27 February 2002

Lance Phillips

In the old days it used to be so easy. You would hand over your hard-earned at the counter of your local record shop, take your goods and leave. You knew (if you cared) that all the right people involved in the production of the record/cassette/CD/MiniDisc (delete according to age) would receive their fair share of the cash you recently parted with (even if the actual process involved was something of a mystery) and you could leave HMV with your conscience clear. If you wanted a high quality audio product in the UK then by and large you weren't given the opportunity to get it for nothing, to get it without the artist or record company being rewarded for their creative endeavours. A combination of the consumer's preference for the genuine article, rigorously enforced anti-counterfeiting policies and effective collecting mechanisms meant that most people would not buy music from anywhere other than a bona fide, professional and law abiding retail outlet and the whole issue of ensuring the rightful distribution of payments to interested parties remained invisible to the consumer.

Then along came a Californian teenager with a particularly simple and effective file sharing computer program, and suddenly all this received wisdom began to look like a particularly shaky house of cards. Now there was an alternative source of music, CD quality as well (or as near as made any difference to most people) and free to boot. Now you did not have to spend £15 for a CD when you only wanted the one good song that it contained. Now you could patrol the web and pick off your musical preferences at will, all from the comfort of your own home. For the consumer, the downside of all this was pretty immaterial - yes it was illegal, though you'd never get caught (just like you would never get caught taping your CDs for your walkman or recording the Top Forty every week from your radio); certainly record companies would lose revenue, but then they charged an unjustifiable amount for CDs anyway; yes, artists would not get paid but any sympathy you may have felt for the majority of acts who do not occupy privileged places within rock's aristocracy was somewhat diluted by the rather unedifying sight of multi-millionaire rock stars suing their own fans, or pontificating on the whole injustice of it all from their mansions in Tuscany.

The industry went on a legal offensive (successfully) and a PR offensive (unsuccessfully, but no surprise there). Napster was seen off in the US courts but to no great cheers of approval from anyone except perhaps Metallica and Sony. However a valuable lesson had been learned: a new music format, and the means to deliver and share that format, gained immediate acceptance with a worldwide audience. Music will continue to exist on hard drives and will continue to travel between these hard drives via the Internet.

So the news that Warner Music Group has recently signed a licensing deal with Echo Networks (to allow Warners to exploit their back catalogue and future rights on-line) is just the latest in a series of initiatives whereby the major record labels are attempting to adjust to the post-Napster world and position themselves in the on-line digital media world. With the legal high ground secure for the time being, the prospect of reaching anything approaching the estimated audience that Napster achieved has focused the minds of the labels onto doing what they do best - selling music. Thus AOL Time Warner, EMI Group and Bertelsmann have joined forces under the umbrella of MusicNet, and Sony Entertainment and Universal Music Group are allied under the title of Pressplay.

For an industry that was desperately trying to persuade the rest of the world that nobody would want music on-line (it takes too long to download, the sound quality is not that good, etc...) and, more particularly, that nobody would want to buy music on-line when they had previously been getting it for free (so is there any point in bothering with on-line content at all?), this all seems like a very interesting turn of events. But there may be gold in them there hills, and record companies cannot live on legal principles alone. Nobody could doubt the outright success of Napster in providing a software product that was easily accessible and very simple to use. The lesson learned was that the file format was here to stay, whether the record companies liked it or not.

The fact that, initially at least, they did not like it should come as no surprise to seasoned observers of the recording industry over the last 40 or 50 years. Scarcely has a technological improvement entered into their lives that has been welcomed with open arms. The normal course of events is to treat such new formats with either at best suspicion, or at worst (the usual reaction) outright hostility and swift litigation. Thus was the introduction of the 45rpm single met with smug scepticism from an industry convinced that nobody would want to purchase a single piece of music of less than 4 minutes duration. The introduction of the compact audio cassette was condemned by those who felt that this would lead to mass duplication of copyright works (correct) and therefore nobody would ever want to buy new material in its original format ever again (incorrect). Incredible as it now may seem, given that the CD is the UK's flagship carrier format, the introduction of the CD was also less than warmly received. Nobody, it was felt, would want to replace their entire record collection with these new shiny disk type things and in any event, the majority of the record buying public would not be remotely interested in the improved sound quality that such a format could bring (all well and good until someone finally woke up to the fact that much money could be made in reissuing entire back catalogues on CDs at vastly inflated prices for a minimal amount of investment). The initial launch of Minidisc and its competitor product Digital Compact Cassette (DCC) led to an outbreak of a format war, brought to a merciful close by the realisation that the most record companies would not provide the necessary software (i.e. music on either format) to support the new system. The fact that Minidisc has now after over 10 years become a credible carrier format says much for Sony's persistence in marketing and supporting the product and such perseverance is, I think, to be applauded.

The music industry in the UK, and particularly the BPI, rightly say that their intention is to protect the artistic and financial investment they make in every record made, and every artist signed. But it is hard to reconcile this laudable aim with some of their actions. Recording agreements are, by and large, manifestly unfair and have not changed in substantive terms for the best part of fifty years. Artists are regularly dropped from record company rosters without hesitation if short term demands so require. Above all there is this reluctance to embrace new formats, a reluctance best reflected in the royalty rates offered to artists in their recording contracts for sales on each new format. The newer the format the lower the rates, despite the fact that each new format has a potential to reach a new or larger audience than was before. Artists receive less in royalties for sales of CDs than they do for cassettes, and less for both than for vinyl sales. An interesting irony, and one surely not lost on the record labels, as CD sales now outnumber vinyl sales by several factors to one in the UK, and more music is sold on cassette worldwide than on any other format.

Napster has taught the recording industry a lesson in marketing music on-line, but at the moment there is a lot of manoeuvering, not a little posturing, some terrifically exciting "initiatives" but not a whole load else. Your average music punter is still a little reluctant to purchase, or indeed listen to, music on-line. This reluctance is understandable for a number of reasons, not the least of which being the generally poor level of bandwidth connection available to users in the UK.

Equally it may well be that those consumers used to acquiring music for free on-line are unwilling to pay for it now. Personally I think this argument is overstated slightly, although undoubtedly contains a kernel of truth. I think that most people who want music are reconciled to the fact that they will have to pay for it - after all they have been doing so since the day that sheet music first became available. Most consumers are quite happy to pay for goods over the Internet; they may argue about the price but not the basic idea. The concept of free music is new, indeed it is concept borne out of Napster; there is no inherent tradition or history to it at all. If a provider can supply a consumer with the goods they want at a price they are prepared to pay and in a manner that they find acceptable, then there is no compelling precedent for the consumer to then turn around and say to the provider "well actually I think I should have this for nothing, just like I did two days ago". What worries me about the industry's approach to on-line music is this preconception - certainly studies that have been made suggest the issue is not so clear-cut. If you are trying to sell on-line music then arguably the best way to do it is not to tell your customers that much as you'd love to provide this service, they can't be trusted to pay for it - surely the better way is to make it so good that people are desperate to have it.

Globally, therefore, there is a substantial audience for on-line music, and it can only grow. It is unlikely that any single on-line music provider will again reach the heady heights of the alleged 60 million or so users using Napster, but any on-line provider of music reaching, say, 5% of that figure will hit upon a sizeable international audience for music, and a sizeable international market for sales.

None of this has resolved the central problem facing such providers. No matter how impressive these alliances sound, and no matter how hard the recording industry tries to persuade you as a punter that it is fully embracing the technology that enables you to receive your music on-line, the sale of on-line content that Napster managed to (albeit illicitly) achieve will remain beyond reach until a working, invisible and customer-friendly system to protect downloaded music from copyright infringement is in place.

Understandably in the light of copyright-infringing activity that Napster promulgated, there must be a real concern that the one user who legitimately buys his 3-minute pop song on-line cannot effectively be prevented from sharing his good fortune with all his cyber-friends. Hence the need for a digital rights management system that can either encrypt the work in question so as to allow for a once-only download or track that work so that corresponding reimbursements/royalty payments can be made to the artist.

Unquestionably in many ways this is an entirely appropriate course of action. The creator of an artistic work should be rewarded for his or her creative input and it is not unreasonable that this reward should be tied into a number of times downloaded/number of times played/number of time duplicated basis. This is, after all, the basis upon which royalties have always been paid to artists and only confirms in the digital world the position that we have all accepted in the analogue world. Except of course that the two are absolutely dissimilar.

Given the embarrassing failure of the Secure Digital Music Initiative (a much vaunted DRM application) and the ease with which it was hacked and cracked (at least to the extent that its credibility as a secure encryption process was fatally damaged) there is within the industry, and other interested parties, a growing realisation that the concept of digital rights management is far easier to define and far more likely to be agreed upon than it is to actually construct. It has often been asked who in the digital on-line era will make money from the Internet - save for hard-core pornographers, possibly Internet gaming companies and mobile phone ring-tone providers, the question is often met with a very gloomy silence. To this list can surely be added whoever cracks the DRM problem.

So we all accept that DRM is necessary if we are going to protect the rights of rights holders in the same way that they have been protected for the last century or so. But it is not clear when this might happen. Recently I attended a seminar where it was suggested that it might be a decade before we see an effective DRM product. Even allowing for the rapid rate of technology that we have seen over the last ten years (which should warn anybody will a predilection for such estimates that they are likely to be proved wrong almost immediately the words have left their lips) it could still be 2-5 years before DRM can provide the protection the music industry is looking for.

For many recording artists, 2-5 years is not just a long time but possibly an entire career. The opportunity for these people to reach an international market otherwise beyond them has all but disappeared, and not because of any technical reasons inherent in the provision of on-line content. It is a financial constraint that is preventing the on-line provision of media content, not a technological one.

So given these circumstances, is there anything that can be done to ensure that on-line delivery of music can happen sooner rather than, for some artists, not at all. To answer this question we need to remind ourselves why the concept of digital rights management is required in the first place.

To a large degree, although by no means exclusively, it is there to ensure that existing revenue streams paid to recording companies, artists, producers, music publishers etc are retained. This is because the fundamental contractual model for the recording industry for the last 40 or 50 years is based upon an assignment of copyright either in the underlying work (or "the song") or in the derivatives of that underlying work (or what we lawyers call "the record"), in return for which the author of the rights is paid a royalty calculated generally as a percentage on either records sold or number of plays achieved. Might therefore the solution be a fundamental re-evaluation of this model and, in particular, its particular relevance to the Internet?

I think that we have to look at in whose interests the royalty model operates. A record company acquires the rights in not only the record but possibly the song as well (although of course this is more usually assigned to a publishing house, albeit one that may still be corporately linked to the record company) in exchange for a percentage based payment. Now it seems to me that there would be a good deal more equity in this arrangement if recording artists received royalties from the moment the record is made available to the public. But royalties are generally not paid by record companies until the initial recording costs have been fully reimbursed. Most recording artists retain a right of audit over revenues generated from the sales of their records and cannot escape the responsibility for ensuring that they know when this happens, but nonetheless the fact remains that in general it is the record company themselves (or possibly a collecting society) that is best placed to determine the point at which an album recoups. So, to put it simply, you get your royalties when the record company says so and not before.

How is the initial advance recouped? It has to be on the sales of the record. To a large extent this is outside the direct control of the artists themselves. There are clearly certain things that artists can do to improve the sales of their albums, including touring and other assorted promotional activities. But in the final analysis your efforts as an artist to sell your record can only be as good as your record company's determination to market that record and ability to get that record into the hands of the consumer wherever they are in the world. Consequently, even where the record company acts entirely honourably in this regard (and there have been some notable exceptions to this rule) it can take several years for a recording to recoup its costs so that the artist can then receive royalties.

Furthermore a combination of poorly drafted recording contracts and creative accountancy have in the past increased the size of the sum that needs to be repaid before royalties are due, to the point where the record never recoups its original costs. In the analogue world there is more than a degree of good sense in this approach; record companies invest a considerable amount of time and money in not only signing and developing artists but also in the mechanics of getting records in shops. Pure economies of scale mean that Sony and EMI probably get their artists' records in HMV shops in Tokyo as cost efficiently as anybody can and they are entitled to receive a return on that money. However, in the digital world I think that some of these factors necessarily fall away. It simply does not cost the same amount of money to deliver a piece of music over the Internet to Japan as it does to ship a crate load of CDs to Tokyo, or indeed to manufacture such CDs in the territory concerned. Nonetheless, if the examples of compact cassettes and CDs are to be followed, recording artists can expect to receive a lesser royalty rate for the sales of their music on-line, despite the fact that there has been no corollary rise in costs to the label.

In these circumstances, it is hard to see precisely what advantage the artist gets from the royalty system. Admittedly they get a large sum of money up front with which to cover their recording costs - but they hand over the intellectual property rights in those sound recordings forever. (Indeed, as an interesting aside, the record company retains the rights in the sound recordings after they have recouped their investment. Copyright law states that rights in sound recordings are owned by the producer of those recordings - i.e. the record company - in consideration of this advance. But this advance is not a gift to an artist from a benevolent record company - it's a loan, and one that must be paid back before the artist sees any income. Moreover, once the album recoups its investment, the artist does not receive in return the rights to their sound recordings. So the record companies get their money back, plus profits and the rights to the sound recordings for the full period allowed by law).

So is there an alternative? Well, yes there is. But it is not one that is likely to find favour with record companies, nor it must be admitted, with certain recording artists. There is no reason why a recording artist cannot licence their on-line rights to a content supplier. Under the terms of that licence, and in return for a very generous licence fee, the licensee would then have the right to provide that music on-line to subscribers in the knowledge that, despite all notices and warnings to the contrary, there is likely to be some degree of unauthorised duplication and therefore copyright infringement. In other words, a tacit acceptance of duplication of recordings along the same lines as currently exists in respect of CDs and copies made onto cassettes, minidiscs and other storage devices. Such licences can be negotiated to the artists' own requirements, and can last for as long as the artist wants; months, years, indefinitely. Licence fees similarly can be negotiated accordingly. Furthermore there is no real reason why, when a suitable digital rights management system has been successfully developed, the artist can turn around to the on-line content supplier and say that they now wish their music to be provided using the digital rights management system. Thus the relationship can then move on to the royalty-based model traditional in the recording industry.

The consequence of this arrangement is that music is placed on-line and is available but that it is understood there will be duplication; artists may need to accept that some duplication is inevitable (although no more inevitable that the kind of duplication artists and the industry have long since learnt to live with). Why would a recording artist wish to do this? They may not, of course, but it would enable them to take advantage of the distribution and super distribution possibilities of trading on-line.

To return to an earlier analogy, if we assume conservative estimates of Napster's total number of users world-wide as being around 60 million and if we further assume that only 5% of that figure would be prepared for music on-line where previously they had received that music for free then an on-line audience of some 3 million potential purchasers becomes a realistic possibility. By way of comparison, according to the October 2001 edition of Music Copyright, 2.7 million sound carrier sales were registered in the whole of Europe in first 6 months of 2000. In other words, three million on-line purchasers of music represents about half the total number of sound carrier sales made in the whole of Europe during the year 2000. Off hand, I can' t think of one recording artist that would turn their nose up at the opportunity of placing their music in front of 3 million on-line purchasers of content, and I stress the word on-line because of course this is in addition to existing off-line sales. New acts would, I am sure, be perfectly happy to at least entertain the concept of being paid a licence fee on an annual basis for the opportunity to get their first or second albums into the homes of three million music purchasers that they would otherwise not reach. That music will be duplicated and artists will not receive compensation in the conventional form of cash in hand; however, as we have seen with analogue cassette copying in the past, if you introduce someone to new music by way of an illegal copy then you almost certainly have created a future customer. A person who receives the latest copy of a Radiohead track "illegally" may well be the person queuing up to buy tickets to see them playing at Madison Square Gardens, buy the T-shirt, get the DVD, wear the video etc, etc.

The argument is made all the more compelling, I believe, when one considers that estimates suggest that the large majority of new artists do not recoup on their first albums at all. In other words they receive no money whatsoever by way of royalties and still do not get the opportunity to take advantage of the distribution possibilities that the Internet has to offer.

Needless to say, neither the record companies, their lawyers nor shareholders will take kindly to this view, and this brings me to the second point of this article. There is no logical reason why Internet intellectual property rights should be necessarily and inalienably linked to conventional off-line rights. As I have mentioned already, I do believe that there probably is no better way of getting the physical product into the shops than the existing system of distribution networks established. However, simply because they can get your album in a physical store relatively cheaply and efficiently does not necessarily mean that they are the best placed people to be delivering on-line content.

For this reason I think recording artists should think very carefully before signing over all Internet rights or Internet related rights under the guise of their recording contract. It may well be that the artists themselves, or some of their mates or some other third party is in a far better position to do this, and do it in a creative manner itself. If an artist is willing to and capable of hiving off their Internet rights, then they may wish to re-examine the manner in which such rights can be marketed. Accordingly, they can negotiate the licence fee on their own behalf but still maintain the traditional recording company relationship which will enable them to exploit their works in the conventional manner. The splitting off of rights is common practice elsewhere, of course, the best and most obvious example being in the world of publishing where authors not only deal with their rights on an exploitation-by-exploitation basis (serialisation rights, television rights, cinema rights, theatrical production rights, etc) but also on a territory by territory basis. Compare this with the conventional recording contract, common examples of which state that the rights to all formats "either known now or in the future invented" are to be assigned to a record company/record publisher "for the World" or increasingly "for the World and the known Universe". Quite apart from the inherent inequity of these words to the artist, not only does this lead to the faintly ludicrous concept of Universe as a defined term in a legal document, it means that as and when mankind reaches Mars then Sony will have the exclusive right to sell records there. I have had the good fortune to listen to Chuck D from Public Enemy giving a keynote address on the issue of DRM; you can imagine his reaction to this.

To some extent, of course, this approach has already been adopted by artists at either end of the success scale. It's not too hard to find music freely and legitimately available on the internet from bands who have yet to sign on the dotted line and hand over all their rights to a record company. Equally, some highly established artists have used their economic muscle and begun to separate their on-line and off-line rights. But the overwhelming majority of signed artists are not in a position to take advantage of this new medium for their music. I think we need to encourage all artists and record companies to consider how they may both benefit from a different form of contractual relationship. The Internet might pose a challenge to the strict, inflexible royalty based revenue model that drives the music industry and which, hitherto, has remained set in stone. Abandoning this idea, even if only temporarily, carries with it the acceptance of unauthorised copying of copyright works. By and large, however, the music industry has tacitly accepted this problem for several years, and it has not proved to be a significant barrier to increased record sales or the general good health of the recording industry.

Personally, I would like to see recording artists retaining far greater control of the creative uses to which their work can be put, but in the past this has been tempered by the need for the product to be put in the hands of the consumer. Clearly, that relationship has now changed. Of course artists who retain their digital rights will then be charged with the responsibility of enforcing their rights of ownership, if they so wish, against unauthorised use of their works. This is a job that can require considerable resources and administration. On the other hand, again there is a precedent here. Recording artists have often retained their own publishing rights within the control of bespoke publishing companies, and then ensured that this publishing company is a member of a relevant collecting society. That collecting society then takes over the responsibility of collecting royalties and enforcing copyright provisions around the world. I can see no reason why the same cannot be true of artists who seek to retain their own Internet rights. Consequently, they can hand over the mechanics of royalty collection to those people who are in a best position to administer that particular service.

In conclusion, I agree that in the long run we cannot accept that the duplication of unauthorised works on the Internet is an inevitability for which there can be no effective sanction. I do believe that a workable digital rights management system will come into place within the next five to ten years that will enable conventional royalty based revenues to be collected for the on-line exploitation of music. All I am suggesting is that in the intervening period both the recording industry and recording artist is faced with a very clear choice.

Either they accept that without effective digital rights management systems there can be no on-line exploitation of rights, and that therefore the opportunity to sell music over the Internet cannot take place until such systems are in place; if this takes 2-5 years, then so be it and the industry and recording artists (despite the fact that they have not be consulted about this) must also accept that they will lose revenue and exposure to potential new audiences around the world.

Alternatively, artists and their lawyers could adopt a more flexible and creative approach to the whole concept of on-line exploitation of rights and at least consider seriously the possibility that the royalty based contractual model may not be the most appropriate way of exploiting those rights until digital rights management becomes a reality.

Irrespective of how long it takes, there is I am sure an audience who wish to purchase music on-line to a far greater degree than is currently possible, and artists who wish to provide this music. With the coming of wider broadband access to the Internet in the UK, I cannot see the number of either group declining. It surely cannot be beyond our ability to bring the two together sooner rather than later.