The Impact of Music Downloads and P2P File-Sharing on the Purchase of Music

Submitted by Birgitte Andersen on 16 November, 2007 - 15:12.

"The Impact of Music Downloads and P2P File-Sharing on the Purchase of Music: A Study for Industry Canada"
by Birgitte Andersen and Marion Frenz
http://strategis.ic.gc.ca/epic/site/ippd-dppi.nsf/en/h_ip01456e.html
Authors' response

We are intrigued by the debate our study has stimulated in various blog-postings on the internet.

Before responding to the debate, we would like to emphasise that, when we entered this research project, we had no preconceived views on what effect downloading of free music may have on music pay-markets.

However, Professor Stan Liebowitz who perhaps is the most prolific advocator against our results (his web-page on IP/File-sharing lists his views), writes in a critique in relation to another paper by Oberholzer-Gee and Strumpf (2007):

"O/S are aware that their conclusion-that file-sharing causes no reduction in record sales-contradicts conventional wisdom. [...] Nevertheless, their results leave an extremely large elephant in the room-if not for file-sharing, why have record sales declined so precipitously?" (Liebowitz, 2007:1)

But, what if we wrongly blame downloaders of free music for declining sales? Then management and policy aimed solely at addressing file-sharing can only fail.

We are in the midst of a technological revolution. New ways in which music is created, delivered and consumed, affect both market and industry structures. There are many different stakeholders affected by this change, including music publishers (the big 4 and the independent), artists and consumers. One should not assume that existing industry structures are also the most optimal in the new technological paradigm. The growth of the online music industry is creating new business opportunities. For example, the responses indicate that free downloads are motivated, among other things, by consumers looking for music that is not available in stores, and that they are not necessarily interested in purchasing the album version but prefer a single file or a digital file. This illustrates a possible opportunity for new artists to enter music pay markets and a change in the way music users prefer music to be delivered and consumed.

We believe that everyone can agree that the better and more diverse data we examine, the closer we come to uncover true relationships. Different data and methods have their unique strengths and weaknesses. If we want to understand the performance of industries and product markets, then we need to understand the strategies of firms who make up these industries and the behaviour of the people who are the consumers. Micro-data is best suited to bring us closer towards that understanding.

Macro data can describe a situation or some relationships at the aggregate level, but such data are limited when it comes to shedding light on explanations of the situation. For this we need micro-data, as we need to understand how the micro behaviour underpin the creation of the situation at the aggregate level. For example, an overall high level of unemployment may seem like an economy in crises at the macro level. However, at the micro level we might find that some declining sectors have huge unemployment and some growing sectors are in need of workers, and this could be due to a very vibrant and dynamic economy with fast changing industry structures.

This type of argument related to conclusions being drawn from macro data, is also the long standing fundamental argument led by evolutionary economists when debating the use and misuse of data and statistics, and it was frequently raised in the methodology debate regarding the proper use of patent statistics.

Therefore, we believe that Liebowitz's analysis, which is based on macro-data, has a weak empirical underpinning, and as a result, the following is probably wrong.

"I have written a recent paper (forthcoming in Management Science) that examines record sales and Internet uses in 99 US cities to measure the impact of file-sharing. While I am partial to my own work, I believe this paper provides the strongest analysis to date of these issues. The methodology avoids many empirical difficulties found in other papers. It concludes that file-sharing is responsible for the entire decline in record sales that has occurred, and that except for file-sharing there would have been an increase in sales since 1999 instead of the strong decline." (Liebowitz, 2007)

His core argument is based on city-level data: record sales measured for an entire city and Internet penetration in a city (used as a proxy for file sharing). Liebowitz writes that, unfortunately, there is no direct measure of P2P music file-sharing. He recognises the weaknesses of his proxy, but these are still the data which underpin his strong conclusion:

"... file-sharing [or internet penetration in his case] appears to have caused the entire decline in record sales and appears to have vitiated what otherwise would have been growth in the industry". (Liebowitz, 2007)

Our own study relies on micro-data obtained by asking individuals to what extent they are engaged in downloading and/or purchasing of music, and about their incentives behind such behaviours. While this may not be without its problems, it clearly has its merits as discussed above if we want to understand the behaviour of people on whom music markets depend on.

The survey provides information on a wide range of variables including:

Downloading from free music markets:

Downloading free music from P2P file-sharing networks, like Kazaa, LimeWire, eDonkey, BearShare or Gnutella
Ripping CDs and copying them onto computers
Downloading free music from promotional website
Downloading music from peoples' private Internet websites
Copying MP3 from friends

Buying music

Number of CDs purchased by respondents
Number of MP3s purchased (i.e. buying music tracks from online pay-sites like iTunes or Archambault)

Incentives

Percentage of P2P downloads to ‘hear before buying'
Percentage of P2P downloads due to wishing to not to buy ‘whole album'
Percentage of P2P downloads due to ‘album too expensive'
Percentage of P2P downloads due to music ‘not elsewhere available'

There are many other aspects to the survey, such as several demographic factors, MP3 ownership, supplementary entertainment goods and more.

Liebowitz's key criticism is that we examine a sub-sample of file-sharers; i.e. only people who declared that they engaged in P2P file-sharing. He states:

"The single biggest problem with the report, however, is that the authors present two sets of results, one for the entire sample and one just for downloaders, and it is only the former results that should be considered. It makes little or no sense to look only at downloaders." (Liebowitz, 2007)

He continues with an example to illustrate his point:

"When we compare the efficacy of a drug, we compare those who take the drug with those that do not." (Liebowitz, 2007)

However, there is a key difference between data based on drug trial experiments and this data. In drug trials people are randomly allocated to those who receive the drug and those who receive a placebo. This is not the case in our dataset. Here, belonging to the group of file-sharers and belonging to the group of non-file-sharers is not a random event. It is a deliberate choice made by each individual to either engage in P2P file-sharing or not to engage in P2P file-sharing. Being a file-sharer is an endogenous decision, just like taking illegal drugs. We expect illegal drug takers and file-sharers to behave different from the rest of the population, and we therefore model the differences in their behaviour.

We now move onto a point Liebowitz made in his first posting, and which he revised in his second posting several days later. In his first posting Liebowitz claimed that we do not control for ‘music interest' in our study. This is still reflected in Internet blogs when contributors state that our finding (a positive association between the number of P2P downloads and CD album purchases for the sub-sample of downloaders) is trivial and can be explained away by the fact that people with a high interest in music, do both: purchase CD albums and download P2P files.

In Liebowitz's second version of his critique he now reconizes that we are controlling for music interest (albeit imperfectly in his view, which means something very different). Nonetheless, the numerical example given by Liebowitz, and still included in his website, is based on the assumption that no controls for music interest are made and therefore is hugely misleading.

Given the 0.44 estimate has been a subject of debate, there is something we believe needs clarification. On page 27 the paper suggests that for an increase in the average number of P2P downloads of 1, the number of CD purchases per year will increase by 1.212/2.718282 or 0.44. This is a point estimate. We compute marginal effects at the means of the regressors, and, thus, the point estimate refers to those people who claim to download approximately 13 P2P files in an average month and not to downloaders who claim more or less downloads in an average months. This is because the assumed relationship is non-linear (negative binomial distribution plus log transformation of the number of P2P downloads). Many arguments against the paper (including the one of Liebowitz) seem to be based upon the assumption that we work from a linear relationship.

Some blogs (resembling Liebowiz's first critique) discuss if our paper, which suggests a positive association between P2P downloading and CD sales for the sample of P2P downloaders, is not valid because we have seen a decline in CD sales. Hence, they find it a weakness that we cannot identify why CD sales have dropped. We can of course speculate why CD sales have declined (and as most other writing in the blogs we have some personal views on this), but this is not the aim of this study.

Birgitte Andersen's blog
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Impact of file sharing on decline of record sales

Submitted by Zeljka on 21 November, 2007 - 13:32.

The recorded music industry is rapidly undergoing a process of Schumpeterian creative destruction (Kozul-Wright, Z. and Jenner, P., "Creative Destruction in the Music Industry and the Copyright", forthcoming). It is facetious to believe in perfect substitutability between downloaded (authorized or unauthorized) musical content and record sales. There is little empirical basis for such an assumption (see Oberholzer-Gee and Strump, 2004). Music consumers are rapidly switching from purchasing records (CDs and other more traditional formats) to a variety of alternative digital formats, such as mobile music devices and other digital formats (such as single track downloads, album downloads, music video online downloads, streams, master recording ring tones, full track audio download to mobile, ringback tunes, music video downloads to mobile and subscription income.).

Indeed, overall earnings of the industry are on the increase, not on the decrease (PWC, 2007). The broader music sector, is now worth more than $US 130 billion globally. Its economic importance extends far further than the recorded music sector, ranging from radio advertising revenue, record company revenues, musical instrument sale, live music sector, music retail sectors, portable digital payers, to music publishing (IFPI, 2007). The so called "demise of the music industry" is highly contentious; indeed and completely disingenuous, for example, Price Waterhouse Cooper argues that the media industry, including music, is in a strongest position since 2000; and predicts a 7.3 per cent growth annually up to $ 1.8 trillion in 2009 (PWC, 2005).

PWCooper (PWC) estimates that the broad entertainment and information sector already accounts for over one trillion us dollars globally and is likely to rise to $ 1.8 trillion by 2009 (PWC, 2006). While sales of recorded music (physical retail) have been on a declining trend since 2002, the sales of digital content have been on a notable increase (by 60 per cent since 2006, IFPI, 2007).

To hold file sharing uniquely responsible for the decline in record sales i.e., largely unauthorized downloading, is basically erroneous and far too simplistic. Moreover, such an assertion indicates a lack of understanding of the dynamics of the current process of creative destruction and transformation to the digital paradigm in the "recorded" music industry. The word "recorded" itself denotes a kind of backward looking perspective, as it may no longer be the primary technological format for the rapidly converging music-ICTs-entertainment-telecommunications industry in the third millennium.

However, it may not be possible to fully "test" this hypothesis econometrically, as we are really comparing apples and oranges. There is no reason to assume that the downloaders would have necessarily bought the equivalent volumes of products in records, CDs or other physical music formats. This assumption can be highly misleading and steers the whole debate in the wrong direction. The implication of such reasoning would be to hinder or even halt the process of technical change and innovation in the music industry, which is not only unadvisable but impossible.

Our own research would support the arguments made in the Andersen and Frenz Study , 2007, that indeed there may be a significant positive relationship between file sharing and purchase or greater use of various other formats containing music content (although not necessarily record sales per se). According to IFPI, legal downloads have risen significantly over the last 5 years and IPR-related earnings have also been on a significant increase at this time (IFPI, 2007; HFA, 2007). While record sales have declined, that does not imply that the entire industry in the decline. Indeed, other segments have risen in volume and in earnings, more than offsetting the decline in record /CD sales (IFPI, 2007; PWC, 2006; Kozul-Wright and Jenner, forthcoming).

The more recent, healthy overall industry earnings indicate the opposite of Liebowitz' assertion that ..."file-sharing appears to have caused the entire decline in record sales and appears to have vitiated what otherwise would have been a growth in the industry" (Liebowitz, 2007). There is no empirical basis for such a facetious assertion. Additionally, there may be many other reasons for decline in record sales (the white elephant in the room), other than increase in file sharing (e.g., transformation to the digital technological paradigm, excessively high prices of CDs, i.e., excessive mark up, standardized quality, decline in purchasing power for luxury goods, lower degrees of choice and diversity, etc).

File sharing and downloading not only increases market exposure but significantly reduces marketing and advertising costs. File sharing, as the imminent dominant mode of music consumption, is proving to be more "efficient" than simply purchasing pre-recorded music. Owing to diffusion of technical change, it is far cheaper, as it reduces the costs of intermediation and allows consumers greater choice over listening patterns; facilitating the growth of demand-driven patterns of consumption thereby enabling greater consumer participation, and more interactive modes of consumption. Global consumers as well as new producers can benefit greatly from the new P2P file sharing technologies that should be facilitated and legalised, rather than hindered.

Improved new technologies cannot be suppressed simply because they threaten vested industry interests. That would be against the logic of the market and the well known dynamics of technical change and innovation, as analysed by Schumpeter over 40 years ago. It is precisely this feature of innovation-led creative destruction that characterizes capitalist markets; explain their resilience, dynamism and ultimate superiority over other forms of production and consumption.

Zeljka Kozul-Wright,
UNCTAD
Geneva, November, 20, 2007.

These views do not necessarily express those of the United Nations.

What strikes me is the issue

Submitted by Simon Roodhouse on 21 November, 2007 - 16:49.

What strikes me is the issue of the music lover who uses all sources to follow his/her interest. It is indeed helpful for those studying the creative industries to know more about how consumers follow their interests.

I guess that the best way to take this forward in the context of the emergence of new digital medias in which creative products and services can be presented or/and commoditized, would (in the case of the music industry) be to undertake the Andersen/Frenz survey again in future and see if or how the results vary.

Simon Roodhouse, Professor of Creative Industries,
University of the Arts, London
Director, Safe Hands Management Ltd: www.safehandsmanagement.com
Director: Creative Industries Observatory: http://www.creativeindustriesobservatory.com/

Reasons for the decline in CD sales

Submitted by Hughie on 29 November, 2007 - 08:08.

What a ridiculous criticism! Just because Anderson and Frenz's numbers don't point to a definitive alternative explanation (that is to Liebowitz's liking) doesn't mean that one doesn't exist. Many have been suggested.

The one I find most plausible (and least discussed) is simply that the sales numbers are no longer adequate to capture the range of sales. Industry figures rely primarily on point-of-sale figures from large retailers but these cannot account for the myriad small operators who are producing, manufacturing and selling CDs using technologies that have become viable primarily since about 2000 (not coincidentally).

For example, my own Celtic folk band sold about 500 CDs in Brisbane in 2001, mainly while busking at the tourist-trap Southbank markets. These sales were not reported to anyone and it only takes another 2000 bands in the world doing the same to account for a sizable chunk of the reported decline. My own research indicates that 2000 bands with this result is a very conservative estimate - and that explanation certainly accords with the noted improvement in the rest of the industry. At that same market was a CD sales stall doing a brisk trade in many major-label and independent CDs that were probably illegally imported copies and were no doubt not reported to anyone, either.

In fact, Derek Sivers reported CDBaby sales figures (http://cdbaby.org/stories/07/09/04/2896257.html and others) which indicate that CD sales are UP for the "rising middle class" of independent musicians. Although their sales do not compensate in aggregate number for the decline among the major stars, they certainly indicate something important that needs to be investigated further.

In truth, the decline is almost certainly a complex result of many factors, including a substitution effect from alternative media, but to criticise a study for failing to find an alternative to the unsupported hypothesis is purile.

Hugh Brown
PhD candidate
Insitute for Creative Industries and Innovation
Queensland University of Technology

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