These crazy bloggers still think they understand the music business

In an op-ed piece in the New York Times on Saturday, British musician Billy Bragg suggests that social networks like Bebo and MySpace should pay royalties for the music that is made available through their services.

He argues against the notion that the "free promotion" provided makes a royalty unreasonable, pointing out that radio stations, which also provide "free promotion," pay royalties.

He even goes so far as to imply that artists are owed some of Bebo's $850m heist, stating:

"The musicians who posted their work on Bebo.com are no different from investors in a start-up enterprise. Their investment is the content provided for free while the site has no liquid assets. Now that the business has reaped huge benefits, surely they deserve a dividend."

While Bragg makes some interesting points, I disagree with him.

Musicians and labels that upload their music to social networks ostensibly know what they're doing and understand that there is no agreement for royalties.

If such an agreement is desired, it should be negotiated beforehand.

Bragg's piece sparked a post by TechCrunch's Michael Arrington with the incendiary title, "These Crazy Musicians Still Think They Should Get Paid For Recorded Music."

In the past, Arrington has argued that the price of recorded music is inevitably marching towards zero due to the fact that it can be reproduced at zero marginal cost.

In his latest post, Arrington states:

"Recorded music is nothing but marketing material to drive awareness of an artist. Websites that bring that music to listeners are doing artists a favor. In fact, they’re doing them a favor that they should (and will) be paid for.

"Young artists and songwriters in particular benefit from these services - Until a few years ago they had almost no way to break into the mainstream without getting a label to promote them. Now those walls are being torn down, and Bragg has the audacity to complain about it."

Not surprisingly, statements like these caused a fury of comments about the rights of artists, the role of record labels, economics and ethics.

I was asked recently by one of my readers to discuss the subject of the music business in the internet age and now seems like the perfect time to do it.

I think such a discussion requires us to address the following topics:

• Intellectual Property Rights
• Economics
• Myth and Faulty Logic
• Pragmatism
• Unintended Consequences

Intellectual Property Rights

The concept of intellectual property is borne out of the belief that "creations of the mind," including artistic works such as music, have value and that the creators of these works should therefore have protection and the right to exploit their creations.

Intellectual property rights are crucial to many industries - not just the music business. These rights, and the ability to enforce them, make all the difference when it comes to turning one's creations into a financially-viable enterprise. Many software developers, for instance, would have little incentive to create useful software packages if copyright didn't exist.

When somebody downloads a song (or software product) without paying for it, it is a violation of the rights holder's intellectual property rights assuming that the rights holder has not authorized it to be downloaded without payment.

There is no reasonable and ethical justification for digital theft.

For instance, many argue that music is overpriced. Rights holders have the ability to charge whatever they want for their intellectual property. If you believe that the value they place on it is out of line with its value to you as a consumer, vote with your wallet and send that message.

You do not have any right to decide that you can take that intellectual property because you do not like the pricing.

Whether you agree with the concept of intellectual property or not, we live in a world where the legal systems of most developed nations have embraced the concept intellectual property rights, and short of an abolition of these, there can be no argument that piracy of recorded music is not an egregious violation of these rights.

Economics

In Michael Arrington's flawed view of economic theory, intellectual property rights are apparently "artificial barriers to a free market". He loves to argue that music is on a "march" towards free because it can be reproduced at zero marginal cost. The fact that thieves who have no right to reproduce it are reproducing it is of no consequence, of course.

Marginal costs are only one part of the equation, however. Producing an album is a time-intensive and resource-intensive process. Time and resources are not free and regardless of the argument, cannot be devalued.

In a comment, Arrington states:

"Companies don’t price goods based on sunk (you say R&D) costs. They price goods based on profit maximization, which is generally the intersection of the supply and demand curves (in efficient, competitive markets). Sunk costs are absolutely irrelevant to pricing. They are only relevant to profitability."

First, I'm quite surprised that somebody with a degree in economics (Arrington) could confuse fixed costs with sunk costs.

The fixed costs associated with producing an album (i.e. studio time, etc.) are not sunk costs, which are "costs that have been incurred and which cannot be recovered to any significant degree."

Furthermore, nobody with any experience in the music business would compare the process of producing an album to the R&D process, and Arrington should note that while R&D costs can be sunk costs, they can also be investment costs. It all depends on the circumstances.

It's also worth noting that there are multiple models for profit maximization. Arrington seems to believe that the record labels should focus on the Marginal Cost-Marginal Revenue Method, even though the Total Cost-Total Revenue Method probably makes more sense.

Of course, pricing is essentially a moot point when one takes the position, like Arrington does, that "recorded music is nothing but marketing material to drive awareness of an artist" and that "if you can’t make money from selling music and the studio costs too much money, my advice is to stop going to the studio, and get a job that allows you to support yourself."

I think that this position is disingenuous. Arrington wants:

• Artists and record labels to offer an in-demand product (recorded music) for free when the greatest fixed costs in the business are related to the production of this product.
  
  
• Artists and record labels to subsidize the give-away with "live music, merchandise and limited edition physical copies of music" - all things that naturally appeal to a much smaller subset of the market.

I doubt that this can work, especially for the independent artists and record labels that just can't drive enough demand for live music, merchandise and limited edition physical copies of music to make the exercise economically viable despite the fact that they may have enough demand for the original product (recorded music).

Of course, that is dependent upon an ability to actually sell their product because they don't have to compete with thieves and critics who want to dictate how they should exploit their own intellectual property rights.

Myth and Faulty Logic

There is a lot of myth and faulty logic present in the discussion about the future of the music business. Two of the most prominent examples of myth and faulty logic:

• The internet has eliminated the need for middlemen (i.e. record labels). Critics of the record label model are quick to point to "experiments" such as those conducted by Radiohead and Nine Inch Nails as evidence that record labels are no longer needed and that new artists can make it on their own.
  
  Yet few critics place any importance on the fact that both Radiohead and Nine Inch Nails were the beneficiaries of major record label promotion and that their ability to eventually go direct to their fans stems from the popularity that was cultivated with the investment of the record labels.
  
  That investment cannot be devalued. After all, EMI, for instance, estimates that only 5% of its acts are profitable. In other words, record labels act like venture capitalists in many ways, and I don't see Arrington calling for the demise of his VC friends.
  
  The truth is that many artists will be the first to admit that they're not savvy when it comes to business and marketing. While I don't necessarily disagree with the argument that labels have "overcharged" for their services, their services do have value. Expecting that hordes of new artists can make a name for themselves and successfully leverage the same types of models implemented by already-popular artists like Radiohead and Nine Inch Nails is downright naive.
  
  
• Piracy primarily reflects a consumer backlash against "evil" record labels. While I don't doubt the fact that many people dislike record labels, piracy is not primarily committed as part of a protest against record labels. It is committed because whenever there is an easy, low-risk method for obtaining something of value that otherwise costs money, large numbers of people will take advantage of it.
  
  Without arguing whether or not Radiohead's "pay us if you like" experiment was "successful" or not, for instance, it demonstrated this. Even though Radiohead created a consumer-friendly model that is the antithesis of what a major record label executive would likely conceive, when presented with an option to obtain something of value for free (i.e. a Radiohead album), most consumers opted for the "free" option.
  
  It's also worth noting that rampant piracy has also impacted independent labels and artists despite the fact that these labels and artists are not "evil." This highlights the fact that there are few Robin Hoods - the vast majority of thieves steal because they want something for free, not because they want to make a point.

Pragmatism

Pragmatically, piracy is a real issue that those in the music business can't ignore. Piracy is unethical and illegal, but it exists and isn't going away. Arrington is absolutely correct when he states "fairness has zero impact on the economic reality that we live in."

I am not in a position to suggest how artists and record labels should deal with the problem. Obviously, a lot of effort has been invested in enforcement, and while I don't necessarily think that having the RIAA sue individual consumers is going to result in a resolution, I understand why it has been done and based on some anecdotal evidence, do think to a certain extent that it has been effective in making it more difficult for the less tech-savvy to find and download pirated music.

That said, relying solely on enforcement efforts is probably not a good bet for rights holders. Rights holders should experiment with new models and many are. Pretending, however, that these will fix the problems caused by a culture where theft is acceptable and intellectual property rights are marginalized is naive.

Unintended Consequences

At the end of the day, I think we tend to ignore the most important implication of music piracy: the unintended consequences.

Few people would walk into a music store and steal a CD but the disinhibiting nature of the internet has helped foment a widespread belief that anonymous digital theft, on the other hand, is acceptable.

Arrington basically categorizes this debate as being based on the notion that the "starving artist [is saying] we have to support him," but this is yet another disingenuous statement. The debate is about intellectual property rights holders being able to get paid when their intellectual property is used - nothing more, nothing less.

Clearly, given the volume of illegal music downloads, consumers see value in music and there is a strong demand for good music. That's not surprising given that music is a universal phenomenon that is interwoven into so many aspects of our daily lives. Many consumers, however, because of the ease with which they can steal this music, do so.

They come up with all sorts of justifications for their unethical actions (i.e. I'm poor and can't afford music) but in the long run, the consequences of these actions will not be favorable to consumers.

Consumers will reap what they sow.

There is the possibility that draconian measures will be implemented to make the digital theft of music much more difficult for the average consumer. Such measures, including ISP-level filtering, may make the internet less "democratic" in areas where there is a legitimate need for such "democracy."

But the most dangerous unintended consequence of digital music theft is that it could eventually hamper the creation of music itself.

If making the music we all love is not a financially-viable enterprise for artists because we continue to steal it and devalue the costs (in both time and money) of producing it, more and more of them may have no choice but to stop creating that music.

Every consumer that steals music is essentially shooting himself in the foot and if he is really one of the few doing so in an effort to help destroy the "evil" record labels, he is essentially cutting off his nose to spite his face.

At some point, the music will stop. The band won't play on and there won't be any fat lady there to sing.

In his seminal book, The Wealth of Nations, Adam Smith noted:

"It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own self-interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages."

We should remember this and recognize that it applies to more than just the people who produce the food we eat. It also applies to the people who produce the music that satiates our souls.