February 05, 2020 Feature

An Economist’s View of the Music Modernization Act: Steps toward a More Market-Oriented Approach to Rate Setting

Chip Hunter

©2020. Published in Landslide, Vol. 12, No. 3, January/February 2020, by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association or the copyright holder.

The Music Modernization Act (MMA), signed into law in late 2018, provides for a range of new regulations and practices in the music business. This includes clarification of federal remedies for copyright infringement of sound recordings made before 1972, a new collective to handle royalty collection and distribution for compulsory mechanical licenses, and a means for potentially paying producers and engineers a portion of sound recording royalties collected under the statutory § 114 licenses.1 While many aspects of the MMA are interesting from an economist’s point of view, perhaps most interesting are those that move the standards and tools for rate setting closer to a market-oriented perspective in the context of digital uses of music. It is those developments that will be reviewed here.

The next section provides a high-level overview of the framework for copyright license fees associated with the use of musical works (in public performances and digital downloads) and the public performance of sound recordings. The section following describes some of the interesting economic implications for future royalty rate-setting proceedings, and the final section concludes with a brief summary of what some would call unfinished work in the music licensing world.

Overview of Music Royalties

From the Spotify playlist at the gym, to the hold music while waiting for a conference call, to the theme song of your favorite TV show, music is ubiquitous in our daily lives. While listening to music might be a simple act, the systems that govern which copyright holders get paid—and how much they get paid—are anything but simple.

Each of two primary groups of music-related copyright owners gets paid for certain uses of their copyrights:

  • Composers and publishers, with the rights to the underlying musical work (the lyrics and notes—what appears on the sheet music); and
  • Record labels and artists, who record a version of a musical work into a sound recording—what we hear performed. (Sometimes, of course, the songwriters are the same people who perform the song on the sound recording.)

Before a musical work can be recorded for the first time, the owners of the copyright to the musical work and the record company must strike a deal regarding use of the work. And, once a song has been recorded, the stream of copyright royalty payments begins. So, in most cases, despite what some may think, the music isn’t free. Songwriters get paid when their works are performed on the air, over the internet, or in a club. They also get paid when a sound recording containing one of their copyrighted works is sold, whether as an MP3 download or an on-demand stream. Record companies and artists also get paid when a sound recording is sold or downloaded, and sometimes when the sound recording is performed.

While the rights may be clear, the scale of copyright ownership and music usage presents another challenge. To understand the massive scale of music and its uses that requires tracking, consider that, together, the performing rights organizations (PROs) ASCAP and BMI represent more than a million and a half songwriters, representing at least 15 million musical works. Fifty million songs are available on both Apple Music and Spotify, and there are more than 10,000 terrestrial radio stations and more than a thousand full-power commercial TV stations in the U.S. that use music in their programming.

In a free and frictionless market, each rights holder could negotiate with each user to determine an appropriate license and fee structure, and then clear payments easily. But, despite great advances in technology, the transactions costs associated with millions of separate, individual licensing agreements overwhelm any chance of such a small-scale bilateral (i.e., one-to-one) system becoming the norm. Given the millions of music creators and copyright holders and the thousands of services that use and distribute music to their customers, negotiating bilateral agreements between every rights holder and music user would be impossible. Independently calculating, collecting, and auditing license fee payments would be similarly difficult.

Instead of a purely bilateral system, systems for administering music copyright have developed in the U.S. that allow for mass licensing, rate setting, and the collection, distribution, and audit of royalty payments. These collective systems coexist with other smaller scale private agreements (e.g., between a record company and a music download service, or between a music publishing company and a music user), which themselves are an important part of the music licensing system. These smaller-scale, private agreements are made on a willing buyer/willing seller basis, although, as noted below, some licensing behavior has been challenged on antitrust grounds.

It’s easy to recognize the benefits of centralized license clearing and royalty payment structures. A music user who wants a license to nearly all published musical works need only contract with and make royalty payments to just a few parties. A copyright holder can minimize the effort involved with granting licenses and getting paid. But these centralized licensing institutions can sometimes present competitive challenges. An organization that represents a large share of important works or sound recordings could potentially exert market power to obtain anticompetitively high rates, raising antitrust concerns.

Some of the mechanisms and institutions for collective licensing and rate setting (and for managing royalty payments) have their roots in legislation, with rate setting handled by the Copyright Royalty Board. For example, SoundExchange was created to administer the statutory license for noninteractive digital performances of sound recordings. Other organizations have emerged to license music usage on a large scale as private, voluntary associations of rights owners (e.g., SESAC) and rights users (e.g., the Radio Music Licensing Committee). However, two of these private associations—ASCAP and BMI—are subject to judicial oversight through consent decrees that govern rate setting, membership rules, and licensing behavior; other private associations have been the subject of private antitrust challenges.

Interesting Economic Implications of the MMA

The patchwork of licensing and rate-setting mechanisms governing mechanical and public performance licenses and fees in the digital context had characteristics that led to somewhat artificial divides among uses. Some uses of musical works had rates set on a willing buyer/willing seller basis, while other rates were set based on a more subjective set of factors. And, two adjacent uses—public performances of sound recordings and public performances of musical works, which might logically be related—had a legislatively erected wall between them, preventing consideration of rates for public performances of sound recordings in rate-setting proceedings for public performances of musical works.

The MMA makes some important steps toward emulating the economic considerations individual actors would internalize when considering executing a license in a free marketplace. First, the policy-oriented goals that underpinned prior rate-setting proceedings for § 115 compulsory mechanical licenses have been replaced with a willing buyer/willing seller standard. Second, the new willing buyer/willing seller standard makes explicit that the rights holder of the underlying work would consider how one use of the work (e.g., to provide digital downloads or interactive streams) might affect income from an alternate use of the copyrighted work (e.g., as a performance royalty on a nonsubscription digital service). Finally, the rates determined by the Copyright Royalty Board for noninteractive streaming of sound recordings are no longer prohibited from being considered during rate-setting proceedings for the public performance of the musical work.

Willing Buyer/Willing Seller Standard for Royalties under a Compulsory Mechanical License

When a sound recording is reproduced, the underlying musical work—expressed in the lyrics and musical notes—is also reproduced. Section 115 allows for the reproduction of musical works that have already been published (i.e., recorded with the explicit consent of the copyright holder of the musical work). As such, the copyright owner of the work is entitled to a mechanical royalty, the license fee for the reproduction. In the predigital age, compulsory mechanical licenses made recordings of cover versions of existing sound recordings possible (a few of you will remember that Jimi Hendrix scored a hit with his cover of Bob Dylan’s “All Along the Watchtower”). With compulsory mechanical licenses, the performer and record company needed to provide a notice of intent to make the recording, and they were granted a compulsory license. Each copy of a sound recording of the “cover” version made under the statutory license would generate a mechanical license royalty for the songwriter and publisher, with a rate determined by the Copyright Royalty Board and its predecessors.2

In the digital context, however, phonorecords of existing sound recordings are created when a music service provides a user with a permanent download, a limited download, or an interactive stream. Both the sound recording and the underlying work are duplicated and transmitted to an individual user. That duplication of the musical work requires a mechanical license and payment of a license fee.

In § 115, the MMA replaced the policy-oriented rate-setting standards specified in § 801(b)(1) with a standard oriented around a transaction between a willing buyer and a willing seller.3 This approach represents a significant step toward emulating the terms that hypothetical participants in a marketplace transaction—a willing buyer and a willing seller—would reach. Indeed, this is how much of private commerce is conducted: if each party to a potential transaction is made better off, or at least no worse off, the transaction will take place. (And, as noted, many arrangements for the use of musical works and sound recordings already take place on a private basis, between willing buyers and willing sellers.)

Three of the retired § 801(b)(1) factors address policy-oriented objectives, which might not be internalized by the parties in a market-based transaction: (1) maximizing the availability of creative works to the public, (2) providing “fair” compensation for both the copyright owner and the copyright user, and (3) minimizing disruptive impact to the industry.4

The first two factors have analogs to factors automatically determined in marketplace transactions: quantity (maximizing available works) and price (“fair” compensation). In a free market, equilibrium prices and quantities reflect the competitive interaction between willing buyers and willing sellers and ensure that neither too many nor too few works are produced. Prices serve as a signal to both music users and music creators of the value of creating additional works. Adopting a willing buyer/willing seller framework allows the copyright royalty judges to benefit from standard economic analyses, which are well suited for forming opinions about equilibrium prices and quantities in the context of a marketplace transaction.

What it means to maximize the availability of creative works and set fair compensation requires guidance before an economist can evaluate whether proposed rates satisfy those criteria. Which creative works should be maximized? There are existing works and works that are yet to be created. The rates set by the court have implications for both the usage of existing music and the creation of new musical works. Setting the rate too low can increase the availability of works today but might reduce the incentives for creating new works. Setting the rate too high can lead to overproduction of new works while simultaneously reducing the availability of existing works to the public as costs to music users increase. And, standard economic theory doesn’t have a definition of what is (or isn’t) “fair.” Fairness is subjective and needs to be defined before an economist can assess whether a particular outcome meets a working definition of fair. And, because fairness is subjective, its meaning can vary from case to case.

The other eliminated § 801(b)(1) factor seeks to reduce disruption of existing industries and practices. But anyone who has followed developments in the music industry over the past 20 years knows that disruption has occurred rapidly and repeatedly. The advent of the internet, the MP3, and file-sharing services like Napster were associated with the demise of recorded music sales. In the wake of the collapse of recorded music sales and file sharing, services like iTunes and eMusic stepped in to offer another means of legal and licensed recorded music distribution: the permanent download. Sound recordings could be purchased in a legal internet marketplace and replayed on the iPod and other devices. Downloads reigned for a very short time, though, as services that offered both on-demand (e.g., Spotify) and noninteractive (e.g., Pandora) streams took over. Insulating portions of an industry can lead to distortionary and inefficient behavior, both within and outside the insulated segment. Given the mix of regulated and private licensing arrangements in music, moving regulated rate setting toward the same standards used in private transactions should lead to more efficient outcomes overall, especially those associated with rapid technological developments and new business models.

The new § 115 willing buyer/willing seller framework also calls explicit attention to how the compulsory licensee’s use of a copyrighted work might affect other income streams generated by the copyright: “whether use of the compulsory licensee’s service may substitute for or may promote the sales of phonorecords or otherwise may interfere with or may enhance the musical work copyright owner’s other streams of revenue from its musical works.”5 This factor reflects the already inherent decision process of a seller who contemplates the effect of selling a product to one customer on the value of that product to another customer. For example, permanent downloads of a song might affect the demand of a noninteractive webcaster or terrestrial radio station for playing that same song. That is, the download might be a substitute for radio airplay, or it might promote radio airplay. In the former case, a rights holder would demand a higher rate for the mechanical license to compensate them for the lost webcast or broadcast public performance revenue. In the latter case, the copyright holder would be willing to accept a lower mechanical license fee because the usage associated with the mechanical license will stimulate revenue from other sources.

Expanded Benchmark Usage with the Repeal of § 114(i)

Section 114(i) prohibited the consideration of royalties established under § 106(6)—those for digital performances of sound recordings—in rate proceedings for public performances of musical works. This meant that ASCAP and BMI—which are subject to rate court oversight—could not use evidence of the value (or even changes in value) of the use of sound recordings in public performances—which require musical works as input—in rate court proceedings.

But one cannot publicly perform a sound recording without simultaneously performing the underlying work. Uncovering the relationship between the value of a sound recording copyright and the value of the copyright in the underlying work requires analysis. It would seem natural that the value of a work of music used in a sound recording might be related to the value of the sound recording itself. In some cases, a relationship might not exist. But being able to at least consider the value of an adjacent right could be informative in a rate-setting proceeding. In any event, this part of the legislation reflects what private agreements have begun to incorporate. For example, in 2016, Pandora announced that it had reached license agreements with private music publishers, ASCAP, and BMI that set royalties for the performance of musical works equal to 20 percent of the sound recording payments.6

Conclusions

The MMA has moved music rate setting in the digital context closer to a marketplace standard, and rate-setting proceedings over the next decade should prove interesting as the basis for rates becomes focused around considerations made in marketplace transactions between willing buyers and willing sellers. Different uses of music are sometimes argued to be substitutes (e.g., listening to custom radio on Pandora vs. listening to terrestrial radio broadcasts) or complements (e.g., sales of music downloads through Apple’s iTunes Store and performances of recorded music on Apple’s iTunes Radio), but in either case, the relationship between uses will normally be considered in marketplace transactions between willing buyers and willing sellers. Thus, a move toward a willing buyer/willing seller framework in regulated proceedings should promote a more efficient overall use of music. And, while economists can certainly be helpful in modeling rates under many rate-setting regimes, our tools work best in the context of evaluating what would likely happen between willing buyers and willing sellers.

Despite the changes from the MMA, some argue that more reform in the music industry is needed. For example, currently there is no performance royalty due on terrestrial broadcasts of sound recordings, though there is for musical works. That is an ongoing battle between the recording and radio industries and includes arguments about the magnitude of benefits that one industry provides the other via feedstock for airplay on the one hand, and promotional activity for recorded music sales on the other.

Similarly, in the world of licensing musical works for public performances, ASCAP and BMI have sought to escape at least some of the restrictions imposed on them by their respective consent decrees, which have been in place for nearly 80 years. They argue that this is especially important as competing PROs, SESAC and Global Music Rights (GMR), have grown in importance, without the restrictions placed on ASCAP and BMI.7 Both SESAC and GMR (the latter was founded only in 2013) represent some of the most successful and well-known songwriters and publishers today, and their success in attracting them likely reflects their ability to offer more attractive compensation and services to their songwriter and publisher members than ASCAP and BMI (as ASCAP and BMI have argued).8 While competition among PROs might lead to shifts in share among them, those shifts are more likely to be distorted to the extent that some PROs are inhibited from innovating due to differential regulatory and legal restrictions.

Endnotes

1. 17 U.S.C. § 114.

2. The most recent determination was in 2017 for the period 2018–2022.

3. Indeed, the old § 801(b)(1) factors have been struck. The MMA also provides a blanket license for digital music providers, replacing notice on a per-song basis, and also establishes a new music licensing collective to maintain a central database of musical works and to collect and distribute royalties.

4. A fourth factor is largely carried over to the new standard and is consistent with a willing buyer/willing seller transaction. See 17 U.S.C. § 115(c)(1)(F)(ii).

5. Id. § 115(c)(1)(F)(i).

6. Pandora Media, Inc., Annual Report (Form 10-K) (Feb. 18, 2016).

7. GMR has a repertory of approximately 41,000 songs, written by 81 songwriters and composers, including Bruce Springsteen, Bruno Mars, John Lennon, Pete Townshend, and members of the Eagles. See Catalog, Global Music Rights, https://globalmusicrights.com/Catalog (last visited Dec. 10, 2019). SESAC has approximately 30,000 affiliates, including Bob Dylan, Neil Diamond, Zac Brown, and Lady Antebellum, with a repertory of more than 400,000 songs. See About SESAC: Our History, SESAC, https://www.sesac.com/#!/our-history (last visited Dec. 10, 2019).

8. ASCAP’s Response to the Department of Justice’s June 5, 2019 Request for Public Comments concerning the ASCAP and BMI Consent Decrees, PC-043 (Aug. 9, 2019), https://media.justice.gov/vod/atr/ascapbmi2019/pc-043.pdf; BMI’s Response to the Department of Justice’s June 5, 2019 Request for Public Comments concerning the BMI and ASCAP Consent Decrees, PC-077 (Aug. 9, 2019), https://media.justice.gov/vod/atr/ascapbmi2019/pc-077.pdf.

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Chip Hunter is a senior vice president at Coherent Economics. He has expertise working on performing rights issues, and also specializes in competition and general damages cases.