September 2005

Variable price fixing?

by on September 30, 2005 · 76 comments

Everybody seems to be freaking out about Warner Music chief Edgar Bronfman saying earlier this week that he would like to see variable pricing on iTunes. Rather than a flat 99-cent rate for all songs, Bronfman would like to charge more for popular songs and less for songs that are older or not in demand.

Some have suggested that this would amount to price fixing. They’re thinking of resale price maintenance, where a firm requires resellers of its product to sell at a certain price. If all the resellers are locked in to the same price, they won’t compete on price, price won’t come down, and the producing firm might get a supra-competive return. But to make this work Warner would have to not only set the prices on iTunes, but everywhere else. You would also have to assume that songs aren’t substitutable, so that consumers wouldn’t just move over to non-Warner songs that are cheaper. You would have to assume that or a cartel of all the major labels, which would really be serious.

What Bronfman is really proposing isn’t that strange at all. As BusinessWeek notes,

Some books cost $25, others $15. There are magazines that sell for $4.95 a copy, while others go for $2.95. And who hasn’t secretly perused the bargain racks of CDs, looking for a $5 disc from that hair-metal band you loved so much in the ’80s? [I'm looking at you, Adam.] All Bronfman suggested was creating an environment where some songs would command a premium and others would do the equivalent of filling the bargain CD bin.

Still, some ask, what business does Bronfman have telling Apple what retail price to charge? He’s the wholesaler, they say. He can charge Apple more if he likes and let Apple decide whether it will raise its prices. The problem with this reasoning is that Apple does not license music from the labels for a flat per-song royalty. Proceeds from each download are reportedly split 35-65, Apple-label. Here’s an explanation of the agreement:

The deal is straightforward. Of the 99 cents of a download, Apple keeps a portion and the rest goes back to the label, which is then responsible for distributing back to the artists, songwriters, publishers, and so on according to the existing terms between the labels and their bands. This makes it really simple for Apple to acquire content because they don’t have to deal with stuff like licensing agreements or paying publishers–all that stuff is the labels’ responsibility.

Bronfman is just trying to make the portion kicked back to Warner variable depending on the song’s market value. And, oh yeah, Apple doesn’t have to take the deal.

Now, I agree with Steve Jobs when he says, “If the price goes up, [consumers] will go back to piracy and everybody loses.” But that just means that Bronfman’s variable pricing scheme would be a dumb business decision because I personally don’t think any song is worth more than 99 cents. Priced above this consumers will download illegally or buy other songs. But variable pricing by itself has nothing to do with illegal price fixing as some have suggested.

On October 25 the DOJ and FTC are jointly holding a workshop on competition policy and the real estate industry. A topic that the workshop will consider is one that I have written about a few times in the past: state laws that restrict competition among buyers’ and sellers’ brokers. Licensing laws that aim to protect consumers have had the ulterior motive of discriminating against online web-based companies that enable the real estate transaction without the need for traditional real estate agents. New York is one such state with onerous licensing laws. A few months ago I filed comments in a rulemaking aimed at updating the law. Unfortunately, the NY Department of State still does not get it. One example from my comments:

the NPRM requires actual or electronic signatures. However, businesses and consumers communicate their desire to form a relationship in a multitude of ways. For communications over the Internet, consumers almost always show their assent to contractual terms by clicking “I Accept” or other similar language evidencing agreement. The AIV rules must recognize that a binding contract is formed when this online assent occurs. Indeed, courts of law routinely uphold these “clickwrap” agreements to be legally binding agreements.

One company that has been on the frontlines in New York is mlx.com. The owner, LaLa Wang, has a great blog about the politics of real estate and law called askLaLa.

Minimum service laws are also protectionist measures aimed to hurt online competitors. The Michigan state legislature has proposed legislation to limit competition in real estate by forcing new requirements on low-cost, online brokers.

Let’s hope there’s something good that comes out of this workshop (there will be if I have a say in it, as I hope to be selected as a panelist).

In case you missed it, The Economist ran an excellent editorial and survey article last week on the ongoing Internet revolution in the phone business. The title on the cover, “How the Internet Killed the Phone Business” is a bit misleading–as the article points out, telephony will likely expand massively as Internet technologies take hold. It’s the existing telephone companies that are at risk. Interestingly, the article argues that its not traditional wireline firms that are most threatened – since they are quickly moving into Internet-based services themselves. Rather, say the authors, stand-alone wireless firms who are more dependent on voice calls have the biggest reason to worry. The magazine’s overall conclusion:

It is now no longer a question of whether VOIP will wipe out traditional telephony, but a question of how quickly it will do so. People in the industry are already talking about the day, perhaps only five years away, when telephony will be a free service offered as part of a bundle of services as an incentive to buy other things such as broadband access or pay-TV services. VOIP, in short, is completely reshaping the telecoms landscape.

Worth reading.

The Wall Street Journal reported today that, in an effort to combat rampant movie and music piracy overseas (especially in China), some media companies are radically cutting prices on their DVDs and CDs to undercut the pirates. Warner Brothers, for example, plans to drop DVD prices to roughly $2 to $4 in China and NBC Universal is apparently planning a similar response for Russia.

I find this business strategy very interesting because I think it has legitimate chance of helping to undercut a significant chunk of the piracy that the studios have to deal with in China and other foreign markets. After all, I would think that many Chinese consumers would be willing to spend a dollar or two more to get the legitimate studio version of a film since its quality is likely better and it probably contains a host of extras not available on the pirated versions. And, hopefully, at least some Chinese consumers will also realize it’s the right thing to do instead of robbing the content companies of any compensation for the wonderful products they produce.

On the other hand, I’m also wondering if this new strategy might backfire on the movie and music studios. In particular, I’m wondering (a) if this will open up global arbitrage opportunities; and (b) if this sort of price discrimination will rub a lot of other consumers back here in the States the wrong way.

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As noted in the post below, the telecommunications reform plan floated recently by the staff of the House Energy and Commerce committee includes some 80 regulations, mandates or restrictions. To be more precise, there are, by my count, 82–more than one per page. Of course, some might quibble over this number– the difference between a rule with two mandates and a rule with one two-part mandate is an ephemeral one. And certainly the mandates vary in significance. Some are trivial, some are burdensome, some are justified, some are outrageous. But any way you look at it, there are an awful lot of them. Here they are:

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More on House Telecom Rewrite

by on September 26, 2005

After excellent posts on the subject by Adam and Braden, it may seem like piling on, but here’s my own take on the telecom reform draft bill. Bottom line: the rewrite needs a rewrite.

House Telecom Rewrite Needs a Rewrite
September 23, 2005
WebMemo #860

What happened to telecom deregulation? That was the question last week after the House Commerce Committee staff released proposed legislation to reform the nation’s telecommunications laws. The product of months of discussion and negotiation, the draft was billed as an effort to sweep away antiquated rules. “New telecommunications services,” said committee chairman Rep. Joe Barton (R-TX), “shouldn’t be hamstrung by old thinking and outdated regulations.”

Unfortunately, the actual proposal falls far short of this goal. While eliminating many unneeded rules, it also imposes many others. In all, the 77-page draft includes some 80 private-sector mandates and restrictions. Not only would telecommunications firms would remain over-regulated, but new rules would be imposed on previously unregulated Internet services. This attempted rewrite of telecommunications laws needs a rewrite itself.

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More on Google Print

by on September 25, 2005 · 6 comments

I’m certainly not going to claim that Google is going to win in court, since fair use determinations are notoriously hard to predict. But I think that on the merits, their case is a lot stronger than Jerry gives them credit for.

It’s not clear to me why Jerry doesn’t consider a parody a derivative work. By definition, a parody takes a work, retains some elements of it, drops some others, and transforms it into a new work. We could imagine an alternative universe in which publishers sold “parody rights” the same way they now sell film rights or sequel rights.

UMG v. mp3.com was a badly reasoned, short-sighted decision, and I think there’s a very good chance that it would have been overturned on appeal. If the decision is right that “Any allegedly positive impact of defendant’s activities on plaintiffs’ prior market in no way frees defendant to usurp a further market that directly derives from reproduction of the plaintiffs’ copyrighted works,” then it’s hard to see how any fair use defense could succeed. After all, one could imagine a world in which Hollywood won the Sony Betamax case and licensed Hollywood-approved VCRs that charged the consumer a fee every time a TV show was recorded. Or, if the music industry had won the Diamond case, they could have licensed MP3 players that send the appropriate publisher a penny every time a song was played. Likewise, if Kelly v. Arriba Soft had come out in favor of Mr. Kelly, perhaps owners of photographs could have licensed “search engine rights” to their photographs.

All fair uses involve reproducing copyrighted content in order to create derivative works. By definition, that undermines the ability of the copyright holder to sell derivative works of the same kind. If that were the standard, no use would withstand fair use scrutiny. That’s why courts have generally focused on the market for the original product, not the market for hypothetical derivative works.

Personally, I think the factor that will weigh most heavily in Google’s favor is factor 1, the purpose and character of the use. As the Supreme Court put it, that factor asks whether a use “merely supersedes the objects of the original creation, or whether and to what extent it is transformative.” MP3.com was arguably superseding the market for ordinary CDs. Google Print is clearly not superseding the market for books. And it’s every bit as transformative as Arriba Soft’s software was.

I think Tim is right that courts are beginning to realize that “new technological realities” make the kind of copying that search engines and other net applications engage in different from “the copying prohibited by traditional copyright law.” But they are really going to have to get it if Google Print Library is to succeed in court.

To me, the most important factor in a court’s fair use analysis is “the effect of the use upon the potential market for or value of the copyrighted work.” 17 USC § 107(4). A parody or critique is certainly fair use because you’ll never be able to buy a parody from the creator of the original. That is a parody will never be a substitute for either the original or derivatives and so won’t have an impact on the market for the original.

However, to have an impact on the market for the original doesn’t require there to be a copy that is an exact substitute for the original. In UMG v. MP3.com, the service in question wasn’t a direct substitute for the record companies’ product, namely CDs. But the use did affect the market for licensing. MP3.com’s wholesale copying of the plaintiffs’ music catalogs prevented them from exercising their exclusive right under copyright to decide whether to license their works or not. This isn’t contradicted by the holding in Kelly v. Arriba Soft either. In that case the court just didn’t find any evidence of market harm. And one thing the courts in MP3.com and Arriba both agreed on explicitly is that even if the allegedly fair use helps the market for the original that’s still no excuse.

So, is there a market that Google is affecting negatively? Well, the case can be made that there is a market for licensing the text of books for just the kind of thing that Google Print wants to do. Amazon.com has a “Search inside the book” feature and they get permission from every publisher before they make their books searchable. You also have to look no further than Google’s Print Publisher program that, unlike its Library program, gets permission and shares revenues. And mind you, the statute only requires that there be a “potential market” that is affected.

As a normative matter I think that what Google Print is trying to do should definitely be included within the meaning of fair use. But I think it might not be such an open-and-shut case as long as the market effect factor of the fair use doctrine isn’t updated to reflect the new realities of the net.

The September 15 discussion draft from the House Energy & Commerce Committee is aimed at reforming the nation’s telecom and cable laws. While it does change and “update” the law, is also succeeds at creating no less than 30 new mandatory and discretionary FCC powers!

It creates new complicated, technology-based rules to replace old ones (see Randy May in his PFF blog entry where he warns against regulatory techno-functional definitions–classifications). Congress should not expand the powers of the FCC by giving it a new role to regulate the latest technologies. But this is precisely what the discussion draft does (and Adam seems to concur in his post that the draft goes way too far in imposing new rules on broadband service and video providers).

At least 30 new functions for the FCC! Talk about full employment for FCC attorneys and economists (and their private sector equivalents). These new powers can be categorized as the ability of the FCC to a) create explicit rules, b) establish procedures, c) increase jurisdictional authority, and d) involve itself in determination proceedings and market oversight.

a) Rules: The draft mandates 18 different rulemakings or official inquiries, such as requiring that the FCC establish rules regarding intercarrier compensation, mandating the terms for franchise licensing, creating national consumer protection rules, devising a federal registration form for companies providing communications service, and any such regulations “as are necessary to implement this Act.”

b) Procedures: The FCC must invent procedures for overseeing the design of broadband infrastructure, for mediating and arbitrating disagreements regarding the exchange of VoIP traffic, and for resolving disputes over consumer complaints.

c) Jurisdiction: The draft bill provides the FCC increased authority to involve itself in standards setting, and even investigate and resolve disputes over network equipment standards.

d) Market Oversight: The FCC would have considerable powers overseeing broadband market decisions, such as the reliability and integrity of communication networks and to whom and on what basis to offer video service.

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Solveig Singleton and I recently released a short analysis of the ongoing ICANN dispute over the proposed “.xxx” top-level domain (TLD). In our PFF Progress Snapshot, we point out that important issues are raised by the recent effort of the United States to intervene at the last moment and interfere with the creation of this new TLD. I encourage you to read our paper but before you do so, if you need some good background on this issue, I highly recommend that you first visit the Internet Governance Project web page and speficially look at the petition that Prof. Milton Mueller and several other ICANN experts put together on this issue.