegemonies”, we finished showing where all the money of your CD purchase goes by reviewing the Songwriter’s Team (Mechanical Royalties) and the Record Label.

In Part 5 “Breaking Even”, we looked at all the people who get paid from your CD purchase, and what kind of sales they need to make to break even.

In Part 6, “The Impact of Piracy”, we will have a revelation – and discover that Music Piracy and “sharing” has killed music sales, as demand for music has remained strong and grown, but consumers are choosing to spend their money on things they can’t get for free.

These are just some of the questions our analysis will answer today. You will be able to use this Treatise over and over again as the most thorough reference material on the subject in print to date. Let’s get to it!

Piracy has killed music sales

I’ll start out by casting my stone. I say that piracy has killed music sales. The only thing that surprised me was how much intricate financial analysis was required to discover beyond a reasonable doubt, the thing that all of our common sense tells us anyway: most people are not going to pay for something if they can find a way to consume it for free. I predicted it back in 1999 when I first saw Napster. Over the years, many people have challenged this idea. Now we’ll investigate the truth by looking at the hard numbers.

The numbers are in – “Napster/music sharing” advocates were wrong

There used to be people who said that “file sharing” would help music sales by offering ‘free promotion’. I haven’t seen any hard data from those people lately. Reason? They were wrong. For the analysis that I will present to you, I wanted to measure growth or decline of various factors that impact piracy. I did the following:

  • Adjusted for inflation – all values were converted to 2008 Dollars
  • Started at 1991 (because that is the earliest accessible Music Retail Revenue data)
  • Adjusted for population growth – all values are normalized on a per-capita basis
  • Divided every resulting figure by its 1991 value to get the ratio of growth or decline

The first thing we’re interested in is how Recorded Music sales have changed over the years. Have they gone up or down? And what about Home Broadband access for Americans? A burglar isn’t breaking into your home without a lock pick. If there is a portion of the population who is okay with stealing the music online, they’ll probably need the tool to achieve their goals. That tool is high-speed internet from their house (or campus). And finally, we should make sure that other economic factors aren’t impacting Recorded Music sales. With all this talk about the economy, a casual observer might think that it’s “the economy’s fault.”

The trends are astounding:

MAJ 7 pic 1

Some events related to the chart:

  1. In 1991, we were on an upswing from the new prevalence of the excellent technology: CDs
  2. This held throughout the 90s until its peak in 1999 (historically typical for the advent of new technologies)
  3. In 1998, widespread MP3 music stealing was becoming rampant on college campuses and in high schools. In addition, the availability of CD Burners allowed people to copy CDs too.
  4. A sharp decline began in 1999 when Shawn Fanning released Napster. This aggressive decline in sales continued through 2003 as more people found music to steal online through Napster, Kazaa, and any other P2P service-du-jour. They could burn the stolen music onto their own CDRs, and take it with them anywhere if they didn’t yet have an iPod.
  5. You can see that in 2002, the decline of the music sales slowed down a bit and even stabilized up through 2004. This corresponds to widespread adoption of the iPod and makes sense. New technologies usually pique interest. Unlike the CD though, the iPod and personal MP3 players only halted the decline for a few years.
  6. What’s fascinating about the upwards slope from 1991 to 1994 representing the boost from the CD technology? When compared to the iPod from 2002 to 2004, if you superimpose the expected near-40% increase that the iPod should have created, it would almost exactly cancel out the declination trend from 1999 – 2002. Actually, THAT’S EXACTLY WHAT YOU SEE! The decline is halted from 2002 – 2004, indicating a strong possibility that the excitement over the iPod technology gave the boost for some paying customers and technology enthusiasts, but that the proliferation of stealing continued during the same time period at the same rate (for those who were already savvy to the ‘sharing’ process).
  7. In 2004, the exponential decline in sales continued as users continued to systematize the way they can steal the music with their friends, through online services, and other P2P software that just won’t go away.

What is fascinating is that home high-speed internet increases at almost the same rate that Music Retail Sales decline. In addition, it is myth that a “tough economy” can be to blame for this, since Discretionary Income increased steadily.

Let’s drive that fact home by looking at the growth of entertainment-related industries:

MAJ 7 pic 2

Disregarding the practical limitations of earned income, people borrowed money like crazy throughout the 90s and 2000s and you even see aspects of the internet/software bubble of the late 90s in there. The total of all entertainment industry growth by 2007 was nearly the same as the growth in Discretionary Income at around 30 – 35% (the light blue line). In fact, it follows the growth in Discretionary Income almost exactly.

As for the fact that people have been spending an ever increasing amount on entertainment for the last two decades with their ever increasing Discretionary Income – this much is evident. So people can’t blame ‘the economy’ for the decline in music sales. People are just choosing to spend their money on other entertainment-related expenses.

In 1991, people spent an average of $49.09 per year on recorded music (in 2008 dollars). At the peak in 1999, we were spending $69.10 per person per year. In 2008, we are now only spending $27.89 per person per year on recorded music.

There is big trouble for music and the economy is not a significant factor in the decline, but a question remains…

Why are people choosing to spend less on music and how much does piracy contribute to the decision?

Hopefully, we’re free-market individuals and if people are just not as interested in music as they used to be, that’s fine. As an Artist, it pains me, but it’s been a nice ride, as they say. From the purview of a Music Biz Pro, I say that music needs a revival! Well, we’re inventing that anyway at MYnstrel, but is music really suffering from lack of interest? The facts show that this is not the case! If you combine the legitimate music sales with illegal music downloading, the consumer demand and consumption of music has never been higher.

Sadly though, this demand has not translated to fair compensation; Artists and the music business are not getting paid for that increase in demand. While sales of concert tickets, licensing, and merchandise have experienced normal historic growth (when corrected for inflation and population), they have not nearly made up for the recorded music retail loss that we just looked at. This should make sense, because:

  1. People only have limited time to attend concerts. They have family, they have friends, they have jobs, and they have school. There is not that much more money that people can spend on tickets, since it requires consumption of their limited free time, and ability to line up their personal schedules to tour dates. These are more significant limiting factors than the ability to pay for a $15 – $30 lawn seat or club ticket.
  2. If people are playing their own stolen digital files, they will not be tuning into the radio more. Why do they want to listen to your DJ and suffer exposure to commercials, when they can play their own music? Some might enjoy the DJ, but I bet those people are the ones already tuned in. Licensing won’t make up for record piracy loss.
  3. If people want a shirt from your band, they’ll pay the $20 – $25. The big fallacy is that if they have a few more bucks because they didn’t pay for your album, then they’ll spend that money on a shirt that they don’t want anyway. Why wouldn’t they be just as inclined to buy their girlfriend a few margaritas, or maybe a DVD or video game with that extra money in their pocket? There’s no telling what they would do with that money, but buying your merchandise is not a probability. Artist merchandise sales are not going to cover the loss for music theft, nor have they even come close to doing so in the past decade, as the numbers prove.

On the one side of the spectrum, you have organizations overstating piracy loss by citing facts like:

  • There were 40 Billion music files stolen online in 2008 (IFPI, 2008)
  • In 16 countries, only one out of 20 downloads are legal (IFPI, 2008)

Well that’s all very alarming, but what percentage of that theft represents the music that people would have paid for, versus the music that they’re just taking advantage of, not listening to, and just passing around like cheap water? The fact that file sharing is rampant, doesn’t mean that people would have paid for those songs if they had to. The numbers we already talked about speak more truth to the impact of piracy than the overstated conclusions that people draw from those “file sharing” figures.

On yet another side of the argument, you have the Napster/file-sharing apologists citing this fact:

  • Legal digital downloads now account for 20% of recorded music sales (as opposed to CDs and other formats), up from 15% in 2007 (IFPI, 2008)

They draw the conclusion that “things are looking up” and “that’s fantastic growth for legal digital downloads”.

No, it’s not. Are they crazy? Maybe they didn’t look at the overall numbers and see the 100% decline of sales in 10 years from our 1999 peak, since Napster. Moreover, the financial model we looked at before is for the United States sales, the largest market, but also one of the cleanest and most law-abiding markets, with lower piracy incidence compared to most other countries. The IFPI figures are worldwide. So even if we extract piracy impact from our model, it will be a very conservative estimate for the worldwide music market.

Thwarting computer hackers – how does it relate to music theft?

The bottom line is that most people are not going to pay for something if they don’t have to. Our common sense tells us that, because we have experience with human nature. You see the proof in our charts. I said this back in 1999 and also predicted other psychological impacts of the Napster culture. When I was doing Software Security Development one principle we used in the process of thwarting hackers was the Clark and Davis cost-benefit ratio for criminals. We will not discuss that complexity here, but we broke down one aspect of its usage based on the 10:80:10 principle:

  • 10% of people will not break the law, even if they know they can get away with it
  • 80% of people are opportunists – they balance the personal risk and selfish rewards of doing the wrong thing before they decide to break the law
  • 10% of people cannot be deterred, they will break the law even with a high chance of getting caught (“the evil 10”)

By raising the probability of getting caught and lowering the chance of successful hacking, we could deter the 80% and make the task harder for the “evil 10”.

I said way back then, that illegal music downloading, with no penalties, and no threat from law enforcement, is going to leave us at somewhere between 10% and 25% of music consumers actually paying for the product and consuming it legally.

After looking at the numbers from a decade of trends, I feel justified in my prediction.

Was DRM (copy protection) ever the answer to this puzzle? Maybe if there weren’t easily accessible alternative unprotected MP3s everywhere. The great solution to this puzzle that MYnstrel believes in is a holistic approach that has nothing to do with locks, shackles, and enforcement.

Other explanations and finding the bottom

I think that a portion of the music sales drop is caused by people choosing DVDs, video games, and some other entertainment over recorded music; however, as children from the late 80s and 90s, we were just as excited about video games that cost the same amount of money back then, but we also bought CDs because we couldn’t steal music online. Oh, and our families also had less Discretionary Income.

I think that the majority of the drop is caused by unfettered access to illegal downloading and CD burning. There’s the claim that the ‘quality of music’ in the last decade was poor, but that is so lame that it’s been regurgitated for decades. Experts have predicted the ‘death of rock and roll’ since the 60s, about once every decade. Even after the grunge craze, we saw tons of great rock bands emerge from the blending of hip hop, funk, and rock with even a spattering of Art Music from the progressive rock influence.

My Zune has never been so happy to be full of incredible music that I paid for and consume legally. Many music insiders also enjoy this luxury. Of course, there could be a lull in content, but a ten-year, 100% decline? I don’t think so. In fact, the point that illegal downloading continues at such astronomical levels indicates that people are still interested in the music content, and approve of its quality.

Where’s the bottom? I say we might see a decline as low as $5 to $20 per person per year spent on recorded music in the future, with technology-inspired peaks that could bump it to $30 to $35. I think it is very unlikely that we’ll see the success of $49 of 1991, and especially not the $70 of 1999.

Of course, a groundbreaking recorded music invention might blow these predictions out of the water. I think MYnstrel has a great shot with our secret recorded music invention that we’ll be releasing by 2019. I don’t think the smorgasbord deals of subscription access (Zune pass, new ISP deals, new legal-Napster subscriptions, etc.) are going to achieve this breakthrough, although they might have a shot at bumping revenues to a short-lived $30/$35 peak in the next decade as they help to mitigate the problem.

Sources

The sources used in this article do not divulge trade secrets of MYnstrel, so we reveal them as follows: Bureau of Labor Statistics (www.bls.gov) to derive Discretionary Income (that’s the money that the average person has after the government takes taxes and after essential spending is covered like food, shelter, and clothes), RIAA (www.riaa.org) for Music Retail Sales, Bureau of Economic Analysis (www.bea.gov) for entertainment-related industry growth, and Pew Internet (www.pewinternet.org) for home broadband penetration.

Next time…

In Part 1 “Yin and Yang”, we laid out the concepts surrounding music piracy and exemplified the philosophies with an entertaining story.

In Part 2 “Where Does Your CD Money Go?”, we established a robust analytical model to determine where all of your money goes when you buy a single CD and elaborated the front-end transactions (Government & Retailer).

In Part 3 “Stratification & Levies”, we laid it out for Distributors, Manufacture/Packaging, Free Goods, and Performance Royalties.

In Part 4 “Writers & Hegemonies”, we showed you where the rest of your money goes – to the Songwriting Team, Publisher, Risk/Losses, and the Record Label.

In Part 5 “Breaking Even”, we looked at all the major players who get paid from your CD purchase, and what kind of sales they need to make to break even.

In Part 6 “The Impact of Piracy”, we established beyond reasonable doubt, the impact of piracy.

In the next article, Part 7, we will use conservative estimates to figure out whose pockets the loss comes out of, and how it impacts all the parties involved. If we’re going to adapt to the market forces and ride the waves that we can’t control, that knowledge is vital.

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