Wall St. and Business Wednesdays: Grokster And StreamCast Face The Music.

The music business should have stuck by Thomas Edison’s technology if it wanted to avoid the threat of piracy. His wax cylinders could record a performance but could not be reproduced; that became possible only with the invention of the flat-disc record some years later. On Tuesday March 29th, America’s Supreme Court began to hear testimony in a case brought by the big entertainment companies that is intended to stop the illegal downloading of copyright-protected music and film. The industry’s target is the peer-to-peer (P2P) technology that allows the swapping of files directly over the internet. The case in question pits two makers of file-sharing software, StreamCast Networks and Grokster, against the entertainment business, represented by one of Hollywood's most famous studios, Metro-Goldwyn-Mayer (MGM). And the judges, despite their years, showed that they were well acquainted with the world of file swappers and the digital gadgetry that a ruling against the P2P firms might stymie.

The entertainment business has long been susceptible to copyright infringement—and it has usually blamed the electronics industry. The music industry first cried foul at the introduction of the cassette-tape recorder in the late 1960s. More recently, the digitisation of music has led to widespread “burning” of music tracks on CDs using home computers. The latest threat to the record companies is a copying technique of even greater speed, ease and scope. Every day some 4m Americans swap music files over the internet, according to figures from Pew, an independent research organisation. Now the swapping of new films online is also gaining ground, to the chagrin of the movie industry. Donald Verrilli, the lawyer representing the entertainment business, said in Tuesday's court hearing that file-sharing was “a gigantic engine of infringement” that allowed the theft of 2.6 billion digital music, film and other files every month.

The file-sharing threat has come at a particularly bad time for the music industry, which is struggling to reverse a long-term decline. According to the IFPI, a recording-industry body, worldwide music sales plunged in value by 22% in the five years to 2003—a drop of over $6 billion. In 2004, sales fell by 1.3%, though that decline looks less bad when revenue from legal digital downloads is added in. Though there has been a debate on the extent to which file-sharers would otherwise have gone out and bought copies of the songs they are downloading, the music industry largely blames them for its ills, noting that CD sales are dipping steeply in countries where broadband internet access is growing fast. Since P2P software allows computers to talk directly to others running the same program without intermediaries, Grokster and StreamCast argue that they are unable to control how their software is being used, and thus are not responsible for any illegal sharing.

Some suggest that the latest attempt to curb illicit file-swapping—legal action against the technology that drives P2P networks—threatens the future of innovation. Justice Antonin Scalia appeared to have some sympathy with this view. He suggested that a ruling for the plaintiffs in MGM v Grokster could stifle development of new technologies, since potential innovators might fear that, as he put it, “I'm a new inventor, I'm going to get sued right away.”

The Betamax Precedent

In court, the two software firms cited the case of Sony’s Betamax technology as a precedent. The home video-recording system, which was eventually superseded by the rival VHS format, faced a suit in 1984 in which Disney and Universal called for its ban. The film studios feared that the ability to record on to video would allow considerable infringement of their copyright. The Supreme Court ruled then that Sony was not liable because the equipment had “substantial” uses other than infringement, such as the recording of TV programmes for later viewing. (Ironically, Sony nowadays owns a giant music-recording business and thus finds itself, awkwardly, on both sides of the argument.)

Similarly, the software produced by StreamCast and Grokster has significant non-infringing uses, such as sharing music that is not copyright-protected and making phone calls over the internet. In fact, some make the case that P2P technology could make the internet more robust and secure by avoiding the use of centralised servers, and that the entertainment companies’ lawsuit is thus harmful to the web as a whole. Richard Taranto, Grokster's lawyer, pressed the justices to apply the Sony precedent but was reminded by Justice Ruth Bader Ginsburg that the previous ruling was longer and less straightforward than merely deciding if a technology had some non-infringing uses.

Napster, the first and best-known of the file-sharing businesses, was killed off by the music industry in 2001. Because it used central servers and so had the ability to block users who broke copyright laws, a judge issued an injunction ordering Napster to shut its servers down. At the time, it boasted some 14m users. Since then, the industry has ramped up action against file-sharing and widened its attack by going after individual downloaders as well.

At present, some 8,000 individuals around the world face lawsuits for illegal file-sharing. The industry has backed up its legal moves with a publicity offensive aimed at convincing the public that unauthorised downloading is theft. As well as cinema- and TV-advertising campaigns, 45m instant messages have gone out to users of P2P services, warning them to stop putting copyright material on the internet. America’s Department of Justice has weighed in too, even suggesting that P2P services could be used to support terrorism. Others have muttered darkly that the technology is a conduit for illegal pornography.

There are some signs that these measures are working: surveys suggest that internet users are becoming more wary of illegal file-sharing, for instance. However, according to the IFPI’s own figures, the number of unauthorised music files on the web has grown in recent months after falling sharply in the first half of 2004 (see chart). The number of users is also up, with 8.6m offering illegal files compared with 6.2m a year ago.

The music business has employed other defensive measures. Apart from a round of mergers and cost-cutting over recent years, the industry has tried to embrace legal downloading. Napster itself was reborn as a legal downloading service. In 2004, says the IFPI, the number of legal-download sites increased four-fold to 230 and the number of legal downloads to over 200m. Apple’s iTunes, the largest legal-download catalogue, has more than 1m songs and handles over 1m downloads a day.

The Supreme Court is expected to take about three months to rule on MGM v Grokster. But even if the entertainment business wins the case, while managing to coax more users into downloading legally, its problems are unlikely to go away. The rush into legal downloading is bound to cannibalise sales of CDs and DVDs, hitting profits. And perhaps the decline in global sales is indicative of a far greater problem for the music industry—that consumers simply think many of its products are not worth paying for.

This article appears in The Economist Global Agenda

Wednesday, March 30, 2005

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