THEROLEOFANTITRUST INPROTECTINGCOMPETITION,INNOVATIONANDCONSUMERS ASTHEDIGITALREVOLUTIONMATURES: THECASEAGAINSTTHEUNIVERSALEMIMERGERANDEBOOKPRICEFIXING

MarkCooper, DirectorofResearch,ConsumerFederationofAmerica Fellow,DonaldMcGannonCommunicationsResearchCenter,FordhamUniversity JodieGriffin, StaffAttorney,PublicKnowledge June2012

ABSTRACT

ThispaperpresentsadetailedanalysisoftheproposedmergerbetweenUniversalMusicGroup (UMG)andEMIbyapplyingthestandardsandmethodsoutlinedintherecentlyrevisedDepartmentof Justice/FederalTradeCommissionMergerGuidelines.ItshowsthattheUMGEMImergerisanunfair methodofcompetitionthatconstitutesanunreasonablerestraintoftradebecauseitwill substantiallylessencompetitionandislikelytoenhancemarketpower.Simplyput,thepost mergerfirmwillhaveastrongincentiveandincreasedabilitytoexercisemarketpower,particularly inundermining,delaying,ordistortingnewdigitaldistributionbusinessmodels,inamarketthathas beenatightoligopolyforoveradecade. Themergercreatesahighlyconcentratedmarketbyeliminatingoneofonlyfourmajorrecord labelsandresultsinanincreaseinconcentrationthatisfivetimesthelevelthattheDOJ/FTCidentify asacauseofconcern.Therecenthistoryofanticompetitive,anticonsumerconductbythistight oligopolyandtheroleofEMIasamaverickinthedigitaleracompoundtheanticompetitiveeffectsof themergerandsignificantlyincreasethelikelihoodthatthemergerwillnotonlyresultinhigher pricesbutalsoundermineincipientcompetition. Claimsthatpiracywillpreventtheabuseofmarketpoweraredirectlyrefutedbyevidenceon consumerpurchasingbehavior,estimatesofelasticitiesofdemandbyacademics,andmarketing researchconductedbythemusicindustry.Theanalysisdemonstratesthattheindustryhas chronicallyandgrosslyoverestimatedtheroleofcopyrightinfringementinthedevelopmentofdigital distribution.Correctingthismisrepresentationoftheextentofinfringementisnecessarytoensure thatpolicymakershaveaproperunderstandingofthefullbenefitsofdigitaltechnologies. Thestrongparallelsbetweentheimpactofthemergeronthedevelopmentofdigital disintermediationinthemusicsectorandtherecentcasebroughtbytheDepartmentofJusticeagainst ebookpublishershighlighttheeconomicefficiencyandconsumerbenefitfromthedigitaldistribution ofgoodsandservices.Theanticompetitivetacticsofthedominant,incumbent,physicalspacefirms remindusthatthesefirmswillstopatnothingtodelaychangeandpreservetheirdominance. Antitrustauthoritiesandothersmustusethefullrangeoftoolsavailabletoprotectcompetition, innovation,andconsumersandensurethatconsumersandtheeconomyenjoythefullbenefitsofthe developmentofdigitaltechnologies.

TABLEOFCONTENTS I.INTRODUCTION A.Purpose 1.TraditionalHorizontalMergerConcerns 2.AKeyMomentintheDevelopmentofDigitalDistribution B.Outline II.THEROLEOFMERGERREVIEWINTHEENFORCEMENTOFTHEANTITRUSTLAWS A. GoverningPrinciples B.TheMergerGuidelines 1. KeyThresholds 2. TheImpactoftheMergeronConcentration III.THEUMGEMIMERGERRAISESSIGNIFICANTCOMPETITIVECONCERNS A.MarketStructure 1.HorizontalConcentration 2.History B.Conduct: 1.ProductOfferings:TheEliminationofSingles 2.PricingPatterns:IllegallyFixingthePriceofCDs 3.Margins 1

IV.PIRACYV.EFFICIENCYASEXPLANATIONSFORTHETRANSFORMATIONOFTHEMUSICMARKET 19 A.TheClaimThatPiracyCanDisciplineMarketPowerDoesNotRingTrue B.TheOriginalClaimsofPiracywereVastlyOverstated C.AnUnsustainable,Anticompetitive,AntiConsumerBusinessModel D.TheBottomLineonPiracyandtheRealLessonsofTechnologicalChangethatthe IndustryResistedSoStrenuously V.THEIMPORTANCEOFINCIPIENTCOMPETITION,COORDINATION,MAVERICKS, ANDMONOPSONY A. TheIncipiencyStandard B.TheContinuingVulnerabilityofNonMajors 1.IndependentLabels 2.UnsignedArtists 3.Monopsony C.TheRoleofMavericks D.ContemporaryPricing 30

VI.LESSONSFROMTHEDOJEBOOKPRICEFIXINGCASE A.TheChallengeofandResponsetoNewDistributionin PublishingandMusic B.Efficiency 1.ConsumerCostSavings 2.AuthorBenefits C.PredatoryPricing D.Conclusion:TheImportanceofDigitalDisintermediationand theRoleofAntitrust BIBLIOGRAPHY APPENDIX:THEWELFAREECONOMICSOFDIGITALDISINTERMEDIATION

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53 58

 LISTOFEXHIBITS II1:DESCRIBINGMARKETSTRUCTURES II2:CONCENTRATIONTHRESHOLDSANDIMPLICATIONSOFMERGER RELATEDINCREASESINHHI III1:IMPACTOFTHEUMGEMIMERGERONMARKETCONCENTRATION III2:STABLELEADINGFIRMSINTHEU.S.MUSICINDUSTRY III3:THEREPEATEDCASCADEOFMUSICMEDIA III4:MEASURESOFLONGTERMMARKETSTRUCTURE III5:U.S.SHIPMENTSOFALBUMSANDSINGLES III6:MARKETSTRUCTUREANDCDPRICING III7:WHOGETSWHATFROMTHEMUSICCONSUMERDOLLAR III8:REVENUEPERUNITSHIPPED IV1:PRICEPOINTSFORDIFFERENTALBUMTECHNOLOGIES IV2:THESMALLIMPACTOFPIRACYONMUSICSPENDING:TIMESPENT LISTENINGV.MUSICSPEND IV3:ALTERNATIVEVIEWSOFTHEEXTENTOFPIRACY IV4:MEASURESOFTHEQUALITYOFNEWRELEASES IV5:COMPONENTSOFSTOCHASTICTREND IV6:FACTORSTHATAFFECTPIRACYV.PURCHASE IV7:NEWALBUMTITLESRELEASED(000) V1:FOURFIRMCONCENTRATIONRATIOBYPRODUCTINTHEDIGITALERA V2:INDEPENDENTLABELSHAREOFTOPSELLINGALBUMSBEFOREAND AFTERDIGITALSALES V3:DIGITALMUSICSALES V4:THEIMPACTOFDIGITALALBUMSALESONPHYSICALCDREVENUE V5:THERECORDINGINDUSTRYPRICINGSTRATEGYINTHEDIGITALERA:RAISESINGLEPRICES MORETHANALBUMSTOINCREASEALBUMSALESANDREVENUEPERUNITSHIPPED VI1:PARALLELPROBLEM,PARALLELILLEGALCONDUCT VI2:WHOGETSWHATFROMBOOKPURCHASEPRICE? VI3:BOOKPUBLISHINGREVENUES VI4:TITLESPUBLISHEDPERYEAR(MILLION)
6 7 8

10 11 11 13 15 16 17 20 21 22 23 26 28 29 32 33 35 40 41 44 47 48 49

I.INTRODUCTION
A.PURPOSE InarecentlettertotheFederalTradeCommission(FTC)andtheCongressionalCommittees withoversightovertheantitrustlaws,theConsumerFederationofAmerica(CFA)andPublic Knowledge(PK)calledforclosescrutinyoftheproposedmergerbetweenUniversalMusicGroup (UMG)andEMI.TheletterpointedoutthattheDepartmentofJustices(DOJ)recentebook antitrustcomplaintimmediatelycastsaspotlightonanotheractionunderreviewbytheantitrust authoritiesthatraisessimilarandparallelissues.(CooperandGriffin,2012) UniversalimmediatelyobjectedtotheparallelwedrewbetweentheDOJcaseagainste bookpricecollusionaswellasourcallforantitrustscrutinyoftheproposedUniversalEMImerger.
CFAsefforttocomparethiscasetothegovernmentsebookcasecompletelymisunderstandsthelaw. Theebookcaseisaboutanallegedillegalpricefixingconspiracy.Marketsharesdontmatterinacase likethat,itsjustasillegalfortwotinybookstorestofixprices,asitisforgiantpublishingcompanies Thelawgoverningmergersistotallydifferent,andmostmergers,likethisone,areultimatelyfoundto bebeneficialtocompetitionandconsumers.(Sisario,2012)

ThispapershowsthattheUniversalresponsecouldnotbemorewrongonbothofthe issuesraisedinitsresponse.
Thelawgoverningmergerreviewisexactlythesameasthelawgoverningcollusion.

UndertheantitrustlawstheUMGEMImergerrepresentsabusinessagreementthat constitutesanunreasonablerestraintoftradethatwillsubstantiallylessen competitionandconstitutesanunfairmethodofcompetition,whichisunlawful becauseitislikelytoenhancemarketpower.(DOJ/FTC,2006)

Aswepointedoutinourletter,thisisaparticularlyimportantmomenttorejectgross misrepresentationsoftheantitrustlaws,liketheoneofferedbyUniversalandthebookpublishers. TheDepartmentofJusticeactionagainstpricefixingbyfivemajorpublishersunderscoresthe ongoingeffortofantitrustauthoritiestodefinetheproperroleforantitrustinthedevelopmentof thedigitaleconomy.Theeconomicefficiencyandconsumerbenefitfromthedigitaldistributionof goodsandservicesaretransformingthewaythemarketmeetsconsumerdemand.Incumbent physicalspacefirmsconfrontedwithamoreefficientbusinessmodelwillstopatnothingto preservetheirdominance.Theactionsofantitrustauthoritiesandotherstoensurethatincipient competitionisnotsquelchedbyanticompetitivetacticsshouldincludethefullrangeofantitrust powersthathavetraditionallybeenusedtoensurethatconsumersandtheeconomyenjoythe benefitsofthegreatestamountofcompetitionpossible(Cooper,2001)denialorconditioningof mergersandacquisitionsthatsubstantiallylessencompetition,reversingactionsthatdefendor expandmonopolypowerbyunderminingcompetition,preventionofunilateralmonopolyabuse, andblockingofcollusion. 1.TraditionalHorizontalMergerConcerns Inseekingtoblockandunravelthepricefixingschemehatchedbyfivepublishers,theDOJ allegedthatacabalofcompanieswithatotalmarketshareoflessthan50%couldundermineor distortthegrowthofnascentcompetitionfromnewdigitaldistributionmodelsbyrefusingtomake

theirproductsavailabletoalternativedistributionmodelsorbymanipulatingtheterms, conditions,orpriceofaccesstotheirproducts.(DOJ,2012) Iffivecompanieswithamarketshareoflessthan50%poseathreattonascent competitionfromdigitaldistributionmodels,doesonecompanywithamarket shareabove40%(Nielsen/Soundscan,2012)poseasimilarthreat?Webelieve theanswerisanemphaticyes. Viewedthroughthelensoftraditionalantitrustpracticeandthelensofnascent developmentofdigitaldistributionmodels,theUMGEMImergerposesa significantthreattocompetitionanddemandsclosescrutinyandvigorous remedybytheFederalTradeCommission(FTC),thesisterantitrustagencyto theDOJthatisreviewingthetransaction.

TherecentlyrevisedjointDOJ/FTCMergerGuidelinesshowthatthismergerraisesserious concentrationconcerns,evenwhenviewedasatraditionalhorizontalmerger.Placedunderthe microscopeofantitrustmergerreview,asthefollowinganalysisdemonstrates,thefactsinthiscase makeitclearthatthemergerisverylikelytoenhancethemarketpowerofthepostmergerfirm andmaketheabuseofthatmarketpowermuchmorelikely.ThepostmergermarketshareofEMI Universalissufficienttogiveitthepowertodistortorevendeterminethefateofdigital distributionmodels. EveniftheFTCdoesnotbelievethata40+%marketsharealonegivesasinglecompanythe powertodeterminelifeordeathforemergingdigitalbusinessmodels,itcertainlymakesitvery easyforthatcompanytoleadtheefforttodoso.Withapostmergerthreefirmmarketshareof 90%,oneortwooftheothermajorlabelsfollowingtheleadofthedominantfirmcouldeasily decidethefateofalternativedistributionmodels.Themarketwouldbevulnerableto anticompetitiveharmresultingfromconsciousparallelism. 2.AKeyMomentintheDevelopmentofDigitalDistribution Whiletraditionalantitrustanalysisbuildsanoverwhelmingcaseagainstthemerger, concernaboutnascentcompetitioninthedigitalspacesignificantlymagnifiesthethreatalready posedbyit.Themostcompellingreasontogivethemergerextremelyclosescrutinyisthe potentialfordevelopmentofalternativebusinessmodelsinthetransitiontodigitalmusic distributioncoupledwithincumbentrecordlabelsstronginterestindiminishingtheimpactof digitaldisintermediationontheircontrolofthemarketplace.Incumbentmajorrecordlabelshave incentivetostiflenewdigitaldistributionplatformsbecausethoseplatformsbegintolevelthe playingfieldamongmajorlabels,independentlabels,andunsignedartists.Themergerwill dramaticallyincreasetheconcentrationofcontroloversoundrecordingsofpopularmusic currentalbums,cataloguealbumsanddeepcataloguealbums,aswellasdigitalalbumsandtracks towhichcompetingdistributionmodelsmusthaveaccesstosucceed. Digitalplatformsaremorelikelytolicenseunknownornichemusicbecause,unliketheir physicalspacepredecessors,theyarenotconstrainedbytimelimits(likeradio)orspacelimits (likephysicalstores).Asaresult,themajorrecordlabelsloseoneoftheirmainsellingpointsto musiciansnamely,thattheyhavetheconnectionsandinfluencethatamusicianabsolutelyneeds togethisorhermusicoutinthemarketplace.Thus,thedominantincumbentlabelsare particularlyincentivizedtostifledigitalplatformsthatwilldecreasetheirinfluenceascomparedto

smallerlabelsorunsignedacts.Byreducingthealternativesavailabletoartists,theypreservetheir marketpowerovercreators. Digitaldisintermediationisapowerful,consumerfriendly,competitionfriendlyforceinthe musicindustry,justasitisinthebookpublishingmarket,butitisnotimmunetotheabuseof marketpowerbyentrenchedphysicalspaceincumbents.Mergerreviewisintendedtobe prophylactic,topreventtheacquisitionofmarketpowerthatraisesthelikelihoodthat anticompetitive,anticonsumerbehaviorswilloccurandbeeffective. Givingafirmwithastronginterestinretardingdigitaldistributionsubstantiallymore abilitytodosoisamistakethatcanbeavoidedbydenyingthemergeroutright,orcrafting conditionsthatpreventtheabuseofthisnewlyacquiredmarketpower.Thatisexactlythe situationintheproposedmergerbetweenUniversalandEMIinthemusicspace.TheFTCmust takestepstopreventthissevereharmtocompetitionbyeitherrejectingthemergeroutright, requiringdivestiturestoreducethestructuraldamagetocompetitioninthemarketforrecorded music,orimposingbehavioralconditionsthatpreventtheabuseofmarketpower. B.OUTLINE Thereportisorganizedasfollows: SectionIIbrieflydescribestheroleofmergerreviewinthearsenalofantitrusttoolsto promotecompetitionandprotectconsumersfromtheabuseofmarketpower. SectionIIIshowsthattheproposedmergerviolatesthemarketstructurethresholdsofthe Guidelinesbyawidemargin.Thepersistenttightoligopolystructure,inthefaceofseveralmajor technologicalchanges,reinforcestheconcernaboutthemerger.Italsoexaminesconductinthe musicsectoroverthepasttwodecades.Itshowsthattheevidencetowhichtheantitrust authoritieslookforinsightintothelikelyimpactofthemergerafterithasfailedthemarket concentrationtestheightens,ratherthanlessens,concernsaboutthismerger. SectionIVtakesupthequestionofpiracy.Itshowsthatpiracywillnotpreventtheabuseof marketpowerinthefuture.Italsoexplainshowtheindustryvastlyoverestimatedtheimpactof piracyinthepast. SectionVreviewsthecurrentsituationinthemusicsectorfromthepointofviewof incipientornascentcompetition.Itshowsthatcompetitionisincipientandstillvulnerableto anticompetitiveattacksbyincumbents,whilethemergereliminatesanimportantplayerwitha recordasamaverickinthedigitalera. SectionVIexpandsontheebookanalysis,showingthattheimpactofdigital disintermediationonthatmarketissimilar,whichhighlightstheneedforantitrustauthoritiesto remainvigilantintheirdefenseofcompetition.Itconcludeswithsomeobservationsonthe importantroleforantitrustinthematuringdigitalrevolution. AppendixApresentsabrief,graphicalexplicationofthewelfareeconomicsofdigital disintermediation.

II.THEROLEOFMERGERREVIEWINTHEENFORCEMENT OFTHEANTITRUSTLAWS A.GOVERNINGPRINCIPLES Mergersmustbeevaluatedundertheantitrustlawsasactsthatraisethemostfundamental concernofantitrust,asthefollowing2006CommentaryonthejointDOJ/FTCMergerGuidelines makesclear.

GoverningLegalPrinciples:Theprincipalfederalantitrustlawsapplicabletomergersaresection7 oftheClaytonAct,section1oftheShermanAct,andsection5oftheFederalTradeCommissionAct. Section7proscribesamergertheeffectsofwhichmaybesubstantiallytolessencompetition.Section 1prohibitsanagreementthatconstitutesanunreasonablerestraintoftrade.Section5,whichthe FederalTradeCommissionenforces,proscribesunfairmethodsofcompetition.Overmanydecades, thefederalcourtshaveprovidedanexpansivebodyofcaselawinterpretingthesestatuteswithinthe factualandeconomiccontextofindividualcases. Thecoreconcernoftheantitrustlaws,includingastheypertaintomergersbetweenrivals,isthe creationorenhancementofmarketpower.Inthecontextofsellersofgoodsorservices,market powermaybedefinedastheabilitytoprofitablymaintainpricesabovecompetitivelevelsfora significantperiodoftime.Marketpowermaybeexercised,however,notonlybyraisingprices,but also,forexample,byreducingqualityorslowinginnovation.Inaddition,mergersalsocancreate marketpoweronthebuyingsideofamarket.Mostmergersbetweenrivalsdonotcreateorenhance marketpower.Manymergers,moreover,enablethemergedfirmtoreduceitscostsandbecomemore efficient,which,inturn,mayleadtolowerprices,higherqualityproducts,orinvestmentsin innovation.However,underthelaw,theAgencieschallengemergersthatarelikelytocreateor enhancethemergedfirm'sabilityeitherunilaterallyorthroughcoordinationwithrivalstoexercise marketpower. Followingtheirmandateundertheantitruststatutoryandcaselaw,theAgenciesfocustheirhorizontal mergeranalysisonwhetherthetransactionsunderreviewarelikelytocreateorenhancemarket power.TheGuidelinessetforththeanalyticalframeworkandstandards,consistentwiththelawand witheconomiclearning,thattheAgenciesusetoassesswhetherananticompetitiveoutcomeislikely. Theunifyingthemeofthatassessmentisthatmergersshouldnotbepermittedtocreateorenhance marketpowerortofacilitateitsexercise.Guidelines0.1.TheGuidelinesareflexible,allowingthe Agencies'analysistoadaptasbusinesspracticesandeconomiclearningevolve. InapplyingtheGuidelinestothetransactionsthateachseparatelyreviews,theAgenciesstrivetoallow transactionsunlikelysubstantiallytolessencompetitiontoproceedasexpeditiouslyaspossible.The Agenciesfocustheirattentiononquicklyidentifyingthosetransactionsthatcouldviolatetheantitrust laws,subjectingthosemergerstogreaterscrutiny.Mostmergersthatposesignificantriskto competitioncometotheAgenciesattentionbeforetheyareconsummatedunderthepremerger notificationandreportingrequirementsoftheHartScottRodinoAntitrustImprovementsActof1976, 15U.S.C.18a(HSR).HSRrequiresthatthepartiestoatransactionaboveacertainsizenotifythe Agenciesbeforeconsummationandprohibitsconsummationofthetransactionuntilexpirationofone ormorewaitingperiodsduringwhichoneoftheAgenciesreviewsthetransaction.Thewaitingperiods providetheAgenciestimetoreviewatransactionbeforeconsummation(DOJ/FTC,2006).

Infact,mergerreviewisoneofthefewareasofantitrustpracticewheretheauthorities traditionallytakeprophylacticmeasurestopreventtheabuseofmarketpower.
Mostmergeranalysisisnecessarilypredictive,requiringanassessmentofwhatwilllikelyhappenifa mergerproceedsascomparedtowhatwilllikelyhappenifitdoesnot.Giventhisinherentneedfor prediction,theseGuidelinesreflectthecongressionalintentthatmergerenforcementshouldinterdict

competitiveproblemsintheirincipiencyandthatcertaintyaboutanticompetitiveeffectisseldom possibleandnotrequiredforamergertobeillegal.(DOJ/FTC,2010:1)

Whetherornotmostmergersareallowedtoproceed,asclaimedbyUniversal,isirrelevant; eachmergermustbereviewedonthebasisofthefactsinthecaseandtheextenttowhichthe specificmergerwillmaketheabuseofmarketpowermorelikely.

TheseGuidelinesshouldbereadwiththeawarenessthatmergeranalysisdoesnotconsistofuniform applicationofasinglemethodology.Rather,itisafactspecificprocessthroughwhichtheAgencies, guidedbytheirextensiveexperience,applyarangeofanalyticaltoolstothereasonablyavailableand reliableevidencetoevaluatecompetitiveconcernsinalimitedperiodoftime(DOJ/FTC,2010:2).

Forthisreasonandtogiveguidancetofirmscontemplatingmergers,theantitrustagencies adoptedMergerGuidelinesalmosthalfacenturyago.ThoseGuidelineshavebeenupdatedseveral times,mostrecentlyin2010.Thus,theagencieshaveaveryfreshsetoftoolstousetoevaluatethe proposedUniversalEMImerger. B.THEMERGERGUIDELINES 1.KeyThresholds UnderthejointDepartmentofJustice/FederalTradeCommissionMergerGuidelines,the considerationofproposedmergersbeginswithastraightforwardanalysisofmarketconcentration. Ifamergerincreasestheconcentrationinthemarketbyanamountthatcouldresultinasignificant increaseinthemarketpowerofthepostmergerfirm,thenthemergerdemandsscrutiny. ConcentrationismeasuredbytheHirschmanHerfindahlIndex(HHI)becausethatindexhasa directrelationshiptoexistenceofmarketpower.(Viscusi,VernonandHarrington,2001:147149, 212213)Thethresholdsatwhichconcernisfeltaboutmergerswereraisedsubstantiallyinthe recentrevisionoftheGuidelines. Amarketthatisconsideredmoderatelyconcentratedusedtobedefinedasonethat exhibitedanHHIbetween1,000and1,800.AnHHIabove1,800wasconsideredahighly concentratedmarket.Translatedintoeverydayterms,amarketwithtenequalsizedcompetitors wouldhaveanHHIof1,000.Amarketwith6equalsizedcompetitorswouldhaveanHHIof1,667. Ineffect,amarketwith10ormoreequalsizedcompetitorswasconsideredunconcentrated,anda marketwithfewerthanroughly5.5wasconsideredhighlyconcentrated.Inbetween,themarket wasconsideredtobemoderatelyconcentrated.Undertherecentlyrevisedguidelines,the unconcentratedthresholdwasraisedto1,800,whilethehighlyconcentratedthresholdwasraised to2,500,ortheequivalentof4equalsizedfirms. Therevisedguidelinesareconsistentwithlongstandingconceptualizationsinthe economicliterature,asdescribedinExhibitII1.Amoderatelyconcentratedmarketwould correspondtoatightoligopoly,whichwasdefinedasamarketwherethetopfourfirms(thefour firmconcentrationratio,orCR4)hadmorethan60percentofthemarket.1Monopolistic competitioninvolvesproductswhosedifferentiationaffordsthefirmsthatproducethemmarket powerwhichisassumedtobeshortlivedasentrywillerodethatmarketpower.The differentiationofcontentinthemusicsectormakesthismarketstructurerelevant,butsomeargue

1Inthecaseof5.5equalsizedfirms,thefourfirmconcentrationratioswouldbe72%.

thattheexistenceofbarrierstoentrycopyrightandeconomiesofscaleinphysicalproductionand distributionopenthewaytolongtermmarketpower.2(Tschmuck,2009:261) EXHIBITII1:DESCRIBINGMARKETSTRUCTURES Departmentof JusticeMerger Guidelines Typeof Market HHI Equivalentsin TermsofEqual SizedFirms 1 2 4 5.5 10 4Firm Share CR4 100 100 100 72 60 40

HighlyConcentrated Monopolya/ Duopolyb/ ModeratelyConcentrated TightOligopoly LooseOligopoly Monopolistic Competition Unconcentrated Atomistic Competition

10,000 5,000 2,500

1,000 200

50

SourcesandNotesa=Antitrustpracticefindsmonopolyfirmswithmarketshareinthe65%to75%range.Thus,HHIsin monopolymarketscanbeaslowas4200;b=Duopoliesneednotbeaperfect50/50split.Duopolieswitha60/40splitwould haveahigherHHI.Sources:U.S.DepartmentofJustice,HorizontalMergerGuidelines,revisedAugust2010,foradiscussionof theHHIthresholds;WilliamG.Shepherd,TheEconomicsofIndustrialOrganization(EnglewoodCliffs,NJ:PrenticeHall,1985), foradiscussionoffourfirmconcentrationratios.

2.TheImpactoftheMergeronConcentration

Duringmergerreview,amergerisevaluatedbyexaminingthelevelofconcentrationofthe postmergermarketandtheimpactofthemergeronthelevelofconcentrationinthemarket.The higherthelevelofpostmergerconcentrationandthelargertheincreaseinconcentration,the greaterthethreattocompetitionandthemorelikelytheantitrustauthoritiesaretoblockamerger ordemandremediestomitigatethepotentialharmsofincreasedmarketpower.

ModeratelyConcentratedMarkets:Mergersresultinginmoderatelyconcentratedmarketsthatinvolve anincreaseintheHHIofmorethan100pointspotentiallyraisesignificantcompetitiveconcernsand oftenwarrantscrutiny. HighlyConcentratedMarkets:Mergersresultinginhighlyconcentratedmarketsthatinvolvean increaseintheHHIofbetween100pointsand200pointspotentiallyraisesignificantcompetitive concernsandoftenwarrantscrutiny.Mergersresultinginhighlyconcentratedmarketsthatinvolvean increaseintheHHIofmorethan200pointswillbepresumedtobelikelytoenhancemarketpower.

2Thus,onewaytoviewdigitaldisintermediationisthereductionofphysicalbarrierstoentry,whichmoves

thesectorbacktowardthemodeloftruemonopolisticcompetition,withitsshorttermexerciseofmarket power.Atthesametime,thesecondmajorbarriertoentry,licensingofcontent,becomesafocalpointof theefforttopreserveorreducelongtermmarketpower.

Thepresumptionmayberebuttedbypersuasiveevidenceshowingthatthemergerisunlikelyto enhancemarketpower.(DOJ/FTC,2010:19)

ExhibitII2showstheconcentrationthresholdsandthemergerrelatedincreasesin concentrationthattriggerconcernsandleadtoscrutiny.IntheCommentsfiledinresponsetothe revisionoftheGuidelines,theConsumerFederationofAmericaobservedthat,whiletherevisions acceptedmoreconcentratedmarketsasthresholdsforconcern,theywouldimproveantitrust enforcementonlyiftheyweredeemedtobemorebindingandledtomoreconsistentactionto blockharmfulmergers.TheUMGEMImergerisexactlythecircumstancewehadinmind.3 EXHIBITII2:CONCENTRATIONTHRESHOLDSANDIMPLICATIONSOFMERGERRELATEDINCREASESINHHI Mergersresultinginhighly Mergersresultinginhighly Mergersresultingin concentratedmarketsthatinvolve concentratedmarketsthat moderatelyconcentrated anincreaseintheHHIofmore marketsthatinvolvean involveanincreaseintheHHI than200pointswillbe increaseintheHHIofmore ofbetween100pointsand than100pointspotentially presumedtobelikelyto 200pointspotentiallyraise enhancemarketpower.The raisesignificant significantcompetitive presumptionmayberebuttedby competitiveconcernsand concernsandoftenwarrant persuasiveevidenceshowingthat oftenwarrantscrutiny. scrutiny. themergerisunlikelytoenhance marketpower. 3000 2500 2000 1500 1000 500 0 ModeratelyConcentrated HighlyConcentrated Highlyconcentrated PostMergerLevel MergerRelatedIncrease Source:U.S.DepartmentofJustice,HorizontalMergerGuidelines,revisedAugust2010. ItturnsoutthatUniversalisnotonlywrongonthebroadprinciplesofantitrustlaw,itis deadwrongwhenthisspecificmergerisviewedthroughthelensoftheMergerGuidelinesapplied tothefactsofthiscase.Asdiscussedinthenextsection,theUMGEMImergerfallsinthehighest levelofconcern,highlightedinExhibitII2.
3Iftherevisionenablestheantitrustauthoritiestomakethethresholdsmorebindingtochallengemergers

moreconsistentlywhentheyviolatethethresholdsthiswillbeanimportantstepforward.Antitrust authoritieshadfailedtochallengeandthecourtshavefailedtoblocktoomanymergers.(CFA,2010:34)

III.THEUMGEMIMERGERRAISESSIGNIFICANTCOMPETITIVECONCERNS A.MARKETSTRUCTURE 1.HorizontalConcentration Byawidemargin,theUMGEMImergerisamergerthatexceedsthelevelswhereamerger isdeemedtopotentiallyraisesignificantcompetitiveconcernsandwarrantscrutiny.Asshown inExhibitIII1,measuredbyrevenues,themergerwouldmovethemarketforrecordedmusicsales fromtheunconcentratedrangetothemoderatelyconcentratedrangebyincreasingtheHHIbyover 500points,fivetimesthelevelthattriggersconcerns.Lookingatthemarketforalbums,whichisa distinctproduct4andthelargestsinglesourceofrecordlabelrevenue,theimpactofthemergeris muchgreater.Foreachofthemajorcategoriesofalbumsthemergermovesthemarketfromthe moderatelyconcentratedleveltothehighlyconcentratedleveladdingover1,000pointstotheHHI. Thisisfivetimesthelevelatwhichamergerispresumedtobelikelytoenhancemarketpower. EXHIBITIII1:IMPACTOFTHEUMGEMIMERGERONMARKETCONCENTRATION
HHI 3500 HHIincreasethatraiseconcerns
aboutmarketpower

3000
2500

2000 1500 1000 500 0

Guideline Guideline Total Albums Current Albums Catalog Albums Physical albums Digital Albums Total Albums Digital Tracks

Mod.Conc. TotalRev. HighConc

Source:MusicandCopyright,2011,UniversalMusicGroupReassertsitRecordedMusicDominancein2010;NielsenCompany &Billboards2011MusicIndustryReport,DepartmentofJustice,FederalTradeCommissionMergerGuidelines,June2010.

Theissueofmarketdefinitionwillbehotlydebated,asalwayshappensinmergerreview, butweareconvincedthatalbumsales,whichremainthedominantsourceofrevenueforthelabels, isawelldefinedmarketthatisextremelyimportant.5Thefactthatallfiveofthemajorproducts

4Enders,2011:14,notesthatOnthedemandside,CDsinvolvealbumsanddigitaldownloadsinvolve

predominantlysingleswhichmakesthemimperfectsubstitutes.

5MergerGuidelinesMarketdefinitionfocusessolelyondemandsubstitutionfactors,i.e.,oncustomers

abilityandwillingnesstosubstituteawayfromoneproducttoanotherinresponsetoapriceincreaseora correspondingnonpricechangesuchasareductioninproductqualityorservice.Marketsharesof differentproductsinnarrowlydefinedmarketsaremorelikelytocapturetherelativecompetitive significanceoftheseproducts,andoftenmoreaccuratelyreflectcompetitionbetweenclosesubstitutes.As aresult,properlydefinedantitrustmarketsoftenexcludesomesubstitutestowhichsomecustomers mightturninthefaceofapriceincreaseevenifsuchsubstitutesprovidealternativesforthosecustomers. Becausetherelativecompetitivesignificanceofmoredistantsubstitutesisapttobeoverstatedbytheir

thatrepresentvirtuallyalloftherevenuestreamsofthemajorlabelsexhibitnearlyidentical marketstructuresandconcentrationeffectsofthemergerincludingthenewdigitalproducts reinforcestheconcernaboutthemerger.Infact,thepostmergerfirmwouldhaveapowerful positioninthedigitalproductspace,controllingsixofthealltimetoptensellingdigitalartistsand albums(Nielsen2012:7). Theimpactofthemergerondigitalalbumconcentrationisnodifferentfromtheimpacton physicalalbums.Aweightedaverageconcentrationanalysisforallalbumsshowsthesameimpacts andlevelsasthephysicalanddigitalalbumsseparately.Thus,itisnotthecasethatdifferentlabels specializeinphysicalanddigitalproducts.Thetightoligopolythathasexistedforadecadein physicalalbumshastransferredtodigitalalbumsandspansbothphysicalanddigitalproducts. Whilethedigitaltracksmarketissomewhatlessconcentratedandtheimpactofthemergeris slightlysmaller,themergerfallsinthehighlyconcentrated,highimpactareaforthisproduct.The controlofdigitalcontentbythetightoligopolyofmajorlabelsmeansthatnewdigitaldistribution servicesaredependentonlabelsforaccesstomarqueecontent. Thepresumptionthatflowsfromthemarketconcentrationanalysiscanberebuttedby examiningotherfactorsthattheMergerGuidelinesidentify.Themergingpartiesoffertwotheories onwhythemergerwillnothavetheanticompetitiveimpactthatthemarketstructureanalysis suggests.(Morgan,2012;Pham,2011) Digitaltechnologieshavecreatedadynamicenvironmentinwhichlargeincumbents areatrisk,shouldtheyengageinabusivepricing. Piracywilldisciplineabusivepricing.

Inthiscase,however,theseotherfactorsonlystrengthenthecaseagainstthemerger. Neitheroftheseclaimswithstandsscrutinywhensubjecttoexaminationbytheadditionalmethods thattheMergerGuidelineslayoutforreviewingmergers.Inotherwords,themergerfailsthefirst bigtest,andeveryoneofthesecondarytests. 2.History Oneparticularlyimportantsetoffactorstobeconsideredisthehistoryofmarketstructure andfirmconductintheindustry.TheAgenciesgivemoreweighttomarketconcentrationwhen marketshareshavebeenstableovertime,especiallyinthefaceofhistoricalchangesinrelative pricesorcosts(DOJ/FC,2010:18).Thislineofanalysisaddressesthefirstdefenseofthemerging partiestorebutthemarketstructuralimpactofthemerger.Thesamesmallnumberoffirmshave beenatthetopofthemusicindustryforalmostaquarterofacentury,inspiteoftwomajor changesinthemediumonwhichmusicisrecordedthatcauseddramaticchangeinthecostof productionandthenatureoftheproduct(ExhibitIII2). Inordertoappreciatetheremarkablestabilityofthedominantfirms,ExhibitIII3presents twoviewsofthehistoryoftechnologicalchangeasthebackdropforownershipstability,whichthe Guidelinesstress.ThetopgraphinExhibitIII3showstheabsolutevalueofrevenuesearnedbythe saleofdifferentmediaacrosstime.Itdepictsdramaticchangeintechnologyandgrowthacross time.Thebottomgraphidentifiesthesametechnologicalchange,butitputsthegrowthin perspective,bycalculatingtherealexpenditures.Technologyhaschanged,tobesure,butalarge
shareofsales,whentheAgenciesrelyonmarketsharesandconcentration,theyusuallydosointhe smallestrelevantmarketsatisfyingthehypotheticalmonopolisttest.(DOJ/FTC,2010:789)

EXHIBITIII2:STABLELEADINGFIRMSINTHEU.S.MUSICINDUSTRY
1.
Majorlabels19881998(BigSix) WarnerMusicGroup 2. EMI 3. SonyMusic (AKACBSRecordsuntil1991) 4. BMGMusic 5. UniversalMusicGroup 6. Polygram Majorlabels19982004(BigFive 1. WarnerMusicGroup 2. EMI 3. SonyMusic 4. BMGMusic 5. UniversalMusicGroup (PolygramabsorbedintoUMG) Majorlabels20042008(BigFour) 1. WarnerMusicGroup 2. EMI 3. SonyBMG (SonyandBMGjointventure) 4. UniversalMusicGroup

Majorlabels2012(ifapproved) 1. SonyMusicEntertainment 2. WarnerMusicGroup 3. UniversalMusicGroup

Majorlabels20082011(BigFour) 1. SonyMusicEntertainment 2. EMIGroup 3. WarnerMusicGroup 4. UniversalMusicGroup

Source:http://en.wikipedia.org/wiki/Record_label

EXHIBITIII3:THEREPEATEDCASCADEOFMUSICMEDIA
Source:MichaelDegusta,TheRealDeathoftheMusicIndustry,February,16,2011;Bain&company,PublishingintheDigital Age,January1011.

10

partoftheapparentgrowthwasduetoinflation.Aboveall,thefirmsthatweredominantatthe onsetofthetransitiontoCDsarethesamefirmsthataredominantafterthetransitiontodigital distribution. ExhibitIII4showsthetwoprimarymeasuresofmarketconcentration.Usingtheoverlap inthedatabetweenNoamandNielsen,thebottomgraphshowsthelongtermmeasureof concentrationthatcoversalmostthirtyyears,withthepostmergermarketastheendpoint.This mergerwouldconstitutethelargestincreaseinconcentrationinanindustrythathasbeenatight oligopolyforoveradecade,atightoligopolythathaspersistedinspiteofamajortechnological change.Thelongtermtrendreinforcestheconcernaboutmarketpowerintheinitialmarket structureanalysisofSectionII. EXHIBITIII4:MEASURESOFLONGTERMMARKETSTRUCTURE MarketSharesofTopFourFirms:LongTermTotalAlbums 100
50 0 1988 1992 Universal 1996 Sony 2000 Warner 2004 EMI 2008 2011 FourFirmCR 2012post

MarketSharesofTopFourFirms:RecentPastTotalAlbums
40 20 0 UMG
Noam2004 Nielsen2007

EMI
Noam2008

SME
Nielsen2008 Nielsen2011

WMG
PostMerger

HHI,LongTermTotalRevenue/Albums
3000

2500 2000 1500

1000

500 0 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Source:EliNoam,MediaOwnershipandConcentrationinAmerica(NewYork:OxfordUniversityPress,2009),Table7.3;The NielsenCompany&Billboards2011MusicIndustryReport,variousyears.

11

B.CONDUCT

Asecondimportanttypeofevidencetowhichtheantitrustauthoritieslookinordertogain insightintohowthemergerwillaffectfutureconductinthesectoristoexaminepastbehavior, particularlyindustryparticipantsbehaviorintrackingandrespondingtopricechangedbysome orallrivals(DOJ/FTC,2010:11).Heretherecordisparticularlytroubling.Theleadingfirmsinthe sectorhaveengagedinarepeatedpatternofanticonsumerandanticompetitivebehavior. Inthemid1990s,themajorrecordlabelsengagedintwopracticesthatimposedsevere harmonconsumersandcompetition.Theyeliminatedthesaleofsingles,eventhoughtheCDwas wellsuitedforthesaleofsingles.Theyadoptedapricefixingschemetokeepalbumpriceshigh, eventhoughthenewcompactdisc(CD)formatdramaticallyloweredtheircostsanddiscounters hadloweredprices.Inshort,theyrestrictedoutputandraisedprices,forcingconsumersto unnecessarilypurchasehundredsofmillionsofoverpricedCDstogetthemusicthattheywanted. Anantitrustconsentdecreeendedpricefixing(FTC:2000)anddigitaldistributionmadethesaleof singlesacompellingalternative.(Nestor,2012) 1.ProductOfferings:TheEliminationofSingles ExhibitIII5showsthepatternofsales,measuredinunitsshippedacrossalmost40years. Theuppergraphshowstheabsolutevalue,whilethelowergraphshowsshipmentspercapita. Singlesconstitutedalargepartoftheoutputoftheindustrythroughthe1980sbutbegantodecline withtheintroductionoftheCDinthemid1980s.Singlesdeclinedslightlyforadecade,then droppedprecipitouslybetween1997and2002,fallingby99percent.Therecordlabelseliminated singlesovertheobjectionofretailersandtothedismayofconsumers.Thegrowthofsalesof singlesaftertheadventofdigitaldistributionisquitedramaticmademuchmoresobytheill consideredsuppressionofsinglesduringtheCDera. Theeliminationofsingleswasaprofitseekingpolicythathadadverseimplicationsfor longtermmusicsales:
[S]inglesmadeupaheftypartoftherecordindustrysincomeButthingshavechanged.Record companieswantconsumerstobuyfulllengthCDswhentheyfallinlovewithasong.Sotheyhaveshut offthespigotwhenitcomestoreleasinglessexpensivecommercialsinglestoretail Thedebaterages.Labelsinsisttheysimplycannotmakeabigenoughreturniffansarebuying$3 singlesinsteadof$16albums.Retailers,though,fumethattheyaresufferingwithoutsingles,which havehistoricallyincreasedfoottrafficinstores,especiallyamongyoungershoppers. Labelslikethesinglewhenitsuitstheirpurposes;duringpartsoftheoverheated1990s,labels releasedtheminfloodsatdeeplydiscountedpricestohelppromoteblockbusteralbumsandclaim fancifulnewsalesrecords Butthatwasthen,thisisnow,andthemusicfansarethelosers.(Boelhert,2004)

Theunitsshippedpercapitadatainthelowergraphsuggeststhattherecentshiftbackto singleshasreturnedtheindustrytoitshistoricalpatternofdemand.UsingthetrendintheCDera fortotalunitsshipped,wefindthatthetotalprojectedunitspercapitaareclosetotheactual numberofunitspercapitashippedtoday.Thisputstheaffinityforsinglesinperspectiveand suggestsmorecontinuityinconsumptionthanisgenerallyrecognized.Theaberrationistheperiod inthe1990swhenthecompaniessuppressedsaleofsinglesandusedanticompetitivepracticesto propupthepriceandsaleofCDalbums.Totheextentthattherewasabubbleinunitsshippedin themid1990s,itwaslikelytheresultofamassivelibraryreplacementasconsumersadoptedthe 12

new,muchmoreconvenientCDmediumfortheirexistingstockofmusic.(Knopper,2010:61,213; OberholzerGeeandStumpf,2007:16;Hong,2004) EXHIBITIII5:U.S.SHIPMENTSOFALBUMSANDSINGLES NumberofUnitsShipped

MilllonUnits 1400

1200 1000

PhysicalAlbums DigitalAlbums Singles

800 600 400 200 0

UnitsShippedPerCapita
6

5 4 3 2 1 0

Albums

TotalUnits

y=0.095x+1.6205 R=0.78377

Source:RecordingIndustryAssociationofAmerica,YearEndShipmentStatistics,variousyears.U.S.BureausoftheCensus,for Population

Someanalystscounttheresistanceandhostilereactiontothenewdigitaltechnologyinthis lineofsuspectconduct(Nestor,2012;Knopper,2010,Tschmuck,2009;Handke,2006).Bethatas itmay,afteraperiodofresistancetothenewdigitalmedium,theindustryadoptedabusiness modelthatfinallymadedigitalmusicavailablein2003.Simultaneously,asecondconsentdecree wentintoeffect.Theavailabilityofdigitalsinglesspurredanimmediateandhugegrowthinunits shippedasthedemandthathadbeensuppressedbytheeliminationofsingleswasexpressedand theconvenienceofthenewmediumunleashed.Digitalalbumsalesdevelopedsomewhatlaterbut 13

1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2204 2005 2006 2007 2008 2009 2010

haverecentlybeenthelargestgrowingsourceofrevenue.Herethegrowthcanbeattributedtothe convenienceandpriceadvantageofthenewmedium. 2.PricingPatterns:IllegallyFixingthePriceofCDs Coincidentwiththeeliminationofsingles,theindustrysteppedupitseffortstoincrease prices.Keepingpriceshighwithanticompetitivepracticesandeliminatingsinglesinorderforthe newCDformattothrivecreatedawindfallfortherecordlabels.Therecordcompaniesminted money,onemajorlabelexectoldme.WemadehugemarginsoffCDs.Wellneverhavethose marginsagain.(Mnookin,2007) However,asurveyofconsumersatthetimeofthefirstconsentdecreein2000revealed significantconsumerdissatisfactionwithrecordingindustrypricing(WilsonMorris,2000).Three quartersofrespondentsfeltthatpricinglevelswereunreasonableandalmostasmanyfeltthey wereexcessivecomparedtootherformsofentertainment.Theysaidtheywouldincreasetheir purchasesofmusicifpricesfellsubstantially,andalmostalltherespondentssaidtheywouldnotbe willingtobuydigitaldownloadsatthesamepricesasCDs.Thepublicwasclearlynotsatisfied. Theconsentdecreesenteredintobythemajorlabelsin2000and2003suggestthatthe industryhadengagedinabusivepricingpracticesinthe1990sastheCDrosetobecomethe dominantmediumformusicdistribution.Thisisanimportantreminderthattechnologicalchange isnoguaranteethatanticompetitiveandanticonsumerbehaviorinviolationoftheantitrustlaws cannottakeplace. Thepricingpatternofthe1990sshowsthatpricefixingbytheindustrywasintendedto managethedramaticdeclineinpricesthatacombinationofnewtechnologyandvigorous competitionhadimposedontheindustry(FTC,2000;Knopper,2010,108112).Thetopgraphin ExhibitIV2breaksthehistoryofCDpricesintothreeperiodsusingnominalpricestheriseofthe CDwhenthetechnologyandeconomiesofscalewerereducingcosts;theperiodofCDdominance, whenpricefixingstoppedthepricereductionsandincreasedprices;andthedigitalera,when consentdecreesandanewdistributionmediumputdownwardpressureonprices.Themiddle graphshowsthethreeperiodsinrealprices. ThebottomgraphinExhibitIII6showsthestrongcorrelationbetweenmarket concentrationandnominalCDpricesintheperiodofpricefixing.RealCDpriceswereflat,which representsthecessationoftheprocessofpricereductionsthathadtypifiedtheCDerauptothat point.Theindustryconcentratedstronglyovertheperiodwhenpricingabusebegan.Theory providesthelinkbetweenthetwo,suggestingthatconcentrationmadepricefixingmoreeffective. Thefactthattheindustryhadsignificantabilitytomanipulatetheavailabilityandpriceof productisthekeyhistoricaltakeawayforevaluatingthecurrentconditionsinthemusicmarket. ConsumersbenefittedgreatlyfromthetechnologicalchangeaftertheintroductionofCDsuntilthe tightoligopolywasagainabletopursueanticonsumer,anticompetitivepractices.

14

EXHIBITIII6:MARKETSTRUCTUREANDCDPRICING ThreePeriodsofCDPricing:NominalPrices
$25 $20 $15 $10 CDRise CDEra DigitalEra 0 200 400 600 800 UnitsShipped(million) 1000 1200

$5 $0

ThreePeriodsofCDPricing:RealPrices
$50 $40 $30 $20 $10 $0 0 200 400 600 800 Unitsshipped(million) 1000 1200 CDRise CDEra DigitalEra

MarketConcentrationandthePriceofCDsintheEraofPriceFixing CDPrices
$25.00 $20.00 $15.00 $10.00 $5.00 $0.00 0 200 400 600 800 HHI 1000 1200 1400 1600 1800 Nominal Real

y=0.0006x+19.488 R=0.0771

y=0.0053x+6.2773 R=0.9435

Source:RIAA,EliNoam,MediaOwnershipandConcentrationinAmerica(NewYork:OxfordUniversityPress,2009),Table7.3 RecordingIndustryAssociationofAmerica,YearEndShipmentStatistics,variousyears.

3.Margins TheMergerGuidelinesidentifyanalysisofmarginsasanimportantconsiderationinthe analysisofthepotentialforpostmergermarketpower.Thehigherthepremergermargin,the smallertherecapturepercentagenecessaryforthecandidatemarkettosatisfythehypothetical 15

monopolisttest(DOJ/FTC,2010:12).Thisobservationonmarginsleadsustoconcludethat,as powerfulastheincentivestoengageinanticompetitivebehaviorwereinthe1990s,theyareeven morepowerfultoday. Inthemature,advancedindustrialsocietyofthelate20thcentury,distributionand transactioncostscametorepresentalargeshareofthetotalcostsofgoodsandservices.Inthe contentindustries,likebookpublishing,music,andnewspapers,transactioncostsareasmuchas 80centsonthedollar.Digitaltechnologiescanlowerproductionanddistributioncostsandgive consumersmuchgreaterflexibilityandchoice,therebydramaticallyimprovingthefitbetween whatisproducedandwhatisconsumed.Astechnologieslowerthecostofproductionand distribution,ascrumdevelopsoverthesocialsurplusthatisreleased.Thesellersofinformation goodsseemtothinkthatbecauseconsumerswerewillingtopayahighpricefortheirphysical productsinthepast,theycankeepthepricehighfordigitalproductsandpocketthecostsavingsas increasedprofit(highermargins). ExhibitIII7comparesthebreakdownofcostsonphysicalCDsanddigitalproducts. Royaltiesforallcreatorsremainaboutthesamewhenlabelsareinvolved.Thebigdifferenceisin theretailerandmanufacturingcosts.Whilethereisnogoodevidenceonexactlywhatthemargins areatpresent,thelabelshavetheincentivetopushpricesupandincreasetheirmargins.In vigorouslycompetitiveindustries(i.e.withlargenumbersofbuyersandsellersandhighelasticities ofsupplyanddemand),thevastbulkofthecostsavingswillbepassedthroughtoconsumers.That isthewhytheantitrustlawsarethefrontlineofconsumerprotection. EXHIBITIII7:WHOGETSWHATFROMTHEMUSICCONSUMERDOLLAR

Percent (cents on a Dollar)

100 90 80 70 60 50 40 30 20 10

0 May & Singer CD Compaine & Gomery - CD Fisher -CD Hull - CD Hull -Digital

Retail

Distribtuion

Manufacturing

Label: Marketing, Overhead, Profit

Royalties

Sources:WilliamFisher,PromisestoKeep(Stanford,StanfordUniversityPress,2004),AppendixforMayandSinger,Compaine andGomeryandFisher;GeoffreyP.Hull,TheRecordingIndustry(NewYork:Routledge,2004),2nded.,pp.182and259forCDs andDigital,respectively.

Toappreciatethefullimpactofthetechnologicalchange,ExhibitIV4showstherevenue perunitshipped,whichcombinessinglesandalbums,innominalandrealterms.Itisinteresting thattheindustryusesthefigureofrevenueperunitshippedasitsbottomlinemeasureof performance.Whenthemediumwasaphysicalproduct(avinylrecord,8tracktapeorCD),this physicalunitmadesense.Themarginalcostofaddingsongstothephysicalunitwassmall,ifnot 16

zero.Inthedigitalage,itmakessenseaswellforthesamereason.Themarginalcostdifference betweenshippingadigitalsingleoranalbumissmall. Therevenuedifferencebetweensinglesandalbumsislargeandthataccountsforthe dramaticchangesreflectedinExhibitIII8.In2003,theRIAAreportsnodigitalshipments.By 2011,80percentofallshipmentsweredigitalsinglesand5percentweredigitalalbums.The numbersarestunning,butaglancebackatExhibitIII3showsthatittookaboutthesameamount oftimeforCDstocoverthesameamountofgroundintermsofmarketshare.Inalittleovera decade(the1999peakofCDalbumstothe2011peakofdigitalunitsandCDalbums),thenumber ofunitsincreasedby50percentandtheamountofrevenuedeclinedby50percent(compare ExhibitsIV1andIV4).In1988CDsmadeupasmallpercentageofunitsshipped;adecadelater theywere99percent.Thedifferenceisthattheoligopolyuseditstightcontroltoshiftallsalesto singlesandpumpupprices. EXHIBITIII8:REVENUEPERUNITSHIPPED
Source:RecordingIndustryAssociationofAmerica,YearEndShipmentStatistics,variousyears.U.S.BureausoftheCensus,for Population

$20 $18 $16 $14 $12 $10 $8 $6 $4 $2 $0 Nominal Real

In2011,consumersboughtabout1.3billiondigitalsinglesatanaverageofjustover$1per single,foratotalcostof$1.5billion.Sinceconsumerstypicallywanttwosongsperalbum (Knopper,2010;Nestor,2010),iftheanticonsumer,anticompetitivepracticesoftherecording industryhadnotbeenthwartedbylawandtechnology,consumerswouldhavebeenforcedtobuy about500millionmorealbumsatanaveragecostofabout$13perCDtogetthemusicthey wanted.Thetotalcostwouldhavebeenabout$6.5billion.Digitalsinglesallowedconsumerneeds tobemetmoreefficientlyataconsumersavingsofmorethan$5billion.Consumerspaidhalfa billionlessfordigitalalbumssales,asshownbelowinSectionV. Theshiftisremarkableandmayseemunsustainable,buttheeconomiccostsavingsflowing fromdigitaltechnologiescanexplainalargepartoftheshift,asshowninExhibitIV3above. Physicalmanufacturing,retail,anddistributionaccountedforabout60percentofthetotalcostofa CD,evenwiththerecordlabelmarginsinflatedbypricefixing.Thesecostscanbedramatically reducedifnoteliminatedbydigitalproductionanddistribution.Astheneedtoadministeralarge 17

physicalproductionanddistributionnetworksandspendalotofresourcestryingtomatchsupply anddemanddecline,thelabelcostsshouldfallsignificantlyaswell.Arevenuereductionof75 percentismatchedbyacostreductionof75percentwitha50percentincreaseinunitsshippedto spreadtheremainingfixedcosts.

18

IV.PIRACYv.EFFICIENCY ASEXPLANATIONSFORTHETRANSFORMATIONOFTHEMUSICMARKET Wepointedoutalmostadecadeagothatthisperiodofartificiallyinflatedrevenueswas usedbytherecordingindustrytomakeoutrageouslyinflatedclaimsaboutpiracyinthedigitalage (ConsumerFederationofAmerica,2005,Cooper,2005,2008and2011).Webelievethismarket structuredatalaysthebasisforrejectingtheclaimbeingmadetodaythatpiracyanddigital technologymitigatetheconcernsaboutmarketpowerintheindustry.Thedominantfirmsarestill dominantandtheystillhavetheabilitytousetheirmarketpowerinanticompetitiveandanti consumerways.Theoverestimationofpastpiracyclaimsisonereasonantitrustauthoritiesshould beskepticaloftheclaimsbeingmadeforpiracywithrespecttoitsabilitytodetertheabuseofpost mergermarketpowertoday.Thereisalsoconsiderabledirectevidencethatrequirestheantitrust authoritiestorejectthatclaim. Thissectionexaminespricingandotherbehaviorinthemusicmarkettoassesstheclaim thatpiracyisadominantforceinthemusicsector.Itshowsthatthisclaimishighlyimplausible. Webeginwiththecontemporaryevidencethatpiracycannotbecountedontopreventpricing abuseandthenshowthattheroleofpiracyinthepastwasoverstated. A.THECLAIMTHATPIRACYCANDISCIPLINEMARKETPOWERDOESNOTRINGTRUE Intodaysmusicmarket,theclaimthatpiracywilldisciplinetheabuseofmarketpoweris contradictedbyagreatdealofevidenceonactualconsumerbehavior.Consumersspentalmost $2.5billionondigitalproductslastyear.Theywouldhavetobefoolstodosoifpiracywereaseasy astherecordlabelsclaim.Moretothepointintermsofthismergerreview,whywouldconsumers whopaid$10.40perdigitalalbum(onaveragein2011)suddenlyresorttopiracyifthepriceof digitalalbumswentupto$11?Here,itisimportanttokeepinmindthatundertheMerger Guidelinesthisistheorderofmagnitudeofapriceincreasethatcommandstheattentionof antitrustofficials.
TheAgenciesmostoftenuseaSSNIP[SmallbutSignificantandNontransitoryIncreaseinPrice]offive percentofthepricepaidbycustomersfortheproductsorservicestowhichthemergingfirms contributevalue.However,whatconstitutesasmallbutsignificantincreaseinprice,commensurate withasignificantlossofcompetitioncausedbythemerger,dependsuponthenatureoftheindustry andthemergingfirmspositionsinit,andtheAgenciesmayaccordinglyuseapriceincreasethatis largerorsmallerthanfivepercent.(DOJ/FTC:10)

Theideathatpiracyeliminatesorevensubstantiallyalterstheelasticityofdemandis contradictedbyindustrygeneratedstudiesandevidence.Aneconometricstudycommissionedby amajorlabeltoexaminetheimpactofpricingflexibilityindigitalsinglesales,foundthatthe elasticityissmallandthatraisingpricesby30percentincreasedrevenues(Danaher,2011).If piracywerethestronglydisciplinaryforcethatUMGclaims,thestudyofpricingflexibilitywould havefoundthatraisingpricesdoesnotincreaserevenues.Theimplicitpriceelasticityofdemandin thatstudyis.36,i.e.a1percentincreaseinpriceresultsina.36percentdecreaseindemand. Otherstudiesputthepriceelasticityat.55(KleinandSlonaker).Thisisarelativelylowelasticity, whenthepiracyargumentwouldleadustoexpectaveryhighnumber.Theseelasticitiesarealso inarangethatmakespriceincreasesprofitable. AWarnerMusicGrouppresentationtotheFederalCommunicationsCommissiononthe musicconsumermadethispointinanotherway.Itreportedonaclassicmarketingstudythatused interviewswithconsumerstoestimatethepricepointsforalbumsdeliveredondifferentmedia 19

(seeExhibitIV1).Theanalysisiscarefultocautionthatitisnotadvocatinganyspecificpricing strategy,butinsteadshowingtherangeofpossibilities. EXHIBITIV1:PRICEPOINTSFORDIFFERENTALBUMTECHNOLOGIES $30 AcceptableRangeHigh Crossover $25 Indierence AcceptableRangeLow $20 $15 $10 $5 $0
CD Digital Source:WarnerMusicGroup,ConsumerInsightsDiscussionforFCC,April2010.

USB

However,fromthepointofviewoftheantitrustauthoritiesreviewingamerger,therange ofpossiblepricesistheissue.Competitionwoulddrivepricestothelowendoftherange,market powerwouldpushittothehigherrangeandwouldgivetheindustrytheincentivetomovedemand tothehighercostproducts(aswehaveseenintheeliminationofsinglesinthe1990s).Withinthe individualtypesofproducts,theacceptablerangerepresents50percentormoreofthepriceof thefinalproduct.Thehighestpricedproductwouldbeabouttwiceasexpensiveasthelowestcost product.Thereisplentyofroomfortheexerciseofmarketpowerinthesepricingscenariosand plentyofcauseforconcernforantitrustauthorities. Infact,thepresentationmadebyWarnerMusicshowedthatpiracywasaverysmallfactor inrecordedmusicspending(seeExhibitV2).Inthisanalysis,piratesrepresentarelativelysmall fractionofthepopulationandtotallisteners.Theirspendingislessthantheirshareofthe populationortimespentlistening,buttherecordlabelslosemoresalestoradiolistenersthan theydotopirates.Comparedtotheperiodwhentherecordlabelswereclaiminglossestopiracy thatequaledmorethanhalfoftheirprojectedrevenues,6piracyisasmallproblemtoday.Infact,as discussedbelow,theearlydebateovertheextentofpiracyidentifiedanumberofreasonsthatthe differencebetweenlisteningandpurchasesmaynotactuallyrepresentlossofsales. Moreover,forthepurposesoftheantitrustanalysis,thequestioniswhetherthisisabig enoughpartofthemarketoronethatwouldexpandquicklyenoughtodisciplinetheabuseofpost
6TheRIAAwebstartsbypointingoutareductioninrevenuesof$6.5billionandthenstatesthat4outof5

digitaldownloadsarethroughillegalsites,leavingalmostnoneofthereductioninrevenuetobe attributedtotheshifttolowcost,legalsinglesanddigitalalbums.Infact,theconsumersavingsdiscussed intheprevioussectionsuggestthatatleastsixseventhsofthereductioninrevenueareduetotheshiftto lowercostdigitalproducts.

20

mergermarketpower.Giventheoverallelasticitiescalculatedforthemusicmarketandthesmall sizeofthisgroup,thatseemshighlyunlikely. EXHIBITIV2:THESMALLIMPACTOFPIRACYONMUSICSPENDING:TIMESPENTLISTENINGV.MUSICSPEND

Source:WarnerMusicGroup,ConsumerInsightsDiscussionforFCC,April2010,

B.THEORIGINALCLAIMSOFPIRACYWEREVASTLYOVERSTATED

Debunkingthepiracyclaimisimportantnotonlybecauseithasbeenerroneouslyinvoked asajustificationforagrosslyanticompetitivemerger,butalsobecauseittendstodownplaythe benefitsthatdigitaldisintermediationcandeliver.Thiscanpotentiallymisleadpolicymakersinto thinkingthatthecostsofanticonsumer,anticompetitivebehavioraresmallinthedigitalage. Inordertounderstandthemagnitudeoftheoverestimationoftheimpactofpiracy,we muststartfromtheanticonsumer,anticompetitivepracticesthattypifiedtheindustryinthe 1990s.Theindustrymighthavebelievedtheeliminationofsinglesandpricefixingthatkeptprices upwerepermanentpartsoftheindustrystructureandthesalesoflibraryreplacementswould continue.Theycertainlyactedthatway.(Knopper,2010)Therefore,theindustrymighthave thoughtthatadecadelatertheindustrywouldbesellingabout1.5billionalbumsataretailvalueof $22.5billion(seethetopgraphinExhibitIV3).Todayitisselling1.6billionunitsatatotal revenueoflessthan$8billion.Theyaresellingmoreunits,butatalowerprice.
Stealingmusicisnot[whats]killingmusic,saysRobertPittman,cofounderofMTVandformerchief operatingofficeroftheillfatedAOLtimeWarnermerger.WhenItalktopeopleinthemusicbusiness, mostofthemadmittheproblemistheyaresellingsongsandnotalbums.Imean,youdothemath (Knopper,2010:181).

However,itiseasytowritethecounterstory.Inthemid1990stheindustrywasextremely, excessivelyprofitable(seethebottomgraphinExhibitIV3).Theeliminationofsingleshadpushed therevenueandmarginsperunitshippedtorecordlevels.Thenewmediumhadcreatedabubble

21

indemandintheformoflibraryreplacement.7Pricefixinghadstoppedthedeclineinrevenueper unit,eventhoughcostsavingscontinued,expandingmargins.Thetightoligopolybehavedtheway rentcollectorsdo.Theyfailedtomaintainqualityandslashedtheturnoverofproduct.A substantialdeclineinrevenuewasinevitableastheprocessoflibraryturnoverwasexhaustedand demandwasdestroyedbypricing/productchoicesandqualitydecisions. EXHIBITIV3:ALTERNATIVEVIEWSOFTHEEXTENTOFPIRACY OptimisticViewofFutureAlbumSales Million ARealisticViewofFutureSales 1800
1600 1400 1000 800 400 200 0
Realis\c y=20.464x39932 R=0.8164

1600 1400 1200 1000 800 600 400 200 0 Singles Albums

Singles Albums TotalUnTs Linear(PriceFixingPeriod)

Op\mis\c y=37.863x74622 R=0.9265

1200

600

Source:RecordingIndustryAssociationofAmerica,YearEndShipmentStatistics,variousyears.

7Anotherpossibilityisthatthe1990swereanaberrationinthatsaleswereabnormallyhighduringthe

decade.ApossiblecauseisthatconsumerswerereplacingtheirvinylcollectionswithCDs,abehaviorthat waslargelycompletedbytheturnofthecentury.Thesubsequentdeclineintheunobservedcomponent maymerelyrepresentareturntomorehistoricallyrepresentativesaleslevel.(KleinandSolaner)

22

Ifweformourexpectationsinthiswaybasedontotalunitsshippedandusetheprebubble, prepricefixingCDperiod(19831992),wearriveatamuchlowerprojection,asinthelowergraph inFigureIV3.Infact,duringthepricefixingperiod,beforeNapster(19951999),saleshad flattened,soaprojectionbasedonthatperiodresultsinalongtermprojectionthatismuchcloser totheonebasedontotalunitsshipped,notalbums.Inthiscounterviewpiracywaslessthanhalfof whattheindustryclaimed.Moreimportantly,thisviewisconsistentwiththedirectevidenceon piracydiscussedabove.Itisnolongeramajorfactorindeterminingsalesandprice.Thedeficitof unitsshippedinthisscenarioishalftheoptimisticview.Thedifferenceinrevenueperunit shipped,ifsingleshadonlymaintainedtheirleveloftheearly1990s,wouldaccountforanotherten percentoflostrevenue. EconometricstudiesoftheimpactofpiracyinthepreiTunesperiodthattakethe countervailingfactorsintoaccountputthedeclineinsalesduetopiracyatabout20percentofthe totalreductioninrevenue.(Hong,2011;PeitzandWalbroeck,2004)Withdigitaldistribution modelsinthemarketplaceanddigitalsalesbooming,thereislittlebasistoarguethatpiracyisa majorfactortodayandagreatdealofeconometricevidencethatfindsitdoesnotcannibalizesales oflegalcontent.(SmithandTelag,2009,Danaher,etal.2011)By2011unitsshippedarewell abovethepredigitaltrend,reflectingtheattractivenessofsinglesandthenewtechnology. Economics,lawandtechnologywerecaughtupwiththeindustry. C.ANUNSUSTAINABLE,ANTICOMPETITIVE,ANTICONSUMERBUSINESSMODEL Wehavealwayslinkedtheeliminationofsinglesandpricefixinginthemid1990stogether asademonstrationofthemarketpowerandanticompetitive,anticonsumerbehaviorofthetight musicoligopoly.Knopper(2010)providesanevenmoredirectlinkbetweenthetwo.Singles playedavitalroleinthemusicindustryaspromotion,tocreatefoottrafficinmusicstores,asa samplingdevice,andasalowcostproductthatexpandedthemusicmarket.Whenthelabels eliminatedthem,theydramaticallyalteredthesupplysideoftheindustry.Knopperarguesthey neededtousetheBigBoxstoresasthevehicletoexpanddemand.Thissetoffthetensionbetween twodistributionchannelsthetraditionalspecialtymusicstoresandtheBigBoxretailers.Price fixingwastheirefforttoresolvethetension.Itlastedforabouthalfadecade,butcamecrashing downunderthesimultaneousweightoftheantitrustlawsandtechnologicalchange.
McManus[aveteranCanadianproducerandsongwriter]begannoticinghecouldntfindasingle anymore.HereiswheretheNorthAmericanmusicindustrymadeitsgreatestmistakeofthe twentiethcenturyWhenitstoppedmakingvinylsinglesandofferednothingtoreplacethem,the industrystoppedawholegenerationfrompickinguptherecordbuyinghabitIfyouthinkabout waterthatstryingtoreachthesurfaceAssoonasNapsteropenedup,thesinglecameroaringback up.IcallNapstertherevengeofthesingle... Foryearsmajorlabelsusedsinglesascheaporfreepromotionaltools.Theindustrywaslookingfor excusestogetridofit.Youhadtheseargumentsthatsingleswerecannibalizingalbumsales.Sothey killedthesingle. Bythelate1990s,therecordbusinesshadboileddownmuchofthebusinesstoasimpleformula:2 goodsongs+10or12mediocresongs=1$15CD Intheshortterm,dozensofartistsandlabelsmademountainsofcashofftheformulaThesewere onehitwonders,buttheactswereluckyenoughtomakerecordsinanerawhenfanshadnoother choicebuttobuythealbumtogetthesingle.Ifyouonlysoldlotioninfivegallonbottles,prettysoon peoplewouldbetiredoritAlbhyGaluten,awellknownproducerwholaterbecameUniversal MusicGroupsseniorvicepresidentforadvancedtechnologyYoucantgoaroundforcingpeopleto buysomethingthattheydonotwant.

23

Yetthatwaspreciselythedirectiontherecordindustrywantedtogo.Howcouldtherecordcompanies makethemhuge?TheanswerwastosellmoreCDs,atbiggerrecordstoresBestBuycouldaffordto dropthepricesonCDs,eventhehotnewtitles,whenTowerandHegewischwerestucksellingthem fortheusualpriceinordertomakeaprofit.Whenthebigboxesgotin,theyjustusedthesame strategythattheyusedwitheverybodyelseSothemajorlabelscameupwithapolicy:Minimum AdvertisedPriceThegovernmentcrackeddownhard(Knopper,2010:105111)

Knopperpicksuplowcostoffreesinglesaspartofthemarketingapproachwhenhe discusseddigitaldistribution.
SalesofiTunessinglessurgedWhileCDsalescontinuetomakeupthebulkofmajorlabelsprofits, iTunesshiftedthebalancedramaticallyandquickly.Althoughthisshiftisgreatforconsumers,itsa negativeforrecordcompanies Thesadfactwasemployeesatmajorrecordlabelslargelydownplayedtheinternetasamarketingtool evenadecadeafterNapsterandahalfdecadeafteriTunes.Inparthiswasduetocorporatepolicy... [N]ewmediamarketersandcertainartistsandmanagershadpushedforyearstogiveaway unprotectedMP3s,forfreeorverycheap,togeneratehypeandpublicityonlineandregaincredibility withyoung,techsavvymusicfansEvenafteriTuneswentonlinein2003,usingpeertopeerservices asmarketingtoolswasstrictlyforbidden,andGodhelpalabelmarketerwhoproposedreleasingafree MP3asapromotionaldevice.(Knopper:198199)

WaldfogelsrecentanalysisofferssystematicsupportforKnoppersobservationaboutthe poorqualityinthelate1990s.Thisisanadditionalpotentialcauseforthedropoffinsalesatthe turnofthecentury.Asharpdeclineinqualitythatbeganinthemid1990sasthepeakofalbum saleswasapproached(seeExhibitIV4).Attheverymomentthatthepricehadstoppeddeclining, qualitywentsouthandsingleswerenolongeravailable.Thesamethingistruewithturnoveratthe topofthecharts(seeExhibitIV5). Demandwassuppressed.ThebottominqualitywasataboutthetimethatNapsterentered thescene. D.THEBOTTOMLINEONPIRACYANDTHEREALLESSONSOFTECHNOLOGICALCHANGETHATTHEINDUSTRY RESISTEDSOSTRENUOUSLY TheindustrygotawaywithitsfictionalpiracystorybecausetheGroksterfilesharingcase wasarguedinearly2005basedondatathatpredatediTunesandthereforedidnotreflectthe growthofdigitaldistributionbusinessmodels.Eventhen,theearlystudieswerealloverthemap. Somestudiesfoundincreasesinsalesresultingfromstimulationincertainpopulationsegments (olderconsumers)thatoffsetlossesinothers(youngerusers,Boorstin,2004).Otherstudiesfound littleornoeffect(PeitzandWaelbroeck,2004).Stillothersfoundlossesthatarenotlarge(Zentner, 2003).Moreover,becauseofrecordingindustrypricingpractices,evenwhererecordingindustry revenuedeclinedasaresultoffilesharing,consumerwelfaremayhaveincreased(Robband Waldfogel,2004).Oneeconomicstudyofdownloadingfoundthattheincreaseinconsumersurplus wasalmost200percentlargerthanthelossofindustryrevenue.Thisunderlyingeconomicpicture alsocastsdoubtontheclaimsthateverydownloadedfileisalostsale.Onecancertainlyarguethat thecombinationofanticompetitivepricingandtheeliminationofsingleshurtconsumersintwo ways.Itpricedasignificantnumberofpeopleoutofthemarketandtransferredagreatdealof surplusfromconsumerstoproducers.

24

EXHIBITIV4:MEASURESOFTHEQUALITYOFNEWRELEASES
Source:JoelWaldfogel,ByeByeMissAmericanPie?TheSupplyofNewRecordedMusicsinceNapster,January2,1011.

25

EXHIBITIV5:COMPONENTSOFSTOCHASTICTREND LAW PriceFixing 1stDecree2ndDecree TECHNOLOGY Napster iTunes

Source:Klein,ChristopherandSheaW.Slonaker.MusicSupply,ChartTurnover,andtheRandomCopyingHypothesisinthe DigitalMusicAge,

Thefactthatsinglesnowplayalargerrolethanatanytimeinnearlythreedecadesmakesit clearthattherewasanimmense,latentdemandforsinglesthathadbeensuppressedbytheanti consumerbundlingpracticesoftheindustry.Thisdemandwasinitiallyexpressedintheformof illicitfilesharing,butquicklyshiftedtolegalsaleswhennewbusinessmodelsmadethatpossible. Morethantwothirdsoffilesharingactivitywasdedicatedtodownloadingofsingles.Indeed,the mostdetailedstudyofdownloadingfoundthatonlyoneortwosongsweredownloadedfromthe mostpopularalbumsandthatdigitalsalesareconcentratedinsinglesbymorethantwentytoone, breakingthelongwornchainsofanticonsumerbundlingandanticompetitivepricing. (OberholzerGeeandStumpf,2004)Therewasevidencethatlowervaluesongsaremorelikelyto bedownloadedthanhighervaluesongs.(RobbandWaldfogel,2004;OberholzerGeeandStumpf, 2005)Thisisconsistentwiththenotionthatsomeofthedownloadswouldnothavebeen purchased,sonosalesarelost.Thereisevidencethatdownloadersinhighpurchasegroups purchasesomeCDsafterdownloadingsomesongsandthatdownloadingincreasespurchasesin thosedemographicgroupsleastlikelytopurchase(Boorstin,2004;Liebowitz,2004).This supportsthepromotionalfunctionofdownloading. 26

Themajorscanarguethattheireffortstodefendtheirpropertyrightsplayedarolein eliminatingpiracy,andthereissomecredibleevidencetosupportthatclaim(Danaher,etal.,2012). However,theeffectivenessofindividualmeasurestoreducepiracyisunclearintheresearch literatureincludingdigitalrightsmanagementingeneral(Vernik,2008,Desai,etal.,2009)aswell asembeddingdestructivecode(Christin,2005,,KemererandSmith,2011;Knopper,2010)andthe overalllitigationapproach.(Bhattacharjee,2008showsmixedresults,OberholzerGeeandStumpf, 2009,Danaher,et.al.2010) Thereisalsoevidencetosupportthepropositionthatthebestantidotetopiracyistooffer productsintheformandwiththetechnologiesthatconsumerswantatreasonableprices(Danaher, etal.,2010).Theeffectivenessofofferingconsumerfriendlyproductsasthebestapproachto dealingwithpiracyisreinforcedbytheclearevidencethatdigitalproductscanbemanagedasa distributionchannelthatdoesnotcannibalizeotherchannelsfordifferentiatedproducts.(Danaher, 2012;Deleersnyder,etal.,2002;Waldfogel,2009;Danaher,etal.,2010;HuandSmith,2011) TheWarnerdiscussionofmusicconsumersintroducedearliersupportsthelatterview(see ExhibitIV6).Legalthreatsandenforcementplaysomeroleindeterringpiracy,butotherfactors likequalityandconveniencearemuchmoreimportant.Whateverthecausesofthereductionin piracy,thebottomlineisthattodayitisnotaprimaryfactorinthesector. Thestoryofdigitaldisintermediationinthemusicindustryisnotastoryofpiracy;itisa storyofefficiency.Supplysidecostshavedeclineddramaticallywhilediversityofproducthas increased.Consumersovereigntyhasbeenrestored,withawiderchoiceandamoreefficientfit betweenconsumerneedsandavailablesupply.Theempiricalevidencesupportstheconclusion that,inspiteofdecliningperunitrevenues,thesupplysideofthemusicindustryisdoingquite well.Inadditiontothefactthattotalunitsshippedhaveincreased,thenumberofartists, (Mortimer,NoskoandSorensen,2010),titles(Handke,2012)andcompanies(Handke,2006)has increased.Qualityisasgoodorbetterthanitwaspriortodigitaldisintermediation(Waldfogel, 2011a)andtheturnoveratthetopofthechartshasincreased(KleinandSlonaker).Independent labelshaveincreasedtheirshareofthemostpopularproducts(Waldfogel,2011b)andsmaller bandshavebenefitedmorethanlargerbands(Mortimer,NoskoandSorenson,2010,Handke, 2006).Complementarygoodoutputisupaswell,includingconcerts(Mortimer,Noskoand Sorenson,2010)andequipment.(OberholzerGeeandStumpf,2009;Handke,2006) Thedecliningcostofproductionanddistributionshouldbevisiblenotonlyinincreased unitsshipped,butalsoinincreaseddiversityoftheproductreleased.AsshowninExhibitIV7,the longtermtrendonthenumberofnewtitlesreleasedshowsasharpbreakintheoutputatthe momentwhendigitaldistributionbecamealegitimatebusinessmodel. Theanalysisofpiracyhasmovedwellbeyondtheearlyphaseofempiricalexperiencewhen thelandmarkSupremeCourtcase,Grokster,wasdecided.Theempiricalevidencesuggests overwhelminglythattheoriginalclaimswereoverstatedandthedirepredictionsofthedemiseof themusicsectorhavenotcometopass(althoughtheexcessiveillgottenprofitsofthemajorlabels havebeensqueezedout).Toseethepiracyargumentsrevivedhereasanexcusetoshortcircuitthe antitrustlawsisparticularlytroublingandmeritscloseexamination.Itdoesnotstanduptothe scrutiny.

27

EXHIBITIV6:FACTORSTHATAFFECTPIRACYV.PURCHASE TopReasonsforDiscontinuingP2PUse WhyPeoplePaytoAcquireMusic

Source:WarnerMusicGroup,ConsumerInsightsDiscussionforFCC,April2010.

28

EXHIBITIV7:NEWALBUMTITLESRELEASED(000)
120 100

80

Physical+Digital Physical

60 40 20

y=1.3143x2593.1 R=0.51481

0 1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

Sources:StatisticalAbstractoftheUnitedStates,Nielsen,/Soundscan,variousissues

29

V.THEIMPORTANCEOFINCIPIENTCOMPETITION,COORDINATION, MAVERICKS,ANDMONPOSONY Doesallthegoodnewsthatthedigitalrevolutionbringstothemusicspacemeanthat antitrustauthoritiescanrelax?Allofthestructuralandbehavioralevidenceindicatesthatthey cannot.Severalotherlinesofanalysisreinforcethisconclusion. A.THEINCIPIENCYSTANDARD Antitrustlawandpracticehavelongrecognizedtheimportanceofincipiencyinmerger review.Indeed,somehavearguedthattherecentrestatementoftheMergerGuidelinesdoesmuch tobringtheagenciesbackintolinewiththelaw.(GrunesandStucke,2011)TheGuidelines mentionincipiencytwice,onceinthegeneralintroductionandonceinthesectionon coordination.
Giventhisinherentneedforprediction,theseGuidelinesreflectthecongressionalintentthatmerger enforcementshouldinterdictcompetitiveproblemsintheirincipiencyandthatcertaintyabout anticompetitiveeffectisseldompossibleandnotrequiredforamergertobeillegal.(DOJ/FTC,2010,p. 1) PursuanttotheClaytonActsincipiencystandard,theAgenciesmaychallengemergersthatintheir judgmentposearealdangerofharmthroughcoordinatedeffects,evenwithoutspecificevidence showingpreciselyhowthecoordinationlikelywouldtakeplace.TheAgenciesarelikelytochallengea mergerifthefollowingthreeconditionsareallmet:(1)themergerwouldsignificantlyincrease concentrationandleadtoamoderatelyorhighlyconcentratedmarket;(2)thatmarketshowssignsof vulnerabilitytocoordinatedconduct(seeSection7.2);and(3)theAgencieshaveacrediblebasison whichtoconcludethatthemergermayenhancethatvulnerability.(DOJ/FTC,2010,p.25)

TheGuidelinesdevoteaconsiderableamountofattentiontothepotentialeffectamerger canhaveinfacilitatingcoordinationamongthefirmsinasector.8Thesalesofrecordedmusicfit thecircumstancesunderwhichcoordinationisamajorconcerntotheantitrustauthorities.

8Amergermaydiminishcompetitionbyenablingorencouragingpostmergercoordinatedinteraction

amongfirmsintherelevantmarketthatharmscustomers.Coordinatedinteractioninvolvesconductby multiplefirmsthatisprofitableforeachofthemonlyasaresultoftheaccommodatingreactionsofthe others.Thesereactionscanbluntafirmsincentivetooffercustomersbetterdealsbyundercuttingthe extenttowhichsuchamovewouldwinbusinessawayfromrivals.Theyalsocanenhanceafirms incentivetoraiseprices,byassuagingthefearthatsuchamovewouldlosecustomerstorivals. Coordinatedinteractionincludesarangeofconduct.Coordinatedinteractioncaninvolvetheexplicit negotiationofacommonunderstandingofhowfirmswillcompeteorrefrainfromcompeting.Such conducttypicallywoulditselfviolatetheantitrustlaws.Coordinatedinteractionalsocaninvolveasimilar commonunderstandingthatisnotexplicitlynegotiatedbutwouldbeenforcedbythedetectionand punishmentofdeviationsthatwouldunderminethecoordinatedinteraction.Coordinatedinteraction alternativelycaninvolveparallelaccommodatingconductnotpursuanttoapriorunderstanding.Parallel accommodatingconductincludessituationsinwhicheachrivalsresponsetocompetitivemovesmadeby othersisindividuallyrational,andnotmotivatedbyretaliationordeterrencenorintendedtosustainan agreeduponmarketoutcome,butneverthelessemboldenspriceincreasesandweakenscompetitive incentivestoreducepricesoroffercustomersbetterterms.Coordinatedinteractionincludesconductnot otherwisecondemnedbytheantitrustlaws.Theabilityofrivalfirmstoengageincoordinatedconduct dependsonthestrengthandpredictabilityofrivalsresponsestoapricechangeorothercompetitive initiative.Undersomecircumstances,amergercanresultinmarketconcentrationsufficienttostrengthen suchresponsesorenablemultiplefirmsinthemarkettopredictthemmoreconfidently,therebyaffecting thecompetitiveincentivesofmultiplefirmsinthemarket,notjustthemergedfirm.

30

Whetheronebelievesincipiencyisrestrictedtothenarrowconcernwithcoordinationora broadbasedconcernundertheantitrustlaws,itdemandsconsiderationinthismergerandisyet anotherreasonthatthemergerposesasignificantthreattocompetition.Inthiscase,anew technologyhasrecentlyenteredthemarketandcompetitivemodelsarenascent,whilethe incumbents,whohaveresistedthetechnology,controlcrucialinputsandcontinuetohavehigh marketshares.Thenumberoffirmsthatcontrolthesecrucialinputsisquitesmallandwillshrink fromfourmajorstothreewiththeproposedmerger,sothatthethreatofharmtocompetition throughtheabuseofenhanced,postmergerunilateralmarketpowerorcoordinationis considerable.Thepostmergermarketstructureisdominatedbythreelargefirmsthathavemulti marketcontactacrossgeographicandproductmarkets.Themergerraisestheconcentration substantiallyinasectorinwhichanticompetitiveconsciousparallelismhasbeenrecentlyfound. TheDepartmentofJusticemadeastrongcaseforconcernabouttheimpactofcontrolof marqueecontentonincipientdigitalcompetitioninitsrecentcomplaintagainsttheComcastNBCU merger.
ThroughtheJV,ComcastseekstogaincontrolofNBCUsprogramming,apotenttoolthatwouldallow ittodisadvantageitstraditionalvideoprogrammingdistributioncompetitors,suchascable,DBS,and thetelcos,andcurbnascentOVDcompetitionbydenyingaccessto,orraisingthecostof,this importantcontent.IfComcastisallowedtoexercisecontroloverthisvitalprogramming,innovationin themarketforvideoprogrammingdistributionwillbediminished,andconsumerswillpayhigher pricesforprogrammingandfacefewerchoices TheimpactoftheJVonemergingcompetitionfromtheOVDsisextremelytroublinggiventhenascent stageofOVDsdevelopmentandthepotentialofthesedistributorstosignificantlyincrease competitionthroughtheintroductionofnewandinnovativefeatures,packaging,pricing,anddelivery methods. Comcasthasanincentivetoencumber,throughitscontroloftheJV,thedevelopmentofnascent distributiontechnologiesandthebusinessmodelsthatunderliethembydenyingOVDsaccesstoNBCU contentorsubstantiallyincreasingthecostofobtainingsuchcontent.Asaresult,Comcastwillfaceless competitivepressuretoinnovate,andthefutureevolutionofOVDswilllikelybemuted.Comcast's incentivesandabilitytoraisethecostofordenyNBCUprogrammingtoitsdistributionrivals, especiallyOVDs,willlessencompetitioninvideoprogrammingdistribution.(DOJ,2011:4,52,54)

B.THECONTINUINGVULNERABILITYOFNONMAJORS Thechallengeforantitrustauthoritiesistounderstandthestateofplaybetweenthe nascentcompetitivebusinessmodelsandthedominantincumbents,keepinginmindthatthelawis particularlyconcernedaboutnascentcompetitionandmaverickfirms.

Therefore,theAgenciesevaluatetheriskofcoordinatedeffectsusingmeasuresofmarket concentration(seeSection5)inconjunctionwithanassessmentofwhetheramarketisvulnerableto coordinatedconduct.SeeSection7.2.TheanalysisinSection7.2appliestomoderatelyandhighly concentratedmarkets,asunconcentratedmarketsareunlikelytobevulnerabletocoordinatedconduct. TheAgenciespresumethatmarketconditionsareconducivetocoordinatedinteractioniffirms representingasubstantialshareintherelevantmarketappeartohavepreviouslyengagedinexpress collusionaffectingtherelevantmarket,unlesscompetitiveconditionsinthemarkethavesincechanged significantly.

31

1.IndependentLabels Asnotedabove,wedonotseeagreatdealofdifferencebetweenthedigitalandphysical productsintermsofthemarketshareofotherfirms(i.e.thefourfirmconcentrationratioacross theproductsissimilar,ExhibitV1).Thereisnodiscernibletrendtowardadecliningfourfirm ratioinanyoftheproducts.Althoughdetaileddataisavailableforonlythepastfouryears,this perioddoesinvolvethevastmajorityofgrowthindigitalsaleswithoutexhibitingmuchreduction ofmarketsharesamongthetopfourfirms. ExhibitV1reflectstheattributionofsalestomajorsthathasbeenstandard.Weareaware ofthedisputebetweenthemajorsandindependentlabelsthatwouldpaintadifferentpicture (Morgan,2011).Webelievethisdisputeprovesthecontinuedimportanceofthemajors,nottheir imminentdemise.Whileindependentlabelshavegrown,theyhavebeenunabletoescapefromthe dominationofthemajorlabels.Weinterprettherecentbrouhahaoverthecalculationofmarket sharesasademonstrationthattheindependentlabelshavefailedtodiminishthemarketpowerof thedominantfirms.Theindependentlabelsaredependentonthemajorsfordistributionofover 60percentoftheircontent,9hardlyademonstrationoftheirabilitytochallengethemajorswith regardtofosteringnewdistributionplatforms.Recognizingtheirvulnerabilitytotheexerciseof marketpower,theyopposethemerger,fearingthestrengthenedgripofamoreconcentrated market.(Spanier,2012) EXHIBITV1:FOURFIRMCONCENTRATIONRATIOBYPRODUCTINTHEDIGITALERA
100 80 70

90

60 50
40 30 10 0 2007 2008 2009 2010 2011 CurrentCD CatalogueCD DigitalAlbums DigitalTracks

20

Source:TheNielsenCompany&Billboards2011MusicIndustryReport,variousyears.

TheeleventhhourconversionofUniversaltocountingtheproductdistributedbythe majorsonbehalfoftheindependentlabelsastrulyindependentisaflipflopbyUniversal,which haslonginsistedthatthosesalesbecountedinitsmarketsharethatcallsthewholeundertaking intoquestion(Morgan,2011).Anotherfactthatcallsthisshiftintoquestionistheapparent

9Thetotalindependentlabelsharewithreclassificationoftheproductdistributedbythemajorsisjustover

30percent,whilethecontentdistributedbyindependentlabelsontheirownbehalfisattributedamarket shareofjustover12percent.

32

increasingrelianceofindependentlabelsonmajorsfordistribution.Itappearsthattheshareofthe Independentlabelsdirectdistributionhasdeclinedsubstantiallyinthepasthalfdecade,from18 percentto12percent,whiledistributionofindependentlabelcontentbymajorshasdoubled,from 9percentto18percent.Theindependentlabelsremaindependentonthemajorlabelsfor distributionintotheBigBoxstoresthatdominatephysicaldistribution(Morgan,2010,Leeds, 2005).Changingthewaymarketsharesarecountedontheeveofamajormergershouldnotbethe basisonwhichthemergerisallowedtoslippastclosescrutiny.Moreover,becausethe reclassificationofsharesisnotuniform(Universalsmarketshareislessaffected)thecalculationof theHHIchangeslessthanthesimpleaveragesuggests. Waldfogelsanalysisoftheroleoftheindependentlabelsreinforcesthisconclusion(see ExhibitV2).Theindependentlabelshareofthetop100and200albumshasgrown,butremainsat fairlylowlevels.With7.5percentofthetop200and12percentofthetop100albumsin2010,itis hardtoarguethattheIndiessignificantlythreatenthemarketpowerofthemajorlabels.Progress hasbeenmade,butnotenoughtoconcludethatthetransitiontothedigitalmediumhaseliminated orevensignificantlyreducedtheconcernaboutmarketpower. EXHIBITV2:INDEPENDENTLABELSHAREOFTOPSELLINGALBUMSBEFOREANDAFTERDIGITALSALES 100%
90% 80% 2002 2010

70% 60%
50% 40% 20% 10% 0%

30%

Top200

Top100

Source:JoelWaldfogel,CopyrightProtection,TechnologicalChangeandthequalityofNewProducts:EvidencefromRecorded MusicSinceNapster,NBERWorkingPaper17503,October2011

However,althoughindependentlabelscurrentlyonlycommandasmallmarketshare,their recentgrowthshowstheirpotentialtoeventuallygrowintocompetitorstothemajorlabels.Major labelscanstiflethiscompetitionbylimitingthenumberofsuccessfuldigitaldistributionplatforms, whicharetheveryplaceswhereindependentlabelsofferingscancompetewiththoseofthemajor labelsonalevelplayingfield.Themajorrecordlabelsmayaccomplishthisbywithholdinglicenses entirelyorbydemandinghighadvances,royaltiesdisproportionatetotheirmarketshare,oran equitystakeinthedigitalserviceasaconditionofalicense.Anyofthesetacticsthreatenthelong termsustainabilityofindependentlabels. Accesstothecontentofthemajorscurrentlyremainsindispensabletobuildingnew distributionmodels.Itisnotfeasibletosucceedonthebasisofunsignedartistsalone.The 33

concentrationofcontrolofalbumsinthehandsofadominantplayerinahighlyconcentrated marketposesaseverethreattocompetitionanddynamicinnovationinthisspace.Asthemajors gaingreaterleverage,alternativesandartistsloseout. Thetaskofsecuringaccesstothenecessarycontenttolaunchdigitaldistribution undertakingsisformidable.Therehavebeensomeverynotablefailuresinthepasthalfdecade, andacquiringcontentmayhaveplayedaroleinmakingadifficulttaskevenmoredifficult.For example,BeyondOblivion,adigitalmusicservicefoundedin2008andbackedbyNewsCorp.and Allen&Co.,aimedtoprovideuserswithanearlyunlimitedselectionofmusicondevicesthatheld BeyondOblivionsoftware.Theservicefiledforbankruptcyinlate2011beforeithadeven launched.Notably,bankruptcyproceedingsrevealedthatBeyondOblivionowedoutstandingdebts of$50millioneachtoSonyMusicEntertainmentandWarnerMusicGroupanastonishingfigure foraservicethatwasneveractuallyusedbyasinglecustomer.Thesekindsofhighadvance royaltiescanhinderadigitalstartupfromlaunchingasuccessfulandsustainableproduct.They alsodiscourageinvestors,whomustshoulderhigherlevelsofriskforanydigitalmusicdistribution servicethatrequiresdirectlicensingfromrecordlabels.Anotheralternativedistributor,thecloud basedmusicserviceLaLaoriginallylaunchedasaCDtradingwebsitein2006.EventuallyLaLa shiftedfromCDswappingtoacloudbasedmusicservice.Registereduserscouldlistentosongs onceforfreeandthenchoosebetweenpurchasingacopyofthesongorpayingtostreamthesong. TheservicewassubsequentlypurchasedbyAppleandshutdownin2010. Ifthelossofalargeindependentcompetitorinatightoligopolymarketisaserious challengetoindependentlabelsthataredependentonthemajorsfordistributionoftheircontent, itisanevenmorecriticalissueforalternativedistributionmodelsthatpossessnocontent whatsoever.Alternativedistributionmodelsmustgainaccesstothecontentofthemajorsto succeedbecause,aswehavealreadyseen,themajorscontrolsuchalargeshareofthemusicthat sellsacrossallmediaandgenres.Ascontrolovermarqueecontentthatisindispensabletothe successofalternativedistributionmodelsbecomesmoreconcentratedinthehandsoftheshrinking numberofmajors,theirabilitytodeterminethefateofalternativemodelsgrows. 2.UnsignedArtists Digitaltechnologieshelpthegreatmassofcontentcreatorsandartistsbyexpandingthe marketandmakingiteasierforartiststodirectlyreachtheconsumer.Thestrikingthingaboutthe breakdownofwhogetswhatfromaphysicalalbumsalediscussedaboveisthesmallsharethat artistsactuallyget.Needlesstosay,asthecostsofphysicaldistributionareeliminated,artists strivetoincreasetheirtake.Asnotedabove,digitaldisintermediationcouldgivethemgreater leverageasagainstlabelsinthescrumovertherentsbothbecausetheycangodirectlytothe audience,andbecausetheyhavemorealternativedistributionintermediaries. Wethinkartistshavebenefitedinthisway.MillionsofartistssellmusiconiTunesand otherdigitaldistributionservices;thevastmajorityoftheseartistshadnowaytoreachthe consumerinthebrickandmortarworldbecausetheycouldnotgetarecordingcontract.Digital distributionhasdiversifiedanddeconcentratedtherecordedmusicspace,butasshownearlier, themajorlabelsstilldominatetherevenuestreamofthemusicindustrythroughtheircontrolof albumsandthealternativedigitalmodelsareearlyintheirevolution. Estimatinghowlargearoledigitaldistributionplaysinallowingunsignedartiststoreach thepublicisdifficult,inpartbecausetherearenocentralizedentitiestocountthem.However, comparingtheestimatesofdigitalsalesfromdistributorstotheestimatesofsalesclaimedbythe 34

representativesoflabels,wedofindagapthattodayiscloseto3billionunitsforApplesongsalone. AssumingthatApplesmarketsharedeclinedto70percent,therewouldbe9billionmoredigital trackssoldthanclaimedbylabels(seeExhibitV3).10Thisiscertainlygoodnewsforunsigned artists,butthequestiontheantitrustauthoritiesfaceiswhetherthedramaticincreasein concentrationincontrolofalbumswouldposeathreattocompetitioninthespace. 3.Monopsony Withthemergercreatinggreatercontroloverdistribution,theextremelytightoligopoly exercisesgreatercontroloveraccesstothepublicanddeniestheindependentlabelsandunsigned musiciansapotentialdistributortousetoreachthepublic.Theproblemthatafflictsthe independentlabelsisevenmoreacuteforartists,aproblemthattheGuidelinesdealwithunderthe topicofmonopsonypower. EXHIBITV3:DIGITALMUSICSALES

Billion 25 20

RIAAU.S.Units IFPAGlobalTracks AppleGlobalSongs Totalw/Apple=70%since2008

15 10 5 0 2004

2005

2006

2007

2008

2009

2010

2011

Sources:RIAAAnnualUnitsShipped,IFPA,DigitalMusicReports,variousyears,Apple,MilestonesasreportedinWikipedia.

Enhancementofmarketpowerbybuyers,sometimescalledmonopsonypower,hasadverseeffects comparabletoenhancementofmarketpowerbysellers.TheAgenciesemployananalogous frameworktoanalyzemergersbetweenrivalpurchasersthatmayenhancetheirmarketpoweras buyers...(2)Amergerbetweentwocompetingsellerspreventsbuyersfromplayingthosesellersoff againsteachotherinnegotiations.Thisalonecansignificantlyenhancetheabilityandincentiveofthe mergedentitytoobtainaresultmorefavorabletoit,andlessfavorabletothebuyer,thanthemerging firmswouldhaveofferedseparatelyabsentthemerger.(22)

Themergerreducesthenumberofmajoroptionsartistshaveinseekingrecorddealsand movingbetweenlabels.Awidervarietyofrecordlabelsoffersartistsmoreoptionstofinda recordingcontractthatwillbestservethatartistandconsumersinterestedinthatartistsmusic.A recordlabelmay,forexample,beheavilyinvolvedintheactualwritingandproductionofthe album,oractmorelikeaninvestorwiththerighttoacceptorrejectthefinishedproduct.Some labelsarealsomorewillingtoexperimentwithnewdistributionmodels,ortosupportanartists strategytofocusonbuildingrelationshipswithfansinsteadoffocusingonmassmarketingtactics.

10TheadjustmenttoApplesaleswouldincludedirectsalesfromartiststoconsumers,althoughthebasisfor

estimatingnonApplesalesinthepressisnotmadeclear.

35

Withrespecttoartists,wehavesomenotableexamplesofcelebritieswhohavechanged labels.Forexample,KatyPerryhasbeensignedtotheRedHill,Island,Columbia,andCapitol (ownedbyEMI)recordlabelsthusfarinhercareer.However,signedartistscurrentlycan,atbest, onlychoosebetweenfourmajorrecordlabelswithsubstantialmarketshare,andmustsign recordingcontractsthatgivethelabeltheoptiontoorderadditionalalbums(oftenfiveorseven) thattheartistmustdeliver.Iftheartistwouldliketoswitchtoanotherrecordlabelmidcontract, theartistmustconvincethatnewlabeltobuyhercontractfromhercurrentlabel,whichcan includereimbursingtheoriginallabelforallofthemoneyithasspentonpreviousalbumsandnot yetrecoupedfromrecordsales.Recordingartiststhusencountermuchdifficultyintryingtoswitch betweenmajorlabelsandhavelittlebargainingleverageagainstrecordlabelswhentheydogetto negotiateanewcontract.TheUMGEMImergerraisesthebroaderconcernthatthismergerwill giveartistsevenfeweroptionsandevenlessbargainingpoweragainstthedominantlabels. Theanalysisofmonopsonypowerrequiresabalancedperspectiveonthedigital transformationsimilartothebalancedperspectivewehavearguedforabovewithrespectto pricing.Theparallelisexact.Thereisnodoubtthatthedigitaltransformationhasbenefited consumers,butthatdoesnotmeanantitrustconcernscanbeabandoned.Thereisnodoubtthat thedigitaltransformationhasbenefitedartists,butthatdoesnotmeanantitrustconcernscanbe abandonedeither. Thus,thestructureofthemusicsectorisastable,tightoligopolymarketstructureina marketthatisundergoingashiftinproductionanddistributiontechnology.Thetightoligopoly structuresurvivedasimilarshiftintherecentpastandtheinitialphaseofthedigital transformationhasnotchangedthedominantfirms.Ifanythingisremarkableaboutthemusic business,itistheabilityofthedominantfirmstopreservetheirdominance. C.THEROLEOFMAVERICKS Theimportanceofcoordinationandpreventionofleakageofcontentunderscoresanother aspectofmergerreviewtheroleofmavericks.Anindividualfirmcanplayaparticularly importantroleinprovidingcompetition.Thisrolecanbeheightenedinthesituationofsystemic stresstothebusinessmodel.
TheAgenciesconsiderwhetheramergermaylessencompetitionbyeliminatingamaverickfirm,i.e., afirmthatplaysadisruptiveroleinthemarkettothebenefitofcustomers.Forexample,ifoneofthe mergingfirmshasastrongincumbencypositionandtheothermergingfirmthreatenstodisrupt marketconditionswithanewtechnologyorbusinessmodel,theirmergercaninvolvethelossofactual orpotentialcompetition.Likewise,oneofthemergingfirmsmayhavetheincentivetotaketheleadin pricecuttingorothercompetitiveconductortoresistincreasesinindustryprices.Afirmthatmay disciplinepricesbasedonitsabilityandincentivetoexpandproductionrapidlyusingavailable capacityalsocanbeamaverick,ascanafirmthathasoftenresistedotherwiseprevailingindustry normstocooperateonpricesettingorothertermsofcompetition(DOJ/FTC,2010:34).

EMIhasbeenwillingtoexperimentsomewhatmoreinthenewdigitalspace.Knopper notestwoinstancesinwhichEMIwasinfrontontheseissues,beingthefirst(andatthetimeonly) labeltohaveDRMfreecontentintheiTunesstore(Knopper,2010:180)andthentodropcopy protectionaltogether,whichKnopper(2010:231)describesaslikedroppingabomb. EMIhasbeenaheadonanumberofotherstepsthatbreakdownthecontentbarriersto entryofdigitaldistributionmodels.Severaloftheaccountspulltheincipiency,coordinationand maverickissuestogether.EMIswillingnesstolicenseitsmusictoadigitaldistributionsitein 36

whichitdidnothaveanownershipinterestwasanotherbigmove,atleastaccordingtoaForbes account,whichalsounderscoredtheimportanceofhavingaccesstocontentforthenew distributionbusinessmodels.

Arewethereyet?Digitalmusicfanshavebeenwaitingforyearsforthesubscriptiondownload amusementparktoopensotheycanrushinandplay,purchasingtrackswithgreatsoundqualityby thegigabyte. EMIbrokecriticalgroundbyagreeingyesterdaytolicenseitsmusictopressplay,thedigitalmusic subscriptionservicethatcompeteswithMusicNetwhichEMIhasastakein.Untilnow,labelshave beenloathtolicensemusictodigitalmusicsitesthattheydon'townatleastinpart.Thelackofasingle Websitewithacompletemusiclibraryisoneofthemajorroadblocksonthepathtoalegitimate digitalmusicmarket,andthisisastepinthatdirection.EMI,theworld'sthirdlargestrecordcompany andtheonlyoneofthetopfivethat'snotpartofamediaconglomerate,hasahistoryofbeingthefirst todigitalmusicdeals. Butthisdealishardlyavictorygiventhatneitherpressplay,whichisownedbySony(nyse:SNEnews people)andVivendi's(nyse:Vnewspeople)Universal,norMusicNet,ownedbyAOLTime Warner(nyse:AOLnewspeople)andBertelsmannaswellasEMI,haveevenlaunchedyet.Thefour othermajormusiclabelsmustfollowEMI'sleadbylicensingtoservicesotherthanthosetheyown,if theyeverwanttocompetewiththefreemusicswappingservices.(Patsuris,2001)

CoordinatedactionandtheimportanceofmavericksaredemonstratedbyEMIsroleinthe socialnetworkspace.
MusicsocialnetProjectPlaylistisstillbarredbyFacebookandMySpacebutadealwithEMIMusic addsconsiderablytothestartupslegitmusicfirepoweranddropsthenumberofmajorsstillsuing thestartuptotwo. EMIMusicisthesecondmajortosignon,followingaDecemberdealwithSony(NYSE:SNE)Music Entertainment.TheSonyandEMIdealsaregoodnewsforthosebankingonPlaylistssuccess.Bob PittmansPilotGroupisaninvestorandPittmanisontheboard;formerFacebookCOOOwnVanNatta signedonasCEO.ProjectPlaylisthelpsusersfindandsharecustommediaplaylists,providingtoolsto streamanddownload.Butthetoolsworkwithorwithoutcopyrightpermissionandthisiswhathas thelabelsandtheRIAAinaknot.MySpace,whichisapartnerwiththefourmajorlabelsinMySpace Music,quicklygaveinandbannedPlaylistappsfromworkingonitspages.Facebookfinallyfollowed afterconsiderablepressure. EMIalsohasdroppedoutoftheRIAAlawsuitfiledagainstthePaloAltobasedcompanylastApril (Kramer,2009).

Theneedforaccesstothefullrangeofcontentisunderscoredbyobservationsabout Spotifyandthecloud,withEMIagainwillingtostepoutearly.
Spotify,theSwedishmusicstreamingserviceusedby10millionpeopleacrossEurope,iscloseto landingadealtolicenseEMIGroupssongsforuseintheU.S.,accordingtosourcesfamiliarwiththe negotiations. EMI,whichpublishessuchactsasKanyeWest,PinkFloydandGarthBrooks,wouldbethesecond majorlabel,afterSonyMusicEntertainment,tosignontoSpotifysplanstointroduceitspopular musicservicetotheU.S.ThatleavesUniversalMusicGroupandWarnerMusicGroupasthetwobig holdouts. ItsunclearwhetherSpotifywouldhaveenoughsongstolaunchaserviceintheU.S.withoutUniversal orWarner.EMIhad10%oftheU.S.musicmarketin2010,whileSonyaccountedfor28%ofthe marketlastyear,accordingtoNielsenSoundScan(LosAngelesTimes,2011).

37

ApplehassignedacloudmusiclicensingagreementwithEMIMusicandisveryneartocompleting dealswithUniversalMusicGroupandSonyMusicEntertainment,multiplemusicindustrysourcestold CNET. WarnerMusicGroupalreadyhadadealinplacewithApple,CNETreportedlastmonth.Thelicensing agreementswillenableAppletolaunchafullylicensedcloudmusicservicetorivalunlicensed offeringsofrivalsAmazonandGoogle. ThenegotiationswithSonyMusicGroupandUniversalMusicGroupcouldbewrappedupasearlyas nextweek,thesourcessaid.Whatthismeansisthatsignedcontractswithallfourofthetopfour recordcompanieswillbeinAppleshippocketonJune6whenApplekicksoffthecompany's WorldwideDevelopersConference.ThesourceswhospokewithCNETdidnotknowwhenApple wouldannouncethedealsorrolloutthecloudservice(Sandoval,2011).

EMIhadahistoryofleadinginthedigitalspace,releasingthefirstdigitalsinglein1996 (Anonymous,2010),beingthefirstjoiniTunespresspass(Rose,2009)andthefirsttosupport applicationdevelopers.

Themusicindustryisntexactlyknownforbeingeasytogetalongwithwhenitcomestotheapp developercommunity.ThatswhyanewdealannouncedtodaybetweenmusicgroupEMIMusicand musicintelligencestartupTheEchoNestisparticularlyintriguing. ThetieupseesTheEchoNesthostandmanageasandboxforappdevelopers.Throughthisportal, EMIMusicwilloffercreativebriefsandopportunitiestocollaborateonbuildingappsforartistssuchas Gorillaz,ThePetShopBoysandTinieTempah. OncedevelopershavesuccessfullyregisteredforanAPIkey,theyreabletosubmitappconceptsto EMIandTheEchoNest.AppsthatareapprovedwillthenbereleasedbyEMIunderarevenuesharing modelthatseesbothdevelopersandrightsholderspaid,andtheintellectualpropertyforthe technologyretainedbythedeveloper.Bothfreewithads,andpaidforappswillbeconsidered,across platformssuchastheWeb,iOSandAndroid. TheinitiativeprovidesaccesstomusicfromthefamousBlueNoteRecordsjazzlabel,andacatalogof thousandsofsongsfromactssuchasCultureClub,ShirleyBasseyandTheVerve.Developerswillbe abletomakeuseofTheEchoNestsvastdatabaseofinformationaboutsongs,fromsimplethingslike tempoandgenre,tocomplexdataaboutthemoodofsongs.Theresalsoaccesstodynamicplaylist APIs,opensourceaudiofingerprinting,audioanalysis,andremixsoftware(Martin,2011).

Thus,wehavealongseriesofinnovativeandmaverickbehaviorsstretchingacrossa decadeandahalf(1996,2001,2007,2009,2011).Combinedwiththeoverwhelmingevidencethat themergerwillsignificantlylessencompetition,thisisanotherfactorthataddstothecaseagainst themerger. Iftherecordedmusicbusinesswascompetitiveandnotprotectedbyhighbarrierstoentry, economictheorywouldhavepredictedthatthesupranormalprofitsofthemid1990swouldbe competedaway.Thiscompetitionshouldhavecomefromfirmsintheindustry,butitdidnot.

Themarketpoweroftheoligopolisticmusicmajorseroded,evidencedbydecreasingsalesfigures.The onlywaytofighttheerosionoftheirmarketpowerisbyfilinglawsuitsagainstmusicservicesand heavymusicdownloadersontheInternetclaimingcopyrightinfringement.Thisisproofforthe hypothesisthattheexistingcopyrightregimeprotectstheoldmusicindustryparadigmandrestrains theunfoldingofinnovativebusinessmodels. Itisstrikingthatpromisingnewmusicmodelsdidnotemergefromtraditionalmusicindustryactors, butfromindustryoutsiders,likecomputerfirms(e.g.AppleandiTunes)andtelecommunicationsand dotcomcompanies(e.g.EricsonnandAmazon.com).Thecommerciallysuccessfulexploitationof

38

musicontheInternetstronglydependsonthelicensingofmusictitlesbythelargepublishinghouses, whichusuallybelongtomajorrecordproducers.Sincethelicensingfeedsamounttomorethanhalfof thetotalcost(plustax)thenewcompetitorsrunatalossoronlymakemarginalprofits,suchasiTunes intheUS.(Tschmuck,2009:p.254)

Oneofthethingsthattheebookcasemakesclearisthatthemembersofanindustryunder thestressofdigitaldisintermediationfeelastrongneedtocoordinate(DOJ,2012).Theyrecognize theirfatesaretiedtogetherandthatleakageofanycontentintothenewdistributionmodelmakes itdifficultforotherstoholdout.InthemusicspaceKnopper(2010:14116,172175)exposes repeatedattemptstocoordinatetheresponsetodigitaldistributionincludingtheinitiallitigation strategyagainstNapster,negotiationswithNapsterduringtheinitiallitigation,thelockstep pursuitofindividuallitigationafterNapster,andseveralunsuccessfuleffortstodevelopalternative digitaltechnologiesincludingthesecuredigitalmusicinitiative,theDRMstrategy,andthe negotiationswithAppleoveriTunes.Timeandagain,thegroupofmajorlabelsisroundedupand holdstogether,overthegrousingofindividualfirmsandexecutiveswithinfirms.Coordinationwas thekeytoalongdelayinmakingdigitalcontentavailable. Whetherornotthiscoordinationofactivitywasillegalatthetime,itdoesunderscorehow importantcoordinationwasperceivedtobeinresponsetoasystemicthreattothebusinessmodel. Allowingthemajorstoshrinktothreemakestheexecutionofthecoordinationeasier. D.CONTEMPORARYPRICING Digitaldisintermediationhascertainlyunderminedoneoftheprimarytacticsthetight oligopolyusedtoextractconsumersurplustheeliminationofsingles.Thereisnodoubtthatthe saleofsingleshadahugeimpactonthesaleofalbums.LiberatedfromthetyrannyofCDalbumsat $15perunit,consumersflockedtosinglesat$0.99perunit.Recently,however,thesaleofdigital albumshasexperiencedastrongupswing.Therewouldappeartobeasignificantmarketfor albums,whenofferedatareasonableprice.AsshowninthetopgraphsofExhibitV4,digital albumscarryapricetagthatisonethirdlowerthanphysicalalbums.Asshowninthebottom graph,itappearsthatthesalesofdigitalalbumshaveexerteddownwardpressureonphysical albumprices.Infact,lookingatquantitiesandpricesofphysicalanddigitalalbumsandsingles,we findthatthepriceandquantityofdigitalalbumsalesaresignificantlyrelatedtothesalesofCD albumsinamodelthatexplainsvirtuallyallthevarianceinCDalbumsalesisnotable.11

11Tobesure,thereisagreatdealofcolinearitybetweenallthesemeasuresandonlysmallanumberofdata

points,butthisfindingisconsistentwiththetheorythatdigitalalbumsareaclosersubstituteforphysical albumsthandigitalsinglesinanidentifiablemarketforalbums.Giventhesmallnumberofobservations, thestatisticalsignificanceofbothdigitalpricesanddigitalsalesintheexpecteddirectionisnotable

LinearRegression:SalesofCDs(scda),SalesofDigitalAlbums(SDA),RealPriceofDigitalAlbums(PDR) Numberofobs=8;F(2,5)=242.77;Prob>F=0.0000;Rsquared=0.9804;RootMSE=34.582 | Robust VarianceInflationFactors scda|Coef. Std.Err.tP>|t|Beta Variable|VIF1/VIF + pdr|9.200.108683 sda|3.366751.1561512.910.033.5736939 sda|9.200.108683 pdr|69.4088223.46872.960.032.4303183 MeanVIF|9.20 cons|174.6214328.85350.530.618

39

Thepricetagof$10foradigitalalbumanddecliningpricesforphysicalalbumsmaylook likeremarkablygooddealsforconsumersgiventhehistoryofpricingintheindustry;digital technologiesaretransformativedramaticallyloweringproduction,distributionandtransaction costs.ThefeesthatdigitaldistributorslikeApplehavetakenmaybetoohighaswell.Withmore competitionandnewbusinessmodels,thepriceofadigitalalbumcouldbelowerandclosertothe cost.Moreover,recentpricingpatternssuggestthattheindustryhasbeguntofigureouthowto maximizepriceinadigitalworld(seeExhibitV5).Raisingpricemoresharplyforsinglesthan albumshastheeffectofshiftingdemandfromsinglestoalbumsandincreasingthetotalrevenue and,moreimportantly,therevenueperunitshipped. EXHIBITV4:THEIMPACTOFDIGITALALBUMSALESONPHYSICALCDREVENUE RevenuePerAlbumUnitShipped
Real2010 $25.00
Physical

$20.00 $15.00

Digital

$10.00

$5.00

$0.00

DigitalAlbumSalesandCDRevenuePerUnitShipped $20.00 $18.00 $16.00 $14.00 $12.00 $10.00 $8.00 $6.00 $4.00 $2.00 $0.00
0
y=0.0438x+18.066 R=0.89624

y=0.0139x+15.188 R=0.57154

Nominal Real

20

40

60

80

100

120

DigitalAlbumSales(MillionUnits)

Source:RecordingIndustryAssociationofAmerica,variousyears.

40

EXHIBITV5:THERECORDINGINDUSTRYPRICINGSTRATEGYINTHEDIGITALERA:RAISESINGLEPRICES MORETHANALBUMSTOINCREASEALBUMSALESANDREVENUEPERUNITSHIPPED
PriceIndicesforDigitalProducts(2004=1)

1.25 1.2 1.15 1.1 1.05 1 0.95 0.9 2004 2005 2006 2007 2008 2009 2010 2011 DigitalAlbums DigitalSingles

TotalRevenueforSinglesandAlbums

Million $1,800 $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 2003

Singles Albums y=219.57x439878 R=0.99987

y=133.6x267711 R=0.99284 2004 2005 2006 2007 2008 2009 2010 2011 2012

RevenuePerUnitShipped($)

2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 2003

PrepricingFlexibility PostPricingFlexibility Preojectedw/oFlexibility 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source:RecordingIndustryAssociationofAmerica,variousyears.

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VI.LESSONSFROMTHEDOJEBOOKPRICEFIXINGCASE ThecomparisonwemakebetweentheUMGEMImergerandtheebookpricefixing complaintisimportantandappropriateforthreeprimaryreasons.Collusivepricefixingand antitrustmergerreviewarecoveredbythesamestatutes.Whileitistruethatcollusivepricefixing isperseillegalandmergerreviewiscasebycase,thereareseveralreasonstodrawaparallel betweenthetwo,beyondthefactthatthebookpublishersclaimthattherewasnocollusionandthe pricingbehaviorwouldpassmusterifanalyzedonacasebycasebasis. First,theDOJ/FTCGuidelinesnotethatonetypeofevidencetowhichtheylookforinsight abouttheimpactofamergerinvolvesexamplesofsimilaractionsorrelatedmarkets.

DirectComparisonsBasedonExperience:TheAgencieslookforhistoricalevents,ornatural experiments,thatareinformativeregardingthecompetitiveeffectsofthemergerEffectsof analogouseventsinsimilarmarketsmayalsobeinformative. TheAgenciesalsolookforreliableevidencebasedonvariationsamongsimilarmarkets(DOJ/FTC, 2010:3).

Whiletheebookcasedoesnotinvolveamerger,itdoesshowusthatdigitalmarketsarenot immunetoabusivepricingbehavior.Actionbyentitiesthatcontrolledamarketsharethatwasnot terriblygreaterthanthepostmergermarketshareofUMGEMIwassuccessfulinpushingupthe pricewiththegoalofcontrollingcompetitionfromdigitaldistribution. Second,theeconomicsandprocessesthataredrivenbydigitaldisintermediationare similarinthetwoexamples.Studyingsimilarcasesstrengthensourunderstandingoftheprocess. Layeringcasesbuildsaroutinepractice,whichishowmuchantitrustenforcementunfolds. Third,webelievethattraditionalantitrustpracticehasacriticalroletoplayinensuring thattheemergingdigitaleconomyisascompetitiveandconsumerfriendlyasitcanbe.Thereis nothinguniqueorunmanageableaboutthedigitaleconomythatrendersantitrustlawandpractice inapplicable.Collusionandmergerreviewaretwoofthemainstaysofantitrustanalysisandstrong supportforantitrustactioninbothofthesecasesisapowerfulreminderofthecontinuing importanceofantitrust. A.THECHALLENGEOFANDRESPONSETONEWDISTRIBUTIONINPUBLISHINGANDMUSIC Ouranalysisofthepracticesdescribedinthepubliclyavailableaccountsoftheebook marketleadsustoconcludethattheyconstituteanticompetitive,anticonsumercollusiveprice fixing.Undercurrentantitrustpracticeanindividualfirmseffortstosetminimumretailpricesis subjecttoacasebycaseruleofreasontest(wethinkitshouldbeperseillegal,butthatisa differentissue).Eveninacasebycaseenvironment,noncollusive;butcoordinatedbehavior betweenfirmstosetminimumpricesisillegal,astheMinimumAdvertisedPricesdecreesshow, especiallywhenoneofthefirsteffectsofthepricefixing,afterincreasingconsumercost,hasbeen toraisepublisherprofits. Notwithstandingthecomplaintsofthepublishersandafewcelebrityauthors,vigorous actiontoblockthepricefixingschemewillbegoodforconsumersandthevastmajorityofauthors. Thisyearthecosttoconsumersofebookpricefixingwilllikelyexceed$200millionandtheabuse willgrowdramatically,iftheDepartmentofJusticedoesnottakeactiontostopthispractice.The currentmagnitudeofharmismorethanenoughtomeritantitrustattention. 42

Claimsthatthiscollusivepricefixingschemeisanefficiencyenhancingstrategydonot standscrutiny.Thepublishersandauthorspresenttwoclassicefficiencyclaimstodefendtheir practice.(Turow,2012)Theyarguethatitpreventsthedominantfirmfrompricinginapredatory mannertounderminecompetition,particularlyfromphysicalspacebookstores.Theyalsoclaim thatbookstoresarevitallynecessarytopreserveanefficientmarketplaceforbooksandacross subsidyfromebookreaderstophysicalbookreadersisnecessarytodoso. Insectoraftersector,wehearthesamecomplaintsoverandover;digitaldistributionwill eliminatephysicaldistribution,creativitywillbestifledandsaleswilldecline.Theoppositeoccurs. Digitaldistributionreplacespartofphysicaldistributionandtheoutputexpands,whileefficiency squeezesthemarginsofintermediaries.Discountersofferconsumerseconomicbenefitsandhigh priceincumbentsalwayscomplainaboutthem.Inasectorwithrapidlydecliningcosts,falling pricesreflectefficiency.Argumentsagainstthembearaheavyburden.Thepublishersand celebrityauthorshavenotcomeclosetomeetingtheburden. Theparallelsbetweenthemusiccaseandtheebookcasegobeyondthebasiccostand efficiencyeconomics.Inthelate2000sthepublishershadthesameproblemastherecordlabels didinthemid1990s.Theywerecaughtbetweentwoverydifferentdistributionchannelsthe newerlowcost,highvolumechannelandthetraditionalhighercost,lowervolumespecialtyshops. Theyhadthesamereaction:theyfixedpricestoreducethecompetitivepressures.Theresultwas toincreaseprofits.TheFTCfiledidenticalcomplaintsagainstthemajorlabels,butallegedno collusion.Itwasconsciousparallelism,butillegaljustthesame. Inthecaseofebooks,thepublishersmayhaveperceivedamoreprofoundsystemicthreat, withtherecognitionthatthenewetailerscouldbecomepublishers.Therecordlabelsdidnotface thisthreatfromthebigboxstoressellingCDsinthe1990s.Bythe2000s,thesystemicthreatwas greaterandcamefromtheoutsideintheformofnewtechnology.
Thepublishersandcelebrityauthorshavebeenconcernedaboutcannibalizationratherthanpiracy foradecade.Interestingly,atthebeginningofthedecade,whentherecordlabelswerelitigating copyright,theinitialcomplaintinthebooksectorwasabouttheeffectofanefficientmarketforused books.TheAuthorsGuildofAmericaandAssociationofAmericanBookPublishers,sentajoint,open lettertoJeffBezos(CEOofAmazon.com) Asaleaderinthebooksellingindustry,Amazons[usedbook]salespracticescanhaveasignificantly deleteriouseffectonnewbooksales.Ifyouraggressivepromotionofusedbooksalesbecomes popularamongAmazoncustomers,thisservicewillcutsignificantlyintothesalesofnewtitles, directlyharmingauthorsandpublishers.(CitedinGhose,SmithandTelang,2006)

Inthemiddleofthedecade,thepublisherstriedchannelmanagementandwindowing (delayingthereleaseofebookstoboostphysicalbooksales).Variousexplanationswereoffered bythemajorpublisherswhowouldlaterbecomethecoconspirators.

ThepublishingplanisfocusedonmaximizingvelocityofthehardcoverbeforeChristmas (HarperCollins).Wethinkthatthispublishingplangivesustheopportunitytomaximizehardcover sales.Wecantsitbackandwatchyearsofbuildingauthorssoldoffatbargainprices(Hachete).The rightplacefortheebookisafterthehardcoverbutbeforethepaperback(SimonandSchuster).(cited inHuandSmith,2011)

Bytheendofthedecadetheyhadresortedtopricefixing.AsbrieflyexcerptedinExhibit VI1,thewordingoftheantitrustcomplaintsintheMinimumAdvertisedPricesettlementsandthe ebookpricefixingcomplaintarestrikinglysimilar. 43

EXHIBITVI1:PARALLELPROBLEM,PARALLELILLEGALCONDUCT IntheMatterofBMGMusic,DocketNo.C3973 PARAGRAPHTHREE:Themajordistributorssellprerecordedmusictonumerousretailersincluding independentretailers,largenationalchains,massmerchandisers,regionalchainsandconsumer serviceddirectlybytheprerecordedmusicdistributors.

electronicsstores.Theyalsosellprerecordedmusictosubdistributorswhointurnsupplyretailersnot

PARAGRAPHFOUR:Therearetworelevantmarketsinthismatter.First,thecommercialdevelopment, Second,theretailsale,byanymeans,ofprerecordedmusic(hereinafter,"retailmarket").Thegeographic scopeofthewholesalemarketistheUnitedStatesofAmerica.Thewholesalemarketischaracterizedby

highentrybarriersthatseriouslylimitthelikelihoodofeffectivenewentry. distributionandwholesalesale,byanymeans,ofprerecordedmusic(hereinafter"wholesalemarket").

discsandotherprerecordedmusicproducts.Thesenewentrantscompetedaggressivelyonpriceand

PARAGRAPHFIVE:Intheearly1990's,severallargeconsumerelectronicschainsbegansellingcompact offeredconsumerssubstantialsavingsonsomeprerecordedmusicproducts.Aretailpricewarensuedand

musicretailersloweredtheirprices. PARAGRAPHSIX:Someretailers,facedwithnewlyinvigoratedpricecompetitionintheretailmarket, policy.In1992and1993,theothermajordistributorsadoptedMAPpolicies.Thesepoliciessetforth

requestedmarginprotectionfromBMG.In1993,BMG,wasalsoconcernedthatdecliningretailpricescould
havewholesalepriceeffects.Thereafter,BMGdecidedtointroduceaMinimumAdvertisedPricing("MAP") minimumadvertisedpricesformostprerecordedmusicproducts.Asdiscussedbelow,theseMAPpolicies weremodifiedbetween1995and1996.In1995and1996,retailpricesincreased.Since1997,wholesale priceshavealsoincreased.

PARAGRAPHSEVEN:TheMAPpolicychangeswhichoccurredin1995and1996significantlytightened newMAPpoliciesprovidedthatanyretailerwhoadvertisedthedistributors'productbelowthe
either60or90days.

theprograms.ByFebruary1,1997,eachofthemajordistributorshadimplementedsimilarpolicies.The

establishedMAPwouldbesubjecttoasuspensionofallcooperativeadvertisingandpromotionalfundsfor
PARAGRAPHNINE:ShortlyafteradoptingthenewMAPpolicies,thedistributorsbeganaggressively enforcingthepolicies.Severalhighprofileenforcementactionsthatresultedinlongperiodsofsuspension werewidelypublicizedbythetradepress.

implementedtoeliminateaggressiveretailpricingandtostabilizeoverallpricesintheretailmarketplace.
Thispolicywassuccessful. PARAGRAPHELEVEN:Thepurpose,effects,tendencyorcapacityoftheactsandpracticesdescribedin

PARAGRAPHTEN:BMG'sstricterMAPpolicy,ineffectsinceJanuary1,1997andcontinuingtodate,was

PARAGRAPHSSIX,SEVEN,EIGHT,NINEandTENrelatingtotheimplementationandenforcementofMAP
policiesareandhavebeentorestraintradeunreasonablyandhindercompetitionintheretailand wholesalemarketsforprerecordedmusicintheUnitedStates,andconstituteaviolationofSection5ofthe FederalTradeCommissionAct,asamended,15U.S.C.45. PARAGRAPHTWELVE:Theaforesaidactsandpracticesoftherespondentwereandaretotheprejudice andinjuryofthepublic.Theseactsandpracticesconstituteunfairmethodsofcompetitioninoraffecting commerceinviolationofSection5oftheFederalTradeCommissionAct,asamended,15U.S.C.45.These actsandpracticesmayrecurintheabsenceofthereliefrequested.

44

UnitedStatesv.Apple,etal.,Complaint,12CV2826,April11,2012
EbooksaleshavebeenincreasingrapidlyeversinceAmazonreleaseditsfirstKindledeviceinNovemberof 2007Amazonsubstantiallyincreasedtheretailmarketforebooks.OneofAmazonsmostsuccessful marketingstrategieswastolowersubstantiallythepriceofnewlyreleasedandbestsellingebooksto $9.99

totheirtraditionalbusinessmodel.ThePublisherdefendantsfearedthatlowerretailpricesforebooks mightleadeventuallytolowerwholesalepricesforebooks,lowerpricesforprintbooks,orother

Publisherssawtheriseinebooks,andparticularlyAmazonspricediscounting,asasubstantialchallenge consequencesthepublishershopedtoavoid.EachPublisherDefendantdesiredhigherretailpricesacross PublisherdefendantshadconcludedthatunilateraleffortstomoreAmazonawayfromitspracticeof

theindustrybefore$9.99becameanentrenchedconsumerexpectation.Bytheendof2009,however,the offeringlowretailpriceswouldnotwork.(1) Together,AppleandthePublisherDefendantsreachedanagreementwherebyretailcompetitionwould cease(whichalltheconspiratorsdesired),retailebookpriceswouldincreasesignificantly(whichthe sold(whichAppledesired).

PublisherDefendantsdesired),andApplewouldbguaranteeda30percentcommissiononeachebookif

Priortotheconspiracy,bothprintbooksandebooksweresoldunderthelongstandingwholesalemodel. freedomtoestablishretailprices.Defendantsweredeterminetoendtherobustretailpricecompetitionin ebooksthatprevailed,tothebenefitofconsumers,undertheywholesalemodel.Theythereforeagreed

jointlytoreplacethewholesalemodelforsellingebookswithanagencymodel Underthismodel,publisherssoldbookstoretailers,andretailers,astheownersofthebooks,hadthe

Wellgoto[an]agencymodels,whereyousetthepricesandwegetour30%,andyes,thecustomerpaysa
littlemore,butthatswhatyouwantanyway(34)

AsAppleCOSteveJobsdescribedthiscompanysstrategyfornegotiatingwiththePublisherDefendants,

unlawfullyeliminatedtothedetrimentofU.S.consumers.(5) ThePublisherDefendantswereespeciallyconcernedthatAmazonwaswellpositionedtoenterthedigital publishingbusinessandtherebysupplantpublishersasintermediariesbetweenauthorsandconsumers. booksatahigherroyaltyratethanthePublisherDefendantsoffered.Amazonsmovethreatenedthe

PublisherDefendantstraditionalpositionasthegatekeepersofthepublishingworld(1011). PenguinGroupCEOJohnMakinsonconveyedthesamemessage Competitionfortheattentionofreaderswillbemostintensefromdigitalcompanieswhoseobjectivemay publishertomountaneffectiveresponse,becauseofboththeresourcesnecessaryandtheriskof Amazonhad,infact,takenstepstodoso,contractingdirectlywithauthorstopublishtheirworksase

Otherpriceandnonpricecompetitionamongebookpublishersandamongebookretailersalsowas

betodisintermediatetraditionalpublishingaltogether.Thisisnotanewthreatbutwedoappeartobeona collisioncoursewithAmazon,andpossiblyGoogleaswell.Itwillnotbepossibleforanyindividual retribution,sotheindustryneedstodevelopacommonstrategy.Thisisthecontextforthedevelopmentof theProjectZinitiatives[jointventures]inLondonandNewYork.(15)

45

B.EFFICIENCY Defendersofthepricefixingschemeclaimthatthesectorwillbelessefficientifonlinesales underminethedistributionofphysicalbooks.Theargumentisthatphysicalbookstoresarevitalto thefunctioningofthesectorbecauseitistheonlywayforreaderstodiscovernewbooksand unknownauthors.Theclaimisthatreadersencounternewbookswhentheybrowsetheshelvesin physicalspacebookstoresanditisthelucky,unknownauthorswhohappentobeontheshelves thatthebrowsersstumbleupon. Inthedigitalagethereisamuchmoreefficientwayforbrowserstoexaminemanymore booksofmanymoreauthors.TheycanuseInternetbrowserstosearchforbooksonline. Moreover,cyberspacelowerstransactioncostssomuchthatauthorscan,unlikeinphysicalspace, findtheiraudiencesdirectly,withoutneedingtorelyonpublishers.Needlesstosay,bycuttingout themiddlemantheydramaticallyincreasetheirincomefromsellingbooks. Asonlinedistributionformanygoodsandservicehasgrown,physicalnetworkshave becomesmaller.Physicalgoodsplayasmallerpartinthepostdigitalmarketandservecustomers withspecificneedsanddesires,whilethevastmajorityofconsumersbenefitfromdigital distribution.Consumerswhoarewillingtopayforphysicalgoodsandvaluetheservicesof bookstorescanandwillsupportthosestores.Publishersfixingpricesisnotthewaytofindthe efficientdivisionoflaborbetweenphysicalspaceandcyberspacedistribution. Theexampleswhereonlinedistributionplayedanimportantroleintransformingthe distributionofgoodsarefamiliarmusic,TowerRecords;computers,CompUSA;electronic devices,CircuitCity;videocassettes,Blockbuster;books,Borders;newspapers,toonumerousto name.Rescuingtheremnantsoftheinefficient,brickandmortardistributionnetworkwouldbea fulltimeundertakingthatimposesmassivecostsonsociety.Whetherthesedistributionnetworks deservetobesubsidizedbythepublicshouldnotbedecidedbyanticompetitiveactionsofprivate corporations. Theacademicresearchintotherelationshipbetweendigitalandphysicalbooksyields resultsthataresimilartothemusicspace,althoughthereislessofit.(Ghose,SmithandTelang, 2006,Kannan,PopeandJain,2009,HuandSmith,2011)Cannibalizationislessofaproblemthanit seems.Lowercostusedbooksexpandthemarket.Thedriverisnotonlyprice,itisalsomuchmore efficientdistribution.Researchonnewebooksalsoshowsthatthedigitalandphysicalproducts aredifferentiated.Withholdingebooksdoesnotgreatlyincreasesalesofphysicalbooks.Theloss ofdigitalsalesismuchlargerthantheincreaseinphysicalsales.Themoreefficientdigital productionanddistributionmodelswillcertainlyputdownwardpressureonprices,butcost savingsmeanthatmoreoutputisdeliveredmoreefficientlytotheconsumer. 1.ConsumerCostSavings Theeconomicimpactofdigitaldisintermediationinthedistributionofbooksparallelsthe impactonmusic,characterizedbyfiercebattlesovercapturingrentsmadepossiblebymore efficientproductionanddistribution.AsshowninExhibitVI2,thecostofproductionand distributionofbooksdeclinedfromabout$17perbooktolessthan$4perbook.Publishersdefend

46

highpricesfordigitalbooksinthenameofpreservingbookstores,12butthereisawidespreadbelief thattheyarealsoseekingtoavoiddownwardpressureonthepricingofphysicalbooks.13 EXHIBITVI2:WHOGETSWHATFROMBOOKPURCHASEPRICE?

$30

$26 PublisherOverhead&Prot $25 CreatorRoyalTes MarkeTng $20 ProducTon $14 $15 DistribuTonandRetail $10 $10 $5 $0 Physical PublisherDigital OnlineDistributor Sources&Notes:AverageofMotokoRich,MathofPublishingMeetstheEBook,NewYorkTimes,February28,2010;JeffreyA. Tractenberg,EBookPricesPropUpPrintSiblings,WallStreetJournal,September12,2011.

Thecoststructureinthemusicandbooksectorsisstrikinglysimilarinphysicalspace (Cooper,2011).Physicalspacedistributionandretailingaccountforabouthalfthepricepaidby theconsumers.Manufacturingisabout10percent.Labelstake20percentformarketingand overhead.Royaltiesforcreatorsareabout15percent(whichtherecordingartistonlyreceives afterpayingthelabelbackforallofitsinvestmentinthealbum).Digitaltechnologiesdramatically lowerthecostofbooks.

Thecostsavingsofdigitaldistributionandproductiondramaticallylowersthecostand triggersabattleoverwhoshouldreapthebenefits.At$9.99foranebook,themarginbefore overheadforpublishersequalsthemarginonaphysicalbook.At$12.99to$14.99foranebook thepublishersmarginperbookforoverheadincreasesdramatically,30to50percent.Moreover, evenifthemargindidnotincrease,therateofprofitwouldlikelyrisebecausethepublishershavea smallerphysicalbusinesstomanage,whichmeansonemightexpectoverheadtodecline. Advertisingcostsalsocangodownwithaccesstoonlineadvertising,especiallyforanonline

12AnotherreasonpublisherswanttoavoidlowerebookpricesisthatprintbooksellerslikeBarnes&Noble,

Bordersandindependentsacrossthecountrywouldbeunabletocompete.Asmoreconsumersbuy electronicreadersandbecomecomfortablewithreadingdigitally,iftheebooksarepricedmuchlower thantheprinteditions,noonebuttheaficionadosandcollectorswillwanttobuypaperbooks.Motoko (2010:B1)(Ifyouwantbookstorestostayalive,thenyouwanttoslowdownthismovementtoebooks, saidMikeShatzkin,chiefexecutiveoftheIdeaLogicalCompany,aconsultanttopublishers.Thesimplest waytoslowdownebooksisnottomakethemtoocheap.). 13Theargumentinvolvesshiftingcostrecoverybetweenhardbacksandpaperbacks.Id.(Moreover,inthe currentprintmodel,publisherscanrecoupmanyoftheircosts,andstarttomakehigherprofits,on paperbackeditions.Ifpublishersstartanewebookslifeatapricesimilartothatofapaperbackbook, andreducethepricelater,itmaybemoredifficulttocovercostsandsupportnewauthors.).

47

audience.Sincethepublisherscostsaredecliningwhiletheirmarginsarerising,weshouldnotbe surprisedtofind,asTimeMagazineputitLargebookpublishersmostrecentearningsreports reflectanewnormal:Revenuesareroughlyflat,butprofitsareupinlargepartduetoebooks (Owen,2012). Ebooksalesareasmallfractionoftotalbooksalestodayanditisuncleartheextentto whichebookswillsupplantphysicalbooks(seeExhibitVI3).Onethingisclear;apricefixing strategythatisintendedtoretardthegrowthofthedigitalalternativeandpreservetheincumbent modelmustnotbeallowedtodistortorfrustratetheefficientoutcome. EXHIBITVI3:BOOKPUBLISHINGREVENUES

Million $30,000

$25,000 $20,000 $15,000

$10,000 $5,000 $0 BookPublishigRevenue EbookRevenue

1999 2000 2001 2002 2003 2204 2005 2006 2007 2008 2009 2010 2011

Sources:BureauoftheCensus,StatisticalAbstractoftheUnitedStates,PublishingIndustries,variousissues;Associationof AmericanPublishers,BookStats,2011ebookrevenuebasedonIanSimpson,OnefifthofU.S.adultsreadebooksasmarket booms:survey,ChicagoTribune,April04,2012,CitingAlbertGrecoonebooksales;Assumesa4.1percentdeclineintotal revenuebasedonJeremyGreenfield,NewData:U.S.EBookRevenuesup117%in201,DigitalBookWorld,February27,2012

2.AuthorBenefits

Theempowermentofcontentcreatorsisevidentinthebookpublishingspace,asitwasin themusicspace.Thedramaticimprovementinthediscoveryandinformationfunctionofthe marketexpandssales.Examplesfrombookpublishing,wheredigitizationofdistributionisjust beginning,highlighttheimportanceofthetransformationoftherelationshipbetweenthecreator andtheaudience. Readingshavelongbeenawayforauthorstoreachaudiences.Thisispartofthediscovery function.Podcastschangethearithmetic.

HorrorwriterScottSigler,oneofthepioneersinthisarea,beganregularlypostingreadingsofhisfirst bookinMarch2005.EarthCore,brokenupinto45minutechunksthathepostedonaweeklybasis, wonanaudienceof10,000listeners.Hissecondbook,Ancestor,didevenbetter,scoring30,000 subscribers.... Thismonth,Siglersfourthbookdebutedinahardcoverreleaseforthefirsttime,fromCrown PublishingGroup,animprintofRandomHouse.Crownhasprintedaninitialrunof100,000copies...

48

Thatsahighfigureforthebookindustry,wheremostlyunknownauthorsusuallygetaninitialprint runofonlyafewthousand(Musgrove,2008:F01).

Siglerisanunsignedartistwhohasusedthenewdistributionmediumtobreakintothe system.Thenewmediumnotonlymakesitpossibletoreachfans,butitinvolveselementsofviral communications.SiglerseditorssaythecompanyhasbeenimpressedthatSiglerfanshave requestedpromotionalmaterialsaboutthebooktotrytospreadthewordaboutthenewhardcover editionAt[anotherauthors]HutchinssWebsite,aministerofpropagandaroutinelysendshis readersonmissionsthatvaryfromburningCDsandpassingthemalongtoprintingout promotionalpostcardsandslippingthemontoshelvesatthelocalbookstore.Directinvolvement andcollaborationarealsopossible.Tofurtherbuildreaderinterestandloyalty,Hutchinsrecently openeduphisfictionalworldtofansandinvitedthemtoaddtheirownstories(Musgrove,2008: F01). Givingcontentawayforfree,thecenteroftherecordingindustrysconcerns,isoneofthe manystrategiesthatartistscanusetostimulatefuturesales.
...TorTeenbooksispublishingthedeadtreeversion,anditwillalsobeavailable...asafree downloadinformatsthatwillbeeasytoreadon,say,thescreenofaPDA. Aswithpodcasts,theideaistowinoverpotentialconvertswithfreecontentinthehopesthatreaders orlistenersbuysomethingdowntheroad(Musgrove,2008:F01).

Havingobservedthestrongsimilaritiesbetweendigitaldistributioninthemusicandbook publishingspacesintermsofcoststructure,growthofsales,pricingandartistuseofnew communicationsmediatoreachtheiraudience,weofferonefinalsimilarity;theproductionofnew works.AsshowninExhibitVI4,digitaltechnologiesbroughtafloodofnontraditionalbooks,even excludingastheexhibitdoes2011,inwhichtheoutputofnontraditionalbookswasthreetimes 2009and2010.Thetimingiscoincidentwiththereleaseofthesecondgenerationofreadersand vigorouscompetitionintheprepricefixingperiod. EXHIBITVI4:TITLESPUBLISHEDPERYEAR(MILLION)

1800

1600 1400 1200 1000 800 TradiTonal+NonTradiTonal TradiTonal

600 400 200 0 1990

y=16.443x32722 R=0.94314

1995

2000

2005

2010

Sources:StatisticalAbstract,Bowker,

49

C.PREDATORYPRICING Aclaimofpricepredationmustshowthattheproductisbeingsoldbelowcostwiththe intentionofdrivingcompetitionoutofthemarket(orpreventingitfromentering)andlater increasingpricestomakeuptheloss.Predatorypricingisanimportantantitrustcomplaintthatis frequentlymadebyhighpricedincumbentsagainstdiscountersandnewentrants.Itisdifficultto proveandtheremedyisnottheformationofaprivatecarteltoraiseprices.Forseveralreasons, thepredatorypricingargumentsofferedbythepublishersandcelebrityauthorsintheebookcase areimplausibleatbest,flatoutwrongatworst. First,thedefendersoftheebookpricefixingschemepointtothewrongcostsasthe predatorythreshold.Theyusethewholesalecostofdeliveringphysicalbookstobrickandmortar retailers,notthecostofdeliveringdigitalbookstoetailers.Thephysicalcostisfarabovethe digitalcost,sothepublishersarepointingtoapricethatembodiesanefforttocaptureagreatdeal ofadditionalrent. Second,thedefendersofthepricefixingschemewouldhavetoshowthatthepriceofthe bundleofereadersandebooks,notjusttheebooksalone,isbelowthecostofthecomponentsof thebundleofhardwareandsoftware.Pricingofereadersandebooksexhibitsastrategythatis theobverseofastandardphysicalspacemarketingstrategypopularizedoveracenturyagoby Gillette:sellingtherazoratalowpriceandmakingbiggermarginsonrazorblades.Thepricing strategyofdiscountingstrongcomplementsnotonlyhasalonghistoryinourcapitalisteconomy,it iscommoninthedigitalspace. Third,aplausiblecasewouldhavetobemadethatthereisapricingstrategytorecoverany lossesinatimeframethatmakespredationprofitable.Thebehavioroftheebookproductspace doesnotsuggestthatthisislikely.Priortothepricefixingscheme,anticompetitivetactics,like demandingexclusivedealsormostfavorednationclauseswerenotprevalent.Economiesofscale andclevermarketingarenotsuspectpractices.Digitalmarketsfrequentlymanifestwinnertake mostoutcomes.Thiscanbeaconcern,ifthemarketsdonotalsoexhibitrapidentryandexitand decliningprices.Stablelowpricesforebooksanddecliningpricesofereaderstypifiedthe productspace;atleastuntilthepricefixingschemewasinstituted.Thismakesitdifficultto executethefinallegofthepredatorystrategy. D.CONCLUSION:THEIMPORTANCEOFDIGITALDISINTERMEDIATIONANDTHEROLEOFANTITRUST Oneofthemostimportantfocalpointsofpublicinterestadvocacyinunderstandingthe impactofthedigitalrevolutiononconsumersistounderstandonhowdigitaldisintermediationhas increasedefficiencyindistributionandbenefitedconsumersinmanymarketsincludingdigital contentindustrieslikemusic,ebooks,newspapers,andvideo,aswellasphysicalspaceindustries. WebelievethattheUMGEMImergerandtheebookcomplaintbothcomeatacrucialmomentfor bothantitrustandthedevelopmentofthedigitaleconomy. TheInternetandthedigitaltechnologyonwhichitridesarecomingtomaturity,afterabout 20yearsofdevelopmentincommercialapplications(Cooper,2012).Unlikemanyotherdisputes overdigitaldistributionofcontent,thesedonotinvolveclaimsofpiracyorconcernsaboutprivacy. Theyareentirelyaboutefficiencyandtacticsthatareintendedtosquelchcompetitionfromamore efficient,consumerfriendlyapproachtotheproductionanddistributionofproducts.Stopping thesepracticeswillsendastrongsignalthatphysicalspaceincumbentswillnotbeallowedtouse anticompetitivepracticestodistortorundermineemergingdigitalalternatives. 50

TheUMGEMImergerispartofalonglistofissuesthatantitrustauthoritieshavefacedin recentyearsasdigitaldisintermediationunsettlesimportantproductmarkets.Accesstocontent fordistributioninnewdigitalmodelshasbeenaprominentpartofseveralantitrustactions, includingtheebookcomplaintandthecomplaintthatlaidthebasisforthesettlementinthe ComcastNBCmerger.14Italsofactoredintotheresistanceofantitrustauthoritiestosuspendthe antitrustlawsinordertoallownewspaperstocontroldigitaldistributionofnewscontent(Cooper 2010b). Thesecontentfocusedactionstopreservecompetitionarepartofanevenlongerlistof casesinwhichtheDOJ,theFTC,andtheFederalCommunicationsCommissionhaverecognizedthe importanceofstoppingoldfashionedanticompetitivebehaviorfromunderminingnascent competitionandthedevelopmentofalternativebusinessmodelsonline.Theireffortsrunthe gamutfromtraditionalconcernsabouthorizontalconcentration(AT&TTMobile)and anticompetitive,mostfavorednationclauses(VisaMasterCare;BlueCrossBlueShield),to unilateralanticompetitivemonopolization(Microsoft;Intel),toverticalleverageinphysicalspace products(Ticketmaster),toverticalleverageindigitalproducts(GoogleATA). Thissharpincreaseinantitrustactivitystemsfromtwofactors.Ontheonehand,the antitrustauthoritieshavecomebacktolifeafteralongslumber.Ontheotherhand,thedramatic transformationoftheeconomydrivenbydigitaltechnologiesispartofthequarterlifecrisisofthe thirdindustrialrevolution.(Cooper,2012b)Theincumbenteconomicorderisbeingoverturned. Themostpowerfulactorswhoareentrenchedintheoldorderwillusetheirresourcestopromote theirinterestsattheexpenseofthepublicinterestunlessantitrustenforcementstepsin. Antitrustinthe21stcenturywillhavetobesensitivetotheneweconomicreality,where smallnumbersofplatformsplayanimportantrole.Largefirmsdominateplatformsatthecenterof thedigitaleconomybecauseofthesuperioreconomicsmadepossiblebydramaticreductionsin transactioncostsandtheeaseandimportanceofverticallinkageindigitalproduction.Because basiceconomicsdriveplatformdominance,itbecomesvitallyimportanttoensureopen competitionforthecomplementsthatflowonthoseplatforms. Theneedforopennessisatwoedgedsword.Theownersoftheplatformsmustnotbe allowedtoleveragetheirmarketpowertodistortcompetitionontheplatform.Thesuppliersofthe complements(inthiscase,music)mustnotbeallowedtomanipulatethesupplyofmarquee contenttodistortplatformcompetitionorextractmonopolyrents,especiallyinthenameof defendinginefficient,outdated,physicalspacebusinessmodels.Blatantlyanticompetitivepractices thatareintendedtofrustrateefficientprocesseslikedigitaldisintermediationmustnotbe tolerated. Thedigitalworldisdifferentfromthetraditionalmodelsinsomerespectsandnotso differentinothers.Digitaltechnologieslowercostsandforcerecordlabels(andbookpublishers, newspapers,videodistributors)togiveconsumersnewchoices.Digitaltechnologiesdonot eliminatetheconcernaboutmarketpower;ifdominantincumbentshavecontrolovermarquee contentorbottleneckfacilities,theycanabusetheirmarketpower.Thus,weviewvigorousaction toaddresstheanticompetitivethreatoftheUMGEMImergerasanimportantpartoftheeffortto

14ActingAssistantAttorneyGeneral,SharisA.Pozen,Remarks,BrookingsInstitution,April23,2012.The

ComcastNBCmergeralsodemonstratedhowbehavioralmergerconditionsmustbemonitoredand enforcedtobeeffectiveinprotectingcompetition.

51

reinvigorateantitrustinAmericaandthebattletoensurethatconsumersgetthefullbenefitofthe digitalrevolution.

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Waldfogel,J.2011a.Bye,Bye,MissAmericanPie?TheSupplyofNewRecordedMusicSinceNapster.NBER WorkingPaperNo.16882. Waldfogel,J.2011b.TheQualityofRecordedMusicsinceNapster:EvidenceBasedontheVintageDistribution ofSalesandAirplay.NBERWorkingPaper17503. Waldfogel,J.2011c.CopyrightProtection,TechnologicalChangeandtheQualityofNewProducts:Evidence fromRecordedMusicSinceNapster.MEA.October14. Waldfogel,J.2009.Lostontheweb:Doeswebdistributionstimulateordepresstelevisionviewing? InformationEconomicsandPolicy,21(2),158168. WarnerMusicGroup,2010.ConsumerInsightsDiscussionforFCC,April2010. WilsonMorris,Michele,2000,28StatesSueMajorLabelsandRetailersOverAllegedPriceFixing Conspiracy,MusicDish,August8,2000. Zentner,A.2005.FileSharingandInternationalSalesofCopyrightedMusic:AnEmpiricalAnalysiswitha PanelofCountries.TopicsinEconomicAnalysis&Policy.5(1)Article21. Zentner,A.2006.MeasuringtheEffectofFileSharingonMusicPurchases.TheJournalofLawandEconomics. 49. Zentner,Alejandro,2004,MeasuringtheEffectofOnlinePiracyofMusicSales,UnpublishedManuscript, UniversityofChicagoPrice,December2003.

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APPENDIX: THEWELFAREECONOMICSOFDIGITALDISINTERMEDIATION Walfogel,oneofthefirstanalyststochallengethemusicindustrysoverstatedclaimsof piracy,hasrecentlyarguedthatitmaybetimetodevotemoreattentiontootheraspectsofthe technologicalrevolutionwearenowexperiencing(Waldfogel,2012).Heoutlinesanumberof issues,including:

effectsondemand,marginalcost,andonfixedcoststhelevelofcopyrightneededtoassureasteady flowofnewcreativeworkmeasurementofsalesdisplacementcausedbyunpaidconsumptionnew pricinganddistributionmodelspossiblewithzeromarginalcost,effectsonthedevelopmentofnew productsgiventhatcostshavedeclined,andeffectsonconsumerdiscoveryofnewproducts,given thepossibleproliferationofnewproducts(Waldfogel2012:12)

Anumberofscholarsmadethisshiftearlyon(e.g.Handke,Tschmuck),somedrawinga distinctionbetweenPlainDestructionorCreativeDestruction(Handke2006).Theunderpinning ofthisshiftmustbeanappreciationofthefullwelfareeconomics(i.e.supplyanddemandsides)of radicaltechnologicalchange,ataskweundertookin2008.Weneedageneralaccountofthethree keyfactorsatthecenterofthisanalysis,decliningcosts,erodingmarketpowerbothintheproducts andpricesofferedtothepublic,andtheshiftindemandforanew,moreconsumerfriendlyproduct (Cooper2008).15Thediscussionisexcerptedbelow,withthegraphicrepresentationbuiltupin steps.

TheeffortbyrecordcompaniestokeepsinglesoutofthemarketandtokeepCDpriceshighwasabald efforttocontinueexercisingmarketpowertoincreaseproducersurplusbycapturingthebulkofthe costsavingsandpreventingconsumersfromenjoyingthebenefitsofmoreefficientdistributionthat wouldflowtotheminacompetitivemarket[ExhibitA1]. Ofequalifnotgreaterimportancewiththeconsumersavingsisthefactthatthetransformation reflectedfundamentaleconomics,notillegalbehavior;anexplosionofdigitalsingleswasinevitable.In aworldofphysicaldistribution,withhighfixedcostsandnearzeromarginalcost,itisgoodbusiness toputasmanysongsasonecanoneachCD.Theneedforbrickandmortardistributioninfrastructure forphysicalproductsreinforcedthislogic.However,recallthatsingleshadthrivedinthat environmentandretailerslikedthembecausetheyattractedtraffictostores.Withtheadventof digitaldistribution,fixedcostsofdistributionallbutdisappear,physicalinfrastructureisnolonger necessary,andtransactioncostsareslashed. Fromtheconsumerspointofviewthistransformationisperfectlyconsistentwitheconomictheory andcanbeexplainedintheclassictermsofwelfareeconomics.Betweentheshiftinthecostcurve [ExhibitA2]andtheeliminationofmarketpower(pricingshiftingfromthemarginalrevenuecurveto thedemandcurve[ExhibitA3])consumerswerethebigwinners Fromtheartistspointofview,thebenefitsofthetransformationarealsoreadilyexplainedinclassic welfareeconomicanalysis.Intheoligopolyenvironment,producersurplusisinflatedbyhighcost productsandresultsinthelargesurplusearnedbyasmallnumberofrecordingcompaniesthat producehighvalueblockbusteralbums.Inthedigitalenvironment,producersurplusismuch smallerandmadeupofthelowcostoutputearnedbyunsignedartists. Themechanismthroughwhichthevastmajorityofartistsbecamebeneficiariesofthenewmarket structureiseasilyexplainedbythereductionoftransactioncosts. Tocompletetheformaleconomicanalysis,itseemsclearthattheoutputexpandingeffectsofthe digitaltransformationgobeyondtheimpactofcostreductionandtheeliminationoftheexerciseof

15Theelementwaspresentinthe2005analyses,buttheformalwelfareeconomicdiscussionwasnot

includedatthetime.

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marketpower[ExhibitA4].Demandshiftsaswell,asaresultofbothproductionandtransaction changes.Newflexible,consumerfriendlyformatsexpanddemand. Theindustryvastlyoverestimatedtherolepiracyplayedinupendingtheoligopolyofrecordcompany power,but,moreimportantly,thatthedigitalrevolutionradicallytransformedthefundamental economicsoftheindustryinadirectionthatisconsumerfriendlyandalsobenefitedthevastmajority ofartists.Nowthatthedusthassettled,theoutcomeofthefirstroundofthedigitalintellectual propertywarssuggestsfundamentalchangesineconomicstructurethatthecontentoligopoliesofthe industrialagewillhavegreatdifficultyresisting[ExhibitA5].Beyondthenarrowquestionofthe overestimationofpiracy,therecentevidencepointsoverwhelminglyinfavorofthosewhosawitas improvingtheperformanceofthemarket.

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ExhibitA1:

Price Fixing, Tight Oligopoly in the Late 1990s

Price 0 Quantity
Predigital Marginal Revenue Predigital Supply Pre-Digital Demand

ExhibitA2:

Digital Technology Lowers Cost

Price 0 Quantity
Predigital Marginal Revenue Predigital Supply Dgitial Supply Pre-Digital Demand

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ExhibitA3:

Digital Technology Undermines Market Power of the Oligopoly

Price 0 Quantity
Predigital Marginal Revenue Predigital Supply Dgitial Supply Pre-Digital Demand

ExhibitA4:

Digital Transformation Lowers Cost, Undermines Market Power and Shifts Demand

Price 0 Quantity
Predigital Marginal Revenue Pre-Digital Demand Predigital Supply Digital Demand Dgitial Supply Postdigital Marginal Revenue

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ExhibitA5:

Consumer surplusunder tightCDoligopoly

Addedconsumer surplusunder digitalCompetition

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