Has file-sharing software damaged CD music sales?
Yesterday's Guardian newspaper included a piece by Oliver Burkeman on the fallout from last Monday's decision of the US Supreme Court that Grokster and StreamCast can be held liable for the illegal exchange of copyright material over their networks (Should I buy this? Real lives, Guardian 29th June 2005)
It included the question "Is there any evidence that file-sharing has actually damaged CD sales?". The studies that he cites suggest not, but they are far from authoritative. A recent paper by the respected American economist Stan J Liebowitz provides a careful review of the various studies of this question, as well as his own empirical analysis. He concludes that "..file-sharing hurts copyright owners and that it is responsible for most, if not all, of the recent decline in sales".
(Liebowitz's paper can be accessed from his web page at http://www.utdallas.edu/~liebowit/intprop/main.htm).
This doesn't mean of course that I approve of the heavy legal
action taken by music and media companies against individual users of the file-sharing software.
Free lunches - if you choose carefully from the menu!
The BBC News website recently had a very interesting piece about the entrepreneur Niklas Zennstrom, the man behind both the file-sharing program Kazaa and Skype, which lets users make very cheap or even free phone calls via the Internet based on the Voice over Internet Protocol, VoIP.
Zennstrom discusses the use of a business model where "some users are paying for services, but not everyone". Skype services are free so long as the caller and the person being called are both Skype users. Skype makes its money out of users who buy additonal services and who use Skype to make or receive calls from conventional telephone networks.
But, as Zennstrom comments, it is not unusual to provide services free to some customers while others have to pay. For example web based e-mail services like Yahoo!, or web-site hosting through Lycos are provided free, so long as you don't exceed the (now quite generous) storage limits. You can also view some of the online stories at the New York Times and Economist web sites for no charge, but you will have to pay (either through a subscription or for an individual download) to access other material.
What is the economic logic behind this? Didn't Milton Friedman famously tell us that "There's No Such Thing As a Free Lunch"?
One way of looking at it is that what you are getting is a free taster. Try out a little of it for free, and if you decide that you like it, maybe you will be happy to pay for more of it. Sometimes products are offered free (to everyone) at the beginning when they are being launched, in an effort to build up the customer base (see my earlier post on the importance of network externalities). But that's not what I am talking about here. For example in the case of Yahoo! mail so long as you stick to the "lite" version of the product you can continue to get it for free (although you will be exposed to advertising messages which will earn revenue for Yahoo!). You don't have to pay anything directly unless you want to move to one of the business "versions" of the product. "Versioning", as described by Shapiro and Varian in their book "Information Rules", is a technique for applying price discrimination. Customers select the version of the product that is in line with their willingness to pay. As we see this might be the free version.
Of course this doesn't mean that Friedman was wrong. There still isn't such a thing as a free lunch - somebody has to pay. But if you select carefully from the menu you can get what you want for free while those who are willing to pay for the full version, or to pay to advertise, provide the funds to keep the service available to you for nothing.
Issues concerning taxation and the Internet have become rather complicated, especially in the United States where there are tensions between the individual states and the Federal authorities. The Internet Tax Freedom Act of 1998 imposed a three year moratorium on new Internet taxes – some states that already had taxes in place were allowed to maintain them – and established the Advisory Commission on Electronic Commerce, which eventually reported in April 2000. [Advisory Commission on Electronic Commerce http://www.ecommercecommission.org/]
The Chair of the ACEC, Virginia Governor James Gilmore III, a strong proponent of an outright ban on Internet taxes, was unable to get the two-thirds support that he needed so the recommendations were limited to
(i) An extension of the moratorium until the end of October 2003
(ii) The end of taxation on Internet access (subscription fees)
(iii) The end of a tax on telephone services (since some Interent access was via telephone lines) – this recommendation was not approved by Congress.
The moratorium has since been extended on several occasions and the Streamlined Sales Tax Project (SSTP) was also launched in July 2003. When at least 10 states accounting for 20% of the population agree to the imposition of a sales tax on Internet transactions then it will take effect across all states. Several companies (e.g. WalMart and Toys-R-Us) have voluntarily introduced online sales tax collection systems but others have steadfastly stuck to the position that if they don’t have a physical presence in a state with an online sales tax they won’t collect it.
In the European Union things are a little clearer. In May 2002 the EU agreed new rules for an online sales tax (VAT). Overseas suppliers were required to register for tax purposes in one of the member countires and to levy the tax at the local rate. This directive came into force in July 2003.
The main arguments in favour of an online sales tax are (i) without it there is not a level playing field – online merchants have a competitive advantage over offline stores and this creates distortionary effects (ii) the individual state budgets are thereby affected since they depend to a large extent on local sales tax revenues. The argument usually deployed by those in favour of a tax ban is that e-commerce is still in its (relative) infancy and applying the tax would inhibit its growth. A similar argument is also used against the imposition of a tax on Internet access. (It would also make it harder to close the "Digital Divide" because it would raise the cost of Internet access.)
For more details on this see my Economics of the Internet lecture notes at http://userweb.port.ac.uk/~judgeg/ENET/ENET8.ppt
A new issue has recently been added to the debate – what some have called the “iPod tax”. Some people have argued that not only should physical goods that are ordered over the Internet but delivered to people's homes offline (for example by mail) be subject to sales tax, but so should information goods that are delivered via the Internet (electronic entertainment - music and film downloads etc.) Last month the Wisconsin Joint Finance Committee considered a proposal for just such a tax, but turned it down on the grounds that it would place at a disadvantage companies trying to operate this kind of business from within the state.
[See “Finance Committee rejects extra tax on Internet buys”, By Katy Williams, Wisconsin Technology Network 25th May 2005 http://wistechnology.com/printarticle.php?id=1870]
In another development a California state appeals court decided that Borders Inc. must collect online sales taxes within the state because their offline stores and their online stores are all part of the same company – their operations are “co-mingled”. [See “Click and Pay a Little More: The Days of Tax-Free Online Shopping May Be Over”, By Bob Tedeschi, New York Times, June 20, 2005. http://www.nytimes.com/2005/06/20/technology/20ecom.html]
What do you think should be done? Please post your comments by clicking on the hotlink below.
What's in a name?
If you were to type the URL www.iTunes.co.uk into your web browser, what kind of web site do you think you would connect to?
You would probably expect to find a website owned by Apple offering downloads for your iPod. And you would be right - now. In fact you will be automatically re-routed to www.apple.com/uk/itunes/ where you can select from "more than 1.2 million tracks from all four major music labels".
But ownership of the iTunes.co.uk URL is disputed. In November 2000, over three years before Apple itself registered the domain name "itunes.com", Benjamin Cohen registered the "itunes.co.uk" name. Last December Apple disputed Cohen's right to own the name and referred the matter to the UK's domain name registrar, Nominet.
In March Nominet ruled that Cohen must hand over the name to Apple. Although he was forced to comply Cohen did not give up the fight. First he filed a Freedom of Information Request with the DTI questioning whether Nominet has the legal authority to force him to transfer the rights to the URL. The reply was interesting. The DTI said that they were "not aware of any statutory recognition of Nominet". Now Cohen is seeking a judicial review of the case in the High Court. In his view the way that Nominet handled the dispute was unfair and biased towards big business.
Is Cohen guilty of what has come to be known as "cybersquatting" (registering a popular sounding domain name in the hope that a company who would wish to use the name would have to pay you for it)? Or did he quite legitimately come up with a name that he wanted to use for his business, well before Apple decided to adopt the iTunes trademark? In that case Apple would have to pay him to hand over the URL, in the same way that in 1999 the BBC had to buy the address bbc.com from Boston Business Computing.
In the US the 1999 Anti-Cybersquatting Consumer Protection Act gives companies that feel they are the victims of cybersquatting the right to initiate arbitration proceedings through the Internet Corporation of Assigned Names and Numbers (ICANN). But the law here clearly needs tidying up.
What is the economics angle on this issue (I hope) I hear you ask? Partly this takes us into the area of the economics of trademarks. Nicholas Economides has written the entry on this topic in the New Palgrave Dictionary of Economics and Law (see Economides, Nicholas, (1998), "Trademarks," in The New Palgrave Dictionary of Economics and the Law, edited by Peter Newman. You can view a draft version of the paper at http://www.stern.nyu.edu/networks/trademarks.pdf)
Economides notes that trademarks convey non-analytical information to the consumer about goods on offer. Rather like a brand name a trademark offers a symbol through which the consumer can make a judgment about the likely quality of the product. Trademarks date back to the makers of jewellery in the Middle Ages. A craftsman's work could be identified through his trademark so that a buyer could be sure that he was getting the real thing and not a fraudulent imitation. Later trademarks came to be more widely used for all kinds of manufactured goods to signal the quality that a buyer might expect to get.
Economides notes that for a company a trademark is an investment. The reputation that goes with a trademark is built up over time and consequently firms will wish to protect this investment. Although he notes that there may be some distortionary effects of trademarks (through the wastage of resources in advertising designed to create a positive mental image) he concludes that these are likely to be small in relation to the potential benefits (for both producers and consumers).
According to John Naughton, writing in yesterday's Observer newspaper, [http://observer.guardian,co.uk/print/0,3858,5219049-102271,00.html]
eBay now has 150 million registered users worldwide who trade about $40 billion worth of goods a year, generating revenues for eBay of about $4 billion.
The main thrust of Naughton's story is that eBay got caught out in its reaction to the auctioning of Live8 concert tickets. When Sir Bob Geldof found out he first asked eBay to ban the auctions, then called on people to subvert the auctions by submitting "impossible bids" - of up to £10 million. When some eBay users did this they found themselves blacklisted by eBay, who said that such actions break eBay's rules.
Naughton also quoted from a leader in last week's Economist newspaper which, commenting on the spectacular success of eBay in the 10 years since it was formed, noted that on the Internet "the pace of change is rapid, and so is the ferocity of the competition."
Which brings me to another news story that I spotted in today's New York Times. Apparently Google is planning an online payments system to compete with eBay's PayPal. Although a Google spokesman declined to comment on the rumours, the New York Times journalist Saul Hansell noted that back in April Google had "filed documents to establish a new corporation in California called the Google Payments Corporation".
As John Naughton also noted, much of the trading on the eBay site now is by small firms selling their (new) products, rather than by people buying and selling used (second-hand) goods. These firms are not big enough to allocate resources to setting up their own web sites - instead they make use of eBay's infrastructure. Using eBay in this way is seen as a method of breaking into e-Commerce. Such firms are unlikely to have the ability to accept payment by credit or debit card, so the PayPal system has provided a valuable alternative mechanism. Google appears to have noticed this and could link its new system to the localised search facility that it has developed.
Predatory pricing behaviour in network markets
Any attempts to explain the dramatic growth of the Internet in the last decade, or indeed the equally rapid spread of Internet related products such as e-mail or even peer to peer file sharing software, will need to recognise the importance of network externalities. Network effects mean that the value of the product to any user increases as the number of other users expands. As a result take-off of the product may be slow to begin with when there are relatively few users but, once a critical mass has been reached, more and more people will want to be part of the network. The network is subject to positive feedback, making participation in the market even more valuable as it grows. This feature of network markets was first recognised by Jeff Rohlfs back in the nineteen-seventies when he was working for an American telephone company. [Rohlfs, J (1974) A Theory of Interdependent Demand for a Communication Service, The Bell Journal of Economics and Management Science 5(1) 16-37.] More recently Rohlfs has expanded and updated his ideas in his book "Bandwagon Effects in High Technology Industries, MIT Press, 2000.
One implication of network externalities of this type is that a producer of a new network product, conscious that it might only be profitable to produce once a critical mass has been reached, may feel justified in keeping the price of the product very low at the beginning of the product's life in an attempt to stimulate sufficient demand quickly to reach this mass. Then, having established some degree of control over the market, the producer may attempt to raise the price so that profits can be earned and the revenue foregone during the launch phase can also be recovered. Of course, in this dynamic environment it may be that the technology develops and improvements in the production process mean that costs can be pushed down in turn enabling profits to be made without pushing up the price to much. But it is not uncommon for network goods to be offered very cheaply at an early stage of their development with prices being pushed up later. An extreme case might even see the product being given away for free early on to quickly build up the customer base; then later a fee is charged once customers have become hooked on the product. Web browsers and web-based news and information services come to mind as example.
The justification for this pattern of behaviour would be that (a) without the low price at the beginning the market would not be able to"take-off", (b) without being able to realise the expectation of higher prices later the company's development costs would not be covered - if there is no prospect of profits in the second phase there would be no incentive for the company to develop the market at all. This sounds OK when we are talking about completely new network goods, but what about when it is applied to a new brand of an exisiting product type? Here the new entrant is trying to displace an incumbent and grab sufficient market share to at least become viable. Alternatively an incumbent might keep the price lower a little longer than necessary to build up sales to the threshold level in order to see off any potential competitors attempting to enter the market.
Is this good for consumers? Well clearly it can be so long as the producer does not (a) eventually establish a monopoly position in the market and then also (b) exploit this monopoly power by pushing up prices so as to extract more than "normal profits". Whilst the sequence of low to high prices might be acceptable as a device for ensuring the initial viability of a market, it would be regarded rather differently if it essentially a predatory pricing strategy designed to capture a market from other suppliers.
A new paper by Joseph Farrell and Michael Katz [Farrell, J and Katz, M (2005) Competition or Predation? Consumer Coordination, Strategic Pricing and Price Floors in Network Markets, Journal of Industrial Economics LIII (2) June 203-231] revisits the issue. In considering a two period model to analyze potential policy intervention against predatory pricing behaviour in markets with network effects, they find that the anti-predation rules proposed by others may not always raise consumer welfare and improve efficiency. It all depends on the way that consumer expectations are formed and coordinated.
It seems appropriate that at an early stage in the life of this blog, which is devoted to issues concerning the economics of the Internet, we should discuss the economics of blogging - "blogonomics".
Blogs come in a range of shapes and sizes, and are used for a variety of different purposes. Some are private and accessible only by a known group of workers within a company. They might be on the company intranet, or on the web but needing a username and password to get into. Usually the software that is used for this kind of blog is purchased (or perhaps licensed) from a company that specialises in weblog software. Manila, from the company UserLand, is an example of the kind of software that can be used to create these company blogs. [http://manila.userland.com/ ]
Public blogs, available on the web and accessible to anyone who comes across them, are usually paid for by advertising. Or if the blog is provided by a portal or search engine company (like Google) the costs are absorbed into the general overheads of the company (which in turn are usually covered mainly by advertising revenue). Google is reported to have paid PyraLabs nearly US$300 in 2003 to acquire its Blogger software (I read that somewhere in a blog!)
These public blogs can range from those that are put together by enthusiastic individuals (like me!) through to commercial operations like Gawker (http://www.gawker.com/) where a team of contributors is paid to update the content. According to Tom Zeller of the International Herald Tribune big companies like Nike and Audi are advertising on Gawker, which now attracts over one million separate visitors each month. [Source: Zeller, Tom Jr "A Blogging Revolution? 'Give me a break'" TechNewsWorld 22nd May 2005 http://www.technewsworld.com/story/43081.html]
So what exactly is a blog? The word itself is a shortening of 'weblog' and it is essentially an online diary where the author (weblogger or "blogger") jots down his or her daily thoughts - and provides links to other web pages that he or she finds interesting. Amy Harmon, writing in the New York Times in February 2003, described a blog as "a kind of hyperlinked online journal". Blogs differ from ordinary home pages in that they are typically filled with a sequence of relatively brief entries that are updated frequently.
Not only is a blog a special type of web page (in the way that it is structured) but it is also created and published in a way that demands little IT or computing skills, or indeed web design knowledge, from its creator. For example to add new material to this blog I simply call up the blogger.com web page (http://www.blogger.com/), enter my user name and password, type in my "stuff" (or copy and paste from a text editor or word processor) and then click on a button to republish my blog. When I first set up the blog there were just three easy steps that I had to follow: 1) Create an account (you have to provide some information about yourself - such as an e-mail address - and choose a username and password) 2) Name your blog (you may find that the name you want is already in use so be prepared to compromise) and 3) choose a template from a variety of onscreen designs.
Blogs add new postings at the top of the file, old entries getting pushed further down the page. Each entry has a title so that a list of titles can be provided for blog readers to choose from if they don't want to work their way through an entire blog. Readers can also post their own comments about any particular entry (although the blogger can usually edit out a comment if it is offensive or otherwise objectionable).
In terms of content blogs can cover pretty much anything, although an important type of blog deals in news, perhaps reporting on topics not covered by conventional news outlets either becuase of their specialist nature, or possibly because they are too controversial or opinionated to be accepted by the established news media. (One complaint that is often made is that blogs are ideologically biased or poorly researched - as if this criticism didn't apply also to some of the tabloid press or TV news channels!).
Some commentators see blogs as a threat to conventional journalism. It certainly provides an unfiltered (unmediated!) outlet for news and views that might not otherwise reach us. Salam Pax, the Baghdad Blogger, provided a daily account of life on the ground in Iraq during the last days of Saddam's regime - http://www.thebaghdadblog.com/home/
Blogs at work
Another use for blogs is for workers contributing to a collaborative project. Rather than keeping in touch by e-mail, members of a project team can post comments on the progress (or lack of it!) to a project blog. Instead of having to sort through a mountain of e-mails a team member only has to search through the single blog. It helps people to keep track of their work - and of course can provide links to longer documents elsewhere on the web or the company intranet. Obviously where coprorate secrets and sensitive information are being shared the blog would have to be private and not accessible by members outside the group. Google is a company that has become a big user of blogs to enhance communication amongst its employees - perhaps this was a factor in it acquiring the blogger software that it now provides for the public to use.
The Economist newspaper (Blogging Goes to Work, 11th March 2004) refers to a slightly different kind of product that can be used for collaborative projects - the wiki. This is a web page that can be edited by any authorized user (apparently "wiki" means "quickly" in Hawaiian). Members of the ISO at the University of Portsmouth make use of wikis to communicate with each other. Like blogs wikis can of course link to regular web pages or intranets where more lengthy and formal documents are stored.
IT Professional make use of public blogs to share ideas and information (that is not of course subject to intellectual property restrictions). For example Tim O'Reilly of weblog.oreilly.com has recently been running a discussion on the question "could the browser function as the interface for all network applications?" (could the web work as an "Internet Operating System"?). Bill Thompson, who contributes regularly to the BBC web pages on IT and technology issues, has his own blog called Billblog[http://bill.verity-networks.com/billblog/].
The blog is seen by marketing people as the perfect device for promoting products, especially as direct marketing by e-mail tends to be viewed as spam.[See "The Blog Marketing Explosion by Richard Ord on the WebProNews.com site - the article is dated 24-10-05 -
Amy Harmon (New York Times 25th August 2003) gave an example of a rather different kind of use for blogs - by dieters providing a kind of online weight-watching service, documenting the blogger's weight on a daily basis, giving dieting tips and ideas and linking to other dieter's blogs to provide mutual support.
Freakonomics and podcasting
Over the weekend I travelled by train rather than car to see my mother, and this gave me the chance to catch up on some reading. (I didn't take my laptop and my mobile phone stayed switched off for the entire length of the journey!). It gave me the chance to catch up on some reading that I have been looking forward to for some weeks. The book I have been itching to read has the eye-catching title "Freakonomics
by Steven D Levitt and Stephen J Dubner. Levitt is a Professor in the Department of Economics at the University of Chicago http://www.src.uchicago.edu/users/levit/
and Editor of the Journal of Political Economy. Dubner is a journalist who wrties for the New York Times and The New Yorker. The book grew out of the collaboration between the two after they met when Dubner went to interview Levitt, who is one of the most interesting economists of his generation. If you haven't come across him before I recommend that you take a look at some of his work - especially if you think economics is too full of mathematics or is too distant from real world problems.
Why mention this book on my enetstuff blog you may ask? The reason is because there are several references in this informative, entertaining and extremely readable book to issues relating to economics and the internet. For example in chapter two, which is all about the value of information, but which is intriguingly titled "How is the Ku Klux Klan like a group of Sumo wrestlers?", he discusses the dramatic fall in the price of life insurance policies in the late 1990s due to the improved information on the prices of such policies provided by price comparison sites such as Quotesmith.com. Some other forms of insurance where the risk relates to the particular characteristics and circumstances of the individual are more difficult to compare, but thirty-year term life policies for $1 million are homogeneous and this makes price comparisons straightforward. Levitt and Dubner point out that almost overnight customers in the US were paying in total about $1 billion less a year for life insurance. Search costs had been dramatically reduced and so had the power of the insurance companies selling such policies to overcharge.
By the way, Freakonomics has it's own blog at http://www.freakonomics.com/blog.php
I also read The Observer newspaper where I found an interesting snippet about podcasting (http://observer.guardian.co.uk/business/story/0,6903,1504433,00.html
- scroll down for the story "Downloads on the up in Radio Pod"). Podcasting is the method of making available audio files via the Internet and it is being taken up by traditional broadcasters such as the BBC, as well as by individuals who don't have access to the usual radio broadcasting outlets. The success of Apple's i-pod means that lots of us out there have the means of listening to MP3 files at the time and place of our choice - so we don't have to tune in just at the set broadcasting time. The BBC has recently been running a trial, making available some of its programmes via the web for downloading onto computers and i-pods. The Observer reporter quotes Simon Nelson, controller of BBC radio and music interactive, as saying "It's surpassing all our expectations. The future is extremely bright. This is the way people expect to get radio in the future."
One of the programmes taking part in the experiment is "In Business
" the weekly Radio 4 programme introduced by Peter Day. I particularly recommend that you listen to last week's programme called "Look, no wires
" in which Peter Day investigates the growth of wireless networks and the way it is affecting business - http://www.bbc.co.uk/radio4/news/inbusiness/inbusiness_20050602.shtml
Yahoo auction fees scrapped in the US
One interesting story this week is that Yahoo! have
announced that the Yahoo auction site (in the US) will be free
to users, with the costs being covered from advertising
revenue rather than subscribers fees. This is obviously a
move designed to take market share from eBay. Last week
eBay announced plans to buy the comparison shopping
search engine Shopping.com This will be an interesting area
I am creating this blog mainly to support two courses that I teach:-
1 The Economics of the Internet (ENET).
This is a module available on postgraduate economics programmes at the University of Portsmouth. The web page for the module ishttp://userweb.port.ac.uk/~judgeg/ENET/
2 The Internet for Business Economists (IfBE).
This is a module on the BSc Business Economics and Computing degree at the University of Surrey. The web page for that module ishttp://members.lycos.co.uk/guyjudge/IfBE2003.html
Both courses aim to show the relevance and importance of economic concepts and models in explaining the development and the pattern of growth of the Internet and its impact on economic activity of various types, and to examine a range of other economic issues raised by the development of the Internet.
I often want to alert students to new developments in the technology, or its use, or point them towards new journal articles or books discussing such developments, particularly from an economics point of view. And I want feedback from the students too, either pointing out things they have come across, or debating issues such as "Would a system of e-mail stamps help to get rid of spam (Unsolicited Bulk Emails)?"
But this blog is available to anyone who might stumble across it to contribute. You can be as formal or informal as you like in your postings - but please keep it clean!