[Federal Register Volume 84, Number 24 (Tuesday, February 5, 2019)]
[Rules and Regulations]
[Pages 1918-2036]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-00249]
[[Page 1917]]
Vol. 84
Tuesday,
No. 24
February 5, 2019
Part III
Library of Congress
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Copyright Royalty Board
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37 CFR Part 385
Determination of Royalty Rates and Terms for Making and Distributing
Phonorecords (Phonorecords III); Final Rule
Federal Register / Vol. 84 , No. 24 / Tuesday, February 5, 2019 /
Rules and Regulations
[[Page 1918]]
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LIBRARY OF CONGRESS
Copyright Royalty Board
37 CFR Part 385
[Docket No. 16-CRB-0003-PR (2018-2022)]
Determination of Royalty Rates and Terms for Making and
Distributing Phonorecords (Phonorecords III)
AGENCY: Copyright Royalty Board, Library of Congress.
ACTION: Final rule and order.
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SUMMARY: The Copyright Royalty Judges announce their final
determination of the rates and terms for making and distributing
phonorecords for the period beginning January 1, 2018, and ending on
December 31, 2022.
DATES:
Effective Date: February 5, 2019.
Applicability Date: The regulations apply to the license period
beginning January 1, 2018, and ending December 31, 2022.
ADDRESSES: The final determination is posted in eCRB at https://app.crb.gov/. For access to the docket to read the final determination
and submitted background documents, go to eCRB and search for docket
number 16-CRB-0003-PR (2018-2022).
FOR FURTHER INFORMATION CONTACT: Anita Blaine, CRB Program Assistant,
by telephone at (202) 707-7658 or by email at [email protected].
SUPPLEMENTARY INFORMATION:
Final Determination
The Copyright Royalty Judges (Judges) commenced the captioned
proceeding to set royalty rates and terms to license the copyrights of
songwriters and publishers in musical works made and distributed as
physical phonorecords, digital downloads, and on-demand digital
streams. See 81 FR 255 (Jan. 5, 2016). The rates and terms determined
herein shall be effective during the rate period January 1, 2018,
through December 31, 2022. Under the Copyright Act, royalty rates for
uses of musical works shall end ``on the effective date of successor
rates and terms, or such other period as the parties may agree.'' 17
U.S.C. 115(c)(3)); The Judges included the designation (2018-2022) in
the docket number for this proceeding for the purpose of designating
the relevant five-year period with the knowledge that affected parties
may agree to successor rates and terms for a different or additional
period. In this proceeding, each party included in its Proposed
Findings of Fact (PFF) and Proposed Conclusions of Law (PCL) a
designation of the rate period as January 1, 2018, through December 31,
2022. The Judges, therefore, adopt that agreed rate period.
For the reasons detailed in this Determination,\1\ the Judges
establish the following section 115 royalty rate structure, and rates,
for the period 2018 through 2022.
For licensing of musical works for all service offerings, the all-
in rate for performances and mechanical reproductions shall be the
greater of the percent of service revenue and Total Content Cost (TCC)
rates in the following table.
2018-2022 All-In Royalty Rates
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2018 2019 2020 2021 2022
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Percent of Revenue.............. 11.4 12.3 13.3 14.2 15.1
Percent of TCC.................. 22.0 23.1 24.1 25.2 26.2
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The Judges also adopt for the new rate period existing royalty
floors in effect for certain streaming configurations.
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\1\ This rate determination is not unanimous. Judge Strickler
prepared, to a disproportionately large degree, the initial drafts
of this Determination. Notwithstanding the Judges' concurrence on
most of the factual recitation and economic analysis, they were
unable to reach consensus on their conclusions. Judge Strickler's
dissenting opinion is appended to and is a part of this rate
determination. Note that all redactions in this publication were
made by the Copyright Royalty Judges and not by the Federal
Register.
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In the Initial Determination issued on January 27, 2018, the Judges
promulgated regulatory terms that made changes in style and substance
of the regulatory terms governing administration of the section 115
licenses. In February 2018, the Judges received a motion from Copyright
Owners (Owners' Motion) and a joint motion from four Services
(Services' Motion) seeking clarification of regulatory terms
promulgated with the Initial Determination.\2\ The Judges treated both
motions as general motions governed by 37 CFR 350.4 and issued their
ruling on the motions by separate Order dated October 29, 2018. The
Judges incorporate the reasoning and rulings in that Order and to the
extent necessary for clarity, include portions of that Order in this
Final Determination. The final text of the amended regulations is set
out below this SUPPLEMENTARY INFORMATION section.
I. Background
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\2\ National Music Publishers' Association and Nashville
Songwriters Association International together filed the Copyright
Owners' Motion for Clarification or Correction . . . (Owners'
Motion). Amazon Digital Services, LLC; Google Inc.; Pandora Media,
Inc. and Spotify USA Inc. filed a Joint Motion for Rehearing to
Clarify the Regulations (Services' Motion). The Judges did not treat
the motions as motions for rehearing under 17 U.S.C. 803(c)(2), as
neither requested a literal rehearing of evidence or legal argument.
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A. Statute and Regulations
The Copyright Act (Act) establishes a compulsory license for use of
musical works in the making and distribution of phonorecords. 17 U.S.C.
115. For purposes of section 115, phonorecords include physical and
digital sound recordings embodying the protected musical works, digital
sound recordings that may be downloaded or streamed on demand by a
listener, and downloaded telephone ringtones. Entities offering bundled
music services and digital music lockers are also permitted to do so
under the section 115 compulsory license.
The section 115 compulsory license created in 1909, reflected
Congress's attempt to balance the exclusive rights of owners of
copyrighted musical works with the public's interest in access to the
protected works. However, Congress made that right subject to a
compulsory license because of concern about monopolistic control of the
piano roll market (and another burgeoning invention, phonorecords). 17
U.S.C. 1
[[Page 1919]]
(1909); see also H.R. Rep. No. 60-2222, at 9 (1909). This license is
often referred to as the ``phonorecords'' license, but is also
identified, synonymously, as the ``mechanical'' license.
Congress revised the mechanical license in its 1976 general
revision of the copyright laws. The 1976 revision also created a new
entity, the Copyright Royalty Tribunal (CRT), to conduct periodic
proceedings to adjust the royalty rate for the license.\3\
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\3\ In 1993, Congress abolished the CRT and replaced it with
copyright arbitration royalty panels (CARPs). Copyright Royalty
Tribunal Reform Act of 1993, Public Law 103-198, 107 Stat. 2304. In
2004, Congress abolished the CARP system and replaced it with the
Copyright Royalty Judges. Copyright Royalty and Distribution Reform
Act of 2004, Public Law 108-419, 118 Stat. 2341.
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In 1995, Congress passed the Digital Performance Right in Sound
Recordings Act (DPRA),\4\ extending the mechanical license to ``digital
phonorecord deliveries'' (DPDs), which Congress defined as each
individual delivery of a phonorecord by digital transmission of a sound
recording which results in a specifically identifiable reproduction by
or for any transmission recipient of a phonorecord of that sound
recording, regardless of whether the digital transmission is also a
public performance of the sound recording or any nondramatic musical
work embodied therein. 17 U.S.C. 115(d). Accordingly, the section 115
mechanical license now covers DPDs, in addition to physical copies.
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\4\ Public Law 104-39, 109 Stat. 336.
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By statute, the Judges commence a proceeding to determine royalty
rates and terms for the section 115 license every fifth year. See 17
U.S.C. 803(b)(1)(A)(i)(V). The Act favors negotiated settlements among
interested parties, but in absence of a settlement, the Judges must
determine ``reasonable rates and terms of royalty payments. . . .'' The
Judges must further set rates that comport with the itemized statutory
policy considerations described in section 801(b)(1) of the Act. Rates
and terms for the mechanical license are codified in chapter III, part
385, title 37, Code of Federal Regulations.
As currently configured, the applicable regulations are divided
into three subparts.\5\ Subpart A regulations govern licenses for
reproductions of musical works (1) in physical form (vinyl albums,
compact discs, and other physical recordings), (2) in digital form when
the consumer purchases a permanent digital copy (download) of the
phonorecord (PDD), and (3) inclusion of a musical work in a purchased
telephone ringtone. Subpart B regulations include licenses for (1)
interactive streaming and limited downloads. The regulations in subpart
C relate to limited offerings, mixed bundles, music bundles, paid
locker services, and purchased content locker services. The current
regulations resulted from a negotiated settlement of the previous
mechanical license proceeding.
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\5\ For clarity, references to the regulations applicable to the
sec. 115 license are to the regulations as configured before
conclusion of the present proceeding. The Judges discuss appropriate
regulatory changes in section VII of this determination.
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B. Prior Proceedings
Until 1976, Congress legislated royalty rates for the mechanical
reproduction of musical works and notes. In 1980, the CRT conducted the
first contested proceeding to set rates for the section 115 compulsory
license. The CRT increased the then-existing rate by more than 45%,
from the statutory 2.75[cent] rate per phonorecord to 4[cent] per
phonorecord. 45 FR 63 (Jan. 2, 1980).\6\ By 1986, the CRT had increased
the mechanical rate to the greater of 5[cent] per musical work or
.95[cent] per minute of playing time or fraction thereof. 46 FR 66267
(Dec. 23, 1981); see 37 CFR 255.3(a)-(c). The next adjustment of the
section 115 rates was scheduled to begin in 1987. However, the parties
entered into a settlement setting the rate at 5.25[cent] per track
beginning on January 1, 1988, and the CRT established a schedule of
rate increases generally based on positive limited percentage changes
in the Consumer Price Index every two years over the following 10
years. See 52 FR 22637 (June 15, 1987). The rate increased until 1996,
when the rate was set at 6.95[cent] per track or 1.3[cent] per minute
of playing time or fraction thereof. See 37 CFR 255.3(d)-(h).
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\6\ The United States Court of Appeals for the District of
Columbia Circuit affirmed the CRT. Recording Industry Ass'n. of
America v. Copyright Royalty Tribunal, 662 F.2d 1 (D.C. Cir. 1981)
(1981 Phonorecords Appeal) (remanded on other grounds).
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The rates set by the 1987 settlement were to expire on December 31,
1997. The Librarian of Congress announced a negotiation period for
copyright owners and users of the section 115 license in late 1996. The
parties reached a settlement regarding rates for another ten-year
period to end in 2008.\7\ Under the settlement, ultimately adopted by
the Librarian, the parties agreed to a rate for physical phonorecords
of 7.1[cent] per track and established a schedule for fixed rate
increases every two years for a 10-year period. At the beginning of
January 2006, the mechanical rate was the larger of 9.1[cent] per track
or 1.75[cent] per minute of playing time or fraction thereof. See 37
CFR 255.3(i)-(m); see also 63 FR 7288 (Feb. 13, 1998).
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\7\ The Librarian initiated the 1996 proceeding during the CARP
period, when controversies regarding royalty rates and terms were
referred to privately retained arbitrators.
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In 2006, with expiration of the previous settlement term nearing,
the Judges commenced a proceeding to adjust the mechanical rates under
section 115. On January 26, 2009, they issued a Determination,
effective March 1, 2009. In that Determination, the Judges noted that
the parties had settled their dispute regarding rates and terms for
conditional downloads, interactive streaming, and incidental digital
phonorecord deliveries (i.e., rates in the new subpart B) (2008
Settlement). See Mechanical and Digital Phonorecord Delivery Rate
Determination, 74 FR 4510, 4514 (Jan. 26, 2009) (Phonorecords I). The
parties who negotiated the 2008 Settlement included the National Music
Publishers Association (NMPA) and the Digital Music Association (DiMA),
the trade association representing its member streaming services.
Written Direct Testimony of Rishi Mirchandani, Trial Ex. 1, at ] 59
(Mirchandani WDT).
The 2008 Settlement rates that the Judges adopted maintained the
existing rate and rate structure at the greater of 9.1[cent] per song
or 1.75[cent] per minute of playing time (or fraction thereof) for
physical phonorecords and permanent digital downloads (PDD). The Judges
also adopted a license rate of 24[cent] per ringtone, a newly regulated
product. 74 FR at 4515. Physical sales, PDDs, and ringtones were
included in subpart A of the regulations.
In 2011, the Judges commenced a proceeding to again determine
section 115 royalty rates and terms. See 76 FR 590 (Jan. 5, 2011). The
participants in that proceeding negotiated a settlement (2012
Settlement) that carried forward the existing rates and added a new
subpart C to the regulations to cover several newly regulated service
offering categories, viz., limited offerings, mixed service bundles,
music bundles, paid locker services, and purchased content locker
services.\8\ The Judges adopted the participants' settlement in 2013.
See Adjustment of Determination of Compulsory License Rates for
Mechanical and Digital Phonorecords, 78 FR 67938 (Nov. 13, 2013)
(Phonorecords II).
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\8\ Once again, the parties to the negotiations included the
NMPA and DiMA. Mirchandani WDT at ] 59.
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The present section 115 proceeding is the third since the
establishment of the Copyright Royalty Board (CRB) program
[[Page 1920]]
under the Copyright Royalty and Distribution Reform Act of 2004.\9\ In
the Phonorecords II settlement, the parties agreed that any future rate
determination presented to the Judges for subparts B and C service
offering configurations would be a de novo rate determination. See 37
CFR 385.17, 385.26 (2016).
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\9\ Public Law 108-419, 118 Stat. 2341.
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C. Statement of the Case
In response to the Judges' notice commencing the present
proceeding, 21 entities filed Petitions to Participate.\10\ The
participants engaged in negotiations and discovery. On June 15, 2016,
some of the participants \11\ notified the Judges of a partial
settlement with regard to rates and terms for physical phonorecords,
PDDs, and ringtones, the service offerings covered by the extant
regulations found in subpart A of part 385. The Judges published notice
of the partial settlement \12\ and accepted and considered comments
from interested parties.\13\
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\10\ Initial Participants were: Amazon Digital Services, LLC
(Amazon); Apple, Inc. (Apple); Broadcast Music, Inc. (BMI); American
Society of Composers, Authors and Publishers (ASCAP); David Powell;
Deezer S.A. (Deezer); Digital Media Association (DiMA); Gear
Publishing Company (Gear); George Johnson d/b/a/GEO Music Group
(GEO); Google, Inc. (Google); Music Reports, Inc. (MRI); Pandora
Media, Inc. (Pandora); Recording Industry Association of America,
Inc. (RIAA); Rhapsody International Inc.; SoundCloud Limited;
Spotify USA Inc.; ``Copyright Owners'' comprised of National Music
Publishers Association (NMPA), The Harry Fox Agency (HFA), Nashville
Songwriters Association International (NSAI), Church Music
Publishers Association (CMPA), Songwriters of North America (SONA),
Omnifone Group Limited; and publishers filing jointly, Universal
Music Group (UMG), Sony Music Entertainment (SME), Warner Music
Group (WMG).
\11\ The settling parties were: NMPA, NSAI, HFA, UMG, and WMG.
As part of the settlement agreement, UMG and WMG withdrew from
further participation in this proceeding.
\12\ See 81 FR 48371 (Jul. 25, 2016).
\13\ Three parties filed comments. American Association of
Independent Music (A2IM), Sony Music Entertainment (SME), and George
Johnson dba GEO Music Group (GEO). A2IM urged adoption of the
settlement and SME approved of all but one provision of the
settlement. GEO objected to the settlement.
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On October 28, 2016, NMPA, Nashville Songwriters Association
International (NSAI), and Sony Music Entertainment (SME) filed a Motion
to Adopt Settlement Industry-Wide. The motion asserted that SME, NMPA,
and NSAI had resolved the issue raised by SME in its response to the
original notice. The Judges evaluated the remaining objection to the
settlement filed by George Johnson dba GEO Music Group (GEO) and found
that GEO had not established that the settlement agreement ``does not
provide a reasonable basis for setting statutory rates and terms.'' See
17 U.S.C. 801(b)(7)(A)(iii). As a part of the second settlement, SME
withdrew from this proceeding. The Judges published the agreed subpart
A regulations as a Final Rule on March 28, 2017.\14\
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\14\ See 82 FR 15297 (Mar. 28, 2017).
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During the course of the present proceeding, the Judges dismissed
some participants and other participants withdrew. Remaining
participants at the time of the hearing were NMPA and NSAI,
representing songwriter and publisher copyright owners (Copyright
Owners) and GEO, a songwriter/publisher/copyright owner, appearing pro
se. Copyright licensees appearing at the hearing were Amazon Digital
Services, LLC (Amazon), Apple Inc. (Apple), Google, Inc. (Google),
Pandora Media, Inc. (Pandora), and Spotify USA Inc. (Spotify),
(collectively, the Services).
Beginning on March 8, 2017, the Judges conducted a hearing that
concluded on April 13, 2017. During the course of the hearing, the
Judges heard oral testimony from 37 witnesses.\15\ The Judges admitted
over 1,100 exhibits, exclusive of demonstrative or illustrative
materials the participants offered to explicate oral testimony. The
participants submitted Proposed Findings of Fact (PFF) and Proposed
Conclusions of Law (PCL) on May 12, 2017, and Replies to those filings
on May 26, 2017. Under 37 CFR 351.4(b)(3), a participant may amend its
rate proposal at any time up to and including the time it files
proposed findings and conclusions. In this proceeding, Copyright Owners
and Google filed amended rate proposals contemporaneously with their
respective PFF and PCL. The parties delivered closing arguments on June
7, 2017.
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\15\ By stipulation of the participants, the Judges also
accepted and considered written testimony from six additional
witnesses who did not appear. Amazon designated and other
participants counter-designated testimony from the Phonorecords I
proceeding, which was admitted as Exhibits 321 and 322.
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Based on the record of this proceeding, the Judges have determined
that the mechanical license rate shall be an All-In rate derived from a
Greater-Of rate structure. Weighing the advantages and disadvantages
highlighted by the participants in this proceeding, the Judges conclude
that a rate that balances a percent-of-service revenue with a percent-
of-TCC (total cost of content) shall be the basis for the All-In
phonorecords royalty. The mechanical portion of the royalty shall be
the greater of those figures, less the actual amount services pay for
the phonorecord performance right. The Judges have no role in setting
the performance right license rates. Further, performance right
licensees pay the performance royalties to music publishers and
songwriters. Services pay mechanical royalties primarily to music
publishers.
II. Context of This Proceeding
A. Changes in Music Consumption Patterns and Revenue Allocation
In recent years, music consumption patterns have undergone profound
shifts--first from purchases of physical albums to downloads of digital
singles, and then from downloads to on-demand access through digital
streaming services. These shifts in music consumption patterns have led
to corresponding changes in the magnitude and relative mix of income
streams to copyright owners; in particular, copyright owners note an
increased reliance on performance royalties as compared to reproduction
and distribution royalties. Witness Statement of David M. Israelite,
Trial Ex. 3014, ] 63 (Israelite WDT).
While earlier format changes (piano rolls to wax cylinders to
lacquer or vinyl discs to CDs) had altered the way households consumed
music, they did not fundamentally alter the distribution of music. For
all these music formats, copyright owners distributed music to
consumers physically, either directly or through record stores. In
addition, with the exception of ``singles,'' after conversion to the
vinyl format, purveyors of music typically distributed a bundle of
songs (an album). Witness Statement of Bart Herbison, Trial Ex. 3015, ]
20 (Herbison WDT).
By the early 2000s, digital data compression and higher-bandwidth
internet connections allowed relatively fast transmission of recorded
music files over the internet, drastically altering the distribution
and consumption of music. Music services \16\ began to offer individual
tracks or songs online as ``digital downloads.'' In 2008, approximately
435 million albums were sold in the U.S. (both digital and physical).
By 2015, that number fell to 249 million.\17\ Sales of singles, by
[[Page 1921]]
contrast, have remained fairly stable over the same period, averaging
approximately one billion per year from 2008 to 2015 (with a peak of
1.4 billion in 2012). Expert Report of Jeffrey A. Eisenach, Trial Ex.
3027, at ] 67 & Table 4 (Eisenach WDT).
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\16\ Digital download sales gained popularity in 2003 when Apple
introduced the iTunes Music Store. The iTunes Store provided a
convenient way for iTunes users to purchase a song or an entire
album, legally, with a single click of the computer mouse. The
iTunes Store also allowed users of Apple's iPod to sync songs
directly to the device. Expert Report of Jui Ramaprasad, Trial Ex.
1615, at 25-26 (Ramaprasad WDT). Prior to the launch of the iTunes
Music Store, virtually all music was sold as albums. Eisenach WDT at
44, n.58.
\17\ Some evidence in the record suggests, however, that since
2013, with the inclusion of ``streaming equivalent'' albums, overall
album consumption may have increased. See Katz WDT at 42.
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Changes in consumption patterns have had an impact on industry
revenues. For example, between 2004 and 2015, record label revenues
from physical sales declined from $15.3 billion to $2 billion, while
digital revenues increased from $230 million to about $4.8 billion. Id.
at ] 44. In 2004, over 98% of music industry revenue was the result of
physical sales. Copyright and the Music Marketplace: A Report of the
Register of Copyrights 70 (Feb. 2015) (Register's Report), citing RIAA-
sourced chart.\18\ Digital downloads made up most of the remaining
revenue. Id. By 2013, revenues from physical sales fell to 35% of
industry total revenues.\19\ Digital downloads, which made up 1.5% of
industry revenues in 2004, had climbed to 40% of industry revenues.
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\18\ The Judges cite the Register's Report as a source of
industry background, developed by the Register of Copyrights
following public hearings held nationwide in 2013 and 2014. The
Judges do not base their conclusions in this Determination on any
background information from the Register's Report that the parties
did not also present as evidence in this proceeding.
\19\ Industry total revenues in this analysis include digital
downloads (40%), physical sales (35%), subscription and streaming
(21%), and ringtones and ringbacks (1%). Copyright and the Music
Marketplace at 70, citing RIAA-sourced chart.
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Changes in music consumption patterns have coincided with an
increase in the use of musical works. Review of relevant market factors
imply, however, that the ways in which those works are used currently
do not compensate copyright owners as well as they did in the past. See
Register's Report at 72-74.\20\
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\20\ Musical works copyright owners complain that streaming
services are at least partially responsible for the paucity of
revenues that the musical works generate for writers and publishers.
They blame streaming services' business practices that favor growth
in user base and market share over maximizing profitability. Digital
services counter that they pay a substantial portion of the revenues
they receive to license copyrighted works and compete with
terrestrial radio, which is exempt from paying performance
royalties. Digital services and broadcasters also argue that the
lack of royalty compensation that makes its way to content creators
is due in large part to the content creators' agreements with
intermediaries, which, they argue, keep a large portion of royalties
earned by content creators for their own account or to recoup
advances. Id. at 76-77.
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B. Emergence of New Streaming Services
Many diverse enterprises have launched music streaming services to
meet growing consumer demand for streaming. Currently, there are at
least 31 music streaming services available from 20 identifiable
providers. Some of the well-known of these include: Amazon, Apple,
Google (and its recently acquired YouTube), Deezer (partnered with
Cricket/AT&T), iHeartRadio, Napster, Pandora, SoundCloud, Spotify, and
Tidal (partnered with Sprint). Written Rebuttal Testimony of Jim
Timmins, Trial Ex. 3036, ] 20 (Timmins WRT). Most of the companies
entering the on-demand streaming music market have done so recently.
Id. ] 21. In the last five years, new entrants to the market have
initiated at least five interactive streaming services, joining Spotify
which launched in the United States in 2011. See id. ] 22.
The largest players in the interactive streaming market by song
catalog are Apple Music, Google Play, and Spotify, each of which each
has a catalog that exceeds [REDACTED] million songs. Tidal, which
provides an outlet for unsigned artists,\21\ has a catalog of over 40
million songs. See Written Direct Testimony of Michael L. Katz, Trial
Ex. 885, ] 34, Table 1 (Katz WDT). By one estimate, in 2016 there were
18 million U.S. on-demand subscribers: Spotify accounted for [REDACTED]
million, followed by Apple Music (4 million), Rhapsody and Tidal (2
million each) and all others accounting for the remaining 4 million.
See id.
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\21\ An ``unsigned artist'' is one recording music but not under
contract to a recording company.
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Some of the services that offer music streaming are pure-play music
providers, such as Spotify and Pandora.\22\ Others, such as Amazon,
Apple Music, and Google Play Music, are part of wider economic
``ecosystems,'' in which a music service is one part of a multi-
product, multi-service aggregation of activities, including some that
are also related to the provision of a retail distribution channel for
music. For example, Amazon is a multi-faceted internet retail business.
Amazon offers a buyers' program for an annual fee (Amazon Prime) that
affords loyalty benefits to members, such as free or reduced rate
shipping or faster delivery on the products members purchase. Amazon
Prime reportedly has approximately [REDACTED] subscribers.\23\ For its
music service offering, Amazon bundles interactive streaming at no
additional cost with its Prime membership. In addition to the Prime
Music service offering, Amazon's U.S.-based business also includes a
physical music store, a digital download store, a purchased content
locker service, Amazon Music Unlimited (a full-catalog subscription
music service), and Amazon Music Unlimited for Echo (a full-catalog
subscription service available through a single Wi-Fi enabled device,
Amazon Echo).\24\ In launching Prime Music, Amazon relied on the
section 115 license as it did for Amazon Music Unlimited and Amazon
Music Unlimited for Echo.\25\
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\22\ Until late 2016, Pandora operated as a noninteractive
streaming service that, did not incur a compulsory license fee for
mechanical royalties. Pandora recently began offering more
interactive features, including a full on-demand tier. Pandora WDS
Introductory Memo at 1-2; Written Direct Testimony of Christopher
Phillips, Trial Ex. 877, at 8 (Phillips WDT).
\23\ Amazon Prime is a $99-per-year service that offers Amazon
customers access to a bundle of services including free two-day
shipping, video streaming, photo storage and e-books, in addition to
Prime Music. Expert Report of Glenn Hubbard, Trial Ex. 22, at 15
(Hubbard WDT).
\24\ Mirchandani WDT at 5.
\25\ 3/15/17 Tr. 1315-16 (Mirchandani).
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Google describes its ``Google Play'' offerings as its ``one-stop-
shop'' for the purchase of Android applications. The Google Play Store
allows users to browse, purchase, and download content, including
music. Google Play Music is Google Play's entire suite of music service
offerings. Google Play Music, launched in 2011, is bundled with the
YouTube Red video service subscription.\26\ It includes several
functionalities: (1) A Music Store; (2) a cloud-based locker service;
(3) an on-demand digital music streaming service; and (4) a section 114
compliant non-interactive digital radio service (in the U.S.).\27\
Levine WDT, Trial Ex. 692, ] 43.
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\26\ Google's experience with music licensing dates at least far
back as 2006, when it acquired YouTube. Written Direct Testimony of
Zahavah Levine, Trial Ex. 692, at 3 (Levine WDT). Google's music
services were part of Google's Android Division but were recently
combined within the YouTube business unit. Id. at 3-4.
\27\ Section 114 of the Act includes requirements for the
compulsory license to perform digitally sound recordings over
noninteractive internet music streaming services.
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The evidence is conflicting regarding whether the market for
streaming services is faring poorly financially or performing about the
same as other emerging industries. See, e.g., Timmins WRT, Trial Ex.
3036, ]] 16-17; Levine WDT ] 16 (``streaming music services generally
remain unprofitable businesses'' with content acquisition costs being
``the biggest barrier to profitability.'') For example, Spotify, one of
the largest pure-play streaming services, has reportedly [REDACTED].
Katz WDS at ] 65. Some estimates place
[[Page 1922]]
Spotify's market value at more than $8 billion, suggesting perhaps,
investors' expectations regarding future profits. Written Rebuttal
Testimony of Marc Rysman, Trial Ex. 3032, ] 11, n.3 (Rysman WRT).\28\
Spotify forecasts being profitable in [REDACTED]. Id. at ] 65 n.80.
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\28\ In 2016, Spotify had over [REDACTED] million monthly active
users, [REDACTED]% of which were in the U.S. [REDACTED] million of
those U.S. users were also Premium subscribers. Written Direct
Testimony of Barry McCarthy, Trial Ex. 1060, ] 2 (McCarthy WDT).
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C. Effects of Streaming on Publishers' and Songwriters' Earnings
Although many songwriters perform their own musical works, it is
also common for songwriters to compose songs to be performed by others.
Songwriters typically enter into contractual arrangements with music
publishers, which promote and license the songwriters' works and
collect royalties on their behalf. Music publishers and songwriters
negotiate a split of the royalty payments. In some cases, songwriters
are commissioned to write a song and are compensated with a flat fee
for the work in exchange for giving up ownership rights to the song and
any royalties it might earn.
The four largest publishers--Sony/ATV, Warner/Chappell, Universal
Music Publishing Group, and Kobalt Music Publishing--collectively
accounted for just over 73 percent of the top 100 radio songs tracked
by Billboard \29\ as of the second quarter in 2016. In addition, there
are several other significant publishers, including BMG and Songs Music
Publishing, and many thousands of smaller music publishers and self-
publishing songwriters. See Katz WDT ] 46.
---------------------------------------------------------------------------
\29\ This Billboard measure tracks songs played on AM-FM
terrestrial radio broadcasters, which are not required to license
the works or the sound recordings they play.
---------------------------------------------------------------------------
Songwriters have three primary sources of ongoing royalty income,
which they generally share with music publishers: Mechanical royalties,
synchronization (``synch'') royalties for use of their works in
conjunction with video or film, and performance royalties.\30\ See Katz
WDT ] 41; Copyright and the Music Marketplace at 69. Songwriters who
are also recording artists receive a share of revenues from their
record labels for the fixing of the musical work in a sound recording.
Sound recording royalties include those from the sale of physical and
digital albums and singles, sound recording synchronization, and
digital performances. Id. Recording artists can also derive income from
live performances, sale of merchandise, and other sources. Id. at 69-
70.
---------------------------------------------------------------------------
\30\ Another revenue source is folio licenses, lyrics, and
musical notations in written form. See Katz WDT ] 31.
---------------------------------------------------------------------------
The shift in consumption from physical sales to streaming coincided
with a reallocation of publisher revenue sources. In 2012, 30% of U.S.
music publisher revenues came from performance royalties and 36% from
mechanical royalties, with the rest coming from synch royalties and
other sources. See Register's Report at 70. By 2014, 52% of music
publisher revenues came from performance royalties \31\ while 23% came
from musical works mechanical royalties, with the remainder coming from
synchronization royalties and other sources. Id at 71, n.344, citing
NMPA press release. By one estimate, mechanical license revenues from
interactive streaming services accounted for only [REDACTED] percent of
total music publishing revenues in 2015. Katz WDT ] 42.\32\
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\31\ Performance royalties are administered primarily by
Performing Rights Organizations acting as collectives and
clearinghouses for songwriters and publishers as licensors, and
broadcasters and streaming services as licensees.
\32\ It is noteworthy that the shift from mechanical royalties
to performance royalties coincides with the shift from sales of
physical phonorecords (e.g., CDs) and downloads, for which no
performance royalty is required, to the use of interactive
streaming, which pays both a mechanical royalty (when a DPD results)
and a performance royalty, and to the use of noninteractive
streaming, which historically pays only a performance royalty but no
mechanical royalty.
---------------------------------------------------------------------------
Evidence in the present record indicates that total publishing
revenue declined by [REDACTED] percent between 2013 and 2014, but
increased by [REDACTED] percent between 2014 and 2015. See Katz WDT ]
58. Large publishers, such as Sony/ATV, UMPG, and Warner Chappell, were
[REDACTED] in 2015, earning a combined $[REDACTED] million from U.S.
publishing operations for that year. Id. ] 59.
III. The Present Rate Structure and Rates
Subpart B of the current regulations contains mechanical royalty
rates payable for the delivery and offering of interactive streams and/
or limited downloads. There are three product distinctions within the
subpart B rate structure:
Portable vs. Nonportable Services
Bundled vs. Unbundled Services
Subscription vs. Ad-Supported Services
37 CFR 385.13. The regulations also separate certain promotional uses
for separate treatment, setting the rate for those promotional uses at
zero.
Each of these offering characteristics can be combined
independently with almost every other characteristic, resulting in a
very complex web of rate calculations. In the 2012 Settlement, the
parties structured rate calculations for both subpart B and subpart C
into three arithmetic segments.
In the first step of the calculation, the parties determine the
All-In royalty pool; that is, the royalty that would be payable based
on a formula balancing the greater of a percent-of-service revenue and
a percentage of one of two other expense measures. One expense measure
if a percent-of-royalties services pay to record companies for sound
recording performance rights, differing depending upon whether the
sound recording licenses are pass-through or not pass-through. For
certain subscription services, the percent-of service revenue is
balanced against the lesser of two or three other potential
mathematical outcomes.\33\
---------------------------------------------------------------------------
\33\ The lesser-of prongs include a per-subscriber per month
prong and percent-of-service payments for sound recording royalties,
differing depending upon whether the sound recording licenses are
pass-through or not pass-through.
---------------------------------------------------------------------------
The second calculation reduces the All-In royalty pool to the
``payable'' royalty pool in a two-step process. First the parties
subtract royalties the services pay for musical works performance
rights from the All-In royalty established in the first calculation.
This remainder is considered the payable royalty pool for certain
service offerings; viz., non-subscription, ad-supported, purchased
content lockers, mixed service bundles, and music bundles. For
subscription service offerings, whether standalone or bundled, and
depending upon whether the offering is portable or non-portable,
streaming only or mixed use, determining the payable royalty pool
requires a balancing of the mechanical remainder against a set rate for
``qualified'' subscribers per month to determine the greater-of result.
The set rate for qualified subscribers differs for each variation of
subscription offering.
The final step in the rate determination for each service offering
is an allocation among licensors based upon the number of plays from
each licensor's catalog.\34\
---------------------------------------------------------------------------
\34\ Calculation of royalties for paid locker services varies
slightly from this formula, but the complexity is similar.
---------------------------------------------------------------------------
The Services, the licensor participants in the present proceeding,
refer to this convoluted process as the establishment of royalty rates
with ``minima.'' According to the Services, these minima are designed
to protect copyright owners from the potential downside of Services'
business models that might
[[Page 1923]]
minimize service revenue and thus manipulate the percent-of-service
revenue rate standard. The Services, whose current royalty payments are
determined under the minima prongs of the formulae, point to the minima
as a reason to keep the percent-of-service revenue ``headline'' rate
low, reasoning that the headline rate is not, or is rarely, binding in
any event.
Notwithstanding the parties' prior agreement to the apparent
complexity, the alternative calculation methods, or the variations in
the descriptions of the service offerings, evidence presented in this
proceeding does not support continuing the fractionalization of the
rate determination for the service offerings at issue. At the
conclusion of the tortured rate calculations required by the present
regulations, the evidence suggests that differences in the rates
Services pay are not great enough to justify the complexity of the
formulae. Some of the rate determination prongs are rarely if ever
triggered. Despite the myriad configurations of rate calculations, some
of the service offerings are incapable of categorization under the
extant rate structure. Apple and Google entered the digital music
delivery marketplace by negotiating direct licenses covering several
compulsory licenses, avoiding the regulatory scheme entirely.
IV. Analysis of Rate Structure Proposals
A. Parties' Proposals
1. The Services (Excluding Apple and Google)
The Services propose rates and rate structures that, while varying
in their particulars, share a number of common elements. Broadly, the
Services propose a rate structure that, in the main, continues the
current rate structure. More particularly, the Services' proposals
share core elements: (1) An ``All-In'' rate for mechanical and
performance rights; (2) based upon a 10.5 percent-of-service revenue
headline rate with minima; (3) without a ``Mechanical Floor.''
a. Amazon
In its Proposed Rates and Terms (Amazon Proposal), Amazon proposes
that the rate structure as currently in the applicable regulations
rollover into the 2018-22 rate period, except: (1) The per subscriber
minimum and/or subscriber-based royalty floors for a ``family account''
should equal 150% of the per subscriber minimum and/or subscriber-based
royalty floor for an individual account; (2) a student subscription
account discount of 50% should be included in the regulations to the
per subscriber minimum and subscriber-based royalty floor that would
otherwise apply under the current regulations; (3) a discount for
annual subscriptions equal to 16.67% of the minimum royalty rate (or
rates) and subscriber-based royalty floor (or floors) that would
otherwise apply under Sec. 385.13; and (4) 15% discount to the minimum
royalty rate (or rates) and subscriber-based royalty floor (or floors)
to reflect a service's actual ``app store'' and carrier billing costs,
not to exceed 15% for each. Amazon Proposal at 1-2.
b. Pandora
Pandora's amended proposed rates and terms (Pandora Amended
Proposal),\35\ seek the following changes from the current regulations:
(1) Elimination of the ``Mechanical Floor;'' (2) elimination of the
alternative computation of sub-minima I and II now in Sec. 385.13 and
in Sec. 385.23 (for subparts B and C, respectively) ``in cases in
which the record company is the section 115 licensee;'' (3) A
broadening of the present ``not to exceed 15%'' reduction of ``Service
Revenues'' in Sec. 385.11 to reflect, in toto, an exclusion of costs
attributable to ``obtaining'' revenue, ``including [but not expressly
limited to] credit card commissions, app store commissions, and similar
payment process charges;'' \36\ and (4) a discount on minimum royalties
for student plans ``not to exceed 50%'' off minimum royalty rates set
forth in Sec. 385.13. Id. at 1, 7.
---------------------------------------------------------------------------
\35\ The Pandora Amended Proposal superseded its original
proposal filed on November 1, 2016, by adding definitions (for
``fraudulent streams'' and ``play'') that do not directly relate to
the royalty rates. See Pandora PFF/PCL, Appx. C.
\36\ Pandora does not expressly describe this change as a change
in rates per se.
---------------------------------------------------------------------------
c. Spotify
In its amended proposed rates and terms, Spotify proposed the
following changes from the current regulations: (1) Removal of the
``Mechanical Floor'' for all licensed activity; and (2) a broadening of
the present ``not to exceed 15%'' reduction of ``Service Revenues'' in
Sec. 385.11 to reflect, in toto, an exclusion of the actual costs
attributable to ``obtaining'' revenue, ``including [but not expressly
limited to] credit card commissions, app store commissions similar
payment process charges, and actual carrier billing cost.'' See Second
Amended Proposed Rates and Terms of Spotify USA Inc., passim.
2. Apple
Apple proposed that the Services pay $0.00091 for each
nonfraudulent stream of a copyrighted musical work lasting 30 seconds
or more. Apple Inc. Proposed Rates and Terms (as amended) at 3-4 (Apple
Amended Proposal). Apple proposed defining a use as any play of a sound
recording of a copyrighted work lasting 30 seconds or more.
Additionally, Apple proposed an exemption for a ``fraudulent stream,''
which it defined as ``a stream that a service reasonably and in good-
faith determines to be fraudulent.'' Id. at 2. For paid locker
services, Apple proposes a $0.17 per subscriber fee, also as a
component of an All-In musical works royalty rate that would include
the ``subpart C'' royalty. Id. at 7-8. For purchased content locker
services, Apple proposed a zero royalty fee. Id. at 7.
3. Google
In its amended proposed rates and terms (Google Amended
Proposal),\37\ Google parts company with the other Services and
proposes that the rate structure ``eliminat[e] . . . different service
categories'' in both subparts B and C and replace them with ``a single,
greater-of rate structure between 10.5% of net service revenue and an
uncapped 15-percent TCC component.'' Google Amended Proposal at 1.\38\
That 15% TCC rate is reduced to 13% for pass-through licenses (i.e.,
where a record company is the licensee under section 115, and the
record company has granted streaming rights to a service). Id. at 33-
34. Google's proposed rate does not include a ``Mechanical Floor.''
Similar to one of Amazon's proposals, Google also seeks a discount in
rates for ``carrier billing costs'' and ``app store commissions,'' plus
``credit card commissions'' and ``similar payment process charges,''
all not to exceed 15%. Id. at 6 (for subpart B); 26 (for subpart
C).\39\ In addition, Google's proposal includes a zero rate for certain
free trial periods. Id. at 35-37.
---------------------------------------------------------------------------
\37\ The Google Amended Proposal amended its original proposal
filed on November 1, 2016. Google originally proposed a subpart B
rate structure that generally followed the existing structure.
Google Written Direct Statement, Introductory Memorandum at 3 (Nov.
1, 2016).
\38\ ``TCC'' is an industry acronym for ``Total Content Cost'',
a shorthand reference to the extant regulatory language describing
generally the amount paid by a service to a record company for the
section 114 right to perform digitally a sound recording. Google's
proposed regulatory terms retain some of the distinctions in service
offerings for purposes of computing per-work royalty allocations.
See, e.g., id. at 29-31. This does not affect the total royalty
charged to the service.
\39\ Google describes this proposed change as a change in the
definition of ``Service Revenue,'' unlike Amazon, which described
its proposed 15% discount as a change in rates. The difference is
mathematically irrelevant.
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[[Page 1924]]
4. Copyright Owners (Excluding GEO)
The Copyright Owners proposed that the Judges adopt a unitary rate
structure for all interactive streaming and limited downloads that are
currently covered by subparts B and C.\40\ Copyright Owners' Amended
Proposed Rates and Terms, at 3 (May 11, 2017) (CO Amended Proposal).
The Copyright Owners structured the proposal as the greater-of a usage
charge and a per-user charge. Specifically, under the Copyright Owners'
proposal, each month the licensee would pay the greater of (a) a per-
play fee ($0.0015) multiplied by the number of interactive streams or
limited downloads during the month and (b) a per-end user \41\ fee
($1.06) multiplied by the number of end users during the month. Id. at
8. The license fee would be for mechanical rights only, and would not
be offset by any performance royalties that the licensee paid for the
same activity. Id.
---------------------------------------------------------------------------
\40\ The Copyright Owners' rate proposal would apply the subpart
A rates to so-called ``music bundles'' (``offerings of two or more
subpart A products to end users as part of one transaction'') which
are currently covered by subpart C. Id. at 3 nn. 2 & 4.
\41\ The proposal would consider each paying subscriber to a
service, or each active user, to be an ``end user.'' Id. at 8-9.
---------------------------------------------------------------------------
5. GEO Music Group
The Judges accepted written and oral testimony from Mr. George
Johnson dba GEO Music Group. Mr. Johnson appeared pro se. Mr. Johnson
is a self-employed songwriter, music publisher, and performer, who
formerly operated his own recording company.\42\ The other participants
in the proceeding agreed to preserve objections to Mr. Johnson's
testimony to avoid interruptions and to submit any objections in
writing after his testimony.
---------------------------------------------------------------------------
\42\ At the time of hearing in the present proceeding, Mr.
Johnson had stepped back from his music business and was employed in
real estate. See 3/9/17 Tr. 418-19 (Johnson).
---------------------------------------------------------------------------
The crux of Mr. Johnson's case is that ``songs and copyrights have
real intrinsic value in dollars'' and that current royalty rates do not
fairly account for that value. Second Amended Written Direct Statement
of George D. Johnson (GEO) for Proposed Subpart C or New Subpart D
Rates and Terms at 3 (Johnson Second AWDS). Mr. Johnson proposes what
he refers to as a ``Buy Button'' or ``Paid Permanent Digital Song
Sale'' (PDS) under a newly created subpart C or subpart D of the
applicable regulations. Id. at 2. Mr. Johnson contends that the PDS
would ``eliminate the unpaid limited download in 37 CFR 385, Subparts B
and C.'' Id. at 3. Under Mr. Johnson's proposal all ``interactive and
non-interactive Subpart B and C streaming services'' would be required
to include a ``buy button'' that ``allows customers to voluntarily buy
or purchase a work as a permanent paid digital download.'' Sec. 385
Regulation Redline and Changes of George D. Johnson (GEO) at 4 (Feb.
20, 2017) (Johnson Redline and Changes). Mr. Johnson proposes that the
cost to the consumer for these permanent paid digital song sales would
be, for 2018: $1.00; 2019: $1.50; 2020: $2.00; 2021: $2.50; 2022:
$3.00. Id.
Mr. Johnson also proposes that proceeds from sales of permanent
downloads purchased through the proposed ``buy button'' be allocated to
the following groups of interested parties under one of two
alternatives (A or B): Artist ($.19 or $.18 per dollar paid by the
consumer), ``record'' (presumably the label or record company) ($.21 or
$.20), ``AFM'' (presumably American Federation of Musicians) ($.01),
``AFTRA'' (presumably American Federation of Television and Radio
Artists) ($.01), Songwriter ($.21 or $.20), Publishers ($.21 or $.20),
and Services ($.16 or $.20). Id. Mr. Johnson refers to the alternative
allocations as royalties but they appear instead to be shares of sales
proceeds that he would allocate to what he believes are all of the
interested parties. He does not explain why or when alternative A
should be applied as opposed to alternative B.
The allocations he proposes would include royalties for the section
112/114 licenses and the section 115 license, divided equally between
the section 115 and section 114 copyright owners. Johnson Redline and
Changes at 4. However, under his proposal the copyright users (the
Services) would still pay a mechanical royalty for streaming
performances of ``$.0015, etc.'' Johnson Second AWDS at 4. It is
unclear what year the $.0015 rate would apply to and what the ``etc.''
means.\43\ In short, Mr. Johnson proposes two alternatives for
allocating revenues from sales that might occur if a customer were to
buy a song directly from a Service. Under Alternative A, the Services
would effectively pay in the aggregate 84% of the PDS revenues to all
copyright owners for licenses under both the section 114 (which
includes section 112 royalties) and 115. Under Alternative B, the
Services would pay 80% of PDS revenues for the same two licenses.
Johnson Second AWDS at 4-5.
---------------------------------------------------------------------------
\43\ In his oral testimony, Mr. Johnson appears to concede that
if a customer purchased a song and paid whatever price he proposes
that an additional streaming rate might not be necessary. 3/9/17 Tr.
432: 14-17 (Johnson) (``my proposal is that if you paid up front . .
. you might not need those Subpart B [streaming] rates.'').
---------------------------------------------------------------------------
In his written direct statement Mr. Johnson does not propose any
benchmark or other evidence that would justify a ``buy button''
requirement with a rate of 80% or 84% of PDS revenues. He does assert,
however, that it is the ``only reasonable proposal that captures the
true value of a music copyright today and historically.'' Johnson
Second AWDS at 5. Ultimately, Mr. Johnson concedes that the Judges
previously rejected his proposal to combine the section 112/114 and 115
rates in Web IV and that the proposal continues to be impracticable. 3/
9/17 Tr. 433: 2-3, 11-12 (Johnson) (``that didn't happen in Web IV and
. . . it won't happen here . . . it's so segmented, all the different
licenses, it's probably impossible.'').
While the Judges appreciate Mr. Johnson's participation in the
proceeding, they must view his proposal through the prism of the
Copyright Act. Nothing in section 115 would authorize the Judges to
require all Services availing themselves of the section 115 license to
include a mandatory ``buy button'' as part of any service offering.
Services may install a ``buy button'' if they wish, but the Judges
cannot mandate that service business innovation as Mr. Johnson
proposes.
Likewise, the Judges have no authority to set the price that
Services charge consumers for purchasing a download whether from a PDD
service offering or through Mr. Johnson's proposed buy button. Even if
the Judges had the authority to impose a ``buy button'' requirement on
the Services, it is unclear what purpose that button would serve other
than to alert consumers to the possibility of buying a song they happen
to stream. The Judges believe consumers of music are already aware that
if they want to buy a song they can do so. Perhaps Mr. Johnson believes
with a buy button, consumers might be more willing to click on the
button and buy the song than if the button were not visible and readily
available. Mr. Johnson provides no evidence to support that premise. As
for the 80% or 84% combined royalty that Mr. Johnson proposes for the
section 112/114 and 115 licenses, he provides no evidence upon which
the Judges might base such a royalty other than his belief that it is
the ``only reasonable proposal that captures the true value of a music
copyright today and historically.'' See Johnson Second AWDS at 5. Mr.
Johnson's opinion alone is insufficient evidence upon which to support
his ``buy button'' proposal.
Given the lack of sufficient substantial and persuasive evidence to
support the
[[Page 1925]]
GEO proposal, the Judges will not further analyze it.\44\ The Judges
respectfully decline to adopt Mr. Johnson's proposed approach to rate
setting.
---------------------------------------------------------------------------
\44\ Mr. Johnson's oral testimony went well beyond his ``buy
button'' proposal and included criticism of the current Copyright
Act as well as criticism of the Services' rate proposals and
business models and other concerns about the music industry more
generally. While the Judges considered Mr. Johnson's testimony in
determining the appropriate royalty rates for the upcoming rate
period, as a lay witness sponsored by no party other than himself
the Judges placed little weight on his opinions regarding the
various rate proposals of the Services and the condition of the
industry. As for his criticism of the Copyright Act, those opinions
are more appropriately directed to Congress.
---------------------------------------------------------------------------
B. Arguments Concerning Elements of the Proposed Rate Structures
1. Per-Unit Rate
Copyright Owners and Apple emphasize that a per-play royalty rate
structure, as compared with a percent-of-revenue structure, provides
transparency and simplicity in reporting to songwriters and publishers,
because it requires only one metric besides the rate itself, i.e., the
number of plays, making it much easier to calculate, report, and
understand. See, e.g., Expert Report of Marc Rysman, Trial Ex. 3026, ]
56 (Rysman WDT); Wheeler WDT, Trial Ex. 1613, ] 19; Expert Report of
Anindya Ghose, Trial Ex. 1617, ]] 83-84 (Ghose WDT); Expert Report of
Jui Ramaprasad, Trial Ex. 1615, ] 41 (Ramaprasad WDT); Witness
Statement of Peter Brodsky, Trial Ex. 3016, ] 76 (Brodsky WDT); 3/22/17
Tr. 2476-78 (Dorn); 3/23/17 Tr. 2855-56 (Ghose). Relatedly, Copyright
Owners argue that a transparent metric tied to actual usage is superior
because, under the alternative percent-of-revenue approach, services
might manipulate revenue through bundling, discounting, and accounting
techniques, or might defer service revenues and emphasize increasing
market share rather than profits. See Rysman WDT ]] 43-45.
Copyright Owners and Apple contrast their proposed per play
approaches with the current rate structure, which they characterize as
cumbersome and convoluted. They emphasize that under the current rate
structure, the Services must perform a series of different greater of
and lesser of calculations, depending on a service's business model, to
determine which prong of the rate structure is operative. See Copyright
Owners' Proposed Findings of Fact (COPFF) (and record citation
therein). Copyright Owners assert that because of this complexity,
publishers and songwriters cannot easily verify the accuracy of data
the Services input when calculating royalty payments. See Brodsky WDT ]
76; Ghose WDT ]] 80, 81, 82; Ramaprasad ]] 4, 38, 42-44; Rysman WDT ]
57; Tr. 2865 (Ghose); Tr. 824 (Joyce); Tr. 247778 (Dorn).
Beyond the issue of complexity, Copyright Owners and Apple argue
that interactive streaming services do not need the present upstream
rate structure in order to adopt any particular downstream business
model. Rather, Copyright Owners and Apple assert that a per-play
structure would establish a level of equality in the royalty rates
across the Services, without regard to business models. Songwriters and
publishers would be paid on the same transparent, fixed amount without
advantaging any one business model over another. 3/23/17 Tr. 2849, 2863
(Ghose). Thus, Copyright Owners and Apple maintain that a royalty based
on the number of plays aligns the compensation paid to the creators of
the content with actual demand for and consumption of their content.
Ghose WDT ] 84; Rysman WDT ]] 9, 58; Testimony of David Dorn, Trial Ex.
1611, ] 33 (Dorn WDT).
Copyright Owners further argue that the present rate structure's
failure to measure royalties based on per-play consumption is
counterintuitive, because it permits a decreasing effective per-play
rate even as the quantity of songs listeners consume via interactive
streaming is increasing. Israelite WDT ] 39. Copyright Owners note, for
example, that listening to [REDACTED] increased from [REDACTED] streams
in July 2014 to [REDACTED] streams in December 2016, a [REDACTED]
increase in the number of streams. Rebuttal Report of Glenn Hubbard,
Trial Exs. 132-33, Ex. 1 and ] 2.22 (Hubbard WRT); 4/13/17 Tr. 5971-72
(Hubbard). However, contemporaneously [REDACTED]'s mechanical royalty
payments to the Copyright Owners only increased [REDACTED], from
$[REDACTED] in mechanical royalties in July 2014 to only $[REDACTED] in
December 2016. Hubbard WRT ] 3.9; 4/13/17 Tr. 5971-73 (Hubbard). The
upshot, Copyright Owners assert, is that, as streaming consumption
increased dramatically from 2014 to 2016, the effective per stream
mechanical royalties paid by [REDACTED] to Copyright Owners decreased
from [REDACTED] per hundred streams in July 2014 to [REDACTED] per
hundred streams in December 2016--only [REDACTED]% of the effective per
stream rate in July 2014. 4/13/17 Tr. 5972-73 (Hubbard).
The Services made four arguments in opposition to the use of a per-
play royalty rate. The overarching theme of these arguments is that an
inflexible ``one size fits all'' rate structure would be ``bad for
services, consumers, and the copyright owners alike.'' See Services'
Joint Proposed Findings of Fact (SJPFF) at 89.
First, the Services argued that an upstream per-play rate would not
align with the downstream demand for ``all-you-can-eat'' streaming
services. As Professor Marx testified, a per stream fee introduces a
number of distortions and inefficiencies, encouraging a capping of
downstream plays and reduces incentives for services to meet the demand
of consumers ``who are going to stream a lot of music.'' Written Direct
Testimony of Leslie Marx, Trial Ex. 1065, ]] 130-131 (Marx WDT). In
this vein, Pandora's then-president, Michael Herring, noted that a per-
play consumption-based model where the revenue is fixed creates
uncertainty and volatility, which discourage investment and hamper
profitability. 3/14/17 Tr. 894-95 (Herring). Mr. Herring noted that
this is a general economic problem that occurs when a retail
subscription business has fixed subscription revenues per customer, but
variable (and unpredictable) costs derived from variable (and
unpredictable) downstream usage. Written Rebuttal Testimony of Michael
Herring, Trial Ex. 888, at ] 17 (Herring WRT); 3/14/17 Tr. 894-98
(Herring); see Mirchandani WDT ] 39 (one-size-fits-all rate is not
``offering agnostic'' as Copyright Owners claim, but rather is
``offering determinative.'').
Second, the Services argued that there is no ``revealed
preference'' in the marketplace for a per-play royalty rate structure
for licensing musical works or sound recordings rights, as opposed to a
percent-of-revenue (with minima) royalty structure. In particular, they
contended that mechanical royalties have never been set on a per-play
basis. See Herring WRT ] 19. The Services also pointed to the
interactive services' direct licenses with music publishers, PROs and
record companies, claiming that all rely on a percent-of-revenue
royalty calculation. SJPFF ]] 174-175 (and record citations therein).
They acknowledged that some of the direct license agreements with
record companies contain alternative per-user prongs but they noted
that this is consistent with the existing rate structure which already
contains a per-subscriber minimum, but not a per-play prong. Id. ] 175.
Further, the Services noted that Apple, which is proposing a per-play
rate, in fact has [REDACTED]. See 3/23/17 Tr. 2857 (Ghose); 3/22/17 Tr.
2479 (Dorn).
[[Page 1926]]
Third, the Services discounted the argument that Copyright Owners'
proposed rate structure is superior to the present rate structure
because the latter is too complicated or cumbersome. They characterized
this criticism as ``overblown'' and assert that any problems arising in
the use of a revenue-based headline rate is mitigated by the inclusion
of per subscriber and TCC minima. SJPFF ] 174. They further noted that
section 801(b)(1) does not list as a criterion or objective that the
rates be simple, easy to understand, or otherwise ``transparent.''
Services' Joint Reply to Apple PFF (SJR(Apple)) at 34, 36. Thus, they
argued, the Judges cannot jettison an otherwise appropriate rate
structure because some unquantified segment of the songwriting
community might be uncertain as to how their royalties were computed.
Separate from these four arguments against per-play rate proposals,
the Services noted a practical problem related to Apple's specific
proposal: Apple's proposal calls for deducting performance royalties
from the per-play mechanical royalty, yet it does not explain how to
convert the typical percent-of-revenue performance royalty into a per
play rate in order to perform that computation.\45\ The Services noted
that Apple Music's Senior Director, David Dorn, was unable to explain
how this calculation would be made. See 3/22/17 Tr. 2508-09 (Dorn).
Thus, the Services asserted that Apple's proposal would introduce
``more complexity, not less,'' SJR (Apple) at 34.
---------------------------------------------------------------------------
\45\ This problem is irrelevant to Copyright Owners' proposal,
because they propose the elimination of the All-In provision in the
rate structure.
---------------------------------------------------------------------------
2. Flexible Rate
The Services propose a rate structure for configurations in extant
subparts B and C that follows the structure in the existing regulations
adopted after the 2012 Settlement.\46\ The Services asserted that they
are not advocating preservation of the basics of the settlement rate
structure merely to preserve the status quo. See 3/13/17 Tr. 564
(Katz). Rather, the Services, through their economic experts, argue
that the settlement rate structure as an appropriate benchmark for the
Judges to weigh, consider, adjust (if appropriate), and apply or
reject, as they would any proffered benchmark. The Services note that
considering the current rate structure as a benchmark is instructive
because it allows for identification of market value by analogy. The
Services assert that examination of a comparable circumstance obviates
the need for experts and the Judges to build a theoretical model from
the ``ground up.'' See 3/13/17 Tr. 691-2 (Katz).
---------------------------------------------------------------------------
\46\ Except when it doesn't. The Services seek the elimination
of the ``Mechanical Floor,'' a significant departure from the
existing structure.
---------------------------------------------------------------------------
The Services' experts opine that, for a number of reasons, the 2012
rate structure is a highly appropriate benchmark. First, they note that
it applies to (1) the same rights; (2) the same uses; and (3) the same
types of market participants. See 3/15/17 Tr. 1082-83 (Leonard); 3/13/
17 Tr. 551, 566-67 (Katz). Additionally, the Services maintain that
because the 2012 rate structure resulted from a negotiated settlement,
it reflects market forces, including an implicit consensus on such
issues as substitutional effects. See 3/13/17 Tr. 580, 722 (Katz). More
broadly, the Services assert the 2012 Settlement demonstrates the
``revealed preferences'' of these economic actors. See 3/15/17 Tr. 1095
(Leonard); see also Amended Written Direct Statement of Gregory K.
Leonard, Trial Ex. 695, ] 72 (Leonard AWDT) (direct license agreements
that track statutory structure evidence ``revealed preference'').
Finally, the Services assert that the 2012 Settlement rate structure as
benchmark is relevant and helpful because, although it was adopted five
years ago, it is nonetheless a relatively recent agreement, covering
the current rate period. See Katz WDT ]] 6, 71; 3/13/17 Tr. 608-09
(Katz); Leonard AWDT ] 45 et seq.; 3/15/17 Tr. 1082 (Leonard).
The Services' experts candidly acknowledge that the rate structure
they advocate cannot be construed economically as the ``best'' approach
to pricing in this market. See, e.g., 4/7/17 Tr. 5574-76 (Marx).
Rather, the Services' experts uniformly link the fact that the marginal
physical cost of streaming is zero to the need for a flexible rate
structure, such as now exists. See, e.g., 3/20/17 Tr. 1829 (Marx); 3/
13/17 Tr. 558 (Katz); 3/15/17 Tr. 122 (Leonard). Indeed, Copyright
Owners' economic experts acknowledge this underlying fact. See, e.g.,
3/30/17 Tr. 4086 (Gans) (streamed music is ``non-rival good.''); 3/27/
17 Tr. 3167 (Watt); 4/3/17 Tr. 4318 (Rysman); 4/13/17 Tr. 5917-18
(Hubbard).
Professor Katz noted that the existing revenue-based rate structure
captures important specific aspects of the economics of the interactive
streaming market, accounting for the variable willingness to pay (WTP)
among listeners and the corollary variable demand for streaming
services. See 3/13/17 Tr. 586-87 (Katz); see also Written Rebuttal
Testimony of Leslie M. Marx, Trial Ex. 1069, ]] 239 et seq. (Marx WRT);
4/7/17 Tr. 5568 (Marx) (present structure serves customer segments with
variety of preferences and WTP).\47\ Professor Rysman, an expert for
Copyright Owners, hypothesized that under the current rate regime
overall revenues might be increasing because of movements ``down the
demand curve'' (i.e., changes in quantity demanded in response to lower
prices), rather than because of, or in addition to, an outward shift of
the demand curve (i.e., increase in demand at every price). 4/3/17 Tr.
4373-74 (Rysman). Professor Hubbard perceives a link between the
existing rate structure and the ``growth in the number of consumers,
number of streams, entry, the number of companies providing the
streaming services, and the identity of the companies providing those
services . . . .'' 4/13/17 Tr. 5978 (Hubbard); see Hubbard WDT ] 4.7
(settlement rate structure provides ``necessary flexibility to
accommodate the underlying economics of [REDACTED]'s various digital
music service offerings.''); \48\ 3/15/17 Tr. 1176 (Leonard)
(notwithstanding changes in streaming marketplace, economic structure
of marketplace, which made percent-of-revenue appropriate, has not
changed).
---------------------------------------------------------------------------
\47\ In more formal economic terms, Professor Katz noted that
the present structure enhances variable pricing that allows
streaming services ``to work [their] way down the demand curve,''
i.e., to engage in price discrimination that expands the market,
providing increased revenue to the Copyright Owners as well as the
Services.'' 3/13/17 Tr. 701 (Katz).
\48\ The Copyright Owners sought to rebut Professor Hubbard's
argument by confronting him with the offerings of Tidal, a streaming
service that does not compete by offering a low-cost service.
Eisenach WDT ]] 49-50. However, Tidal's offering of a higher priced
subscription service that provides enhanced features such as hi-
fidelity sound quality actually proves the point that Professor
Hubbard and the other Service economists are making: There is a
segmentation of demand across product characteristics and WTP that
permits differential pricing in this industry.
---------------------------------------------------------------------------
The Services' experts further assert that the multiple pricing
structures necessary to satisfy the WTP and the differentiated quality
preferences of downstream listeners relate directly to the upstream
rate structure to be established in this proceeding. Professor Marx
opines that the appropriate upstream rate structure is derived from the
characteristics of downstream demand. 3/20/17 Tr. 1967 (Marx) (rate
structure upstream should be derived from need to exploit WTP of users
downstream via a percentage of revenue). This upstream to downstream
consonance in rate structures represents an application of the concept
of ``derived demand,'' whereby the demand upstream for inputs is
dependent upon the demand for the
[[Page 1927]]
final product downstream. Id.; see P. Krugman & R. Wells,
Microeconomics at 511 (2d ed. 2009) (``[D]emand in a factor market is .
. . derived demand . . . [t]hat is, demand for the factor is derived
from the [downstream] firm's output choice'').
The Services' economists also contend that the existing rate
structure has produced generally positive practical consequences in the
marketplace. As the Services' joint accounting expert, Professor Mark
Zmijewski testified, the decrease in publishing royalties from the sale
of product under subpart A since 2014 has been offset by an increase in
music publisher royalties (mechanical + performance royalties) over the
same period. Expert Report of Mark E. Zmijewski, Trial Ex. 1070, ]] 38,
40 (Zmijewski WRT); 4/12/17 Tr. 5783 (Zmijewski). Professor Hubbard
dismisses as economically ``meaningless'' the argument that Copyright
Owners have suffered relative economic injury under the current rate
structure simply because the increase in their revenues from
interactive streaming has been proportionately less than the growth in
the number of interactive streams. 4/13/17 Tr. 5971-73 (Hubbard). There
is no evidence in this record that, if the price of the services
available to these low to zero WTP listeners had been increased, they
would have paid the higher price. In fact, the only survey evidence in
the record suggests that listeners to streaming services have a highly
elastic demand, i.e., they are highly sensitive to price increases.\49\
---------------------------------------------------------------------------
\49\ In a real-life example of this phenomenon, [REDACTED]
explained [REDACTED]'s internal analysis of the marketplace impact
of [REDACTED]'s decision to discount the monthly subscription price
of its [REDACTED] service [REDACTED]. The analysis indicated that
[REDACTED]% of the subscribers were new to the interactive streaming
segment of the market, and [REDACTED]% came from existing
subscribers to other services at the standard $9.99 monthly price.
As [REDACTED] explained, music publishers would lose royalties on
$[REDACTED] of revenue on the [REDACTED]% who migrated away from a
$9.99 service, but would add royalties on the $[REDACTED] for each
subscriber who was part of the [REDACTED]% cohort. See 3/16/17 Tr.
1576-1639 ([REDACTED]); see also 3/21/17 Tr. 2243-44 (Hubbard).
---------------------------------------------------------------------------
On the Licensee Services' side of the ledger, Professor Katz
identifies the entry of new interactive streaming services and new
investment in existing interactive streaming services during the
present rate period as evidence that the present rate structure is
``working.'' 3/13/17 Tr. 667 (Katz). He notes the ubiquity of percent-
of-revenue based royalty structures in the music industry, indicating
(as a matter of revealed preference) the practicality of a revenue-
based royalty system. See 3/13/17 Tr. 766-67 (Katz).\50\
---------------------------------------------------------------------------
\50\ There is a facially discordant aspect to the Services'
argument. They are consistently incurring losses under this rate
structure and the present rates, yet they are essentially content
for the present rates and structure to be continued. The presence of
chronic losses would facially suggest that the Services would be in
need of rate reduction (as some of their experts suggest would be
proper given their analyses). This conundrum is explained by the
Services' engaging in competition for market share, as discussed
infra.
---------------------------------------------------------------------------
Although the Services' economic experts extol the benefits of the
current rate structure, they acknowledge the problem, whether
hypothetical or real, that the Services have an incentive and a
capacity to minimize the amount of revenue that is attributed to the
revenue base. Further, even absent any wrongful intent with regard to
the measurement of revenue, the Services recognize that attribution of
revenue across product/service lines of various service offerings can
be difficult and imprecise. See, e.g., 4/5/17 Tr. 5000 (Katz).
Additionally, the Services might focus on long-term profit
maximization, thereby deferring shorter-term profits through
temporarily lower downstream pricing in a manner that suppresses
revenue over that shorter-term. The Services might also use music as a
``loss leader,'' displacing streaming revenue to encourage consumers to
enter into the so-called economic ``ecosystem'' of the streaming
services, especially the multi-product/service firms in this
proceeding, such as Amazon, Apple, and Google. The operators of these
multi-product environments might assume music consumers can be exposed
to other goods and services available for purchase. Third, the Services
might obscure royalty-based streaming revenue by offering product
bundles that include music service offerings with other goods and
services, rendering it difficult to allocate the bundle revenue between
royalty-bearing service revenue and revenue attributable to other
products in the bundle.
Professor Katz testified, however, that the existing rate structure
accommodates these bundling, deferral, and displacement issues by the
use of minima that are triggered if the royalty resulting from the
headline percent-of-service revenue falls below the established minima.
Katz WDT ]] 82-83; 3/13/17 Tr. 670 (Katz). Moreover, he concluded that
because the marketplace appears to be functioning, the alternative
minimum rates must be adequately handling revenue measurement issues.
Id. at 738; 4/5/17 Tr. 5055-57 (Katz). In similar fashion, Dr. Leonard
opined that the 2012 Settlement rate structure created a number of
``buckets'' to deal with problems of this sort, although he
acknowledged that there was no reason why adjustments could not be made
to the ``buckets'' going forward. 3/15/17 Tr. 1227-28 (Leonard); see
also 3/13/17 Tr. 670-71 (Katz) (did not analyze whether to adjust
``specific rates'' of the minima).
Copyright Owners criticize the 2012 rate structure because of the
inherent problems with measurement of revenue. Specifically, Copyright
Owners focus on deferral and displacement problems. See Rysman WDT ]
13. With regard to revenue deferral, Copyright Owners argue that the
services' attempt to grow their customer base and future profits is
fueled by a strategic decision to lower retail prices, thus sacrificing
current revenue for future economic benefits. Id.; see also 3/21/17 Tr.
2081-83 ([REDACTED]).
The Services concede that there is a period in the life-cycle of a
streaming service when ``user numbers'' may be more important to a
service, its investors, and its market price; however there comes a
time, in the ``late-stage private and public markets,'' when
``[REDACTED].'' Written Rebuttal Testimony of Barry McCarthy, Trial Ex.
1066, ]] 37 (McCarthy WRT).\51\ The Services argue, however, that
Copyright Owners misunderstand the emphasis on long term growth. That
emphasis, they argue, relates to the Services' willingness to sacrifice
short-term profitability by incurring up-front costs, which has no
bearing on current period revenues. 3/21/17 Tr. 2085 ([REDACTED]). The
Services nonetheless acknowledge that they focus currently on the
second derivative of revenue--the ``growth of the growth''--rather than
revenue growth.
---------------------------------------------------------------------------
\51\ No witness offered any testimony that might indicate
whether the currently operating Services perceive themselves to be
at the beginning, middle, or ``late-stage'' of this cycle.
---------------------------------------------------------------------------
The Judges find that the record in this proceeding indicates that
the Services do seek to engage to some extent in revenue deferral to
promote a long-term growth strategy. A long-term strategy that
emphasizes scale over current revenue can be rational, especially when
a critical input is a quasi-public good. Growth in market share and
revenues is not matched by a commensurate increase in the cost of
inputs, whose marginal cost of production (reproduction in this
context) is zero. It appears to the Judges that the nature of the
downstream interactive streaming market and its reliance on scaling for
success, results
[[Page 1928]]
necessarily in a competition for the market rather than simply
competition in the market. This competition emphasizes the importance
of the dynamic creation of new markets and ``new demand curves,''
recognizing that short-term profit or revenue maximization might be
inconsistent competing for the market long-term.
When the Services pay royalties as a percent of their current
revenue, the input suppliers, i.e., Copyright Owners, are likewise
deferring some revenue to a later time period and assuming some risk as
to the ultimate existence of that future revenue. One way the Copyright
Owners could avoid this impact would be to refuse to accept a percent-
of-revenue form of payment and move to a fixed per-unit price. Another
way would be to establish a pricing structure that provides minima and
floors, below which the revenue could not fall. The bargain struck
between Copyright Owners and Services in 2012 is an example of the
latter structure.
In this proceeding, the Services assert there is no evidentiary
support for Copyright Owners' conclusory assertion that the Services
intentionally displace revenue by engaging in ``cross-selling'' or
revenue bundling. See SJPFF at 308. The Judges agree that there is no
support for any sweeping inference that cross-selling has diminished
the revenue base.
Regardless of the existence or extent of cross-selling, Copyright
Owners argue that the Services manipulate revenue calculations in their
favor, allegedly defining revenue in opportunistic ways. See Rysman WDT
] 44; Rysman WRT ] 15; see also Ghose WDT ]] 78 (arguing on behalf of
Apple that ``service revenue for . . . bundles is subjective and can be
interpreted differently by different service providers''). Copyright
Owners maintain that they cannot discern the alleged manipulation and
opportunism as it occurs, because the booking of revenue among lines of
business is ``opaque to publishers.'' Rysman WDT ] 43; Rysman WRT ] 15;
Ghose WDT ]] 80-81. In support of this assertion of revenue
manipulation, Copyright Owners point to [REDACTED].
Before [REDACTED] engaged in [REDACTED], it engaged in a pricing
analysis to determine its optimal price point for [REDACTED] and
interactive streaming access. See [REDACTED] Pricing Study--Final
Report, Trial Ex. 113 ([red] Study). [REDACTED] contends its pricing
analysis demonstrated that [REDACTED]. Trial Ex. 111, ] 14 n.9
([REDACTED] WRT). In conjunction with [REDACTED]. [REDACTED] lowered
the [REDACTED] subscription price to $[REDACTED] per month, compared to
the full $[REDACTED] per month price. Amazon determined that Prime
members who were unwilling to pay the full [REDACTED]/month
subscription price for [REDACTED] could be enticed to pay $[REDACTED]
per month less, subscribing to [REDACTED] service at $[REDACTED]/month.
Id. ] 22.
[REDACTED] maintains these [REDACTED] created ``unique distribution
channels'' generating new listeners and thus new royalties for the
licensors without cannibalizing higher royalties at the full
$[REDACTED] per month subscription price. Id. ]] 25, 21-22.\52\
[REDACTED] asserts that the net benefits of its pricing strategies are
confirmed by a consumer survey undertaken by [REDACTED] Mr. Robert L.
Klein, Chairman and co-founder of Applied Marketing Science, Inc.
(``AMS''), a market research and consulting firm. In that survey (Klein
Survey), Mr. Klein identified [REDACTED]. At a high level, the Klein
Survey results indicated that [REDACTED]'s music listeners had an
overall high elasticity of demand for streamed music, meaning that
their subscription demand was highly sensitive to changes in
subscription prices. Written Rebuttal Testimony of Robert L. Klein,
Trial Ex. 249, ] 67 (Klein WRT).\53\
---------------------------------------------------------------------------
\52\ More precisely, although some [REDACTED] listeners might
have paid the full subscription price, the [REDACTED] pricing
analysis indicated that any revenue losses arising from discounts
obtained by these sub-groups were dwarfed in term of revenue gains
from the new subscribers at the lower discounted rates [REDACTED].
[REDACTED] WRT ] 22.
\53\ It is important to note that Copyright Owners' attacks on
the Klein Survey are not levelled by any witnesses, nor contradicted
by their own survey expert, because Copyright Owners elected not to
proffer such an expert in their direct (or rebuttal) cases. Rather,
Copyright Owners elected to make a descriptive argument regarding
the elasticity of demand among different segments of the market, as
opposed to a survey-based or econometric study of price elasticity.
---------------------------------------------------------------------------
Copyright Owners attack the Klein Survey on several fronts. The
arguments made by Copyright Owners are insufficient, however, to
seriously weaken the probative value of the Klein Survey. In the end,
the Judges are not persuaded by the Copyright Owners' revenue bundling
arguments not to adopt a flexible, revenue-based royalty rate.
3. All-In Rate vs. Independent Mechanical Rate
The current mechanical royalty rate is calculated as a so-called
``All-In'' rate. When calculating the mechanical rate the parties
subtract from the base rate the amount paid by the interactive
streaming services to performing rights organizations (PROS) for the
musical works performance right. All five Services urge the Judges to
establish a statutory rate structure for the forthcoming rate period
that contains this ``All-In'' feature; whereas Copyright Owners request
that the rate for the forthcoming rate period be set without regard to
the amounts the Services pay PROs for the performance rights.
According to the Services, a key aspect of the 2008 and 2012
settlements was the deduction of expenses for public performance
royalties; in other words, the top-line rate the Services paid under
the section 115 license would be added to the performance rights
royalties for an All-In musical works fee from the Services' point of
view. Levine WDT ] 35; Written Direct Testimony of Adam Parness, Trial
Ex. 875, ] 7 (Parness WDT); 3/8/17 Tr. 298-99 (Parness). According to
Apple, the absence of any value in the mechanical license separate from
the performance license is underscored by the fact that interactive
streaming is the only distribution channel that pays both a performance
royalty and a mechanical royalty. Noninteractive services, SDARS, and
terrestrial radio pay a performance royalty but not a mechanical
royalty, whereas record companies pay a mechanical royalty under
subpart A but not a performance royalty. Rebuttal Testimony of David
Dorn, Trial Ex. 1612, ] 10 (Dorn WRT).
According to the Services this All-In rate structure is consistent
with the parties' expectations in settling Phonorecords I and II. See
SJPFF ] 112. Additionally, the Services note that many direct licenses
between musical works copyright owners and streaming services
incorporate the ``All-In'' feature of the existing section 115 license.
See SJPFF ]] 143-145 (and record citations therein).
Separately, Apple concurs in the proposal of an ``All-In'' rate in
the forthcoming rate period. According to Apple, the Judges
should adopt an All-In rate for interactive streaming because (1)
mechanical and performance royalties are complementary rights that
must be considered together in order to prevent exorbitant costs,
(2) the current statute use an All-In rate, (3) All-In rates provide
greater predictability for businesses, and (4) recent fragmentation
and uncertainty with respect to performance licenses threaten to
exacerbate the problems of high costs and uncertainty already
present in the industry.
Apple PFF ]] 138, et seq. (and record citations therein). Apple
maintains that, as a policy matter, an All-In rate helps maintain
royalties at an economically
[[Page 1929]]
efficient level because it sets a single value for all of the rights
that interactive streaming services must obtain from publishers and
songwriters. See Rebuttal Report of Professor Jui Ramaprasad, Trial Ex.
1616, ] 13 (Ramaprasad WRT) (separate mechanical royalty could lead to
``unreasonably high combined royalties for publishers and
songwriters''); 3/23/17 Tr. 2667-69, 2670 (Ramaprasad); see also
Leonard AWDT ] 56; Katz WDT ] 94; Written Direct Testimony of Michael
Herring, Trial Ex. 880, ] 59 (Herring WDT). Accordingly, Apple asserts
that adoption of an All-In rate will ensure that these two
complementary rights are considered in tandem, with the cost of one
offset against the cost of the other. See Dorn WRT ] 15; see also 3/13/
17 Tr. 587-588 (Katz); 3/15/17 Tr. 1191-92 (Leonard); Herring WDT ] 59.
Apple, consistent with the other Services, argues that the All-In
rate structure is particularly important because of recent
``fragmentation'' \54\ and uncertainty in performance rights licensing.
The Services all claim this potential fragmentation threatens to
exacerbate existing uncertainty over royalty costs. See Dorn WRT ]] 17-
18; Ramaprasad WRT ]] 13, 63; Parness WDT ]] 16-20; Katz WDT ]] 87-94;
3/13/17 Tr. 602-04 (Katz). Apple notes that this problem may be
amplified because of the emergence of a fourth PRO, Global Music Rights
(GMR) in addition to SESAC which, like GMR, is not subject to musical
works performance license proceedings in the Rate Court.\55\ Parness
WDT ] 18; Katz WDT ] 91; see 3/9/17 Tr. 382-83 (Parness); 3/13/17 Tr.
(Katz) 602-04.\56\ The Services also raise the specter of future
``withdrawals'' by music publishers from one or more PROs.
---------------------------------------------------------------------------
\54\ In this context, ``fragmentation'' refers to the existence
of more than one owner of copyrights to a single musical work.
\55\ Since 1941, ASCAP and BMI have been subject to Consent
Decrees they reached with the Department of Justice in a DOJ
antitrust suit. See, e.g., United States v. Broadcast Music, Inc.,
1940-43 Trade Cas. ] 56,096 (W.D.Wis. 1941).
\56\ Apple also claims that there is recent legal uncertainty
because of the 2016 decision regarding fractional licensing in
United States v. Broadcast Music Inc., 64 Civ. 3787 (LLS), 2016 WL
4989938 (S.D.N.Y. Sept. 16, 2016), which Apple claims has created
even more market power for the owners of musical works. Apple
hypothesizes fractional licensing ``almost certainly will lead to
higher total payments for performance rights, higher transactions
costs, and greater uncertainty.'' Parness WDT ] 20. In the BMI case,
according to Apple, the Rate Court confirmed that PROs can grant
licenses for fractional interests in musical works, meaning that in
order to offer a work, interactive streaming services must obtain
licenses from every entity with any de minimis interest in the work.
Id.
---------------------------------------------------------------------------
Copyright Owners' initial response to the All-In structure is a
jurisdictional argument. They emphasize that this is a proceeding to
set rates and terms for the section 115 compulsory mechanical license
to make and distribute phonorecords, not to perform works. 17 U.S.C.
115, 801(b)(1). More particularly, Copyright Owners note that, the
section 115 compulsory license explicitly applies solely to the
exclusive rights bestowed by clauses (1) and (3) of section 106; that
is the rights to make and to distribute phonorecords of [nondramatic
musical] works.'' This proceeding does relate to the exclusive right
provided by clause (4) to perform the work publicly. 17 U.S.C. 106,
115. Thus, Copyright Owners argue, the public performance right
provided by 17 U.S.C. 106(4) is an entirely separate and divisible
right from the mechanical right at issue in this proceeding and is not
subject to the section 115 license. See COPCOL ] 314 (citing 17 U.S.C.
106, 115, 201(d) and 2 Nimmer on Copyright sec. 8.04[B] (``[T]he
compulsory license does not convey the right to publicly perform the
nondramatic musical work contained in the phonorecords made under that
license. Similarly, a grant of performing rights does not, in itself,
confer the right to make phonorecords of the work.'')).
Copyright Owners note that performance royalties are negotiated
between licensors and licensees, subject to challenge in a Rate Court
proceeding. They conclude that the Judges cannot set an ``All-In'' rate
because they have ``not been vested with the authority to set rates for
performance rights because they are not covered by section 115.''
Copyright Owners' Proposed Conclusions of Law ] 315 (COPCL). Copyright
Owners further note that the Services have not provided evidence in
this proceeding to justify an ``All-In'' rate, such as evidence showing
the rates and terms in existing performance licenses; the duration of
such licenses; benchmarks for performance rights licenses; and the
impact of interactive streaming on other sources of performance income,
including non-interactive streaming, terrestrial radio, and satellite
radio income. Further, Copyright Owners point out that the PROs and all
music publishers would be necessary parties for any such determination.
See id. ] 319.
For these reasons, Copyright Owners decry as mere ``sophistry'' the
Services' argument that they are not asking the Judges to set
performance rates, but rather only to ``set'' a ``mechanical'' rate
that permits them to deduct what they pay as a performance royalty.
More particularly, they argue that this approach, if adopted, would
leave the mechanical rate indeterminate, subject to negotiations or
judicial action regarding the performance license rate. See id. ] 320.
Indeed, Copyright Owners note, under the Services' ``All-In'' proposal,
the mechanical rate could be zero (if performance royalties are agreed
to or set by the Rate Court at a rate that is greater than or equal to
the ``All-In'' rate proposed by the Services here). Copyright Owners
argue that a mechanical royalty rate of zero ``is anything but
reasonable. . . .'' Id. ] 322.
In an evidentiary attack, Copyright Owners demonstrate that the
only percipient witness who engaged directly in the 2008 negotiations
involving the ``All-In'' rate was the NMPA president, David Israelite.
By contrast, the Services' two witnesses, Mr. Parness and Ms. Levine,
did not participate directly in those negotiations. See Copyright
Owners' Reply Proposed Findings of Fact ] 125 (CORFF). Thus, Copyright
Owners assert that the Services cannot credibly argue based on what the
negotiating parties actually intended with regard to, inter alia, the
``All-In'' rate.\57\
---------------------------------------------------------------------------
\57\ Copyright Owners take this argument one step further--
maintaining that consequently the Services ``have presented no
competent evidence that an ``All-In'' rate structure ``is consistent
with the parties' expectations in settling Phonorecords I and II.''
CORSJPCL ] 112. It is difficult to conclude that this fundamental
rate structure, agreed to in two separate settlements between the
parties, was not consonant with their ``expectations.''
---------------------------------------------------------------------------
Copyright Owners also take aim at the Services' argument that it
matters not whether they pay royalties designated as ``performance'' or
``mechanical,'' because the same rights owners are also receiving
performance royalties. According to Copyright Owners, this argument (1)
ignores the Copyright Act's separate and distinct mechanical and
performance rights; (2) ignores that the rates for the use of those two
rights, to the extent not agreed, are set in different jurisdictions;
and (3) ignores the disruption that would be caused by eliminating
mechanical royalties, e.g., disruptions arising from (a) the fact that
mechanical royalties are the most significant source of recoupment of
advances to songwriters; and (b) songwriters receive a greater share of
mechanical royalties than they do of performance royalties (both
because of the standard splits in songwriter agreements and the fact
that performance income, unlike mechanical income, is diminished by PRO
commissions). COPCL ] 323; COPFF ] 640.
[[Page 1930]]
Copyright Owners also assert that ``a single All-In payment will .
. . diminish payments to songwriters, and will negatively impact the
publishers' ability to recoup advances, which will, in turn, negatively
impact the size and number of future advances.'' Witness Statement of
Thomas Kelly, Trial Ex. 3017, ] 66 (Kelly WDT); Witness Statement of
Michael Sammis, Trial Ex. 3019, ] 27 (Sammis WDT); Witness Statement of
Annette Yocum, Trial Ex. 3021, ] 23 (Yocum WDT); Israelite WDT ] 71.
Copyright Owners counter the Services' claim that increasing
``fractionalization'' of licenses justifies an ``All-In'' rate as a red
herring. Specifically, they argue there has always been fractional
licensing of performance rights by the PROs; there typically are
multiple songwriters and publishers with ownership rights in a song and
they might not all be affiliated with the same PRO. The recent
litigation only confirmed that there is no legal basis on which any one
PRO has the right to license rights it does not have. Rebuttal Witness
Statement of David M. Israelite, Trial Ex. 3030, ]] 65-66 (Israelite
WRT); 3/29/17 Tr. 3662-63 (Israelite); 3/9/17 Tr. 372-373 (Parness).
Moreover, contrary to the Services' assertions, they presented no
evidence that the presence of GMR, a new PRO, has altered the extent of
fragmentation in any manner, let alone increased the degree of
fragmentation in the marketplace. Copyright Owners point out that the
Services admitted that GMR represents fewer than 100 songwriters and
has a meager market share of roughly 3 percent of the performance
market. 3/9/17 Tr. 365-67 (Parness); see Israelite WRT ] 59. Copyright
Owners also note that the Services presented no evidence either that
there has been an increase in performance rates in licenses issued by
GMR, or, more generally, of any actual or potential impact of this
alleged ``fragmentation'' of the performance rights marketplace on
their interactive streaming businesses. 3/9/17 Tr. 381 (Parness)).
Finally, Copyright Owners note that, if it ever were a
justification for an All-In rate, the issue of publisher withdrawals
from PROs has been overtaken by events. Specifically, they note that
the ASCAP and BMI Rate Courts in the Southern District of New York, the
Second Circuit, and the Department of Justice have determined that
partial withdrawals by publishers are not permitted. Israelite WRT ]]
62-63, citing In re Pandora Media, 785 F.3d 73, 77-78 (2d Cir. 2015),
aff'g 6 F. Supp. 3d 317 (S.D.N.Y. 2014).\58\
---------------------------------------------------------------------------
\58\ See also Determination of Royalty Rates and Terms for
Making and Distributing Phonorecords (Phonorecords III); subpart A
Configurations of the Mechanical License, Docket No. 16-CRB-0003-PR,
82 FR 15297, 15298 n. 15 (March 28, 2017). (``[M]usic licensing is
fragmented, both by reason of the Consent Decree and the
fragmentation of the statutory licensing schemes in the Act. These
issues are beyond the scope of authority of the Judges; they can
only be addressed by Congress.'').
---------------------------------------------------------------------------
4. Mechanical Floor
Copyright Owners urge the Judges to retain the feature of the
extant rate regulations establishing a Mechanical Floor; that is, a
rate below which the calculated mechanical license rate could not
fall.\59\ They emphasize that the revenue displacement and deferral
problems they perceive under a percent-of-revenue rate structure are
alleviated with a Mechanical Floor because that rate is based on a per-
subscriber calculation. COPFF ]] 639-40. Copyright Owners maintain that
the Services' desire to eliminate the Mechanical Floor is nothing other
than a ``thinly veiled effort to sharply reduce the already unfairly
low mechanical royalties.'' COPFF ] 644. The import of the Mechanical
Floor is underscored by Dr. Eisenach who testifies that, in 2015, the
Services triggered the Mechanical Floor in over 43% of service-months
(66 of 152 such months). Written Rebuttal Testimony of Jeffrey A.
Eisenach, Trial Ex. 3033, ] 115 (Eisenach WRT).
---------------------------------------------------------------------------
\59\ If the All-In Rate calculation results in a dollar royalty
payment below the stated Mechanical Floor rate, then that floor rate
would bind.
---------------------------------------------------------------------------
Copyright Owners further argue that the Mechanical Floor is
necessary to preserve a source of publishers' advances to songwriters
and recoupments of prior advances. COPFF ] 640 (and record citations
therein). They assert that songwriters benefit more from publishing
agreements than from performance agreements with PROs because, under
current publishing agreements, songwriters typically receive 75% or
more of mechanical royalty income; whereas, PRO's split performance
royalty income 50/50 between publishers and songwriters. Id. Moreover,
PROs charge songwriters an administrative fee, further reducing the
value of the performance royalty income relative to mechanical royalty
income. Id.
Despite their proffer of the 2012 rates as an appropriate
benchmark, the Services \60\ propose elimination of the Mechanical
Floor in the forthcoming rate period. In support of this position, the
Services assert that they acquiesced to the Copyright Owners'
insistence on the Mechanical Floor in the 2012 Settlement, because they
believed the Mechanical Floor was ``illusory,'' i.e., that it was
``highly unlikely to ever be triggered. . . .'' SJPFF ]] 127, 160 (and
record citations therein).\61\ According to the Services, experience
has shown that the Mechanical Floor in the current rate structure has
added uncertainty and has led to Services paying ``windfall'' royalties
to Copyright Owners well above the stated ``All-In'' amount. See Apple
PFF ]] 85, 165; see also Google PCOL ] 22 (triggering of Mechanical
Floor caused in some circumstances by Copyright Owners leveraging
market power).
---------------------------------------------------------------------------
\60\ Although Apple does not join in the endorsement of the 2012
rates as benchmark, Apple does propose elimination of the Mechanical
Floor for the upcoming rate period. Apple Inc. Proposed Rates and
Terms, at 4, 7-8 (royalties calculated by multiplying number of
streams times per-stream rate, subtracting public performance
royalties, and allocating per work) (May 11, 2017). Google's revised
rate proposal, which also does not rely on the 2012 rate as a
benchmark, does not include a Mechanical Floor. See, Google Amended
Proposal, at 1.
\61\ This claimed ``illusion'' became a reality, as the
[REDACTED], has been paying the vast majority of its royalties
pursuant to the Mechanical Floor, as has [REDACTED]. See, e.g., Marx
WDT ] 76; Marx WRT ] 40.
---------------------------------------------------------------------------
The Services argue that the Mechanical Floor is tantamount to a
separate rate and defeats the benefits of an All-In rate. Apple PFF ]]
164-167 (and record citations therein). They acknowledge the mechanical
rights and public performance rights are ``perfect complements'' from
the perspective of an interactive streaming service, but assert there
is no economic rationale for setting the two rates separately from one
another. Id. ] 88. The Services fear the alternative minimum Mechanical
Floor could supersede a ``reasonable headline royalty rate.'' Marx WDT
] 165; see Leonard AWDT ]] 54, 80-81 (``perfect complements'' argue for
elimination of Mechanical Floor). The Services also argue that removal
or adjustment of the Mechanical Floor would improve economic
efficiency. Marx WDT ]] 135, 165.
5. Greater-Of per Unit/per User Structure
Copyright Owners' proposal constitutes a ``greater of'' rate
structure, whereby the royalty would equal the greater of $.0015 per
play and $1.06 per-end user per month. In support of this approach,
Copyright Owners contend it establishes a value for each copy of a
musical work, independent of the Services' business models and pricing
strategies. Rysman WDT ] 89. They argue that the greater-of structure
is no more complicated than a per-play rate alone and is much less
complicated
[[Page 1931]]
than the 2012 Settlement rate structure. According to Copyright Owners,
a per-user rate adds only one additional metric for royalty
calculation. Brodsky WDT ] 76. Copyright Owners also assert that their
usage-based structure is aligned with the value of the licensed copies
because couples rates with usage and consumption. CORFF at 22. Finally,
Copyright Owners note that in music licensing agreements it is not
uncommon to find royalty rates set in a greater-of formula that
includes a per-user and a per-play prong, as well a percent-of-revenue
prong. See CORFF at 97 (and record citations therein).
The Services assert that the greater-of aspect of Copyright Owners'
rate proposal would lead to absurd and inequitable results, well above
the rates established under Copyright Owners' per-play rate prong.
Professor Ghose, one of Apple's economic expert witnesses, calculated
that under Copyright Owners' greater-of structure, interactive
streaming services would pay under the per-user prong if the number of
monthly streams per user averaged less than 707. 4/12/17 Tr. 5686-87
(Ghose). In other words, the hypothetical service would be required to
pay $1.06 per user rather than $0.0015 per stream.\62\ Id. at 5687.
---------------------------------------------------------------------------
\62\ Professor Ghose used a hypothetical scenario in which a
service had one user who listened to 300 streams in a given month.
Under Copyright Owners' $0.0015 per play prong, the service would
pay $ 0.0015 x 300, or $.45 in royalties. Under Copyright Owners'
per user prong, the service would pay a royalty of $1.06 for the one
user, which is an effective per play rate of $0.0035 per play ($1.06
/ 300) or more than twice the $0.0015 per-play rate. 4/12/17 Tr.
5687 (Ghose).
---------------------------------------------------------------------------
Importantly, Apple argues that the record in this proceeding shows
that Services' monthly streams have been historically less than 707 per
user per month. Specifically, relying on data in Dr. Leonard's Written
Rebuttal Testimony, Apple contends that the annual weighted average
number of streams per user per month across current subpart B and
subpart C service offerings has been below [REDACTED] in each year from
2012 to 2016, while the average number of streams per user per month
has exceeded 707 (which would trigger the per play prong) only
[REDACTED] according to service-by-service data. Id.; \63\ see Written
Rebuttal Testimony of Gregory K. Leonard, Trial Ex. 698, at Ex. 3b
(Leonard WRT). Apple argues that these historical data indicate that
the Services would consistently pay more than the $0.0015 per play rate
emphasized by Copyright Owners in this proceeding. See Apple PFF
284.\64\
---------------------------------------------------------------------------
\63\ Deezer averaged [REDACTED] streams in 2014 and Tidal
averaged [REDACTED] streams in 2016. Id.
\64\ This analysis underscores the inconsistency between
Copyright Owners' claim that each stream of a musical work has
``inherent value.'' See, e.g., Israelite WDT ] 39 (it ``makes no
sense'' if ``[e]ach service effectively pays to the publisher and
songwriter a different per-play royalty''). But in reality,
Copyright owners understand that each musical work also contributes
to a different value--access value (what economists call ``option
value'')--when the musical works are collectivized and offered
through an interactive streaming service, resulting in different
effective per play rates paid by services if the per user prong is
triggered. To explain this inconsistency, Copyright owners note the
existence of a second ``inherent value''--not created by the
songwriter in his or her composition--but rather created by the
user--who inherently values access to a full repertoire. But these
two purportedly ``inherent'' values are inconsistent (which is why
there are two prongs in the proposal) and, given the heterogeneity
of listeners, the ``access value'' is not ``homogeneous throughout
the market. These points illustrate but some of the reasons why a
single per play rate is inappropriate.
---------------------------------------------------------------------------
According to Apple, even Copyright Owners' own expert, using
different data, found that if the Copyright Owners' proposal had been
in effect, [REDACTED] of the [REDACTED] Services he reviewed would have
been required to pay under the per-user prong in December 2015. Rysman
WRT ] 87, Table 1. Professor Rysman's data for December 2014 indicated
that [REDACTED] of the [REDACTED] Services would have been required to
pay under the per-user prong. Id. at Table 2.
Copyright Owners do not dispute the statistical analyses; rather,
they claim that the binding nature of the per-user prong is not
problematic. They cite sound recording performance license agreements
in which a per-user of prong binds interactive streaming services at a
rate of $[REDACTED], well above the $1.06 proposed by Copyright Owners
for mechanical licenses. See CORPFF (Apple) at 104. Copyright Owners
also attempt to support the higher effective per play rates by
explaining that per-user rates reflect the value of access to the
publishers' repertoires, not just the value of an individual stream.
See CORPFF (Apple) at 104-05 (and citations therein).
C. 2012 Settlement as Rate Structure Benchmark
The Services request a rate structure that (although not uniform in
the respective particulars) generally tracks the present rate structure
(including the All-In rate approach, but excluding the present
Mechanical Floor). More particularly, they propose a structure based on
a ``headline'' percent-of-revenue royalty, but, subject to certain
minima that are triggered if the revenue-based royalty is either too
low or inapplicable.
By contrast, Copyright Owners seek a radical departure from the
present rate structure. First, Copyright Owners seek to eliminate the
All-In rate, thus decoupling the mechanical rate from the performance
rate. Second, they advocate for a replacement of the ``percent-of-
revenue with minima'' structure and a substitution of a rate equal to
the greater of a per-play royalty and a per-user royalty. Copyright
Owners' Amended Proposed Rates and Terms at 8.
Copyright Owners criticize using the 2012 rate structure as a
benchmark for rates in the present market. Copyright Owners contend
that results of a negotiated settlement have limited evidentiary value
in the present context. They also argue that the parties arrived at the
2012 rate structure and rates in a market that was not mature and that,
thus, the settlement rates were merely ``experimental.'' The Copyright
Owners further contend that any benchmark based upon a compulsory,
statutory rate is suspect because of the ``shadow'' of the statutory
construct.
1. Evidentiary Value of Settlement Rates
Copyright Owners criticize the relevance of the 2012 settlement-
based rate structure. First, they note that, as terms in a settlement,
the elements of the rate structure do not reflect the structure the
market would set, but rather reflect the parties' own understanding of
how the Judges would rule in the absence of a settlement.
Second, Copyright Owners assert that, assuming arguendo that the
current rate structure can be used for benchmarking purposes, the
Services have not presented competent evidence or testimony as to the
intentions of the settling parties who had negotiated the 2012
settlement, or, for that matter, the 2008 settlement that preceded it.
Specifically, Copyright Owners claim that the witnesses who were called
by the Services to testify did not negotiate directly with the
Copyright Owners. 3/29/17 Tr. 3621-22 (Israelite).\65\ More
particularly, the two Services' witnesses who provided testimony
concerning the negotiations, Adam Parness and Zahavah Levine,
acknowledged they had no direct involvement in the Phonorecords I
negotiations, and Ms. Levine did not engage in direct negotiations with
regard to the Phonorecords II settlement either. 3/9/17 Tr. 339-40
(Parness); 3/29/17 Tr. 3885-86 (Israelite); Israelite WRT ] 14
(indicating that Ms. Levine had left Real Networks in 2006, before her
former
[[Page 1932]]
subordinate was negotiating the 2008 settlement).
---------------------------------------------------------------------------
\65\ See supra note 57 and accompanying text.
---------------------------------------------------------------------------
Mr. Parness testified, at the time of the Phonorecords I
settlement, he was Director of Musical Licensing for RealNetworks,
Inc., an interactive streaming service and a member of DiMA, its
bargaining representative. In that capacity, Mr. Parness was ``actively
involved'' on behalf of Real Networks. Parness WDT ] 5. Substantively,
Mr. Parness testified to his understanding that the important aspects
of the Phonorecords I negotiations and settlement were: (1) An
agreement that noninteractive services did not need a mechanical
license; (2) the interactive mechanical license would be calculated on
an ``All-In'' basis; (3) the rate would be structured as a percent-of-
revenue with certain minima; and the headline rate would be 10.5%.
Parness WDT ] 7. He noted that the rate minima were included at the
behest of Copyright Owners, who were concerned that low retail pricing
by the services would cause a revenue-based rate to result in too
little royalty revenue. Id. ] 8. Mr. Parness further testified, with
regard to the 2012 negotiations, that he directly negotiated with Mr.
Israelite and the general counsel for the NMPA- negotiations that led
to the parties' agreement essentially to maintain the subpart B
structure and to create what became the new subpart C rate structure.
Id. at 11; see also 3/9/17 Tr. 325-27 (Parness).
Ms. Levine, who was employed by Google YouTube at the relevant
time, testified that in the Phonorecords II negotiations, Copyright
Owners sought an increase in the subpart B rates, the services refused,
and Copyright Owners ultimately withdrew that demand. Written Rebuttal
Statement of Zahavah Levine, Trial Ex. 697, ] 2 (Levine WRT). Ms.
Levine was not directly involved in the negotiations, however, as DiMA
represented the interests of the services in those negotiations.
Knowing the outcome of the negotiations does not illuminate the thought
processes (or the horse-trading) that actually drove the negotiations
or shaped the settlement structure.
The Copyright Owners proffered no specific testimony as to how or
why the provisions of the 2008 and 2012 settlements were negotiated and
valued, either in their constituent parts or as they were integrated
into the rate structure ultimately adopted.
2. The 2012 Rates Were ``Experimental''
Copyright Owners maintain that the current rate structure was
``experimental,'' i.e., when it was first agreed to there was no data
to evaluate the business and Copyright Owners lacked knowledge as to
the future development of the interactive market. Thus, they claim to
have accepted the present rate structure because it offered protection
against poorly monetized services, through the establishment of the
alternate prongs. In fact, it was Copyright Owners that first proposed
the three tiered rate structure that now exists, but the specific
percentages and rates were the subject of negotiation. Copyright
Owners' understanding of the characterization of the 2012 rates is
informative; Mr. Israelite, who engaged in the negotiations, did not
view the minima in the structure as minima, but rather as alternative
rate prongs by which Copyright Owners would be paid the greatest of the
rates calculated. 3/29/17 Tr. 3637 (Israelite). Copyright Owners
acknowledge that they had no idea which prong would bind--because they
had no control over the services business models or over the
performance rates that are deductions to the All-In rate--so they
negotiated all three alternatives to reflect that uncertainty. Id. at
3636-38.
With regard to the Mechanical Floor, Copyright Owners assert that
they required this provision in part to protect against a severe or
complete reduction in mechanical royalties that would as possible by
virtue of the All-In structure. See Israelite WRT ]] 19-22, 29, 81; 3/
29/17 Tr. 3632, 3634-36, 3638, 3754, 3764-65 (Israelite); 3/8/17 Tr.
259 (Levine).\66\
---------------------------------------------------------------------------
\66\ The Mechanical Floor is discussed in greater detail, supra,
section IV.B.4.
---------------------------------------------------------------------------
The Services assert that there is no record evidence, beyond Mr.
Israelite's testimony, that the existing rate structure was, or
remains, experimental. They further note that by 2012, when this rate
structure was renewed, consumer adoption of streaming was obvious,
contrary to Copyright Owners' allegations. Levine WRT ] 5. The Services
also assert that numerous services, including those backed by large
companies, such as Yahoo and Microsoft, had already entered the market,
and some of those services had achieved significant subscriber numbers.
3/8/17 Tr. 155-57 (Levine); see also Parness WDT ] 12.
The Services also dispute the assertion that there was no
significant market development by the time of Phonorecords II. Levine
WRT ]] 5-6; 3/8/17 Tr. 171-72, 270-72 (Levine). Numerous services,
including the more recent large new entrants, had already entered the
market, with some realizing significant subscriber numbers. Id. at 155-
57 (Levine).
3. The ``Shadow'' of the Statutory License
Copyright Owners assert that any benchmark, including the Services'
proffered benchmarks, based on rates set for a compulsory license, is
inherently suspect, because they are distorted by the so-called
``shadow'' of the statutory license. This is a recurring criticism.
See, e.g., Web IV, 81 FR at 26329-31.
More particularly, Copyright Owners argue: ``The royalty rate
contained in virtually any agreement made by a music publisher or
songwriter with a license for rights subject to the compulsory license
will be depressed by the availability of the compulsory license.''
COPFF ] 708 (and record citations therein). In summary, this alleged
shadow diminishes the value of a benchmark rate that was formed by
private actors who negotiated the rate while understanding that either
party could refuse to consummate a contract and instead participate in
a proceeding before the Judges to establish a rate. Thus, neither side
can utilize any bargaining power to threaten to actually ``walk away''
from negotiations and refuse to enter into a license. In that sense,
therefore, any bargain they struck would be subject to the so-called
``shadow'' of the regulatory proceeding.
The metaphorical shadow actually can be cast in two ways. First,
when the parties are negotiating, they are aware of the rates
established in prior proceedings, which shape their expectations of the
likely outcome if they do not enter into a negotiated agreement.
Second, there is the alleged shadow of the upcoming proceeding, should
the parties fail to negotiate an agreement. That in futuro shadow
reflects not merely the prior rulings of this tribunal (and its
predecessors), but also any predictions the parties may make regarding,
for example, the Judges' likely positions with regard to the present
and changing nature of the industries involved, the economic issues,
the weight of various types of evidence, the credibility of witnesses
and the Judges' application of the 801(b)(1) standards.
The argument that the shadow taints the use of statutory rates, and
direct agreements otherwise subject to the statutory license must be
considered in light of section 115 of the Copyright Act, which provides
that in addition to the objectives set forth in section 801(b)(1), in
establishing such rates and terms, the Copyright Royalty Judges may
consider rates and terms under voluntary license agreements described
in subparagraphs (B) and (C). 17 U.S.C. 115(c)(3)(D). Subparagraphs (B)
and (C), respectively,
[[Page 1933]]
refer to agreements on ``the terms and rates of royalty payments under
this section'' by ``persons entitled to obtain a compulsory license
under [17 U.S.C. 115(a)(1)]'' and ``licenses'' covering ``digital
phonorecord deliveries.'' Id. Thus, it is beyond dispute that Congress
has authorized the Judges, in their discretion, to consider such
agreements as evidence, notwithstanding the argument that the
compulsory license may cast a shadow over those agreements.
Additionally, the Judges may consider the existing statutory rates
themselves as evidence of the appropriate rate for the forthcoming rate
period. Indeed, the Judges may consider existing rates as dispositive
evidence when setting new rates. Music Choice, supra, 774 F.3d at 1012
(the Judges may ``use[ ] the prevailing rate as the starting point of
their Section 801(b) analysis'' and may ultimately find that ``the
prevailing rate was reasonable given the Section 801(b) factors.''). Of
course, the fact that the Copyright Act and the D.C. Circuit grant the
Judges statutory authority to consider statutory rates and related
agreements as evidence does not instruct the Judges as to how much
weight to afford such agreements. The exercise of that judicial
discretion remains with the Judges.
Further, there is no reason to find such benchmark agreements per
se inferior to other marketplace benchmark agreements that may be
unaffected by the shadow, because the latter may be subject to their
own imperfections and incompatibilities with the target market. Thus,
the Judges must not only consider (i) the importance, vel non, of any
``shadow-based'' differences between the regulated benchmark market and
an unregulated market; but also (ii) how those differences (if any)
compare to the differences (if any) between the unregulated market and
the target market (e.g., differences based on complementary oligopoly
power, bargaining constraints and product differentiation).\67\
---------------------------------------------------------------------------
\67\ The Judges note that one of the two benchmarking methods
relied upon by Copyright Owners subtracts the statutory rate set in
Web III for noninteractive streaming from a royalty rate derived
from the unregulated market for sound recording licenses between
labels and interactive streaming services. This would seem to
violate the Copyright Owners' own assertion that statutorily set
rates cannot be used to establish reasonable rates. However,
Copyright Owners' expert testified that, in his opinion, the Judges
in Web III accurately identified the market rate for noninteractive
streaming, so that rate could be utilized as if it were set in the
market. 4/4/17 Tr. 4643 (Eisenach). This assertion proves too much.
If one expert on behalf of a party may equate a rate set by the
Judges with the market rate, why cannot the Judges, or any other
party's expert, do the same? The end result of such an approach
takes us back to the point the Judges made at the outset in this
section: Any rate set by the Judges or influenced by the Judges'
rate-setting process must be considered on its own merits.
---------------------------------------------------------------------------
In the present proceeding, the parties weigh in on the shadow issue
with several additional arguments. Copyright Owners emphasize that the
purpose of their benchmarking approach is to avoid the distortions of
the shadow, by utilizing the unregulated sound recording agreements
between labels and interactive streaming services and then applying a
ratio of sound recording to musical works royalties, also in
unregulated contexts, to develop a benchmark wholly free of the shadow
cast by the statute. See Eisenach WDT ]] 34-40. The Judges agree that a
strength of the Copyright Owners' benchmarking approach is that it
allows for the identification of marketplace benchmarks, so that the
Judges can ascertain whether there are analogous markets from which
statutory rates can be derived.
The Services' experts discount the shadow argument and, indeed,
essentially rely on the statutory rates in subpart B and in subpart A
as their benchmarks. Professor Marx opines that the statutory rates are
superior in at least one way, because they incorporate the elements the
Judges must consider--both the market forces and the section 801(b)(1)
factors that are the bases for the statutory rates. 3/20/17 Tr. 1843-
44, 1914 (Marx); see also 3/13/17 Tr. 575 (Katz) (the shadow leads the
parties to meet the 801(b)(1) objectives).
However, when the rates are the product of settlements rather than
a Determination by the Judges, they do not reflect the Judges'
application of the elements of section 801(b)(1). Rather, the
settlement rates reflect (implicitly) the parties' predictions of how
the Judges may apply such factors. Although the Judges reasonably can,
and do, accept the parties' understanding of how market forces shape
their negotiations (indeed, economic actors' agreements are part and
parcel of the market),\68\ the Judges cannot defer to any implicit
``mindreading'' by the parties as to the Judges' application of the
elements of section 801(b)(1). Rather, the Judges have a duty to
independently apply the statute. Accordingly, the Judges reject the
idea that rates and terms reached through a settlement can be
understood to supersede--or can be assumed to embody--the Judges'
application of the statutory elements set forth in section 801(b)(1).
However, if on further analysis, the Judges find that provisions
arising from a settlement reflect the statutory principles set forth in
section 801(b)(1), then the Judges may adopt the provisions of that
settlement if it is superior to the evidence submitted in support of
alternative rates and terms.
---------------------------------------------------------------------------
\68\ For example, the Judges regularly assume that the parties
have ``baked-in'' the values of promotion and substitution when
agreeing to rates. See, e.g., Web IV, 61 FR at 26326.
---------------------------------------------------------------------------
With regard to the alleged impact of the shadow, Professor Katz
offers a perspective. He opines that the so-called shadow imbues
licensees with countervailing power, to offset or mitigate the
bargaining power of licensors who otherwise have the ability to
threaten to ``walk away'' from negotiations and thus decimate the
licensees' businesses. 3/13/17 Tr. 661 (Katz). The Judges find merit in
this perspective, because it underscores the fact that a purpose of the
compulsory license is to prevent the licensor from utilizing or
monetizing the ability to ``walk away'' as a cudgel to obtain a better
bargain. In this limited sense, the agreements created under the so-
called shadow thus are beneficial, to the extent that they provide one
potential way in which to offset the complementary oligopoly power of
the record companies, especially the Majors. Indeed, this
countervailing power argument is consistent with the Judges' ``shadow''
analysis in Web IV, 81 FR, at 26330-31 (noting the counterbalancing
effect of the statutory license in establishing effectively competitive
rates).\69\
---------------------------------------------------------------------------
\69\ The Shapley analyses conducted by Professors Marx and Watt
also eliminate this ``walk away'' power by valuing all possible
orderings of the players' arrivals. See discussion, infra, section
V.D.1.
---------------------------------------------------------------------------
Professor Leonard presents yet another perspective on the statutory
benchmarks, arguing that the alleged shadow they cast acts as a ``focal
point'' around which parties negotiate, with the statutory license
acting as either a ceiling or a floor. 3/15/17 Tr. 1263 (Leonard). In a
second-best market where price discrimination is economically
appropriate, the continuation of a rate structure, over two rate
cycles, might suggest the parties' acceptance of that structure as an
efficient ``focal point,'' absent sufficient evidence to the contrary.
However, as the Judges noted in Web IV, whatever theoretical appeal
there may be in this focal point analysis (if any), it cannot be
credited as an independent basis for using an existing statutory rate,
absent ``a sufficient connection between theory and evidence.'' Id. at
26630.
[[Page 1934]]
D. Greater-Of Percent of Revenue/TCC Rate Structure
In its revised rate proposal Google presents an all-in royalty rate
for all service offerings set as the greater of 10.5% of revenue and
15% of TCC. TCC is one metric used in computing mechanical royalties
under the 2012 rates and numerous direct licenses. In the 2012 rate
structure a percentage of TCC is generally combined with percentage of
revenue in a greater-of calculation, but is capped by a fixed per-
subscriber royalty. See, e.g., 37 CFR 385.13(a)(3), (b). A number of
direct licenses in the record mirror this approach, or directly
incorporate the terms of 37 CFR part 385. See, e.g., Leonard AWDT ] 54
(describing royalty calculation methodology in direct licenses between
[REDACTED] and several music publishers, including [REDACTED],
[REDACTED], and [REDACTED]; License Agreement between [REDACTED] and
[REDACTED], Trial Ex. 749, at ] 6(a) ([REDACTED]).
Several direct licenses between [REDACTED] and music publishers
base royalties on a straight, uncapped \70\ percentage of TCC, with no
``greater-of'' prong. See, e.g., Music Publishing Rights Agreement
between [REDACTED] and [REDACTED], Trial Ex. 760, at ] 5(a) (all-in
mechanical rate of [REDACTED]% of TCC); accord Leonard AWDT ] 64
(describing terms of [REDACTED] direct licenses with music publishers
including [REDACTED], [REDACTED], [REDACTED], [REDACTED], and
[REDACTED]). Still other direct licenses include an uncapped TCC metric
in a three-pronged ``greater-of'' calculation (along with percentage of
revenue and a per-subscriber fee). See, e.g., [REDACTED] Music
Publishing Rights Agreement with [REDACTED], Trial Ex. 757, at ]
4(a)(ii) and (iii). Some direct licenses eschew TCC entirely and
compute royalties as the greater of a percentage of revenue and a per-
subscriber fee. See Leonard AWDT ] 71 (describing terms of six
agreements with [REDACTED]).
---------------------------------------------------------------------------
\70\ In other words, TCC is not part of a ``lesser-of''
calculation with another metric such as a per-subscriber fee.
---------------------------------------------------------------------------
Dr. Leonard, an expert for Google, reviewed and analyzed a number
of direct licenses that Google and other services have entered into
with muCsic publishers for, inter alia, mechanical rights. Dr. Leonard
found the agreements to be useful benchmarks due to the similarity of
rights, parties, economic circumstances, and time period. See 3/15/17
Tr. 1084 (Leonard). He found the direct agreements to support the
reasonableness of Google's proposed rate structure, notwithstanding
variations among the agreements and between many of the agreements and
Google's rate proposal. At the time, Google was proposing a structure
that (like other of the Services' proposals) largely followed the
statutory rate structure, but without a Mechanical Floor. Nevertheless,
Dr. Leonard's analysis demonstrates that the marketplace supports a
number of rate structures, and that no single structure, or element of
a structure, is indispensable. The Judges find that Dr. Leonard's
analysis, and the marketplace benchmarks that he relies on, support the
rate structure that Google proposes in its amended rate proposal.
E. Judges' Conclusion Concerning Rate Structure
In their rate determination proceedings, the Judges are informed,
but not bound, by the parties' proposals. The Judges' task is to
analyze the record evidence and determine a rate structure and rates
that are reasonable, even though they might vary from any one party's
proposals. Weighing all the evidence and based on the reasoning in this
Determination, the Judges conclude that a flexible, revenue-based rate
structure is the most efficient means of facilitating beneficial price
discrimination in the downstream market.\71\ The Judges, therefore,
reject the per-play/per-user rate structures proposed by the Copyright
Owners and Apple.
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\71\ Rates based on a percent-of-revenue (even without any
alternative rate prongs) are themselves a form of price
discrimination. See J. Cirace, CBS v. ASCAP: An Economic Analysis of
a Political Problem, 47 Ford. Rev. 277, 288 (1978); W.R. Johnson,
Creative Pricing in Markets for Intellectual Property, 2 Rev. Econ.
Res. Copyrt., Issues 39, 40-41 (2005). To the extent they
incorporate revenue-sharing in the underlying licenses between
services and record companies, percent of TCC rates are also a form
of price discrimination.
---------------------------------------------------------------------------
The Judges also find that the All-In rate is a necessary and proper
element of a mechanical rate determination and conclude it must remain
in the rate structure for the forthcoming rate period. Specifically,
the Judges find that the deduction of performance royalties accounts
appropriately for the perfect complementarity of the performance and
mechanical licenses.\72\ The Judges reject the argument that the All-In
feature is unlawful because the Judges do not regulate performance
rates. The All-In feature does not constitute a regulation of the
performance rate, but rather represents a cost exclusion (or deduction)
from the mechanical rate. The Judges and the parties recognize that the
royalties otherwise due under a revenue-based format may exclude
certain costs. See 73 CFR 385.11(Definition of ``Service Revenue,''
paragraph (3) therein).\73\
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\72\ As discussed infra, the fact that the performance right and
the mechanical right are necessary complements to the licensees does
not, however, end the inquiry. As Copyright Owners point out, the
publishers use mechanical royalties in part to fund advances to
songwriters or to assure their subsequent recoupment. The Judges
will, therefore, retain the ``Mechanical Floor'' for the upcoming
rate period, to ensure the continuation of this important source of
liquidity to songwriters.
\73\ The Judges recognize that the reduction of the mechanical
rate interim calculation by the amount of the performance rate in
``Step 2'' (see Sec. 385.12(b)(2)), acts as an exclusion from
royalties rather than a deduction from revenue (by analogy, just as
a tax credit is a subtraction from taxes, whereas a tax deduction is
a subtraction from income). However, there is no statutory or
regulatory impediment that prohibits this exclusion from royalties,
especially given the economic interrelationship between performance
rights and mechanical rights, discussed in the text infra.
---------------------------------------------------------------------------
Two of the proposed rate structures--the Services' variations on
the existing structure and Google's proposed structure--have the
foregoing elements. Of those two, the Judges find that Google's
proposal is superior for the following reasons.
First, the use of an uncapped TCC metric is the most direct means
of implementing a key finding of the Shapley analyses conducted by
experts for participants on both sides in this proceeding: The ratio of
sound recording royalties to musical works royalties should be lower
than it is under the current rate structure.\74\ Incorporating an
uncapped TCC metric into the rate structure permits the Judges to
influence that ratio directly.\75\
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\74\ The Shapley analyses are discussed infra, section V.D.
\75\ Google notes, concerning its proposal, that the removal of
a cap on TCC ``does leave the services exposed to the labels' market
power, and would warrant close watching if adopted.'' GPFF ] 73.
While true, Google fails to note that the services are already
exposed to the labels' market power. Record companies could, if they
so chose, put the Services out of business entirely. Uncapping the
TCC rate prong does not change that. Nor can any decision by this
tribunal. While the possibility of the record companies using their
market power in a way that harms the Services is a real concern, the
Judges cannot allow that concern to grow into a form of paralysis,
where any change from the status quo is deemed too dangerous to
contemplate. Any increase in mechanical royalty rates, whether or
not they are computed with reference to record company royalties,
has the potential of leading to a bad outcome for the Services. Even
maintaining the status quo could lead to a bad outcome for the
Services, as it surely would for the songwriters and publishers.
Ultimately the Judges must go where the evidence leads them and, as
with any economic exercise, trust in the rational self-interest of
the market participants.
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Second, an uncapped TCC prong effectively imports into the rate
structure the protections that record companies have negotiated with
services to avoid the undue diminution
[[Page 1935]]
of revenue through the practice of revenue deferral.\76\ The Judges
find that the present record indicates that the Services do seek to
engage to some extent in revenue deferral in order to promote their
long-term growth strategy. A long-term strategy that emphasizes scale
over current revenue can be rational, especially when a critical input
is a quasi-public good. Growth in market share and revenues is not
matched by a commensurate increase in the cost of such inputs, whose
marginal cost of production, or reproduction as in this case, is zero.
It appears to the Judges that the nature of the downstream interactive
streaming market, and its reliance on scaling for success, results
necessarily in a competition for the market rather than simply
competition in the market.\77\ Revenue deferral argues against adopting
a pure percent-of-revenue rate structure.
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\76\ See 4/6/17 Tr. 5215-16 (Leonard); see also GPFF ] 73
(arguing that ``removing the caps allows the TCC prong to flexibly
protect against downside risks associated with revenue deferment,
displacement, or attribution issues.'').
\77\ This is the form of dynamic competition known as
Schumpeterian competition (named after the economist Joseph
Schumpeter). Such competition emphasizes the importance of the
dynamic creation of new markets and ``new demand curves,''
recognizing that short-term profit or revenue maximization may be
inconsistent with the rationality of competing for the market in
this manner.
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Third, in the absence of Congressional guidance as to the meaning
of a ``reasonable rate,'' the Judges determine that, as a matter of
policy, transparency and administrative rationality are factors in
determining whether a rate is ``reasonable.'' Those who pay and receive
royalties, those who calculate the royalties, and those (like the
Judges) who are sometimes called upon to interpret the regulations
implementing the royalties, are best served by a rate structure that is
understandable and administrable. Absent compelling reasons to adopt a
more complex rate structure (which are not present in the record),
simpler is better.\78\ Google's proposed rate structure reduces the
Rube-Goldberg-esque complexity and impenetrability of the existing,
settlement-based rate regulations. In particular, it merges ten
separate rates for different service offerings into a single rate that
would apply to all service offerings, thus avoiding the potential for
confusion and conflict as new service offerings emerge that do not fall
neatly into any of the existing categories.
---------------------------------------------------------------------------
\78\ ``There is beauty in simplicity.'' 3/23/17 Tr. at 2855
(Ghose).
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Fourth, Google's proposed rate structure is supported by voluntary
agreements that were reached outside the context of litigation. They
are thus free from trade-offs motivated by avoiding litigation cost, as
distinguished from the underlying economics of the transaction. The
same cannot be said of the existing rate structure. While both are
affected by the ``shadow'' of the compulsory license, the Judges find
the voluntary agreements more informative of the behavior of market
participants.
The Judges adopt Google's proposed rate structure for the foregoing
reasons.\79\ However, the Judges modify Google's proposed rate
structure by including the Mechanical Floor from certain configurations
in the existing rate structure. The Mechanical Floor appropriately
balances the Service's need for the predictability of an All-In rate
with publishers' and songwriters' need for a failsafe to ensure that
mechanical royalties will not vanish either through the actions of the
Services or the PROs and the Rate Court. Testimony of publishers and
songwriters has established the critical role that mechanical royalties
play in making songwriting a viable profession.\80\
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\79\ The Copyright Owners have two overarching objections to
Google's revised rate proposal. The first is a procedural objection:
Google's revised proposal was submitted after all evidence was taken
and the Copyright Owner's had no opportunity to cross-examine any
witness about it. See CO Reply to GPFF at 1-2, 18. Google was
entitled, under the Judges' procedural regulations, to change its
rate proposal up to, and including, the filing of proposed findings
and conclusions. 37 CFR 351.4(b)(3). Google did so--at the Judges'
request. See 4/13/17 Tr. 6019. The Judges find no merit in the
Copyright Owners' procedural objection.
The Copyright Owners also argue that Google's revised rate
proposal is without evidentiary support. See, e.g., CO Reply to GPFF
at 2, 15-18. The Judges do not rely on Google's proposed findings.
Rather, the Judges rely upon the evidence in the record they deem
relevant and persuasive. The Judges have found sufficient evidence
to support the rate structure, and the rates within that structure,
as detailed in this Determination. The Determination speaks for
itself.
\80\ See infra, section VI.A.
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The Judges reject the Services' arguments for eliminating the
Mechanical Floor. For example, the Judges find the Services' argument
that the mechanical right has no standalone value to be incomplete and,
to an extent, self-serving. To the music publishers and songwriters,
the mechanical right does have a value in the funding of songwriters, a
value not provided by the performance royalty. By analogy, the cost of
any publisher input, not just the cost of providing liquidity to
songwriters, such as, for example, the cost of heating the buildings in
which songwriters toil, has no standalone value to the Services, yet no
one would assert that the licensors are not entitled to royalties from
which they can recover their heating costs. Liquidity funding for
songwriters is a necessity, just as heat is a necessity--the
complementary nature of the rights to the Services is of no relevance.
The Judges also reject Apple's argument that the Mechanical Floor
should be eliminated because of the potential for fragmented musical
works licenses due to threatened publisher withdrawal from PROs, and
the creation of new PROs. The Services have offered no evidence that
the introduction of the new PRO, Global Music Rights, will have any
impact on the performance royalty rate. As confirmed by recent
litigation, partial withdrawals are not permitted by the rate court,
the Second Circuit, or the Department of Justice. There is no evidence
of a trend of increasing performance rates. Fractional (a/k/a
fragmented) licensing has always been present in the market. See CORPFF
at pp. 87-90 (and record citations therein).
Finally, the Judges reject Google's proposed rates within that
structure. Google's proposed rates are derived from the subpart A
benchmark that the Judges have rejected. See GPFF ]] 21, 26-30.\81\ The
Judges look elsewhere in the record for reasonable percent-of-revenue
and TCC rates to use in the two prongs of Google's proposed greater-of
rate structure.
---------------------------------------------------------------------------
\81\ The subpart A benchmark is discussed infra, section V.B.3.
---------------------------------------------------------------------------
The Judges' adoption of a Mechanical Floor for the selected
streaming services satisfies the objectives of section 801(b)(1). The
Mechanical Floor offers protection for Copyright Owners, thus
maximizing the availability of creative works to the public. The
``safety net'' of the Mechanical Floor assures a fair return to
Copyright Owners, serving as a counterweight to the All-In rate,
without an unfair impact on the income of the copyright users. The
balanced protection of the songwriter's livelihood afforded by the
Mechanical Floor recognizes the contribution of musical works to all
music delivery mechanisms. Finally, the current regulations include
Mechanical Floor rates; the Judges' retention of those rates for
streaming services is not disruptive to the music industry.
In the Owners' Motion, the Copyright Owners argued that the Judges'
elimination of a subscriber-based minimum fee for paid locker services
and limited downloads could only have been an oversight. For all the
reasons detailed in the Judges' Order on the motions for clarification,
the Judges' decision was purposeful. Paid locker
[[Page 1936]]
services and limited offerings are licensed uses that are of a nature
totally different from other streaming services. The existing
regulations treated them differently and afforded them an alternative
minimum royalty. The existing minimum for these services was not a
Mechanical Floor.
V. Determining Royalty Rates
Establishing a rate structure resolves only one aspect of the
overall rate determination. The next issue for the Judges to decide is
the setting of rates within the appropriate rate structure. In that
regard, it is noteworthy that several of the Services' expert
economists have asserted that, although the 2012 rate structure is an
appropriate benchmark, the rates within that structure should be
modified.\82\ Thus, the Judges must consider the record evidence that
relates to the rates themselves in order to determine the rates to be
set for the forthcoming rate period within the price discriminatory
rate structure.
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\82\ To be sure, those Services' witnesses advocated for a
reduction in the rates, but their acknowledgement that the
usefulness of the 2012 structure does not ipso facto demonstrate the
appropriateness of the 2012 rates is a general point that the Judges
readily accept.
---------------------------------------------------------------------------
A. Rejection of the Copyright Owners' Approach
Copyright Owners proposed a single per-unit rate (in their greater-
of format). They did not propose a set of different rates (per-unit or
otherwise), that would be applicable to a rate structure similar to the
2012 rate structure. Thus, the Judges consider the benchmarking
approach undertaken by Copyright Owners for the purpose of determining
whether any portions of their benchmarking exercise provides evidence
of rates that the Judges should properly incorporate into the
differentiated rate structure they are adopting in this determination.
Copyright Owners' proposal for a per-unit rate is based on an
overarching premise: A single musical work has an ``inherent value.''
See, e.g., Israelite WDT ]] 29, 31, 33, 48; Herbison WDT ] 35; Brodsky
WDT ] 68. To make that principle operational, Copyright Owners
presented a benchmarking analysis through Dr. Eisenach, one of their
economic expert witnesses.
1. Dr. Eisenach's Methodology
a. Benchmarking
Dr. Eisenach sought to identify benchmarks that support Copyright
Owners' per-play and per end-user rate for the mechanical license. He
began by noting that ``an economically valid approach for assessing the
value of intellectual property rights which are subject to compulsory
licenses is to examine market-based valuations of reasonably comparable
benchmark rights--that is, fair market valuations determined by
voluntary negotiations.'' Eisenach WDT ] 8 (emphasis added). In
selecting potential benchmarks, Dr. Eisenach identified what he
understood to be key characteristics'' that would make a benchmark
useful: ``[U]nderlying market factors . . . ; the term or time period
covered by the agreements; factors affecting the relative bargaining
power of the parties; and differences in the services being offered.''
Id. ] 80.
Dr. Eisenach found useful the license terms for the sound recording
rights utilized by interactive streaming services, because they are
negotiated freely between record companies (a/k/a labels) and the
interactive streaming services. Id. These rates made attractive inputs
for his analysis because they: (1) Relate to the same composite good--
the sound recording that also embodied the musical work; and (2) the
interactive streaming service licensees were the same licensees as in
this proceeding. Thus, to an important degree, Dr. Eisenach found these
agreements to possess characteristics similar to those in the
mechanical license market at issue in this proceeding. Moreover, Dr.
Eisenach found that ``[d]ata on the royalties paid under these licenses
are available and allow . . . estimat[ion of] the rates actually paid
by the [interactive] streaming services to the labels for sound
recordings on both a per-play and a per-user basis.'' Id.
However, as Dr. Eisenach noted, these benchmark agreements related
to a different right--the right to a license of sound recordings--not
the right to license musical works broadly, or to the mechanical
license more specifically. Thus, as with any benchmark that does not
match-up with the target market in all respects,\83\ Dr. Eisenach had
to examine how the rates set forth in the benchmark agreements for
interactive streaming of sound recordings could be utilized. Id. More
particularly, Dr. Eisenach posited that there may be a relationship (or
ratio) between the sound recording royalty rate and the musical works
royalty rate. To that end, he ``examine[d] a variety of markets in
which sound recording and musical works rights are both required in
order to ascertain the relative value of the two rights as actually
reflected in the marketplace.'' Id. (emphasis added).
---------------------------------------------------------------------------
\83\ The lack of a perfect identity is essentially tautological.
If a ``benchmark'' was identical to the target market, it would be
the target market. The issue for economists and for the Judges is to
identify the differences, weigh the importance of those differences,
and then either rely on the benchmark, reject or adjust the
benchmark so that it is probative, or find that the proffered
benchmark is so inapposite that it, even with any proffered
adjustments, it must be disregarded.
---------------------------------------------------------------------------
Through this examination, Dr. Eisenach concluded that these
proposed benchmarks ``establish upper and lower bounds for the relative
value of sound recording and musical works rights . . . estimate[d] to
be between 1:1 and 4.76:1.'' Id. To make these ratios more instructive,
the Judges note that the inverse of these ratios (e.g., 1:4.76 instead
of 4.76:1) can be expressed as a percentage. Thus, the ratio of 1:4.76
is equivalent to a statement that musical works royalties equal 21% of
sound recording royalties in agreements struck in the purported
benchmark market. More obviously, the 1:1 ratio means that, in
agreements within that purported benchmark market, musical works
royalties equal 100% of sound recording rates. By converting the ratios
into percentages, it is easier to see that the high end of Dr.
Eisenach's benchmark range is almost five times as large as the low end
of the range.
b. Dr. Eisenach's Potential Benchmarks
Dr. Eisenach considered a variety of benchmark categories in which
the licensee was obligated to acquire licenses for musical works and
licenses for sound recordings. His selection and consideration of each
category of benchmark markets are itemized below.
i. The Current Section 115 Statutory Rates
The current statutory rate structure contains several alternate
rates explicitly calculated as a percentage of payments made by
interactive streaming services to the record companies for sound
recording rights. Such rates are identified in the industry as the
``TCC'' rates, an acronym for ``Total Content Cost.'' Id. ] 82.\84\ In
the subpart B category, the TCC is 22% for ad-supported services and
21% for portable subscriptions. Id.; see also 37 CFR 385.13(b)(2) and
(c)(2).\85\ These percentage figures correspond to sound recording to
musical works royalties of 4.55:1 and 4.76:1, respectively.
---------------------------------------------------------------------------
\84\ This rate prong is sometimes identified as ``TCCi,'' which
is an acronym the parties adopted for ``Total Content Cost
Integrity.''
\85\ Lower percentages apply if the record companies' revenue
includes revenue to be ``passed through'' by them to pay mechanical
license royalties. However, according to Dr. Eisenach, such ``pass-
throughs'' are not typical. Id. at 82 n.67.
---------------------------------------------------------------------------
Dr. Eisenach notes that these statutory rates were not set by the
Judges pursuant to a contested hearing, but rather reflect two
settlements, one in
[[Page 1937]]
2008 and the other in 2012. Id. ] 83. However, Dr. Eisenach discounts
the value of these settlement rates for three reasons. First, he notes
that they were established prior to the ``marketplace success'' of
Spotify in the interactive streaming industry.\86\ Second, he notes
that the settlements, although voluntary, ``were negotiated under the
full shadow of the compulsory license.'' Third, he finds that, although
the settlement incorporates rate prongs based on a percent of sound
recording rates (the TCC prongs), those provisions are part of a
``lesser of'' segment of the rate structure, and thus capped by
alternative per subscriber rates. Id. & n.70. Thus, Dr. Eisenach
concludes: ``In my opinion, the evidence . . . indicates that the
relative valuation ratios implied by the current section 115 compulsory
license . . . represent an upper bound on the relative market
valuations of the sound recording and musical works rights.'' Id. ] 92
(emphasis added). (As an ``upper bound,'' these ratios would represent
the lower bound of the reciprocal percentage of the value musical works
rights relative to sound recording rights, again, 21% and 22%.).
---------------------------------------------------------------------------
\86\ Spotify was launched in the United States in the summer of
2011. See 3/20/17 Tr. 1778 (Page).
---------------------------------------------------------------------------
The Judges note that Dr. Eisenach identifies the 21% and 22% TCC
rates within the current rate structure. Thus, for example, if the
sound recording royalty rate for interactive streaming is 60% of
revenue, then, using these TCC figures, the implied musical work
royalty rate is calculated as 12.6% of revenue (.21 x .60) (a ratio of
4.76:1), or 13.2% (.22 x .60) (a ratio of 4.5:1). Again, because Dr.
Eisenach opines that these are upper bounds on the relative market
valuations,'' that is the equivalent of opining that they represent the
lower bound of a percentage-based royalty calculated via this ratio
approach.
ii. Direct Licenses Between Parties Potentially Subject to a Section
115 Compulsory License
Dr. Eisenach also examined direct agreements between record
companies and interactive streaming services that contained rates for
sound recordings and mechanical royalties, respectively. See, e.g., id.
]] 84-91. In such cases, the ratio of sound recording to musical works
royalties ranged tightly between 4.2:1 and 4.76:1, closely tracking the
regulatory ratios implicit in the section 115 TCC. Id. ] 92. (The 4.2:1
ratio equates to a TCC rate of 23.8%, and the 4.76:1 ratio equates to a
mechanical rate of 21%.).
According to Dr. Eisenach, the similarity of these direct contract
rate ratios to the statutory ratios reflects the ``shadow of the
statutory license,'' by which direct negotiations between parties
regarding rights that are subject to (or can be fashioned to be subject
to) a statutory license are influenced by the presence of statutory
compulsory rates and/or the prospect of a future rate proceeding. 4/4/
17 Tr. 4591 (Eisenach) (``The underlying problem with looking at an
agreement negotiated under the shadow of a license'' is that [i]t
shifts bargaining power from the compelled party to the uncompelled
party by the very nature of the exercise.'').\87\
---------------------------------------------------------------------------
\87\ The Judges discuss the issue of the ``shadow'' of the
statutory license in section IV.C.3.
---------------------------------------------------------------------------
Given these limitations, Dr. Eisenach concluded, as he did with
regard to the actual section 115 rates licenses, that ``[i]n my
opinion, the evidence presented . . . indicates that the relative
valuation ratios implied by the . . . negotiations under [the
statutory] shadow--ranging from 4.2:1 [23.8%%] to 4.76:1[21%]--
represent an upper bound on the relative market valuations of the sound
recording and musical works rights.'' Eisenach WDT ] 92.
iii. Synchronization Agreements
Synchronization (Synch) agreements are agreements by audio-video
producers, such as movie and television producers, with, respectively,
music publishers and record companies, allowing for the use,
respectively, of the musical works and the sound recordings in ``timed
synchronization'' with the movie or television episode. See generally
D. Passman, All you Need to Know About the Music Business 265 (9th ed.
2015). Dr. Eisenach found these Synch Agreements to be a mixed bag in
terms of their value as a benchmark. On the one hand, he recognized
that the licenses they conveyed ``do not apply to music streaming
services as such'' but, on the other hand, they ``are negotiated
completely outside the shadow of the compulsory license. . . .'' Id. ]
93. Dr. Eisenach notes, from his review of other testimony and an
industry treatise, that these freely negotiated market agreements grant
the musical composition royalty payments equal to the corresponding
royalty paid for the sound recording,'' which is the equivalent of a
1:1 sound recording to musical works ratio.\88\ Id. ]] 94-95 & nn.87,
88.
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\88\ Dr. Eisenach finds this 1;1 ratio to be present in the two
types of Synch agreements he identified. One version represents an
agreement relating to a specific musical work and sound recording
combination. The other version, a ``Micro-Synch'' agreement, which
he describes as ``essentially `blanket' synch licenses, in that the
license grants the right to synchronize not just one particular song
. . . but any song in the publisher's catalog (or a significant
portion thereof). . . .'' Eisenach WDT ] 96.
---------------------------------------------------------------------------
Dr. Eisenach finds this 1:1 relationship to be important benchmark
evidence, concluding:
The synch and micro-sync examples confirm that in circumstances
in which licensees require both sound recording and musical
composition copyrights in order to offer their service, and where
that service is not entitled to a compulsory license for either
right, the sound recording rights and the musical composition rights
are in many cases equally valued, that is, the ratio of the two
values is 1:1.
Id. ] 98.
iv. YouTube Agreements
Dr. Eisenach also examined licenses between: (1) YouTube (owned by
Google) and record companies; and (2) YouTube and music publishers, to
determine their potential usefulness as benchmarks. He noted that they
provide further insight into the relative value of sound recordings and
musical works. He added that, because these licenses also include
[REDACTED] (which, he noted, are not [REDACTED] uses) these rights are
partially outside the purported shadow of compulsory licensing.
Moreover, these agreements essentially grant to YouTube [REDACTED],
analogous to the provision of on-demand streaming by the interactive
services licensed under subpart B. Additionally, Dr. Eisenach noted
that these YouTube agreements met certain standards for a useful
benchmark, viz. the parties, the domestic (U.S.) market and the time
period all correspond to the parties, market and time period involved
here. Id. ] 100. For these reasons, Dr. Eisenach concluded that ``for
purposes of assessing the relative value of the sound recording and
musical works rights, the YouTube agreements represent reasonably
comparable benchmarks for the purpose of assessing the relative value
of sound recordings and musical works rights.'' Id.
In his original Written Direct Testimony, Dr. Eisenach relied upon
seven agreements between YouTube and several music publishers
pertaining to [REDACTED]. Id. ] 101 n.93. In those [REDACTED]
agreements, Dr. Eisenach found that publishers receive [REDACTED] when
the video is [REDACTED]. However, with regard to the revenue received
by the record companies, Dr. Eisenach could only speculate based on
public reports as to the percent of revenue received by the record
companies for the sound
[[Page 1938]]
recordings embedded in the posted YouTube videos. Id. ] 102. Thus, he
was unable to make an informed argument in his original written
testimony regarding the ratio of sound recording royalties to music
publisher royalties in his YouTube [REDACTED] benchmark analysis.
However, after the Judges compelled Google to produce in discovery
copies of the YouTube agreements with the record companies, Dr.
Eisenach filed (with the Judges' approval) Supplemental Written
Rebuttal Testimony (SWRT) addressing these agreements. In that
testimony, Dr. Eisenach examined 49 YouTube licenses with eight record
labels and four form agreements (under which approximately 1,350
independent labels are actively licensed), spanning the period 2012 to
2019. Eisenach SWRT ] 6 & n.5. Dr. Eisenach identified nine of these
licenses specifically in his SWRT, and noted that YouTube paid to
[REDACTED] for sound recordings in a [REDACTED]--which Dr. Eisenach
found to be the comparable YouTube category--whereas the [REDACTED]
received [REDACTED]. Id. & Table 1.
As Dr. Eisenach accurately calculated, the [REDACTED] revenue split
reflects a ratio of [REDACTED]:1, (a musical works rate equal to
[REDACTED]% of the sound recording rate), whereas the [REDACTED]
revenue split reflects a ratio of [REDACTED]:1 (a musical works rate
equal to [REDACTED]% of the sound recording rate).
v. The Pandora ``Opt-Out'' Deals
Dr. Eisenach also examined certain direct licensing agreements
entered into between Pandora and major music publishers from 2012
through 2016, to determine whether they constituted useful benchmarks
in this proceeding. Id. ] 103. Pandora had negotiated these direct
agreements with major publishers for musical works rights after certain
publishers had decided to ``opt-out,'' i.e., to withdraw their digital
music performance rights from performance rights organizations (PROs),
and asserted the right to negotiate directly with a digital streaming
service. As Dr. Eisenach acknowledges, the music publishers' legal
right to withdraw these rights remained uncertain during that five year
period. Nonetheless, Pandora negotiated several agreements with an
understanding that the rates contained in those direct agreements might
not be subject to rate court review.\89\
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\89\ The ``rate court'' is a short-hand reference to the
proceedings before designated judges in the U.S. District Court for
the Southern District of New York, who set performance royalty
rates, pursuant to existing consent decrees between the U.S.
Department of Justice and, respectively ASCAP and BMI.
---------------------------------------------------------------------------
Given this phenomenon, and given that the markets and parties
involved in the Pandora agreements are somewhat comparable to the
markets and parties at issue in this proceeding,\90\ Dr. Eisenach
concluded that these agreements provided ``significant insight into the
relative value of the sound recording and musical works rights in this
proceeding.'' Id.
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\90\ At the relevant time, Pandora operated a noninteractive
service and only paid the performance right royalty, not the
mechanical right royalty, for the right to use musical works.
Because the parties agree that the performance right and the
mechanical right are perfect complements, Pandora's payments for the
performance right are relevant and probative.
---------------------------------------------------------------------------
Dr. Eisenach compared the musical works rates in these ``opt-out''
agreements with the sound recording royalty rates paid by Pandora,
which he obtained from the revenue disclosures in Pandora's Form 10K
filed with the SEC that provided royalties (``Content Costs'') as a
percent of revenue, and he also relied on data contained in prior rate
court decisions. Eisenach WDT ] 125 & Table 6. With this data, he
calculated that the ratio of sound recording: Musical works royalties
in existing agreements was [REDACTED]:1 for 2018, i.e., the musical
works rate equaled [REDACTED]% of sound recording royalties. This
[REDACTED]% ratio would correspond to a mechanical rate of [REDACTED],
assuming, arguendo, the sound recording rate is 60%.
Dr. Eisenach also made an estimation and forecast, linking the
passage of time to an assumption that after the Rate Court proceedings
concluded (and all appeals were exhausted) the parties, without further
legal uncertainty, would permanently be ``permitted to negotiate freely
outside of the control of the rate courts.'' He made this estimation
and forecast through a temporal linear regression, extrapolating from
the prior [REDACTED] in these Pandora ``opt out'' musical works rates.
See Eisenach WDT ] 129. Dr. Eisenach's linear regression further
[REDACTED] the ratio to [REDACTED], which would be equivalent to
[REDACTED] the musical works rate, as a percentage of sound recording
royalties, from the [REDACTED]% noted above for actual agreements in
force in 2018 to [REDACTED]%, almost a [REDACTED]% [REDACTED] based on
the extrapolation alone. Id. ]] 104; 128 & Table 8, Fig. 13. (This
[REDACTED]% ratio would correspond to a musical works rate of
[REDACTED], assuming the sound recording rate is 60%.)
However, the assumption behind Dr. Eisenach's regression was not
borne out. In 2015, the Second Circuit Court of appeals affirmed a 2014
decision by the Southern District of New York, prohibiting such partial
withdrawals. In re Pandora Media, 785 F.3d 73, 77-78 (2d Cir. 2015),
aff'g 6 F. Supp. 3d 317, 322 (S.D.N.Y. 2014). Subsequently, in August
2016, the Department of Justice issued a statement announcing that,
consistent with these judicial decisions, it would not permit partial
withdrawals under the existing consent decrees. See Eisenach WDT ] 114,
n.109. Moreover, there were actual Pandora ``Opt-Out'' agreements that
set rates through 2018 that established a sound recording to musical
works ratio of [REDACTED]:1, that Dr. Eisenach chose to disregard in
favor of his extrapolated lower ratio.
Having calculated these five benchmarks, Dr. Eisenach applied them
in two separate methods to estimate the mechanical rate to be adopted
in this proceeding.
c. Dr. Eisenach's Ratio Equivalency Approach
Dr. Eisenach testified that ``[f]or music users that require both
sound recording rights and musical works rights, the two sets of rights
can be thought of in economic terms, as perfect complements in
production: Without both inputs, output is zero.'' Id. ] 76 (emphasis
added).\91\ Dr. Eisenach also notes that, ``for interactive streaming
services, the two categories of rights [sound recordings and musical
works] are further divided into a reproduction license [i.e., the
mechanical license] and a performance license . . . .'' Id. (Thus, the
mechanical license and the performance license likewise are perfect
complements with each other and with the sound recording license.)
---------------------------------------------------------------------------
\91\ Google's economic expert, Dr. Gregory Leonard, made an
important qualification regarding this point: At the time a musical
work is selected by a label for recording by an artist, ex ante
recording, the label can choose among competing and substitutable
musical works. Thus, it is only ex post recording that the
particular musical work that had actually been selected is necessary
to create a level of output (and value) greater than zero. 4/5/17
Tr. 5180-81 (Leonard).
---------------------------------------------------------------------------
[[Page 1939]]
Dr. Eisenach acknowledges that [t]he relative value of sound
recording [to] musical works licenses may depend on a variety of
factors, and traditionally the relationship has differed across
different types of services and situations.'' Id. ] 78. Dr. Eisenach
eschewed unnecessary ``assumptions, complexities and uncertainties
associated with theoretical debates'' as to why the particular existing
market ratios existed. Id. ] 79. Rather, instead of ``put[ting] forward
a general theory of relative valuation,'' he found it ``sufficient . .
. to assume that the relative values of the two rights should be stable
across similar or identical market contexts.'' Id.
d. Dr. Eisenach's Two Methods for Estimating the Mechanical Rate
i. Method #1
Dr. Eisenach's Method #1 for estimating the mechanical rate is
based on the following premises:
1. The sound recording royalty paid by interactive streaming
services is unregulated and thus negotiated in the marketplace.
Eisenach WDT ] 16.
2. The sound recording royalty paid by noninteractive services is
regulated, but, Dr. Eisenach finds the royalties set by the Judges in
Web III to reflect a market rate. 4/4/17 Tr. 4643 (Eisenach); see also
Eisenach WDT ] 136 & n.123.
3. The interactive streaming services require a mechanical license
(the license at issue in this proceeding), whereas the noninteractive
services are not required to obtain a mechanical licenses.\92\
---------------------------------------------------------------------------
\92\ The affected industries have agreed through settlements
that interactive services pay mechanical royalties but
noninteractive services do not. See Parness WDT ] 7. No party in the
present proceeding has sought a mechanical license rate for
noninteractive services.
---------------------------------------------------------------------------
4. According to Dr. Eisenach, the difference between the rates paid
by interactive services and non-interactive services for their
respective sound recording licenses equals the value of the remaining
license, i.e., the mechanical license. Id. ] 137 (``[T]he difference
between these two rights is akin to a `mechanical' right for sound
recordings, directly paralleling the mechanical right for musical works
in this proceeding.'').\93\
---------------------------------------------------------------------------
\93\ Dr. Eisenach refers at times to this difference in sound
recording royalties as the ``implied value of the mechanical
right.'' See, e.g., id. ] 138. However, this difference is only an
input for deriving the mechanical rate implied by his analysis (as
noted in the subsequent step), and the Judges choose to consider the
final rate developed by Dr. Eisenach in Method #1 as the ``implied
mechanical rate'' he advances through this method.
---------------------------------------------------------------------------
5. The mechanical rate implied by this difference in sound
recording rates must be ``adjust[ed] for the relative value of sound
recordings [to] musical works'' (as discussed supra). Id. ] 140.
Dr. Eisenach combines these steps and expresses his Method #1 in
the form of an algebraic equation:
MRMW = (SRIS - SRNIS)/
RVSR/MW,
Where
MRMW = Mechanical Rate for Musical Works
SRIS = Sound Recording Rate for Interactive Streaming
(All In)
SRNIS = Sound Recording Rate for Non-Interactive
Streaming (Performance Only)
RVSR/MW = Relative Value of Sound Recording to Musical
Works Rights.
Eisenach WDT ] 140.
Dr. Eisenach determined the per play rate paid by interactive
services by identifying certain services and ``tally[ing] the total
payments . . . and divid[ing] by the total number of interactive
streams the service reports.'' Id. ] 148. The average sound recording
per play royalty calculated by Dr. Eisenach was $[REDACTED] (or
$[REDACTED] per 100 plays), when excluding [REDACTED]. Id. Table
11.\94\
The final inputs for Dr. Eisenach's Method #1 have already been
identified, i.e., the $0.0020 per play (or $0.20 per 100 plays) royalty
rate estimated for noninteractive streaming, and the several benchmark
ratios of sound recording: Musical works royalties in the markets
selected by Dr. Eisenach. After Dr. Eisenach inserted the foregoing
data into the algebraic expression set forth above, he presented his
data in the following tabular form:
Musical Works Mechanical per 100 Plays Rate Calculation
[Method 1]
----------------------------------------------------------------------------------------------------------------
SRNIS per 100
SRIS per 100 Difference RVSR/MW MRMW per 100
(1) (2) (3)................ (4)................ (5)
----------------------------------------------------------------------------------------------------------------
$[REDACTED]...................... $0.20 $[REDACTED]........ 1:1................ $[REDACTED].
$[REDACTED]...................... 0.20 $[REDACTED]........ [REDACTED]:1....... $[REDACTED].
$[REDACTED]...................... 0.20 $[REDACTED]........ [REDACTED]:1....... $[REDACTED].
$[REDACTED]...................... 0.20 $[REDACTED]........ [REDACTED]:1....... $[REDACTED].
$[REDACTED]...................... 0.20 $[REDACTED]........ 4.76:1............. $[REDACTED].
----------------------------------------------------------------------------------------------------------------
See id., Table 12.\95\ Thus, applying his five potential benchmark
ratios, Dr. Eisenach determined that the mechanical works royalty rate
the Judges should set in this proceeding ranged from $[REDACTED] per
play to $[REDACTED] per play (see column (5) above, dividing by 100 to
reduce the rate from ``per 100'' to per play).
---------------------------------------------------------------------------
\94\ Dr. Eisenach's decision to rely on a per play calculation
that excluded [REDACTED] and all of Dr. Eisenach's challenged data
selections, are discussed infra in the Judges' analysis of his
benchmarking approach and the criticisms levelled by the Services.
\95\ Dr. Eisenach testified that the [REDACTED]:1 ratio should
be revised [REDACTED] to [REDACTED]:1, to reflect the sound
recording royalty rates in the [REDACTED] licenses he examined after
the Judges compelled [REDACTED] to produce [REDACTED]'s agreements
with record companies.
---------------------------------------------------------------------------
ii. Method #2
Dr. Eisenach describes his Method #2 as an alternative method of
deriving a market-derived mechanical royalty. His Method #2 ``derive[s]
an All-In musical works value based on the relative value of sound
recordings to musical works and then remove[s] the amount of public
performance rights paid for musical works, leaving just the mechanical
rate.'' Id. ] 142. The algebraic expression for Method #2 is:
MRMW = (SRIS/RVSR/MW) -
PRMW,
Where PRMW is the public performance royalty rate for
musical works, and the other variables are as defined and described
in Method #1.
Id.
Dr. Eisenach calculates PRMW, as an average of
$[REDACTED] per 100 plays for the licensees that he included in his
data analysis. Id. ] 156, Table 13. Applying all the inputs across the
various benchmark ratios, the results from Dr. Eisenach's Method #2 can
also be depicted in tabular form, as set forth below:
[[Page 1940]]
Musical Works Mechanical per 100 Plays Rate Calculation
[Method 2]
----------------------------------------------------------------------------------------------------------------
SRIS RVSR/MW Ratio adj. (Avg.) PRMW MRMW
(1) (2)............... (3) = (2) x (1)... (4)............... (5)
----------------------------------------------------------------------------------------------------------------
$[REDACTED]..................... 1:1............... $[REDACTED]....... $[REDACTED]....... $[REDACTED].
$[REDACTED]..................... [REDACTED]:1...... $[REDACTED]....... $[REDACTED]....... $[REDACTED].
$[REDACTED]..................... [REDACTED]:1...... $[REDACTED]....... $[REDACTED]....... $[REDACTED].
$[REDACTED]..................... [REDACTED]:1...... $[REDACTED]....... $[REDACTED]....... $[REDACTED].
$[REDACTED]..................... 4.76:1............ $[REDACTED]....... $[REDACTED]....... $[REDACTED].
----------------------------------------------------------------------------------------------------------------
See id., Table 14.
After considering all of his benchmarks from both of his methods,
Dr. Eisenach concluded that ``the YouTube and Pandora [Opt Out]
agreements represent the most comparable and reliable benchmarks,
implying ratios of [REDACTED]:1 and [REDACTED]:1, respectively, with a
mid-point of [REDACTED]:1.'' Id. ] 130 (The Judges note that converting
these end-points and mid-point of his range to TCC percentages results
in a range from [REDACTED]% to [REDACTED]% and a mid-point of
[REDACTED]%.) \96\
---------------------------------------------------------------------------
\96\ Dr. Eisenach also calculates a per user rate, using his
Method #2. As he explains, ``this is accomplished by calculating
All-In publisher royalties on a per user basis and subtracting the
average effective per-user performance royalties to publishers,
leaving an appropriate rate for mechanical royalties.'' Id. ] 159.
He finds that the sound recording rate per user is $[REDACTED] (the
per user analog to the $[REDACTED] per 100 plays in his per play
analysis). Applying the same ratios and utilizing similar market
data as in his per play approach, Dr. Eisenach concludes that a
``mechanical rate of between $[REDACTED] and $[REDACTED] per user
reflects the range of relative values for sound recordings and
musical works. . . .'' Id. ] 165. Finally, he notes that, at the
[REDACTED]:1 ratio (his mid-point of the YouTube and Pandora
benchmarks, the ``mechanical only'' rate would be $[REDACTED] per
user (greater than the $1.06 per user rate proposed by Copyright
Owners.) Id.
---------------------------------------------------------------------------
2. Analysis of Dr. Eisenach's Benchmark Methods
a. Dr. Eisenach's Ratio of Sound Recordings-to-Musical Works
The Judges find Dr. Eisenach's attempt to identify comparable
benchmarks and corresponding ratios of sound recording rates to musical
works rates to be a reasonable first step in seeking to identify usable
benchmarks. The Judges find potentially useful his decision to rely on
empirics over abstract theory, viz., that a tightly clustered set of
ratios across several markets would tend to support applying a
reasonably central tendency from among those ratios to identify a ratio
that could aid in the identification of the statutory rates.\97\
---------------------------------------------------------------------------
\97\ Dr. Eisenach eschewed unnecessary ``assumptions,
complexities and uncertainties associated with theoretical debates''
as to why the particular existing market ratios existed. Id. ] 79.
In this regard, the Judges understand that Dr. Eisenach was
following a well-acknowledged principle of economic analysis,
articulated by the Nobel laureate economist Milton Friedman, who
famously eschewed excessive theorizing that failed to match the
predictive power of empirical analysis. See M. Friedman, The
Methodology of Positive Economics, reprinted in D. Hausman, The
Philosophy of Economics at 145, 148-149 (3d ed. 2008).
---------------------------------------------------------------------------
However, the data that Dr. Eisenach identified was not sufficiently
clustered to establish a predictive ratio within the data set. That is,
the problem does not lie in the analysis, but rather in the
implications from the data regarding ratios of sound recording
royalties to musical works royalties. The Services make this very
criticism, noting the instability of the ratio across the several
markets in which Dr. Eisenach identified potential benchmarks. See
SJRPFF ] 241 (and record citations therein). Apple finds that the wide
range of ratios is unsurprising, because Dr. Eisenach's benchmarks do
not relate to the same products and same uses of the two rights.
Indeed, Apple's [REDACTED], confirming, according to Apple, that there
is no fundamental market ratio that can be applied in this proceeding.
Dorn WRT ]] 6, 24, 28-29.
To be sure, this point does not go unnoticed by Dr. Eisenach, who
focuses on the royalty ratios arising from two potential benchmarks in
the middle of his range--the Pandora ``Opt-Out'' agreements and the
User Audio YouTube agreements.
The Services assert an additional and fundamental criticism of Dr.
Eisenach's approach. They note that his use of sound recording
royalties paid by interactive services embeds within his analysis the
inefficiently high rates that arise in that unregulated market through
the complementary oligopoly structure of the sound recording industry
and the Cournot Complements inefficiencies that arise in such a market.
See Corrected Written Rebuttal Testimony of Michael L. Katz, Trial Ex.
886, ] 56; Marx WRT ]] 137-141; Hubbard CWRT ]] 6.26-6.27; Leonard WRT
]] 24, 44. The Judges agree with this criticism.
The Judges explained at length in Web IV how the complementary
oligopoly nature of the sound recording market compromises the value of
rates set therein as useful benchmarks for an ``effectively
competitive'' market. In Web IV, the Judges were provided with evidence
of the ability of noninteractive services to steer some performances
toward recordings licensed by record companies that agreed to lower
rates in exchange for increased plays. Here, the Judges were not
presented with such evidence, likely because an interactive streaming
service needs to play any particular song whenever the listener seeks
to access that song (that is the essence of an interactive service).
Thus, the Judges have no direct evidence sufficient to apply a discount
on the interactive sound recording rate to adjust that potential
benchmark in order to fashion an effectively competitive rate, as
required by the ``reasonable rate'' language in section 801(b)(1).
b. Dr. Eisenach's Specific Benchmarks
i. Section 115 Benchmark
The Services assert that Dr. Eisenach's calculation of a section
115 ``valuation ratio'' of 4.76:1 is incomplete, because he limited
this statutory ratio to the 21% and 22%TCC prongs. They note that under
the percentage-of-revenue prong of section 115 (10.5%), this
statutorily-derived ratio would have ranged between 5:1 and 6:1, see 4/
5/17 Tr. 5152 (Leonard), implying a musical works rate equal to only
16.67% to 20% of sound recording royalty rates. The Judges agree that
Dr. Eisenach's statutory benchmarks would have been more comprehensive
if he had included the ``valuation ratios'' derived from this headline
prong of the present royalty rate structure. However, the fact that the
existing rate structure, on which the Services rely in this proceeding,
includes the potential use of the 21% and 22% prongs, demonstrates the
usefulness of this benchmark as a representation of a rate the parties
are willing to accept.
ii. Direct Licenses
The Services disagree with Dr. Eisenach's minimization of the
relevance of this benchmark. They argue that the direct licenses
between
[[Page 1941]]
interactive services and music publishers ``are by far the most
directly apposite benchmarks used in Dr. Eisenach's analysis,'' because
they, like the section 115 rates and terms themselves, possess the
characteristics of a useful benchmark, viz. they: (1) Are voluntary;
(2) concern the same licensors/publisher; (3) relate to the same
market; and (4) pertain to the same rights. See Katz WDT ]] 97-113;
Leonard AWDT ]] 45-70; see also 4/5/17 Tr. 5152 (Leonard) (noting that,
for services paying under the percentage-of-revenue prong under section
115 and based on prevailing sound recording rates, ``[t]he ratio would
be more like . . . 5-to-1 to 6-to-1'').
The Judges find that these direct licenses are as useful, if not
more so, than the 115 benchmark itself. The so-called ``shadow'' of
section 115 provides a default rate for the licensing parties, so
direct licenses that deviate in some manner from the rates in the
statutory license are revealing a preference for other rates and terms
that, at least marginally, are below the statutory rate. Thus, as the
Services note, these benchmarks are useful, because ``these agreements
. . . were voluntarily entered both in 2008 and 2012, by the very same
publishers in the same markets and for the same rights. . . .'' SJPFF ]
261 (and record citations therein). More generally, the Judges find
that the so-called ``shadow'' of the statutory license on a benchmark
does not disqualify that benchmark as useful evidence, though it goes
to its weight.
iii. Synchronization Licenses
The Services also take issue with Dr. Eisenach's inclusion of
synchronization licenses in his collection of benchmarks. See, e.g.,
Leonard WRT ]] 37-40 (testifying that synchronization licenses are not
comparable for interactive streaming licenses because synchronization
differs in important economic respects from streaming); Hubbard CWRT ]]
6.31-6.32 (testifying on various ``economic characteristics of synch
licenses, that render the ratio between sound recording royalties and
musical works royalties different between synch and interactive
streaming services''); Marx WRT ]] 148-151 (``Synch royalty rates are a
poor benchmark for streaming royalty rates''). Even Dr. Eisenach
acknowledged that, at best, the low ratio in the synch licenses
indicates an unusually high musical works royalty rate among his
collection of benchmarks. 4/4/17 Tr. 4671, 4799 (Eisenach); Eisenach
WDT Appx. A-9.
In a prior proceeding, the Judges rejected the synch license
benchmark as useful ``[b]ecause of the large degree of its
incomparability.'' See Phonorecords I, 74 FR at 4519. The Judges find
that nothing in the present record supports a departure from that prior
finding. The lack of comparability remains because the synchronization
market differs in important economic respects from the streaming
market. See Leonard WRT ] 39. Because synch rights pertain to media
such as music used in films or in television episodes,\98\ the
historical equal valuation of publishing rights and sound recording
rights arises from the particular conditions faced in those industries.
Id. Movie and television producers may have a certain musical work in
mind as a good fit for a particular scene in the film. Id. However,
these producers have the option of making their own sound recording of
that musical work, and for this reason, cover songs are quite common in
films. Id.; see also Ex. 1069, Marx WRT ] 149 (``Both film and
television production companies have the option of recording their own
versions of songs, rather than paying royalties to use a pre-recorded
song. . . . This option gives the users of synch rights, such as movie
producers, more bargaining power relative to the labels than would be
the case with streaming services.''). Thus, the contribution to value
of the sound recording is less vis-[agrave]-vis the musical work in the
synch market. Leonard WRT ] 39.
---------------------------------------------------------------------------
\98\ The Copyright Owners also rely on blanket (``microsynch'')
licenses by which publishers grant their entire catalogs for use in
synchronized audio-video productions, and they also rely on synch
licenses for mobile and video game applications. The Judges'
critique of synch licenses as benchmarks is equally applicable to
these licenses.
---------------------------------------------------------------------------
Additionally, in the case of synchronization rights, the
marketplace for sound recording rights is more competitive than other
music licensing contexts because individual sound recordings compete
against one another for inclusion in the final product (e.g., a movie
or television episode). By contrast, in the interactive streaming
market, services must build a catalog of sound recordings and their
included musical works, so that many works can be streamed to
listeners. Id.\99\ That is, in the interactive streaming market, the
sound recordings are ``must have'' complements, not in competition with
each other. However, in the synch market the sound recording of any
given musical work identified by the movie or television produce is a
substitute good, in competition with any other existing or future sound
recording of the same musical work for inclusion in the movie or
television show.
---------------------------------------------------------------------------
\99\ As discussed infra, Dr. Leonard makes an analogous point
with regard to the weaker bargaining position of musical works when
record companies and artists select a song to be recorded. Like the
movie or television producer who can choose among a number of
somewhat substitutable recordings, a record producer can choose
among a number of somewhat substitutable musical works.
---------------------------------------------------------------------------
iv. YouTube Licenses
The Services disagree with Dr. Eisenach's opinion that the YouTube
licenses on which he relies constitute strong benchmarks. As an initial
point, they note that, from a statutory perspective, the video
component of the YouTube licenses renders those licenses inapposite as
benchmarks in this proceeding. See SJRPFF ] 249 (and record citations
therein) (noting that YouTube's ability to utilize the ``safe harbor''
provisions of 17 U.S.C. 512 provides YouTube with strong negotiating
power against publishers and labels because the copyright holders must
identify unauthorized uploadings and issue ``take down notices,'' a
cumbersome and often futile process). The Judges agree that this
statutory provision significantly alters the bargaining landscape
between the sound recording and the musical works licensors, on the one
hand, and YouTube as the licensee, on the other.
The Services further maintain that, even assuming YouTube licenses
are appropriate benchmarks, Dr. Eisenach has relied on the wrong type
of YouTube licenses for his benchmark analysis. As noted, Dr. Eisenach
selected the agreements and rates pertaining to [REDACTED]. He selected
this type of YouTube contract because neither the musical works license
nor the sound recording license is subject to the section 115 license.
See SEJRPFF ] 350 (and record citations therein).
However, the Services maintain that the more appropriate YouTube
benchmarks would be the agreements between YouTube and publisher and
record companies, respectively, for [REDACTED]--agreements that contain
a [REDACTED] royalty rate, rather than the [REDACTED] figure from the
[REDACTED] YouTube agreements. If the Services' are correct in their
assertion that the [REDACTED] YouTube agreements are the appropriate
benchmark inputs, the sound recording: Musical works ratio (applying
the [REDACTED] royalty rate) thus increases to as low as [REDACTED],
implying a ratio as high as [REDACTED]:1, implying a musical works rate
of [REDACTED]%, far lower than Dr. Eisenach's calculated YouTube
royalty of [REDACTED]% (but still above Copyright Owners' proposed
rate). If the [REDACTED] royalty rate of
[[Page 1942]]
[REDACTED]% is applied instead, the ratio rises to [REDACTED], or
[REDACTED]:1, implying a musical works rate of [REDACTED]%.
The Judges find that the static-image YouTube rates are more
analogous to the interactive market, compared with the YouTube
agreements concerning embedded videos. The salient rationale in Dr.
Eisenach's analysis is the sound recording to musical works ratio, so
injecting the video as another element of value into the mix renders
the sound recording to musical works ratio too difficult to identify
with sufficient certainty. However, the Services assert that, given
that the Majors comprise [REDACTED]% of the YouTube market, the
appropriate ratio should be [REDACTED], implying the [REDACTED]% of
sound recording percentage identified above. The Judges find that it
would be proper to weight the YouTube benchmark by applying a
[REDACTED]% weight to [REDACTED]%, and a [REDACTED]% weight to
[REDACTED]%, which results in a benchmark rate of [REDACTED]%
([REDACTED]).\100\
---------------------------------------------------------------------------
\100\ If the sound recording royalty rate for interactive
streaming is 60%, as discussed infra, this YouTube benchmark equals
[REDACTED] x 0.60 = [REDACTED]%.
---------------------------------------------------------------------------
Finally, the Services take issue with Copyright Owners' assertion
that YouTube is a competitor to interactive streaming services, despite
the acknowledgements by those services that such competition is
present. Compare CPFF ]] 263-266 (and record citations therein) with
SJRPFF ]] 263-266 (and record citations therein). The Judges find that
competition does not in itself make the rates in those YouTube
agreements particularly helpful benchmarks, because the addition of
video content creates a bundling of value distinguishable from the
value of interactive streaming alone. However, Google's/YouTube's
acknowledgement of the competitive posture of YouTube vis-[agrave]-vis
interactive streaming services renders the ratio of sound recording:
Musical works royalty ratio in the YouTube stati-screen agreements a
useful benchmark in this proceeding.
Even in those cases, however, the YouTube royalty rates and ratios
remain imperfect because other relevant factors are not necessarily
constant. The Judges agree that the relatively strong bargaining power
of the licensee created by the DMCA ``safe harbor'' provisions,
distinguishes the YouTube market from the market for streaming
services. Copyright Owners seek to minimize this lack of comparability
by arguing that, although YouTube's relatively strong bargaining power
depresses the copyright holders' royalties, ``[s]ince the DMCA safe
harbor applies equally to sound recording and musical works copyrights,
there is no reason to think that their relative valuation would be
affected.'' Eisenach WRT at 66. However, Copyright Owners do not
provide any factual support for this conclusory assumption of a
``relative value'' effect, and the Judges thus cannot find with
sufficient certainty that it in fact is likely that the enhanced
bargaining position of YouTube affects the publishers and the labels
equally. Accordingly, the Judges do not find the YouTube market and
licenses to be sufficiently analogous to the interactive streaming
market to make the benchmark derived from the YouTube analysis to be
useful in determining rates in this proceeding.
v. Pandora ``Opt-Out'' Agreements
Together with his YouTube benchmark, Dr. Eisenach finds the Pandora
``Opt-Out'' agreements to be the most useful among the several
potential benchmarks he examined. The Judges agree. The Judges agree
with Dr. Eisenach that the Pandora ``Opt-Out'' agreements are useful
benchmarks. These agreements have the level of comparability necessary
for a benchmark to be useful. However, the Judges do not agree with Dr.
Eisenach's attempt to extrapolate from the actual rates in those Opt-
Out Agreements. Rather, the Judges find that the [REDACTED]:1 ratio Dr.
Eisenach identified for the year 2018 in existing agreements is the
most useful benchmark derived from the ``Opt-Out'' data. As the
Services note, Pandora's most recent direct license agreements during
the ``Opt-Out'' period with the publishers who control many of the
works embodied in the sound recordings performed by Pandora provide
that publisher royalties will be determined [REDACTED].\101\ This
resulted in a shift of the sound recording: Musical works ratio to
[REDACTED]:1, implying a musical works TCC percentage of [REDACTED]%.
See Katz CWRT ]] 101-104; Herring WRT ]] 28-29).
---------------------------------------------------------------------------
\101\ Pandora's status as a purely noninteractive service prior
to 2018 does not decrease the relevancy of this benchmark, because:
(1) Noninteractive and interactive services both pay performance
royalties; (2) noninteractive services historically have not paid
mechanical royalties; and (3) the performance license and the
mechanical license are perfect complements.
---------------------------------------------------------------------------
The Judges reject Dr. Eisenach's identification of a useful trend
in the shrinking of that ratio (i.e., a growth in the musical works
royalty percentage). His change in the ratio to [REDACTED]:1 was driven
by expectations regarding the likelihood of an uncertain change in the
legal landscape regarding publisher withdrawals from performing rights
organizations. Such uncertain potential changes are not well-captured
by mapping them over a time horizon. Moreover, as the Services note and
as Dr. Eisenach concurs, even assuming such a change in relative
uncertainty could be captured in a regression, other regression forms,
such as a quadratic form, could be used to demonstrate a return of the
ratio to its prior level (an equally plausible future event) rather
than a continuation of its shorter-term increase. See 4/5/17 Tr. 495963
(Katz); Katz CWRT ]] 104-107, Table 1, F; 4/4/17 Tr. 4807-08 (Eisenach)
(linear form of regression not ``material'').
c. Dr. Eisenach's per Play Sound Recording Rate
The Judges also have difficulty relying on the data set Dr.
Eisenach developed for his estimation of a $[REDACTED] per play sound
recording royalty rate. He used that $[REDACTED] per play figure in
several benchmark ratios. Two principal problems with Dr. Eisenach's
data are:
1. The data covered a non-random sample of only approximately
15% of all interactive plays; and
2. the data excluded [REDACTED]'s [REDACTED] services, large
portions of the interactive streaming market. Inclusion of those
[REDACTED] services would have reduced his per play rate from
$[REDACTED] to $[REDACTED]. Inclusion of only [REDACTED] service
would have reduced the $[REDACTED] estimate to $[REDACTED].
SJRFF ] 22 (and record citations therein).
Dr. Eisenach explained his small data sample as resulting in part
from his deliberate decision to omit several sound recording labels
[REDACTED], which he asserted gave them an incentive to allow
[REDACTED] to pay below-market royalties. Eisenach WDT ] 150. The
Judges acknowledge Dr. Eisenach's assertion that this fact could, on
the margin, drive down the royalties paid by [REDACTED] to those
labels. However, the evidence does not bear that out, because the
royalty rates [REDACTED] pays to these labels are comparable to the
rates it pays to other labels that do not have [REDACTED]. More
particularly, the [REDACTED] contracts with record labels that Dr.
Eisenach reviewed show the same [REDACTED], a rate no lower than the
rate paid by other interactive streaming services. 4/4/17 Tr. 473953
(Eisenach); see also, e.g., Trial Ex. 2760 (Digital
[[Page 1943]]
Product Agreement Specific Terms between [REDACTED] and [REDACTED],
2013, [REDACTED]0005221); Trial Ex. 2765 (Digital Audio Distribution
Agreement between [REDACTED] and [REDACTED], July 1, 2013,
[REDACTED]0005548). Further, for every dollar in royalties a label
[REDACTED], the label would [REDACTED].
With regard to the specific omission of data from Spotify's ad-
supported service, Copyright Owners make additional arguments. They
claim that the ad-supported service does not reflect the actual value
of the sound recordings, because that service acts as a funnel to draw
listeners to the subscription service. Therefore, Copyright Owners
maintain, the ad-supported service is essentially a loss-leader, with
the difference between the higher effective per play rates for
subscription services and the lower effective per play rates for ad-
supported services more in the nature of a marketing expense that
should not be deducted from Dr. Eisenach's royalty calculations. See
Eisenach WDT ] 148, n.127.
That analysis, however, omits the fact that Spotify's ad-supported
service only [REDACTED]. See Marx WDT ] 55, n.77. [REDACTED]. These
listeners and the advertising revenue they generate are real and
reflect the WTP of a large swath of interactive listeners.\102\ See
Marx WRT ] 115-16 (``[O]ne aspect of the ad-supported service is to
provide an on-ramp to paid services, it also has another important
aspect, namely to serve low WTP customers. . . .''). Copyright Owners'
economists err in not calculating the impact of Copyright Owners'
proposal on ad-supported services. Ad-supported services currently make
up [REDACTED] and [REDACTED]% of all streams in the industry. The
Judges agree with Professor Marx that Dr. Eisenach's omission of the
Spotify data undercuts his analysis.\103\
---------------------------------------------------------------------------
\102\ In the parlance of platform economics, Spotify's ad-
supported service provides a multi-platform approach, in which
listeners, advertisers, sound recording rights holders and musical
works holders all combine to obtain revenue based on the mutual
values each brings to that platform.
\103\ Copyright Owners belatedly propose that if the Judges
intend to include the Spotify ad-supported service in the rate
structure and rate calculations, they should establish (1) separate
rates for ad-supported services that are not incorporated into the
calculation of rates set for other services; and (2) separate terms
for an ad-supported service that limit the functionality of the
service, to avoid potential cannibalization of services paying
higher royalties. COPCL at 106, n.34. This argument is a tacit
acknowledgement by Copyright Owners that a segmented market might
require a differentiated rate structure, even as they strenuously
dispute the appropriateness of such a structure.
---------------------------------------------------------------------------
The Judges accept, to some degree, Copyright Owners' argument that
ad-supported services are a marketing tool to identify future
subscribers. Until those subscribers are identified and ``signed,''
however, they are not subscribers. In that sense, ad-supported services
may be marketing tools, but they do not reduce present royalties
because the future subscribers have not yet been identified. There is
no record evidence that Spotify's hard cost saving translates directly
into royalty revenue lost to Copyright Owners. Apparently, Copyright
Owners argue that their loss is in the form of an opportunity cost,
i.e., losing the opportunity to obtain subscription-level royalties
from the ad-supported listeners. But if Spotify paid subscription-level
royalties for all ad-supported listeners, it would be paying an
implicit marketing cost that inefficiently was allocated to the
[REDACTED]% or so ad-supported listeners who, historically, will not
become paid subscribers.
The use of an ad-supported service as a ``freemium'' model serves a
dual purpose: First, it is an efficient means of marketing--segregating
listeners according to WTP--still allowing them to ``experience''
interactive streaming, while, second, simultaneously providing ad-
revenue-based royalties to Copyright Owners. If Spotify substituted
advertising as a marketing tool, Copyright Owners would realize zero
royalties until the advertising resulted in new subscribers.\104\
---------------------------------------------------------------------------
\104\ The provision of a monetarily free-to-the user service is
a reasonable marketing tool, and the Judges are loathe to second-
guess the business model incorporating that marketing approach,
especially while it provides royalties to rights owners. Also, the
Judges do not find it relevant that other interactive streaming
services have not utilized an ad-supported service. There is no
record evidence regarding why other Services have ceded that market
to Spotify.
---------------------------------------------------------------------------
d. Analysis of Dr. Eisenach's Method #1
The Services criticize Dr. Eisenach's Method #1 calculation as
being based upon the incorrect assumption that the entire difference
between interactive and noninteractive rates must be attributed to the
mechanical license right. As the Services properly note, there are
several reasons, all unrelated to the mechanical right and license, why
interactive rates are higher than noninteractive rates for musical
works performance rights. Leonard WRT ] 55; Katz CWRT ]] 117-118;
Hubbard CWRT ] 6.4; 4/5/17 Tr. 4972-74 (Katz). Dr. Eisenach's Method #1
did not account for the presence of the ephemeral right in licensing
noninteractive streaming, which accounts for 5% of the noninteractive
rate. See 4/4/17 Tr. 485152 (Eisenach); 4/5/17 Tr. 5158-61 (Leonard);
see also Leonard WRT ]] 55-56.
Further, there is a difference in the performance rights royalty
rates PROs charge interactive and noninteractive services that is not
captured by Method #1. See, e.g., In re Petition of Pandora Media,
Inc., 6 F. Supp. 3d at 330. Had Dr. Eisenach considered other
explanations for the difference between the All-In sound recording
royalty rates for interactive and noninteractive services, he might
well have estimated a mechanical rate ``[REDACTED]'' See Katz CWRT ]
122.
The Services also note the impact in Method #1 of Dr. Eisenach's
decision to omit [REDACTED] data from his modeling. The Services
contend adding the [REDACTED] data to Dr. Eisenach's effective per play
rate for sound recording results in a per-play rate of $[REDACTED]. See
4/4/17 Tr. 4771-74 (Eisenach).
Combining the foregoing criticisms, the Services conclude:
If one were to use $[REDACTED] per hundred plays for the sound
recording rate (which includes the [REDACTED] data) (id. at 4771-
74), reduce that by 12% as the Board did in Web IV for complementary
oligopoly power, increase the $[REDACTED] per hundred plays Dr.
Eisenach uses for musical works performance rights by 60% to account
for the difference in ASCAP rates identified by Judge Cote, and then
apply Dr. Eisenach's invalid ``valuation ratio'' of [REDACTED]:1,
the result would be $[REDACTED] per hundred plays ($[REDACTED] per
play), way below the $0.15 per hundred plays rate ($.0015 per play)
that Dr. Eisenach attempts to validate.
SJPFF ] 279 (and record citations therein).
The Judges agree with the Services that Eisenach's Method #1 does
not provide a useful benchmark in this proceeding. The absence of
interactive streaming data from [REDACTED] is a critical omission. The
fact that much of that data relates to [REDACTED] services [REDACTED]
does not justify removing the data from a market analysis; that service
is a part of the market. In fact, Copyright Owners' argument proves too
much. That is, their willingness to distinguish and isolate the
[REDACTED] service and related data actually underscores the need for a
differentiated/price discriminatory rate structure, such as the Judges
have adopted in this proceeding.
The Judges are less sanguine, however, with regard to the Services'
argument for a 12% reduction to the sound recording rates to reflect
the complementary oligopoly effect arising
[[Page 1944]]
from the ``must have'' status of the sound recordings in the
interactive streaming distribution channel. The Judges are reluctant to
simply import the 12% rate reduction from Web IV into other
determinations, even though that figure was used to adjust from
interactive streaming rates to noninteractive streaming rates. The
specific 12% figure was based on record evidence derived from steering
experiments and agreements analyzed in Web IV.
The Judges agree with the Services that it is inaccurate in Method
#1 to subtract a performance rate that reflects the higher interactive
performance rate, rather than the lower noninteractive performance
rate.
e. Analysis of Dr. Eisenach's Method #2
The Judges find that Dr. Eisenach's Method #2 does not contain
sufficient industrywide performance royalty and sound recording data to
provide a meaningful analysis for determining a per-user monthly
mechanical works royalty. The Judges are also troubled by the apparent
inconsistent use of Rate Court established rates in Method #2, when Dr.
Eisenach had indicated in other contexts that rates unshackled from
Rate Court decisions provide a truer indication of market rates.
The Judges understand that Dr. Eisenach omitted [REDACTED] user
data because of [REDACTED], which is itself a function of its
[REDACTED] service. The Judges recognize that combining [REDACTED] user
data with other interactive streaming services' data would
significantly change the results, in a manner that Copyright Owners
find to be anomalous. See CORPFF at 183-184 (noting what Copyright
Owners describe as ``[t]he profound impropriety of ``blending''
[REDACTED] rate into Copyright Owners' benchmarking and calculations.)
However, that seeming anomaly actually underscores why the Judges find
a differentiated rate structure to be appropriate.
The royalty rates paid by all Services should be reflective of the
differentiated WTP of listeners.
f. Conclusion
For the foregoing reasons, the Judges do not adopt Dr. Eisenach's
proposed benchmark rates as the mechanical rates for the upcoming rate
period. However, the Judges do find several of the benchmark rates
implied by his sound recording to musical works ratios to be useful
guideposts for identifying the headline percent-of-revenue rate to be
incorporated into the rate structure in the forthcoming rate period.
B. Rejection of Services' 2012-Based Proposals
1. Section 115 Benchmark Rates
The Services do not examine in detail the particular rates within
the existing rate structure. Rather, they treat the rates within that
structure as benchmarks, i.e., generally indicative of a sufficiently
analogous market \105\ that has ``baked-in'' relevant economic
considerations in arriving at an agreement. Dr. Eisenach did not
analyze why he chose the levels for the rates and ratios on which he
relied as benchmarks or consider the subjective understandings of the
parties who negotiated his benchmarks. Similarly, the Services'
economists elected to rely on the 2012 rates as objectively useful
without further inspection.\106\
---------------------------------------------------------------------------
\105\ Here, the ``analogous market'' is the same as the target
market across all dimensions, except that the benchmark is
temporally removed from the target, with the rates in the benchmark
having been formed five years ago.
\106\ This point is not made to be critical of Dr. Eisenach's
approach, but rather to show that the Services' reliance on the 2012
settlement as a benchmark shares this similar analytical
characteristic, typical and appropriate for the benchmarking method.
(The factual wrinkle here is that, hypothetically, the Services
could have called witnesses and presented testimony regarding the
negotiations that led to the 2012 (and 2008) settlements, but did
not, rendering the 2012 benchmark similar to other benchmarks taken
from other markets. Mr. Israelite provided some testimony on behalf
of Copyright Owners regarding those negotiations (as discussed
supra), but even that testimony related to the rate structure,
rather than to the level of the rates themselves.
---------------------------------------------------------------------------
Copyright Owners take the Services to task for failing to present
evidence of the negotiations that led to the prior settlements. They
argue that, without relevant evidence or testimony, the Services cannot
provide support for their proposed rates. The Services take a very
broad approach in their attempt to establish the usefulness of the rate
levels within the 2012 benchmark. They note that music publishers have
consistently realized profits under these rates, including profits from
musical works royalties. Copyright Owners counter that mechanical
royalties have not created a profit for Copyright Owners, and the
Services' assertion of overall publisher profitability is based on
their lumping of performance royalties together with mechanical
royalties.
The Services maintain that they relied on the continuation of the
existing rates in developing their business models. For example,
Pandora, the latest entrant into the interactive streaming market,
asserts that it based its decision to enter this market on its
assumption that mechanical royalty rates would not increase. Herring
WRT ] 3.
The Judges categorically reject this argument. The statute is plain
in its requirement that the rates be established de novo each rate
period. A party might feel confident that past is prologue and that the
parties will agree to roll over the extant rates for another period. A
party could be sanguine as to its ability to make persuasive arguments
to keep the rates unchanged. A party might conclude that the mechanical
rate is such a small proportion of a licensee's total royalty
obligation that its increase would be unlikely to alter long-term
business plans. But for sophisticated commercial entities to claim that
they assumed the rates would remain static is incredible.
The record indicates that an increase in the rates might affect
different interactive streaming services in different ways. In
particular, there might be a dichotomous effect as between essentially
pure play streaming services (such as Spotify and Pandora) and the
larger new entrants with a wider commercial ``ecosystem'' (such as
Amazon, Apple and Google). As Spotify's CFO testified:
The Copyright Owners argue that ``a change in market-wide
royalty rates such as this would affect all participants in a
similar way,'' suggesting that the industry as a whole could
increase prices without affecting their relative price points.
Rysman WDT ] 94. However, not all Digital Services use the same
business model. For example, several Digital Services are owned by
large corporate parents who can use streaming music as a ``loss
leader'' to build brand awareness, keep users in their broader
ecosystem, or promote other products and/or services. See, e.g.,
Rysman WDT ] 29 . . . . The industry has already seen a few examples
of downward pressure on prices from this strategy. See WDT ] 50.
[REDACTED] See WDT ] 73.
McCarthy WRT ] 38; see Written Direct Testimony of Barry McCarthy,
Trial Ex. 1060, ] 50-51 (McCarthy WDT) ([REDACTED]); McCarthy WRT ] 36
([REDACTED]).\107\
---------------------------------------------------------------------------
\107\ As noted elsewhere, the Judges find it highly informative
that the Services agree to a continuation of the present rates even
though: (1) They are all losing money under these rates; and (2)
their experts suggest much lower rates than the Services propose.
While the assertions of ``conservatism'' and reasonableness''
suggest strategic prudence, the Services' acquiescence to these
rates indicates that year-over-year accounting losses are not of
great concern--certainly not great enough for the Services to rely
on their own experts' opinions to advocate for lower rates. Rather,
they seem to be locked in a battle for market share, in which the
single survivor, or the several survivors serving discrete
downstream segments, can acquire the market power sufficient to
appropriate a sufficient share of the surplus, as explained in the
discussion of the Shapley value. That is, the interactive streaming
services seemed to be in a Schumpeterian competition for the market,
not merely in competition in the market. Given this finding, the
Judges do not find that the year-over-year losses suffered by the
Services constitute a serious competitive detriment. Accordingly, in
setting effectively competitive rates, the Judges are more concerned
with providing the Copyright Owners with a rate that appropriately
compensates them in a manner consistent with the relevant and
persuasive benchmarks, even if the Services may incur a somewhat
higher level of accounting losses. Alternately stated, the Judges
find that it would be highly coincidental (and is unsupported by any
evidence) that the present rate levels establish in essence a
maximum level of losses the Services collectively can sustain, such
that a reduction in losses is unnecessary but an increase in losses
will lead to their demise.
---------------------------------------------------------------------------
[[Page 1945]]
The Judges construe this argument as an iteration of the ``business
model'' argument that they have consistently rejected. The Judges
cannot and will not set rates to protect any particular streaming
service business model. The Judges distinguish between: (1) Business
models that are necessary reflections of the fundamental nature of
market demand, particularly, the varied WTP among listeners; and (2)
business models that may simply be unable to meet dynamic competition.
If pure play interactive streaming services are unable to match the
pricing power of businesses imbued with the self-financing power of a
large commercial ecosystem, nothing in section 801(b)(1) permits, let
alone requires, the Judges to protect those pure play interactive
streaming services from the forces of horizontal competition. Moreover,
any disruption arising from the disparate impact of a rate increase
among interactive streaming services would not constitute
``disruption'' under Factor D. Disruption resulting from competition
would not upend the structure of the industry or generally prevailing
industry practices; rather it would influence particular business
models.
2. The Services' Subpart A Benchmark
The Services utilize the rate in extant subpart A as an additional
benchmark for the subpart B rates to be determined in this proceeding.
Subpart A describes the rates record companies pay Copyright Owners for
the mechanical license, i.e., the right to reproduce musical works in
digital or physical formats. The particular subpart A benchmark rate on
which the Services' rely is the existing rate, which the subpart A
participants have agreed to continue through the forthcoming rate
period through settlement.\108\
---------------------------------------------------------------------------
\108\ The Services did not rely on the settlement that led to
the continuation of these rates into the next rate period as a
benchmark. The Services moved for discovery regarding this most
recent settlement but the Judges denied that motion on the grounds
that the new settlement was not a benchmark on which the Copyright
Owners had relied and therefore was not within the scope of
allowable discovery. See 37 CFR 351.5 (scope of discovery limited to
materials relevant to the responding party's Written Direct
Statement). The Copyright Owners did not proffer any evidence
regarding their most recent settlement.
---------------------------------------------------------------------------
In support of this benchmark, the Services emphasize that the total
revenue created by the sale of digital phonorecord downloads and CDs is
essentially commensurate with the revenues created through interactive
streaming, indicative of an equivalent financial importance to
publishers when negotiating rates with licensees in subparts A and B
respectively. See 3/20/17 Tr. 1845 (Marx) (``downloads, in particular,
are comparable to interactive streaming.''). Also, although the subpart
A rate is the product of a settlement, the Services argue that the rate
is a useful benchmark because it reflects both the industry's sense of
the market rate and the industry's sense of how the Judges would apply
the section 801(b)(1) considerations to those market rates. 3/15/17 Tr.
1184, 1186 (Leonard); 3/20/17 Tr. 1842-43 (Marx).
In opposition, Copyright Owners argue, for several reasons, that
the subpart A rates are not proper benchmarks. First, they emphasize
that revenue from the sale of PDDs and CDs has been declining over the
past several years. Second, they note, as the Services acknowledge,
that the parties are not identical; specifically, the licensees in
subpart A are record companies whereas in subpart B the licensees are
interactive streaming services. See, e.g., 3/15/17 Tr. 1193 (Leonard).
Third, Copyright Owners emphasize that the existing subpart A rate is
itself the product of a settlement, rather than a market rate. Fourth,
and relatedly, they raise their overarching argument against any
purported benchmark rate set in ``the shadow'' of the statutory
license, because the licensee record companies had the option of
refusing to settle and to seek instead a potentially lower statutory
rate.
Copyright Owners note that the subpart A settlement establishes a
per-unit royalty rate of $0.091 per physical or digital download
delivery (with higher per-unit rates for longer songs), rendering that
rate inapposite as a benchmark for the Services' present subpart B
proposal. See 3/20/17 Tr. 1960 (Marx). In support of this position,
Copyright Owners argue that because the subpart A rate is expressed as
a monetary unit price, Copyright Owners have eliminated the risk that
retailers' downstream pricing decisions will affect the Copyright
Owners. More specifically, they note that, ``[u]nder the subpart A rate
structure, the [record company] (as licensee) pays the same [penny
rate] amount in mechanical royalties regardless of the price at which
the sound recording is ultimately sold [within the] range of price
points for individual tracks in the market ranging from $0.49 to $1.29
and the mechanical penny rate binds regardless of the price of the
track. COPFF ] 727 (citing Ramaprasad WDT ] 28 & Table 1; 3/20/17 Tr.
1956-58 (Marx)).
Copyright Owners further attempt to distinguish subpart A from
subpart B based on the fact that downstream listeners to PDDs and CDs
(and any other physical embodiment of a sound recording) become owners
of the sound recording and the musical work embodied within it, whereas
under subpart B the listeners only obtain access to the musical works
for as long as they remain subscribers or registered listeners (to a
non-subscription service). The Judges find this point to be a
distinction without a sufficient economic difference. The Judges note
with favor the testimony of Professor Leonard, who said of the
``ownership vs. access'' distinction that, although it is a real legal
distinction, it does not reflect as fundamental an economic difference
as might appear on the surface. Leonard WRT ] 27; 3/15/17 Tr. 1098,
1113 (Leonard).
The Judges accept Professor Leonard's economic analogy. Ownership
is in essence a more comprehensive and unconditional form of access. A
downstream purchaser acquires ownership of the digital or physical
reproduction of a sound recording and the embodied musical work for an
up-front charge (the purchase price). The purchaser then has unlimited
free access to that sound recording/musical work going forward. A
subscriber to an interactive streaming service pays an up-front charge
(usually monthly), and then likewise has unlimited access to the entire
catalog of sound recordings (and the embodied musical works) for each
paid period.
In economic terms, each approach contains the features of a ``two-
part tariff,'' where the end user pays a fixed access fee (an
``option'' price, i.e., the right to use the owned or accessible music)
and a zero marginal per play charge that efficiently corresponds with
the zero physical marginal cost of creating another play of the owned
or accessible sound recording/musical work.\109\ The salient difference
is that the subscriber does not get unlimited marginal plays for zero
additional charge. The monthly subscription fee is the measure of the
marginal cost to the
[[Page 1946]]
listener who streams. Determination of the allocation of that marginal
cost is impossible, however, as the Judges recognize that the
subscription fee allows for access to a large, comprehensive
repertoire, whereas access stemming from the purchase of a download,
CD, or vinyl record is limited to the specific sound recording and
embodied musical work. For this reason, there is less access value in
the sale of a download or a CD, compared to the access value of a
subscription to a streaming service, rendering the subpart A rate at
best a guideline as to the rates below which the subpart B and C rates
cannot fall.\110\
---------------------------------------------------------------------------
\109\ This point is more general in nature. Any item that is
``owned'' creates value in use because it is capable of being
accessed, not that it is continuously accessed.
\110\ The Judges note though that Copyright Owners' appropriate
reliance on the different access value in subpart A is an argument
relating to the downstream value, confirming that upstream value
demand is a ``derived demand,'' based on values in the downstream
market. This argument therefore further undercuts Copyright Owners'
claim that there is an ``inherent value'' in musical works that
applies in these proceedings.
---------------------------------------------------------------------------
In other respects, the Judges find the subpart A settlement to be
somewhat useful. The licensed right in question is identical: The right
to reproduce musical works for sale into a downstream market. Further,
the licensors, i.e., the music publishers and songwriters, are
identical. Finally, the time period is reasonably recent and Copyright
Owners have not explained whether or how the particular market forces
in the subpart A market sectors have changed since 2012 to make the
rate obsolete. The usefulness of the subpart A rate as a benchmark is
limited, however, because: (1) The access value of downstream services
is greater than the access value of an individual purchase of a sound
recording/musical work; (2) there is a partial difference in economic
risk to the licensors between a per-unit royalty and a royalty based on
a percent-of-revenue (with minima); and (3) the licensees in the
benchmark market are not the same.
3. The Two Subpart A Benchmarking Approaches
In their first benchmarking exercise, the Services attempt to
convert the per-unit rate in subpart A into a subpart B percent-of-
revenue rate. To that end, they attempt to identify an equivalency
between a given number of interactive streams and a single play of a
purchased DPD.
Professor Marx first applies a conversion ratio of PDDs to streams
of 1:150, calculated by the RIAA. Second, she takes note of an academic
study which estimated that marketplace 137 interactive streams was
equivalent to the sale of one DPD. Marx WDT ] 108 & n.21 (citing L.
Aguiar and J. Waldfogel, Streaming Reaches Flood Stage: Does Spotify
Stimulate or Depress Music Sales?, (working paper, National Bureau of
Economic Research, 2015)); Katz WDT ] 110 (same). Apple's economic
expert, Professor Ramaprasad, also relied on the Aguiar/Waldfogel
article to support Apple's benchmark per play proposal. Ramaprasad WDT
] 56, n.102.\111\
---------------------------------------------------------------------------
\111\ Professor Ramaprasad also relied on two other equivalency
ratios, the first from Billboard magazine, and the second from
another entity, UK Charts Company (UK Charts). However, she
acknowledges that the Billboard ratio combines video streaming
royalty data with audio streaming royalty data, which results in an
overestimation of the ratio of streams to track sales relative to an
audio-stream-only analysis. 3/26/17 Tr. 2760-61 (Ramaprasad). She
also acknowledges that UK Charts changed its ratio from 100:1 to
150:1 without explanation, rendering uncertain that purported
industry standard. See COPFF ] 683 (and record citations therein).
Also, there was no evidence indicating that streaming and download
activity in the United Kingdom would be comparable to U.S. activity.
---------------------------------------------------------------------------
Professor Marx applied this approach and formula to Spotify's
revenues. She calculated that, given the number of songs played on
Spotify that were longer than five minutes, the per-recording rate in
subpart A is $[REDACTED]. Dividing that per recording rate by 137
yields $[REDACTED] royalty per stream. She then multiplied that per
stream ``equivalent'' royalty by the total number of streams to
estimate a total royalty. Professor Marx then divided the total royalty
by total revenues. Given the All-In approach proposed by the Services,
Professor Marx subtracted Spotify's performance royalty rate of
[REDACTED]% of revenue to determine a mechanical royalty rate of
[REDACTED]% of revenue using this approach. Marx WDT ] 112, Fig. 22.
When she applied the Aguiar/Waldfogel 137:1 ratio, she identified a
musical works All-In royalty rate derived from subpart A of [REDACTED]%
of revenue, and a mechanical royalty rate (i.e., after subtracting the
[REDACTED]% performance rate) of [REDACTED]% of revenue.
On behalf of Pandora, Professor Katz used the same 1:150 conversion
ratio as Professor Marx. He calculated a mechanical rate implied by the
subpart A rate of [REDACTED]% of revenue, higher than Professor Marx's
implied rate, but still lower than the existing headline rate of 10.5%
in subpart B. Katz WDT ] 111.
On behalf of Apple, Professor Ramaprasad utilized the same 1:150
ratio, which she adopted from Billboard magazine's ``Stream Equivalent
Albums'' analysis. Ramaprasad WDT ] 84. Because Apple has advocated for
a per-stream rate, her conversion was expressed on a per-stream basis,
at $0.00061 per stream. Professor Ramaprasad noted that this rate was
not only lower than the $0.0015 per stream rate proposed by Copyright
Owners, but also significantly lower than Apple's own proposed per-
stream rate of $0.00091. Ramaprasad WDT ] 86. When Professor Ramaprasad
applied the Waldfogel/Aguiar 1:137 ratio, expressed on a per-play
basis, she calculated a rate of $0.00066 per stream for interactive
streaming, which she noted was even lower than the per-stream rate of
$0.00091 Apple had proposed.
The Judges do not base any conclusions on this ``conversion''
approach. Copyright Owners express numerous criticism of the ratio
approach, and many of those criticisms, each on its own merit, serve to
discredit the ratio approach. First, the Services and Apple simply
adopted the equivalence ratios without defining what ``equivalence''
means. For example, the RIAA used the concept to identify albums that
were sufficiently popular to garner ``gold'' or ``platinum'' awards.
That use, absent other evidence, does not indicate that the conversion
ratio is appropriate for rate-setting purposes. See generally Rysman
WRT ] 96; 3/23/17 Tr. 2775-76 (Ramaprasad). Second, and relatedly, the
experts who relied on the Aguiar/Waldfogel article did not verify that
the input data that was used by the authors was appropriate for the
purposes for which it has been relied upon in this proceeding. See 3/
20/17 Tr. 1945-46 (Marx); 3/23/17 Tr. 2789-90 (Ramaprasad). Third, the
Aguiar/Waldfogel article appears not to specifically address two issues
that would make the equivalency ratio meaningful: (a) What happens to
the download behavior of an individual who adopts streaming; and (b)
how the availability of streaming alters the consumption of a
particular song. See Rysman WRT ] 97. Fourth, the experts for the
Services and Apple ignore that Aguiar and Waldfogel conducted an
additional analysis described in the same article on which they rely.
In that second analysis, the authors compared the weekly data from
Spotify for the period April to December 2013 with weekly data from
Nielson on digital download sales for the same songs during the same
overlapping time period. That approach, which Aguiar and Waldfogel
called their ``matched aggregate sales'' analysis, yielded a ratio of
43:1, implying a much higher
[[Page 1947]]
mechanical rate for streaming. See COPFF ]] 663-64 (and record
citations therein).
The Services and Apple offer insufficient evidence to overcome
these criticisms of their ``equivalence'' approach to applying the
subpart A rates in this proceeding. Accordingly, the Judges do not rely
on these ``equivalence'' approaches in this determination.
By contrast, the Services' second subpart A benchmarking approach,
utilized by both Professor Marx and Dr. Leonard, is more
straightforward; it does not require a conversion of downloads into
stream-equivalents. Rather, under this approach, Professor Marx simply
divides the effective per-unit download royalty of $.096 by the average
retail price of a download, $1.10, to calculate an All-In musical works
royalty percent of [REDACTED]%. Subtracting Spotify's [REDACTED]%
performance rate nets a mechanical works rate of [REDACTED]. In similar
fashion, given an average CD price of $1.24 per song, she finds that
the All-In musical works rate equals [REDACTED]%. Subtracting Spotify's
[REDACTED]% performance rate nets an ``effective'' mechanical royalty
rate of [REDACTED]% under this approach. Thus, she concludes that the
Services' proposal in general, and Spotify's proposal in particular,
are conservative and reasonable, because those proposals provide for
substantially higher royalty rates than suggested by this subpart A
benchmark analysis. Marx WDT ]] 113-114 & Fig. 23.
Dr. Leonard did a similar calculation. He found that, applying the
subpart A rates expressed as a percentage of revenue, interactive
streaming services would pay an All-In rate to Copyright Owners of 8.7%
of revenue, based on the average retail price of digital downloads in
2015. Leonard AWDT ] 42. Dr. Leonard further calculated that, expressed
as a percentage of payments to the record labels (rather than total
downstream revenues) the subpart A settlement reflects a payment of
14.2% of sound recording royalties, when compared to payments to record
labels in 2015. Leonard AWDT ] 46.
Using updated 2016 data, which lowered the DPD retail price to
$.99, Dr. Leonard calculated an ``effective'' percentage royalty rate
of 9.6%. 3/15/17 Tr. 1108-09 (Leonard). Dr. Leonard then adjusted this
result to make it comparable to Google's proposal, which seeks a
reduction of up to 15% of certain costs incurred to acquire revenues.
Adjusting for this cost reduction, Dr. Leonard concludes that the
equivalent percent of revenue (after deducting similar costs) in
subpart A was 10.2% in 2015 and 11.3% in 2016. Id. at 1109.
Copyright Owners do not dispute the calculations made by Professor
Marx and Dr. Leonard. However, their general criticisms of the overall
concept of using subpart A as a benchmark, discussed and rejected
below, are equally applicable to this second approach.
The Judges find that the subpart A benchmark determined by this
second approach is useful--not to establish the appropriate benchmark--
but to incorporate into the development of a zone of reasonableness of
royalty rates within the rate structure adopted by the Judges in this
proceeding. The subpart A rates satisfy important criteria for a useful
benchmark: The licensors are the same in the benchmark and target
market; the rights licensed are the same in both markets; the time
period of the rates in both markets is proximate; and the amount of
revenue realized by the licensors in both markets is comparable.
Additionally, the second approach is straightforward--simply converting
a per unit price into a percent of revenue. Finally, the Judges take
note of a point made by Professor Marx: Copyright Owners, like any
seller/licensor, would rationally seek to equalize the rate of return
from each distribution channel, i.e., from licensing rights to sell
DPDs/CDs under subpart A and from licensing interactive streaming
services under subpart B. As she explains:
This principle of equalizing rates of return across different
platforms has some similarities with that underlying the approach of
W. Baumol and G. Sidak, ``The Pricing of Inputs Sold to
Competitors,'' . . . . They propose an efficient component pricing
rule whose purpose is to ensure that the bottleneck owner (in our
case, the copyright holder) should get compensation for access from
all downstream market participants, whether existing or new
entrants, that leaves him as well off as he would have been absent
entry.
Marx WDT ] 104, n.118.
The Judges first identified this principle in Web IV, through a
colloquy with an economic witness, and it remains persuasive in this
proceeding. See Web IV, 81 FR at 26344 (Economic expert, Professor
Daniel Rubinfeld, acknowledging as ``a fundamental economic process of
profit maximization . . . [licensors] would want to make sure that the
marginal return that they could get in each sector would be equal,
because if the marginal return was greater in the interactive space
than the noninteractive . . . you would want to continue to pour
resources, recordings in this case, into the [interactive] space until
that marginal return was equivalent to the return in the noninteractive
space.''). Further, the Judges only recently credited this ``efficient
component pricing rule''/opportunity cost approach in SDARS III.\112\
---------------------------------------------------------------------------
\112\ Of course, because copies of musical works (embodied in
copies of sound recordings) are non-rivalrous quasi-public goods,
licensing a copy to licensees in one platform does not prevent the
licensing of another copy to licensees on a different platform. The
equalization of returns for such goods relates to the elimination of
opportunity costs.
---------------------------------------------------------------------------
C. Rejection of Apple's Proposed Rate
Apple proposes an All-In per-unit rate of $0.00091 per play.
However, that rate is premised on two analytical factors that the
Judges have rejected in this proceeding. First, as a single, per-play
rate, Apple's proposal fails to reflect the variable WTP in the market,
rendering it a less efficient upstream royalty rate. Second, Apple's
proposed $0.00091 per-play rate is derived from the subpart A
conversion ratio approach that the Judges rejected in this proceeding.
D. Deriving Royalty Rates From Shapley Analyses
The Judges look to the Shapley analyses \113\ utilized by the
Professors Marx and Watt and, to a lesser extent, the ``Shapley-
inspired'' analysis utilized by Professor Gans, as one means of
deriving a reasonable royalty rate (or range of reasonable royalty
rates).\114\ The Judges defined and described the Shapley value in a
prior distribution proceeding: ``[T]the Shapley value gives each player
his `average marginal contribution to the players that precede him,'
where averages are taken with respect to all potential orders of the
players.'' Distribution of 1998 and 1999 Cable Royalty Funds, 80 FR
13423, 13429 (Docket No. 2008-1) (March 13, 2015) (citing U. Rothblum,
Combinatorial Representations of the Shapley Value Based on Average
Relative Payoffs, in The Shapley Value: Essays in Honor of Lloyd S.
Shapley 121 (A. Roth ed. 1988)); see Expert Report of Joshua Gans,
Trial Ex. 3028, ] 64 (Gans WDT) (``The Shapley value approach . . .
models bargaining processes in a free market by considering all the
ways each party to a bargain would add value by agreeing to the bargain
and then assigns to each party their average contribution to the
cooperative bargain.''); Marx WDT ] 144 (``The idea of the Shapley
value is that each party should pay according to its average
contribution to cost or be paid according
[[Page 1948]]
to its average contribution to value. It embodies a notion of
fairness.''); Written Rebuttal Testimony of Richard Watt, Trial Ex.
3034, ] 23 (Watt WRT) (``The Shapley model is a game theory model that
is ultimately designed to model the outcome in a hypothetical `fair'
market environment. It is closely aligned to bargaining models, when
all bargainers are on an equal footing in the process.'').
---------------------------------------------------------------------------
\113\ The ``Shapley Analysis'' or ``Shapley Models'' are so
called based on the work of Nobel Economics Prize winner, Dr. Lloyd
S. Shapley.
\114\ The Judges will revisit the Shapley Analyses in evaluating
factors B and C under section 801(b)(1).
---------------------------------------------------------------------------
1. Shapley Models
A Shapley Analysis requires the economic modeler to identify
downstream revenues available for division among the parties. The
economic modeler must also input costs that each provider must recover
out of downstream revenues, in order to identify the residue, i.e., the
Shapley ``surplus,'' available for division among the parties. A
Shapley Model is cost-based, similar to a public utility-style rate-
setting process, which identifies a utility's costs to be recovered
before determining an appropriate rate of return.\115\ In the present
case, Copyright Owners and the Services have applied this general
approach in different ways, and each challenges the appropriateness of
the other's model.
---------------------------------------------------------------------------
\115\ Unlike in public utility regulation, the Shapley Analysis
considers the costs of all input providers whose returns will be
determined. In traditional public utility rate regulation, the
utility is a monopoly and thus the only provider of a regulated
input.
---------------------------------------------------------------------------
To summarize the differences in their approaches, Professor Marx
utilizes a Shapley Model that purposely alters the actual market
structure in order to obtain results that intentionally deviate from
the market-based distribution of profits. She makes these alterations
in her model to determine rates she identifies as reflecting a ``fair''
division of the surplus (Factor B) and recompense for the parties'
relative roles (Factor C). By contrast, Professor Watt's ``correction''
of Professor Marx's model rejects her alteration of the market
structure. Rather, he maintains that the incorporation of ``all
potential orders of the players'' in her model (as in all Shapley
Models) already eliminates the hold-out power of any input provider who
might threaten to walk away from a transaction.
Professor Gans, like Professor Watt, does not attempt to alter the
market structure. However, Professor Gans concedes that he is not
attempting to derive Shapley values from a ground-up analysis. Rather,
Professor Gans takes as a given Dr. Eisenach's estimation that record
companies receive a royalty of $[REDACTED] per play from interactive
streaming services. Since Professor Gans identifies musical works and
sound recordings as perfect complements, he assumes that the musical
works licensors would receive the same profit as the record companies
(but not the same royalty rate, given their different costs). Because
this is not a Shapley ground-up approach, which would require
estimating the input costs of all three input providers--the record
companies, the music publishers, and the interactive streaming
services, Professor Gans candidly acknowledged on cross-examination
that he did not perform a full-fledged Shapley Analysis. He describes
his methodology as a ``Shapley-inspired'' approach. 3/30/17 Tr. 4109
(Gans).
a. Professor Marx's Shapley Analysis
Professor Marx testified that, as an initial matter ``[t]he Shapley
value depends upon how [the modeler] delineate[s] the entities
contributing to a particular outcome.'' Marx WDT ] 145. More
particularly, Professor Marx delineated the entities in a manner that
she claimed to ``adjust[ ] the model for monopoly power.'' 3/20/17 Tr.
1862-63 (Marx). She modeled the downstream interactive streaming
services as a combined single service and added to her model other
distribution types as another form of downstream distribution to
account for the potential opportunity cost of interactive streaming. By
modeling the downstream market in this manner, Professor Marx
artificially, but intentionally, treated the Services as a single
service, a device to countervail the allegedly real market power of the
collectives (the music publishers and the record companies
respectively) that owned the other inputs. Professor Marx concluded the
publishers' and record companies' must be offset to establish a fair
division of the surplus and a fair rate. See 3/20/17 Tr. 1865, 1907
(Marx).
With regard to the upstream market of copyright holders, Professor
Marx utilized two separate approaches. In her self-described
``baseline'' approach, she ``treat[ed] rights holders as one upstream
entity, reflecting the broad overlap in ownership between publishers
and record labels.'' Marx WDT ]] 146, 162. In her ``alternative''
approach, she uncoupled the two collectivized copyright holders,
grouping the songwriters/publishers, on the one hand, and the recording
artists/record companies, on the other. Id. The two purposes of her
alternative approach were: (1) To separately allocate surplus and
indicate rates for musical works (the subject of this proceeding); and
(2) to illuminate the additional ``bargaining power'' of each category
of copyright holder when these two categories of necessary complements
arrive separately in the input market under the Shapley methodology. 3/
20/17 Tr. 1883-84 (Marx).
i. Professor Marx's Baseline Approach
Professor Marx noted the undisputed principle that ``[t]he
calculation of the Shapley value depends on the total value created by
all the entities together and the values created by each possible
subset of entities.'' Marx WDT ] 147. Equally undisputed is the
understanding that ``[t]hese values are functions of the associated
revenue and costs.'' Id.
The surplus to be divided (from which rates can be derived) is
realized at the downstream end of the distribution chain when revenues
are received from retail consumers. That surplus can be measured as the
profits of the downstream streaming services (and the alternative
services in her model), i.e., their ``revenue minus . . . non-content
costs.'' \116\ The total combined value created by the delivery of the
sound recordings through the interactive (and substitutional) streaming
services consists of: (1) The aforementioned profits downstream (i.e.,
service revenue - non-content cost) minus (2) ``the copyright owners'
non-content costs. Simply put, ``surplus'' reflects the amount of
retail revenue that the input providers can split among themselves
after their non-content costs (i.e., the costs they do not simply pay
to each other) have been recovered.
---------------------------------------------------------------------------
\116\ Content costs, as opposed to non-content costs, are not
deducted because the content costs comprise the surplus to be
allocated in terms of royalties paid and residual (if any) that
remains with the interactive streaming (and substitute) services.
The non-content costs, as discussed infra, must be recovered by each
input provider as part of its Shapley value, because entities must
recover costs to the extent their share of revenues allows such
recovery.
---------------------------------------------------------------------------
In her Shapley Analysis, Professor Marx relied on 2015 data from
Warner/Chappell for her music publisher non-content cost data and its
ownership-affiliated record company, Warner Music Group, for record
company non-content costs.\117\ Utilizing the Warner cost data and
extrapolating to the entire industry, Professor Marx estimated that
``Musical Work Copyright Holders' Total Non-Content Costs'' equaled
$424 million; and ``Sound Recording Copyright Holders' Total non-
content
[[Page 1949]]
costs equaled $2.605 billion (more than six times musical works'
copyright holders' non-content costs). Total licensors' upstream non-
content costs totaled $3.028 billion. Id. ] 150, Fig. 26.
---------------------------------------------------------------------------
\117\ Professor Marx was limited to the Warner data for non-
content costs because, among all major holders of musical works and
sound recording copyrights, ``only Warner . . . breaks down its cost
by geographic region and by source in enough detail to estimate the
amounts needed.'' Marx WDT ]] 149-150.
---------------------------------------------------------------------------
Turning to the downstream distribution outlets, Professor Marx
identified and relied on Spotify's 2015 revenue and cost data from for
interactive streaming services; for the alternative distribution modes,
she relied on Pandora's and Sirius XM's revenue and cost data. Id. ]
152 & nn.149-52. Using that data, Professor Marx estimated interactive
streaming revenue of $[REDACTED] billion; and (2) interactive streaming
profit of $[REDACTED]. For the alternative distributors (Pandora and
Sirius XM), she estimated (1) revenues of $8.514 billion; and (2)
profits of $3.576 billion. The total downstream revenue, according to
Professor Marx, equaled an estimated $10.118 billion. Id. ] 153 & Fig.
27.
Professor Marx noted some degree of substitution between
interactive streaming services and alternative distribution channels
(e.g., non-interactive internet radio and satellite radio). Id. ] 154.
She opined that ``it is difficult to determine the exact value of this
substitution effect,'' so she reported a range of Shapley value
calculations that corresponded to ``a range of possible substitution
effects.'' Id.
These data were inputs into Professor Marx's Shapley algorithm,
i.e., assigning value to each input provider for each potential order
of arrival among these categories of providers to the market. The
multiple values were summed and averaged as required by the Shapley
methodology to arrive at the ``Shapley value,'' which accounts for each
entity's revenues and (non-content) costs under each possible ordering
of market-arrivals.
Based on the foregoing, Professor Marx estimated that the total
royalty payment due from the Services to Copyright Owners would range
from $[REDACTED] million to $[REDACTED] million, depending on varying
assumptions as to the substitution between interactive services and
alternate delivery channels. This range of revenues reflected a
``percent of revenue'' paid by interactive streaming services to all
copyright holders (musical works and sound recordings) ranging from
[REDACTED]% to [REDACTED]%. Id. ]] 159-160. Professor Marx then noted
that this is well below the combined royalty rate of [REDACTED]%
Spotify pays for musical works and sound recording rights, indicating
that the actual combined royalty payments are clearly too high. Id. ]
161.\118\
---------------------------------------------------------------------------
\118\ Because her baseline approach combines sound recording and
musical works licensors into a single entity, Professor Marx does
not break out separate royalties for musical works performances or
mechanical licenses. However, she recommends that the mechanical
rate should be lowered based on this finding. Professor Marx does
specifically estimate the musical works rate under her Alternative
approach.
---------------------------------------------------------------------------
ii. Professor Marx's Alternative Approach
Professor Marx also performed an ``alternative'' Shapley Analysis
in which she modeled the upstream market as two entities: ``a
representative copyright holder for musical works and a representative
copyright holder for sound recordings.'' Id. ] 163. In all other
respects, Professor Marx's methodology was the same as in her baseline
approach. See id. ] 199, App. B.
Under the alternative approach with two owners of collective
copyrights upstream, interactive streaming services' total royalty
payments range from [REDACTED]% to [REDACTED]% of service revenue. Id.
Sound recording copyright holders' total royalty income under this
alternative approach ranged from [REDACTED]% to [REDACTED]% of revenue.
Id. Professor Marx explained that this higher range of combined
royalties arose from the fact that splitting the copyright holders into
two creates two ``must-haves'' providing each upstream entity with more
``market power and consequently higher payoffs than the baseline
calculation.'' Id. ] 164, n.153. By splitting the upstream licensors
into two categories (record companies and songwriters/publishers),
Professor Marx calculated that ``musical work copyright holders' total
royalty income as a percentage of revenue ranges from [REDACTED]% to
[REDACTED]%.'' Id. ] 163. By way of comparison, Spotify actually pays
[REDACTED]% of its revenue for musical works royalties (i.e., All-In
royalties). Accordingly, Professor Marx concludes that ``[b]ecause this
proceeding is about mechanical rates, the fairness component of 801(b)
factors suggests that interactive streaming's mechanical rates should
be reduced from their current level.'' Id. ] 161.
iii. Copyright Owners' Criticisms
Copyright Owners criticize Professor Marx's model for ``failing to
accurately reflect realities of the market, where current observed
market rates for sound recording royalties alone are approximately 60%
of service revenue. See Watt WRT ] 23; Written Rebuttal Testimony of
Joshua Gans, Trial Ex. 3035, ]] 19, 28 (Gans WRT); see also COPFF ]
741. More technically, Copyright Owners object to Professor Marx's
joinder of the sound recording and musical works rights holders as a
single upstream entity in her ``baseline'' model, claiming that
combination had the undisputed effect of lowering Shapley values, and
hence royalties, available to be divided between the two categories of
rights holders. Gans WRT ] 21; Watt WRT App. 3 at 2 (in real world, as
opposed to stylized Shapley-world, rights holders would not jointly
negotiate with licensees); see also COPFF ] 742. Further, Professor
Gans questions Professor Marx's rationale for her joint negotiation
assumption, viz., the overlapping ownership interests of record
companies and music publishers. Gans WRT ] 21.
The Judges find this criticism of Professor Marx's baseline
approach to be appropriate, in that it was not necessary to combine the
two rights holders in a Shapley Analysis. As Professor Watt explained
in his separate criticism, there is no need to collapse the rights
holders into a single bargaining entity to eliminate holdout power by
the respective rights holders, because the ``heart and soul'' of the
Shapley Model is exclusion of the holdout value that any input supplier
could exploit in an actual bargain. 3/27/17 Tr. 3073 (Watt). He
emphasized that, because the Shapley Model incorporates all possible
``arrivals'' of input suppliers, it eliminates from the valuation and
allocation exercise the effect of an essential input supplier holding
out every time or arriving simultaneously with another input supplier
(or apparently creating Cournot Complement inefficiencies). Id. at
3069-70.
However, the foregoing criticism does not pertain to Professor
Marx's second Shapley Model--her ``Alternative'' model--in which she
maintains the two separate rights holders for musical works and sound
recordings. Marx WDT ] 146, n.153; 3/20/17 Tr. 1871-72 (Marx). With
regard to this Alternative model, Copyright Owners level a more general
criticism of Professor Marx's approach that does pertain to her
Alternative model (as well as her Baseline model). They assert, through
both Professors Gans and Watt, that Professor Marx wrongly distorted
the actual market in yet another manner--by assuming the existence of
only one interactive streaming service--rather than the presence of
competing interactive streaming services. Watt WRT ]] 25, 32 n.19, 17;
Gans WRT ]] 55-56; see also COPFF ] 755. By this change, they argue,
Professor Marx inflated the Shapley surplus attributable
[[Page 1950]]
to the interactive streaming services compared to the actual proportion
they would receive in the market.
According to Professor Gans, this simplified assumption belies the
fact that the market is replete with many substitutable interactive
streaming services, whose competition inter se reduces each service's
bargaining power. The problem, he opines, is that to the extent the
entities being combined are substitutes for one another-such as
alternative music services-then combining them ignores the effects of
competition between them, thereby inflating their combined share of
surplus from the joint enterprise (i.e. their Shapley value). Gans WRT
] 21.
Professor Marx does not deny that she intentionally elevated the
market power of the services by combining them in the model as a single
agent. However, she explained that she made this adjustment to offset
the concentrated market power that the rightsholders possess, separate
and apart from any holdout power, which the Shapley ordering algorithm
would address. Thus, Professor Marx explained that her alteration of
market power apparently was designed to address an issue--market
power--that the Shapley Analysis does not address. 3/20/17 Tr. 1863
(Marx) (``I want a model that represents a fair outcome in the absence
of market power, so I am going to have to be careful about how I
construct the model that I am not putting in market power into the
model.'').\119\
---------------------------------------------------------------------------
\119\ Although at first blush it would seem more appropriate for
Professor Marx to have directly adjusted the copyright holders'
market power by breaking them up into several entities each with
less bargaining power, such an approach would make Shapley modeling
less tractable (by increasing the number of arrival alternatives in
the algorithm), compared with the practicality of equalizing market
power by inflating the power of the streaming services (by reducing
them to a single representative agent). For example, in Professor
Marx's ``alternative'' Shapley Model, she models four entities, two
upstream (musical works holders and sound recording holders), and
two downstream (the representative single streaming service and a
single alternate distribution outlet). With these four entities, the
number of different arrival orders is 4! (factorial), or 24. If
Professor Marx instead had broken the musical works copyright
holders and the sound recording copyright holders respectively into
two entities, the number of total entities would have increased from
4 to 6. The number of arrival orders would then have increased from
24 to 720.
---------------------------------------------------------------------------
Professor Gans testified that Professor Marx's approach was
erroneous because Shapley values are meant to incorporate market power
asymmetries, not to eliminate them. Gans WRT ] 31 (Shapley values
incorporate market power asymmetries). However, the Judges note that
Professor Gans acknowledged that in an Australian legal proceeding, he
too combined multiple downstream entities into a single entity in his
Shapley Model in ``comparison'' to two upstream rights holders. 3/30/17
Tr. 4179 (Gans). Additionally, Professor Watt has authored and
published an article (cited at Gans WDT ] 65, n.36) in which he too
``artificially'' equalized market power between rights holders and
licenses (radio stations) in the same manner. See R. Watt, Fair
Copyright Remuneration: The Case of Music Radio, 7, 25, 35 (2010) 7
Rev. of Econ. Res. on Copyright Issues 21, 25, 35 (2010)
(``artificially'' modeling the ``demand side of the market as a single
unit, rather than individual radio stations . . . thereby . . .
add[ing] (notionally) monopsony power to the demand side'' to offset
the monopoly power of the input supplier).
In essence, the import of this criticism is not the faithfulness of
Professor Marx's testimony to the Shapley Model; rather, it pertains to
her decision to include an adjustment for market power asymmetry that
seeks to equalize market power as between Copyright Owners and the
streaming services. Her adjustment is consistent with testimony by
Professor Katz, who cautioned that a Shapley Analysis takes the
parties' market power as a given, locking-in whatever disparities
exist. 4/15/15 Tr. 4992-93 (Katz).
The Judges agree with Professor Watt and find that the Shapley
Analysis, taking the number of sellers in the market as a given,
eliminates the ``hold-out'' problem that would otherwise cause a rate
to be unreasonable, in that it would fail to reflect effective (or
workable) competition. However, Professor Marx's Shapley Model also
attempts to eliminate a separate factor--market power--that she asserts
renders a market-based Shapley Analysis incompatible with the
objectives of Factors B and C of section 801(b)(1). The Judges will
consider the appropriateness of Professor Marx's adjustment for market
power in their discussion of these two factors.\120\ For purposes of
deriving a reasonable (and effectively competitive) rate prior to
application of the 801(b)(1) factors, it is sufficient to note that
Professor Marx's adjustment is not inconsistent with the traditional
Shapley Analysis (as both Professors Watt and Gans have acknowledged in
their work outside of this proceeding), and does not disqualify her
Shapley value analysis from further consideration.
---------------------------------------------------------------------------
\120\ See infra, section VI.B. Although the Judges find a market
power adjustment relevant in a section 801(b)(1) Factor B and C
analysis, it is not a consideration when determining a rate that
reflects ``effective competition.'' An effectively competitive rate
need not adjust for market power because such a rate does not
include consideration of these two factors or their public utility
style legislative history antecedents.
---------------------------------------------------------------------------
Professor Marx's alternative approach yielded a musical works
royalty rate of between [REDACTED]% and [REDACTED]% of service revenue.
3/20/17 Tr. 1885 (Marx). In that alternative model, Professor Marx
found that Spotify's total royalties for musical works and sound
recordings combined would range from [REDACTED]% to [REDACTED]% of
total revenue, meaning that payments for sound recording rights would
be approximately [REDACTED]% to [REDACTED]% of total revenue. Id. The
ratio of sound recording royalties to musical works royalties under
Professor Marx's model is no lower than [REDACTED]% to [REDACTED]%, or
[REDACTED]:1. Stated as a percentage of sound recording royalties
(i.e., TCC), musical works royalties would thus be [REDACTED]%.\121\
---------------------------------------------------------------------------
\121\ TCC percentage is the reciprocal of the sound recording to
musical work royalty ratio, expressed as a percentage. Thus, 1/
[redacted] = [redacted] (rounded) or [REDACTED]%.
---------------------------------------------------------------------------
b. Professor Gans's ``Shapley-Inspired Approach''
On behalf of Copyright Owners, Professor Gans presented a model
that he described as ``inspired'' by the Shapley approach, but not per
se a Shapley Analysis. 3/30/17 Tr. 4109 (Gans). At a high level, his
Shapley-inspired approach attempted to determine the ratio of sound
recording royalties to musical works royalties that would prevail in an
unconstrained market. After calculating that ratio, he estimated what
publisher mechanical royalty rates would be in a market without
compulsory licensing by multiplying the benchmark sound recording rates
by this ratio. Gans WDT ] 63.
Professor Gans began his analysis with two critical assumptions:
(1) Publishers and record companies must have equal Shapley values
(i.e., must recover equal profits from total surplus), because musical
compositions and sound recording performances are perfect complements
and essential components of the streamed performance; \122\ and (2)
record
[[Page 1951]]
company profits from interactive streaming services are used as
benchmark Shapley values. Gans WDT ] 77. The royalties that result from
Professor Gans's analysis will differ, given the different level of
costs incurred by music publishers and record companies respectively.
See Gans WDT ]] 23, 71, 74, 76; Gans WRT ]] 15-17; see also 3/30/17 Tr.
3989 (Gans).
---------------------------------------------------------------------------
\122\ Modeling the market as having two upstream suppliers of
complementary inputs (i.e., a musical works copyright owner and a
sound recordings copyright owner) produces the result that Professor
Gans assumed in his analysis: The upstream suppliers reap equal
profits, though their royalties differ due to differences in their
cost structures. Professors Marx, in her ``alternative approach,''
and Watt, in his ``Shapley Model with 3 Streaming Services, models
the market in this way. Marx WDT ] 201 (Figure 33 in Appendix B)
(fifth column shows identical Shapley values for both upstream
providers); Trial Ex. 2619, at 8 (Appendix 3 to Watt WRT) (``Since
there are only two players in this game, and each would have veto
rights over the business, the net surplus would be shared equally
between them.'').
---------------------------------------------------------------------------
Echoing Dr. Eisenach, Professor Gans found these assumptions
critical because agreements between record companies and interactive
streaming services are freely negotiated, i.e., they are not set by any
regulatory body or formally subject to an ongoing judicial consent
decree and, accordingly, are also not subject to any regulatory or
judicial ``shadow'' that arguably might be cast from such governmental
regulation in the market. Accordingly, Professor Gans uses the profits
arising from these unregulated market transactions to estimate what the
mechanical rate for publishers would be if they too were also able to
freely negotiate the rates for the licensing of their works. See Gans
WDT ] 75.
Professor Gans utilized data from projections in a Goldman Sachs
analysis to identify the aggregate profits of the record companies and
the music publishers, respectively. See 3/30/17 Tr. 4017 (Gans). Given
his assumption that sound recordings and musical works were both
``essential'' inputs and thus able to claim an equal share of the
profits, Professor Gans posed the question: ``[H]ow much revenue do we
need to hand to the publishers so that they end up earning the same
profits as the labels? Id. at 4018.
He found that, for the music publishers to recover their costs and
achieve profits commensurate with those of the record companies under
his approach, the ratio of sound recording royalties to musical works
royalties derived from his Shapley-inspired analysis was 2.5:1 (which
attributes equal profits to both classes of rights holders and
acknowledges the higher costs incurred by record companies compared to
music publishers). See Gans WDT ] 77, Table 3.
As noted, Professor Gans made a key assumption, treating as
accurate Dr. Eisenach's calculation of an effective per play rate for
sound recordings of $[REDACTED]. Given those two inputs (the 2.5:1
ratio and the $[REDACTED] per play rate) Professor Gans's approach
indicated a market-derived musical works per play royalty rate of
$[REDACTED] (rounded). Id. ] 78, Table 3. However, because the musical
works royalty is comprised of the mechanical rate and the performance
rate paid to PROs (not to publishers), Professor Gans had to subtract
the performance rate. He determined that the percent of revenues
attributable to mechanical royalties was 81% of the total musical works
royalties, under his approach. Thus, he estimated a mechanical royalty
rate of $[REDACTED].\123\ well above the Copyright Owners' proposed
$0.0015 statutory per play rate, and thus confirming the reasonableness
of the Copyright Owners' proposal. Id. ] 78.
---------------------------------------------------------------------------
\123\ [redacted] x 0.81 = 0.0025 (rounded).
---------------------------------------------------------------------------
On this basis, Professor Gans also concluded that his Shapley-
inspired approach supports the Copyright Owners' per-user rate
proposal. Applying the Shapley -based ratio of 2.5:1 to the benchmark
per-user rate negotiated by the labels of $[REDACTED] per user per
month, and after subtracting the value of the performance rights
royalty, Professor Gans obtains an equivalent publisher mechanical rate
of $[REDACTED] (rounded) per user per month (i.e., ($[REDACTED]/2.5) x
80%\124\). Id. ] 85.
---------------------------------------------------------------------------
\124\ Professor Gans multiplies the per play rate by 81% but the
per user rate by 80%. Compare Gans WDT ] 78 with Gans WDT ] 85. The
rate derived by Professor Gans was the 80% figure. Gans WDT ] 77,
Table 3, line 17. This discrepancy has no impact on the relevance of
his analysis.
---------------------------------------------------------------------------
The Judges do not accept the rates derived by Professor Gans's
Shapley-inspired model, because of its assumption and use of the
$[REDACTED] per play sound recording interactive rate. Dr. Eisenach's
$[REDACTED] per play sound recording rate is not supported by the
weight of the evidence. Moreover, the record company profits are
inflated by the inefficient rates created through the Cournot
Complements problem that affects the agreements between record
companies and streaming services, as noted by the Services' experts in
this proceeding, and as the Judges noted in Web IV.
However, the Judges find the ratio of sound recording to musical
work royalties that Professor Gans derived from his analysis to be
informative. Professor Gans computed this ratio based on an assumption
of equal Shapley values between musical works and sound recording
copyright owners. The Judges find this assumption to be reasonable and
confirmed by Professor Marx's Shapley Analysis. The Judges also find
Professor Gans's reliance on financial analysts' projections for the
respective industries to be reasonable.
Expressed as a percentage of sound recording royalties, Professor
Gans's 2.5:1 sound recordings to musical works royalty ratio yields a
musical works royalty rate of 40% of TCC.
c. Professor Watt's Shapley Analysis
As a rebuttal witness, Professor Watt testified regarding purported
defects in Professor Marx's Shapley Model. In addition, he presented
alternative modeling intended to apply an adjusted version of Professor
Marx's Shapley Model.
Professor Watt found that Professor Marx's approaches contained
several flaws and methodological issues. See 3/27/17 Tr. 3057 (Watt).
Accordingly, he, like Professor Gans, attempted to adjust her modeling
in a manner that, in his opinion, generated ``decent, believable
results.'' Id. at 3058.
In his Shapley Model adjusting Professor Marx's analysis, Professor
Watt found that at least [REDACTED]% of interactive streaming revenue
should be allocated to the rights holders (as distinguished from a
range of [REDACTED]% to [REDACTED]% of total revenues going to rights
holders under Professor Marx's analysis). Of this [REDACTED]%,
[REDACTED]% should be retained by the musical works copyright holders
and [REDACTED]% should be allocated to record companies. Expressed as
percentages of revenue, musical works copyright owners would receive
[REDACTED]%\125\ of total interactive streaming revenue while record
companies would receive [REDACTED]%.\126\ See Watt WRT ] 35; 3/27/17
Tr. 3083, 3115-16 (Watt).\127\ The ratio of sound recording to musical
works royalties under Professor Watt's analysis is thus [REDACTED]% to
[REDACTED]%, or [REDACTED]:1. Expressed as a percentage of sound
recording royalties, musical works royalties would be [REDACTED]%.
---------------------------------------------------------------------------
\125\ [REDACTED] (rounded).
\126\ [REDACTED] (rounded).
\127\ At present, record companies receive approximately 60% of
total interactive streaming revenue, substantially higher than the
[REDACTED]% calculated by Professor Watt. He explains that the
reason for this difference is clear; the mechanical rate is
artificially depressed by regulation, allowing the sound recording
rate (set in an unregulated market) to appropriate a larger share of
the royalties, given the perfect complementarity of the two rights.
Watt WRT ] 36.
---------------------------------------------------------------------------
2. Deriving a Royalty Rate
Professors Marx, Gans, and Watt reached conclusions that were
broadly consistent insofar as they all found that the ratio of sound
recording to musical
[[Page 1952]]
works royalty rates should decline. The following table summarizes
these experts ratios, expressed both as ratios and percentages, and
includes for comparison the actual ratio of sound recording to musical
works royalties paid by Spotify, as well as the ratio implied by the
prevailing headline percent of revenue rates for musical works and
sound recordings.
Sound Recording to Musical Works Ratios and TCC Percentages
----------------------------------------------------------------------------------------------------------------
Scenario Ratio TCC percentage \128\
----------------------------------------------------------------------------------------------------------------
Watt Shapley Analysis............ [REDACTED]:1.......................... [REDACTED]
Gans Shapley-inspired Analysis... [REDACTED]:1.......................... [REDACTED]
Marx Shapley Analysis............ [REDACTED]:1.......................... [REDACTED]
Spotify Actual................... [REDACTED]:1.......................... [REDACTED]
Headline Percent of Revenue Rates 5.71:1................................ 17.5
----------------------------------------------------------------------------------------------------------------
All of the experts' ratios are well below the current ratio of
approximately [REDACTED]:1 for Spotify, and approximately 5.71:1
comparing the 10.5% headline rate to an average sound recording rate of
approximately 60% of revenue. Accordingly, under their respective
Shapley Models, Professors Marx, Gans, and Watt appear to be in general
agreement that the ratio of sound recording to musical works royalties
should decline.
---------------------------------------------------------------------------
\128\ TCC percentage is the reciprocal of the sound recording to
musical work royalty ratio, expressed as a percentage.
---------------------------------------------------------------------------
Both Professor Marx's and Professor Watt's models show lower
combined royalties being paid by services than are currently paid in
the marketplace. Professor Marx's model produces combined royalties of
between [REDACTED]% and [REDACTED]% of service revenue, while Professor
Watt's model produces combined royalties of between [REDACTED]% and
[REDACTED]%.\129\ Even the highest of these values is less than
[REDACTED].
---------------------------------------------------------------------------
\129\ Professor Watt identified [REDACTED]%--the arithmetic mean
of these two numbers--as his preferred figure.
---------------------------------------------------------------------------
The discrepancy in total royalties between the models and the real
world is explained, in part, by the absence of supranormal
complementary oligopoly profits in the Shapley Model, and the presence
of those profits in the actual market. In addition, the total royalties
paid in Professor Marx's model are lowered still further by her
decision to equalize bargaining power between the content providers and
services by modeling the services as a single entity.
Even with lower combined royalties, the models also show musical
works royalties at or above the prevailing headline rate of 10.5%.
Mathematically that is possible only because the models also yield
lower royalties for sound recordings at all levels of total royalties.
The following tables show the percentage revenue royalty rates for
musical works and sound recordings that are produced by applying the
experts' ratios to the different levels of total royalties. The final
column shows the rates yielded by applying the ratios to Spotify's
total royalty obligation of [REDACTED]%.
Implied Musical Work Royalty (% of Revenue) Based on Ratio and Total Royalties \130\
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Expert Ratio TCC % [REDACTED] % [REDACTED] % [REDACTED] % [REDACTED] % [REDACTED] % [REDACTED] %
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Watt............................................................ [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED]
Gans............................................................ [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED]
Marx............................................................ [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Implied Sound Recording Royalty (% of Revenue) based on Ratio and Total Royalties \131\
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Expert Ratio TCC % [REDACTED] % [REDACTED] % [REDACTED] % [REDACTED] % [REDACTED] % [REDACTED] %
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Watt............................................................ [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED]
Gans............................................................ [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED]
Marx............................................................ [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED] [REDACTED]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Professor Watt explains the discrepancy between the sound recording
royalty rates yielded by the Shapley Analysis and the higher rates that
exist in the market:
---------------------------------------------------------------------------
\130\ The royalty rate is computed using the formula Rmw = Rt /
(1 + r) where Rmw is the musical work royalty rate, Rt is the
combined royalty rate for musical works and sound recordings, and r
is the ratio of sound recording to musical work royalties.
\131\ The royalty rate is computed using the formula Rsr = Rt /
(1 + 1/r) where Rsr is the musical work royalty rate, Rt is the
combined royalty rate for musical works and sound recordings, and r
is the ratio of sound recording to musical work royalties.
[The reason] my predicted fraction of revenues for sound
recording royalties is significantly less than what is observed in
the market [is] simple. The statutory rate for mechanical royalties
in the United States is significantly below the predicted fair rate,
and the statutory rate effectively removes the musical works
rightsholders from the bargaining table with the services. Since
this leaves the sound recording rightsholders as the only remaining
essential input, bargaining theory tells us that they will
---------------------------------------------------------------------------
successfully obtain most of the available surplus.
Watt WRT ] 36.\132\
---------------------------------------------------------------------------
\132\ More specifically, Professor Watt calculates that, for
each dollar that the statutory rate holds down fair market musical
works royalties, [REDACTED] cents is captured by the record
companies (and [REDACTED] cents is captured by the streaming
services). Watt WRT ] 23, n.13 & App. 3.
---------------------------------------------------------------------------
Applying the ratios derived from the experts' models to the higher
total royalties that prevail in the marketplace would yield musical
works royalty rates higher than the models predict. For example, based
on Professor Marx's lowest estimate of overall royalties of
[REDACTED]%, her [REDACTED]:1
[[Page 1953]]
ratio (or [REDACTED]% TCC percentage) would yield percent-of-revenue
rates for musical works of [REDACTED]%.\133\ Using Spotify as an
example, however, actual combined royalties for musical works and sound
recordings are approximately [REDACTED]% of revenue. That same
[REDACTED]:1 ratio would yield a percent-of-revenue rate for musical
works of [REDACTED]%.\134\ or nearly [REDACTED] percentage points
higher than the model.
---------------------------------------------------------------------------
\133\ [REDACTED] (rounded).
\134\ [REDACTED]
---------------------------------------------------------------------------
This is problematic because the sound recording rate against which
the TCC rate would be applied is inflated both by the existence of
complementary oligopoly conditions in the market for sound recordings
and what Professor Watt describes as the record companies' ability to
obtain most of the available surplus due to the music publishers'
absence from the bargaining table. In order to derive usable TCC rates
from the Shapley Analyses the Judges must address these two issues.
The Judges find that the problem of, in essence, importing
complementary oligopoly profits into the musical works rate through a
TCC percentage can be avoided by reducing the TCC percentage.
Specifically, the TCC percentage should be reduced to a level that
produces the same (non-complementary-oligopoly) percentage revenue rate
when applied to the existing [REDACTED]% combined royalty as the
Shapley-produced TCC percentage yields when applied to the theoretical
combined royalties in the model. For example, Professor Watt's Shapley
Analysis produces a [REDACTED]:1 sound recording to musical work ratio,
or a [REDACTED]% TCC percentage. At his preferred combined royalty rate
of [REDACTED]%, the implied musical works rate is [REDACTED]% of
revenue. The TCC rate that produces the same [REDACTED]% of revenue
rate under existing conditions would be [REDACTED]%.\135\ These
adjusted TCC rates are summarized in the following table.
---------------------------------------------------------------------------
\135\ The target TCC rate is computed using the formula TCC = 1
/ ((Rt/Rmw)-1), where Rt is the combined royalty rate in the
marketplace ([REDACTED]%), and Rmw is the musical work royalty rate
yielded by the Shapley value analysis.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Adjusted TCC using Adjusted TCC using Adjusted TCC using Adjusted TCC using Adjusted TCC using
Expert TCC from model [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]%
combined royalties combined royalties combined royalties combined royalties combined royalties
--------------------------------------------------------------------------------------------------------------------------------------------------------
Watt............................ [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]%
Gans............................ [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]%
Marx............................ [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]%
--------------------------------------------------------------------------------------------------------------------------------------------------------
As to the issue of applying a TCC percentage to a sound recording
royalty rate that is artificially high as a result of musical works
rates being held artificially low through regulation, the Judges rely
on Professor Watt's insight (demonstrated by his bargaining model) that
sound recording royalty rates in the unregulated market will decline in
response to an increase in the compulsory license rate for musical
works.
[T]he reason why the sound recording rate is so very high is
because the statutory rate is very low. And if you increase the
statutory rate, the bargained sound recording rate will go down.
3/27/17 Tr. 3090 (Watt). Professor Watt's bargaining model predicts
that the total of musical works and sound recordings royalties would
stay ``almost the same'' in response to an increase in the statutory
royalty. Id. at 3091.
As must-have suppliers in an unregulated market, record companies
are in a position to walk away from negotiations with the Services and,
effectively, put them out of business. That they have not done so
demonstrates that it is not in their economic interest to do so.\136\
The decline in sales of physical copies and permanent digital
downloads, along with the growth of streaming, is a powerful economic
motivation for record companies to pursue deals with the Services that
ensure the continued survival and growth of the music streaming
industry. In negotiating those deals both sides will be cognizant of
the effect on the Services' content cost of a decision by this body.
---------------------------------------------------------------------------
\136\ The evidence in Web IV revealed that the record companies'
strategy has been to ``[REDACTED].'' Web IV (restricted version) at
63.
---------------------------------------------------------------------------
In his separate opinion, Judge Strickler expresses concern that
``if mechanical royalty rates were to increase to a level that
significantly reduced the profits of the record companies from
streaming, there is no evidence in the record in this proceeding that
indicates whether the record companies would decide to maintain the
current vertical structure of the market and docilely accept such a
revenue loss.'' \137\ The Judges acknowledge the concern articulated by
Judge Strickler, but note that it applies potentially to any rate
increase for musical works that reduces record company streaming
profits.\138\ Just as the Judges have noted that there is no evidence
to suggest that the current level of short-term losses is the maximum
that the Services can absorb in their Shumpeterian competition for
market share, they note that there is no basis to assume that record
companies will head for the exits if their profits from streaming drop
below current levels. At bottom, this concern goes not to the decision
whether or not to increase the mechanical rate, or to adopt a
particular rate structure, but to the magnitude of any rate increase,
and measures that should be taken to reduce any disruption the increase
might cause to the industry. The Judges take both concerns into account
in this Determination.
---------------------------------------------------------------------------
\137\ Judge Strickler expresses concern that an increase in the
mechanical rate might prompt the record companies to create (or
acquire) their own streaming services, rather than accept a lower
royalty rate from the existing Services. It is well-established that
it is not the Judges' role to protect the current players in the
industry. Companies--even major players in the industry--enter and
exit the market regularly. That market fluidity is not the sort of
disruption the Judges consider under the fourth 801(b)(1) factor.
\138\ The Judges note that Professor Watt's insight applies not
only to a Shapley-derived TCC rate, but to any rate structure that
results in an increase in what services pay for musical works.
Bargaining theory instructs that the services and the record
companies will take into account any increase in the statutory
royalties that the services must pay.
---------------------------------------------------------------------------
The foregoing exercise produced a broad range of potential rates:
TCC rates ranging from [REDACTED]% to [REDACTED]%, which correspond to
implied percent of revenue rates from [REDACTED]% to [REDACTED]%. The
Judges narrow that range by reference to the strength of the evidence
supporting the numbers underlying those rates.
Professor Watt testified that the data Professor Marx used in her
Shapley model was derived from 2015 Spotify financials and, as a
result, understated current downstream revenue. Watt WRT ]] 37, 43-44.
In addition, Professor Marx included a number of items as downstream
costs that, in Professor Watt's view, should be excluded from
[[Page 1954]]
the model. Id. ]] 57-59. The net effect of understating downstream
revenue and overstating downstream costs is to drive down the amount of
surplus allocated to the upstream content providers. Id. ] 42. Although
Professor Marx addressed the reasons for her decision to use 2015 cost
and revenue data in her model, she did not address the effect that her
choice had on allocation of surplus, or attempt in any way to correct
for it. See 3/20/17 Tr. 1880-81, 1906-08 (Marx). The Judges find that
the total royalty values produced by Professor Marx's models understate
what would be a fair allocation of surplus to the upstream content
providers. Consequently, the Judges view Professor Marx's top value for
total royalties ([REDACTED]%) to constitute a lower bound for total
royalties in computing a royalty rate.
As Professor Watt's total royalty figures were presented as
rebuttal testimony, Professor Marx, on behalf of the services, did not
have an opportunity to rebut them. The Judges give them weight only to
the extent of viewing his lowest figure ([REDACTED]%) as an upper bound
for total royalties in computing a royalty rate.
In a similar vein, Professor Marx did not have an opportunity to
rebut Professor Watt's [REDACTED]:1 sound recording to musical work
royalty ratio. Professor Watt derived that ratio using data from
Professor Marx's model, yet produced vastly different results. See
Trial Ex. 2619, at 9 (Appendix 3 to Watt WRT). The reason for this
disparity in outcome was not adequately explored or explained. The
Judges give Professor Watt's [REDACTED]:1 ratio no weight.\139\
---------------------------------------------------------------------------
\139\ By contrast, Professor Marx had ample opportunity to
critique Professor Gans's report. See Marx WRT ]] 73-75. Her
criticism focuses on his decision not to use the Shapley model to
determine the division of surplus between the downstream services
and the upstream copyright owners. Id. ] 74. She does not challenge
the specific ratio of sound recording to musical works royalties
that he derives from his model and that the Judges use here.
---------------------------------------------------------------------------
The Judges are left with the following potential royalty rates.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Adjusted TCC using Implied percent of Adjusted TCC using Implied percent of
Expert TCC from model [REDACTED]% revenue rate using [REDACTED]% revenue rate using
combined royalties [REDACTED]% combined royalties [REDACTED]%
--------------------------------------------------------------------------------------------------------------------------------------------------------
Gans................................................ [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]%
Marx................................................ [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]% [REDACTED]%
--------------------------------------------------------------------------------------------------------------------------------------------------------
The Judges find, therefore, that the zone of reasonable rates
ranges from [REDACTED]% to [REDACTED]% of TCC, or, expressed as
equivalent percent of revenue rates, [REDACTED]% to [REDACTED]%. Taking
into consideration the totality of the evidence presented in this
proceeding, the Judges select [REDACTED]% of TCC/[REDACTED]% of revenue
as the most appropriate rate within that zone of reasonableness.
E. Other Royalty Rates
1. Royalty Rate for Incidental Digital Phonorecord Deliveries
The Act requires the Judges in setting phonorecord mechanical
license royalty rates and terms to distinguish between (i) digital
phonorecord deliveries where the reproduction or distribution of a
phonorecord is incidental to the transmission which constitutes the
digital phonorecord delivery, and (ii) digital phonorecord deliveries
in general. 17 U.S.C. 115(c)(3)(C), (D). The extant regulations do not
mention incidental DPDs, but provide that a limited download is ``a
general digital phonorecord delivery under 17 U.S.C. 115(c)(3)(C) and
(D).'' 37 CFR 385.11 (and incorporated into Sec. 385.21). It appears
the parties' 2012 Settlement terms failed to make the distinction the
statute requires of the Judges.
Legislative history leading up to the enactment of the Digital
Performance Right in Sound Recording Act of 1995 describes incidental
DPDs as the transmission of copies that are made solely to facilitate
streaming, i.e., via a transmission system ``designed to allow
transmission recipients to hear sound recordings substantially at the
time of transmission.'' See S. Rep. No. 104-138, at 39 (1995). If the
recipient does not retain those copies for subsequent playback, then
the copies are considered ``incidental deliveries.'' Id. Copies
retained for subsequent playback, whether ``limited'' or ``permanent''
fall into the category of ``general phonorecord delivery.'' Id.
Further, if a transmission system supports retention of digital
phonorecords for subsequent playback, but the transmission recipient
chooses not to do so, then the initial delivery could be consider
incidental. Id.
The Copyright Office explored the question of identifying
incidental DPDs in an extended rulemaking proceeding.\140\ During the
study of the issue, Services identified potentially incidental copies
at the service offering level (variously called ``server-, root-,
encoded-, or cached-'' copies) as well as at the end user level (often
called ``buffer'' copies). The question, however, remained unresolved.
In Phonorecords I, the Judges adopted the 2008 Settlement which
included ``an incidental digital phonorecord delivery'' in the
definition of ``Interactive Stream.'' 74 FR at 4529. After a finding of
legal error by the Register of Copyrights (Register),\141\ the Judges
deleted the reference. See 74 FR 6832, 6833 (Feb. 11, 2009). The
distinction did not reappear in the Phonorecords II adoption of the
2012 Settlement. See 78 FR 67938, 67943 (Nov. 13, 2013).
---------------------------------------------------------------------------
\140\ When it issued an interim rule, the Copyright Office
concluded that in a determination turning upon a conclusion of
``when a DPD is an incidental DPD,'' the Judges should make that
determination ``in the context of a factual inquiry . . . if such a
determination proves to be relevant.'' 73 FR 66173, 66179 (Nov. 7,
2008).
\141\ The Register noted that the regulation the Judges adopted
as part of a settlement among the parties ``overstates the scope of
the section 115 license with respect to interactive streams.'' 74 FR
at 4539. By way of clarification, the Register noted that ``an
interactive stream that delivers a reproduction of a sound recording
that qualifies as a DPD is, for purposes of the license, an
incidental DPD.'' Id. (``a stream--whether interactive or non-
interactive--may or may not result in a DPD depending on whether all
the aforementioned criteria are met.'').
---------------------------------------------------------------------------
The record in this proceeding is devoid of factual evidence that
demands the rate distinction. The Judges conclude, however, that they
may, indeed must, address the distinction as a matter of law. Reviewing
the legislative history, the statutory language, and the history of
study of the issue by the Copyright Office, the Judges conclude that
classification of an incidental DPD is a function of a Service's
technological functionality and, to some extent, an end user's
subsequent conduct.
In the context of interactive streaming and similar modes of
delivery where there is no general DPD, the royalty rates in this
determination covering that mode of delivery are, de facto, the royalty
rates for the incidental DPDs that enable the activity. To the extent
[[Page 1955]]
any of the configurations covered by the royalty rates set in this
determination entail both incidental and general DPDs, the royalty rate
is for all DPDs, incidental or general, that result from the
activity.\142\
---------------------------------------------------------------------------
\142\ The rates for permanent digital downloads and limited
downloads set by the parties to the March 2017 subpart A settlement
do not distinguish between incidental DPDs and DPDs in general. The
Judges deem those rates to cover all DPDs, incidental and general,
that result from those modes of delivery.
---------------------------------------------------------------------------
2. Royalty Rates for Non-Revenue Bearing Service Offerings
In the 2012 rates and terms, the parties essentially rolled forward
the rate structure first constructed in the 2008 Settlement. In 2012,
the parties created a separate aggregation of service offerings in a
new subpart C \143\ to the regulations, agreeing to rates and terms
similar to those to which they agreed in subpart B for interactive
streams and limited digital downloads. Based on the evidence in this
record, it appears limited offerings, and bundled service offerings are
not different in kind from interactive streaming and limited downloads.
No party offered compelling evidence to establish the necessity for
segregating the current subpart C service offering configurations from
current subpart B service offering configurations.
---------------------------------------------------------------------------
\143\ The so-called subpart C service offerings included limited
offerings, mixed service bundles, music bundles, paid locker
services, and purchased content locker services.
---------------------------------------------------------------------------
In their review of the current and proposed rates and terms,
however, the Judges see a basis to distinguish promotional or non-
revenue producing offerings from revenue-producing offerings. In some
instances locker services--particularly purchased content locker
services--are free to the user and produce no revenue for the Service
separate from the purchase price for the content. In some instances, a
service may transmit a sound recording embodying a musical work that
fits the definition of a promotional offering; that is, a sound
recording that a Record Company makes available at no cost to the
service and for a limited period. The Services' transmissions of those
sound recordings are made solely for the purpose of promoting a
particular sound recording, an album, or the artist performing the
musical work. Record companies distributing promotional recordings bear
responsibility, if any there be, for the licensing of the embodied
musical work. In other instances, a Service might offer a free or
reduced-price subscription to its streams, or modified versions of its
subscription-based services, to entice free users to become paying
subscribers after the free trial period. When services choose to
deliver no-cost or non-revenue bearing offerings qualifying as
promotional, ``free trial,'' or no-charge locker services, the Services
will not pay mechanical musical works royalties. Neither shall the
Services deduct the costs of those service offerings from service
revenue, for purposes of calculating royalties payable on a percent of
service revenue.
VI. The Four Itemized Factors in Section 801(b)(1)
The Copyright Act requires that the Judges establish ``reasonable''
rates and terms for the section 115 license. In addition, section
801(b)(1) instructs the Judges to set these rates ``to achieve the
following objectives'':
Factor A: To maximize the availability of creative works to the
public;
Factor B: To afford the copyright owner a fair return for his or
her creative work and the copyright user a fair income under
existing economic conditions;
Factor C: To reflect the relative roles of the copyright owner
and the copyright user in the product made available to the public
with respect to relative creative contribution, technological
contribution, capital investment, cost, risk, and contribution to
the opening of new markets for creative expression and media for
their communication; and
Factor D: To minimize any disruptive impact on the structure of
the industries involved and on generally prevailing industry
practices.
17 U.S.C. 115(c), 801(b)(1).\144\
---------------------------------------------------------------------------
\144\ The 1976 Act applied section 801(b)(1) and its four-factor
test to new licenses. The lone existing statutory license carried
forward into the 1976 Act from the 1909 Copyright Act and made
subject to this standard was the mechanical license at issue in this
proceeding.
---------------------------------------------------------------------------
The four itemized factors in section 801(b)(1) require the Judges
to exercise ``legislative discretion'' in making independent policy
determinations that balance the interests of copyright owners and
users.'' SoundExchange, Inc. v. Librarian of Cong., 571 F.3d 1220, 1224
(D.C. Cir. 2009); see Recording Indus. Ass'n Am. v. CRT, 662 F.2d 1, 8-
9 (D.C. Cir. 1981) (``Phonorecords 1981 Appeal'') (analyzing identical
factors applied by predecessor rate-setting body and holding that
statutory policy objectives of 801(b)(1) ``invite the [Board] to
exercise a legislative discretion in determining copyright policy in
order to achieve an equitable division of music industry profits
between the copyright owners and users'').
The four factors ``pull in opposing directions,'' leading to a
``range of reasonable royalty rates that would serve all these
objectives adequately but to differing degrees.'' Phonorecords 1981
Appeal, 662 F.2d at 9. (D.C. Cir. 1981) (citations omitted). Certain
factors require determinations ``of a judgmental or predictive
nature,'' while others call for a broad fairness inquiry. Id. at 8
(citations & quotations omitted). Accordingly, the Judges are ``free to
choose'' within the range of reasonable rates . . . within a `zone of
reasonableness.' '' Id. at 9 (citations omitted).
In prior rate determination proceedings, the Judges have undertaken
the ``reasonableness'' analysis followed by consideration of the four
itemized factors. They followed that approach in this proceeding. The
Judges conclude, however, that their consideration of the four itemized
section 801(b)(1) factors in this proceeding also provides further
support for their findings regarding a reasonable rate structure and
reasonable rates.
The D.C. Circuit recently reiterated the relationship between the
801(b) standard and market-based rates by contrasting that standard
with the willing buyer/willing-seller standard set forth in 17 U.S.C.
114(f)(2)(B). The court noted that the two standards are
distinguishable by the fact that, unlike section 114(f)(2)(B), section
801(b)(1) does not focus on unregulated marketplace rates.
SoundExchange, Inc. v. Muzak LLC, 854 F.3d 713, 715 (D.C. Cir. 2017).
However, to the extent market factors may implicitly address any (or
all) of the four itemized factors, the reasonable, market-based rates
may remain unadjusted. If the evidence suggests that market-based rates
fail to address any (or all) of these four itemized policy factors, the
Judges may adjust the reasonable, market-based rate appropriately. See
Determination of Rates and Terms . . . , 73 FR 4080, 4094 (Jan. 24,
2008) (SDARS I) (applying same factors, holding ``[t]he ultimate
question is whether it is necessary to adjust the result indicated by
marketplace evidence in order to achieve th[e] policy
objective[s].'').\145\
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\145\ Thus, the Judges reject Copyright Owners' argument that
the first three itemized section 801(b)(1) factors per se reflect
the same forces that shape the rate set in the marketplace. See 4/4/
17 Tr. 4589, 4666 (Eisenach).
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A. Factor A: Maximizing Availability of Creative Works to the Public
Factor A provides that rates and terms should be determined to
``maximize the availability of creative works to the public.'' 17
U.S.C. 801(b)(1)(A). Of particular importance, this provision
unambiguously links the upstream rates
[[Page 1956]]
and terms that the Judges are setting with the downstream market, in
which ``the public'' is listening to sound recordings that embody
musical works.
In the SDARS I Determination, the Judges made a general statement,
attributed to an expert economic witness, Dr. Ordover, that ``[w]e
agree . . . that `voluntary transactions between buyers and sellers as
mediated by the market are the most effective way to implement
efficient allocations of societal resources.' '' SDARS I, 73 FR at 4094
(quoting from Written Direct Testimony of Janusz Ordover at 11).
However, as the Judges' present discussion of the economics of this
market should make plain, they do not agree that such a broad statement
captures all the economic realities of the market. In fact, Professor
Ordover's full testimony in SDARS I demonstrates that he based his
statement on the same particular aspects of the pricing of copies of
intellectual property (such as musical works or sound recordings) that
the Services' expert witnesses and the Judges have identified in this
proceeding.
On behalf of the Services in the present proceeding, Professor Marx
approaches Factor A in a manner that is at once novel (for these
proceedings) and consistent with fundamental and relevant economic
principles. Specifically, she asserts that maximization of the
availability of musical works (embodied in sound recordings) to the
public, through interactive streaming, requires that the combined
``producer surplus'' and ``consumer surplus'' be maximized, because
that leads to listening by all segments of the public regardless of
their WTP. In Professor Marx's analysis ``producer surplus'' means
``the amount by which the total revenue received by a firm for units of
its product exceeds the total marginal cost. . . .'' A Schotter,
Microeconomics: A Modern Approach at 389 (2009).\146\ The ``consumer'
surplus'' means ``[t]he difference between what the consumer would be
willing [and able] to pay and what the consumer actually has to pay.''
Mansfield & Yohe, at 93.
---------------------------------------------------------------------------
\146\ For present purposes, marginal cost includes opportunity
cost as well as marginal production cost, regarding the marginal
cost of distributing copies of the musical works (embodied in
interactively streamed sound recordings).
---------------------------------------------------------------------------
When a perfectly competitive market is in equilibrium (or tending
that way) ``the sum of consumer surplus . . . and producer surplus . .
. is maximized.'' Schotter, at 420. By contrast, if a market is not
perfectly competitive because the sellers have some degree of market
power, then the level of output is somewhat restricted, producer
surplus is increased and consumer surplus is decreased--with a portion
of the overall surplus redistributed to producers/sellers. Another
portion lost as ``a pure `deadweight' loss . . . the principal measure
of the allocation of harm'' arising from the exercise of market power.
Mansfield & Yohe, supra, at 499; see Schotter, at 398 (accepted
definition of ``deadweight loss'' is ``[t]he dollar measure of the loss
that society suffers when units of a good whose marginal social
benefits exceed the marginal social cost of providing them are not
produced because of the profit-maximizing motives of the firm
involved.'').\147\
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\147\ To be clear, this ``harm'' is not conclusive evidence that
such static market power is harmful, or even inefficient, on
balance, in a dynamic sense. A monopoly may be more efficient in
reducing unit costs because of necessary scale (such as a natural
monopoly) or because of superior production techniques. And again,
when marginal production costs (of copies) are essentially zero,
exercise of market power by copyright owners (including owners of
collectivized repertoires such as record companies, music publishers
and PROS) can be necessary to induce the production of copyrighted
goods (such as musical works and sound recordings), because without
production there is nothing to be copied. But these efficiencies
only demonstrate why such market power should not be dissipated, and
are not relevant to the narrower issues at hand: how to maximize the
availability of goods and to set reasonable rates given the
otherwise beneficial existence of such market power.
---------------------------------------------------------------------------
As the foregoing definitions imply, the two surpluses are measured
by reference to a single equilibrium price. However, when Copyright
Owners, like any sellers, are able to price discriminate, they enlarge
the total value of the combined surpluses, diminish the ``deadweight
loss'' and appropriate the larger, combined surplus for the producers.
See H. Varian, Intermediate Microeconomics: A Modern Approach 462-63
(2010) (With price discrimination, ``[j]ust as in the case of a
competitive market, the sum of producer's and consumer's surplus is
maximized [but with] the producer . . . getting the entire surplus
generated in the market. . . .'').
Professor Marx marshals these microeconomic principles to explain
why the 2012 Settlement rate structure tends to incentivize and support
the maximization of musical works available to the public under Factor
A. Marx WDT ]] 119-122, 123-133. As she testified at the hearing:
[H]aving different means of price discrimination is going to
allow greater efficiency to be achieved [i]f we have a way for low
willingness to pay consumers to access music, for example, student
discounts, family discounts or ad-supported streaming, where low-
willingness-to-pay consumers can still access music in a way that
still allows some monetization of that provision of that service.
3/20/17 Tr. 1894-95 (Marx) (emphasis added); see Marx WDT ] 12 (``An
economic interpretation of [F]actor A is that the royalty structure
should ``maximize the pie'' of total producer and consumer surplus. . .
.'').
Professor Marx contends that the price discriminatory rate
structure is superior to a per play model in maximizing the
availability of musical works to the public:
The subscription model provides an efficiency benefit because
the price of a play is equal to the marginal cost of roughly zero--a
subscriber faces the true marginal cost of playing a song over the
internet and thus consumes music at the efficient level. When
subscribers face a per-play royalty cost of zero, interactive
streaming services have the appropriate incentive to encourage music
listening at the margin.
In contrast, if interactive streaming services faced a positive
per-play royalty cost, they would have a diminished incentive to
attract and retain high-use consumers, the very type of consumers
who create the most social surplus through their listening. They
would also have an incentive to discourage music listening among the
high-use consumers they retain. The higher the level of per-play
royalties is, the more this incentive might affect the behavior of
interactive streaming services.
Id. at ]] 130-131 & n. 135.\148\
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\148\ With regard to Factor A as it relates to Copyright Owners'
proposal, Professor Marx also notes the supply-side ``Cournot
Complements'' problem created by Copyright Owners' reliance on the
unregulated sound recording market. This is a problem because rates
in such a ``must have'' unregulated market can be even higher than
monopoly rates, thereby depressing the quantity supplied--contrary
to a goal of maximizing the availability of musical works. See 4/7/
17 Tr. 5532 (Marx).
---------------------------------------------------------------------------
Professor Marx's analysis is based on an understanding that
maximizing the availability of musical works is a function of
incentives to distributors and a function of downstream demand. She
notes, however, that the variable, percent-of-revenue rate structure is
consistent with agreements in the unregulated upstream sound recording
market, where record companies license sound recordings to these same
interactive streaming services. She notes:
Ironically, given the preference of . . . Copyright Owners'
economists for market outcomes, . . . they support a proposal that
would tend to eliminate [REDACTED] interactive streaming, which the
unregulated sound recording side of the market has facilitated.
[Copyright Owners'] proposal would also completely do away with
percentage-of-revenue rates that form a key part of unregulated
rates negotiated between
[[Page 1957]]
music labels and interactive streaming services.
Marx WRT ] 84 (emphasis added).
Beyond Professor Marx's theoretical arguments, Dr. Leonard notes
that the existing (price-discriminatory) rate structure that has
existed for two rate periods. He contends there is no evidence that
songwriters as a group have diminished their supply of musical works to
the public. In fact, he notes that the music publishing sector has been
profitable throughout the present rate period. 3/15/17 Tr. 1120
(Leonard).
Dr. Leonard is correct that there is no evidence in the record that
songwriters as a group have diminished their supply of musical works to
the public. No participant performed such an empirical study.
Nevertheless, there is ample, uncontroverted testimony that songwriters
have seen a marked decline in mechanical royalty income over the past
two decades, and that this decline has rendered it increasingly
difficult for non-performing songwriters (i.e., songwriters with income
from songwriting only and not from performing or recording music) to
earn a living practicing their craft. For example, Mr. Steve Bogard, a
successful veteran songwriter from Nashville, testified that ``I have
written many songs that have become hits and continue to do so.
However, over the past few years, my income has not reflected my
continued success because the interactive streaming services are paying
a fraction of what I earn from physical sales and permanent
downloads.'' Witness Statement of Steve Bogard, Trial Ex. 3025, ] 32
(Bogard WDT). Lee Thomas Miller, another successful Nashville-based
songwriter, when asked to describe the mechanical royalty income he
earns from on-demand streaming, stated ``[i]t is so insignificant that
we rarely even scroll down and look at the line items. . . . [Y]ou look
at these numbers of millions of spins and then you look at the tens of
dollars that they pay.'' 3/28/17 Tr. 3517-18 (Miller).
Mechanical royalties play a critical role in enabling professional
songwriters to write songs as a full-time occupation.\149\ Professional
songwriters have traditionally subsisted on a ``draw,'' a periodic
advance against future mechanical royalties that music publishers pay
out like a salary. See 3/23/17 Tr. 2931 (Herbison). ``In many cases,
the advances we pay our songwriters are their main source of income to
cover living expenses, allowing them to dedicate as much of their time
as possible to songwriting instead of having to take other work to make
ends meet.'' Witness Statement of Justin Kalifowitz, Trial Ex. 3022, ]
15 (Kalifowitz WDT). If the mechanical royalties from which music
publishers can recoup advances decrease, so too do the advances that
music publishers are willing to pay out. ``[I]n the non-digital era,
those draws for brand new writers, it wasn't uncommon for them to be in
the $20,000, $30,000 range when those dollars meant more, 20 years ago.
Today the standard is $12,000.'' 3/23/17 Tr. 2932 (Herbison).
---------------------------------------------------------------------------
\149\ Justin Kalifowitz, founder and CEO of an independent music
publisher, testified that ``[q]uality songwriting cannot be
relegated to a part-time hobby; it is a calling and a career.''
Witness Statement of Justin Kalifowitz, Trial Ex. 3022, ] 14
(Kalifowitz WDT).
---------------------------------------------------------------------------
The decline in royalties has diminished some music publishers'
willingness to make or continue publishing agreements with songwriters:
The availability of publishing deals has significantly
decreased. It is alarming that in Nashville there are so many fewer
songwriters than there were just a few years ago. Most estimates say
that there are less than one-quarter of the number of professional
songwriters than there were just 10 years ago. Many songwriters in
Nashville who earned a full-time living from royalty payments are no
longer signed to publishing deals.
Bogard WDT ] 41. Diminished availability of publishing deals means
fewer new songwriters entering the profession:
Publishers cannot afford to sign as many songwriters as they did
in the past. Music publishers typically invested in younger writers
who might not produce immediate results and then recouped their
money when those writers started earning royalties on album cuts.
Now, when they do sign writers, music publishers increasingly turn
to recording artist and producer writers, so they can hedge their
bets with a better chance of recordings being released.
Bogard WDT ] 42; see also Witness Statement of Liz Rose, Trial Ex.
3024, ] 20 (Rose WDT) (``we used to sign more songwriters and give them
five or six years to hone their craft . . . but we can't afford to do
that anymore''). Development of those songwriters who are fortunate
enough to sign publishing deals is also suffering.
When I first arrived in Nashville, experienced and established
songwriters would invite young, talented songwriters to write with
them. This was a very illuminating experience for the young
songwriters and helped them grow into better professionals. It also
gave the established writer new ideas and influences. Today, a
professional non-performing songwriter cannot simply try to write a
great song alone or with co-writers who are also professional
songwriters, then hope that an artist records it.
Now, an established songwriter cannot mentor young songwriters
if he or she wants to maintain his living. Veteran songwriters, such
as myself, simply do not have time. Instead, I spend three to four
days a week with young recording artists who already have record
deals and need help writing their songs. These recording artists are
sometimes very talented songwriters, but it often takes the craft
and art of the professional writer to turn their thoughts into
commercial songs.
Id. ]] 44-45; see also Witness Statement of Lee Thomas Miller, Trial
Ex. 3023, at ] 6 (L. Miller WDT) (``Publishers can simply not afford to
`develop' as many writers as they once did.'').
To be sure, not all of the diminution of mechanical royalty income
has been a result of the shift from physical product and permanent
downloads to streaming. Digital piracy, and the unbundling of the album
\150\ have played significant parts in reducing songwriter income. See
3/23/17 Tr. 2937, 2940-41 (Herbison). It is not within the Judges'
authority to roll back the clock, as it were, and remedy every economic
force that has diminished songwriters' income over the past two
decades. Nevertheless, the Judges find that the evidence in this
proceeding supports a conclusion that the existing rates for mechanical
royalties from interactive streaming are a contributing factor in the
decline in songwriter income, and that this decline has led to fewer
songwriters. If this trend continues, the availability of quality songs
will inevitably decrease.\151\
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\150\ Album sales provided songwriters income from ``album
cuts,'' i.e., songs that were not hits, but provided royalty income
from album sales. In the current singles market that dominates
download sales, hit singles get sold (and provide royalty income),
but lesser-known tracks generally have much lower sales and
royalties. 3/23/17 Tr. 2938-40 (Herbison). Similarly, interactive
streaming permits listeners to stream individual songs, even if they
were released as part of an album. Noninteractive streaming of
albums is not permitted without a waiver of the sound recording
performance complement. 17 U.S.C. 114(d)(2)(C)(i), j(13)(A)).
\151\ The Judges do not discount the quality of existing songs.
Indeed, music publishers continue to market the ``old standards'' to
young performers. The Judges do not measure availability of creative
works by looking at music publishers' profits or by counting
recycled songs contributing to those profits. Maximizing the
availability of creative works includes, if not focuses on, new
creative works.
---------------------------------------------------------------------------
Copyright Owners, principally through the rebuttal testimony of
Professor Watt, argue that Professor Marx has made a fundamental error
in equating the maximizing of availability of musical works with a
maximization of the sum of the producer and consumer surplus. Watt WRT
] 10. According to Professor Watt, ``A better understanding of
criterion A is that the royalty payments should ensure that a
[[Page 1958]]
plentiful supply of works is forthcoming into the future. . . .'' Id.
To accomplish that end, Professor Watt argues the rates should be set
to ensure that ``creators are given the correct incentives to continue
to create and make available valuable works.'' Id.
Professor Watt argues that even if the rates and rate structure are
designed to maximize consumer and producer surplus, that maximization
would not inform the Judges as to whether that result satisfies Factor
A. Rather, according to Professor Watt
In effect, a royalty structure is simply a way in which producer
surplus, once created, is shared between the interactive streaming
firms and the copyright holders, but in and of itself, the structure
does not determine the size of either producer or consumer surplus.
Consumer surplus and producer surplus are both entirely determined
by the interplay of the demand curve for the product in question
(here, interactive music streaming) and the way the product is
priced by the interactive streaming industry to its consumers. That
is, regardless of the structure of the royalty payments, the ``size
of the pie'' is determined by the unilateral decisions made by
interactive streaming firms about their pricing to consumers.
Watt WRT ] 11.
Professor Watt also attempts to de-couple the upstream and
downstream rate structures by analogizing interactive streaming to a
retail restaurant offering of an ``all you can eat buffet.'' He
concludes that a retailer, such as an interactive streaming service or
a buffet restaurant, can pay for inputs (musical works or food) per-
unit while still charging an up-front access fee ($9.99 per monthly
subscription or $9.99 for a buffet meal). By this analogy, Professor
Watt purports to demonstrate that interactive streaming services do not
require non-unit royalty rates to serve their downstream listeners. Id.
] 12.
Professor Watt asserts that Spotify's claim that listeners to it
ad-supported service do not pay a marginal positive price is
inaccurate. He notes that listening to advertising that interrupts the
music imposes a time-related/annoyance cost that the listeners must
accept.\152\ This suggests to Professor Watt that per-unit pricing (at
least in a non-monetary manner) indeed is possible downstream. Id. ]
13.
---------------------------------------------------------------------------
\152\ The record does not address an assessment of the
advertising interruption cost. Advertising in today's technological
environment is often informative, especially when it is targeted to
specific listeners, adding some measure of value, rather than cost,
to the listener.
---------------------------------------------------------------------------
Professor Watt further opines that any positive marginal cost
pricing of songs by interactive streaming services on subscription
plans necessarily would be offset by a reduction in the up-front
subscription price. He suggests that this consequence would not
necessarily be deleterious for the streaming service because ``[w]ith
the reduction in the fixed fee (along with the positive per-unit
price), it becomes entirely possible that consumers who were not
initially in the market now find it to be in their interests to join
the market, consuming positive amounts of streamed music where
previously they consumed none.'' Id. ] 15.
In their affirmative case regarding Factor A, Copyright Owners
argue that ``availability maximization'' should be considered through
the lens of the creators, who seek high rates as a signal to spur
creation and would see low rates as a disincentive.
In undertaking a Factor A evaluation, the Judges are cognizant of
the double meaning of ``availability'' of creative works in a tiered
market such as the music streaming business at issue in this
proceeding. On the one (upstream) hand, maximizing availability of
creative works might refer to encouraging artists to produce more
prolifically. On the other (downstream) hand, maximizing availability
might refer to encouraging more entry into the music streaming business
to maximize options for end-users and, presumably expand the overall
consumption of music. The Judges must weigh the impact of their rate
decisions so as not to favor one interpretation of availability of
creative works over the other.
With regard to the downstream market, the Judges find that
Professor Marx's analysis of how a price discriminatory model maximizes
availability is correct. Price discrimination not only serves low WTP
listeners, but it also indirectly serves copyright owners, by
incentivizing interactive streaming services to increase the total
revenue that price discrimination enables. Any seller or licensor would
prefer to maximize its revenue, and a rate structure that will effect
such maximization thus would be the best structural inducement. For
purposes of applying Factor A, a rate structure that better increases
revenues, ceteris paribus, should induce more production of musical
works, a result that Copyright Owners should desire.\153\
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\153\ This point appears to raise a question: How could
Copyright Owners and their economic experts argue against a rate
structure that inures to their benefit as well? The answer is: They
do not. As stated supra, they advocate for a rate set under the
bargaining room theory, through which mutually beneficial rate
structures can still be negotiated, but not subject to the
``reasonable rate'' and itemized factor analysis required by law. In
those negotiations, as Dr. Eisenach candidly acknowledged, Copyright
Owners would have a different threat point to use in order to obtain
better rates and terms.
---------------------------------------------------------------------------
By contrast, to equate ``availability'' solely with a higher rate
would produce, ultimately, a lower surplus. The Judges find that
Copyright Owners have taken a cramped and unrealistic view of
incentives created by price discrimination. Although a per-unit rate
structure with higher royalty rates might have an immediate superficial
appeal, the consequence will most assuredly be lower revenues both
downstream and upstream.
The Judges find that the objective of maximizing the availability
of musical works downstream to the public is furthered by an upstream
rate structure that enhances the ability of the interactive streaming
services to engage in downstream price discrimination (``down the
demand curve,'' increasing revenue for both Copyright Owners and the
interactive streaming services).
In sum, the Judges are persuaded that Professor Marx's analysis of
Factor A is consistent with the purpose of that statutory objective and
sound economic theory. An upstream rate structure based on monetizing
downstream variable WTP will facilitate beneficial price
discrimination. In turn, that price discrimination will allow for more
affordable access ``down the demand curve,'' making musical works
available to more members of the public. The rate structure determined
by the Judges, in which both rate prongs monetize downstream variable
WTP, satisfies Factor A.
Although largely anecdotal and unsupported by sophisticated
surveys, studies, or economic theories, the uncontroverted evidence
from songwriters and publishers should not go unheeded. That evidence
points strongly to the need to increase royalty rates to ensure the
continued viability of songwriting as a profession. The rate determined
by the Judges represents a 44% increase over the current headline rate,
and thus satisfies the Factor A objective in this respect as well.
B. Factors B and C: Fair Income and Returns and Consideration of the
Parties' Relative Roles
Factor B directs the Judges to set rates that ``afford the
copyright owner a fair return for his or her creative work and the
copyright user a fair income under existing economic conditions.''
Factor C, instructs the Judges to weigh ``the relative roles of the
copyright owner and copyright user in the product made available to the
public,'' across several dimensions. 17 U.S.C. 801(b)(1)(B), (C).
[[Page 1959]]
Congress included Factors B and C in section 801(b)(1) to establish
a legal standard for the Judges to use to move their determination of
new rates for existing licenses beyond a strictly market-based
analysis. In an attempt to pass constitutional muster, Congress crafted
statutory language that paralleled public utility-style regulatory
principles.\154\ According to 1967 Congressional testimony, these
principles were ill-suited for setting rates that equitably divided
compensation for the ``relative roles'' of licensors and licensees in
order to provide a ``fair'' outcome.\155\ However, as the parties'
economic experts make clear in their approaches to Factors B and C in
this proceeding, the discipline of economics has evolved since Mr.
Nathan criticized as economically impossible any regulatory attempt to
equitably divide creative contributions.\156\
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\154\ Public utility-style regulation, especially in 1967 when
Congress was working on copyright reform legislation, was classic
rate-of-return regulation. Essentially, the regulator would
establish the utility's costs and determine the rate charged to
customers (or rates charged to different customers), sufficient to
provide the utility with a reasonable rate of return. See generally
Decker, Modern Economic Regulation at 104 (2014).
\155\ See Hearing on S. 597, Subcomm. on Patents, Trademarks and
Copyrights of the S. Committee on the Judiciary (Mar. 20-21, 1967).
\156\ Economics experts in the present proceeding for both
Copyright Owners and the Services acknowledge that microeconomic
principles (pre-Shapley values) do not provide insights as to what
constitutes ``fairness.'' See, e.g., 3/30/17 Tr. 3991 (Gans)
(``fairness . . . is not a topic that is sitting in an economics
textbook somewhere.''); 3/20/17 Tr. 1830 (Marx) (``Fairness is not a
notion that has a unique definition within economics.''); 1128-29
(Leonard) (``economists . . . typically don't do `fair' ''); 4/13/17
Tr. 5919 (Hubbard) (``Economists aren't philosophers. I can't go to
the biggest picture meaning of `fair'. . . .''). Rather, economists
attempt to identify ex ante ``fairness'' by identifying fair
processes in the workings of and structure of markets, in
bargaining, and in the efficiency of outcomes generated by these
processes, although their understanding of what constitutes a fair
``process'' varies. See, e.g. 3/13/17 Tr. 555 (Katz) (``[T]he most
useful or practical way of thinking about it here was really to
focus on whether the process is fair'' . . . [and] a conception
that's often used in economics is that a process is fair if it's . .
. competitive or the outcome of a competitive market. A competitive
bargaining process is fair. And so that's the--the central notion of
fairness that I used here.''); 3/15/17 Tr. 1129 (Leonard) (``My
concept of fair . . . and what I think a lot of economists would say
is that if you have . . . a negotiation between two parties and
there are no . . . constraints such as holdup . . . and there's no
market power . . . again I hesitate to use the word, so maybe I'll
put it in quotes, would be fair.); Eisenach WDT ] 24 (``a rate set
at the fair market value by definition provides fair returns and
incomes to both the licensee and licensor.'')
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In the present proceeding, the parties' economic experts agreed on
the propriety of joint consideration of Factors B and C either through
a Shapley value analysis or an analysis ``inspired'' by the Shapley
valuation approach.\157\ See Marx WDT ]] 11-2 (considering ``a `fair
return' according to . . . relative contributions (factors B and C)''
because of the use of ``[a]n economic interpretation of factors B and C
. . . a commonly used economic approach, the Shapley value, which . . .
operationalizes the concept of fair return based on relative
contributions.''); Watt WRT ] 22 (``I agree with Dr. Marx's assertion
that the Shapley model is a very appropriate methodology for finding a
rate that satisfies factors B and C of 801(b); see also Gans WDT ]] 65
n. 35, 67 (noting the Shapley approach provides for a ``fair
allocation'' as among input suppliers to reflect ``the contributions
made by each party.''). The Judges concur with this joint analysis.
---------------------------------------------------------------------------
\157\ The Shapley approach, named for Nobel Memorial Prize
winner Dr. Lloyd Shapley, represents a method for identifying fair
outcomes, previously unaddressed in microeconomics. Congress did not
apply the Shapley value approach, perhaps because this methodology,
although developed in 1953, was not yet widespread in the economic
literature in 1967.
---------------------------------------------------------------------------
The Judges used Shapley analyses to derive royalty rates in this
Determination, and discussed the experts' respective Shapley (or
Shapley-inspired) models in that context.\158\ To summarize briefly,
Professors Marx, Gans, and Watt's analyses all produced a lower ratio
of sound record to musical work royalties than exists under current
conditions, implying that a fair allocation of surplus between those
two groups would be more even than under the current market structure.
Professors Marx's and Watt's Shapley analyses also pointed to a lower
overall percentage of service revenue being directed to copyright
royalties than exists under the current rate structure. Due, in part,
to her decision to design the model to equalize bargaining power
between copyright owners and users, Professor Marx's model produced
lower overall royalties for copyright owners than Professor Watt's
model.
---------------------------------------------------------------------------
\158\ See supra, section V.D.1.
---------------------------------------------------------------------------
The Judges have determined a rate that is computed based on the
highest value of overall royalties predicted by Professor Marx's model
and the ratio of sound recording to musical work royalties determined
by Professor Gans's analysis.\159\ The Judges find that these rates are
consistent with the experts' analyses and constitute a fair allocation
of revenue between copyright owners and services. The Judges' analysis
with regard to Factors B and C demonstrates (whether that analysis was
undertaken as part of the reasonable rate analysis or as a separate
analysis), that there is no basis to depart from the Judges'
determination of the reasonable rate structure and rates as set forth
supra.
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\159\ See supra, section V.D.2.
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C. Factor D: Avoidance of Disruption
The last itemized factor of section 801(b)(1) directs the Judges
``to minimize any disruptive impact on the structure of the industries
involved and on generally prevailing industry practices.'' 17 U.S.C.
801(b)(1)(D). In Phonorecords I, 74 FR at 4525, the Judges reiterated
their understanding of Factor D, concluding that a rate would need
adjustment under Factor D if that rate
directly produces an adverse impact that is substantial, immediate
and irreversible in the short-run because there is insufficient time
for either [party] to adequately adapt to the changed circumstance
produced by the rate change and, as a consequence, such adverse
impacts threaten the viability of the music delivery service
currently offered to consumers under this license.
Id. The Judges adopt and apply in this Determination the same Factor D
test.
Copyright Owners and Apple advocate a complete abandonment of the
current rate structure. The upshot of each proposal is a dramatic swing
in royalties: Increases under Copyright Owners' proposal and decreases
under Apple's proposal. For all the reasons detailed in this
Determination, the Judges do not adopt either of the per-unit rate
structures these parties advocate. The Judges decline to make the
requested changes in rate structure not because the structure is
different and unfamiliar, but because of the dramatic, disruptive
effects of the proposed per-unit rate structures.
The Services advocate essentially the rate structure that now
exists. See SJPFF at 1. The Judges' proposed rate structure adopts some
attributes of the existing rate structure, incorporating the
economically reasonable features and abandoning unsupported features
that unduly fracture and complicate the rate structure.
The record shows that interactive streaming services are failing to
realize an accounting profit under the current structure and nothing
the Judges do in this proceeding will change the Services' business
models to change that circumstance.\160\ The Services remain in
business and new streaming services enter the market despite the
existence of
[[Page 1960]]
chronic accounting losses. The Services' inability to become profitable
will persist based on the record, under existing competitive
conditions. As Mr. Pakman testified: [N]o current music subscription
service--including marquee brands like Pandora, Spotify and Rhapsody--
can ever be profitable, even if they execute perfectly. . . .''
Testimony of David B. Pakman, Trial Ex. 696, ] 23 n.5 (citation
omitted) (Pakman WDT). Although Mr. Pakman blames the lack of
profitability (in part) on the level of mechanical royalties, the
Judges find, based on the Services' own acknowledgement, that the lack
of profitability is a function of a lack of scale (which is another way
of indicating that market share is divided among too many competing
interactive streaming services). Id. Lowering mechanical royalties to
provide the Services profitability, in the face of the acknowledged
problem of a lack of scale, would constitute an unwarranted subsidy to
these services at the expense of Copyright Owners.\161\
---------------------------------------------------------------------------
\160\ It is likely the Services have made and will make business
decisions that defer accounting profits. The Judges' approach offers
no criticism of the Services' business decisions; rather, the Judges
attempt to assure a structure that permits the Services' competitive
tactics without penalizing the creators of the works they exploit.
\161\ Copyright Owners argue that the services could attempt to
cut their non-content costs in order to remain sustainable. They
suggest that the services emulate Sirius XM, which successfully
reduced its non-content costs as a percent of revenue. See Rysman
WDT ]] 98-100. However, as Spotify's CFO, Mr. McCarthy notes, Sirius
and XM (the pre-merger predecessors to Sirius XM) ``nearly
bankrupted themselves and merged in order to survive.'' McCarthy WRT
] 42. Moreover, not only were Sirius XM's content costs lower as a
percent of revenue, but also its ``costs declined as a percentage of
revenue as they grew their subscriber base. . . . Their costs
declined as they achieved scale.'' Id. Once again, the necessity of
scale remains paramount.
---------------------------------------------------------------------------
Although the Services have indicated their ability to withstand
short-term losses as they compete for scale/market share, the record
also indicates that there is a limit to such losses, however imprecise
and unknown, beyond which services will be unable to attract capital
and survive until the long run market d[eacute]nouement. As Dr. Leonard
testified, ``[REDACTED] is relevant and suggests [REDACTED].'' Leonard
AWDT ] 101 n.151. This testimony reflects the well-understood principle
that ``[t]here is no specific time period . . . that separates the
short run from the long run.'' R. Pindyck & D. Rubinfeld,
Microeconomics at 190 (6th ed. 2005). Thus, although the Services
appear able to withstand current rates, a rate increase of the
magnitude sought by Copyright Owners would run the very real risk of
preventing the services from surviving the ``short-run,'' threatening
the type of disruption Factor D is intended to prevent.
While the reasonable rate determined by the Judges does not present
the same risk of disruption as the rates sought by the Copyright
Owners, it does represent a not insubstantial increase of approximately
44% over the current headline rate. In order to mitigate the risk of
short-term market disruption, and to afford the services sufficient
opportunity ``to adequately adapt to the changed circumstance produced
by the rate change,'' the Judges will phase in the new rate in equal
annual increments over the rate period. Thus, the rates for the 2018-
2022 rate period shall be the greater of the percent of revenue and
percent of TCC rates in the following table:
----------------------------------------------------------------------------------------------------------------
2018 2019 2020 2021 2022
----------------------------------------------------------------------------------------------------------------
Percent of Revenue.............. 11.4 12.3 13.3 14.2 15.1
Percent of TCC.................. 22.0 23.1 24.1 25.2 26.2
----------------------------------------------------------------------------------------------------------------
The Judges' rate structure continues to produce an All-In rate,
from which the portion for the mechanical rights is derived. The two
rights are perfect complements. Without sufficient evidence to
establish independent respective values, any attempt to segregate the
two could result in disruptive unintended consequences. In the rate
structure the Judges adopt, they attempt to ensure that no one of the
myriad licenses required for the public to enjoy broadcast music
swallows up payment for any other license.
VII. Terms
Before enactment of the Copyright Royalty and Distribution Reform
Act of 2004, the Register held exclusive authority to set terms for use
of the section 115 compulsory license(s). In the 2004 Act, Congress
gave the Judges authority to set ``reasonable rates and terms of
royalty payments'' for section 115 licenses, as well as terms
establishing ``requirements by which copyright owners may receive
reasonable notice of the use of their works under . . . section [115],
and under which records of such use shall be kept and made available. .
. . '' See 17 U.S.C. 115(c)(3)(D), 801(b)(1). The Register retained
authority to regulate ``notice of intention to obtain the section 115
license and requirements regarding monthly payment and monthly and
annual statements of account. . . .'' See Final Order, Division of
Authority Between the Copyright Royalty Judges and the Register of
Copyrights under Section 115 Statutory License, 73 FR 48396, 48397
(Aug. 19, 2008) (Register's Rulemaking Opinion). In adopting terms, the
Judges may adopt ``additional terms `necessary to effectively implement
the statutory license.' '' Id. at 48398. In this Determination the
Judges' cleave to the division of authority between them and the
Register, declining to adopt terms any of the participants proposed
that might impinge on the Register's authority.
The extant regulations for the section 115 license have developed
over time. Participants in prior proceedings crafted the regulations to
codify the structure and terms of their settlements. The most recent
regulatory amendment occurred in November 2017, when record labels and
Copyright Owners negotiated a settlement relating to the use of musical
works embodied in physical phonorecords, permanent digital downloads
and ringtones, the so-called ``subpart A'' configurations.
With the Judges' determination to change section 115 rate
structures and to realign service offerings for rate purposes, the
regulatory terms must likewise change. Further, beginning in 2013-14
with the Web IV determination, the Judges launched an initiative to
simplify copyright royalty regulations, by eliminating duplication and,
to the extent possible, using plain English. The regulations codifying
the terms of the present determination are no exception. To standardize
the part 385 regulations, the Judges begin with a reorganization that
consolidates all regulations of general application in a new subpart A.
In this Determination, it is not the Judges' intention to change
the agreed terms for extant subpart A. The Judges do, however, move
some of the agreed subpart A regulations to the new subpart A
regulations of general application. Further, given the changes in rate
structures effected by this determination, the Judges now include Music
Bundle configurations in the same regulatory category as the
constituent parts of the music bundle, viz., physical phonorecords,
permanent digital downloads, and ringtones.
[[Page 1961]]
Regulations specific to physical phonorecords, PDDs, and ringtones
adopted by agreement together with regulations specific to Music
Bundles will now appear in subpart B.
New subpart C includes all streaming service offerings that are
revenue bearing, including offerings that the Services market at
discounted prices, such as annual subscriptions, family plans, or
student plans. Regulations for promotional streams and service
offerings for which the Licensee receives no consideration and that are
free to the end-user are contained in subpart D.
A. Definitions
1. Service Revenue
Participants in the present proceeding disagree on the definition
of Service Revenue to be used in setting a base for application of the
percent of revenue prong in the greater-of rate structure. Copyright
Owners' proposed per-unit rate structure obviates the need for a
Service Revenue definition; consequently it does not include one.
Pandora seeks an express exclusion of revenue from a Services'
products outside the purview of the section 115 license, e.g.,
Pandora's linked concert ticket sales app, TicketFly. Pandora PFF 84.
Pandora also seeks to expand the current deduction from gross revenues
for the costs associated with producing advertising revenue by
permitting a similar deduction for such costs of doing business as
credit card fees, app store fees, and carrier service billings. Id. PFF
85; see Herring WDT ] 63. Interestingly, Amazon joins in this request
even though Amazon [REDACTED]. See Amazon PFF ] 107 (and record
citations therein).
For the Judges, it is almost axiomatic that revenues from product
offerings unrelated to the section 115 license should not be included
in the revenue base for calculation of section 115 royalties. On the
other hand, the section 115 revenues should not be diminished by such
costs of doing business as paying app store and carrier service fees
and commissions or credit card fees. The Judges will retain the cost-
of-revenue-production deduction for marketing to create advertising
revenue but decline to deduct other administrative costs from the
revenue base.
Amazon and Pandora also ask for adjustments to per-subscriber
calculations to accommodate discounted service offerings, such as
discounted annual subscriptions, family plans, and student accounts.
See, e.g., Amazon PCL ]] 36-39; Pandora PFF ] 83. The rationale offered
by the Services is that discounts for a family group or for a student
build the ultimate customer base, by orienting the discounted service
users to their particular formatting and increasing user comfort and
convenience. Id. Copyright Owners urge the Judges to require the
Services to pay the same royalty rate for discounted offerings as they
pay for full-price subscription offerings.
Relying on their rationale for choosing a percent-of-revenue rate
structure rather than a per-unit rate structure, the Judges recognize
that the Services are, to some extent, focusing more on growth of
market share than growth of revenue. But the Judges also recognize that
marketing reduced rate subscriptions to families and students is aimed
at monetizing a segment of the market with a low WTP (or ability to
pay) that might not otherwise subscribe at all. The Services, as they
work toward profitability, are likely to continue to market
aggressively to users with the WTP full subscription prices and to
monetize other users in hopes of getting them into the ``funnel'' for
full-price subscriptions.
2. Fraudulent Streams
Apple, Google, Pandora, and Spotify seek inclusion of a definition
of ``fraudulent streams'' in the section 115 regulations to avoid
royalty payments for them. Google proposes defining a fraudulent stream
in terms of the origin of the request with an alternative quantitative
limitation. See Google Inc.'s Amended Proposed Rates and Terms at 3.
Spotify combines the two criteria. See Spotify's PFF/PCL at 115. Apple
revised its original quantitative definition to a reasonableness
determination delegated to the Service. See Apple Inc. Proposed Rates
and Terms at 2.
In light of technological developments that permit non-human
streaming of sound recordings for purposes other than consumer
listening, the Judges concur that these non-consumer streams should not
be counted in determining the allocation of royalties. Accordingly, a
definition of Fraudulent Stream is appropriate. The Judges conclude
that the definition should establish a quantitative measure, removing
the subjective determinations of the various Services from the
equation.
3. Royalty-Bearing Streams
Apple led the Services in asking for a definition of ``Play'' that
eliminates from any per-play calculation a stream lasting fewer than 30
seconds. Apple contends including these partial plays are not
indicative of true consumer demand. See Ghose WDT ]] 54, 60. Mr. Vogel,
testifying for Spotify asserted that counting streams of under 30
seconds affords a substantial windfall to Copyright Owners. Written
Rebuttal Testimony of Paul Vogel, Trial Ex. 1068, ] ] 39-40 (Vogel
WRT). Pandora and Spotify join in the request to add a 30-second
threshold to the definition of ``Play.'' Apple contends that the time
threshold is a feature of [REDACTED]. Apple PFF ] 240. Copyright Owners
argue against the proposal arguing that the definition for section 115
should align with that adopted for noninteractive streaming licenses
under section 114.
The Judges' rate structure in this proceeding does not stand on a
per-play base. Nonetheless, the section 115 regulations must clarify
that allocation of mechanical royalties is based on the relative number
of plays of a Copyright Owners' works. Copyright Owners advocate for a
per-unit rate structure that reflects demand. The Judges cannot find
that a partial play of a work signifies consumer demand; in fact, a
skip-though might indicate just the opposite consumer conclusion. The
Judges adopt the definition of ``Play'' that exempts streams of under
30 seconds for tracks that are, in their entirety longer than 30
seconds.
4. Pass-Through Licenses
The extant regulations provide alternative measures in the calculus
for finding the greater-of all-in royalty pool or, in some instances,
the measure of the lesser-of prong to be used to determine the greater-
of royalty pool. The difference is in the percent-of-TCC depending on
whether the record company's licenses are ``pass-through'' or not. The
parties offered minimal evidence on the topic. Pandora proposed to
eliminate the distinction as ``unnecessary.'' Pandora PFF ] 79.
Pandora's conclusion is consistent with Professor Eisenach's
observation that the pass-through rate is rarely used. Eisenach WDT ]
82 n.67.
The Judges find the separate pass-through TCC rate is unnecessary
and decline to include one in the regulations.
B. Offerings
1. Limited Downloads and Interactive Streaming
The Judges do not alter definitions identifying Limited Downloads
and Interactive Streaming, as the settling parties defined those
service offerings in the 2012 Settlement. The Judges do, however, add
other offering
[[Page 1962]]
configurations to those configurations to enlarge the rate category.
2. Mixed Bundles
In the current regulations based on the 2012 Settlement, mixed
service bundles regulated in current subpart C and are differentiated
from music bundles in the same subpart. Compare 37 CFR 385.21
(definition of ``mixed service bundle'') with id. (definition of
``music bundle'').\162\ The rate structures for the two bundle types,
with one exception, and the rates for the two bundle types are
identical. The difference between the bundle calculations occurs at the
final step, allocation of the payable royalty pool. For mixed service
bundles, the payable royalty pool is allocated to musical works
rightsholders on the basis of relative number of plays. For music
bundles, which include up to three service configurations, the payable
royalty pool is subdivided by configuration (CD, PDD, ringtone) and the
per-play allocation is calculated for each configuration separately.
---------------------------------------------------------------------------
\162\ ``Mixed service bundles'' are a product package that
includes music access together with a non-music product, such as
Internet services. A ``music bundle'' refers to packaging different
music access configurations in a single music sale for a single
price, such as authorizing a PDD with the purchase of a CD.
---------------------------------------------------------------------------
Copyright Owners proposed combining regulations for mixed bundle
offerings with the regulations for their component parts. The Judges
conclude that the differences in kind between mixed offerings including
streaming and a mixed music offering including only currently regulated
configurations are sufficient to separate them. Mixed bundles will be
subject to the streaming rate structure, with allocation allowed based
on the relative values of music streaming and any other bundled
offering.
3. Music Bundles
The Judges now include Music Bundles with the regulations adopted
for physical phonorecords, permanent downloads, and ringtones--the
three potential components of a ``music bundle.'' Each separate
offering within the bundled configuration shall be subject to the rate
agreed by the parties that proposed the subpart A settlement, as
applicable to that component part.
4. Lockers
In the existing regulations, Paid Locker Services and Purchased
Content Locker Services are both royalty-bearing configurations. In the
present proceeding, the only evidence regarding locker services was
expository. To the extent Services offered a purchased content locker
service, the evidence was that those Services are exiting the arena.
For example, Apple described its Purchased Content Locker Service as a
non-remunerative service that it is phasing out and no longer
marketing. See, e.g., Apple PCL 52.
For Purchased Content Locker Services that do not generate revenue
for the Service, no royalty should accrue. For Paid Locker Services, a
Service receives subscription payments \163\ and subscription revenues
for those offerings are part of the service revenue to which the
percent-of-revenue calculation applies.
---------------------------------------------------------------------------
\163\ The Judges heard no testimony regarding ad-supported
locker services, but to the extent they exist, the conclusions for
subscription paid locker services apply equally to ad-supported
locker services.
---------------------------------------------------------------------------
5. Family and Student Plans
The Judges adopt here a greater-of rate structure that measures a
percent of service revenue against a percent of TCC. The basic rate
calculations are straightforward. The Judges also adopt a Mechanical
Floor for Offerings that currently have a Mechanical Floor alternative.
In the present proceeding, the Judges adopt a Mechanical Floor for
certain configurations. For purposes of determining that minimum rate,
should the need ever arise, the parties ask for clarification regarding
subscriber counts.
The Services presented evidence of three subscription variations:
Discounted annual subscriptions, family subscriptions, and student
subscriptions. A discounted annual subscription is no different from
any subscription for purposes of calculating the per-subscriber minimum
mechanical rate.
As an example, Spotify proposed, albeit for a different purpose in
a different rate structure, that family accounts be treated as 1.5
subscribers per month and student accounts be treated as .5 subscriber
per month. See, e.g., Spotify Second Amended Proposed Rates and Terms
at 16. Copyright Owners' rate proposal is based not on subscribers, but
on end users, which they define to include any person who streams at
least one play during an accounting period, apparently without regard
to that user's subscription status.
For purposes of calculating a Mechanical Floor rate, the Judges
adopt the Services' proposal, in the form articulated by Spotify.
Family accounts are to be counted as 1.5 subscribers and student
accounts are to be counted as .5 subscriber.
6. Unremunerated Offerings
No party in this proceeding offered evidence or argument against
continuing the zero royalty rate for promotional streams, as they are
defined in the regulations. The Judges accept the agreed definition in
the extant regulations, with substantial editing to eliminate
unnecessary complexity, and adopt the agreed zero rate for promotional
streams.
In addition, the Judges include in the new subpart D regulations
other offerings for which a Service receives no remuneration. Free
trial subscriptions and purchased content locker services that are free
to the user and not associated with any revenue (such as advertising
revenue) bear a royalty rate of zero.
C. Reporting and Auditing
Among the areas open to the Judges for rulemaking are notice and
recordkeeping, to the extent the Judges find it necessary to augment
the Register's reporting rules. The Judges' regulations must be
supported by record evidence and may include guidance on how payments
are made and when, accounting practices, audits, and acceptable
deductions from royalties. See Register's Rulemaking Opinion at 48398.
With respect to the section 115 licenses, the Register's regulations
address licensees' Notice of Intent to obtain a section 115 license,
details of the licensees' monthly payments, and specifications for
licensees' monthly and annual Statements of Account. Id. at 48397.
In the present proceeding, the parties' proposed terms by and large
described rate structures and calculations of payable rates. Given the
rate structure the Judges adopt, many of the parties' proposed terms
are inapplicable. Some participants did propose rule changes that are
appropriate even with the new rate structure and that would
appropriately augment the Register's rules. In some instances, however,
the parties' regulatory proposals are proffered as part of their legal
argument but are not supported by factual evidence in the record.
The Judges include in the part 385 regulations provisions that
augment the part 210 statement of information Services must record and
retain with regard to promotional and trial streaming offerings. The
Judges decline to adopt other changes to part 210 requested by Spotify.
The Judges will forward those change requests to the Register of
Copyrights for such consideration as the Register deems appropriate.
[[Page 1963]]
D. Late Fees
The Act expressly authorizes the Judges to include in a
determination ``terms with respect to late payment . . .'' provided the
late payment terms in no way interfere with other rights or remedies of
copyright holders. 17 U.S.C. 801(c)(7). In the extant regulations, only
subpart A contains a provision for late fees. The Judges did not
previously include late fee provisions in prior subparts B and C
because the settling parties did not include those provisions. In the
present proceeding, Copyright Owners asked the Judges to adopt late fee
provisions for all royalty payments. Copyright Owners contend that
adding the late fee provision to all section 115 royalties simply
``clarifies'' the intention of the parties that settled on rates and
terms in 2012.
The Judges cannot divine the intentions or missed opportunities of
parties not before them. On the other hand, the Judges are aware that
section 115 establishes a royalty due date and assigns to the Register
of Copyrights authority to develop regulations detailing payment
procedures. See 17 U.S.C. 115(c)(5). Rate terms under other sections of
the Act require licensees to pay a late fee, if warranted. The Judges
see no reason for Copyright Owners to receive late fees for ``subpart
A'' activities, but forego late fees for other licensed activities. A
late fee provision is now included in the subpart containing
regulations of general application and applies to all section 115
royalties.
E. Part 210 Regulations
The Register's rules are codified in part 210 of 37 CFR. The Judges
decline to adopt proposed changes that encroach on the settled part 210
regulations. The Judges defer to the Copyright Office for terms that
are the responsibility of and under the authority of the Register of
Copyrights.
VIII. Conclusion
The section 115 phonorecords license has a long history.
Application of the license has changed significantly as the methods of
musical works delivery have evolved.\164\ While the current market,
increasingly dominated by digital streaming, cannot be characterized as
immature, it cannot either be characterized as stable.
---------------------------------------------------------------------------
\164\ Passage of the Hatch-Goodlatte Music Modernization Act
(MMA) introduces further changes in the administration of the
section 115 license. Under the MMA, the Register and the Judges are
required to make sweeping changes to applicable regulations. Rather
than attempt to adapt the regulations the Judges adopt based on the
record before them in this proceeding, the Judges will engage in a
notice and comment rulemaking procedure to conform all affected
regulations to the provisions of the MMA.
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Determination of royalty rates and terms for the section 115
license is complex and arduous, and reasonable people can differ as to
the best approach--as evidenced by the issuance of a dissenting opinion
in this proceeding. Judge Strickler's dissent follows this majority
opinion and the regulatory terms codifying the Determination are set
out below this SUPPLEMENTARY INFORMATION section.
In this market, with the evidence before them, the Judges have
attempted to establish royalty rates and terms that compensate
songwriters and music publishers and offer to licensees appropriate
returns and incentives for continued development. The rates and terms
established in this Final Determination shall supplant existing rates
and terms effective as of January 1, 2018.
The Register of Copyrights may review the Judges' Determination for
legal error in resolving a material issue of substantive copyright law.
The Librarian shall cause the Judges' Determination, and any correction
thereto by the Register, to be published in the Federal Register no
later than the conclusion of the 60-day review period.
Suzanne M. Barnett,
Chief Copyright Royalty Judge.
Jesse M. Feder,
Copyright Royalty Judge.
Dated: November 5, 2018
DISSENTING OPINION OF COPYRIGHT ROYALTY JUDGE DAVID R. STRICKLER
I respectfully dissent from the Majority Opinion, for the reasons
set forth below.
II. The Majority Opinion Lacks an Adequate Basis in the Record
A. The Rate Structure Adopted by the Majority was not proposed during
the Proceeding.
The Majority Opinion establishes an all-in rate and rate structure
for performances and mechanical reproductions, equal to the greater of
the percent of total service revenue and Total Content Cost (TCC), as
set forth in the following table:
----------------------------------------------------------------------------------------------------------------
2018 (percent) 2019 (percent) 2020 (percent) 2021 (percent) 2022 (percent)
----------------------------------------------------------------------------------------------------------------
Percent of Revenue.............. 11.4 12.3 13.3 14.2 15.1
Percent of TCC \165\............ 22.0 23.1 24.1 25.2 26.2
----------------------------------------------------------------------------------------------------------------
See Majority Opinion, supra at 1.\166\
---------------------------------------------------------------------------
\165\ ``TCC'' is shorthand for ``Total Content Cost,'' the
cryptic industry terminology used to measure royalties paid by
interactive streaming services to music publishers for musical
works, as a percent of these services' payment to record companies
for sound recording licenses.
\166\ As this Dissent was initially written, the Majority
Opinion was not final and therefore the page citations had been left
blank. Page numbers are now included.
The Majority does not deny that this rate structure was never
proposed by any party during the proceeding. In fact, this rate
structure was only proposed after the hearing, when the record had
already been closed. More particularly, this rate structure was
proposed post-hearing by Google, Inc. (Google) in an amended rate
proposal, which Google supported in its Proposed Findings of Fact and
Conclusions of Law (GPFF). See GPFF ] 4.\167\ (However, the majority
expressly asserts that, although they selected this rate structure
after consideration of Google's post-hearing amended rate proposal,
they ``did not rely'' on Google's post-hearing proposal. Majority
Opinion at 37 n.39)
---------------------------------------------------------------------------
\167\ However, Google proposed rates that were well below the
rates adopted by the majority. See GPFF ] 4 (proposing the greater
of 10.5 percent of service revenue or 15 percent of TCC). In the
event these rates are deemed too low by the Judges (as has
occurred), Google requests that the Judges abandon this structure
and adopt instead the 2012 rate structure, because that structure
``still adhere[s] to the Sec. 801(b) factors by setting sustainable,
fair rates that would not disrupt the industry.'' Id. ] 8.
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The fact that the two prongs in this rate structure were not
combined as the only two parts of a rate structure proposed by any
party during the hearing is critical. The gravamen of this proceeding
was the issue of how to combine different proposed rate prongs (and
discard others) in order to establish a rate structure that meets the
statutory requirements that the structure be ``reasonable'' and that it
address the four itemized statutory objectives. See 17 U.S.C.
801(b)(1). The majority has selected two rates that, although parts of
[[Page 1964]]
other proposals made during the proceeding, were never combined in this
manner during the hearing. Because it is the combination of rates that
is crucial, the majority erred by plucking two rates from the record,
combining them post-hearing, and then wrongly declaring that this
``mash-up'' was actually based on the record.
Copyright Owners filed a post-hearing submission that calls these
matters to the Judges' attention, in connection with Google's identical
rate structure contained in its amended rate proposal submitted after
the record had closed.\168\ Copyright Owners' Reply to Google's
Proposed Findings of Fact and Conclusions of Law (CORPFF-Google). In
their submission, Copyright Owners correctly noted the absence of an
evidentiary record to support the combination of a percent-of-revenue
rate and a TCC rate. See CORPFF-Google at p. 2 (``Google's new proposal
is not only unsupported by any evidence, it is divorced from the
evidence in the record [and] neither Dr. Leonard [Google's expert
witness] nor any other expert opined on the new proposal, let alone
provide a basis for assessing its reasonableness.''). As a substantive
matter, Copyright Owners describe this mix-and-match rate structure as
a Frankenstein's Monster. Id. at pp. 2, 17. Using a different analogy,
they argue that this jury rigged rate structure is nothing more than an
unlitigated, post-hearing selection of one rate from ``Column A'' and
another from ``Column B.'' Id. at p. 15.
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\168\ A party is entitled to ``revise its . . . requested rate
at any time during the proceeding up to, and including, the filing
of the proposed findings of fact and conclusions of law.'' 37 CFR
351.4(b)(3). However, nothing in the regulations permits the
amendment to create a new rate structure that was not supported by
the evidence at the hearing. Otherwise, a party could subvert the
entire adversarial process by inserting a new proposal after the
record had closed.
---------------------------------------------------------------------------
Because this particular rate structure was not proffered at the
hearing, the parties had no ability to mount a challenge to it during
the proceeding. The statute and the Judges' regulations set forth in
detail how the parties must present evidence, testimony and arguments.
See 17 U.S.C. 803(b)(6); 37 CFR 351.1 through 351.15. At the hearing in
this proceeding (as in all rate proceedings), the parties submitted
detailed written testimonies, engaged in extensive direct and cross-
examination of witnesses, including expert economic witnesses, who
supported and attacked the rate proposals made a part of the record. It
must come as quite a shock when, after all that testimony, evidence and
analysis has been presented, the majority decides to ignore the
parties' rate proposals presented at the hearing and create a new
combination that no party had presented. I do not think the majority
can overcome this problem by relying on the fact that the two elements
of the majority's new rate structure appeared in different rate
proposals, because, again, the key issue in this proceeding was how to
establish a rate structure that combined various rate prongs.
This shock to the parties is not speculative, and the
inappropriateness of using an amended rate proposal to inject untested
rate structures was clearly articulated by Copyright Owners' counsel at
oral argument. As counsel explained:
[Google] decided it would be a good idea to give you something
simple. . . . I agree that they are allowed to change their
proposal, but when I talk about the inability to address all the
depth, no one has been able to analyze it. They haven't run numbers,
right? There are no forecasts for this proposal. [N]o one has been
able to test out what this proposal would do. So that's why I say it
is difficult to address it all because we weren't given an
opportunity to have our experts test out the structure.
6/7/17 Tr. 6275-76 (Copyright Owners' Closing Argument).
The majority's error in creating and adopting its own rate
structure (identical in structure to Google's post-hearing structure)
has created a real risk of economic harm that the parties were not able
to address at the hearing. As discussed below, this risk of harm
extends not only to Copyright Owners, but also to the interactive
streaming services, a fact acknowledged by Google, the proponent of
this rate structure, as explained below.
B. The Majority Opinion Causes Injury to Licensees and Licensors
1. Injury to Licensees (the Services)
The crucial aspect of the majority's rate structure, absent from
any rate proposal presented at the hearing, is the use of an uncapped
TCC prong in a greater of rate structure. Because the TCC prong will be
triggered when it is greater than the percent-of-revenue prong, the
mechanical royalty rate will be determined by reference to whatever
rate has been established by the record companies for sound recording
royalties. However, it is undisputed that the record companies, by
statutory design, have the unfettered legal ability to set their sound
recording royalty rates, allowing them to exercise their economic power
to demand rates that embody their ``complementary oligopoly'' status,
as previously described by the Judges. See Web IV, 81 FR 26316, 26333-
34 (May 2, 2016). Accordingly, whenever the record companies demand and
obtain a higher sound recording royalty rate, under the majority's rate
structure, the services' section 115 mechanical royalty rate must
increase as well.\169\
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\169\ Tying the section 115 mechanical license royalty to
another rate is analogous to what a country does when it adopts a
``currency board,'' giving up its own sovereignty over the value of
its currency by tying it to the value of another currency. Here, the
majority has relinquished its ``sovereignty'' over the setting of
rates over the five year rate term, 2018-2022.
---------------------------------------------------------------------------
Although it proposed such a structure, Google candidly identified
this exact risk arising from an uncapped TCC. Specifically, Google
acknowledged:
Having no cap on TCC . . . leaves the services exposed to the
labels' market power, and would warrant close watching if adopted .
. . .
Google PFF ] 73 (emphasis added). But obvious and crucial questions
arise: Who would do the ``watching''? When would such watching occur?
Congress directed the Judges to be the ``watchers,'' and Congress
instructed that the ``watching'' should occur only through rate
proceedings, scheduled at specified intervals. The majority has not
adequately addressed Google's candid warning as to the risk of an
uncapped TCC, to the extent it has even addressed the issue at all.
The injury to the services from the majority's uncapped TCC rate
structure is easily demonstrated. For example, as discussed infra, the
unregulated sound recording royalty rate charged to interactive
streaming now ranges from approximately [REDACTED] % TO [REDACTED] % of
total service revenue. With a TCC of 26.2% (the majority's TCC rate in
2022) the TCC prong would equal as much as [REDACTED] % (i.e.,
[REDACTED]). However, if the unregulated record companies demanded 70%
of revenue as sound recording royalty payments, the mechanical rate
would then rise to 18.34% (i.e., .70 x .262). This would be a
[REDACTED] % increase in the mechanical rate, arising from the exercise
of the absolute discretion and self-interest of the record companies.
Moreover, the total royalty cost to the service paying these royalties
would be [REDACTED] %, leaving the service with only [REDACTED] % of
revenue to fund the rest of its operations.
It is important to distinguish the TCC rate in the 2012 benchmark,
advocated in this Dissent, with the TCC rate in the Majority Opinion.
Under the 2012 benchmark, the TCC is capped in a ``lesser of'' prong,
such that, if the prong in which the TCC is set forth should be
[[Page 1965]]
triggered, it generally cannot exceed a specified per-subscriber rate,
thus placing a limit on the reliance on the effect of the record
companies' market power. See, e.g., 37 CFR 385.13(a)(2) and (3). This
has been a tradeoff the services have been willing to accept, because
they have agreed to settlements in 2008 and again in 2012 incorporating
this constrained use of TCC. However, they never accepted a complete
deferral to the sound recording rate as an uncapped measure of the
mechanical rate for all tiers of service.
The majority apparently responds to this problem of record company
influence and market power with a figurative shrug. First, the majority
concedes that Google's expressed concern is ``true,'' but irrelevant,
because the record companies could put the services out of business
with high rates at any time, even without the imposition of the TCC
prong. Majority Opinion, supra at 35 n. 75. But this point ignores the
fact that, at present, the record companies do not have to be concerned
with a reduction of their royalties because of the linking of those
royalties to the mechanical license royalties. That is new and, as
explained infra, the record companies may decide to keep their rates
high despite the increase in mechanical rates, or decide it is in their
interest to avoid a reduction in royalty revenue by creating a
completely different paradigm for streaming, by which the record
companies move the streaming service in-house and effectively destroy
the existing services. Is this speculative? Of course it is, but that
is precisely the problem. As Copyright Owners' counsel stated in
closing argument, and as Google intimated in its post-hearing filing,
the potential impact of the record companies' responses to such a rate
structure, given their market power, needed to be tested at the
hearing, which, of course, it was not.
Then, in what may reasonably be characterized as a combination of
naivet[eacute] and wishful thinking, the majority notes that the
parties simply ``must . . . trust in the rational self-interest of the
market participants.'' Id. at 36 n.75. But Congress delegated the
authority to set mechanical royalty rates to the Judges and, as noted
in both the Majority Opinion and this Dissent, the section 801(b)(1)
standards and objectives are not to be determined simply by reference
to the market, let alone by a referral to a market actor economically
adverse to the parties in this proceeding.\170\
---------------------------------------------------------------------------
\170\ It may be the case that sound recording rights and the
musical works rights should be placed on an equal regulatory (or
deregulatory) footing. However, that is the role of Congress, not
the Judges, and the Judges cannot fix the disparity in the
regulatory structure by simply ceding to the record companies the
power to set mechanical royalty rates (And even if the Judges could
accomplish this, they certainly could not do so absent a record, and
after the record had closed).
---------------------------------------------------------------------------
2. Injury to Licensors (Copyright Owners)
The Majority Opinion's rate structure would jeopardize Copyright
Owners as well, as they note in their post-hearing filing in response
to Google. In that reply, Copyright Owners take note of the new risks--
unaddressed at the hearing--that they would face under such a
structure:
--record companies could acquire the streaming services, and then
set low internal sound recording royalty rates (transfer prices)
that would amount to ``sweetheart'' deals intended to diminish the
royalties paid to Copyright Owners;
--services could start their own record companies, and then engage
in the same transfer pricing/''sweetheart'' deals that include low
sound recording royalties;
--record companies could grant sound recording licenses in exchange
for equity interests in services (short of outright acquisition) and
then agree to accept lower royalty rates than would exist in the
absence of the equity payments, thus reducing mechanical license
royalties.
CORPFF-Google at pp. 2-3, 24, 40, 44.
Also of great importance to Copyright Owners, a rate structure
limited to a percent of revenue or a TCC rate does nothing to protect
Copyright Owners from the potential displacement, deferment, bundling
or attribution indeterminacy of a revenue-based structure. That is,
even a TCC prong is a revenue-based prong, but under that prong the
task of calculating ``revenue'' is delegated to the record companies,
over whom the Judges have no control.
Google claims that its proposed structure (and, by extension, the
majority's structure) does protect against the problems that can arise
under a revenue-based royalty. GPFF ]] 67, 72 (``Because record labels
will always protect their own interest, this prong ensures that,
through that process, they also protect the interest of Copyright
Owners . . . . Today, Copyright Owners still recognize the virtue of
the TCC structure in protecting their interest . . . .'').
However, Copyright Owners rightly note that they obtain no legal
protection under such a TCC prong. In making this argument regarding
displacement and deferral of revenue, Copyright Owners lay out
comprehensively all the problems inherent in an uncapped TC prong set
in a greater of rate structure, such as adopted in the majority
opinion:
The notion that Google's TCC prong will provide protection from
revenue gaming, deferral and displacement, and other revenue prong
problems is unsupported and speculative. Relying on just the TCC to
solve those admitted problems leaves the Copyright Owners'
protection from such problems entirely outside the statute . . . .
[REDACTED] are what protects the Copyright Owners from price-
slashing by the services. What is left unanswered . . . is . . . how
can it be reasonable to ask the Judges to set a rate that does not
itself provide for a fair return . . . but simply puts the Copyright
Owners' fair return in the hands of the labels to negotiate terms
that will adequately protect the publishers and songwriters as well?
The labels do not have a mandate to ensure that the Services provide
a fair return to the Copyright Owners, and cannot be directed to
ensure such. Indeed, labels may not have the same incentives as
songwriters and publishers to negotiate such protections in their
deals. To wit, a label could make an agreement with a service that
includes only a revenue prong in exchange for equity or some other
consideration that it may never include in the applicable revenue
subject to the TCC. . . . [W]hat if Google purchased one or more
record labels and did not have to pay any label royalties? Or what
if Spotify chose to avail itself of the compulsory license to create
its own master recordings embodying musical works--which it is
already doing [COPFF ] 396]--and chose to compensate itself for its
use of the master recordings on a sweetheart basis (or not at all)?
Or what if one or more labels decided to enter the interactive
streaming market and did not have to pay themselves royalties? In
each case, the Copyright Owners' protection--the protection that the
Services admit the Copyright Owners need and is provided by the
TCC--would be gone.
CORPFF-Google at 39-41 (emphasis in original).
I cannot improve upon Copyright Owners' statement of the problems
they face from an uncapped TCC rate prong in a greater of structure.
The majority however dismisses this argument, stating (as noted
supra) that they do not rely on ``Google's revised rate proposal.''
Majority Opinion at 37 n.39. However, that response misses the point:
Google's argument is the same as the majority's argument with regard to
rate structure. Because one is deficient as a consequence of not having
been not presented and tested at the hearing--failing to afford the
parties the ability to cross-examine witnesses and present a rebuttal
case--then the other is deficient as well.
C. The Majority Misunderstands the Record
The majority pins its novel rate structure not on any party's
proposals, but rather on the direct mechanical license agreements
entered into [REDACTED] and a single license entered into by a non-
participant and
[[Page 1966]]
peripheral licensee, Microsoft.\171\ See Majority Opinion, supra, at
34. However, the majority recognizes that many other interactive
streaming agreements with music publishers contain different rate
structures, including the rate structure consistent with the 2012
benchmark. Id.
---------------------------------------------------------------------------
\171\ There is no record evidence that Microsoft continues to
operate an interactive streaming service.
---------------------------------------------------------------------------
But the majority's rationale for relying on the [REDACTED] (and
Microsoft) agreements to support its rate structure is bewildering. The
majority, relying on the testimony of Dr. Leonard, writes that the
``marketplace supports a number of rate structures and that no single
structure or element of a structure is indispensable.'' Id. at 34. The
majority's reliance on this point is bewildering because it (rightly)
praises a market with multiple rate structures as support for its
adoption of a single rate structure. This makes no sense.
Moreover, the ``marketplace'' of which the majority speaks so
approvingly is not an unregulated market. Rather, it is a
``marketplace'' that has flourished for a decade, as discussed infra in
this Dissent, while the 2012 benchmark (and its fundamentally identical
economic antecedent, the 2008 rate structure) were in place. It is this
regulated ``marketplace,'' with its multi-tiered rate structure, that
has enabled creation of the multiplicity of rates that the majority
lauds. Unwittingly the majority has adopted the perverse notion that
``no good deed goes unpunished,'' by relying on the benefits of the
2012 benchmark as a basis to eliminate it! Perhaps the more appropriate
adage to follow should be: ``If it ain't broke, don't fix it.'' \172\
---------------------------------------------------------------------------
\172\ I note that Google's economic expert, Dr. Leonard, did not
testify in support of the rate structure for which the majority and
Google have advocated for the first time post-hearing. In fact, he
opined that the 2012 rate structure (without the Mechanical Floor)
was the best rate structure for the 2018-2022 rate period.
---------------------------------------------------------------------------
D. The Majority Makes the Heroic Assumption that the Major Record
Companies will Docilely Accept Millions of Dollars in Lost Revenue, by
Agreeing to Accept Lower Sound Recording Royalties
The majority is sanguine as to the impact of the uncapped TCC prong
rate in its proposed rate structure, because it has confidence that the
major record companies will recognize that they have no choice but to
decrease their royalty rates and reduce their revenues by millions of
dollars, in order to subsidize the section 115 royalty rate increases
adopted in the Majority Opinion. The complacency of the majority is
based on the application of the Shapley value approaches modeled by
experts for the services and for Copyright Owners.
To summarize,\173\ the Shapley models estimate a ``surplus'' of
revenue from downstream revenues, after all the non-content costs of
the market participants are recovered, that is available to be
distributed among the services and the input providers, i.e., the
record companies (who provide the sound recordings) and the music
publishers (who provide the music works). The division of that surplus
is determined by an algorithm that measures and averages the value of
each party's contribution to the creation of the surplus, over all
possible arrival sequences in the marketplace.
---------------------------------------------------------------------------
\173\ The Shapley value approach is described in more detail,
infra.
---------------------------------------------------------------------------
As the majority correctly notes, the parties' Shapley value models
all predict that the ratio of sound recording royalties to musical
works royalties should decrease from current levels. However, the
majority is merely assuming that the sound recording rates will adjust
downward. They base their assumption on the testimony of Professor
Watt, who identified what another economic witness (Professor Katz, for
Pandora) described as the ``see-saw'' effect. Simply put, this effect
arises from the assumption that the interactive streaming services must
be permitted to retain enough revenue to survive,\174\ but, beyond
that, the suppliers of the two ``must have'' inputs can negotiate in a
free market to share equally the remainder of the surplus generated by
downstream revenue. (They receive different percentages of total
revenue because, although their share of the Shapley surplus is equal,
they have different non-content costs).\175\
---------------------------------------------------------------------------
\174\ I will return to this crucial assumption presently.
\175\ Another Shapley value expert for Copyright Owners,
Professor Gans, does not concede that the ``see-saw'' effect will
occur. Rather, he testified that the services might simply raise
downstream prices or pay the higher royalties out of higher profits
(which to date do not exist). Gans WRT ] 32. This opinion only
underscores the tenuous nature of the see-saw hypothesis.
---------------------------------------------------------------------------
In this see-saw paradigm, the present ratio of sound recording:
musical works royalties is too high at present, according to the
Shapley valuations, because the mechanical royalty has been set under
section 115 at too low a rate, allowing the record companies to
appropriate the remainder of the surplus, i.e., more than the
percentage suggested by the Shapley approach. According to the majority
and the Shapley experts, applying the Shapley values would eliminate
this regulatory effect and, the ratio of sound recording royalties to
musical works royalties theoretically then should fall, with the fall
in the ratio arising from a significant reduction in sound recording
royalties and an increase in musical works rates.
But theory must meet reality. As I note in greater detail infra in
connection with my own analysis of the Shapley approach, no witness
could state whether this see-saw effect would occur, and there were no
witnesses from the record companies who testified that the record
companies would impotently acquiesce to a significant loss in royalties
to accommodate the diversion of a huge economic surplus away from them
and to the Copyright Owners.\176\
---------------------------------------------------------------------------
\176\ The record companies would have to accept substantial
losses in royalty income. According to the RIAA, interactive
streaming revenues for 2015 totaled $1.604 billion. See Marx WDT ]
153 & App. B.1.b (citing RIAA figures). The extent of this assumed
loss by record companies, absent any evidence, makes the assumption
of the see-saw effect completely unreasonable.
---------------------------------------------------------------------------
I am unwilling to adopt the hypothetically plausible idea of a see-
saw effect impacting the division of this surplus, when there is simply
no evidence that such an adjustment would occur. Given the $1.604
billion in interactive streaming revenue reported by RIAA, I cannot
merely assume that the record companies would acquiesce to a
substantial reduction in royalty revenue, rather than seek some other
market structure in which to protect this revenue, such as, for
example, resurrecting the idea of establishing or otherwise integrating
their own streaming services. The Services' experts, and Apple's
expert, testified that any purported see-saw effect was indeterminate
with regard to its impact on the interactive streaming services. See 4/
5/17 Tr. 4944-45 (Katz) (acknowledging the possibility that a
mechanical royalty rate increase would affect sound recording royalties
in the future but not immediately, and that there is no reliable
estimate of the size of any such adjustment); 4/7/17 Tr. 5515-
5516(Marx) ((stating that there would ``[m]aybe [there would] be some
adjustment on the sound recording side . . . . [H]ow those negotiations
play out, I think it's complicated and hard to guess''); 4/5/17 Tr.
5704-05 (Ghose) (``[I]t's quite likely that the streaming service will
want to maintain their royalties and their revenues at the current
levels. And so, you know, to me it seems like an extreme statement that
the entire increase in publisher profits will come at the expense of
the streaming services.''). And, to repeat, Copyright Owners own
Shapley value expert, Professor Gans, suggests that the
[[Page 1967]]
burden will fall on the services, not the record companies.
To convince itself of the unlikelihood of such results, the
majority notes that, as a matter of economic theory, given the present
interactive streaming market structure, the record companies already
have the economic power to put streaming services out of business,
because the market in which record companies and interactive streaming
services negotiate is unregulated. Indeed, the record companies'
strategy has been to `[REDACTED].'' Web IV, supra, at 63 (restricted
version).
But the static nature of this assumption is not reasonable in this
context. It may be reasonable to assume, given the royalty revenue
allocations now present in the interactive streaming market, that the
record companies would continue to find it in their self-interest to
maintain the existence of interactive streaming services. However, if
mechanical royalty rates were to increase significantly, there is no
evidence in the record in this proceeding that indicates whether the
record companies would decide to maintain the current vertical
structure of the market and docilely accept such a revenue loss. For
example, they could create their own streaming services (perhaps
learning the lessons from the failed Pressplay and MusicNet attempts of
the past). Or, they could adopt what Professor Gans suggests, maintain
the sound recording royalty rates, thereby hastening a more immediate
exit of streaming services from the market, or reduce their potential
for success, making them ripe for acquisition by record companies at
distress prices.\177\
---------------------------------------------------------------------------
\177\ The majority dismisses the risk of the destruction of the
present market structure as not the type of disruption that the
Judges may consider. Majority Opinion at 74 n.137. However, the
majority finds that it must implement its 44% rate increase
incrementally over five years, because a more sudden implementation
would be disruptive under the statutory standard. It seems apparent
that establishing a rate structure that cedes control to the record
companies who can increase the mechanical rate at will is at least
as disruptive to the industry. Moreover, the disruption is not
merely to one business, but rather to every service and every
service business model now in operation. (Recall that even Google,
who claims to support this rate structure, acknowledges that the
services are subject to abuse from the record companies' market
power, and Google puzzlingly calls on ``someone'' to ``watch'' the
situation.) Moreover, as Copyright Owners point out, as discussed
supra, even they face significant risk from this structure. Indeed,
this rate structure is an ``equal opportunity disrupter.''
---------------------------------------------------------------------------
In any event, from an evidentiary perspective, there is no reason
why the Judges should either indulge in or dismiss such speculation.
There is absolutely no evidence that such a significant shift in
royalty distribution would occur, nor is there sufficient evidence as
to the potential consequences of such a draconian reallocation of
revenue. Accordingly, I cannot agree with a rate structure that
implicitly depends on the voluntary reduction in royalty income of by
an unregulated input provider to whom the majority has ceded control
over the statutory rates.
E. The Majority Denigrates the Parties' Ten- Year Rate Structure as a
``Rube- Goldberg-esque'' Device.
The majority disparages the parties' ten year rate structure,
spanning two settlements, as ``Rube-Goldberg-esque.'' Moreover, the
majority characterizes the existing structure as ``impenetrable.'' That
is a remarkable statement, given that the parties have operated under
the structure for a decade--clearly they know how to penetrate the
language and understand its meaning. It may be true, as discussed in
more detail infra, that some songwriters and others may find the
calculation of their royalties to be difficult to understand. However,
the creative artists can utilize the services of their agents--the NMPA
and others--to answer any questions that may arise. It seems close to
hubris for any jurist to dismiss a decade-long voluntary rate
structure, one that the parties have extended by agreement, as
``impenetrable,'' merely because the jurist finds the structure too
difficult to understand.
The majority also indicates that it has the power to make certain
that the regulations it adopts are sufficiently simple and
understandable. Such a common sense point cannot be disputed, but it is
misapplied here. Again, the proof of the pudding is in the eating, so
to speak; the parties have operated under the existing rate structure
for a prolonged period, belying any concern that the Judges should
adopt regulations that are simpler, and reject those that are more
complicated. Moreover, as noted infra (in response to the same
``complexity'' argument made by Copyright Owners), the issue of
regulatory complexity is not a factor or objective in the rate-setting
process under section 801(b)(1). Thus, if the 2012 rate structure
otherwise is best suited to effectuate the statutory objectives as
compared with the other alternatives, there is no basis for the
complexity of the structure to override the specific application of the
express statutory factors.
III. The Majority Opinion is Legally Erroneous
A. The Majority has not ``Determined'' Statutory Rates
Pursuant to 17 U.S.C. 801(b)(1), the Judges have the duty to make a
determination'' of rates that are ``reasonable'' and that are
calculated to achieve four itemized sets of objectives. The majority's
two-pronged rate proposal fails to discharge this duty. Rather, the
majority has adopted a rate structure that is indeterminate, allowing
the record companies, especially the major record companies with ``must
have'' repertoires, to set the mechanical rates that are paid under
section 115.
Merely setting the ratio between sound recording royalty rates and
mechanical royalty rates is not the same as actually making a
``determination'' setting the rates. As noted in Section I, supra,
pegging the regulated mechanical royalty rate to the unregulated sound
recording royalty rate through the ``greater of'' uncapped TCC prong
leaves the statutory mechanical rate indeterminate. Nothing in section
801(b)(1) permits the setting of an indeterminate rate that becomes
determined only when an unregulated private party sets its own
rates.\178\
---------------------------------------------------------------------------
\178\ This point needs to be distinguished from the case where
the parties voluntarily agree to recognize the perfect
complementarity between inputs, such as in the ``All-In'' context,
and deduct the cost of the perfectly complementary performance right
when calculating the mechanical license. In the ``All-In'' case, the
parties' prior agreement is part and parcel of the useful 2012
benchmark adopted in this Dissent, and the licensors are essentially
the same underlying entities.
---------------------------------------------------------------------------
B. The Majority Decision Unlawfully Delegates to Private Entities,
Unrepresented in this Proceeding (the Record Companies), the Ability to
Set the Section 115 Royalty Rates
The majority's adoption of an uncapped TC C prong in a greater of
structure constitutes an improper delegation of a statutory duty to the
record companies, who are private entities. However, the majority has
not cited any authority supporting such a private delegation, nor has
it suggested that its uncapped TCC presents an issue regarding the
delegation of duties.
The Supreme Court and the D.C. Circuit have established a ``private
nondelegation doctrine,'' which prohibits the delegation of statutory
duties to private entities. Carter v. Carter Coal Co., 298 U.S. 238
(1936); Ass'n of Am. R.R.s v. U.S. Dep't of Transp., 721 F.3d 666, 675
(D.C. Cir. 2013), vacated and remanded sub nom. Dep't of Transp. v.
Ass'n of Am. R.Rs.,
[[Page 1968]]
135 S.Ct. (2015) (Railroad v. DOT). In Railroad v. DOT, the D.C.
Circuit struck down a statute that explicitly delegated regulatory
authority to Amtrak, allegedly a private entity, to develop standards
to evaluate passenger service quality. Id. at 673-677. The Association
of American Railroads had challenged the delegation of authority to
Amtrak, claiming it was a private entity and that the holding in Carter
Coal precluded the delegation of such authority to a private entity.
The D.C. Circuit agreed that this express grant of authority by
Congress to a private entity was unconstitutional under the private
nondelegation doctrine. Id.\179\
---------------------------------------------------------------------------
\179\ The Supreme Court vacated and remanded the case, after
granting certiorari, holding that Amtrak was not in fact a private
entity.
---------------------------------------------------------------------------
If Congress cannot expressly delegate statutory and regulatory
power to a private entity, then, a fortiori, a subordinate
administrative agency, the Copyright Royalty Board, cannot (or at least
should not) be able to implicitly delegate statutory and regulatory
authority to private entities. Yet in this case, the majority has
implicitly made such a subdelegation, yoking the mechanical royalty
rates paid by interactive streaming services to the rates set by record
companies, an unregulated sector of the music industry. Thus as
explained supra, the level of rates can rise at the unfettered
discretion of the record companies, to the detriment of the streaming
services, and the measurement of royalties can lead to the diminution
of the royalty base, to the injury of Copyright Owners, through the
record companies' unbound right to define ``revenue'' and to
compartmentalize consideration (e.g., through equity instead of
royalties).\180\
---------------------------------------------------------------------------
\180\ The majority's concern for ``transparency,'' expressed as
a criticism of the parties' workable ten year rate structure,
disappears in connection with it delegation of rate-setting to the
record companies. The definition of revenue, the handling of bundled
products and the exclusion of certain consideration from royalties
will remain opaque to the Judges and to Copyright Owners.
---------------------------------------------------------------------------
Not only does the private delegation of section 115 rate-setting
authority via the pegging of that rate to the unregulated sound
recording royalty rate appear to violate the private non- delegation
doctrine, it also appears to be inconsistent with the Judges' expansive
powers under Chevron U.S.A. Inc. v. Nat'l Resources Defense Council,
467 U.S. 837 (1984). Under the Chevron doctrine, courts defer to
administrative agencies for three broad reasons: First, the agencies
are presumed to have technical expertise. Second, as arms of the
government, they are politically accountable. Third, an express
delegation of authority by Congress to a public agency is an expression
of legislative intent as to how a statute should be applied. See K.
Brown, Public Law and Private Lawmakers, 93 Wash. U. L. Rev. 616, 655-
57 (2016).
However, when an agency in turn delegates its powers to private
entities, such as the record companies, these rationales disappear.
With regard to the first rationale, technical expertise, the record
companies certainly have expertise in the area of music royalty rate-
setting. However, that expertise is married to an intention--indeed, a
fiduciary obligation--that they seek to maximize their own profit, even
if that maximization ``conflict[s] with the legislative mandates of
Congress,'' such as the standards set forth in section 801(b)(1). See
id. at 655. As for the second rationale, private entities, such as the
record companies in this context, ``are not beholden to the democratic
process,'' and the public therefore ``has no legal mechanism'' to hold
them accountable. Thus, the second Chevron rationale is inapplicable.
See id. at 657. Finally, with regard to the third basis for Chevron
deference, legislative intent, private entities do not have the
interest in filling in the interstices of ambiguous statutory authority
by ascertaining the public interest. See id. at 658. Indeed, as
corporations, their duty is to their shareholders, which, to state the
obvious, is not the same as the public interest expressed in section
801(b)(1).
In the present case, the private delegation is even more
problematic. The record companies to whom implicit rate-setting
authority has been delegated are not in any sense neutral. In relation
to the interactive streaming services, the record companies are
licensors, seeking payment from the interactive streaming services. In
relation to Copyright Owners, they are competitors for royalty revenue,
in the sense that both the record companies and music publishers are
input providers who compete for the downstream revenue generated by the
interactive streaming services. It is hard to imagine that the Majority
Opinion would (or should) be afforded Chevron deference, when the
structure it creates smacks too much of the fox guarding not one but
two henhouses.
Of course, a full evaluation of these legal issues, by the parties
and the Judges, was skirted, because no party proposed during the
hearing a rate structure with an uncapped TCC. If this structure had
been proposed, the parties would most certainly have fully briefed the
issue in their proposed Conclusions of Law and Reply Proposed
Conclusions of Law. Alas, they were not given that opportunity, and the
majority has acted without the aid of the parties' input.
There is a better approach. As set forth in full infra, I have
presented an Alternative Dissenting Determination.
ALTERNATE DISSENTING DETERMINATION
IV. INTRODUCTION
The Copyright Royalty Judges (Judges) commenced the captioned
proceeding to set royalty rates and terms to license the copyrights of
songwriters and publishers in musical works made and distributed as
physical phonorecords, digital downloads, and on-demand digital streams
during the rate period January 1, 2018, through December 31, 2022. See
81 FR 255 (Jan. 5, 2016).
Below, I set forth my alternative analysis, rate structure and
rates, in the form of a comprehensive alternative determination.
V. ALTERNATIVE DETERMINATION OF RATE STRUCTURE AND RATES
In this alternative determination, I would establish the section
115 royalty rate structure, and rates, for the period 2018 through
2022, by adopting the 2012 settlement as the appropriate benchmark,
thereby maintaining the same structure and rates as now exist under the
current regulations. My decision in this regard is based on a
comparative analysis of that benchmark and other benchmarks, and a
consideration of other record evidence submitted by the parties, as
fully set forth herein.
Additionally, had the record evidence not included the 2012 rate
structure and rates as a designated benchmark, I nonetheless would have
established for the 2018-2022 period the same rate structure and rates
as now exist, pursuant to the Judges' authority to adopt the existing
rates and rate structure when they find that those prevailing
provisions better satisfy the statutory standards than any other
proposed structures and rates properly discernible from the record
evidence. Music Choice v. Copyright Royalty Bd., 774 F.3d 1000, 1009
(D.C. Cir. 2014).
A. Background
1. Statute and Regulations
The Copyright Act (Act) establishes a compulsory license for use of
musical works in the making and distribution of phonorecords. 17 U.S.C.
115. Phonorecords licenses now include physical and digital sound
recordings embodying the protected musical works as well as digital
sound recordings that may be streamed on demand by a listener.
The Section 115 compulsory license, created in 1909, reflected
Congress's
[[Page 1969]]
attempt to balance the exclusive rights of owners of copyrighted
musical works with the public's interest in accessing protected works.
In 1897, Congress extended copyright protection for the benefit of
rightsholders to the performance of their musical compositions. Act of
Jan. 6, 1897, 54th Cong., 2d Sess. Ch. 4, 29 Stat. 481 (1897). However,
at the dawn of the 20th century, the standardization and
commercialization of a prior technological advance roiled the musical
works markets. That period saw the expansion of the manufacture and
sale of piano rolls--a system of perforated notations that could be
used in conjunction with ``player pianos''--to play music
automatically.
The copyright implications of this commercial advancement were
adjudicated in a 1908 Supreme Court decision, White-Smith Music
Publishing Co. v. Apollo Co., 209 U.S. 1 (1908). That decision held
that piano rolls did not embody a system of notation that could be read
and therefore were not ``copies'' of musical works within the meaning
of the existing copyright laws, but rather were merely parts of devices
for mechanically performing the music. Id. at 17. Thus, the owners of
otherwise copyright-protected musical works lacked such protection vis-
[agrave]-vis piano rolls.
In reaction to that decision, Congress expanded the rights of
musical works copyright owners to include the right to make
``mechanical'' reproductions, such as piano rolls, that embody musical
works. However, Congress made that right subject to a compulsory
license because of concern about monopolistic control of the piano roll
market by the makers of piano rolls (and another burgeoning invention,
phonorecords). 17 U.S.C. 1 (1909); see also H.R. Rep. No. 60-2222, at 9
(1909).\181\ Specifically, under the 1909 legislation, upon payment of
a royalty rate of 2[cent] per ``mechanical,'' any person was permitted
to manufacture and distribute a reproduction of a musical work.
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\181\ Because of this history, and the fading importance of
mechanical piano rolls, this license is often referred to as the
``phonorecords'' license, but still also remains identified,
synonymously, as the ``mechanical'' license. In point of fact, vinyl
records, CDs, tapes and any other physical reproductions would still
constitute ``mechanical'' reproductions.
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Congress revised the mechanical license in its broader 1976
revision of the copyright laws. Among the various changes relating to
the phonorecords license, Congress directed licensees to provide
copyright owners with a pre-use written ``notice of intention,'' in
order to obtain the Section 115 license. The 1976 revisions to the
Copyright Act retained the then extant royalty fee of 2.75[cent] per
phonorecord (or 0.5[cent] per minute of playing time or fraction
thereof, whichever amount was larger). However, the 1976 revision also
created a new entity, the Copyright Royalty Tribunal (CRT), to conduct
periodic proceedings to adjust the rate.\182\
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\182\ See H.R. Rep. No. 94-1476 at 111 (1976); 17 U.S.C. chapter
8 (1978). In 1993, Congress abolished the CRT and replaced it with
copyright arbitration royalty panels (CARPs). Copyright Royalty
Tribunal Reform Act of 1993, Public Law No. 103-198, 107 Stat. 2304.
In turn, Congress abolished the CARP system and replaced it with
proceedings before the Copyright Royalty Judges. Copyright Royalty
and Distribution Reform Act of 2004, Public Law No. 108-419, 118
Stat. 2341.
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In 1995, Congress passed the Digital Performance Right in Sound
Recordings Act (DPRA), Public Law No. 104-39, 109 Stat. 336, extending
the mechanical license to ``digital phonorecord deliveries'' (DPDs)
(emphasis added), which the statute defines as each individual delivery
of a phonorecord by digital transmission of a sound recording which
results in a specifically identifiable reproduction by or for any
transmission recipient of a phonorecord of that sound recording,
regardless of whether the digital transmission is also a public
performance of the sound recording or any nondramatic musical work
embodied therein. 17 U.S.C. 115(d). Accordingly, the license now covers
DPDs, in addition to physical copies, such as compact discs (CDs),
vinyl records and cassette tapes.
A proceeding to determine reasonable royalty rates and terms for
the section 115 mechanical license is commenced by the Judges on the
schedule provided by 17 U.S.C. 803(b)(1)(A)(i)(V). Although a contested
hearing may ultimately be necessary, the Act strongly encourages
negotiated settlements among interested parties. See 17 U.S.C.
115(c)(3)(E)(i) (``License agreements voluntarily negotiated at any
time between one or more copyright owners . . . and one or more persons
entitled to obtain a compulsory license . . . shall be given effect in
lieu of any determination . . . .''); 17 U.S.C. 803(b)(3) (requiring a
``Voluntary Negotiation Period''); 17 U.S.C. 803(b)(6)(C)(x) (requiring
a settlement conference prior to a hearing).
As currently configured, the applicable regulations are divided
into three subparts. Subpart A regulations govern licenses for
reproductions of musical works (1) in physical form (vinyl albums,
compact discs, and other physical recordings), (2) in digital form when
the consumer purchases a permanent digital copy (download) of the
phonorecord, and (3) inclusion of a musical work in a purchased
telephone ringtone. Subpart B regulations govern licenses for
interactive streaming and limited downloads. Subpart C regulations
govern limited offerings, mixed bundles, music bundles, paid locker
services, and purchased content locker services.
2. Prior Proceedings
In 1980, the CRT conducted the first contested proceeding to set
rates for the Section 115 compulsory license. The CRT increased the
then-existing rate by more than 45%, from 2.75[cent] rate per
phonorecord to 4[cent] per phonorecord. 45 FR 63 (Jan. 2, 1980).\183\
By 1986, the CRT had increased the mechanical rate to the greater of
5[cent] per musical work or .95[cent] per minute of playing time or
fraction thereof. 46 FR 66267 (Dec. 23, 1981); see also 37 CFR
255.3(a)-(c). The next adjustment of the Section 115 rates was
scheduled to begin in 1987. However, the parties entered into a
settlement that the CRT adopted, setting the rate at 5.25[cent] per
track beginning on January 1, 1988, and established a schedule of rate
increases generally based on positive limited percentage changes in the
Consumer Price Index every two years over the next 10 years. See 52 FR
22637 (June 15, 1987). The rate increased until 1996, when the rate was
set at the greater of 6.95[cent] per track or 1.3[cent] per minute of
playing time or fraction thereof. See 37 CFR 255.3(d)-(h).
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\183\ The United States Court of Appeals for the District of
Columbia Circuit affirmed the CRT. Recording Industry Ass'n. of
America v. Copyright Royalty Tribunal, 662 F.2d 1 (D.C. Cir. 1981)
(1981 Phonorecords Appeal) (remanded on other grounds).
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The rates set by the CRT pursuant to the 1987 settlement were set
to expire on December 31, 1997. The Librarian of Congress announced a
negotiation period for owners and users of the section 115 license in
late 1996, during which the parties reached a settlement regarding
rates for a ten-year period to end in 2008.\184\ Under the settlement,
(ultimately adopted by the Librarian), the rate for physical
phonorecords was set at 7.1[cent] per track beginning on January 1,
1998, and a schedule was established for fixed rate increases every two
years over the next 10-year period with the rate beginning on January
1, 2006, being the larger of 9.1[cent] per track or 1.75[cent] per
minute of playing time or fraction thereof. See 37 CFR 255.3(i)-(m);
see also 63 FR 7288 (Feb. 13, 1998).
[[Page 1970]]
The rates adopted for DPDs for the 10-year period were the same as
those set for physical phonorecords, and the rates for incidental DPDs
were deferred until the next scheduled rate proceeding. See 37 CFR
255.5, 255.6; see also 64 FR 6221 (Feb. 9, 1999).
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\184\ The Librarian initiated the 1976 proceeding during the
period after the termination of the CRT and the inception of the
CRB, a time during which controversies regarding royalty rates and
terms were referred to privately retained arbitrators under the CARP
program,
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In 2006, with expiration of the previous settlement term nearing,
the Judges commenced a proceeding to adjust the mechanical rates under
section 115. On January 26, 2009, they issued a Determination,
effective March 1, 2009. In that Determination, the Judges noted that
the parties had settled their dispute regarding rates and terms for
conditional downloads, interactive streaming and incidental digital
phonorecord deliveries (i.e., rates in the new subpart B). Mechanical
and Digital Phonorecord Delivery Rate Determination, 74 FR 4510, 4514
(Jan. 26, 2009) (Phonorecords I). The parties who negotiated the
settlement included the NMPA and DiMA, the trade association
representing its member streaming services. Testimony of Rishi
Mirchandani, Trial Ex. 1, ] 59 (Mirchandani WDT).
With regard to the subpart A rates, the Judges in Phonorecords I
rejected the parties' proffered benchmark evidence, and instead adopted
the existing rates and rate structure, holding as follows:
Based on the evidence before us, we conclude that no single
benchmark offered in evidence is wholly satisfactory with respect to
all of the products for which we must set rates. . . . [W]e are not
persuaded that the . . . existing rate . . . now in effect for
nearly three years is . . . inappropriate.
Phonorecords I at 4522 (emphasis added).
Thus, in the first (and only) litigated section 115 proceeding
before the Judges, they adopted the existing rates and structure for
the subsequent rate period, rather than rates and a structure that were
proposed by the parties, because the Judges were concerned that the
parties' proposals would not be appropriate for all of the products at
issue.\185\
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\185\ That is, the Judges in Phonorecords I recognized that the
existing rate structure and rates were sufficient to cover all
products at issue, a result that this Dissent likewise would
accomplish. But, a fortiori, in the present case this result is also
backed by an evidentiary record supporting the continuation of the
existing structure and rates, because the present regulatory
structure has been presented by the Services as a benchmark, rather
than as a default position.
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In 2013, the Judges adopted a settlement that carried forward the
existing rates and added a new subpart, subpart C, which, as noted
supra, covers several newly regulated categories--``limited offerings,
mixed service bundles, music bundles, paid locker services and
purchased content locker services.'' Adjustment of Determination of
Compulsory License Rates for Mechanical and Digital Phonorecords, 78 FR
67938 (Nov. 13, 2013) (Phonorecords II). Once again, the settling
parties included the trade associations for the licensors and
licensees, NMPA and DiMA, respectively. Mirchandani WDT ] 59.
The present section 115 proceeding thus is the third since the
Judges were given jurisdiction under the Copyright Royalty and
Distribution Reform Act of 2004.\186\ In the Phonorecords II
settlement, the parties agreed that any future rate determination for
subparts B and C configurations presented to the Judges would be a de
novo rate determination. See 37 CFR 385.17, 385.26 (2016). However,
they did not agree that the existing rate structure or rates could not
be considered as the bases for future rate determinations.\187\
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\186\ Pub. L. No. 108-419, 118 Stat. 2341.
\187\ The Phonorecords I settlement agreement contained a clause
stating that ``[s]uch royalty rates shall not be cited, relied upon,
or proffered as evidence or otherwise used in the Proceeding,''
where ``the Proceeding'' was a defined term meaning Phonorecords I.
Trial Ex. 6013, Phonorecords I Agreement at Sec. 3. By contrast, the
Phonorecords II settlement agreement did not contain such a clause
that would preclude reliance on the evidentiary value of the
Phonorecords II royalty rates. See Trial Ex. 6014, Phonorecords II
Agreement at Sec. 5.5 (including a full-integration clause of the
Phonorecords II wrapper agreement). I find this distinction
important, because it demonstrates that the parties to the 2012
settlement understood the evidentiary value of the Phonorecords II
settlement in the next section 115 proceeding, i.e., this
proceeding.
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B. The Present Proceeding
In response to the Judges' notice regarding the present proceeding,
21 entities filed Petitions to Participate.\188\ The participants
engaged in negotiations and discovery. On June 15, 2016, some of the
participants \189\ notified the Judges of a partial settlement with
regard to rates and terms for physical phonorecords, permanent digital
downloads, and ringtones--the services covered by the extant
regulations found in subpart A of part 385. The Judges published notice
of the partial settlement \190\ and accepted and considered comments
from interested parties.\191\
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\188\ Initial Participants were: Amazon Digital Services, LLC
(Amazon); Apple, Inc. (Apple); Broadcast Music, Inc. (BMI); American
Society of Composers, Authors and Publishers (ASCAP); David Powell;
Deezer S.A. (Deezer); Digital Media Association (DiMA); Gear
Publishing Company (Gear); George Johnson d/b/a/GEO Music Group
(GEO); Google, Inc. (Google); Music Reports, Inc. (MRI); Pandora
Media, Inc. (Pandora); Recording Industry Association of America,
Inc. (RIAA); Rhapsody International Inc.; SoundCloud Limited;
Spotify USA Inc.; ``Copyright Owners'' comprised of National Music
Publishers Association (NMPA), The Harry Fox Agency (HFA), Nashville
Songwriters Association International (NSAI), Church Music
Publishers Association (CMPA), Songwriters of North America (SONA),
Omnifone Group Limited; and publishers filing jointly, Universal
Music Group (UMG), Sony Music Entertainment (SME), Warner Music
Group (WMG).
\189\ The settling parties were: NMPA, NSAI, HFA, UMG, and WMG.
As part of the settlement agreement, UMG and WMG withdrew from
further participation in this proceeding.
\190\ See 81 FR 48371 (Jul. 25, 2016).
\191\ Three parties filed comments. American Association of
Independent Music (A2IM), Sony Music Entertainment (Sony), and
George Johnson dba GEO Music Group (GEO). A2IM urged adoption of the
settlement and Sony approved of all but one provision of the
settlement. GEO objected to the settlement.
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On October 28, 2016, NMPA, Nashville Songwriters Association
International (NSAI), and Sony Music Entertainment (SME) filed a Motion
to Adopt Settlement Industry-Wide. The motion asserted that SME, NMPA,
and NSAI had resolved the issue raised by SME in response to the
original notice. The Judges evaluated the remaining objection to the
settlement filed by George Johnson dba GEO Music Group (GEO) and found
that GEO had not established that the settlement agreement ``does not
provide a reasonable basis for setting statutory rates and terms.'' See
17 U.S.C. 801(b)(7)(A)(iii). As a part of the second settlement, Sony
withdrew from this proceeding. The Judges published the agreed subpart
A regulations as a Final Rule on March 28, 2017.\192\
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\192\ See 82 FR 15297 (Mar. 28, 2017).
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During the course of the proceeding, the Judges dismissed some
participants and other participants withdrew. Remaining participants at
the time of the hearing were NMPA and NSAI, representing songwriters
and publisher copyright owners (collectively Copyright Owners), and
GEO, the pro se songwriter/copyright owner. Licensees of the copyrights
appearing at the hearing were Amazon Digital Services, LLC (Amazon),
Apple Inc. (Apple), Google, Inc. (Google), Pandora Media, Inc.
(Pandora), and Spotify USA Inc. (Spotify) (collectively referred to as
the Services).
Beginning on March 8, 2017, the Judges conducted a twenty-one day
hearing that concluded on April 13, 2017. During the course of the
hearing, the Judges heard oral testimony from 37 witnesses,\193\ and
admitted over 1,100 exhibits. The participants submitted
[[Page 1971]]
Proposed Findings of Fact (PFF) and Proposed Conclusions of Law (PCL)
on May 12, 2017, and Replies to those filings on May 26, 2017. On June
7, 2017, counsel for the parties made their closing arguments.
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\193\ By stipulation of the participants, the Judges also
accepted and considered written testimony from six additional
witnesses who did not appear. Amazon designated and other
participants counterdesignated testimony from the Phonorecords I
proceeding, which was admitted as Exhibits 321 and 322.
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Under 37 CFR 351.4(b)(3), a participant may amend its rate proposal
at any time up to and including the time it files proposed findings and
conclusions.\194\ In this proceeding, Copyright Owners, Google, Pandora
and Spotify each filed an amended rate proposal with its filing of a
PFF and PCOL.
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\194\ Nothing in Sec. 351.4 permits the Judges to credit an
amended rate proposal that is not adequately supported by the record
evidence.
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The parties delivered closing arguments on June 7, 2017.
C. Overview of the Licensing Parties
1. The Licensees: The Streaming Services
Many diverse enterprises have launched new music streaming services
to meet growing consumer demand for streaming. Currently, there are at
least 31 music streaming services available from 20 identifiable
providers. Some of the well-known of these include: Amazon, Apple,
Google (and its recently acquired YouTube), Deezer (partnered with
Cricket/AT&T), iHeartRadio, Napster, Pandora, SoundCloud, Spotify, and
Tidal (partnered with Sprint). Written Rebuttal Testimony of Jim
Timmins, Trial Ex. 3036, ] 20 (Timmins WRT). Most of the companies
entering the on-demand streaming music market have done so recently.
Id. ] 21. In the last five years, new entrants to the market have
initiated at least five interactive streaming services, joining Spotify
which launched in the United States in 2011. Id. ] 22.
By one estimate, as of 2016 there were [REDACTED] million United
States on-demand subscribers: Spotify accounted for [REDACTED] million,
[REDACTED] Apple Music (4 million), Rhapsody and Tidal (2 million
each), and all others accounting for the remaining 4 million. Written
Testimony of Michael L. Katz (On behalf of Pandora Media, Inc.) ] 34,
Table 1 (Katz WDT). According to Spotify, as of June 2016, it had
approximately [REDACTED] million monthly average users (MAU) in the
United States, of which [REDACTED] million were subscribers, with
apparently [REDACTED] million users of Spotify's ad-supported service.
Written Direct Testimony of Barry McCarthy (On behalf of Spotify USA
Inc.) ] 6 (McCarthy WDT).
Some of the services that offer music streaming are pure-play music
providers, such as Spotify and Pandora.\195\ Others, such as Amazon,
Apple Music, and Google Play Music, are part of wider economic
``ecosystems,'' in which a music service is one part of a multi-
product, multi-service aggregation of activities, including some that
are also related to the provision of a retail distribution channel for
music. For example, Amazon is a multi-faceted internet retail business.
Amazon offers a buyers' program for an annual fee (Amazon Prime) that
affords loyalty benefits to members, such as free or reduced rate
shipping or faster delivery on the products it markets. For its music
service, Amazon bundles interactive streaming at no additional cost
with its Prime Membership, [REDACTED].\196\ In addition to the Prime
Music service, Amazon's U.S.-based business also includes an online
store to purchase CDS and vinyl records, a digital download store, a
purchased content locker service, Amazon Music Unlimited (a full-
catalog subscription music service), and Amazon Music Unlimited for
Echo (a full-catalog subscription service available through a single
Wi-Fi enabled Amazon Echo device).\197\ In launching Prime Music,
Amazon relied on the Section 115 license as it did for Amazon Music
Unlimited and Amazon Music Unlimited for Echo.\198\
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\195\ Until late 2016, Pandora operated as a noninteractive
streaming service, arguably not subject to the compulsory license
for mechanical royalties, but Pandora recently began offering more
interactive features, including a full on-demand tier. Introductory
Memorandum to the Written Direct Statement of Pandora Media, Inc. at
1-2; Written Direct Testimony of Christopher Phillips at 8 (Phillips
WDT).
\196\ Amazon Prime is a $99- per-year service that offers Amazon
customers access to a bundle of services including free two-day
shipping, video streaming, photo storage and e-books, in addition to
Prime Music. Expert Report of Glenn Hubbard, November 1, 2016 at 15
(Hubbard WDT).
\197\ Mirchandani WDT at 5.
\198\ 3/15/17 Tr. 1315-16 (Mirchandani).
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Google describes its Google Play offerings as its ``one-stop-shop''
for the purchase of Android apps. The Google Play Store allows users to
browse, purchase, and download content, including music. Google Play
Music is Google Play's entire suite of music services. Google Play
Music, launched in 2011, is bundled with the YouTube Red video service
subscription.\199\ See Expert Report of Jui Ramaprasad November 1, 2016
at Table 2, and ] 62, n.105 (Ramaprasad WDT). It includes several
functionalities: (1) Music Store; (2) a cloud-based locker service; (3)
an on-demand digital music streaming service; and (4) a Section 114
compliant non-interactive digital radio service (in the U.S.). Written
Direct Testimony of Zahavah Levine, Trial Ex. 692, ] 43 (Levine WDT).
---------------------------------------------------------------------------
\199\ Google's experience with music licensing dates at least
far back as 2006, when it acquired YouTube. Levine WDT at 3.
Google's music services were part of Google's Android Division but
were recently combined within the YouTube business unit. Id. at 3-4.
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The largest services entered direct agreements with publishers to
license their musical works. The terms of those licensing agreements
varied. For example, Apple agreed to [REDACTED] with the major
publishers that includes a minimum [REDACTED]. Expert Report of Jeffrey
A. Eisenach, Ph.D. ]] 84-92 (Eisenach WDT). In these agreements,
[REDACTED]. Id. ] 87 n.79.
Google's practice is to [REDACTED]. Levine WDT ]] 51-52.\200\
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\200\ According to Ms. Levine, labels historically have not
passed through mechanical rights to subscription services so the
lower percentages are irrelevant. Levine WDT at n.5.
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There is conflicting evidence about whether the market for
streaming services is faring poorly financially or performing about the
same as other emerging industries. See, e.g., Timmins WRT ]] 16-17;
Levine WDT ] 16 (``streaming music services generally remain
unprofitable businesses'' with content acquisition costs (primarily
music royalties) being ``the biggest barrier to profitability.'') For
example, Spotify, one of the largest pure-play streaming services, has
reportedly [REDACTED]. Katz WDT ] 65. Nevertheless, some estimates
place Spotify's market value at more than $8 billion, suggesting
perhaps, investors' expectation of future profits. Expert Report of
Marc Rysman, Ph.D. ] 150 (Rysman WDT).\201\
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\201\ The implications of the different perspectives on industry
profit and losses are considered infra in this Dissent.
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2. The Licensors: Publishers and Songwriters
The four largest publishers--Sony/ATV ([REDACTED] percent), Warner/
Chappell ([REDACTED] percent), Universal Music Publishing Group (UMPG)
([REDACTED] percent), and Kobalt Music Publishing ([REDACTED]
percent)--collectively accounted for just over 73 percent of the top
100 radio songs tracked by Billboard as of the second quarter in 2016.
Katz WDT ] 46. In addition, there are several other significant
publishers, including BMG and Songs Music Publishing, and many
thousands of smaller music publishers and self-publishing songwriters.
Id.
Songwriters have three primary sources of ongoing royalty income,
which they generally share with music publishers: mechanical royalties,
[[Page 1972]]
synchronization (``synch'') royalties, and performance royalties.\202\
See Katz WDT ] 41; Copyright and the Music Marketplace: A Report of the
Register of Copyrights at 69 (Feb. 2015) (Register's Report).\203\
Songwriters who are also recording artists receive a share of revenues
from their record labels for the fixing of the musical work in a sound
recording. Sound recording royalties include those from the sale of
physical and digital albums and singles, sound recording
synchronization, and digital performances. Id. Recording artists can
also derive income from live performances, sale of merchandise, and
other sources. Id. at 69-70.
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\202\ Another revenue source is folio licenses, lyrics, and
musical notations in written form. Katz WDT at 31.
\203\ References to the Register's Report are incorporated
herein to provide background information. This Dissent is not based
on factual information or opinion contained therein, as that
document is not record evidence in this proceeding.
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The shift in consumption from physical sales to streaming coincided
with a reallocation of publisher revenue sources. In 2012, 30% of U.S.
publisher revenues came from performance royalties and 36% from
mechanical royalties, with the rest coming from synch royalties and
other sources. See Register's Report at 70. By 2014, 52% of music
publisher revenues came from performance royalties, while 23% came from
mechanical royalties, with the remainder coming from synch royalties
and other sources. Id at 71, n.344. By one estimate, mechanical license
revenues from interactive streaming services accounted for only
[REDACTED] percent of total music publishing revenues in 2015. Katz WDT
] 42.
It is noteworthy that the shift from mechanical royalties to
performance royalties coincided with the shift from sales of
phonorecords, DPDs, and CDS, for which no performance royalty is
required, to the use of interactive streaming, for which a performance
royalty and a mechanical royalty are both required. Further (as
discussed more fully infra), the latter is reduced pursuant to an
``All-In'' formula that reflects the perfect complementarity of the
performance and mechanical licenses (i.e., neither license has any
value to an interactive streaming service without the other).
Additionally, noninteractive streaming pays only a performance royalty
but no mechanical royalty, providing a further basis for mechanical
royalties to be a smaller percentage of the publishers' total revenues,
assuming growth in noninteractive streaming. See Services' Joint
Proposed Findings of Fact and Conclusions of Law ]] 271, 283 (SJPFF).)
Total publishing revenue declined by [REDACTED] percent between
2013 and 2014, but then increased by [REDACTED] percent between 2014
and 2015. Katz WDT ] 58. The largest publishers, Sony/ATV, UMPG, and
Warner Chappell, [REDACTED], earning a combined $[REDACTED] million
from U.S. publishing operations for that year. Id. ] 59.
D. The Rate-Setting Standards in Section 801(b)(1)
1. The Legal Basis for the Four Itemized Objectives
The Copyright Act requires that the Judges establish ``reasonable''
rates and terms for the Section 115 license. In addition, section
801(b)(1) instructs the Judges to set these rates ``to achieve the
following objectives'':
Factor A: To maximize the availability of creative works to the
public;
Factor B: To afford the copyright owner a fair return for his or
her creative work and the copyright user a fair income under
existing economic conditions;
Factor C: To reflect the relative roles of the copyright owner
and the copyright user in the product made available to the public
with respect to relative creative contribution, technological
contribution, capital investment, cost, risk, and contribution to
the opening of new markets for creative expression and media for
their communication; and
Factor D: To minimize any disruptive impact on the structure of
the industries involved and on generally prevailing industry
practices.
17 U.S.C. 115(c) and 17 U.S.C. 801(b)(1).\204\
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\204\ The 1976 Act applied section 801(b)(1) and its four-factor
test to new licenses. The mechanical license at issue in this
proceeding is the lone existing statutory license carried forward
into the 1976 Act from the 1909 Copyright Act and made subject to
the 801(b)(1) standards.
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In the 1981 Phonorecords Appeal, the D.C. Circuit noted the
interplay among these four objectives:
[T]he statutory factors pull in opposing directions, and
reconciliation of these objectives is committed to the Tribunal as
part of its mandate to determine ``reasonable'' ` royalty rates . .
. . [T]he Tribunal was not told which factors should receive higher
priorities. To the extent that the statutory objectives determine a
range of reasonable royalty rates that would serve all these
objectives adequately but to differing degrees, the Tribunal is free
to choose among those rates, and courts are without authority to set
aside the particular rate chosen by the Tribunal if it lies within a
``zone of reasonableness.''
Id. at 9.
When applying the foregoing standards, the Judges are not required
to establish rates that are mathematically precise, given the nature of
the statutory task and the controlling legal precedents. Nat'l Cable
Television Ass'n v. Copyright Royalty Tribunal, 724 F.2d 176, 182 (D.C.
Cir. 1983) (``Ratemaking generally is an intensely practical affair. .
. . The Tribunal's work particularly, in both ratemaking and royalty
distribution, necessarily involves estimates and approximations. There
has never been any pretense that the CRT's rulings rest on precise
mathematical calculations; it suffices that they lie within a `zone of
reasonableness.' '') (citations omitted).
The Judges also have discretion as to whether and how they choose
to integrate their application of the ``reasonable rate'' standard with
their analysis of the four itemized factors in section 801(b)(1). They
may: (1) establish a ``reasonable rate'' as an initial step, and then
apply the four itemized factors; or (2) integrate their analysis of the
four itemized factors into a single ``reasonable rate'' approach--even
beginning that approach with a consideration of the four factors.
Compare Recording Industry Ass'n of America, Inc. v. Librarian of
Congress, 176 F.3d 528, 533 (D.C. Cir. 1999) (approving of the latter
approach) with Phonorecords I (applying the former approach, explaining
that ``the issue at hand in analyzing the section 801(b) factors is
whether these [four] policy objectives weigh in favor of divergence
from the results indicated by the benchmark marketplace evidence.'') 73
FR at 4094 (Jan. 24, 2008) (quoting SDARS I).\205\
---------------------------------------------------------------------------
\205\ In the present proceeding, the parties' arguments combine
both approaches. For example, as discussed infra, the issue of
``rate structure'' is analyzed by the parties as a marketplace
issue, which places it in the analytical ``reasonable rate'' box,
and also as a Factor B and Factor C issue, affecting the analysis of
``fair'' return and income and the ``relative roles'' of the
parties. Thus, in this Dissent, I shall also on occasion apply the
same analyses to certain ``reasonable rate'' and ``itemized factor''
issues.
---------------------------------------------------------------------------
2. The Economic Basis for the Four Itemized Objectives
The legal and regulatory process of setting statutory royalty rates
and terms has long been informed by economics. See, e.g., W. Blaisdell,
Study No. 6, The Economic Aspects of the Compulsory License, U.S.
Senate Subcommittee on Patents, Trademarks and Copyrights (October
1958) (Senate Study). This is certainly true with regard to the
establishment of the standards set forth in section 801(b)(1). The
legislative history in the long build-up to the adoption of these
standards is highlighted by dueling economic
[[Page 1973]]
positions taken in Congressional testimony in 1967 by the licensors,
through the NMPA and its economic witness, Robert R. Nathan, and by the
licensees, the RIAA, through their counsel, Thurman Arnold, Esq., a
well-known advocate of strong antitrust enforcement. See Hearing on S.
597, Subcomm. on Patents, Trademarks and Copyrights of the S. Committee
on the Judiciary (Mar. 20-21, 1967) (Senate Hearing).
Mr. Nathan expressed incredulity that the songwriting industry
would even be subject to a compulsory mechanical licensing scheme. Id.
at 382.\206\ Mr. Nathan did not see any basis for treating this license
differently than how ``we generally function under competitive
marketplace bargaining arrangements whereby most entities in our
economy bargain for that which goes into the creation of goods and
services and also bargain the price for which those goods and services
are sold.'' Id.
---------------------------------------------------------------------------
\206\ This overarching criticism of the existence of statutory
license was echoed in the present proceeding by NMPA's President,
David Israelite. 3/29/17 Tr. 3677 (acknowledging that he ``always
disapproved of the compulsory licensing system, ever since [he] knew
about it.) (Israelite); see also Witness Statement of David M.
Israelite ] 55 (Israelite WDT) (``I feel it is important . . . to
express my view that [the compulsory license] is no longer necessary
. . . .'').
---------------------------------------------------------------------------
Thus, in his 1967 testimony, Mr. Nathan advocated that Congress
eliminate the compulsory license and the statutory rate. Importantly
for the present proceeding, he specifically urged Congress (if it did
not eliminate the compulsory license) to resist replacing the fixed
statutory fee with a regulatory standard to be implemented by a quasi-
adjudicatory body, as one might regulate a public utility. He explained
to Congress: ``[O]ne might ask . . . whether the music publishing
industry has any characteristics of a public utility. I submit . . .
that there is nothing in the music publishing industry which gives [it]
the characteristics or the elements of a public utility . . . .'' Id.
at 383. Mr. Nathan noted what he understood to be a key distinction:
Unlike traditional public utilities like ``railroad systems'' or
``streetcar lines,'' the songwriting and publishing industry is ``a
creative and non-standardized area,'' and ``[m]onopoly and public
utility aspects are just not prevalent in this industry.'' Id.
The opposing position of the licensees, expressed by Mr. Arnold on
behalf of the RIAA, contained the seeds of the standard ultimately
adopted in section 801(b)(1). As Mr. Arnold testified, the statute
should include, inter alia, ``accepted standards of statutory
ratemaking,'' including a rate ``that insures the party against whom it
is imposed a reasonable return on . . . investment'' and ``that divides
the rewards for the respective creative contributions of the record
producers [as licensees] and the copyright owners . . . equitably
between them.'' Id. at 469.
Mr. Nathan criticized this approach on two fronts. First, he argued
that the ``personal service'' nature of the songwriting and publishing
industry precluded application of a ``reasonable rate of return''
requirement for the setting of the compulsory royalty rate.\207\
Second, with regard to the division of the ``rewards'' proposed in Mr.
Arnold's testimony, Mr. Nathan stated that ``I have never in all my
experience encountered this novel concept of dividing rewards for
creative contributions as a meaningful and relevant standard of
ratemaking.'' Id. at 1093-94.
---------------------------------------------------------------------------
\207\ The Judges note that this unique ``personal service''
aspect of the business is less economically significant when, as is
typical, published songs are collected and owned by large publishing
firms, and such firms each price their repertoires jointly through
blanket licenses.
---------------------------------------------------------------------------
This 1967 dispute was never resolved. Rather, the issue languished
until 1980, when, Congress abandoned the statutorily-fixed rate and
substituted a regulatory rate-setting process. However, the post-1967
legislative history did not elucidate how rates set under the new
statutory standard were to be related (if at all) to marketplace rates,
either as a matter of law or a matter of economic policy. F. Greenman &
A. Deutsch, The Copyright Royalty Tribunal and the Statutory Mechanical
Royalty: History and Prospect, 1 Cardozo Arts & Ent. L.J. 1, 53, 59
(1982).\208\
---------------------------------------------------------------------------
\208\ The standards apparently were adopted to ensure the
constitutionality of the delegation of rate-setting by Congress to
an administrative body. See SDARS I, 73 FR at 4082 (citing Hearings
on H.R. 2223 before the Subcomm. on Courts, Civil Liberties, and the
Administration of Justice of the House Comm. on the Judiciary, 94th
Cong., 1922 (1975)).
---------------------------------------------------------------------------
3. The ``Bargaining Room'' Rate-Setting Theory Under Section 801(b)(1)
a. The Bargaining Room Theory in Historical Context
A corollary to the debate regarding the standard to be established
in section 801(b)(1) was another dispute: whether the statutory rates
and terms should be set pursuant to what was coined the ``bargaining
room theory'' of rate-setting. This theory was summarized by Mr.
Nathan: When setting a statutory or regulatory rate, the rate-setter
should allow for ``opening up of the bargaining range [with] a higher
ceiling so that more bargaining can take place,'' which would ``permit
competitive bargaining . . . .'' Senate Hearing at 384, 421. In fact,
Mr. Nathan and the NMPA were quite specific as to how the rate-setter
should determine the range for bargaining under this theory: ``[T]he
rate should be high enough to allow and encourage private negotiation,
but not so high as to make the compulsory licensing provision
meaningless . . . .'' Id. at 417.
Before the Senate Judiciary Committee, the RIAA's attorney, Mr.
Arnold, asserted that incorporating the bargaining room theory into the
new statute would flaunt the purpose of a compulsory license:
[T]o set a statutory rate so high as to promote negotiations by a
record manufacturer and a publisher below that statutory rate
violates and contradicts the very purpose of imposing the compulsory
license on the music publisher.
Senate Hearing at 468.
The bargaining room theory would permit different pairings of
licensors and licensees to enter into agreements at varying rates below
the statutory rate. Indeed, a CBS Records witness before the Senate
Judiciary Committee acknowledged that ``[a] higher ceiling would permit
wider variation in royalty rates. . . . '' Id. at 417 (emphasis added).
Further, Mr. Nathan explained this commercial desire for a variety of
rates in somewhat more formal economic terms: ``[A] prudent businessman
. . . merely wants to price his goods on the apparent willingness of
the consumer to pay.'' Id. at 419 (emphasis added).
The House Judiciary Committee adopted the bargaining room theory
in its report:
The committee is setting a statutory rate at the high end of a
range within which the parties can negotiate, now and in the future,
for actual payment of a rate that reflects market values at the
time, but one that is not so high as to make it economically
impractical for record producers [as licensees] to invoke the
compulsory license if negotiations fail.
H.R. Rep. at 21.
Despite movement in the House, in the event, the language in
section 801(b)(1) as enacted did not address the bargaining room
theory, but rather set forth the aforementioned requirement for the
establishment of ``reasonable'' rates and for the achievement of the
objectives set forth in Factors A through D. As two attorneys who were
involved in the process of crafting section 801(b)(1) wrote in their
exhaustive history of the process:
The most significant elements of the statutory criteria may be
what they omit.
[[Page 1974]]
They do not include any explicit mention of the standard . . .
adopted by the House Judiciary Committee in 1967 that the statutory
rate should be at the high end of a range within which the parties
can negotiate . . . for an actual payment of a rate that reflects
market values and . . . not so high . . . as to make it economically
impractical for record producers to invoke the compulsory license if
negotiations fail.
Greenman & Deutsch, supra, at 59.
In 1981, the CRT ruled that, as a matter of law, the language in
section 801(b)(1) precluded the use the bargaining room approach to
rate-setting. Adjustment of Royalty Payable under Compulsory License
for Making and Distributing Phonorecords, 46 FR 10466, 10478 (1981). On
appeal, the D.C. Circuit affirmed the CRT's decision to eschew this
approach. 1981 Phonorecords Appeal, supra. However, the D.C. Circuit's
affirmance was not based on the CRT's conclusion that the ``bargaining
room'' approach was impermissible as a matter of law. Rather, the
appellate court held that the CRT had exercised its lawful statutory
discretion--in the form of a policy determination--to reject the use of
the ``bargaining room'' approach. Id. at 37. With regard to the legal
question as to whether the ``bargaining room'' theory could be applied
by the rate-setter, the D.C. Circuit held that ``the statutory criteria
. . . do not explicitly address the bargaining room question, and that
dispute can only be resolved through the [CRT's] articulation of
principles that flesh out the statutory notions of `reasonable' rates
and `fair' returns.'' Id. at 36. As the authors of the historical
article noted, this appellate ruling preserved for future litigants the
right to advocate for a policy change to allow for an implementation of
the ``bargaining room'' approach under section 801(b)(1). Greenman &
Deutsch, supra, at 64. Those ``future litigants'' have arrived in this
proceeding.
b. The Bargaining Room Theory in the Present Proceeding
In the present case, the parties disagree on the issue of whether
the Judges should apply the bargaining room theory of rate-setting in
this determination. Compare Copyright Owners' Reply to Services' Joint
Proposed Findings of Fact and Conclusions of Law at 146 (CORPFF-JS)
(``Copyright Owners . . . contend that . . . [the] bargaining room
theory [is a] quite permissible consideration[ ] under 801(b)(1)
analysis . . .'') with Services' Joint Reply to the Copyright Owners'
Proposed Findings of Fact and Conclusions of Law at 28 (SJRPFF-CO)
(``[a] rate creating `bargaining room' under which copyright users must
try to make private deals [is] inconsistent with Section 801(b)(1) . .
.''). In further support of their argument in favor of the bargaining
room theory, Copyright Owners emphasize the inability of the Judges (or
anyone) to identify present market rates precisely, let alone over the
five year rate period. Proposed Conclusions of Law of Copyright Owners
] 89 (COPCOL) (``the compulsory license set by the Judges cannot
possibly contemplate every single business model that may develop in
the ensuing time.''). Their reasoning is a reprise of the original
argument for the bargaining room theory: If the statutory rate is set
below market rates, then the parties will never negotiate upward toward
the market rates, because the licensees will always prefer to invoke
the right to use the licensed work at the below-market statutory rates.
However, if the Judges set the statutory rate above what they find to
be market rates, different licensees who each have a maximum
willingness to pay (WTP) below such a statutory rate would seek to
negotiate lower rates with the licensors. In response to such requests
to negotiate, according to this argument, Copyright Owners would
respond by negotiating various lower rates for those licensees,
provided lower rates were also in the self-interest of Copyright
Owners. 4/3/17 Tr. 4431 (Rysman).
I find, as a matter of policy, that the bargaining room theory is
not applicable to the setting of rates in the present case. Rather, I
agree with the policy decision in Phonorecords I that the rate setting
policies made explicit in section 801(b)(1) are best discharged if the
Judges identify rate structures and rates that reflect the standards
set forth in the statutory provision. Indeed, if the Judges were to
supplant the statutory factors with a theory leading to rates
intentionally designed to substitute discretionary bargaining, the
parties would essentially be returned to a purely market-based rate-
setting approach. See 3/21/17 Tr. 2194 (Hubbard) (adoption of the
``bargaining room theory'' would ``extensively'' shift bargaining power
to the Copyright Owners); see also 3/13/17 Tr. 569 (Katz) (``the
statutory proceeding . . . ``help[s] offset the possible asymmetries''
in bargaining power).
Notably, section 801(b)(1) does not require the Judges even to
attempt to set market rates, or to use market rates to establish
``reasonable'' rates under the statute. Music Choice, 774 F.3d, supra,
at 1010. (``Copyright Act permits, but does not require, the Judges to
use market rates to help determine reasonable rates'') (emphasis
added). Moreover, as noted supra, the Judges are required to consider
not only the reasonableness of the rates, but also how the four
itemized factors listed in section 801(b)(1) bear on the reasonableness
of the rates, i.e., the maximization of the public ``availability'' of
musical works, ``fair'' return, ``fair'' income and ``minimize[d] . . .
disruptive impact.'' These are not factors necessarily implicated or
fully addressed by a market-based analysis. If the Judges were to adopt
wholesale the bargaining room theory, they would eliminate the value of
those extra-market factors. Finally, as Dr. Eisenach conceded, adoption
of the bargaining room theory would alter the parties' respective
``threat points'' (a/k/a ``disagreement points'') in the ``Nash
context,'' increasing Copyright Owners' bargaining power as compared
with the non-application of the bargaining room approach. 4/4/17 Tr.
4846-47 (Eisenach).\209\
---------------------------------------------------------------------------
\209\ A ``threat point'' or ``disagreement point'' is a concept
from bargaining (game) theory (specifically, in the Nash bargaining
model) representing the value point at which a party will walk away
from negotiations--thereby affecting the value of the ultimate
bargain. See SDARS II, 74 FR 23054, 23056-57 (April 7, 2017)
(summarizing the Nash model).
---------------------------------------------------------------------------
In addition, an application of the bargaining room theory would be
inconsistent with another purpose of statutory licensing--the
minimization of transaction costs. If each interactive streaming
service were required to negotiate separately with each music
publisher, the process would diminish the transaction cost savings,
which is an important reason for statutory licensing. See 4/6/17 Tr.
5233 (Leonard) (``the point of having this kind of compulsory licensing
setting is to reduce transactions cost and to . . . prevent the
exercise of market power and prevent disruption in the marketplace.'');
4/13/17 Tr. 5901 (Hubbard) (most listeners demonstrate low WTP such
that ``notion of negotiation with [that] entire long tail is a lot of
transactions costs . . . which would seem to me to be at odds with the
801(b) factors. . . . [I]t . . . would seem to subvert the very purpose
of this hearing to just suggest wholesale private renegotiation.'').
On balance, based on the foregoing, I do not accept and will not
apply the bargaining room theory to establish either the rate structure
or the zone of reasonable rates.
E. The Present Rate Structure and Rates
Subpart B sets forth mechanical royalty rates in connection with
the delivery and offering of interactive streams and/or limited
downloads.
[[Page 1975]]
There are three product distinctions within the subpart B rate
structure:
(a) Nonportable vs. Portable Services
(b) Unbundled vs. Bundled Services
(c) Subscription vs. Ad-Supported Services
37 CFR 385.13.
Copyright Owners provide a helpful and more specific summary of
these categories:
(a) ``standalone non-portable subscription--streaming only''
services (i.e., tethered to a computer);
(b) ``standalone non-portable subscription--mixed'' (i.e., both
streaming and limited download) services;
(c) ``standalone portable'' subscription streaming and limited
download services (i.e., accessible on mobile or other Internet-
enabled devices);
(d) ``bundled subscription services'' which are streaming and
limited download services bundled with another product or service;
and
(e) ``free [to the end user] nonsubscription/ad-supported
services.''
Copyright Owners' Written Direct Statement, Proposed Rates and Terms at
B-3 (Copyright Owners' Proposal) (quoting 37 CFR 385.13).
More granularly, the present subpart B rate structure and rates and
for interactive streaming and limited downloads, as agreed to by the
parties in their 2012 settlement, are set forth in full at 37 CFR
385.12 and 385.13, and are summarized below: \210\
---------------------------------------------------------------------------
\210\ This summary is set forth in the Amended Expert Witness
Statement of Dr. Gregory Leonard, Google's economic expert witness.
See Amended Expert Witness Statement of Dr. Gregory K. Leonard ] 25
(Leonard AWDT). I find Dr. Leonard's format to be particularly
useful, but I note that all the parties clearly and consistently
summarized the existing rate structure. See also, e.g., Israelite
WDT ] 28.
---------------------------------------------------------------------------
1. Calculate the ``All-In'' Publishing Royalty for the Service
Offering
a. maximum of 10.5% of service revenue and the following minimum
royalties based on the type of service:
(i) Standalone Non-Portable Subscription, Streaming Only:
--lesser of 22% of service payments for sound recording rights \211\
and $0.50 per subscriber per month.
---------------------------------------------------------------------------
\211\ To be clear, these alternative percentages reflect percent
of payments to record companies for sound recording rights,
unregulated and set in the market, not the percent of revenue
received by the interactive streaming services. That is, these are
the so-called ``TCC'' rates.
---------------------------------------------------------------------------
(ii) Standalone Non-Portable Subscription, Mixed Use:
--lesser of 21% of service payments for sound recording rights and
$0.50 per subscriber per month.
(iii) Standalone Portable Subscription, Mixed Use:
--lesser of 21% of service payments for sound recording rights and
$0.80 per subscriber per month.
(iv) Bundled Subscription Services:
--21% of service payments for sound recording rights.
(v) Free Non-Subscription/Ad-Supported Services:
--22% of service payments for sound recording rights.
2. Subtract Applicable Performance Royalties [the ``All-In''
Calculation] (i.e., subtract from the result in the previous step the
``total amount of royalties for public performance of musical works
that has been or will be expensed pursuant to public performance
licenses in connection with uses of musical works through such
offering.'')
3. Compare the maximum of the result from the previous steps and
the following mechanical-only per subscriber royalty floors based on
the type of service: \212\
---------------------------------------------------------------------------
\212\ This is the so-called ``Mechanical Floor'' rate, discussed
infra.
---------------------------------------------------------------------------
(a) Standalone Non-Portable Subscription, Streaming Only: $0.15 per
subscriber per month.
(b) Standalone Non-Portable Subscription, Mixed Use: $0.30 per
subscriber per month.
(c) Standalone Portable Subscription, Mixed Use: $0.50 per
subscriber per month.
(d) Bundled Subscription Services: $0.25 per active subscriber per
month.
(e) Free Non-Subscription/Ad-Supported Services: Not
Applicable.\213\
---------------------------------------------------------------------------
\213\ The regulations also describe how the royalty revenue
collected shall be allocated among musical works that had been
played on the interactive streaming services. That allocation is
made on a per play basis, and, under the parties' proposals in this
proceeding, that general allocation principle would remain
unchanged. Compare Copyright Owners' Proposal at B-14-15 with, e.g.,
Second Amended Proposed Rates and Terms of Spotify USA Inc. at 12-13
(Spotify's Proposal).
---------------------------------------------------------------------------
Subpart C of part 385 sets forth the royalty structure and rates
for licensing mechanical rights for five categories: limited offerings,
mixed service bundles, music bundles, paid locker services, and
purchased content locker services. The present subpart C rate
structure, established consensually in the 2012 settlement, are set
forth at 37 CFR 385.20 through 385.26. As succinctly summarized by Dr.
Leonard (see Leonard AWDT ] 26), the structure and rates are as
follows:
1. Calculate the ``All-In'' Publishing Royalty for the Service
Offering
a. Maximum of the applicable percentage of service revenue based on
the type of service:
(i) Mixed Service Bundle: 11.35% of service revenue.
(ii) Music Bundles: 11.35% of service revenue.
(iii) Limited Offering: 10.5% of service revenue.
(iv) Paid Locker Service: 12% of incremental service revenue.
(v) Purchased Content Locker: 12% of service revenue.
and
b. The applicable ``All-In'' minimum, also based on the type of
service:
(i) Mixed Service Bundle: 21% of service payments for sound
recording rights.
(ii) Music Bundles: 21% of service payments for sound recording
rights.
(iii) Limited Offering: 21% of service payments for sound recording
rights (subject to a further minimum payment of $0.18 per subscriber
per month).
(iv) Paid Locker Service: 20.65% of service payments for sound
recording rights (subject to a further minimum payment of $0.17 per
subscriber per month).
(v) Purchased Content Locker: 22% of any incremental service
payments to record companies for sound recording rights (above the
otherwise applicable payments for permanent digital downloads and
ringtones).
2. Subtract Applicable Performance Royalties
Subtract from the result in the previous step the ``total amount of
royalties for public performance of musical works that has been or will
be expensed pursuant to public performance licenses in connection with
uses of musical works through such subpart C offering.'' \214\
---------------------------------------------------------------------------
\214\ As under subpart B, collected royalties under subpart C
are allocated on a per play basis. The Services, and Apple, do not
propose a change in this regard. Copyright Owners, given their
proposal that subpart C be eliminated, would utilize the subpart B
allocation methodology for the service offerings now in subpart C.
---------------------------------------------------------------------------
At the time of the hearing, the services paid the following subpart
B mechanical rates: \215\
---------------------------------------------------------------------------
\215\ Pandora had not begun its interactive streaming service at
the time of the hearing. However, since November 2015, Pandora
asserts that it has entered into direct licenses with thousands of
music publishers that cover the mechanical rights that are at issue
in this proceeding. Written Direct Testimony of Michael Herring ] 49
(Herring WDT). See, e.g., PAN Dir. Exs. 6-7. Many of those deals
bundle interactive streaming (for which mechanical and performance
rights are required) and noninteractive streaming (for which,
arguably, no mechanical license is required). Katz WDT ] 105.
[[Page 1976]]
----------------------------------------------------------------------------------------------------------------
Reg or direct
Licensee/service Rate prong Rate contract Source
----------------------------------------------------------------------------------------------------------------
Amazon Unlimited for Echo....... [REDACTED]........ $[REDACTED]....... Sec. [REDACTED]. Brost WDT,\216\
Ex. 18 (HX 20).
Amazon Prime.................... [REDACTED]........ $[REDACTED]....... Sec. [REDACTED]. Marx \217\ WRT ]
40.
Apple Music..................... Not Applicable.... [REDACTED]........ Direct contracts.. Wheeler \218\ WDT
]] 10, 12; HX
1432, HX 1434, HX
1435.
[REDACTED]...................... [REDACTED]........ [REDACTED]........ [REDACTED]........ Leonard AWDT ] 52
et seq.
Spotify/Ad-Supported............ [REDACTED]........ [REDACTED]........ Sec. [REDACTED]. Marx WDT \219\ ]
Sec. [REDACTED]. 83.
Spotify Subscription............ [REDACTED]........ $[REDACTED]....... Sec. [REDACTED]. Marx WDT ] 76.
----------------------------------------------------------------------------------------------------------------
F. The Economic Framework for Analyzing the Rate Structure Issues
---------------------------------------------------------------------------
\216\ Written Direct Testimony of Kelly Brost.
\217\ Written Rebuttal Testimony of Leslie M. Marx.
\218\ Written Direct Testimony of Rob Wheeler.
\219\ Written Direct Testimony of Leslie M. Marx.
---------------------------------------------------------------------------
The parties' proposals are based on varying explicit and implicit
assumptions regarding the economic principles that underlie the
licensing of musical works. During the hearing, the parties have urged
the Judges to apply certain economic principles, often imploring the
Judges to recognize that the economic underpinnings of their arguments
can be found in the teachings of a generic introductory ``Economics
101'' course. See, e.g., 3/8/17 Tr. 133 (Copyright Owners' Opening
Statement); 3/14/17 Tr. 920 (Herring); 4/13/17 Tr. 5917 (Lane). I
generally agree that, particularly with regard to the rate structure,
it is helpful to ``begin at the beginning''--i.e., with basic economic
principles--so that the subsequent analyses are grounded in some basic
concepts.
Basic economic theory teaches that supply and demand determine an
equilibrium market price. See, e.g., W. Nicholson & C. Snyder,
Microeconomic Theory at 10 (10th ed. 2008) (``[D]emand and supply
interact to determine the equilibrium price and the quantity that will
be traded in the market.''); see also Final Rule and Order,
Determination of Reasonable Rates and Terms for the Digital Performance
of Sound Recordings, Docket No. 96-5 CARP DSTRA, 63 FR 25394, 25404
(May 8, 1998) (``CARP PSS 1998'') (noting that ``price [is] set in the
marketplace according to the laws of supply and demand. . . .'');
Eisenach WDT ] 34 (``the interplay between supply and demand results in
a market price.'')
With regard to the supply of an ``ordinary private good'' in a
perfectly competitive market,\220\ it is well understood that there is
typically a positive correlation between price and quantity (causing
the well-known upward slope of a supply curve). See, e.g., C. Byun, The
Economics of the Popular Music Industry at 74 (2016) (``The firm's
supply curve is upward sloping, since the relationship between price
and quantity supplied by the firm is positive.'') This positive
correlation is the consequence of several factors. Among those factors
is the increasing marginal physical cost of inputs required to create
the product. Marx WDT ] 38 n.39 (`` `Marginal cost' is defined as the
increase in total cost resulting from an additional unit of output.'').
The marginal cost of inputs generally increases because, inter alia,
inputs are scarce and a seller must pay more for each unit of an input
as it becomes more scarce, or if additional units are less productive.
See Krugman & Wells, Microeconomics at 312-13 (2d ed. 2009).
Additionally, input sellers must consider the opportunity cost of
supplying an input to a particular buyer, i.e., any revenue foregone by
selling that scarce input to that particular buyer rather than to
another buyer who was willing to pay a higher price. See E. Mansfield &
G. Yohe, Microeconomics at 242 (11th ed. 2004) (``opportunity cost'' of
an input is ``the value of that input if it were employed in its most
valuable alternative use.'').
---------------------------------------------------------------------------
\220\ A ``private good is ``one that is both excludable and
rival in consumption,'' i.e., the supplier can prevent non-payers
from consuming the good, and each unit of the good cannot be
consumed by more than one person simultaneously. P. Krugman & R.
Wells, Microeconomics at pp. G-2, G-7 (2d ed. 2009). The distinction
between a private good and a public good is discussed infra.
---------------------------------------------------------------------------
In this proceeding, the products being licensed by Copyright Owners
to the interactive streaming services for distribution are collections
(repertoires) of additional copies of a song embodied in a sound
recording--not the original or first copy of the song or the sound
recording. The marginal physical cost of such additional digital copies
of a musical work embodied in a sound recording is essentially zero.
See Written Rebuttal Testimony of Marc Rysman, Ph.D. ] 71 (Rysman WRT)
(``Intellectual property commonly may have little to no marginal costs
to reproduce. . . .''); Marx WDT ] 117 (``the marginal costs of
providing rights to a particular musical work and streaming it to the
consumer are effectively zero); Written Rebuttal Testimony of Richard
Watt (Ph.D.) (On behalf of the NMPA and the NSAI) ] 44 n.48 (Watt WRT)
(considering reliable Professor Marx's conclusion that ``[a] marginal
cost of zero is a close approximation of true costs of delivery.'');
Expert Rebuttal Report of Glenn Hubbard, February 15, 2017 ] 4.20
(Hubbard WRT) (``copyrighted music work . . . has zero marginal
production costs''); Rebuttal Expert Witness Statement of Dr. Gregory
K. Leonard ]] 6, 95 (Leonard WRT) (acknowledging ``the zero marginal
cost of a stream''); Corrected Written Testimony of Michael L. Katz (On
behalf of Pandora Media, Inc.) ] 26 (Katz CWRT) (``The creation and
distribution of musical works has . . . zero or near-zero marginal
costs.''); 3/30/17 Tr. 4085-40866, (Gans) (agreeing that the ``marginal
physical cost'' of ``additional electronic versions of sound recordings
. . . embody[ing] musical works is zero); see generally W. Landes,
Copyright in R. Towse, A Handbook of Cultural Economics at 100 (2d ed.
2011) (``[T]he cost of reproducing the [copyrighted] work that
additional users can be added at a negligible or even zero cost.'') So,
there is an important basic distinction between the marginal physical
costs associated with creating additional units of ordinary private
goods and additional digital copies of songs/sound recordings.
With regard to demand, there is a negative correlation between
price and quantity (causing the equally well-known downward slope of a
demand curve). See, e.g., Krugman & Wells, supra, at 63-64. This
negative correlation is also the consequence of several factors. For
present purposes, two factors are pertinent. First, a buyer's demand is
a function of the benefit the buyer realizes from acquiring the good--
what economists term ``utility.'' Second, buyers' ability to satisfy
their desire for
[[Page 1977]]
utility is constrained by their ability to pay--what economists call a
``budget constraint.'' To simplify somewhat, the point where a buyer's
utility and ability to pay intersect represents a point on the buyer's
demand curve, indicating his or her ``Willingness to Pay'' (WTP).\221\
See Byun, supra at 26-27 (The demand curve represents a mapping of all
such points, reflecting both (1) the ``intuitive'' idea that the more
expensive a good, the greater its ``budget'' impact, lowering the
quantity demanded; and (2) diminishing marginal ``utility,'' as
reflected in the buyer's willingness to pay [(WTP)] for additional
units of the good); see also Pindyck & Rubinfeld, supra, at 83, 140
(``[P]references and budget constraints . . . determine how individual
consumers choose how much of each good to buy . . . choos[ing] goods to
maximize the satisfaction they can achieve, given the limited budget
available to them.'' . . . [C]onsumers' demand curves for a commodity
can be derived from information about their tastes . . . and from their
budget constraints.'').\222\ The market demand curve for an ordinary
private good is the horizontal sum of all quantities demanded at each
price reflected in the demand curves of all potential buyers. Byun,
supra, at 27; Pindyck & Rubinfeld, supra, at 141.\223\
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\221\ Thus, it is important to keep in mind that WTP
incorporates ``Ability To Pay,'' when evaluating the distinctions
among the interactive streaming services' various tier offerings and
the issue of price discrimination. See C. Sunstein, Willingness to
Pay vs. Welfare, 1 Harv. L. & Pol. Rev. 303, 310 (2007) (noting the
``need to make a distinction . . . between WTP and ability to pay .
. . . When . . . people show a low WTP, it may be because their
ability to pay is low [b]ut their low WTP does not demonstrate that
they would gain little in terms of welfare from receiving the
relevant good.'') (emphasis in original).
\222\ When discussing consumer demand, economists often leave
implicit the distinction between the budget constraint, which
reveals an ability (or inability) to pay, and the WTP, by combining
both in the WTP phrase. In this Dissent, I shall use the WTP phrase
in its combined form, unless distinction is of some importance in
this proceeding.
\223\ These two aspects of demand are reflected in the present
proceeding by the services' attempts to design a ``range of
products'' with different ``price points'' (reflecting consumers'
varying budget constraint/WTP) and ``features to accommodate
preferences'' (reflecting differences in utility). See, e.g.,
Phillips WDT 16 (describing Pandora's design of its new interactive
streaming offerings).
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Importantly for the present proceeding, changes along the demand
curve (i.e., changes in quantity demanded in response to changes in
price) must be distinguished from changes in demand, i.e., shifts of
the entire demand curve representing a different quantity demanded at
each price. A movement ``down the demand curve'' would reflect an
increase in new buyers whose WTP was equal to the lower price as the
demand curve descends, i.e., whose WTP was less than higher prices
along the demand curve. By contrast, an upward shift of the entire
demand curve can be the consequence of several factors, including a
reduction in the price of a competing (substitute) good and a change in
consumer tastes. To reiterate, this distinction between an increase in
quantity demanded and an increase in demand is of particular importance
in this proceeding, as will be evident as I compare and contrast the
parties' economic arguments. See Krugman & Wells, supra, at 66-67
(``[W]hen you're doing economic analysis, it's important to make the
distinction between changes in the quantity demanded, which involve
movements along a demand curve, and shifts of the demand curve.'').
It is also important--especially in this proceeding--to distinguish
markets vertically. There are two markets implicated in this
proceeding. There is the upstream market for the sale and purchase of
inputs, here, licenses for the collected copies (entire repertoires) of
musical works embodied in the streamed sound recordings. There is also
the downstream market for the sale and purchase of the final product,
comprised of both (1) the right to listen to a given sound recording/
musical work; and (2) an ``option'' value,'' i.e., a right to access a
large repertoire of sound recordings/musical works. The dynamics of
these two markets are different, yet they are economically intertwined.
They are economically different in certain obvious ways, in that the
upstream market consists of licensors and licensees whereas the
downstream market is comprised of streaming services and listeners
(subscribers or users) with the markets exhibiting different degrees of
(inter alia) competition, market power, homogeneity and preferences
among the participants in each market. However, they are interdependent
as well, because the upstream demand of the interactive streaming
services for musical works (and the sound recordings in which they are
embodied)--known as ``factors'' of production or ``inputs''--is derived
from the downstream demand of listeners to and users of the interactive
streaming services. This interdependency causes upstream demand to be
characterized as ``derived demand.'' See Krugman & Wells, supra, at 511
(``[D]emand in a factor market is . . . derived demand . . . [t]hat is,
demand for the factor is derived from the [downstream] firm's output
choice.'').\224\
---------------------------------------------------------------------------
\224\ Importantly, this economic interdependency exists as a
matter of law as well as economics in this proceeding. Section
801(b)(1)(A) explicitly makes the link between the upstream and
downstream markets relevant to the setting of upstream rates in this
proceeding, by instructing the Judges to set upstream rates that
``maximize the availability of creative works to the public,'' i.e.,
to the downstream listeners.
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In perfectly competitive markets for ordinary private goods, prices
tend toward an ``equilibrium'' price where there is an intersection
between quantity demanded (on the demand curve) and the quantity
supplied (on the supply curve). In that market, the positive price
equals both marginal cost and marginal benefit.\225\ That price would
allow for a reasonable estimation of a per unit price that economists
would be able to identify, in terms of economic efficiency, as a fair
market price. See, e.g., G. Niels, H. Jenkins & J. Kavanagh, Economics
for Competition Lawyers ] 1.4.7 (2d ed. 2016) (The ``equilibrium
price'' reflects ``allocative efficiency'' on the demand side and
``productive efficiency'' on the supply side.''); Nicholson & Snyder,
supra at 469-72 (``[P]erfectly competitive markets lead to efficiency
in the relationship between production [supply] and preferences
[demand]. . . .'') \226\
---------------------------------------------------------------------------
\225\ If the market is imperfect, i.e., if the seller has some
market power, then the positive price will exceed marginal cost.
\226\ There are other particular requirements that must be
satisfied for a market to be perfectly competitive such that the
resulting price reflects these fair market efficiencies. See
Mansfield & Yohe, supra at 290-91 (Perfect competition requires: (1)
Homogeneous products across sellers; (2) no seller or buyer is so
large as to affect the product price (i.e., all participants are
price-takers rather than price-makers; (3) all resources are
completely mobile across markets, i.e., they can freely enter or
exit the market); and (4) all market participants (consumers,
producers and input suppliers) have ``perfect knowledge'' of all
relevant information.
---------------------------------------------------------------------------
This snapshot of a perfectly competitive market for an ordinary
private good is described in the typical ``Economics 101'' course.
However, because (as noted supra) the marginal physical cost of
supplying an additional copy of a song/sound recording is essentially
zero, at least one key condition for efficient per-unit pricing does
not exist. A price above zero would not reflect allocative efficiency,
because price must equal marginal cost to create such efficiency.
However, at a price of zero--that is, equal to marginal cost--no
supplier would have an economic incentive to incur the cost of
producing the original version of the musical work. As one scholar has
summarized:
There is a conflict between the competing goals of ensuring
access to intellectual
[[Page 1978]]
property at a price equal to marginal cost and providing incentives
for the production of information. Finding the balance between
access and incentives arising from the free access and exclusive
rights norms is characterized as the static/dynamic dilemma or the
short-run/long-run dilemma.
D. Barnes, The Incentive/Access Tradeoff, 9 Nw. J. Tech. & Intell.
Prop. 96, 96 (2010).
The distinction between normal private goods and intellectual
property applies specifically in the markets for musical works and
sound recordings. As a Canadian scholar recently explained:
For normal goods and services, the optimal level of consumption
is generally considered to be the level achieved when the price of
the good is equal to its marginal production cost. . . . This level
corresponds to what economists call a first-best optimum, which
requires that fixed costs be covered one way or another. A
competitive market is generally the preferred mechanism for defining
and achieving an optimal level of production and consumption for
normal goods.
With information goods or assets, the problem is somewhat more
difficult since the same unit . . . think of a musical work or sound
recording . . . can be listened to and enjoyed many times by many
different users or consumers now and in the future as consumption
does not destroy or alter the unit in question.
M. Boyer, The Competitive Market Value of Copyright in Music: A Digital
Gordian Knot, Toulouse School of Economics Working Paper at 18 (Sept.
2017) (emphasis added).\227\
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\227\ This point highlights a particular distinction between
private goods and products with public good characteristics
(discussed infra), upending the ``economic efficiency'' principles
of for private goods markets taught in an ``Economics 101'' class.
See C. Yoo, Copyright and Public Good Economics: A Misunderstood
Relation,'' 155 U. Pa .L. Rev. 635, 638 (2007) (There is ``an
interesting inversion of the conditions for the efficient allocation
of private goods. For private goods, consumers pay the same price
and signal the different valuations that they place on the good by
purchasing different quantities. For pure public goods, consumers
consume the same quantity of production and signal the intensity of
preferences by their willingness to pay different prices.''). This
principle is particularly applicable in response to the argument
that economic efficiency is fostered by per-unit pricing in the
market at issue in this proceeding.
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Economists have analyzed and modeled this conundrum, utilizing
approaches beyond those in a basic ``Economics 101'' classroom. See P.
Samuelson, Aspects of Public Expenditure Theories, 40 The Rev. of Econ.
& Statistics, 332, 336 (1958) (when attempting to price additional
copies of public goods with marginal costs approximating zero ``the
easy formulas of classical economics no longer light our way.'').
Copies of intellectual property goods, including especially
electronic copies, are understood not to be ``private'' goods as in the
simple model sketched supra, but rather are ``quasi- public goods.'' A
``public good'' has two characteristics. First, it has a zero marginal
production cost (formally, they are ``non-rivalrous in consumption,''
because consumption of one unit does not prevent another unit from
being consumed). Second, the provider of the public good cannot prevent
consumption of the good by non-payers (formally, ``non-
excludability''). See Nicholson & Snyder, supra, at 679. A ``quasi-
public good'' (sometimes called an ``impure public good'' or a ``mixed
good'') possesses only one of these two public goods characteristics.
See, e.g., G. Dosi & J. Stiglitz, The Role of Intellectual Property
Rights in the Development Process, with Some Lessons from Developed
Countries: An Introduction at 6, Inst. of Economics, Laboratory of
Economics and Management, Working Paper 2013/23 (Nov. 2013) (defining a
quasi-public good as one where either ``it is . . . hard to exclude
others'' or, ``even if it were possible, it is inefficient to do
so.''). In the market at issue in this proceeding, one person's
accessing of a streamed copy of sound recording (and the musical work
embodied within it) on an interactive streaming service is not in
rivalry with another person's listening to a copy of the same sound
recording/song (i.e., one person's listening does not cause a marginal
increase in physical cost to the licensors),\228\ but the licensors can
exclude any person from listening who does not subscribe to or register
with the interactive streaming service. When piracy is uncontrolled,
copies of sound recordings (and the musical works embodied therein)
resemble pure public goods. When piracy is reduced, these reproductions
are more in the nature of quasi-public goods, because they are still
not rivalrous in consumption.
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\228\ This non-rival aspect of streamed music is not only a
theoretical underpinning of the interactive markets, but also is the
crucial basis for the services' plans (discussed infra) to achieve
``scale'' and, ultimately, profitability, as discussed infra. See
generally J. Haskel & S. Westlake, Capitalism without Capital at 66
(2017) (``From an economic point of view, scalability derives from .
. . what economists call `non-rivalry.' '').
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An additional complexity: The products supplied in the market
(upstream and downstream) in this proceeding are not simply individual
copies of discrete musical works. Rather, the product is the collection
of repertoires of musical works, collectivized (through ownership,
administration and distribution) by the music publishers and, in final
(downstream) delivery), through the major record companies (and a
constellation of smaller publishers).
These collective activities are highly concentrated among only a
few such publishers. As noted supra, the four largest publishers--Sony/
ATV ([REDACTED] percent), Warner/Chappell ([REDACTED] percent),
Universal Music Publishing Group (UMPG) ([REDACTED] percent), and
Kobalt Music Publishing ([REDACTED] percent)--collectively accounted
for just over 73 percent of the top 100 radio songs tracked by
Billboard \229\ as of the second quarter in 2016. Katz WDT ] 46. The
collective nature of the principal music publishers is further made
clear from the testimony of their witnesses in this proceeding. See
Witness Statement of Peter Brodsky ] 5 (Brodsky WDT) (Sony/ATV Music
Publishing owns and administers ``the largest catalog of musical
compositions in the world, with over [REDACTED] songs written by
[REDACTED] of songwriters''); Witness Statement of David Kokakis ] 10
(Kokakis WDT) (UMPG owns and administers [REDACTED] compositions);
Witness Statement of Gregg Barron ] 5 (BMG owns and administers
[REDACTED] compositions); Witness Statement of Annette Yocum ] 8
(Warner/Chappell owns and administers [REDACTED] compositions).\230\
---------------------------------------------------------------------------
\229\ This Billboard measure tracks songs played on AM-FM
terrestrial radio broadcasters, which are not required to license
the works or the sound recordings they play.
\230\ The sound recording market is also highly concentrated.
See Marx WDT ] 149 (``The three major labels, Sony Music
Entertainment, Inc., Warner Music Group, and Universal Music Group
(`UMG'), account for roughly 65% of US recording industry
revenue.''). Also, the performance rights collectives are highly
concentrated, with ASCAP and BMI representing over 90% of the songs
available for licensing in the United States. See Register's Report
at 20.
---------------------------------------------------------------------------
The mechanical license thus is in the nature of a blanket license
(notwithstanding that the interactive streaming service must first
serve a Notice of Intention (NOI) on the copyright owner in order to
utilize the statutory mechanical license in connection with each
individual song). 17 U.S.C. 115(b); 37 CFR 201.18). Much of the
economic value of a collection of millions of copyrights within one
publishing umbrella lies in the economizing on transaction costs--
allowing large entities to administer the copyrights. See generally S.
Besen, S. Kirby and S. Salop, An Economic Analysis of Copyright
Collectives, 78 Va.L.Rev. 383 (1992); R. Watt, Copyright Collectives:
Some Basic Economic Theory, reprinted in R. Watt (ed.),
[[Page 1979]]
Handbook on the Economics of Copyright at 168-170 (2014).\231\
---------------------------------------------------------------------------
\231\ The economic concept of a collective organization is
broader than the more common and narrow conception of ``collection
societies'' as limited to PROs. See A. Katz, Copyright Collectives:
Good Solution, But for Which Problem, at 2, n.7, reprinted in R.
Dreyfuss & D. Zimmerman (eds.) Working Within the Boundaries of
Intellectual Property Law (2010) (``The term `copyright collectives'
encompasses various types of organizations, with different mandates,
structures, forms of governance and regulatory oversight.'').
---------------------------------------------------------------------------
However, along with the efficiencies of collective ownership comes
the market power of the collective. As has been noted:
In so much as copyright law establishes a . . . monopoly of each
copyright holder in his or her own item of intellectual property,
copyright collectives imply an even larger monopoly situation for
entire specific types of intellectual property in general. Exactly
how this monopoly power affects social welfare is a natural point of
discussion. . . . [T]here are social costs involved when a natural
monopoly \232\ is run by only one firm, since that firm will not
sell its output at the socially optimal price, but rather at the
pure profit maximizing price. It is for this reason that most
natural monopolies are subject to heavy regulation. . . . The
administration and marketing of intellectual property has many
aspects of a natural monopoly. . . . The fact that unregulated
copyright collectives do not achieve a social optimum establishes
strong theoretical foundations for arguing that such collectives
should be regulated.
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\232\ When large publishing houses or major record labels
control large swaths of the market, and their products are ``must
haves,'' they are ``complementary oligopolists'' rather than
monopolists, a difference that leads to supranormal pricing and
greater inefficiencies than arise from monopoly. See Web IV, 81 FR
26316, 26348 (May 2, 2016).
R. Watt, Copyright and Economic Theory: Friends or Foes at 163, 190
(2000); see also C. Handke, The Economics of Collective Copyright
Management at 9, reprinted in Watt, Handbook of the Economics of
Copyright, supra (entities controlling a collection of copyrights are
natural monopolies).
Thus, the ``product'' that is licensed to interactive streaming
services can be modeled not merely as the individual musical work or
sound recording, but also as access to copies of a large repertoire of
songs. Such access can be offered through various delivery channels,
such as interactive streaming, noninteractive streaming and satellite
radio.
At this point of analysis, therefore, the concept of ``opportunity
cost'' is of particular importance.\233\ When a collective sets the
royalty rate to be paid by a distribution channel to provide such
downstream access, in order to maximize profits, it must: (1) Consider
potential royalty revenue from the various distribution channels; (2)
determine whether these distribution channels/licensees serve
overlapping downstream listeners; (3) minimize opportunity costs by
attempting to equalize (on the margin) royalty revenue paid by such
overlapping licensees; (4) refuse licenses to distributor categories
that would ``cannibalize'' higher royalty revenues from other
distribution channels; and (5) identify the distribution channels that
provide access to listeners who would not otherwise pay for a higher-
priced distribution channel because of their low WTP (i.e.,
distribution channels and listeners that do not cause ``substitution''
or ``cannibalization'').
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\233\ To repeat, the ``opportunity cost'' of using an input is
the foregone value of the most highly-valued alternative use of that
input. See generally Pindyck & Rubinfeld, supra, at 689 (defining
``opportunity cost'' as the ``[c]ost associated with opportunities
that are foregone when a firm's resources are not put to their best
alternative use.'').
---------------------------------------------------------------------------
For the category of services that fall in number (5) above,
licensors would negotiate a royalty without regard to opportunity cost
(i.e., without fear of ``substitution'' or ``cannibalization''),
because no such opportunity costs would be present. Compare Expert
Report of Joshua Gans on Behalf of Copyright Owners ] 50 (Gans WDT)
(``The opportunity cost of licensing musical works to a given
interactive streaming service depends on the royalty income lost as a
result of doing so. There are numerous potential sources of that lost
royalty income, including lost revenue from another interactive
streaming service (that may pay higher rates), as well as lost physical
sales, downloads and radio/webcasting revenue.'') with Hubbard WRT ]
4.3 (``a songwriter's opportunity cost of licensing to a service that
is both market expanding and that does not ``cannibalize'' users from
other services is relatively low.'').
Thus, the simple ``Economics 101'' model--which suggests a simple
single per-unit price--is not applicable. (``We are not in Kansas
anymore,'' or, to repeat Professor Samuelson's elegant phraseology,
``the easy formulas of classical economics no longer light our way.'').
Accordingly, to analyze the parties' proposed rate structures, the
Judges must consider economic models informed by the economic
principles that reflect these market realities. Fortunately, the Judges
hardly are operating in a vacuum, either in a theoretical or practical
sense, given the testimony provided by the economic witnesses in this
proceeding.
One analytical approach to the issues raised by the economics of
copyrights involves the application of concepts from the sub-field of
``welfare economics.'' As one of Copyright Owners' economist-experts
noted, the pricing issue raised in this proceeding invokes principles
from the branch of this sub-discipline. 3/27/17 Tr. 3032 (Watt)
(defining ``welfare economics'' informally as ``what economists use
when we talk about efficiency and we talk about producer/consumer
surplus and things like that.'') \234\; see also Pindyck & Rubinfeld,
supra, at 590 (defining ``welfare economics as the ``normative
evaluation of markets and economic policy.''). A core principle of
welfare economics, and thus of economics writ large, is the ``theory of
the second best.'' \235\ Simply stated--and in a manner applicable
here--the theory provides: ``When it is not possible to obtain the most
desirable economic outcome in a situation--marginal cost pricing in
this case--society has to compromise and accept the next most desirable
outcome.'' A. Schotter, Microeconomics: A Modern Approach at 427-428
(2009) (emphasis added).\236\ It is accurate to state that the Judges'
practical task in this case is to determine a rate structure and rates
that are economically ``second best'' in this economic context and
satisfy the legal requirements of section 801(b)(1).
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\234\ It should be noted that Professor Watt decidedly rejects
the applicability of welfare economics as a tool with regard to
Factor A of section 801(b)(1)--unless ``availability'' were to be
equated with ``use'' of copyrighted musical works. See id. at 3033.
\235\ The ``Theory of the Second Best'' was originally developed
more than sixty years ago. See R. G. Lipsey and K. Lancaster, The
General Theory of Second Best, 24 Rev. Econ. Stud. 11 (1956-1957).
\236\ As Professor Marx notes, the first theorem of welfare
economics provides ``that the allocation of resources is efficient
in a general equilibrium with perfect competition, and in a
perfectly competitive market, price equals firms' marginal cost.
Marx WDT ] 116 n.129 (citing B. Douglas Bernheim and Michael D.
Whinston, Microeconomics 561-62, 601-02).
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Because the theory of the second best by its very nature does not
provide for a single ``first best'' outcome, it provides ammunition for
all economic experts in this proceeding to use to take pot shots at the
models and proposals put forth by their adversaries. If no alternative
is ``first best,'' then each suffers from some imperfection or market
distortion compared with the unattainable ``first best'' outcome in a
perfectly competitive market. But because the ``first best' solution is
unattainable, levying such criticisms is akin to shooting fish in a
barrel.
The salient criticisms, and the difficult task for this tribunal,
involve
[[Page 1980]]
weighing various ``second best'' alternatives, as presented through--
and limited by--the record, to identify the rate structure that better
satisfies the statutory criteria, as construed by the D.C. Circuit and
prior applicable determinations and decisions by the Judges, their
predecessors, the Librarian and the Register. See 17 U.S.C. 803(a)(1).
At the theoretical extremes are two unacceptable approaches to
rate-setting: (1) setting price equal to the marginal physical cost of
copying, which is zero; and (2) setting price on a per unit basis that
exceeds marginal physical cost. In the chasm between these two
inadequate approaches exist many alternative rate structures with
varying rates for various segments of the market. In general terms,
these alternative rate-setting structures are forms of ``price
discrimination,'' which, in the broadest sense, means simply a
departure from a single, per-unit price. See, e.g., H. Varian,
Intermediate Microeconomics: A Modern Approach 462 (2010) (defining
``price discrimination'' as''[s]elling different units of output at
different prices''). For example, rates based on a percent-of-revenue
(even without any alternative rate prongs) are themselves a blunt form
of price discrimination. J. Cirace, CBS v. ASCAP: An Economic Analysis
of a Political Problem, 47 Ford. Rev. 277, 288 (1978) (``A license fee
based upon a percentage of gross revenue is discriminatory in that it
grants the same number of rights to different licensees for different
total dollar amounts, depending upon their ability to pay [and] [t]he
effectiveness of price discrimination is significantly enhanced by the
all-or-nothing blanket license.''); W.R. Johnson, Creative Pricing in
Markets for Intellectual Property, 2 Rev. Econ. Rsch. Copyrt. Issues
39, 40-41 (2005) (identifying revenue sharing licenses as a form of
price discrimination).\237\
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\237\ Even in the case of an ordinary private good with
increasing marginal costs, sellers will prefer to price
discriminate, increasing the ``producer surplus'' and shrinking the
``consumer surplus,'' if they can identify the WTP of different
segments of the demand curve and can avoid after-market arbitrage
(i.e., avoiding low WTP buyers re-selling to higher WTP buyers and
thus depriving sellers of the benefits of price discrimination). See
Nicholson & Snyder, supra, at 503 (``whether a price discrimination
strategy is feasible depends crucially on the inability of buyers of
the good to practice arbitrage.''). Further, sellers of cultural
goods generally use price discrimination when they have excess
supply and temporally-limited demand. See W. Baumol, Applied Welfare
Economics, in R. Towse, A Handbook of Cultural Economics at 26 (1st
ed. 2003) (noting that for theatres ``[s]olvency generally requires
price discrimination,'' thereby avoiding the economic loss arising
from ``half-empty theatres''). Moreover, even sellers of all sorts
of goods, and even in a competitive market, will find it rational to
attempt to use price discrimination whenever it becomes apparent
that marginal sales at lower prices to low WTP buyers will at least
cover some fixed costs. See W. Baumol, Regulation Misread by Misread
Theory: Perfect Competition and Competition-Imposed Price
Discrimination at 6 (2005) (``[U]nder competitive conditions the
firm will normally be forced to adopt discriminatory pricing
wherever . . . feasible. . . . [U]niform pricing is not to be taken
as the normal characteristic of equilibrium of the competitive
firm.''). Thus, the ``general'' per-unit pricing presented in
Economics 101 may not be quite so ubiquitous, placing any per-unit
pricing proposal in this proceeding on even more tenuous grounds.
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The Judges have utilized a price discriminatory approach previously
to reflect a segmented marketplace. In Web IV, the Judges set three
different per play royalty rates for sound recording licenses for
noninteractive services pursuant to section 114; one rate for ad-
supported services; a higher rate for subscription services; and a
lower rate for educational broadcasters. See Web IV, supra, 81 FR at
26346, 26405, Likewise, in the rate court, the royalty rate paid to
songwriters for performances on noninteractive services is lower than
the rate paid for performances on interactive services. See In re
Pandora Media, 6 F.Supp.2d 317, 360 (S.D.N.Y. 2014), aff'd sub nom
Pandora Media, Inc. v. ASCAP, 785 F.3d 73 (2d Cir. 2015) (setting
noninteractive performance royalties paid by noninteractive services
below the rate by interactive services, and noting that ``[i]f there
was one principle regarding rate structure on which the parties agreed
at trial it was that the rate for customized radio should be set below
the rate for on-demand interactive services.'').
Perfect price discrimination (i.e., ``first-degree'' price
discrimination) is essentially not possible. (For example, a senior
discount may be afforded to a millionaire who has a WTP, based in part
on income, far above the price imputed in his or her senior discount.)
See generally Nicholson & Snyder, supra, at 505 (``First-degree price
discrimination poses a considerable information burden for the
monopoly--it must know the demand function for each potential
buyer.''). However, the existence of any imperfection, whether in a
price discriminatory royalty or any royalty, is not indicative of the
unacceptability of the price structure as an appropriate benchmark or
statutory rate structure. Rather, such imperfections must be weighed
against the imperfections in any other proffered pricing structure.
Thus, when a regulator is tasked with rate-setting, the process
inescapably requires the use of informed judgment in order to consider
the competing benefits and costs of any proposed rate structures and
levels. See generally 1 A. Kahn, The Economics of Regulation 198 (1970)
(``The decision about what kinds of modifications second-best
considerations recommend can be made only by looking at the facts in
each individual case. No set of economic principles can substitute for
the use of judgment in their application.''). In the present context,
that judgment is informed through the adjudicatory process that places
the economic experts of the licensors and licensees in an adversarial
proceeding, revealing the strengths and weaknesses of their approaches,
through direct and rebuttal written testimony, direct and cross-
examination, and inquiries from the Judges.\238\
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\238\ Thus, in contrast with the Majority Opinion, this Dissent
does not attempt to arbitrarily select disparate elements from the
record to create, post-hearing, a rate structure that was not
subject to this adversarial process.
---------------------------------------------------------------------------
I consider these various approaches in the context of the foregoing
economic principles.
G. The Parties' Proposals
1. The Services (i.e., excluding Apple)
The Services propose respective rates and rate structures that--
while varying in their particulars--share a number of common elements.
Broadly, the Services propose a rate structure that in the main
continues the current rate structure. More particularly, the Services'
proposals share the following core elements:
(1) the rate should continue be set as an ``All-In'' rate for
musical works licenses, i.e., a mechanical rate that permits all
services to deduct royalties paid to the same rights holders and
their agents for performing rights;
(2) the rate should continue to be structured as a percentage of
revenue, subject to certain minima; and
(3) the ``All-In'' headline rates should continue, with the
subpart B headline rate maintained at 10.5% of revenue.
However, the Services propose that the ``Mechanical Floor'' in the
existing rate structure be discontinued.
The principle additional and differing particulars of the rate
structures proposed by each Service are set forth below.
a. Amazon
In its May 11, 2017 ``Proposed Rates and Terms'' (Amazon Proposal),
Amazon proposes that the rate structure as currently set forth in the
applicable regulations should rollover into the 2018-2022 rate period,
except as otherwise proposed by Amazon. Amazon Proposal at 1. In that
regard, the following elements comprise the core structure of Amazon's
proposed
[[Page 1981]]
rate structure that would constitute changes in the current
regulations:
The per subscriber minimum and/or subscriber-based
royalty floors for a ``family account'' should equal 150% of the per
subscriber minimum and/or subscriber-based royalty floor for an
individual account.
A student subscription account discount of 50% should
be included in the regulations to the per subscriber minimum and
subscriber-based royalty floor that would otherwise apply under the
current regulations.
A discount for annual subscriptions equal to 16.67% of
the minimum royalty rate (or rates) and subscriber-based royalty
floor (or floors) that would otherwise apply under Sec. 385.13.
A 15% discount to the minimum royalty rate (or rates)
and subscriber-based royalty floor (or floors) to reflect a
service's actual ``app store'' and carrier billing costs, not to
exceed 15% for each.
Amazon Proposal at 1-2.
b. Google
As noted supra, in its May 11, 2017 ``Amended Proposed Rates and
Terms'' (Google Amended Proposal),\239\ Google proposes a rate
structure that combines certain elements, eliminates other elements and
uses specific rates, together in a combination that was not presented
at the hearing.\240\ Specifically, the Google Amended Proposal set
forth a rate structure that ``eliminat[es] . . . different service
categories'' and replaces them with ``a single, greater-of rate
structure between 10.5% of net service revenue and an uncapped 15-
percent TCC component.'' Id. at 1.\241\ Similar to one of Amazon's
proposals, Google also seeks a discount in rates for ``carrier billing
costs'' and ``app store commissions,'' plus ``credit card commissions''
and ```similar payment process charges,'' all not to exceed 15%. Id. at
6 (for subpart B); 26 (for subpart C).\242\
---------------------------------------------------------------------------
\239\ The Google Amended Proposal amended its original proposal
filed on November 1, 2016. Google originally proposed a subpart B
rate structure that generally followed the existing structure.
Google Written Direct Statement, Introductory Memorandum at 3 (Nov.
1, 2016).
\240\ Google's post-hearing proposal appears to have been an
impetus for the majority to invent its own post-hearing structure of
rates, albeit different in its particulars even from Google's post-
hearing proposal.
\241\ As noted supra, ``TCC'' is an industry acronym for ``Total
Content Cost.''
\242\ Google describes this proposed change as a change in the
definition of ``Service Revenue,'' unlike Amazon, which described
its proposed 15% discount as a change in rates. The difference is
mathematically irrelevant, and, for the sake of completeness and
consistency, these 15% discount proposals are treated here as
proposed changes in rates.
---------------------------------------------------------------------------
Google also proposed a new rate of 13% of the record company's
total wholesale revenue from the music bundle in accordance with GAAP
for the provision of music bundles under subpart C, where the record
company is the licensee. Google Amended Proposal at 33-34.
Additionally, Google proposed a new royalty of 15% ``of the applicable
consideration expensed by the service, if any . . . incremental to the
applicable consideration expensed for the right to make the relevant
permanent digital downloads and ringtones.'' Id. at 34.\243\
---------------------------------------------------------------------------
\243\ Google's proposed single 10.5% TCC rate does not include
the ``Mechanical-Only Floor'' that Pandora and Spotify expressly
seek to eliminate. The ``Mechanical-Only'' Floor, found in 37 CFR
385.15, ensures that music publishers and songwriters will receive
no less than a fixed per-subscriber amount of between $0.25 and
$0.50, regardless of the amount that remains after deduction of
musical works performance royalties from the ``All-In'' rate.
---------------------------------------------------------------------------
However, Google is in favor of the general elements of the
Services' proposal, set forth supra, if the Judges were to: (a) reject
its amended proposal in toto, see Google's Proposed Findings of Fact
and Conclusions of Law ] 8 (Google PFF); or (b) adopt Google's amended
proposal but incorporate a TCC rate greater than the 15% proposed by
Google. See id. ] 47.
c. Pandora
In its May 11, 2017 ``Proposed Rates and Terms (As Amended)''
(Pandora Amended Proposal),\244\ Pandora seeks the following changes
from the current regulations:
---------------------------------------------------------------------------
\244\ The Pandora Amended Proposal superseded its original
proposal filed on November 1, 2016, by adding definitions (for
``fraudulent streams'' and ``play'') that do not directly relate to
the royalty rates. See Pandora Media, Inc.'s Proposed Findings of
Fact and Conclusions of Law Appx. C (Pandora PFFCOL).
Elimination of the alternative computation of
subminimums I and II now in Sec. 385.13 and in Sec. 385.23 (for
subparts B and C respectively) ``in cases in which the record
company is the Section 115 licensee.''
A broadening of the present ``not to exceed 15%''
reduction of ``Service Revenues'' in Sec. 385.11 to reflect, in
toto, an exclusion of costs attributable to ``obtaining'' revenue,
``including [but not expressly limited to] credit card commissions,
app store commissions, and similar payment process charges.'' \245\
---------------------------------------------------------------------------
\245\ Pandora does not expressly describe this change as a
change in rates per se.
---------------------------------------------------------------------------
A discount on minimum royalties for student plans ``not
to exceed 50%'' off minimum royalty rates set forth in Sec. 385.13.
Id. at 1, 7.
d. Spotify
In its May 11, 2017 ``Second Amended Proposed Rates and Terms''
(Spotify's Second Amended Proposal), Spotify seeks the following
changes from the current regulations:
For all licensed activity, the ``mechanical-only''
royalty floor should be removed, i.e., removed from Sec. Sec.
385.12(b)(3)(ii) and 385.13(a)(1) & (3) for: (a) standalone non-
portable subscription-streaming only; and (b) standalone portable
subscriptions service.
A broadening of the present ``not to exceed 15%''
reduction of ``Service Revenues'' in Sec. 385.11 to reflect, in
toto, an exclusion of the actual costs attributable to ``obtaining''
revenue, ``including [but not expressly limited to] credit card
commissions, app store commissions similar payment process charges,
and actual carrier billing cost.''
2. Apple
Apple proposed that the Services pay or $0.00091 for each non-
fraudulent stream of a copyrighted musical work lasting 30 seconds or
more. Apple Inc. Proposed Rates and Terms (as amended) at 3-4. Apple
proposed defining a use as any play of a sound recording or a
copyrighted work lasting 30 seconds or more. Additionally, Apple
proposed an exemption for a ``fraudulent stream,'' which it proposes be
defined as ``a stream that a service reasonably and in good-faith
determines to be fraudulent.'' Id. at 2.
For paid locker services, Apple proposes a $0.17 per subscriber
fee, also as a component of an ``All-In'' musical works royalty rate
that would include the ``Subpart C'' royalty, the mechanical royalty,
and the public performance royalty. Id. at 7-8. For purchased content
locker services, Apple proposes a zero royalty fee. Id. at 7.
3. Copyright Owners
The Copyright Owners proposed that the Judges adopt a unitary
greater-of rate structure for all interactive streaming and limited
downloads that are currently covered by Subparts B and C.\246\
Copyright Owners' Amended Proposed Rates and Terms, at 3 (May 11, 2017)
(Copyright Owners' Amended Proposal). The proposal was structured as
the greater of a usage charge and a per-user charge. Specifically, each
month the licensee would pay the greater of (a) a per-play fee
($0.0015) multiplied by the number of interactive streams or limited
downloads during the month and (b) a per-end user \247\ fee
[[Page 1982]]
($1.06) multiplied by the number of end users during the month. Id. at
8. The license fee would be for mechanical rights only, and would not
be offset by any performance royalties that the licensee paid for the
same activity (i.e., the existing ``All-In'' aspect of the rate
structure would be eliminated). Id.
---------------------------------------------------------------------------
\246\ The Copyright Owners' rate proposal would apply the
subpart A rates to so-called ``music bundles'' (``offerings of two
or more Subpart A products to end users as part of one
transaction'') which are currently covered by subpart C. Id. at 3
nn. 2 & 4.
\247\ Copyright Owners' original proposal defined ``end user''
as any person who ``had access'' to a standalone music service. Id.
at 8-9. However, Copyright Owners narrowed their proposed definition
of ``end user'' to include any person who (a) pays a fee for access
to a standalone music service offering licensed activity during the
relevant accounting period, or (b) makes at least one play of
licensed activity during the relevant accounting period. This would
apparently have the effect of, for example, excluding as an ``end
user'' any Amazon Prime member or listener to Spotify's ad-supported
service who did not listen to any song in the accounting period.
Copyright Owners' Amended Proposal at 8.
---------------------------------------------------------------------------
H. The Structure of the Rates for the Forthcoming Rate Period
1. Per-Play or Percent of Revenue (with Minima)
a. Copyright Owners'/Apple's Argument for a Per-Unit Rate 248
---------------------------------------------------------------------------
\248\ Copyright Owners' per-unit proposal contains two prongs in
a greater-of structure. The first is a per-play prong, and the
second is a per-user prong. The greater-of proposal is considered
infra.
---------------------------------------------------------------------------
Copyright Owners and Apple emphasize that a per play royalty rate
structure, as compared with a percent of revenue-based structure,
provides transparency and simplicity in reporting to songwriters and
publishers, because it requires only one metric besides the rate
itself--the number of plays, making it much easier to calculate and
report, and for songwriter/licensors to understand. See, e.g., Rysman
WDT ] 56; Wheeler WDT ] 19; Expert Report of Anindya Ghose November 1,
2016 ]] 83-84 (Ghose WDT); Ramaprasad WDT ] 41; Brodsky WDT ] 76; 3/22/
17 Tr. 2476-78 (Dorn); 3/22/17 Tr. 2855-56 (Ghose). Relatedly,
Copyright Owners argue that a transparent metric tied to actual usage
is superior because, under the alternative percent-of-revenue approach,
services can manipulate revenue through bundling, discounting, and
accounting techniques. Licensors also note that licensees' might defer
service revenues and emphasize increasing market share rather than
profits. Rysman WDT ]] 43-45.
Copyright Owners and Apple contrast their proposed per play
approaches with the current rate structure, which they characterize as
cumbersome and convoluted. They emphasize that under the current rate
structure, the services must perform a series of different greater of
and lesser of calculations, depending on a service's business model, to
determine which prong of the rate structure is operative. Proposed
Findings of Fact of Copyright Owners ] 16 (COPFF) (and record citation
therein). Copyright Owners assert that because of this complexity,
publishers and songwriters cannot easily verify the accuracy of data
the services input when calculating royalty payments. See Brodsky WDT ]
76; Ghose WDT ]] 80, 81, 82; Ramaprasad WDT ]] 4, 38, 42-44; Rysman WDT
] 57; 3/23/17 Tr. 2865 (Ghose); 3/22/17 Tr. 2477-78 (Dorn).
Beyond the issue of complexity, Copyright Owners and Apple argue
that interactive streaming services do not need the present upstream
rate structure in order to adopt any particular downstream business
model. Rather, Copyright Owners and Apple assert that a per-play
structure would establish a level of equality in the royalty rates
across these services, without regard to business models, and the
services could price downstream in whatever manner they choose. But
regardless of the downstream pricing structure, songwriters and
publishers would be paid on the same transparent, fixed amount--without
advantaging any one business model over another. See, e.g., 3/23/17 Tr.
2849, 2863 (Ghose)
Thus, Copyright Owners and Apple maintain that a royalty based on
the number of plays aligns the compensation paid to the creators of the
content with the actual demand for and consumption of their content.
Ghose WDT ] 84; Rysman WDT ]] 9, 58; Testimony of David Dorn ] 33 (Dorn
WDT).
Copyright Owners further argue that the present rate structure's
failure to measure royalties based on per play consumption is
counterintuitive, because it permits a decreasing effective per play
rate even as the quantity of songs that listeners ``consume'' via
interactive streaming is increasing. Israelite WDT ] 39. Copyright
Owners note, for example, that listening to [REDACTED] increased from
[REDACTED] streams in July 2014 to [REDACTED] streams in December 2016,
a fifteen-fold increase in the number of streams. Hubbard WRT, Ex. 1;
id. at WRT ] 2.22; 4/13/17 Tr. 5971-72 (Hubbard). However,
contemporaneously [REDACTED] mechanical royalty payments to the
Copyright Owners only increased [REDACTED]. (Hubbard WRT ] 3.9; 4/13/17
Tr. 5971-73 (Hubbard). The upshot, Copyright Owners assert, is that, as
streaming consumption increased dramatically from 2014 to 2016, the
effective per stream mechanical royalties paid by [REDACTED] to
Copyright Owners decreased from [REDACTED]to [REDACTED]. 4/13/17 Tr.
5972-73 (Hubbard).
Finally, Copyright Owners assert that a per-unit rate is
appropriate because a musical work has an ``inherent value.'' See,
e.g., Israelite WDT at 10; ]] 29(B), 30, 31(C); Brodsky WDT ] 68 At the
hearing, NMPA's president, Mr. Israelite explained how he construes the
``inherent value'' of a musical work: ``[W]homever owns an individual
copyright is the one to define it. I think that would be the most
appropriate definition of it. What someone is willing to license it for
would be that inherent value to that owner. That would be my view. . .
. That would be the market value.'' 3/29/17 Tr. 3707 (Israelite).
b. The Services' Arguments in Opposition to a Per-Play Rate Structure
The Services make several arguments in opposition to the use of a
proposed per-play royalty rate. The overarching theme of these
arguments is that an inflexible ``one size fits all'' rate structure
would be ``bad for services, consumers, and the copyright owners
alike.'' Services' Joint Proposed Findings of Fact and Conclusions of
Law at p. 89 (SJPFF).
First, they argue that an upstream per-play rate would not align
with the downstream demand for ``all-you-can-eat'' streaming services.
As Professor Marx testified, a per stream fee introduces a number of
distortions and inefficiencies, encouraging a capping of downstream
plays and reduces incentives for services to meet the demand of
consumers ``who are going to stream a lot of music.'' Marx WDT ]] 130-
131. In this vein, Pandora's then president, Michael Herring, noted
that a per-play consumption-based model where the revenue is fixed per
user creates uncertainty and volatility around prospective margins, and
the uncertainty discourages investment and hampers profitability. 3/14/
17 Tr. 894-95 (Herring). Mr. Herring notes that this a general economic
problem that occurs when a retail subscription business has fixed
subscription revenues per customer but costs that are variable and
unpredictable because the downstream quantity of units accessed are
themselves variable and unpredictable. Written Rebuttal Testimony of
Michael Herring ] 17 (Herring WRT); 3/14/17 Tr. 894-98 (Herring). See
also Mirchandani WDT ] 39 (one-size-fits-all rate is not ``offering
agnostic'' as Copyright Owners claim, but rather is ``offering
determinative.'')
Second, the Services argue that there is no ``revealed preference''
in the marketplace for musical works and sound recordings for a per-
play royalty, as opposed to a percent of revenue royalty (with minima).
In particular, they point out that mechanical royalties have never been
set on a per play basis. See Herring WRT ] 19. The Services
[[Page 1983]]
also point to the direct licenses interactive services regularly enter
into with music publishers, PROs and record companies--[REDACTED].
SJPFF ]] 174-75 (and record citations therein). They acknowledge that
some of the agreements with record companies contain alternative per-
user prongs, id.] 175, but they note that this is consistent with the
existing rate structure which already contains a per subscriber minima,
but not a per play prong. Further, the Services note that [REDACTED].
See 3/23/17 Tr. 2857 (Ghose); see also 3/22/17 Tr. 2479 (Dorn) (Apple
paying [REDACTED] rate under direct licenses with publishers).
Third, the Services discount the argument that Copyright Owners'
proposed rate structure is superior to the present rate structure
because the latter is too complicated or cumbersome. They characterize
this criticism as ``overblown,'' and further take note that the
detailed nature of the structure is designed to ameliorate any problems
associated with the use or calculation of a revenue-based headline
rate, by the inclusion of per subscriber and TCC minima. SJPFF ] 174.
They further note that section 801(b)(1) does not list as a criteria or
objective that the rates must be simple or easy for songwriters to
understand, or otherwise ``transparent.'' Services' Joint Reply to
Apple Inc.'s Findings of Fact and Conclusions of Law at 34, 36 (SJRPFF-
A). Thus, they argue, the Judges cannot jettison an otherwise
appropriate rate structure because some unquantified segment of the
songwriting community might be uncertain as to how their royalties were
computed.
Finally, separate from these arguments against per-play rate
proposals, the Services note a vexing problem related to Apple's
specific proposal: How to convert the typical percent-of-revenue
performance royalty into a per play rate in order to subtract it from
Apple's proposed per play mechanical rate, so as to calculate the
``All-In'' rate? (This problem is irrelevant to Copyright Owners'
proposal, because they propose the elimination of the ``All-In''
provision in the rate structure.) The Services note that Apple Music's
Senior Director, David Dorn, was unable to explain how this calculation
would be made. See 3/22/17 Tr. 2508-09 (Dorn). Thus, the Services
assert that Apple's proposal would introduce ``more complexity, not
less.'' SJRPFF-A at 34.
2. An Issue within the Per-Unit Approach: Copyright Owners' ``Greater-
Of'' Rate Proposal
Copyright Owners propose a ``greater of'' per-unit structure,
whereby the royalty would equal the greater of $.0015 per play and
$1.06 per-end user per month. In support of this approach, Copyright
Owners assert that it establishes a value for each copy that is
independent of the services' business models and pricing strategies.
Rysman WDT ] 89. They argue that the greater of structure is not any
more complicated than a per play rate alone--and much less complicated
than the 2012 rate structure--because adding a per-user royalty rate to
the structure requires only one additional metric for royalty
calculation--the number of users. Brodsky WDT ] 76. Copyright Owners
also assert that their greater-of structure is a usage-based approach,
aligned with the value of the licensed copies because each rate tier is
tied to a ``particular use,'' as it couples rates with usage and
consumption. CORPFF-JS at p. 22. Finally, Copyright Owners note that in
music licensing agreements it is not uncommon to find royalty rates set
in a greater of formula that includes a per user and a per play prong
(as well a percent-of-revenue prong). See CORPFF-JS at p. 97 (and
record citations therein).
The services (i.e., including Apple) assert that the greater-of
aspect of Copyright Owners' rate proposal would lead to absurd and
inequitable results, well above the rates established under Copyright
Owners' per-play rate prong. This point is explained in detail by
Professor Ghose, one of Apple's economic expert witnesses. Professor
Ghose explains that under Copyright Owners' greater of structure,
interactive streaming services would pay under the per-user prong if
the average number of monthly streams per user was less than 707. 4/12/
17 Tr. 5686-5687 (Ghose). Thus, such a service would be required to pay
the $1.06 per user rather than $0.0015 per stream. Id. at 5687. As an
example, Professor Ghose used a hypothetical scenario in which a
service had one user who listened to 300 streams in a given month.
Under Copyright Owners' $0.0015 per play prong, the service would pay $
0.0015 x 300, equal to $.45 in royalties. Under its per user prong, the
service would pay a royalty of $1.06 for the one user, which is an
effective per play rate of 1.06 / 300, which equals effectively $
0.0035 per play, more than two times the $0.0015 rate under the stated
per play prong. 4/12 Tr. 5687 (Ghose).
Importantly, Apple argues from the record evidence that Professor
Ghose's example is representative, because services monthly streams
have historically been less than 707. More granularly, relying on data
in Dr. Leonard's written rebuttal testimony, Apple contends that the
annual weighted average number of streams per-month per-user across
current Subpart B and Subpart C services has always been below
[REDACTED] in each year from 2012 to 2016. See Leonard WRT Ex. 3b. More
particularly, the number of monthly per user streams for each of those
five years was [REDACTED] (in 2012), [REDACTED] (in 2013), [REDACTED]
(in 2014), [REDACTED] (in 2015) and [REDACTED] (in 2016). Id.
Additionally, the average number of streams per-month per-user has
exceeded 707 (which would trigger the per play prong) [REDACTED]
according to the service-by-service data. Id. (Deezer averaged
[REDACTED] streams in 2014 and Tidal averaged [REDACTED] streams in
2016. Id.) Apple argues that this historical data indicates that the
services would consistently pay more than the $0.0015 per play rate.
See Apple Inc.'s Findings of Fact and Conclusions of Law
F284 (Apple PFF).\249\
---------------------------------------------------------------------------
\249\ This analysis also underscores the inaccuracy of Copyright
Owners' claim that each stream of a musical work has ``inherent
value.'' See, e.g., Israelite WDT ] 39 (It ``makes no sense'' if
``[e]ach service effectively pays to the publisher and songwriter a
different per-play royalty.'') But in reality, Copyright Owners
understand that each musical work also contributes to a different
value--access value (what economists call ``option value'')--when
the musical works are collectivized and offered through an
interactive streaming service, resulting in different effective per
play rates paid by services if the per user prong is triggered. To
explain this inconsistency, Copyright Owners note the existence of a
second ``inherent value''--the access or option value noted above--
not created by the songwriter in his or her composition--but rather
created by the publisher to provide a separate value for the user--
who inherently values access to a full repertoire. But these two
purportedly ``inherent'' values are inconsistent (which is why there
are two prongs in the proposal) and, given the heterogeneity of
listeners, neither value is homogeneous throughout the market.
---------------------------------------------------------------------------
According to Apple, even Copyright Owners' own expert, using
different data, found that [REDACTED] services he reviewed would have
been required to pay under the per-user prong in December 2015, if the
Copyright Owners' proposal had been in effect. Rysman WRT ] 87, Table
1. In like fashion, Professor Rysman's data for December 2014 data
indicated that [REDACTED] services would have been required to pay
under the per-user prong. Id. at Table 2.
Professor Ghose expands the hypothetical scenarios in an attempt to
[[Page 1984]]
demonstrate what he considers to be the absurdity of Copyright Owners'
greater-of approach, as depicted in his chart, reproduced below:
[GRAPHIC] [TIFF OMITTED] TR05FE19.015
Copyright Owners do not dispute these analyses. Rather, they make
two points. First, they claim that the binding nature of the per user
prong is not problematic, because the [REDACTED]. See Copyright Owners'
Reply to Apple's Proposed Findings of Fact and Conclusions of Law at
104 (CORPFF-A). I find this argument to be a non-sequitur, because
sound recording rates in this context certainly have no bearing on the
present issue, and Copyright Owners also do not indicate which prong
would otherwise apply in those sound recording licenses. In fact, a
review of the citations in CORPFF-A at 104 reveals that [REDACTED]. See
COPFF ] ] 72, 91-92, 95.
Second, as noted supra, Copyright Owners attempt to support what
appear to be absurd effective per play rates by explaining that the per
user rates reflect the value of access to the repertoires, as opposed
to the value of an individual stream--again, what economists refer to
as an ``option price. See CORPFF-A at 104-105 (and citations therein).
I agree that this access or option value is real. However, when such a
value is inserted into a greater-of rate formula--where the access
value is supplanted by the per play value, and vice versa- the pricing
resembles a game of ``heads I win, tails you lose.'' Moreover, as noted
supra, the marginal physical cost of an additional stream is zero, so
it is economically inefficient to marry a per play fee to a per user
fee in a greater of approach. Cf. Leonard 3/15/17 Tr. 1122-23 (Leonard)
(efficient pricing would utilize an up-front fee and a zero per play
fee thereafter).
None of the parties presented any economic or policy analysis of
such a ``greater-of'' formula aside from its witnesses' own
testimonies. Further, I did not identify any such academic or industry
analyses of this ``greater-of'' approach. However, the Copyright Board
of Canada has criticized this type of rate structure in the following
manner, which I find persuasive:
[A] ``greater-of'' tariff [i.e., rate] would not be fair and
equitable, because it would provide an undue advantage to
[licensors] on two counts. To be fair and equitable, a tariff should
neither overcompensate nor undercompensate rights owners. If set
correctly, neither a per-play rate nor a percentage-of-revenue rate
will tend to do so, to the extent that each captures a (different)
measure of usage. On the other hand, a tariff set at the greater of
those two rates is hedged in favor of the collective. It may prevent
undercompensation if a service has low revenues; it does not prevent
overcompensation in the case of a high-revenue service that uses few
sound recordings. A greater-of formulation also burdens users with
an unfair share of risks. [Licensors] benefit[ ] if there are high
revenues and a large number of plays, if there are high revenues and
a small number of plays, and if there are low revenues and a large
number of plays. Only if there are low revenues and a small number
of plays does the user benefit. By contrast, either a per-play or a
percentage-of-revenue tariff, with or without a minimum fee,
allocates risk between [licensors] and the users more evenly.
Copyright Board of Canada, Statement of Royalties . . . Re:Sound Tariff
8--Non-interactive and Semi-interactive Webcasts 2009-2012, Decision of
the Board at 27-28 (May 16, 2014).
I recognize that the 2012 rate structure also contains a greater-of
formula. Importantly, though, the alternative prong is not a per play
prong, avoiding the unfairness identified in the Canadian Judges'
opinion. Also, the 2012 greater-of structure was a negotiated bargain,
indicating a revealed preference among all potential alternatives.
Moreover, the alternative to the percent-of-revenue prong is itself a
``lesser-of'' formulation, dampening the impact of the ``greater-''of''
structure. Thus, the 2012 rate structure has the effect of moderating
the negative impact of a greater of formulation such as proposed by
Copyright Owners by keeping rates, calculated on either prong, on bases
and at levels the parties agreed were acceptable.
In sum and as explained supra, many economic trade-offs must be
weighed in
[[Page 1985]]
establishing pricing in this second-best scenario. Some rate structures
tend to balance the several factors and thus are reasonable, whereas
others may tend to favor one side of the transaction over the other and
do not meet the standard of reasonableness. Copyright Owners' greater-
of approach represents such a one-sided structure, and accordingly I
would reject this structure.
3. The Services' Argument for a Percent-of-Revenue Structure (with
Minima)
a. The Services' General Benchmark
Returning to the issue of per-unit pricing vs. percent-of-revenue
pricing (with minima), the Services propose a rate structure for
Subparts B and C that generally follows the structure set forth in the
existing regulations adopted after the Judges approved the parties'
2012 settlement.\250\ The Services emphasize that they are not simply
advocating that the basics of the 2012 rate structure should be
preserved merely because there is a benefit in preserving the status
quo. See 3/13/17 Tr. 564 (Katz) (relying on the 2012 structure as an
excellent benchmark, ``not because it's the status quo.'').
---------------------------------------------------------------------------
\250\ Except when they do not. As noted supra, the Services seek
the elimination of the ``Mechanical Floor,'' a significant departure
from the existing structure. I discuss that issue elsewhere in this
Dissent.
---------------------------------------------------------------------------
Rather, the Services, through their economic experts, put forth the
2012 rate structure (sans Mechanical Floor) as an appropriate
benchmark--for the Judges to weigh, consider, adjust (if appropriate)
and apply or reject--as they would with any proffered benchmark. See
SJRPFF-CO at pp. 803-04 (and case law and record citations therein).
The Services note that considering the current rate structure as a
benchmark (rather than as a mere attempt to preserve aspects of the
status quo) is instructive because it allows for an identification of
market value by analogy--through the examination of a comparable
circumstance, rather than requiring the experts and the Judges to build
a theoretical model from the ``ground up'' to represent the industry at
issue, and without requiring the Judges to substitute their analysis
and judgment as to why terms were included within the benchmarks. See
3/13/17 Tr. 691-2 (Katz) (``[My overall approach has been just ask the
question [if] we take this as a benchmark . . . [i]s it reasonable to
take the [2012] structure? . . . . [I]n trying to rely on the
benchmark, I am trying to say, okay, well, the industry decided this,
let me ask, is it working overall? . . . '' [T]hat's what I would tend
to do with any benchmark. I am using it as a benchmark to avoid having
to model things and build it from the ground up.'') (emphasis added).
The Services' experts opine that, for a number of reasons, the 2012
rate structure is not only a benchmark, but also that it is a highly
appropriate benchmark. First, they note that the 2012 rate structure
embodies characteristics that the Judges have consistently identified
as part and parcel of an appropriate benchmark. That is, the 2012 rate
structure applies to: (a) the same rights; (b) the same uses; and (c)
the same types of market participants. See 3/15/17 Tr. 1082-83
(Leonard); 3/13/17 Tr. 551, 566-7 (Katz).
Additionally, because the 2012 rate structure was the product of a
settlement between and among market participants, the Services maintain
that it reflects market forces, including an implicit consensus as to
the effects of the structure on piracy and potential substitution
across platforms. See 3/13/17 Tr. 580, 722 (Katz). More broadly, they
argue that because the 2012 rate structure was agreed to by market
participants who had assumedly weighed the costs and benefits of their
agreement, it therefore demonstrates the ``revealed preferences'' of
these economic actors. See 3/15/17 Tr. 1095 (Leonard); see also Leonard
AWDT ] 74 (direct license agreements that track the regulatory rate
structure are further evidence of a ``revealed preference'' for that
structure).
Another Service expert notes that--because the Services have
different tiers of listeners paying at different levels--their economic
incentives are aligned with Copyright Owners--to avoid substitution of
their higher priced services by their lower priced services (i.e., to
avoid opportunity costs). Thus, the incentives that existed when the
2012 rate structure was first implemented remain in effect. See 3/21/17
Tr. 2192 (Hubbard) (testifying that there continues to be a
``substantial heterogeneity on the consume side of the market.'').\251\
Finally, the Services assert that the 2012 benchmark is relevant and
helpful because, although it was entered into five years ago, it is
nonetheless a relatively recent agreement, covering the current rate
period and serving as a template for current agreements. See Katz WDT
]] 6, 71; 3/13/17 Tr. 608-09 (Katz); Leonard AWDT ] 47 et seq. (noting
that ``existing agreements'' regularly track the section 115
provisions); 3/15/17 Tr. 1082 (Leonard). As noted by Amazon's Head of
Content Acquisition, Mr. Mirchandani, the 2012 rate structure has been
demonstrated to be ``workable,'' even if ``imperfect.'' Mirchandani WDT
] 7.
---------------------------------------------------------------------------
\251\ Professor Hubbard further notes that he identified no
empirical evidence in the record of any opportunity costs incurred
by Copyright Owners as a consequence of the extant rate structure,
and that the survey results obtained by the Klein Survey support his
claim that substitution/cannibalization is not a material economic
factor. 4/13/17 Tr. 5918 (Hubbard). This issue is discussed in
greater detail infra.
---------------------------------------------------------------------------
The Services' experts further emphasize that the structure of
current rates satisfactorily reflects the economic market conditions in
which the mechanical license for interactive streaming is used. See 4/
13/17 Tr. 5943 (Hubbard) (acknowledging a ``love'' of competitive
markets, and recognizing that there are supply and demand
considerations in this market that require the more flexible pricing
structure generally provided in the current regulations). (I understand
Professor Hubbard's reference to the particularities of ``this market''
to relate to the quasi-public good nature of the copies of musical
works/sound recordings, as discussed in this Dissent, supra.)
The Services' experts candidly acknowledge that the rate structure
they advocate is not necessarily the ``best'' approach to pricing in
this market. See 4/7/17 Tr. 5574-6 (Marx); see also Mirchandani WDT,
supra. Rather, the Services' link the fact that the marginal physical
cost of streaming is zero to the need for a flexible rate structure
such as now exists. Professor Hubbard links the zero marginal physical
cost characteristic to the setting of royalty rates by noting that,
because ``[t]he marginal production cost at issue here is--is zero. . .
. it's not clear why it's not better to bring new customers into the
market on which royalties would be paid and, of course, zero marginal
cost incurred.'' 4/13/17 Tr. 5917-18 (Hubbard). See also Marx WDT ] 97
(``Setting the price of marginal downstream listening at its marginal
cost of zero induces more music consumption and variety than per-song
or per-album pricing.''). I understand this testimony to be consistent
with the economic point, discussed supra, that, in the ``second-best
world'' created by the characteristics of this market, no one can claim
that any given rate structure is the ``best.''
Professor Katz notes that the existing rate structure captures
important specific aspects of the economics of the interactive
streaming market, accounting for: (1) the variable WTP among listeners;
and (2) the corollary
[[Page 1986]]
variable demand for streaming services. See 313/17 Tr. 586-87 (Katz);
see also Marx WRT ] 239 et seq.; 4/7/17 Tr. 5568 (Marx) (noting that
the present structure serves differentiated products offered to
customer segments with a variety of preferences and WTP). In more
formal economic terms, Professor Katz notes that the present structure
enhances variable pricing that allows streaming services ``to
work[][their]way down the demand curve,'' i.e., to engage in price
discrimination that expands the market, providing increased revenue to
the Copyright Owners as well as the Services. 3/13/17 Tr. 701
(Katz).\252\ I understand this testimony to be consistent with the
economic point, made supra, that a price discriminatory rate structure
is appropriate in markets with zero marginal physical cost, varying WTP
and the absence of arbitrage.
---------------------------------------------------------------------------
\252\ A Copyright Owner economic expert, Professor Rysman,
acknowledges that--under the current rate regime--revenues may be
increasing because of movements ``down the demand curve'' (i.e.,
changes in quantity demanded in response to lower prices), rather
than because of--or in addition to--an outward shift of the demand
curve (i.e., an increase in demand at every price). 4/3/17 Tr. 4373-
74 (Rysman).
---------------------------------------------------------------------------
Professor Hubbard attempts to capture the interrelationship between
the economics of this market and the existing rate structure as
follows:
[F]rom an economic perspective, you can think of this market and
this industry as being composed of different customer segments by
tastes and preferences and willingness to pay. And so no rate
structure can really work without understanding that, and no
business model can really work without understanding that.
[I]n terms of rate structures, the Phonorecords II framework
from the previous proceeding does offer a benchmark to start because
it provides for differences in distinct product categories in terms
of music service offerings, pricing possibilities, and so on. And it
has encouraged a very diverse digital music offering set from actual
competitors.
3/21/17 Tr. 2175-76 (Hubbard).\253\ Moreover, Professor Hubbard
perceives a link between the existing rate structure and the ``growth
in the number of consumers, number of streams, entry, the number of
companies providing the streaming services, and the identity of the
companies providing those services . . . .'' 4/13/17 Tr. 5978
(Hubbard); see also Hubbard WDT ] 4.7 ([REDACTED]).\254\ See also 3/15/
17 Tr. 1176 (Leonard) (noting that notwithstanding the changes and
growth in the streaming marketplace over the current rate period, the
underlying economic structure of the marketplace--that made a percent-
of-revenue based royalty appropriate--has not changed).
---------------------------------------------------------------------------
\253\ Professor Hubbard's point that the variety of business
models in the industry is a consequence of the various customer
characteristics is noteworthy as a distinguishing counterpoint to
the simple clich[eacute] that the Judges should be ``business model
neutral.'' 3/21/17 Tr. 2175-76 (Hubbard).
\254\ The Copyright Owners sought to rebut Professor Hubbard's
argument by confronting him with the offerings of Tidal, a streaming
service that does not compete by offering a low-cost service.
Eisenach WDT ]] 49-50. However, Tidal's offering of a higher priced
subscription service that provides enhanced features such as hi-
fidelity sound quality actually proves the point that Professor
Hubbard and the other Service economists are making: There is a
segmentation of demand across product characteristic and WTP that
permits differential pricing in this industry.
---------------------------------------------------------------------------
The Services' experts further assert that the multiple pricing
structures necessary to satisfy the WTP and the differentiated quality
preferences of downstream listeners relate directly to the upstream
rate structure to be established in this proceeding. For example,
Professor Marx opines that the appropriate upstream rate structure is
derived from the characteristics of downstream demand. 3/20/17 Tr. 1967
(Marx) (agreeing that the rate structure upstream should be derived
from the need to exploit the willingness to pay of various users
downstream via a percentage of revenue because downstream listeners
have varying willingness to pay that should be exploited for the mutual
benefit of copyright licensees and licensors). Professor Marx further
acknowledged that this upstream:downstream consonance in rate
structures represents an application of the concept of ``derived
demand,'' whereby the demand upstream for inputs is dependent upon the
demand for the final product downstream. Id. Moreover, Dr. Leonard
notes that ``the downstream company is going to have a lot more
information about . . . the business, about what makes sense,'' 4/6/17
Tr. 5238 (Leonard).
The Services also note that the existing rate structure has
produced generally positive practical consequences in the marketplace.
Their joint accounting expert, Professor Mark Zmijewski, testified that
the decrease in publishing royalties from the sale of product under
Subpart A since 2014 has been offset by an increase in music publisher
royalties (mechanical + performance royalties) over the same period.
Expert Report of Mark E. Zmijewski February 15, 2017 ]] 38, 40
(Zmijewski WRT); 4/12/17 Tr. 5783 (Zmijewski); see also 4/13/17 Tr.
5897 (Hubbard) (``the evidence that I reviewed suggests that the
copyright holders have actually benefitted from this structure . . .
.'').
More particularly, Professor Zmijewski testified that:
1. Total revenues reported by the NMPA for NMPA members from all
royalty sources \255\ [REDACTED] from approximately $ [REDACTED] in
2014 to $ [REDACTED] in 2015, a [REDACTED] in royalty revenue. Id. ]
41.
---------------------------------------------------------------------------
\255\ All royalty sources include mechanical royalties from
physical phonorecords, digital downloads and streaming; performance
royalties from streaming and non-streaming; and synchronization.
Zmijewski WRT ] 41.
---------------------------------------------------------------------------
2. The [REDACTED] in (1) above includes an [REDACTED] in
mechanical royalties from streaming from $ [REDACTED] in 2014 to $
[REDACTED] in 2015, a [REDACTED] in royalty revenue derived from the
mechanical license. Id.
3. The [REDACTED] in (1) above includes an [REDACTED] in
performance royalties from streaming from 4 [REDACTED] in 2014 to $
[REDACTED] in 2015, a [REDACTED]. Id.
4. Mechanical royalty revenue for the sale of downloads and
physical phonorecords [REDACTED] in 2014 to $ [REDACTED] in 2015 (a
[REDACTED] of $ [REDACTED]), while the combination of mechanical and
performance royalty revenue royalty from streaming [REDACTED] from $
[REDACTED] in 2014 to $ [REDACTED] (an [REDACTED] of $ [REDACTED]).
Thus, the [REDACTED] in royalty revenue from streaming outstripped
the [REDACTED] from the sale of downloads and physical phonorecords
by $ [REDACTED]. Id. ] 38.\256\
\256\ By contrast, looking only at mechanical royalty revenue,
for the sale of digital downloads and physical phonorecords
mechanical royalty revenue [REDACTED] from $ [REDACTED] in 2014 to $
[REDACTED] (as noted in (4) above, whereas mechanical royalty from
streaming [REDACTED] from $ [REDACTED] in 2014 to $ [REDACTED] in
2015. Thus, the $ [REDACTED] in mechanical royalty revenue from
streaming [REDACTED] in mechanical royalty revenue from the sale of
digital and physical phonorecords. This comparison is the metric
from Professor Zmijewski's analysis that Copyright Owners assert is
most relevant.
---------------------------------------------------------------------------
Moving to a comparison of revenue growth to streaming growth,
Professor Hubbard dismisses as economically ``meaningless'' the
argument that Copyright Owners have suffered relative economic injury
under the current rate structure simply because the increase in their
revenues from interactive streaming has been proportionately less than
the growth in the number of interactive streams--leading
mathematically--to a lower implicit or effective per stream royalty
rate. 4/13/17 Tr. 5971-73 (Hubbard). That is, there is no evidence
that, if the price of the services available to these low to zero WTP
listeners had been increased, they would have paid the higher price,
rather than declined to utilize a royalty-bearing interactive streaming
service. In fact, the only survey evidence in the record (the Klein
Survey, discussed infra) suggests that listeners to
[[Page 1987]]
streaming services have a highly elastic demand, i.e., they are highly
sensitive to price increases. I understand Professor Hubbard's point to
be highlighting the distinction, also discussed in the economics
overview, supra, between an ``increase in demand'' and an ``increase in
quantity demanded.''
On the licensee (interactive streaming service) side of the ledger,
Professor Katz identifies the entry of new interactive streaming
services (including Pandora) and new investment in existing interactive
streaming services during the present rate period as evidence that the
present rate structure is ``working.'' 3/13/17 Tr. 667 (Katz). In fact,
he notes the ubiquity of percentage-of-revenue based royalty structures
in the music industry, indicating (as a matter of revealed preference)
the practicality of such a revenue-based royalty system. See 3/13/17
Tr. 766-67 (Katz); see also 4/5/17 Tr. 5166-67 (Leonard) (``[I]n the
area of intellectual property licensing . . . percentage-of-revenue is
not exactly surprising. In fact, I would say it is probably the most
common approach that you see as a general matter. . . . [N]arrowing
into the area we're talking about here of interactive streaming, it is
pretty common here, too. . . .'').
In sum, given ``how the industry has performed'' under the current
rate structure, the Services conclude that it is therefore appropriate
to continue that basic structure going forward. 3/13/17 Tr. 565 (Katz).
The Services' economic experts do not ignore the fact that there
may be revenue attribution problems when interactive streaming is
combined with other products or services. They acknowledge that, even
absent any wrongful intent with regard to the identification and
measurement of revenue, attribution of revenue across product/service
lines of various services can be difficult and imprecise. See, e.g., 4/
5/17 Tr. 5000 (Katz) (the problem of measuring revenue is ``certainly a
factor that goes into thinking about reasonableness.'').\257\
---------------------------------------------------------------------------
\257\ This Dissent considers the specific deferral and
displacement arguments in more detail infra.
---------------------------------------------------------------------------
However, Professor Katz testified that the existing rate structure
agreed to by the parties accommodates these bundling, deferral and
displacement issues via the use of a second rate prong that would be
triggered if the royalty revenue resulting from the headline rate of
10.5% of streaming revenue fell below the royalty revenue generated by
that second prong. Katz WDT ]] 82-83; 3/13/17 Tr. 670 (Katz). Moreover,
Professor Katz concluded that, because the marketplace appears to be
functioning (in the sense that publishers are earning profits and new
and existing interactive streaming services continue to operate despite
accounting losses), these revenue-measurement issues are being
adequately handled by the alternative rate prong, even if an altered
second prong might work better. Id. at 738; 4/5/17 Tr. 5055-57 (Katz)
(also noting that ``ecosystem'' entities in the mold of Amazon, Apple
and Google, such as Yahoo, were in the marketplace when the existing
rate structure was formulated). In similar fashion, Dr. Leonard opined
that the 2012 rate structure created a number of ``buckets'' to deal
with problems of this sort. 3/15/17 Tr. 1227-28 (Leonard).
More broadly, the Services' position regarding the use of the two
prongs and their alternate rates to ameliorate the revenue-measurement
problems is summed up by Professor Katz as follows:
[T]he primary reason [for the two rate prongs] . . . is because
of the measurement issues that can come up when having royalties
based on a . . . percentage of revenues because there can be issues
about how to appropriately assign revenues to a service. And so I
think the minim[a] can play an important role when those--you know,
when those measurement problems are severe, you can turn to the
minimum instead. . . . [W]hat I have in mind, right, is that what
would happen if you could imagine an entrepreneur coming along and
saying we want to have a service and have some incredibly low price
and not a very good monetization model, where a copyright owner
would say--in an effectively competitive market, would say, wait a
minute, I don't want to license to you on those terms. It's--I just
think the possibility of getting a return is so low, I'm not going
to do it, even though you, as an entrepreneur, are willing to try
this. I as the copyright owner want some sort of, you know, return
on it. And that's what the minimum also helps to do.
3/13/17 Tr. 599 (Katz.); see also 3/20/17 Tr. 1900-01 (Marx) (minima
protect against revenue measurement problems); 4/7/17 Tr. 5584 (Marx)
(noting that the statutory minima play ``two roles''--protecting the
Copyright Owners from ``revenue mismeasurement'' by creating the
``greater of'' prong, '' but incorporating the per subscriber rate
prong in the ``lesser of'' component to protect the services from
``manipulation of the sound recording royalties'' on which the TCC
prong is calculated).
Another particular issue raised by the existing structure relates
to the significant percentage of listeners to interactive streaming
services that are ``free'' to the user. For example, as of August 2016,
Spotify had [REDACTED] million average monthly users on its ad-
supported service, compared with [REDACTED] million subscribers to its
subscription service. Marx WDT ] 49 n.62 & Fig. 7; Hubbard WDT ] 3.14
and Ex. 4 ([REDACTED]. Accordingly, the treatment of such services in
the rate structure is of particular importance. The majority of the
listeners to the ad-supported format use Spotify's ad-supported
service, although there are other such services available in the
market, including SoundCloud and Deezer. See COPFF ] 341 (and record
citations therein). (The arguments regarding the appropriate rate
structure pertaining to ``free to the user'' services overlaps to an
extent with the argument regarding ad-supported services, and I
consider them jointly.)
The Services assert that they offer ad-supported or other free-to-
the-user interactive streaming tiers to meet the demand of a large
cohort of the listening population that does not have a positive WTP
for streamed music. [REDACTED]. 3/21/17 Tr. 2179-83 (Hubbard); see also
Marx WDT ]] 53-54; Katz WDT ] 86. [REDACTED]. 4/13/17 Tr. 5906
(Hubbard) (``[REDACTED]'') see also 4/5/17 Tr. 5231 (Leonard) (``the
funneling is itself a mechanism to separate out the people who really
value music and want to just be able to listen to what they want to
listen to, versus people who . . . are not willing to pay that amount
of money . . . .''). In this regard, Spotify most aggressively markets
itself as an ``up-seller''--providing its ad-supported service as a
funnel to convert low WTP listeners into subscribers. Spotify's
strategy, as explained by its in-house economist, is as follows:
One of Spotify's key beliefs in its commercial strategy is that
moving someone from piracy to a legal music service needs to be
frictionless--otherwise, they won't come. Often a Spotify user's
journey begins in our free-to-users ad-supported tier, and upgrades
to a paid (or premium) subscription as he or she becomes more
familiar with the enhanced paid-only features through trial
promotions and/or marketing efforts. . . . This presents a ``you
help me today and I'll help you tomorrow'' licensing proposition: as
rightsholders allow Spotify to use their content, Spotify in turn
helps rightsholders, by first taking users from free options that
pay little to no royalties--such as piracy, or even AM/FM radio--to
an ad-supported service that generates higher royalties, and then
further taking these users to a paid service . . . .
Written Direct Testimony of Will Page (On behalf of Spotify USA Inc.)
(Page WDT) ]] 13-14.
Mr. Page notes the success of Spotify in growing the overall
``royalty pie'' in its home country of Sweden, where
[[Page 1988]]
``[w]hat wasn't understood [in 2009], but is appreciated now, is that
the vast majority of the adult population in all key markets spends
zero on music. Spotify's core commercial proposition was to grow the
business by growing the average revenue per person across the entire
population, not by holding onto a shrinking minority of people buying
albums or PDDs.'' Id. ] 24.
To avoid substitution (i.e., cannibalization) that would reduce
revenues to the services and the rightsholders alike, the services
differentiate such ``funneling'' products by intentionally structuring
them as inferior in quality compared to subscription tiers, for example
by interspersing songs with ads (as in the Spotify ``free'' tier) and
by offering a more limited repertoire of songs (as with Amazon Prime
Music). As Professor Hubbard explains, ``free-to-the listener'' tiers
must be inferior in some manner of quality in order to sort out
listeners who have a WTP sufficient to pay for the higher-priced (i.e.,
subscription) tier. He elucidates this point by analogizing to the
discriminatory pricing of airline seating, whereby different classes of
seating combine varying amenity packages with higher prices (i.e.,
first class, business class and coach). Hubbard WDT ] 3.15.\258\
---------------------------------------------------------------------------
\258\ Professor Hubbard's example parallels the insight of the
19th century French economist, Jules Dupuit, one of the first
economists to explain the economics of price discrimination. Dupuit
examined the pricing of several classes of seating on railway
carriages. As he noted: ``[A] good many . . . travelers in third
class, travel[ ] without a roof over the carriage, on poorly
upholstered seats . . . . It would cost very little . . . to put
some meters of leather and kilos of horse-hair [on the seats], and
it is beyond greed to withhold them. It is not because of the
several thousand francs which they would have to spend to cover the
third class wagons or to upholster the benches that a particular
railway has uncovered carriages and wooden benches; it would happily
sacrifice this for the sake of its popularity. Its goal is to stop
the traveler who can pay for the second class trip from going third
class. It hurts the poor not because it wants them to personally
suffer, but to scare the rich. The comfort in third class is
deliberately reduced to dissuade travelers who are ready to pay for
higher levels of comfort from traveling at the cheaper fares.''
Jules Dupuit, De l.infuence des p[eacute]ages sur l'utilit[eacute]
des voies de communication, Annales des Ponts et Chauss[eacute]es,
17, m[eacute]moires et documents 207 (1849), quoted in T. Randolph
Beard & Robert B. Ekelund, Jr., Quality Choice and Price
Discrimination: A Note on Dupuit's Conjecture, 57 So. Econ. J. 1155,
1156-57 (1991).
---------------------------------------------------------------------------
The use of an ad-supported service as a ``freemium'' model thus
serves a dual purpose: First, it is an efficient means of marketing--
segregating listeners according to WTP--allowing them to ``experience''
interactive streaming, while, second, still providing royalties to
Copyright Owners. (If Spotify substituted self-advertising in other
media as a marketing tool instead of offering an ad supported service,
Copyright Owners would realize zero royalties until such self-
advertising resulted in new subscribers.) \259\
---------------------------------------------------------------------------
\259\ The interactive streaming of music is an ``experiential''
good. See Byun, supra, at 23 (``Music is a specific type of good,
known as an experiential good, meaning that it must be experienced
or sampled before the customer can assess . . . quality . . . and .
. . utility.'') Thus, the provision of a monetarily ``free-to-the
user'' service is a reasonable marketing tool, and the Judges are
loath to second-guess the business model incorporating that
marketing approach, especially after it has proven successful while
still providing royalties to rights owners. See Page WDT ] 27
(Spotify's freemium model monetizes through subscriptions more
successfully than the sale of downloads and CDs, as well as
terrestrial radio and, of course, piracy). Also, the Judges do not
find it relevant that many other interactive streaming services have
not utilized an ad-supported service, absent record evidence as to
why they have ceded that significant market (and marketing) niche
principally to Spotify.
---------------------------------------------------------------------------
With regard to the tangible economic benefits of such downstream
products to the upstream Copyright Owners, Professor Marx notes that an
ad-supported service is in the nature of a multi-party ``platform,''
creating an intersection among streaming services, listeners and
advertisers. 3/21/17 Tr. 2013 (Marx). This is why she emphasizes, as
did Mr. Page, supra, that ``Spotify's ad-supported service is
monetizing . . . low-willingness-to-pay listeners better than
[REDACTED], terrestrial radio, and, of course, piracy.'' 4/7/17 Tr.
5503 (Marx); see also Marx WRT at 14, Fig. 7 (comparing ``musical works
royalties per user-hour across these alternatives).
Professor Marx also noted that it is inappropriate to consider the
royalty rates paid by higher-priced interactive streaming services,
such as Tidal, as evidence supporting a finding that ad-supported or
other ``free to the listener'' services pay too little in royalties.
She notes that the ad-supported and other ``free to the listener''
tiers represent the exploitation of the low WTP segment of the demand
curve, whereas other services seek to exploit the higher end of the
demand curve. For example, and as noted supra, Tidal offers a $20 per
month subscription tier that can generate higher royalties, but does so
by offering a differentiated product of higher quality via a premium
high-fidelity. 3/21/17 Tr. 5601-02 (Marx).
4. Copyright Owners' Argument against the 2012 Percent-of-Revenue
Structure (with Minima) and Judicial Analysis of that Argument
a. The Allegedly Limited Evidentiary Value of Settlement Rates
Copyright Owners criticize the relevancy of the 2012 settlement-
based rate structure. First, they note that, as terms in a settlement,
the elements of the rate structure do not reflect the structure the
market would set, but rather reflect only the parties' own prediction
of how the Judges would rule in the absence of a settlement. See 4/4/17
Tr. 4591 (Eisenach).
Second, Copyright Owners dismiss any relevancy in the fact that
they agreed in the 2012 settlement to maintain virtually unchanged the
Subpart B rate structure and rates set forth in the 2008 settlement.
They claim that this essential status quo was maintained because there
had been only a two-year window between the Phonorecords I settlement
and the commencement of proceedings in Phonorecords II, and that no
meaningful market changes occurred in that short time period. However,
the Services dispute the substantive assertion that there was no
significant market development by the time of Phonorecords II. Written
Rebuttal Statement of Zahavah Levine (On behalf of Google, Inc.) ]] 5-6
(Levine WRT); 3/8/17 Tr. 171-172; 270-272 (Levine). Numerous services,
including the more recent large new entrants, had already entered the
market, with some realizing significant subscriber numbers. Id. at 155-
157 (Levine). Ms. Levine further testified that the Subpart B rates
could not reasonably be construed as ``experimental'' during the
Phonorecords II negotiations, and by the time of the Phonorecords II
settlement, other significant market changes had occurred in the music
delivery market. Id. ] 5. For example, she notes that Rhapsody had
already been in the market for approximately ten years and had
approximately one million paying listeners. Id. ]] 5-6.
Third, Copyright Owners assert that [REDACTED]. Rebuttal Witness
Statement of David M. Israelite ] 28 (Israelite WRT); 3/29/17 Tr. 3649-
3652 (Israelite). However, the Services respond by noting that there is
no evidence to support Mr. Israelite's testimony regarding the
[REDACTED]. And, notwithstanding his testimony regarding [REDACTED],
the Services note that the NMPA incurred the expense of a year-long
negotiation with the Services to seek higher rates, create new service
categories in Subpart C, and changes to the TCC calculations. Id. at
159, 161-164; 3/29/17 Tr. 3856 (Israelite).
Fourth, Copyright Owners assert, assuming arguendo that the current
rate structure can be used for benchmarking purposes, that the Services
have not presented competent evidence or testimony as to the intentions
of the settling parties who had negotiated the
[[Page 1989]]
2012 settlement, or, for that matter, the 2008 settlement that preceded
it. Specifically, Copyright Owners claim that the witnesses who were
called by the Services to testify in this regard did not negotiate
directly with the Copyright Owners in connection with these
settlements. 3/29/17 Tr. 3621-22 (Israelite). More particularly, the
two Services' witnesses who provided testimony in this regard, Adam
Parness and Zahavah Levine, acknowledged they had no direct involvement
in the Phonorecords I negotiations, and Ms. Levine did not engage in
direct negotiations with regard to the Phonorecords II settlement
either. 3/9/17 Tr. 339-40 (Parness); 3/29/17 Tr. 3885-86 (Israelite);
see also Israelite WRT ] 14 (indicating that Ms. Levine had left Real
Networks in 2006, before her former subordinate was negotiating the
2008 settlement).
However, the evidence indicates that Ms. Levine and Mr. Parness
were involved in the contemporaneous internal discussions of
negotiation strategy on behalf of the Services, which makes their
testimony relevant as to the intentions of the Services involved in
those earlier negotiations. More particularly, Ms. Levine was employed
by Google/You Tube when the 2012 settlement was negotiated and
finalized. At that time, Google was a member of DiMA, the trade
association representing the interests of actual and potential
interactive streaming services. See Phonorecords II, DiMA Petition to
Participate. Thus, Ms. Levine was competent to give testimony as to the
parties' positions in the negotiations.
Mr. Parness testified, at the time of the Phonorecords I
settlement, he was Director of Musical Licensing for RealNetworks,
Inc., an interactive streaming service and a member of DiMA, its
bargaining representative. In that capacity, Mr. Parness was ``actively
involved'' on behalf of Real Networks. Written Direct Testimony of Adam
Parness (on behalf of Pandora Media, Inc.) ] 5 (Parness WDT). Mr.
Parness understood that the important aspects of the Phonorecords I
negotiations and settlement were: (1) an agreement that noninteractive
services did not need a mechanical license; (2) the interactive
mechanical license would be calculated on an ``All-In'' basis; (3) the
rate would be structured as a percent-on-revenue with certain minima;
and the headline rate would be 10.5%. Parness WDT ] 7. He noted that
the rate minima were included at the behest of Copyright Owners, who
were concerned that a purely revenue-based rate might result in too
little revenue. Id. ] 8. Mr. Parness further testified, with regard to
the 2012 negotiations, that he directly negotiated with Mr. Israelite
and the general counsel for the NMPA, negotiations that led to the
parties' agreement essentially to maintain the Subpart B structure and
to create what became the new Subpart C rate structure. Id. at 11; see
also 3/9/17 Tr. 325-27 (Parness).
Ms. Levine testified that in the Phonorecords II negotiations,
Copyright Owners sought an increase in the Subpart B rates, the
services refused, and Copyright Owners ultimately withdrew that demand.
Levine WRT ] 2. The implication from this testimony is that the
stability of the rate structure is not indicative of the absence of
negotiations, but, at least according to Ms. Levine, that rate
structure stability was a by-product of the negotiating process.
b. The Settlement Rates are Anachronistic
On behalf of Copyright Owners, Mr. Israelite described their
willingness to continue the 2008 rate structure through 2017 (ten years
in total) as reflective of their understanding that the interactive
streaming market was still not ``mature,'' Israelite WDT ] 108; WRT ]
26, and thus the ten year rate structure remained ``experimental.''
Israelite WDT ] ] 81, 103; Israelite WRT ] ] 4, 19, 26, 32. This issue
is discussed in more detail infra.\260\
---------------------------------------------------------------------------
\260\ In an attempt to dig deeper into why Copyright Owners
agreed to particulars in the settlements regarding the TCC prong,
the Judges asked Dr. Eisenach if Copyright Owners had provided him
with information regarding the 2012 settlement. He responded by
stating that ``[w]hen I've asked the question, I've found people
chuckle . . . when I ask the question, people say: `Nobody really
knows.' . . . . Someone may know, but that's what I've been told.''
4/4/17 Tr. 4611 (Eisenach). I am perplexed by the response provided
to Dr. Eisenach, because the history of the present rates would seem
to be of great relevance, ascertainable and not subject to being
laughed off when a party's own expert seeks such information.
---------------------------------------------------------------------------
More particularly, Copyright Owners maintain that the current rate
structure was ``experimental'' because there had been no data to
evaluate the interactive streaming business, and Copyright Owners
lacked knowledge as to the future development of the interactive
market. Israelite WDT ]] 33, 81, 95); Israelite WRT ]] 4, 17, 18, 19,
29; 3/29/17 Tr. 3631-32, 3754, 3764-65 (Israelite); see also COPFF ]
421 (and record citations therein).
Whether experimental or otherwise, [REDACTED]. Id. at 3636-38.
In response, the Services assert that there is no record evidence,
beyond Mr. Israelite's testimony, that the existing rate structure was,
or remains, experimental. They further note (as referenced supra) that
by 2012, when this rate structure was renewed, consumer adoption of
streaming was obvious, contrary to Copyright Owners' allegations.
Levine WRT ] 5. The Services also assert that numerous services,
including those backed by large companies, such as Yahoo and Microsoft,
had already entered the market, and some of those services had achieved
significant subscriber numbers. 3/8/17 Tr. 155:14-157:12 (Levine); see
also Parness WDT ] 12.
c. Alleged Displacement and Deferral of Revenue
Copyright Owners criticize the 2012 rate structure because its
reliance on a revenue-based structure creates problems regarding the
measurement of revenue. Specifically, Copyright Owners allege that
services can displace revenue properly attributable to streaming and
allocate it to other products within the owners' broader economic
``ecosystem.'' Also, they allege that services can and do defer revenue
from the present into the future, foregoing present profits in order to
grow their customer base to achieve a market share that allows for
long-term profits.\261\ See Rysman WDT ] 13.
---------------------------------------------------------------------------
\261\ This strategy is referred to as ``scaling,'' and is
discussed in more detail infra.
---------------------------------------------------------------------------
The problems associated with revenue measurement and attribution
arise in various contexts. First, the Services may focus on long-term
profit or revenue maximization, thereby possibly deferring shorter-term
profits through temporarily lower downstream pricing (i.e., revenue
deferral) in a manner that suppresses revenue over that shorter-term.
Second, the services may use music as a ``loss leader,'' displacing
streaming revenue and encouraging consumers to enter into the so-called
economic ``ecosystem'' of the streaming services, especially the multi-
product/service firms in this proceeding--Amazon, Apple and Google--
within which consumers can be exposed to other goods and services
available for purchase. Third, the interactive streaming services may
obscure royalty-based streaming revenue by offering product bundles
that include their music services with other goods and services,
rendering it difficult to parse out the bundled revenue as between the
royalty-bearing revenue (from the interactive service) and the revenue
attributable to the other items in the bundle.
i. Deferral
With regard to revenue deferral, Copyright Owners argue that the
services' focus on future growth, not
[[Page 1990]]
current revenues. See [REDACTED] ([REDACTED]). By way of example,
Copyright Owners highlight a particular aspect of [REDACTED] business
model: [REDACTED]. Id. at 2168-69 ([REDACTED]). The economic upshot of
such a focus on the long-run rather than on present revenues, according
to Copyright Owners, has caused revenues to grow annually by only 31%
from 2013 to 2014, and by only 34% from 2014 to 2015, even as the
number of streams over these two periods has grown by 63% and 101%
respectively. Ghose WDT ] 74.
The Services respond by noting that Copyright Owners did not
conduct an empirical analysis to confirm the extent to which to which
interactive streaming services actually engage in revenue deferral, and
that their expert was therefore compelled to qualify his conclusions by
conceding only that such revenue deferral ``may'' occur. See 4/3/17 Tr.
4344-43, 4347, 4349 (Rysman). Additionally, the Services assert that
the primary industry pricing model--$9.99 per month for unlimited
access--has existed since the early 2000's, belying Copyright Owners'
assertion that there has been a change in pricing in the current rate
period intended to build market share. See Levine WRT ] 6 (describing
how Rhapsody ``pioneered'' the subscription on-demand model in the
early 2000's and how the $9.99 model was adopted by, e.g., MOG, Rdio
and Rara).
[REDACTED]
The Services also argue that Copyright Owners misunderstand the
services' emphasis on [REDACTED]. However, as noted supra, the Services
do acknowledge that they focus broadly on [REDACTED]. Id. at 2082, 2141
([REDACTED]).
The Services also disagree with Copyright Owners' assertion that
[REDACTED], 4/7/2017 Tr. 5498 (Marx); 3/21/17 Tr. 2169 (McCarthy); and
[REDACTED]. 4/6/2017 Tr. 5327 (Vogel). Thus, the business model, they
argue, is reflective of the fundamental structure of market demand,
rather than evidence of revenue deferment.
I find that the record indicates that the services do seek to
engage to some extent in revenue deferral in order to promote their
long-term growth strategy. A long-term strategy that emphasizes scale
over current revenue can be rational, especially when a critical input
is a quasi-public good--because growth in market share and revenues is
not matched by a commensurate increase in the cost of such inputs,
whose marginal cost of production (reproduction, actually, because they
are copies of sound recordings/musical works) is zero. This is the
success-through-scalability discussed infra. See generally Haskel &
Westlake, supra, at 65-66 (profitability through scaling is enhanced by
the use of inputs with zero marginal costs).
It appears that the nature of the downstream interactive streaming
market, and its reliance on scaling for success, results necessarily in
a competition for the market rather than simply competition in the
market. This is the form of dynamic competition known as Schumpeterian
competition (named after the economist Joseph Schumpeter). Such
competition emphasizes the importance of the dynamic creation of new
markets and ``new demand curves,'' recognizing that short-term profit
or revenue maximization may be inconsistent with rational competition
for the market. That is, this form of competition recognizes that
businesses and investors do not simply seek out commercial activities
that will merely earn returns available elsewhere in the economy, but
rather seek out longer-term supranormal profits, investing in
businesses that appear able to satisfy consumer demand and capture
large swaths of market share--a dynamic and enduring process that
creates and ultimately destroys various business entities and markets
in the process (which Schumpeter coined as ``creative destruction.'')
See J. Sidak & D. Teese, Dynamic Competition in Antitrust Law, 5J.
Comp. L. & Econ.5, 581 (2009). Indeed, Amazon's economic expert
witness, Professor Hubbard, acknowledged that ``[t]he music industry
exemplifies this process'' of Schumpeterian ``creative destruction.''
Hubbard WDT ] 2.1 & n. 1.
Of course, when royalties are paid as a percent of current revenue,
the input supplier, i.e., Copyright Owners in the present case, are
likewise deferring some revenue to a later time period (and also
assuming some risk as to the ultimate existence of that future
revenue). One way the input supplier can avoid this impact is to refuse
to accept a percent of revenue form of payment and move to a fixed per-
unit input price. This is what Copyright Owners seek in this
proceeding, subject to a bargaining room approach by which they could
switch back to the old approach (or any other approach) through purely
market-based negotiations, but free from the statutory standards of
section 801(b)(1). However, another way in which the input supplier can
mitigate the effect of such revenue deferrals is to establish a pricing
structure that provides alternate rate prongs and floors, below which
the royalty revenue cannot fall. This is precisely the bargain struck
between Copyright Owners and services in 2008 and 2012, and that has
been ongoing through the present day.
Are there even better ways to address this issue? Perhaps, but by
the very nature of this adversarial proceeding, the Judges cannot
identify the theoretically optimal manner by which the revenue deferral
phenomenon should be addressed. Rather, the choices before the Judges
are stark: the per-unit pricing proposals submitted by Copyright Owners
and Apple, and the tiered rate structure now in existence and generally
(but not uniformly) presented by the Services as the appropriate
benchmark.\262\ As discussed infra, I have identified the 2012 rate
structure as the best benchmark from among these proposals. The revenue
deferral phenomenon indicates the need for Copyright Owners to protect
themselves, but it does not indicate that, on balance, the issue is
better resolved by the unacceptable per unit pricing proposals
submitted in this proceeding. Accordingly, I do not find the revenue
deferral issue to be a sufficient basis to reject the 2012 benchmark in
favor of Copyright Owners' or Apple's per-unit rate proposals.\263\
---------------------------------------------------------------------------
\262\ As I note in this Dissent, there is no sufficient evidence
to allow the Judges to mold their unique rate structure, and the
majority has erred in its attempt to do so.
\263\ Looked at from a different perspective, this issue pits
the music publishing business model against the interactive
streaming business model. Music publishers must maximize revenues
(subject to any cost constraints) over some time horizon, and their
argument in this proceeding indicates that they seek to maximize
royalty revenue over the short-run, so that current songwriters
receive royalties based on current revenue that is not deferred
because of the interactive streaming services' long-term business
model. See Rysman WDT ] 50. The music publishers could instead pay
royalties to songwriters based (at least in part) on an index of
several years of revenue to be consistent with the long-term
business models of the interactive streaming entities. See Leonard
WRT ] 60 (noting that advances from publishers to songwriters are
examples of such a long-run ``smoothing'' of royalty revenues). Or,
as Copyright Owners urge, the Judges could require the interactive
streaming services to abandon the revenue-based royalty structure
(with protective alternate prongs and floors) and to accept
inefficient per-unit rates, thereby compromising their downstream
businesses. In keeping with the Judges' long-standing position, I
believe the Judges should remain business model neutral, and decline
to favor one challenged business model over another. Instead, I
would adopt the 2012 rate structure that embodies a negotiated
compromise by the parties that has adequately addressed this revenue
deferral issue.
---------------------------------------------------------------------------
ii. Displacement through Bundling
Copyright Owners argue that services also displace revenue by
engaging in ``cross-selling'' by which they sell access to musical
works/sound recordings through the bundling of that
[[Page 1991]]
access with other goods or services, allocating too much revenue to the
non-music portion of the bundle, rather than attributing the correct
amount to the music service and thus, to the revenue base. Written
Rebuttal Testimony of Christopher C. Barry, CPA, CFF (on behalf of
Copyright Owners) ] 7. Copyright Owners argue that the services
manipulate revenue calculations in their favor, allegedly defining
revenue in opportunistic ways. See Rysman WDT ] 44; Rysman WRT ] 15;
Ghose WDT ]] 62-81. They maintain that they cannot discern such
manipulation and opportunism as it occurs, because the booking of
revenue among lines of business is ``opaque to publishers''--especially
in comparison to the identification of the number of consumers or the
number of streams. Rysman WDT ] 43; Rysman WRT ] 15; Ghose WDT ]] 80-
81.
In response, the Services assert there is no evidentiary support
for this overall and conclusory assertion. JSRPFF at p. 308. In
connection with the assertion of displacement-through-bundling, both
parties examine--essentially as an emblematic case study--Amazon's
pricing of interactive music in a bundle with one of its products. That
study is addressed below.
Amazon Products and Pricing: A Case Study
[REDACTED]
Survey Results
[REDACTED]. \264\
---------------------------------------------------------------------------
\264\ With regard to this topic, see the discussion of
``cannibalization,'' infra.
---------------------------------------------------------------------------
Other Potential Displacements from Bundling
With regard to other bundled offerings that Copyright Owners claim
to improperly diminish revenue and hence the royalty base, the evidence
is more descriptive than statistical. With regard to Google Play Music,
Copyright Owners point to evidence suggesting that Google ``leverages
its music business to drive revenue elsewhere within its enterprise.''
COPFF ] 482A et seq. (and record citations therein). Google, in
response, argues that this argument is preposterous because ``Google's
other products already reach literally hundreds of millions of people
in the U.S. [and] [t]he idea that Google is intentionally driving down
the price of Google Play Music in order to ``grow a base of customers''
who will then be more likely to use Search or Gmail or Google Maps
simply strains credulity. . . . . The value proposition flows in the
opposite direction.'' Levine WRT ]] 8-9.
With regard to Pandora, Copyright Owners note that it has expanded
beyond its ``pureplay'' origins by acquiring Ticketfly, a fan-to-fan
live concert ticket exchange business. 3/9/17 Tr. 408-410 (Phillips).
According to Copyright Owners, in the future, Pandora may generate
revenue from this ancillary business--revenue that arguably should be
included as ``service revenue'' in a revenue based rate structure.
Rysman WRT ] 34. However, Pandora notes that Ticketfly is a small
operation relative to Pandora's overall business and, as Copyright
Owners acknowledge, any use by Pandora of resources it obtained through
streaming music to benefit Ticketfly would be realized in the future,
making such a link speculative at this time. Moreover, Pandora argues
that, if and when Pandora may drive incremental attendance at concerts
and other live events through Ticketfly, music publishers and
songwriters would benefit directly from such attendance. See Herring
WRT ] 34.
[REDACTED]. It has announced an offering of a subscription together
with a subscription to The New York Times, i.e., a separate entity
offering a separate product. According to Copyright Owners, Rysman WRT
] 36. However, [REDACTED]. SJRPFF at p. 868.
Finally, with regard to Apple, Copyright Owners note that the
various music and other services and products are available through
Apple, including iTunes download purchases, Beats music service and, of
course, Apple's ubiquitous non-music products. See COPFF ]] 523-527.
Although Copyright Owners do not identify any specific bundling or
product-to-product displacement, they note more broadly that ``Apple's
interactive streaming service can operate as a gateway into the iTunes
ecosystem, which Apple uses to sell iPhones, apps, and other
products.'' Kokakis WDT ] 60.
Findings Regarding Displacement, Discounts and Bundling
I find the parties' back-and-forth on these bundling, discounting
and displacement issues (absent a separate analysis of any given
bundle/discount, such as presented by Amazon with regard to the bundled
$7.99 price for Echo for Prime members) to be indeterminate--and for
good reason. As the Judges have found previously, all such bundling,
and associated discounts, constitute forms of price discrimination,
whereby a seller can increase total revenues for the bundle and through
a discount beyond the revenue realized if each item was sold at its
separate or undiscounted price. See SDARS I Underpayment Ruling at 18-
19. The parties in the present proceeding do not so much dispute this
point as they argue whether the bundles discounts and alleged
displacements tend, on balance, to increase the revenue base (by adding
new subscribers) or to decrease the revenue base (by reducing per
subscriber revenue). I agree with Copyright Owners that the services
may be using bundling and associated discounts in a manner that is
inconsistent with short-run maximization of revenues, or even profits,
but they may also be growing the revenue base.
The import of this dispute in the present case is how the presence
of bundling and discounting bears, initially, on the rate structure
and, then, on the rates within that structure. With regard to the rate
structure, the rate prongs in the 2012 benchmark that the Services are
urging the Judges to adopt deal with these revenue measurement and
attribution issues by the use of a greater-of rate structure, whereby--
if the revenue-based royalty is lower than the other prong (typically a
per-subscriber, a TCC prong or the Mechanical Floor)--then one of the
latter prongs becomes applicable. By contrast, Copyright Owners'
proposal provides for a greater-of per unit/per-user royalty that does
not contain any features pertaining to bundling. As between these two
alternatives, I find that the 2012 rate structure is clearly more
consonant with the marketplace reality of varying WTP, through the use
of price discrimination through bundling and, indeed, has accommodated
such bundling for a decade.
I acknowledge Copyright Owners' argument that the bundling they
anticipated may well have been of a different nature (e.g., bundling
interactive streaming with cell phone or internet service) when they
agreed to the bundle provisions in the 2012 settlement, and that they
had not contemplated the myriad ways in which bundling would occur
going forward, especially with the entry of large multi-product
``ecosystem'' firms such as Amazon, Apple and Google. However, what
that possible difference between anticipated and actual bundling
indicates to me is that, hypothetically, perhaps a different bundling
structure, or different rates within the structure, might be more
appropriate than the 2012 rate structure in this regard. But the Judges
cannot deal in hypothetical rate structures and rates: Copyright Owners
(and Apple) did not propose such an alternative structure; instead, so
[[Page 1992]]
to speak, they threw out the baby with the bath water, rejecting any
price discriminatory rate structure (and bundling is a form of price
discrimination)--proposing instead to replace such a structure with a
non-discriminatory rate that fails to address the varying WTP among
listeners from which upstream demand by the interactive streaming
services is derived.
In these proceedings, the Judges are bound by the parties'
proposals, unless there are record facts that permit the Judges to mold
a rate structure or rates that vary from the proposals.\265\ Here, with
regard to the impact of bundling and other price discriminatory
elements of the rate structure, the choices are stark. Only the 2012
benchmark proposed by the Services addresses these issues, and in a
manner that has existed in the market for a decade.\266\
---------------------------------------------------------------------------
\265\ As noted supra, the Judges may also find that the existing
rate structure and rates are appropriate, if the benchmarks
proffered by all the parties are insufficient. See Music Choice,
supra. Thus, the 2012 rate structure would have been an appropriate
structure for the forthcoming rate period even if it had not been
affirmatively advocated as a benchmark by the Services.
\266\ I note an important difference between the bundling issue
in the SDARS context and that issue here. For the SDARS, the issue
was how to measure revenue where only a pure revenue-based rate
structure exists, and the Judges noted the difficulty in assigning
value to different elements of the bundle. Here, the 2012 benchmark
(the parties' agreement) addresses this indeterminacy by adopting
alternative royalty prongs, which, as noted in the text, supra, is
one way to resolve the indeterminacy problem.
---------------------------------------------------------------------------
d. Cannibalization
Copyright Owners assert that the Services' benchmarking approach
fails to account for the ``cannibalization'' of digital download and
physical sales, through listeners' substitution of interactive
streaming for the purchase of digital downloads and physical products,
mainly CDs. In support of this argument, Copyright Owners point to the
contemporaneous increase in interactive streaming and the decrease in
the sales of digital downloads and CDs. They note that the sale of
digital albums and digital tracks decreased by 9.4% and 12.5%,
respectively from 2013 to 2014, and by an additional 2.9% and 12.5%,
respectively, from 2014 to 2015. See Israelite WDT ] 70; Ex. 2773 (2014
Nielsen Report), at 2; Ex. 2780 (2015 Nielsen Report), at 7, 8. Thus,
they argue that the royalty structure (and rates) must account for this
substitution effect through an increase in the royalties on interactive
streaming. See COPFF ]] 575-586 (and record citations therein).
The Services do not dispute these statistics. However, the Services
argue that Copyright Owners have not presented any evidence that would
support the claim that declining physical and download sales have been
caused by increases in interactive streaming. Thus, in the absence of
such evidence, the Services argue that Copyright Owners have merely
assumed causation from correlation. See JSRPFF at p. 380 (and record
citations therein).
In fact, they point to the testimony of NMPA's own witness, Bart
Herbison, Executive Director of Copyright Owner participant NSAI. Mr.
Herbison testified that he did not ``blam[e] the loss of songwriters on
streaming,'' acknowledging that piracy and disaggregation of the album
were major problems for songwriters prior to the popularity of
streaming, and therefore, overall, he was ``not ascribing any large
percentage of [lower mechanical royalties] to streaming.'' 3/23/17 Tr.
2940-41, 2945, 2955-56 (Herbison).
Moreover, not only do the Services note the absence of proof that
these changes were caused by interactive streaming, they note that the
changes can just as easily be attributed to changing ``consumer
preferences,'' for which the interactive streaming services should not
be penalized. See 3/21/17 Tr. 2227-28 (Hubbard) (such changes do not
reflect cannibalization, but rather how the industry has evolved to
satisfy ``contemporary consumers' preferences'' and to ``respond to
consumer demand.'').
I find that there is no sufficient evidence to indicate that
interactive streaming has caused the decline of the sale of physical
and digital sound recordings. Moreover, even assuming arguendo any
sales of digital downloads and physical product was caused by the
listeners' preference for interactive streaming, the effect of such a
phenomenon on songwriter royalties is unclear. Record companies, as
licensees, pay royalties to music publishers, under subpart A, for the
musical works embodied by record companies in digital downloads and
physical product. Assuming a portion of that royalty revenue is lost
(``cannibalized'') by interactive streaming, the services that utilize
the musical works in those streams pay both a mechanical royalty and a
performance royalty in exchange for the licenses to use the musical
works. There is insufficient evidence in the record to conclude that,
on balance, there is a net substitution effect that results in lower
royalties paid for musical works.
Further, I agree with the Services that Copyright Owners' attempt
to compare sales of downloads and physical product (which generate
mechanical royalties under subpart A) with revenues from interactive
streaming (that generate mechanical royalties under subparts B and C,
and performance royalties) is inconsistent with Copyright Owners'
(persuasive) argument, discussed infra, that there is no sufficient
evidence to correlate listening across purchases and streaming
services. The Services correctly note that the sale of a download or a
CD (or a vinyl record) allows the purchaser to ``access'' that purchase
an indefinite number of times, whereas access through a streaming
service likewise allows for listening (to various songs) for an
indeterminate number of times. In this regard, Copyright Owners'
proposed per-unit royalty rate for streaming is simply not consistent
with pricing per unit sold under subpart B, because the items purchased
are themselves inconsistent in nature--as Copyright Owners (again,
persuasively) argue in opposition to the use of commercial and academic
conversion ratios to correlate the number of times a consumer listens
to a song in the purchased product and streaming spheres.
e. The ``Shadow'' of the Statutory License
Copyright Owners assert that any benchmark, including the Services'
proffered benchmarks, based on rates set for a compulsory license, are
inherently suspect, because they are distorted by the so-called
``shadow'' of the statutory license. This is a recurring criticism.
See, e.g., Web IV 81 FR at 26329-31.
More particularly, Copyright Owners argue: ``The royalty rate
contained in virtually any agreement made by a music publisher or
songwriter with a license for rights subject to the compulsory license
will be depressed by the availability of the compulsory license.''
COPFF ] 708 (and record citations therein). In summary, this alleged
shadow purportedly diminishes the value of a rate that was formed by
private actors who negotiated while understanding that either party
could refuse to consummate a contract and instead participate in a
proceeding before the Judges to establish a rate. Thus, neither side
can utilize any bargaining power to threaten to actually ``walk away''
from negotiations and refuse to enter into a license. In that sense,
therefore, any bargain they struck would be subject to the so-called
``shadow'' of the regulatory proceeding.
The argument that the shadow taints the use of statutory rates, and
direct agreements otherwise subject to the statutory license is
undercut, however, by section 115 of the Copyright Act,
[[Page 1993]]
which provides that in addition to the objectives set forth in section
801(b)(1), in establishing such rates and terms, the Copyright Royalty
Judges may consider rates and terms under voluntary license agreements
described in subparagraphs (B) and (C). 17 U.S.C. 115(c)(3)(D). The two
subparagraphs referenced therein, subparagraphs (B) and (C),
respectively, refer to agreements on ``the terms and rates of royalty
payments under this section'' by ``persons entitled to obtain a
compulsory license under [17 U.S.C. 115](a)(1)]; and ``licenses''
covering ``digital phonorecord deliveries.'' Id. Thus, it is beyond
dispute that Congress has authorized the Judges, in their discretion,
to consider such agreements as evidence, irrespective of--or perhaps
because of--the shadow cast by the compulsory license.
Additionally, as noted supra, the Judges may consider the existing
statutory rates themselves as evidence of the appropriate rate for the
forthcoming rate period, even when those rates were not the product of
a settlement. Indeed, the Judges may consider existing rates as the
starting point and the end point of their analysis. Music Choice,
supra, 774 F.3d at 1012 (the Judges may ``use[ ] the prevailing rate as
the starting point of their Section 801(b) analysis'' and may
ultimately find that ``the prevailing rate was reasonable given the
Section 801(b) factors.'').
Of course, the fact that the Copyright Act and the D.C. Circuit
grant the Judges statutory authority to consider and rely on statutory
rates and related settlement agreements as evidence does not instruct
the Judges as to how much weight to afford such agreements. The
exercise of that judicial discretion remains with the Judges.
But with regard to the particular issue of the so-called shadow of
the statutory rate, there is no reason to find such benchmark
agreements per se inferior to other marketplace benchmark agreements
that may be unaffected by the shadow, because those other benchmarks
may be subject to their own imperfections and incompatibilities with
the target market. Thus, the Judges must not only consider (i) the
importance, vel non, of any potential ``shadow-based'' differences
between the regulated benchmark market and an unregulated market that
might impact the probative value of the former, but also (ii) how those
differences (if any) compare to the differences (if any) between the
unregulated market and the target market (e.g., differences based on
complementary oligopoly power, bargaining constraints and product
differentiation).\267\ In the present case, because Copyright Owners'
and Apple's proposals are structured as per-unit rates, they suffer
from deficiencies that dwarf any alleged problems associated by the
alleged shadow of the 2012 statutory benchmark; that is, assuming
arguendo that the shadow on balance is problematic rather than
beneficial.
---------------------------------------------------------------------------
\267\ The Judges note that one of the two benchmarking methods
relied upon by Copyright Owners subtracts the statutory rate set in
Web III for noninteractive streaming from a royalty rate derived
from the unregulated market for sound recording licenses between
labels and interactive streaming services. This would seem to
violate the Copyright Owners' own assertion that statutorily set
rates are tainted by a regulatory shadow and thus cannot be used to
establish reasonable rates. However, Copyright Owners' expert
testified that, in his opinion, the Judges in Web III accurately
identified the market rate for noninteractive streaming, so that
rate could be utilized as if it were set in the market. 4/4/17 Tr.
4643 (Eisenach). This assertion proves too much. If one expert on
behalf of a party may equate a rate set by the Judges with the
market rate, why cannot the Judges, or any other party's expert, do
the same with regard to a different statutory rate? The end result
of such an approach takes us back to the point the Judges made at
the outset in this section: any rate set by the Judges or influenced
by the Judges' rate-setting process must be considered on its own
merits.
---------------------------------------------------------------------------
In the present proceeding, the parties weigh-in on the shadow issue
with several, more particular, arguments. Copyright Owners emphasize
that the purpose of their benchmarking approach is to avoid the
distortions of the shadow, by utilizing the unregulated sound recording
agreements between labels and interactive streaming services and then
applying a ratio of sound recording: musical works royalties, (the
latter also in unregulated contexts), to develop a benchmark wholly
free of the shadow cast by the statute. 4/4/17 Tr. 4191 (Eisenach)
(``[T]he underlying problem with looking at an agreement negotiated
under the shadow of a license [is that][i]t shifts bargaining power
from the compelled party to the uncompelled party by the very nature of
the exercise.'').
The Services' experts discount the foregoing shadow criticism.
Indeed, what Copyright Owners considered vice, the Services laud as
virtue. That is, the shift in bargaining power is precisely what makes
any shadow effect of the statutory license tolerable. Professor Katz
points out that rates set voluntarily by the parties in a settlement
under the ``shadow'' provide two important benefits. 3/13/17 Tr. 661
(Katz). First, with a statutory rate-setting proceeding as a backstop,
large licensors cannot credibly threaten to ``hold out'' and ``walk
away'' from the negotiations without an agreement, thereby negating
their ability to use their ``must have'' status as a cudgel to obtain
rates that can exceed even monopoly-level rates. Second, when such
negotiations are conducted with all the parties at the figurative table
(including perhaps trade associations), no single party, whether
licensor or licensee, has disproportionate market power in the
negotiations.
I agree with Professor Katz that settlement agreements reached in
the shadow are useful. Because the statutory proceeding is the
backstop, the power of any entity simply to refuse to strike a deal
except on its own unilateral terms is effectively negated. Thus, such
settlement agreements tend to eliminate complementary oligopoly
inefficiencies, and provide guidance as to an effectively competitive
rate. Indeed, this argument is consistent with the Judges' ``shadow''
analysis in Web IV, supra, at 26330-31 (noting the counterbalancing
effect of the statutory license in establishing effectively competitive
rates). Further, when such settlement agreements are industrywide, they
tend to eliminate disproportionate market power, and the resulting
rates thus may be evidence of a rate that is fair and thus consonant
with Factor B of section 801(b)(1). (This issue is discussed in further
detail in connection with the Factors B and C analysis, infra.)
Although Copyright Owners are theoretically correct in noting that some
licenses might have otherwise been negotiated at rates higher than the
settlement rate that was affected by the shadow, that is simply the
tradeoff that the statutory scheme makes in its identification of
settlement rates as evidentiary benchmarks. That is, such a theoretical
problem needs to be weighed against the salutary aspects of settlement
rate structures and rates, discussed supra. I find that the benefits of
the settlement process, in this proceeding, easily outweigh the loss of
any hypothetical deals that may have been reached above the settlement
rates, especially because, in the absence of the shadow, rates higher
than the settlement rate would be a function, in part, of the Copyright
Owners' complementary oligopoly and other market power, which
compulsory statutory licensing has been designed to mitigate.
Although I recognize the market-based value of a benchmark
agreement reached under the shadow of the statutory license, (indeed,
economic actors' settlement agreements are part and parcel of the
market \268\), I cannot
[[Page 1994]]
defer to any implicit ``mindreading'' by contracting parties as to the
Judges' application of the all the non-market elements of section
801(b)(1). Rather, the Judges have a duty to independently apply the
itemized factors listed in the statute. Accordingly, I reject the idea
that rates and terms reached through a settlement must be understood to
supersede--or can be assumed to embody--the Judges' application of the
statutory elements set forth in section 801(b)(1). However, if on
further analysis, the Judges find that provisions arising from an
agreement in fact do reflect the statutory principles set forth in
section 801(b)(1), then the Judges may adopt the provisions of that
settlement in toto, again, if those provisions are superior to the
evidence submitted in support of alternative rates and terms.
---------------------------------------------------------------------------
\268\ For example, the Judges regularly assume in a benchmarking
approach that the contracting parties have ``baked-in'' the values
of discrete items in their agreement. See, e.g., Web IV, supra, at
26366.
---------------------------------------------------------------------------
5. The ``All-In'' Rate Structure and the ``Mechanical Floor''
a. The ``All-In'' Rate Structure
The current mechanical royalty rate is calculated as a so-called
``All-In'' rate. Simply put, the last step when calculating the
mechanical rate is to subtract from the intermediate figure the rate
paid by the interactive streaming services to performing rights
organizations (PROs) for the ``public performance'' right. All five
services (i.e., including Apple) urge the Judges to establish a
statutory rate structure for the forthcoming rate period that contains
this ``All-In'' feature, whereas Copyright Owners request that the rate
for the forthcoming rate period be set without regard to the royalty
rate paid by the services to the PROs for the performance rights. I
examine the parties' arguments seriatim below.
i. The Services' Position (including Apple's Position)
According to the services, a key aspect of the 2008 and 2012
settlements was that the rates paid by services for mechanical
royalties would allow for a deduction of expenses for public
performance royalties, i.e., the top-line rate paid under the Section
115 license would be ``All-In'' from the services' point of view.
Levine WDT ] 35; Parness WDT ] 7; 3/8/17 Tr. 298-99 (Parness). In this
regard, a Google fact witness, Zahavah Levine, testified that as far
back as 2001, the streaming services wanted to avoid what she described
as a ``double dip'' problem, whereby a service might need to conduct
separate negotiations with PROs and with music publishers in order to
obtain usable musical works license rights. 3/8/17 Tr. 147-148
(Levine). In fact, prior to settlement, some members of the streaming
community expressed a view that the value of any mechanical right
implicated by interactive streaming is essentially zero, because the
Copyright Owners are already compensated through performance payments
to the PROs. 3/29/17 Tr. 3645-47 (Israelite). According to Apple, the
absence of any separate value in the mechanical rate (when separated
from the performance rate) is underscored by the fact that interactive
streaming is the only distribution channel that pays both a performance
royalty and a mechanical royalty. Rebuttal Testimony of David Dorn ] 10
(Dorn WRT).
Thus, according to the services, a determining factor in the 2008
settlement was Copyright Owners' agreement to a deduction of
performance fees, via the acceptance of an ``All-In'' rate. 3/8/17 Tr.
298-301 (Parness); Parness WDT ] 7; 3/8/17 Tr. 170-71 (Levine)
(explaining benefits of ``All-In'' rate structure). In fact, for the
services, according to one of its witnesses, the ``All-In'' nature of
the rate was a determining factor in the parties reaching a settlement.
3/8/17 Tr. 300-301 (Parness).
Accordingly, the services argue that this ``All-In'' rate structure
is consistent with the parties' expectations in settling Phonorecords I
and II. See SJPFF ] 112. Additionally, the Services point out that many
direct licenses between musical works copyright owners and streaming
services incorporate the ``All-In'' feature of the existing section 115
license. See JSPFFCOL ]] 143-145 (and record citations therein). The
services also emphasize that the Copyright Owners' recent settlement of
the Subpart A rates--approved by the Judges--implies an ``All-In''
feature. Specifically, one of the services' expert economic witnesses,
Dr. Leonard, testified that, expressed as a percentage of payments to
the record labels (not as a percentage of total streaming service
revenue), the subpart A settlement reflects a payment of 15.8% of
``All-In'' sound recording royalties in 2006, and of 14.2% of ``All-
In'' sound recording royalties, when compared to payments to record
labels in 2015. Leonard AWDT ] 46 (noting that ``these ratios are lower
than the current ratios of musical works-to-sound recordings royalties
contained in Section 385, Subparts B and C (e.g., musical works
royalties are between 17.36% and 21% of the service payment to record
companies for sound recordings for Standalone Portable Subscription,
Mixed Use services covered under Subpart B.'')).\269\
---------------------------------------------------------------------------
\269\ Of course, the subpart A rates are implicitly ``All-In''
because record companies do not pay performance royalties. I
consider further, infra, the evidentiary value of the subpart A
settlement and rates.
---------------------------------------------------------------------------
Finally in this regard, the services assert that the Judges have
made similar determinations for analogous sets of rights in other
proceedings. For instance, they note that the Judges effectively set an
``All-In'' licensing rate for reproductions of sound recordings and
performances of sound recordings under 17 U.S.C. 112 and 114. The
services analogize the relationship of the performance right and the
mechanical right, on the one hand, with the sound recording ephemeral
right and the sound recording performance right on the other,
characterizing both pairs of rights as ``perfect complements.'' See
SJPFFCOL ] 114 (citing Web IV, 81 FR at 26397-98 (discussing bundling
of Secs. 112 and 114 rights and noting that licensees ``would be
agnostic with respect to the allocation of those rates to the Section
112 and 114 license holders.'').
Separately, as noted supra, Apple concurs with the adoption of an
``All-In'' rate in the forthcoming rate period. According to Apple, the
Judges should adopt an ``All-In'' rate for interactive streaming
because (1) mechanical and performance royalties are complementary
rights that must be considered together in order to prevent exorbitant
costs; (2) the current statute uses an ``All-In'' rate; (3) ``All-In''
rates provide greater predictability for businesses; and (4) recent
fragmentation and uncertainty with respect to performance licenses
threaten to exacerbate the problems of high costs and uncertainty
already present in the industry.'' APFF ] 138 et seq. (and record
citations therein). As a policy matter, Apple maintains that an ``All-
In'' rate helps maintain royalties at an economically efficient level
because it sets a single value for all of the rights that interactive
streaming services must obtain from publishers and songwriters. See 3/
23/17 Tr. (Ramaprasad) 2667- 2669, 2670 (a mechanical-only rate could
cause ``exorbitant'' rates, but an ``All-In'' rate would not); Expert
Rebuttal Report of Professor Jui Ramaprasad February 15, 2017 ] 13
(Ramaprasad WRT) (a mechanical-only royalty could lead to
``unreasonably high combined royalties for publishers and
songwriters''); see also Leonard AWDT ] 58; Katz WDT ] 94; Herring WDT
] 59. Accordingly, Apple asserts that, by adoption of an ``All-In''
rate, the streaming services avoid two separate
[[Page 1995]]
negotiations for the performance right and the mechanical right--
ensuring that these two complementary rights are considered in tandem,
with the cost of one impacting the cost of the other. See Dorn WRT ]
15; see also 3/13/17 Tr. 587-588 (Katz); 3/15/17 Tr. 1191-1192
(Leonard); Herring WDT ] 59.
Further in this regard, Apple maintains, if a full mechanical-only
rate were adopted in lieu of an ``All-In'' rate, interactive streaming
services would need to pay for mechanical rights pursuant to the
statute and then engage in an entirely separate negotiation for the
performance right. Dorn WRT ]] 14-15; Ramaprasad WRT ] 13. This could
lead to an undeserved windfall for publishers and songwriters as, after
this negotiation, total royalty payments that interactive streaming
services pay for musical works could be exponentially higher than
whatever mechanical-only rate the Judges adopt. Dorn WRT ]] 14-15;
Ramaprasad WRT ] 13. Apple avers that this would be unfair--because the
royalty payments are all made to the same entities, i.e., the
publishers and songwriters. Dorn WRT ]] 15-16; see also Herring WDT ]
59.\270\
---------------------------------------------------------------------------
\270\ Pandora and Google separately make the same arguments as
Apple in this regard. See Pandora PFFCOL ]] 35-36 (and record
citations therein); Google PFF ] 29 (and record citations therein).
---------------------------------------------------------------------------
As noted supra, Apple, consistent with the other Services, argues
that the ``All-In'' rate structure is particularly important because of
relatively recent industry developments. Specifically, Apple takes note
of the recent ``fragmentation'' \271\ and uncertainty in performance
rights licensing that the services all claim to threaten an
exacerbation of the existing uncertainty over royalty costs. See Dorn
WRT ]] 17-18; Ramaprasad WRT ]] 13, 63; Parness WDT ]] 16-20; Katz WDT
]] 87-94; Tr. 3/13/17 Tr. 602-604 (Katz). Apple notes that this problem
may be exacerbated because of the emergence of a fourth PRO, Global
Music Rights (GMR), in addition to ASCAP and BMI, as well as SESAC
which (like GMR, and unlike ASCP and BMI) is not subject to a consent
decree and rate court review (as discussed infra). Parness WDT ] 18;
Katz WDT ] 91. See 3/9/17 Tr. 382-83 (Parness); 3/13/17 Tr. (Katz) 602-
604.
---------------------------------------------------------------------------
\271\ ``Fragmentation'' refers to the existence of more than one
owner of copyrights to a musical work, requiring an interactive
streaming service to engage in a costly and uncertain attempt to
locate each owner and provide it with a separate Notice of Intent
and to bear the risk of a potential infringement action if one or
more copyright owners is not located. SJPFF ]] 162-63 (and record
citations therein).
---------------------------------------------------------------------------
In addition to the problems created by potential fragmentation, the
services also raise the specter of future ``withdrawals'' by music
publishers from one or more PROs. As Apple notes, in the past few
years, publishers have taken steps to effectuate such withdrawals,
especially from PROs that are governed by consent decrees. Dorn WRT ]
18; Ramaprasad WRT ]] 13, 63; Parness WDT ] 17; Katz WDT ] 91. Apple
points to the example of one large publisher, UMPG, which moved a
portion of its catalog from ASCAP, a PRO governed by a consent decree,
to SESAC, which is not. 3/27/17 Tr. 3207 (Kokakis). Apple also notes
that UMPG also fully withdrew from BMI for a brief period in June 2014.
3/27/17 Tr. 3204 (Kokakis). Moreover, Apple maintains that, even when
publishers have not actually withdrawn, ``[s]everal publishers of
significant commercial importance have threatened [to withdraw entirely
from ASCAP and BMI].'' 3/9/17 Tr. 376-81(Parness); see also Parness WDT
] 17; 3/27/17 Tr. 3206 (Kokakis) (UMPG executive confirming that he and
the services ``had discussed at times the possibility of Universal
withdrawing'' fully from a PRO); 3/28/17 Tr. 3310-3313 (Kokakis)
([REDACTED]). Apple maintains that these events and threats of
withdrawal create uncertainty in the performance rights marketplace and
portend a potential increase in performance royalty costs for
interactive streaming, which could not be ameliorated in the absence of
an ``All-In'' rate. See Ramaprasad WRT ] 63 (the only certain result of
publishers withdrawing is that performance royalties ``will
increase''); 3/8/17 Tr. 256-57, 262-63(Levine); 3/13/17 Tr. 602-04
(Katz) (fragmentation leads to higher performance rights costs).
ii. Copyright Owners' Position Regarding an ``All-In'' Royalty Rate
Copyright Owners initial argument is jurisdictional in nature; they
emphasize that this is a proceeding to set rates and terms for the
Section 115 compulsory mechanical license to make and distribute
phonorecords, not to perform works. 17 U.S.C. 115, 801(b)(1). More
particularly, they note that, whereas the Section 115 compulsory
license explicitly applies solely to ``the exclusive rights provided by
clauses (1) and (3) of section 106, to make and to distribute
phonorecords of [nondramatic musical] works,'' it does apply to the
exclusive right provided by clause (4) to perform the work publicly. 17
U.S.C. 106, 115. Thus, Copyright Owners argue, the public performance
right provided by 17 U.S.C. 106(4) is an entirely separate and
divisible right from the mechanical right at issue in this proceeding
and is not subject to the Section 115 license. See COPCOL ] 314 (citing
17 U.S.C. 106, 115, 201(d); Ex. 920 at 16; 2 Nimmer on Copyright Sec.
8.04[B] (``[T]he compulsory license does not convey the right to
publicly perform the nondramatic musical work contained in the
phonorecords made under that license. Similarly, a grant of performing
rights does not, in itself, confer the right to make phonorecords of
the work.'')).
Copyright Owners further note that performance royalties are set in
negotiations between licensors and licensees, subject to challenge in a
``rate court'' proceeding, and conclude that the Judges cannot set an
``All-In'' rate because they have ``not been vested with the authority
to set rates for performance rights because they are not covered by
Section 115.'' COPCOL ] 315.\272\
---------------------------------------------------------------------------
\272\ Copyright Owners note that performance royalties are set
directly in negotiations between licensors and licensees, but if the
either of the two largest PROs (ASCAP and BMI) and licensees are
unable to enter into consensual agreements, they rates are set in a
federal court action in the Southern District of New York (before a
designated ``rate court'' judge), pursuant to existing Consent
Decrees. See COPCOL ] 316; Register's Report at 20, 34, 37, 41.
---------------------------------------------------------------------------
Copyright Owners also argue in this regard that the services have
not provided evidence in this proceeding to justify and support an
``All-In'' rate, such as evidence showing the rates and terms in
existing performance licenses; the duration of such licenses;
benchmarks for performance rights licenses; and the impact of
interactive streaming on other sources of performance income, including
non-interactive streaming, terrestrial radio and satellite radio
income. Further, Copyright Owners point out that the PROs and/or all
music publishers are all necessary parties for any such determination,
but they were not proffered by the services. See COPCOL ] 319.
For these reasons, Copyright Owners decry as mere ``sophistry'' the
services' argument that they are not asking the Judges to set
performance rates, but rather only to ``set'' a ``mechanical'' rate
that permits them to deduct what they pay as a performance royalty.
More particularly, they argue that this approach, if adopted, would
leave the mechanical rate indeterminate, subject to whatever is decided
in negotiations or judicial action regarding the mechanical rate. See
COPCOL ] 320. Indeed, Copyright Owners note, under the Services' ``All-
In'' proposal, the mechanical rate could be zero (if performance
royalties are agreed to or set by the rate courts at a rate that is
[[Page 1996]]
greater than or equal to the ``All-In'' rate proposed by the Services
here)--and, they argue, ``a mechanical royalty rate of zero ``is
anything but reasonable.'' COPCOL ] 322.
In an evidentiary attack, Copyright Owners demonstrate that the
only percipient witness who engaged directly in the 2008 negotiations
involving the ``All-In'' rate (or any other matter) was the NMPA
president, David Israelite, and that, by contrast, the services' two
witnesses, Mr. Parness and Ms. Levine, did not participate directly in
those negotiations. See CORPFF-JS at 58. Thus, Copyright Owners assert
that the services cannot credibly argue based on what the negotiating
parties actually intended with regard to, inter alia, the ``All-In''
rate.\273\
---------------------------------------------------------------------------
\273\ Copyright Owners take this argument one step further--
maintaining that consequently the Services ``have presented no
competent evidence that an ``All-In'' rate structure ``is consistent
with the parties' expectations in settling Phonorecords I and II.''
CORSJPCL ] 112. It is difficult to conclude that this fundamental
rate structure, agreed to in two separate settlements between the
parties, was not consonant with their ``expectations.''
---------------------------------------------------------------------------
Copyright Owners also take aim at the services' argument that it
matters not whether they pay royalties designated as ``performance'' or
``mechanical,'' because the same rights owners are also receiving
performance royalties. According to Copyright Owners, this argument:
(1) ignores the fact that the Copyright Act creates separate and
distinct mechanical and performance rights, and made only the former
subject to compulsory licensing under Section 115; (2) ignores the fact
that the rates for the use of those two rights, to the extent not
agreed, are set in different jurisdictions; and (3) ignores the
disruption that would be caused by eliminating mechanical royalties--
disruptions arising from (a) the fact that mechanical royalties are the
most significant source of recoupment of advances to songwriters; and
(b) songwriters receive a greater share of mechanical royalties than
they do of performance royalties (both because of the standard splits
in songwriter agreements and the fact that performance income, unlike
mechanical income, is diminished by PRO commissions). COPCOL ] 323;
COPFF ] 640.\274\ See also Witness Statement of Thomas Kelly ] 66;
Witness Statement of Michael Sammis ] 27; Yocum WDT ] 23; Israelite WDT
] 71 (all asserting that combining mechanical royalties and performance
income in a single ``All-In'' payment will diminish payments to
songwriters, and will negatively impact the publishers' ability to
recoup advances, which will, in turn, negatively impact the size and
number of future advances).
---------------------------------------------------------------------------
\274\ Copyright Owners note that, in Phonorecords I, Judge
Sledge voiced a similar sentiment from the bench, referring to
consideration of the performance royalty as a ``waste of time.''
COPFF ] 597 (and record citations therein). The Judges are not bound
by any prior statement by a Judge that is not a part of a prior
determination. Moreover, the Judges note that they are not in this
proceeding ``setting'' the performance royalty rate, but rather
considering whether that royalty payment should be a deduction in
the formula for calculating the mechanical license.
---------------------------------------------------------------------------
Copyright Owners further assert that the Services' claim that
increasing ``fractionalization'' of licenses justifies an ``All-In''
rate is a red herring. Specifically, they argue that there has always
been fractional licensing of performance rights by the PROs, because
there typically are multiple songwriters and publishers with ownership
rights in a song and they may not all be affiliated with the same PRO,
and there is no legal basis on which any one PRO has the right to
license rights that it does not have. Israelite WRT ]] 65-66; 3/29/17
Tr. 3662-63 (Israelite); HX-327; 3/9/17 Tr. 372-73 (Parness). Moreover,
they claim that, contrary to the Services' assertions, the presence of
GMR has not altered the extent of fragmentation in any manner, let
alone increased the degree of fragmentation in the marketplace. In
particular, Copyright Owners point out that the Services admitted that
GMR represents fewer than 100 songwriters and has a meager market share
of roughly 3 percent of the performance market. 3/9/17 Tr. 365-67
(Parness); see also Israelite WRT ] 59. Copyright Owners also note that
the Services presented no evidence either that there has been an
increase in performance rates in licenses issued by GMR, or, more
generally, of any actual or potential impact of this alleged
``fragmentation'' of the performance rights marketplace on their
interactive streaming businesses. 3/9/17 Tr. 381 (Parness).
Next, Copyright Owners note that the issue of publisher withdrawals
from PROs--if it ever was a justification for an ``All-In'' rate--has
been overtaken by events. Specifically, they note that the ASCAP and
BMI rate courts in the Southern District of New York, the Second
Circuit and the Department of Justice have determined that partial
withdrawals by publishers are not permitted. Ex. 876, at 4; Israelite
WRT ]] 62-63, citing In re Pandora Media, Inc., supra, 1.
b. The ``Mechanical Floor''
i. Copyright Owners' Position
Copyright Owners urge the Judges to retain the Mechanical
Floor.\275\ They emphasize that the Mechanical Floor establishes a
minimum value protecting the mechanical right, in that it cannot be
reduced by subtracting the performance royalty as occurs under the
``All-In'' rate. See Israelite WRT ]] 19-22, 29, 81; 3/29/17 Tr. 3632,
3634-3636, 3638, 3754, 3764-3765 (Israelite); 3/8/17 Tr. 259 (Levine).
---------------------------------------------------------------------------
\275\ The Mechanical Floor refers to the step in the rate
calculation after the ``All-In'' rate has been calculated. If that
calculation would result in a dollar royalty payment below the
stated Mechanical Floor rate, then the Mechanical Floor rate would
bind.
---------------------------------------------------------------------------
They also note that the revenue displacement and deferral problems
they allege to exist under a percentage of revenue ``do not exist''
with the Mechanical Floor because that rate is expressed on a per
subscriber basis. COPFF ]] 639-40. [REDACTED]. In this regard,
Copyright Owners maintain that the Services' desire to eliminate the
Mechanical Floor is nothing other than a ``thinly veiled effort to
sharply reduce the already unfairly low mechanical royalties.'' COPFF ]
644. The import of the Mechanical Floor is underscored by Dr. Eisenach
who testifies that, in 2015, [REDACTED]. Written Rebuttal Testimony of
Jeffrey A. Eisenach, Ph.D. ] 115 (Eisenach WRT).
Copyright Owners further argue that the Mechanical Floor is
necessary to preserve a source of royalty revenue for the payment of
advances to songwriters and the funding of recoupments of prior
advances paid by publishers to songwriters. COPFF ] 640 (and record
citations therein). They also point out that songwriters benefit more
from publishing agreements than from agreements with PROs, because,
under current publishing agreements, songwriters typically receive 75%
or more of mechanical income whereas the PRO's split performance income
50/50 between publishers and songwriters. Id. Finally, Copyright Owners
note that the PROs charge songwriters a fee, further reducing the value
of the performance income relative to income. Id.
ii. The Services' and Apple's Arguments for Eliminating the Mechanical
Floor
Despite their trumpeting of the 2012 settlement as an appropriate
benchmark, the Services (and Apple, which does not rely on the 2012
structure) propose the elimination from that benchmark of the
Mechanical Floor in the forthcoming
[[Page 1997]]
rate period. In support of this position, they make the following
arguments:
When negotiating both the Phonorecords I and
Phonorecords II settlements, the services acquiesced to the
Copyright Owners' insistence that this Mechanical Floor be included
in the rate structure, because the services believed that the
Mechanical Floor was ``illusory,'' i.e., that it was ``highly
unlikely to ever be triggered . . . .'' SJPFF ]] 127, 160 (and
record citations therein). See also Apple PFF ]] 85, 165 (arguing
that the Mechanical Floor in the current rate structure adds
uncertainty and leads to services paying ``windfall'' royalties to
the Copyright Owners well above the ``All-In'' amount); Google PCOL
] 22 (asserting that the triggering of the Mechanical Floor in some
circumstances has been caused by Copyright Owners leveraging market
power). In this regard, the Services assert that the parties who
negotiated the Phonorecords settlements did not expect a Mechanical
Floor to bind, due to longstanding, stable public performance rates.
3/8/17 Tr. 309 (Parness); Parness WDT ]] 9, 21; Levine WDT ] 35; 3/
8/17 Tr. 254:24-256:8 (Levine).
Past and potential future fragmentation of the
licensing of public performance rights, threatened withdrawals by
music publishers from PROs and the advent of new PROs, all combine
to increase the likelihood that the Mechanical Floor will be
triggered. Katz WDT ]] 87, 91.
Because mechanical rights and public performance rights
are ``perfect complements'' from the perspective of an interactive
streaming service, there is no economic rationale for setting the
two rates separately from one another. Id. ] 88. See also Leonard
AWDT ]] 56, 82-83 (relying on the ``perfect complements'' argument
to advocate for an elimination of the Mechanical Floor). Marx WDT ]]
135, 165 (``Economic efficiency would be improved by removing the
$0.50 per-subscriber fee floor from the paid subscriber mechanical
royalty formula'' and ``[REDACTED]'').
[REDACTED] Id.
Triggering of the Mechanical Floor would not reflect an
increase in the value of performance rights or mechanical rights,
but rather would reflect the ability of copyright holders to exert
market power over interactive services in the form of supra-
competitive performance rights license fees. Id. 94.
A Mechanical Floor defeats the benefits of an ``All-
In'' rate. Apple PFF ]] 164-167. (and record citations therein).
It is incorrect that Copyright Owners ``had no control
over'' public performance rates. The Services note that the same
publishers that are members of the NMPA board, controlling its
policy and strategy, are also member of the board of ASCAP, the
largest PRO. SJRPFF-CO at p. 284 (citing In re Pandora Media, Inc.,
6 F. Supp. 3d 317, 341 (S.D.N.Y 2014) (describing how
representatives of UMPG, Sony/ATV, and BMG all work with each other
as ASCAP board members and work with David Israelite of the NMPA).
[REDACTED]
c. Findings Regarding the ``All-In'' Rate and the Mechanical Floor
I find that the ``All-In'' rate is a necessary and proper element
of the 2012 benchmark, and must remain in the rate structure for the
forthcoming rate period. As an initial matter, I reject Copyright
Owners' argument that the ``All-In'' feature is unlawful because the
Judges do not regulate performance rates. The ``All-In'' feature does
not constitute a regulation of the performance rate, but rather
represents a cost exclusion (or deduction) from the mechanical rate. I
recognize, as do the parties, that the royalties otherwise due under a
revenue-based format may exclude certain costs. See 73 CFR
385.11(Definition of ``Service Revenue,'' paragraph (3) therein).\276\
---------------------------------------------------------------------------
\276\ I recognize that the reduction of the mechanical rate
interim calculation by the amount of the performance rate in ``Step
2'' (see Sec. 385.12(b)(2)), acts as an exclusion from royalties
rather than a deduction from revenue (by analogy, just as a tax
credit is a subtraction from taxes, whereas a tax deduction is a
subtraction from income). However, there is no statutory or
regulatory impediment that prohibits this exclusion from royalties.
Also, it is noteworthy that the costs that are excluded under
current Sec. 385.12(b)(2) are all costs over which the Judges have
no authority.
---------------------------------------------------------------------------
The exclusion of performance royalties in the ``All-In''
calculation is also necessary, because--as all parties and economists
agree--mechanical rights and performance rights are perfect
complements. That is, each right is worthless without the other. See
generally, Varian, supra, at 40 (``Perfect complements are goods that
are always consumed together in fixed proportions . . . A nice example
is that of right and left shoes. . . . Having only one out of a pair of
shoes doesn't do the consumer a bit of good.'').
Accordingly, if the mechanical rate was set in this proceeding
without a credit for the performance rate, the perfect complementarity
of the two licenses would be ignored, and the interactive streaming
services would pay two times for the same economic right--the right to
stream the musical work embodied in the sound recording. Further, as
the Services note, there is a substantial overlap not only in the
songwriters who receive royalties from both licenses, but also in the
entities that negotiate these rates on their behalf. Thus, it is
appropriate to continue to recognize the economic and bargaining-entity
overlaps by continuing to exclude the performance rate through the
``All-In'' rate structure. In this regard, I agree with the Services
and Apple that the Judges' treatment of the ephemeral license as
embodied within the sound recording license in combined section 112 and
114 proceedings is implicitly an acknowledgment that the royalties for
licenses which are perfectly complementary can be calculated in a
manner that reduces one royalty to reflect another royalty i.e., the
sound recording license is reduced by the value of the ephemeral
license. See Web IV, 81 FR, supra, at 26398 (``The Judges . . . find
that the minimum fee for the [s]ection 112 license should be subsumed
under the minimum fee for the [s]ection 114 license, 5% of which shall
be allocable to the [s]ection 112 license holders, with the remaining
95% allocated to the [s]ection 114 license holders.''). Of particular
importance for this Dissent is the fact that the subsuming of the
section 112 ephemeral license fee within the section 114 license was
done at the behest of the parties, and in fact dates back to the
parties' agreement as to that issue since Web I. See Web IV, supra, 81
FR at 26396-97 (``The current $500 minimum fee for commercial
webcasters has been in force for more than a dozen years, and has been
voluntarily re-adopted by licensors and licensees.'').\277\
---------------------------------------------------------------------------
\277\ The consensual nature of the handling of these perfect
complements in Webcasting proceedings underscores the difference
between the appropriateness of adopting an ``All-In'' rate that has
been the subject of long-standing agreement in this proceeding (ten
years) and the inappropriateness of the majority's binding of the
parties in this proceeding to the rates of another perfect
complement, the sound recording rate.
---------------------------------------------------------------------------
However, the performance license and the mechanical license, while
overlapping in important respects, do not overlap in all respects.
Consequently, I find that, for several reasons, the Mechanical Floor
now in the regulations should also be included in the rate structure
for the forthcoming rate period.
First, the fact that the performance right and the mechanical right
are necessary complements to the licensees does not end the inquiry. As
Copyright Owners point out, the mechanical royalties are used by the
publishers in part to fund advances to songwriters, and their
subsequent recoupment, thus providing an important source of liquidity
to songwriters, pending the later payment of royalties. If the ``All-
In'' rate substantially reduces or fully eliminates the mechanical
portion of the calculation, the pool of funds available for advances
and recoupments would be reduced.
Thus, the Services' argument that the mechanical right has no
standalone value, while sufficient to support an ``All-In'' rate, is
incomplete and, to an extent, self-serving, with regard to the
Mechanical Floor issue. To the music publishers and songwriters, the
[[Page 1998]]
mechanical right does have a separate value, in the funding of
songwriters, a value not provided by the performance royalty. It is
essentially a source of royalty revenue that has been designated and
created through an arm's length negotiation, by which songwriter
advances and recoupments can be funded. The fact that this pool or
source of revenue arises from the payment by services for the
mechanical right that is a perfect complement (from their perspective)
to the performance right is not the point; Copyright Owners have a
right to the benefit of the 2012 bargain \278\ that identified a floor
below which their source of advances/recoupment funds would not fall.
By analogy, the cost of any publisher input, not just the cost of
providing liquidity to songwriters, such as, for example, the cost of
heating the buildings in which songwriters toil, has no direct,
standalone value to the services, yet no one would assert that the
licensors are not entitled to a pool of royalty revenue sufficient to
recover their heating costs. Liquidity funding for songwriters is a
necessity, just as heat is a necessity--and the complementary nature of
the rights to the Services is of no relevance in that regard. (In fact,
providing financial liquidity to songwriters, like providing them with
a heated building, of course indirectly does benefit the services,
because songwriters who are financially illiquid or physically frozen
from lack of heat, are equally unable to write the musical works that
the services must play.) \279\
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\278\ I note that the majority maintains the Mechanical Floor.
However, the Mechanical Floor was part of the trade-off of
consideration within the 2012 benchmark settlement. It is
inconsistent for the majority to maintain this vestige of the 2012
benchmark while rejecting its other aspects, in favor of the post-
hearing rate structure they have created. This yet another example
of how the majority's rate structure--to borrow from Copyright
Owners' analogy--picks provisions from columns A, B . . . and now C,
when inventing its post-hearing structure.
\279\ From a more technical economic perspective, all productive
upstream inputs benefit downstream re-sellers.
---------------------------------------------------------------------------
In recognition of the importance of advances to songwriters,
Professor Katz speculates that the problem of recouping advances could
be solved by transferring some of the advancements from the music
publishers to the PROs. 3/13/17 Tr. 607 (Katz). However, I am loath to
join in speculation that parties over whom the Judges have no
jurisdiction will voluntarily change the conduct of their businesses,
and then bootstrap those speculative predictions to support their
rulings.\280\
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\280\ This is the same principle that leaves me reluctant to
rely on speculation inherent in the Majority Opinion and in
Copyright Owners' ``see-saw'' assertion regarding an assumed
willingness by record companies to agree to a decrease in sound
recording royalties in response to an increase in mechanical
royalties, as discussed infra. Also, the point in the accompanying
text should be contrasted with the basis for adoption of an ``All-
In'' rate: The industry over which the Judges have jurisdiction in
this proceeding for ten years has operated under a rate structure
(which I find to be a useful benchmark), that incorporates the
``All-In'' adjustment to account for the performance royalties.
Thus, the Mechanical Floor and the ``All-In'' structure are both
parts of the 2012 benchmark, revealing the parties' longstanding
willingness and ability to operate under an overall structure in
which performance royalties are subject only to a limited deduction
in the calculation of the mechanical royalty.
---------------------------------------------------------------------------
Second, although the services assert that they had dismissed the
triggering of the Mechanical Floor as ``illusory,'' that dismissal was
demonstrably incorrect, as evidenced by the large number and percent of
service-months in which the Mechanical Floor has been triggered.
Moreover, [REDACTED]. Marx WDT ] 76. More generally, the Mechanical
Floor provides a form of insurance to Copyright Owners that the
mechanical royalty will not be reduced or eliminated if services
trigger that rate alternative because of relatively high performance
rates.
Third, I am unpersuaded by the Services' argument that the sole
reason the Mechanical Floor has been triggered is because the
performance royalty rate has increased significantly ``to levels not
foreseen when the Mechanical Floor was negotiated.'' SJRPFF-CO at pp.
411-12. I find that criticism puzzling; the purpose of the Mechanical
Floor is to limit the extent to which the performance royalty rate
would diminish the mechanical rate through the ``All-In'' approach.
Thus, the services are asserting that the essential nature of the
Mechanical Floor is a bug, when in fact it is a defining feature--
again, a form of rate insurance for which the music publishers/
songwriters bargained, and to which the services acquiesced, when
agreeing to the 2008 and 2012 settlements.
Fourth, I do not find that the potential for further fragmentation
of musical works licenses and publisher withdrawals is a sufficient
reason to consider eliminating the Mechanical Floor. Copyright Owners
have convincingly argued that: (1) Services have offered no evidence
that the introduction of the new PRO, GMR, will have any impact on the
performance royalty rate; (2) partial withdrawals are not permitted by
the rate court, the Second Circuit or the Department of Justice; (3)
there is no evidence of increasing performance rates (and the rate
courts can ensure ``reasonable'' rates charged by the two largest PROs,
ASCAP and BMI); and (4) some fractional (a/k/a fragmented) licensing
has always been present in the market. See CORPFF-JS at pp. 87-90 (and
record citations therein).
Fifth, I reject a further complaint, [REDACTED], that the
Mechanical Floor is perverse, because lower retail pricing that
diminishes revenues will increase the likelihood that the Mechanical
Floor will bite. I see this too as a feature of this floor--not a bug.
As Pandora's witness, Mr. Parness, explained (see 3/9/17 Tr. 354
(Parness)), the Mechanical Floor was made part of the ongoing
settlement terms expressly because Copyright Owners were fearful that
retail pricing would be too low and generate decreased royalties under
other prongs.
Finally, I do not agree with the assertion that the presence of the
Mechanical Floor rate ``defeats the benefits'' of an ``All-In'' rate.
To be sure, the Mechanical Floor limits the value of the effective cost
reduction embodied in the ``All-In'' rate, but that limitation does not
defeat the ``All-In'' rate. This critique actually underscores a
broader infirmity in the services' arguments in opposition to a
continuation of the Mechanical Floor. They maintain that the 2012
settlement, carrying forward essentially the structure of the 2008
settlement, has worked satisfactorily for licensors and licensees
alike. I agree, finding that the present rate structure should be
continued. However, the Services, contrary to their basic argument,
seek to disrupt the status quo that they otherwise recommend, in order
to obtain a better bargain than contained in that benchmark. To put the
point colloquially, the Services cannot have their cake and eat it too.
6. Findings Regarding the Rate Structure
Based on the foregoing, and as detailed further below, I conclude
that the 2012 rate structure constitutes a usable objective benchmark
in this proceeding.\281\ Based on the foregoing, I reject the per-unit
rate structure advocated by Copyright Owners. I also reject the
services' proposal to eliminate the Mechanical Floor.
---------------------------------------------------------------------------
\281\ I note once again that, separate and apart from its
usefulness as a benchmark in this proceeding, the existing rate
structure can also constitute a reasonable rate that the Judges may
adopt, particularly in the absence of any contrary probative record
evidence. See Music Choice, supra, 774 F.3d at 1010.
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[[Page 1999]]
7. The 2012 Benchmark, in its Entirety, is a More Useful Benchmark than
a Per-Unit Rate Structure or the Services' Modified Version of the 2012
Benchmark
I further find that the discriminatory rate structure in the 2012
benchmark renders it a more useful benchmark than the per-unit
proposals set forth by Copyright Owners and Apple. Although the 2012
rate structure is not necessarily the best structure that could have
been designed, it possesses the characteristics of a useful and
beneficial benchmark. In that regard, I take note of the four classic
characteristics of an appropriate benchmark, as identified by the
federal rate court:
In choosing a benchmark and determining how it should be adjusted, a
rate court must determine [1] the degree of comparability of the
negotiating parties to the parties contending in the rate
proceeding, [2] the comparability of the rights in question, and [3]
the similarity of the economic circumstances affecting the earlier
negotiators and the current litigants, as well as [4] the degree to
which the assertedly analogous market under examination reflects an
adequate degree of competition to justify reliance on agreements
that it has spawned.
In re Pandora Media, supra, at 354.
The 2012 benchmark meets these criteria. First, it pertains to the
same rights at issue in this proceeding. Second, the licensors (music
publishers) and licensees (interactive streaming services) categories
are comparable (if not identical).\282\ Third, the economic
circumstances are sufficiently similar and the same in crucial
respects, i.e., the ongoing differentiated nature of this marketplace
and the zero marginal physical cost of the licensed copies, (as
discussed supra). Fourth, the 2012 benchmark it reflects a rate
structure with an adequate degree of competition because, as explained
in connection with the discussion of the shadow effects, it is a rate
free of complementary oligopoly effects and of an imbalance in market
power. Further with regard to this fourth point, the parties have been
operating over the past ten years under this basic rate structure, with
profits accruing to the licensors and admittedly tolerable losses for
the licensees.
---------------------------------------------------------------------------
\282\ Copyright Owners assert that the different identities of
the licensees, particularly the market entry of Amazon, Apple and
Google, and their bundling and discounting of interactive streaming,
diminish the comparability of the 2012 benchmark. The Services note
that even prior to the entry of these three entities, similar
multiproduct firms were licensees--including Yahoo and Microsoft. I
discuss the bundling and discounting issues elsewhere in this
Dissent.
---------------------------------------------------------------------------
More particularly, I re-emphasize that, as a matter of law, section
115 specifically provides that settlements shall constitute evidence of
market rates. Therefore, I cannot simply disregard the settlement rates
as immaterial evidence. See 17 U.S.C. 115(c)(3)(D). Of course (as noted
supra), the Judges may give whatever weight they think is proper to
such evidence, without running afoul of any statutory duty. As
explained in further detail below, for a number of reasons, I not only
find this benchmark useful, I also accord substantial weight to this
benchmark.
First, the record indicates that Copyright Owners have demonstrated
(albeit tacitly) their understanding that, if the Judges did not set a
price discriminatory rate structure to reflect the varying WTP,
Copyright Owners would have to invent it. This finding is apparent from
a careful reading of their advocacy for the adoption of a bargaining
room approach to rate-setting. That approach is explicitly premised on
the idea that Copyright Owners would offer to enter into multiple and
different price discriminatory agreements with various services, if the
high statutory rate set under the bargaining room theory is too high
for some services to operate. This point is made clear by the testimony
of Professor Rysman and Dr. Eisenach. See, e.g. 4/3/17 Tr. 4390, 4431
(Rysman) (lauding the bargaining room approach as reflecting the
``economical element of price discrimination . . . the [licensor] is
picking its prices carefully.'') (emphasis added).
The following colloquy between the Judges and Dr. Eisenach is also
instructive:
[THE JUDGES]
Are you familiar with the concept of the bargaining theory of
rate setting . . . [t]he idea that rate setters, such as this Board,
should set rates that are higher than the market rate for certain
users because they can then, as you are testifying to now, can
bargain with the licensors for lower rates to use a bargaining
concept in the setting of rates?
[DR. EISENACH]
So as you have just stated it, I think that is consistent with
my testimony in this matter, which is that the compulsory license
serves as a back-stop. It is a guaranteed cap on what anyone would
have to pay. The ability to negotiate mutually beneficial bargains
below that cap is there for all of the parties. And the incentives
to do so are there as well.
4/4/17 Tr. 4845 (Eisenach) (emphasis and underscore added); see also
id. at 4843-44 (``one thing that I took into account in considering . .
. higher mechanical rates . . . is the ability of streaming services to
negotiate direct deals with the publishers. . . . We're looking here at
an upper and not a lower end. . . . [I]f the Copyright Owners' proposal
were adopted, [the services] would have the ability to negotiate direct
agreements with publishers.'') (emphasis and underscore added).
Professor Rysman, echoed Dr. Eisenach in this regard, when
discussing the potential impact on Spotify of Copyright Owners'
proposed substantial rate increase:
[REDACTED]
4/3/17 Tr. 4390, 4431 (Rysman) (emphasis added).
Thus, I find there to be no real dispute as to the need for an
upstream discriminatory rate structure. To borrow from a classic story,
I perceive that the parties are not in disagreement as to what kind of
rate structure is needed in the market, but are rather ``haggling over
the price.'' \283\ Perhaps more importantly, the parties appear to be
in disagreement as to who and what shall be in control of the setting
of rates, the Judges and the statute on the one hand, or Copyright
Owners and the unregulated market on the other. The answer is--as it
must be according to statute--that it is the Judges who set the rates.
They are instructed by statute and guided by precedent to set a
reasonable rate and to consider several itemized factors, not to cede
that authority to any market participant.\284\ Further, as Professor
Katz testified, the statutory license, and negotiations undertaken
under the so-called shadow of that license, incorporate a
countervailing power that allows the streaming services a more equal
bargaining position. 3/13/17 Tr. 577 (Katz). Under the bargaining room
approach, that salutary aspect of the statutory scheme would be
eliminated.
---------------------------------------------------------------------------
\283\ The provenance of the story in which the quoted phrase is
the punch line is uncertain, and has been variously attributed to,
inter alios, George Bernard Shaw, Winston Churchill, Groucho Marx,
Mark Twain, W.C. Fields, and Bertrand Russell.
\284\ This point underscores a defect in the Majority Opinion.
Under its provisions, participants in a neighboring market, the
record companies in the sound recording market, who license their
own perfect complement, will have economic control over the
mechanical royalty rate, via the TCC prong.
---------------------------------------------------------------------------
Second, and related to the prior point, I find the 2012 rate
structure to be a very useful benchmark because it embodies a price
discriminatory rate structure that reflects the downstream market's
segmentation by WTP. Although Copyright Owners correctly argue that
discriminatory upstream rates are not required in order to accommodate
downstream price discrimination, they do not provide a sufficient
counter-argument to the Services' point that the upstream rate should
also be price discriminatory in order to incentivize,
[[Page 2000]]
rather than jeopardize, the downstream licensees' satisfaction of the
varying WTP among listeners. Absent such a structure, the services are
more likely to face the vexing problem of essentially fixed revenues
and variable costs, under the ``all-you-can-eat'' model demanded by
listeners. Although Copyright Owners may well be correct in their
argument that an upstream discriminatory rate structure can be
accomplished without resort to a revenue-based rate structure (that is,
for example, via different per-play rates), neither Copyright Owners
nor Apple proposed such an alternative discriminatory rate or provided
evidence by which the Judges could mold such rates (as they did in Web
IV).
Third, I find insufficient evidence to support Copyright Owners'
assertion that the market in 2012 was not yet ``mature''--compared with
the market at present--and that the 2012 rate structure was thus
``experimental.'' At a high level, all markets are not ``mature,'' in
the sense that they are dynamic and thus subject to change, making all
rate structures ``temporary,'' if not ``experimental.'' Moreover, the
ongoing creative destruction in the streaming industry has only
reinforced the fact that, even since 2012, the interactive streaming
services market is still not yet ``mature.'' See. e.g., Written Direct
Testimony of Paul Joyce (on behalf of Google Inc.) ] 17 (Joyce WDT)
(describing Google Play Music as ``nascent compared to other
participants in the streaming music market.'') \285\
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\285\ In this regard, it is noteworthy that another of Copyright
Owners' expert economic witnesses--expressly echoing a prior
licensor expert in Phonorecords I--opines that the present
interactive streaming market is ``unlike a mature business.'' See
Watt WRT ] 40 (``Interactive streaming of music is a relatively new
enterprise, made of some relatively new companies and companies new
to the space.''). Although Professor Watt was making this point for
the purpose of explaining how to identify revenues and costs for
inclusion in a Shapley value analysis (discussed infra), unlike
``Schrodinger's Cat,'' the interactive streaming market cannot be
two contradictory things at once, simultaneously ``mature'' for the
purpose of avoiding a discriminatory rate structure and ``not
mature'' for Shapley purposes.
---------------------------------------------------------------------------
However, even if Copyright Owners' maturity/experimental argument
had merit, it does not supersede the convincing economic logic that a
price discriminatory rate structure remains appropriate, because the
economic fundamentals endure. The cost of producing an additional copy
of a musical work remains zero. A market segmented by WTP is
efficiently served through price discrimination. Upstream demand for
licenses is a derived demand, see 3/20/17 Tr. 1967-68 (Marx), and thus
a function of the segmented downstream demand, making an upstream
discriminatory rate structure more efficient, even if not necessary. I
find that, in a second-best world such as the interactive streaming
industry, a consonance between upstream and downstream pricing
structures enhances efficiency.\286\
---------------------------------------------------------------------------
\286\ Of course, as explained supra, all second-best markets are
inefficient in the static sense. Thus, under the bargaining room
approach that Copyright Owners endorse, they would exchange one
``inefficiency'' (percent of revenue pricing) with another (unit
pricing above marginal cost) and then seek to negotiate away the
latter inefficiency, outside the ``reasonable rate'' requirement and
without regard to itemized statutory factors in section 801(b)(1).
---------------------------------------------------------------------------
Fourth, Copyright Owners argument that the 2012 benchmark, with its
attendant multi-pronged rate structure, is inconsistent with the idea
that a musical work has (or should have) a single ``inherent'' value,
see, e.g., Israelite WDT at 10; ] ] 29(B), 30, 31(C); Brodsky WDT ] 68,
is actually inconsistent with Copyright Owners' own proposed rate
structure. That is, Copyright Owners' proposal, that the statutory rate
automatically should shift from a per-play rate to a per-user rate if
the latter leads to greater royalties, belies their fealty to the
``inherent value'' argument. Rather, their greater-of approach
demonstrates their eagerness to jettison this concept if another
measurement tool (the per user rate) could result in greater revenue.
That is, Copyright Owners' proposal seeks to accommodate two separate
values (value-in-use and access (option) value, while denying that
other marketplace values can exist, even if they reflect varying WTP
and varying ability-to-pay).
I recognize that the 2012 benchmark is also a greater-of approach,
but it blends into that approach a ``lesser of'' approach (per
subscriber or TCC) within one of the ``greater of'' prongs. Thus, there
is no real fundamental dispute between Copyright Owners and the
Services as to whether rates may be disconnected from unit pricing.
Rather, the question is whether the disconnect will be made to benefit
only Copyright Owners (in a manner that would cause substantial
negative impact to Services, (as detailed in Professor Ghose's rebuttal
testimony, discussed supra), or will be structured to reflect the
parties' historical and ongoing bargain that softens and balances the
impact of a greater-of structure. See 4/7/17 Tr. 5584 (Marx) (noting
that Copyright Owners' ``greater-of'' proposal lacks the balance in the
2012 structure that combines a ``greater of'' structure'' with a
``lesser of'' prong). \287\
---------------------------------------------------------------------------
\287\ Again, it bears emphasis that the 2012 benchmark provides
Copyright Owners with an access (option) value prong, in the form of
a per-subscriber rate.
---------------------------------------------------------------------------
Fifth, I rely on the 2012 rate structure as an objective benchmark.
Thus, the absence of more direct testimony regarding what went through
the minds of the negotiators of the 2008 and the 2012 settlement does
not diminish the objective value of this benchmark. I do not place
dispositive weight on the subjective reasons why the parties may have
entered into the prior settlements. I view the terms of the 2012
settlement as potential objective benchmark information. See, e.g., 3/
13/17 Tr. 550-51, 566 (Katz) (acknowledging his lack of knowledge as to
why the parties negotiated specific provisions of the 2012 settlement,
but noting that objectively the results of the settlement demonstrate
the satisfactory performances of the market). Further, both Professor
Katz and another Services' expert, Professor Hubbard, noted that the
current rate structure remains valuable, not based on their
consideration of the parties' subjective understandings at the time of
settlement, but rather because the market has not since changed in a
manner that would create a basis to depart from a multiple-rate
upstream rate structure. Katz WDT ] 80 (``My analysis has identified no
changes in industry conditions since then [2012] that would require
changing the fundamental structure of the percentage-of-revenue
prong.''); 4/13/17 Tr. 5977-78 (Hubbard) (changes in the market are
``not uncorrelated with the structure that was in place'' in 2012). In
this regard, it bears emphasis that Dr. Eisenach, quite properly,
relied on several potential benchmarks for his rate analysis, without
attempting to examine the parties who negotiated those benchmark
agreements. He too was treating potential benchmarks in an objective
manner, consistent with my understanding of the long-standing method of
using benchmarks for the setting of rates.
Sixth, I do not credit the arguments by Copyright Owners and Apple
(and by the majority) that the present rate structure is complex. If
some songwriters find their royalty statements confusing, that is a
real concern that should be resolved. However, one of the benefits of a
collective, be it the publishers themselves, or, the NMPA, the NSAI or
a PRO, is that these collectives have the expertise and resources to
identify and explain how
[[Page 2001]]
royalties are computed and distributed. There is no good reason why the
rate structure that is consonant with the parties' ten year history and
with the relevant economic model should be sacrificed on the slender
argument that ``simpler is better than complicated.'' I agree that,
ceteris paribus, the rate structure should be simple but, as Albert
Einstein is credited with saying: ``Everything should be made as simple
as possible, but no simpler.'' The 2012 rate structure meets this
criterion.\288\
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\288\ I note that Copyright Owners not only voluntarily agreed
to this multi-tiered rate structure in 2008, they were the parties
who had proposed this structure, and they then ratified its
usefulness by adopting it anew in the 2012 settlement. Moreover,
Copyright Owners agreed to a similar tiered structure for the new
subpart C rates in that 2012 settlement. These facts belie the
assertion that Copyright Owners found this rate structure to be too
confusing.
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Accordingly, for the reasons set forth in this Section III of the
Dissent, I find the 2012 rate structure, in its entirety, to be the
appropriate benchmark for the rate structure in the forthcoming period.
I. THE PARTIES' PROPOSED RATES
Establishing a rate structure resolves only one aspect of the
overall rate determination. The next issue to decide is whether the
rates within the 2012 benchmark are appropriate, whether they need to
be changed and, if so, whether the record provides a basis for
identifying different rates. Unlike the majority, I hew to the record,
and do not attempt to divine from the record brand new post-hearing
rates (or rate structures) that were never presented by the parties,
and thus never subjected to examination by the parties' counsel and
economists.
Copyright Owners have identified per play and per user rates in
their rate proposal. Although I have rejected that rate structure, I
review Copyright Owners' evidence regarding the setting of such rates.
If that evidence is informative, and if the record permits, I would
attempt to convert Copyright Owners' per-unit rate proposal into a
percent of revenue rate with appropriate minima, consistent with the
2012 benchmark rate structure.
On the other side of the ledger, several of the Services' expert
economists have asserted that, although the 2012 benchmark sets forth a
generally appropriate rate structure, and that the rates have been
acceptable to the Services, the rates within that structure are in fact
too high and should be reduced for the forthcoming rate period.
Accordingly, I also examine those lower rates to determine if they
should be incorporated into the 20212 benchmark for the forthcoming
rate period.
1. The Copyright Owners' Benchmark Rates
a. Overview of Approach
Copyright Owners identified potential rates through an analysis
undertaken by one of their economic experts, Dr. Eisenach, of several
benchmarks, and of relationships between musical works and sound
recording royalties that he identified in various markets. He began by
noting that ``an economically valid approach for assessing the value of
intellectual property rights which are subject to compulsory licenses
is to examine market-based valuations of reasonably comparable
benchmark rights--that is, fair market valuations determined by
voluntary negotiations.'' Eisenach WDT ] 8 (emphasis added). In
selecting potential benchmarks, Dr. Eisenach identified what he
understood to be key characteristics that would make a benchmark
useful: ``[U]nderlying market factors . . . ; the term or time period
covered by the agreements; factors affecting the relative bargaining
power of the parties; and differences in the services being offered.''
Id. ] 80.
Dr. Eisenach found useful the license terms for the sound recording
rights utilized by interactive streaming services, because they are
negotiated freely between record companies and the interactive
streaming services. Id. These rates made attractive inputs for his
analysis because they: (1) relate to the same composite good--the sound
recording that also embodied the musical work; and (2) the interactive
streaming service licensees were the same licensees as in this
proceeding. Thus, to an important degree, Dr. Eisenach found these
agreements to possess characteristics similar to those in the
mechanical license market at issue in this proceeding. Moreover, Dr.
Eisenach found that ``[d]ata on the royalties paid under these licenses
are available and allow . . . estimat[ion of] the rates actually paid
by the [interactive] streaming services to the labels for sound
recordings on both a per-play and a per-user basis.'' Id.
However, as Dr. Eisenach noted, these benchmark agreements related
to a different right--the right to a license of sound recordings--not
the right to license musical works broadly, or to the mechanical
license more specifically. Thus, as with any benchmark that does not
match-up with the target market in all respects, Dr. Eisenach examined
how the rates set forth in the sound recording: interactive streaming
benchmark agreements could be utilized. Id. More particularly, Dr.
Eisenach posited that there may be a relationship--a ratio--between the
sound recording royalty rate and the musical works royalty rate. To
that end, he ``examine[d] a variety of markets in which sound recording
and musical works rights are both required in order to ascertain the
relative value of the two rights as actually reflected in the
marketplace.'' Id. (emphasis added).
Through this examination, Dr. Eisenach concluded that these
proposed benchmarks ``establish upper and lower bounds for the relative
value of sound recording and musical works rights . . . estimate[d] to
be between 1:1 and 4.76:1.'' Id. To make these ratios more instructive,
I note that the inverse of these ratios (e.g., 1:4.76 instead of
4.76:1) can be expressed as a percentage. Thus, the ratio of 1:4.76 is
equivalent to a statement that musical works royalties equal 21% of
sound recording royalties in agreements struck in the purported
benchmark market. More obviously, the 1:1 ratio means that, in
agreements within that purported benchmark market, musical works
royalties equal 100% of sound recording rates. By converting the ratios
into percentages, it becomes apparent that the high end of Dr.
Eisenach's benchmark range is almost five times as large as the low end
of the range.
b. Economic Relationship between Sound Recording and Musical Works
Rights
Dr. Eisenach testified that ``[f]or music users that require both
sound recording rights and musical works rights, the two sets of rights
can be thought of in economic terms, as perfect complements in
production: Without both inputs, output is zero.'' Id. ] 76 (emphasis
added). Dr. Eisenach also notes that, ``for interactive streaming
services, the two categories of rights [sound recordings and musical
works] are further divided into a reproduction license [i.e., the
mechanical license] and a performance license. . . .'' Id. (Thus, the
mechanical license and the performance license likewise are perfect
complements with each other and with the sound recording license.)
Dr. Eisenach acknowledges that ``[t]he relative value of sound
recording [to] musical works licenses may depend on a variety of
factors, and traditionally the relationship has differed across
different types of services and situations.'' Id. ] 78. Dr. Eisenach
eschewed unnecessary ``assumptions, complexities and uncertainties
associated with theoretical debates'' as to why the particular existing
market
[[Page 2002]]
ratios existed. Id. ] 79. Rather, instead of ``put[ting] forward a
general theory of relative valuation,'' he found it ``sufficient . . .
to assume that the relative values of the two rights should be stable
across similar or identical market contexts.'' Id.
c. Dr. Eisenach's Potential Benchmarks
Dr. Eisenach considered a variety of benchmark categories in which
the licensee was obligated to acquire licenses for musical works and
licenses for sound recordings. His selection and consideration of each
category of benchmark markets are itemized below.
i. The Current Section 115 Statutory Rates
The current statutory rate structure contains several alternate
rates explicitly calculated as a percentage of payments made by
interactive streaming services to the record companies for sound
recording rights. As noted supra, such rates are identified in the
industry as the ``TCC'' rates, the acronym for ``Total Content Cost.''
Id. ] 82. In the Subpart B category, the TCC is 22% for ad-supported
services and 21% for portable subscriptions. Id.; see also 37 CFR
385.13(b)(2) and (c)(2).\289\ These percentage figures correspond to
sound recording: musical works royalty ratios of 4.55:1 and 4.76:1,
respectively.
---------------------------------------------------------------------------
\289\ Lower percentages apply if the record companies' revenue
includes revenue to be ``passed through'' by them to pay mechanical
license royalties. However, according to Dr. Eisenach, such ``pass
throughs'' are not typical. Id. ] 82 n.67.
---------------------------------------------------------------------------
Dr. Eisenach notes that these statutory rates were not set by the
Judges pursuant to a contested hearing, but rather (as noted supra)
reflect two consecutive settlements (spanning approximately a decade),
first in 2008 and again in 2012. Id. ] 83. Dr. Eisenach discounts the
value of these settlement rates for three reasons. First, he notes that
they were established prior to the ``marketplace success'' of Spotify
in the interactive streaming industry.\290\ Second, he notes that the
settlements, although voluntary, ``were negotiated under the full
shadow of the compulsory license.'' \291\ Third, he finds that,
although the settlement incorporates rate prongs based on a percent of
sound recording rates (the TCC prongs), those provisions are part of a
``lesser of'' segment of the rate structure, and thus capped by
alternative per subscriber rates. Id. & n.70. Thus, Dr. Eisenach
concludes: ``In my opinion, the evidence . . . indicates that the
relative valuation ratios implied by the current Section 115 compulsory
license . . . represent an upper bound on the relative market
valuations of the sound recording and musical works rights.'' Id. ] 92
(emphasis added). (As an ``upper bound,'' these ratios would represent
the lower bound of the reciprocal percentage of the value musical works
rights relative to sound recording rights, again, 21% and 22%.)
---------------------------------------------------------------------------
\290\ Spotify was launched in the United States in the summer of
2011. 3/20/17 Tr.1778 (Page).
\291\ I discuss the ``shadow'' argument supra.
---------------------------------------------------------------------------
The 21% and 22% TCC rates within section 115 identified by Dr.
Eisenach imply certain approximate percent-of-revenue rates, i.e.,
percent of total service revenue (not percent of sound recording
revenue). For example, if the sound recording royalty rate for
interactive streaming is [REDACTED] %,\292\ then, using these section
115 TCC figures, the implied musical work royalty rate would be
calculated as [REDACTED][ %, or [REDACTED] %. To take the low end of
the range, if the sound recording royalty rate is [REDACTED] % then,
applying these TCC figures, the implied musical work royalty rate would
be calculated as [REDACTED] %, or [REDACTED] %. Again, because Dr.
Eisenach opines that these are upper bounds on the relative market
valuations,'' that is the equivalent of opining that they represent the
lower bound of a percentage-based royalty calculated via this ratio
approach.
---------------------------------------------------------------------------
\292\ [REDACTED]; 4/7/2017 Tr. 5509 (Marx) (indicating most
recent sound recording royalty payments equaled [REDACTED] % of
revenue); Marx WDT ] 62 (``In 2015, Spotify paid [REDACTED] % of its
US gross revenue for sound recording royalties based on its
negotiated rates with record labels summarizing Spotify's rates
under various agreements); see generally SJPFF ] 87 ([REDACTED]).
---------------------------------------------------------------------------
ii. Direct Licenses between Parties Potentially Subject to a Section
115 Compulsory License
Dr. Eisenach also examined direct agreements between record
companies and interactive streaming services that contain rates for
sound recordings and mechanical royalties, respectively. See, e.g., id.
] ] at 84-91. In such cases, the ratio of sound recording:musical works
royalties ranged tightly between 4.2:1 to 4.76:1, closely tracking the
regulatory ratios implicit in the section 115 TCC. Id. ] 92. (The 4.2:1
ratio equates to a TCC rate of 23.8%, and the 4.76:1 ratio equates to a
mechanical rate of 21%.)
According to Dr. Eisenach, the similarity of these direct contract
rate ratios to the statutory ratios reflects the ``shadow of the
statutory license,'' by which direct negotiations between parties
regarding rights that are subject to a statutory license are influenced
by the presence of statutory compulsory rates and/or the prospect of a
future rate proceeding. 4/4/17 Tr. 4591 (Eisenach) (``The underlying
problem with looking at an agreement negotiated under the shadow of a
license'' is that [i]t shifts bargaining power from the compelled party
to the uncompelled party by the very nature of the exercise.'').\293\
---------------------------------------------------------------------------
\293\ Again, I discussed the issue of the ``shadow'' of the
statutory license supra. Suffice it to note here that the ``shadow''
of the statutory license does not ``shift'' bargaining power so much
as it eliminates unequal bargaining power. Although the interactive
services have the legal right to refuse to license at rates set by
the Judges (the legal compulsion operates only on the licensors),
such refusal of the services to obtain licenses would shut them out
of the interactive streaming market in which they have made
substantial investments (unless they attempted to engage in piracy
which certainly would be quickly shut down). So, it would be absurd
for the services not to license at rates set in a section 115
proceeding. And, if they did so refuse, Copyright Owners could then
attempt to move the listeners of the erstwhile interactive streaming
service to other distribution channels such as purchased downloads
and physical products, which they claim are sufficiently profitable
for them and, they claim, have been cannibalized by interactive
streaming. Or, as Copyright Owners indicate (as discussed supra),
under the bargaining room approach, if the statutory rate was set
too high for some services, Copyright Owners could negotiate lower
rates, free of the statutory ``reasonableness'' requirement, without
regard to the four itemized objective in section 801(b)(1), and with
the complementary oligopoly power to ``hold out'' and ``walk away,
or to threaten to do so, to obtain a higher rate than would be set
under the statute.
---------------------------------------------------------------------------
Given these limitations, Dr. Eisenach concluded, as he did with
regard to the actual section 115 rates licenses, that ``[i]n my
opinion, the evidence presented . . . indicates that the relative
valuation ratios implied by the . . . negotiations under [the
statutory] shadow--ranging from 4.2:1 [23.8%%] to 4.76:1[21%]--
represent an upper bound on the relative market valuations of the sound
recording and musical works rights.'' Eisenach WDT ] 92 (emphasis
added).
iii. Synchronization Agreements
Synchronization (Synch) Agreements are license contracts between
audio-video producers, such as movie and television producers, with,
respectively, music publishers and record companies, allowing for the
use, respectively, of the musical works and the sound recordings in
``timed synchronization'' with the movie or television episode. See
generally D. Passman, All you Need to Know about the Music Business 265
(9th ed. 2015). Dr. Eisenach found these Synch Agreements to be a mixed
bag in terms of their value as a benchmark. On the one hand, he
recognized that the licenses they conveyed ``do not apply to music
streaming services as such'' but, on the other hand, they ``are
negotiated completely outside the shadow of the
[[Page 2003]]
compulsory license. . . . '' Id. ] 93. Dr. Eisenach notes, from his
review of other testimony and an industry treatise, that these freely
negotiated market agreements grant the musical composition royalty
payments equal to the corresponding royalty paid for the sound
recording,'' id. ] ] 94-95 & nn.87, 88, which is the equivalent of a
1:1 sound recording:musical works ratio.\294\
---------------------------------------------------------------------------
\294\ Dr. Eisenach finds this 1:1 ratio to be present in the two
types of Synch Agreements he identified. One version represents an
agreement relating to a specific musical work and sound recording
combination. The other version, a ``Micro-Synch'' Agreement, which
he describes as ``essentially `blanket' synch licenses, in that the
license grants the right to synchronize not just one particular song
. . . but any song in the publisher's catalog (or a significant
portion thereof). . . .'' Eisenach WDT ] 96.
---------------------------------------------------------------------------
Dr. Eisenach finds this 1:1 relationship to be important benchmark
evidence, concluding as follows:
The synch and micro-sync examples confirm that in circumstances in
which licensees require both sound recording and musical composition
copyrights in order to offer their service, and where that service
is not entitled to a compulsory license for either right, the sound
recording rights and the musical composition rights are in many
cases equally valued, that is, the ratio of the two values is 1:1.
Id. ] 98.
iv. YouTube Agreements
Dr. Eisenach also examined licenses between: (1) YouTube (owned by
Google) and record companies; and (2) YouTube and music publishers, to
determine their potential usefulness as benchmarks. [REDACTED]. For
these reasons, Dr. Eisenach concluded that for purposes of assessing
the relative value of the sound recording and musical works rights, the
YouTube agreements represent reasonably comparable benchmarks. Id.
In his original Written Direct Testimony, Dr. Eisenach relied upon
seven agreements between YouTube and several music publishers
pertaining to [REDACTED]. Id. ] 101 n.93. [REDACTED]. However, with
regard to the revenue received by the record companies, Dr. Eisenach
could only speculate based on public reports as to the percent of
revenue received by the record companies for the sound recordings
embedded in the posted YouTube videos. Id. ] 102. Thus, he was unable
to make an informed argument in his original written testimony
regarding the ratio of sound recording royalties:music publisher
royalties in his YouTube [REDACTED].
However, after the Judges compelled Google to produce in discovery
copies of the YouTube agreements with the record companies, Dr.
Eisenach filed (with the Judges' approval) Supplemental Written
Rebuttal Testimony (SWRT) addressing these agreements. In that
testimony, Dr. Eisenach examined [REDACTED]. Eisenach SWRT ] 6, and n.
5. Dr. Eisenach identified nine of these licenses specifically in his
SWRT, and noted that YouTube paid to [REDACTED]--which Dr. Eisenach
found to be the comparable YouTube category--whereas [REDACTED]. Id.
and Table 1 therein.
As Dr. Eisenach accurately calculated, the [REDACTED] revenue split
reflects a ratio of [REDACTED], (a musical works rate equal to
[REDACTED] % of the sound recording rate), whereas the [REDACTED]
revenue split reflects a ratio of [REDACTED] (a musical works rate
equal to [REDACTED] % of the sound recording rate).\295\
---------------------------------------------------------------------------
\295\ Although Dr. Eisenach does not emphasize the following
point, the actual percentages of revenue reflect that musical works
royalties constitute only [REDACTED]% of total revenues in these
YouTube agreements, [REDACTED]. Also, these data indicate that
YouTube, as licensee, retains [REDACTED]% to [REDACTED]% of the
total revenue attributable to these benchmark agreements,
[REDACTED].
---------------------------------------------------------------------------
v. The Pandora ``Opt-Out'' Deals
Dr. Eisenach also examined certain direct licensing agreements
entered into between Pandora and major music publishers covering the
period from 2012 through 2018, to determine whether they constituted
useful benchmarks in this proceeding. Id. ] 103. Pandora had negotiated
these direct agreements with major publishers for musical works rights
after certain publishers had decided to ``opt-out,'' i.e., to withdraw
their digital music performance rights from PROs, and asserted the
right to negotiate directly with a digital streaming service. As Dr.
Eisenach acknowledges, the music publishers' legal right to withdraw
these rights remained uncertain during an extended period. Pandora thus
negotiated several such ``Opt-Out'' Agreements with an understanding
that the rates contained in those direct agreements might not be
subject to rate court review.
Given this unique circumstance, and given that the markets and
parties involved in the Pandora Opt-Out agreements are somewhat
comparable to the markets and parties at issue in this proceeding,\296\
Dr. Eisenach concluded that these agreements provided ``significant
insight into the relative value of the sound recording and musical
works rights in this proceeding.'' Id. (emphasis added).
---------------------------------------------------------------------------
\296\ Pandora was only a noninteractive service at that time,
and only paid the performance right royalty, not the mechanical
right royalty, for the right to use musical works. Because the
parties agree that the performance right and the mechanical right
are perfect complements, Pandora's payments for the performance
right are relevant and probative.
---------------------------------------------------------------------------
Dr. Eisenach compared the musical works rates in these ``Opt-Out''
agreements with the sound recording royalty rates paid by Pandora,
which he obtained from the revenue disclosures in Pandora's Form 10K
filed with the SEC that provided royalties (``Content Costs'') as a
percent of revenue, and he also relied on data contained in prior rate
court decisions. Eisenach WDT ] 125 & Table 6. With this data, he
calculated that the ratio of sound recording: musical works royalties
in existing agreements was [REDACTED] for 2018, i.e., the musical works
rate equaled [REDACTED]% of sound recording royalties. This [REDACTED]%
ratio would correspond to a mechanical rate of [REDACTED]%, assuming,
arguendo, the sound recording rate is [REDACTED]%, or [REDACTED]% if
the sound recording rate is [REDACTED]%.
Dr. Eisenach also made a forecast, by which he linked the passage
of time to an assumption that, after the rate court proceedings
concluded, the parties, without any further legal uncertainty, would
permanently be ``permitted to negotiate freely outside of the control
of the rate courts.'' He made this estimation and forecast through a
temporal linear regression, extrapolating from the prior [REDACTED] in
these Pandora ``opt out'' musical works rates. See Eisenach WDT ] 129.
Dr. Eisenach's linear regression further [REDACTED] the ratio to
[REDACTED], which would be equivalent to [REDACTED] the musical works
rate, as a percentage of sound recording royalties, from the
[REDACTED]% noted above for actual agreements in force in 2018 to
[REDACTED]%. almost a [REDACTED] based on the extrapolation alone. Id.
] ] 104; 128 & Table 8, Fig. 13. (This [REDACTED]% ratio would
correspond to a musical works rate of [REDACTED]%. assuming the sound
recording rate is [REDACTED]% and [REDACTED]% if the sound recording
rate was [REDACTED]%.)
d. Dr. Eisenach's Two Methods for Estimating the Mechanical Rate
Having calculated these five benchmarks, Dr. Eisenach applied them
in two separate methods to estimate the mechanical rate to be adopted
in this proceeding.
i. Method #1
Dr. Eisenach's Method #1 for estimating the mechanical rate is
based on the following premises:
[[Page 2004]]
1.The sound recording royalty paid by interactive streaming
services is unregulated and thus negotiated in the marketplace.
Eisenach WDT ] 16.
2.The sound recording royalty paid by noninteractive services is
regulated, but Dr, Eisenach find the royalties set by the Judges in Web
III to reflect a market rate. 4/4/17 Tr. 4643 (Eisenach); see also
Eisenach WDT ] 136 and n.123.
3. The interactive streaming services require a mechanical license
(the license at issue in this proceeding), whereas the noninteractive
services are not required to obtain a mechanical licenses.
4. According to Dr. Eisenach, the difference between the rates paid
by interactive services and noninteractive services for their
respective sound recording licenses equals the value of the remaining
license, i.e., the mechanical license. Id. ] 137 (``[T]he difference
between these two rights is akin to a `mechanical' right for sound
recordings, directly paralleling the mechanical right for musical works
in this proceeding.'').
5.The mechanical rate implied by this difference in sound recording
rates must be ``adjust[ed] for the relative value of sound recordings
[to] musical works'' (as discussed supra). Id. ] 140.
Dr. Eisenach combines these steps and expresses his Method #1 in
the form of the following algebraic equation:
MRMW = (SRIS-SRNIS)/
RVSR/MW,
where
MRMW = Mechanical Rate for Musical Works
SRIS = Sound Recording Rate for Interactive Streaming
(All In)
SRNIS = Sound Recording Rate for Non-Interactive
Streaming (Performance Only)
RVSR/MW = Relative Value of Sound Recording to Musical
Works Rights.
Eisenach WDT ] 140.
Dr. Eisenach determined the per play rate paid by interactive
services by identifying certain services, but [REDACTED], and
``tally[ing] the total payments . . . and divid[ing] by the total
number of interactive streams the service reports.'' Id. ] 148. The
average sound recording per play royalty calculated by Dr. Eisenach was
$[REDACTED] ([REDACTED]). Id. Table 11.
Dr. Eisenach estimated the rate paid by noninteractive services for
sound recordings at $0.0020 per play, or $0.20 per 100 plays. He made
this estimate by taking note of the various rates paid in 2015 pursuant
to the Judges' Web III Determination and pursuant to the pureplay rates
paid under an earlier settlement. Id. ] 136 & n.123. However, he
candidly acknowledged that he found it ``not possible to know the
average amount paid by non-interactive webcasters,'' and he
acknowledged that the subsequent Web IV Determination had superseded
those noninteractive sound recording rates. Id. at n. 123.
His final inputs, discussed supra, are the several benchmark ratios
of sound recording: musical works royalties in the markets that he had
selected.
After Dr. Eisenach inserted the foregoing data into the algebraic
expression set forth above, he presented his data in the following
tabular form:
Musical Works Mechanical per 100 Plays Rate Calculation
[Method 1]
----------------------------------------------------------------------------------------------------------------
(1) (2) (3) (4) (5)
SRIS per 100 SRNIS per 100 Difference......... RVSR/MW............ MRMW per 100
[REDACTED]....................... $0.20 [REDACTED]......... 1:1................ [REDACTED]
[REDACTED]....................... 0.20 [REDACTED]......... [REDACTED]......... [REDACTED]
[REDACTED]....................... 0.20 [REDACTED]......... [REDACTED]......... [REDACTED]
[REDACTED]....................... 0.20 [REDACTED]......... [REDACTED]......... [REDACTED]
[REDACTED]....................... 0.20 [REDACTED]......... 4.76:1............. [REDACTED]
----------------------------------------------------------------------------------------------------------------
See id. Table 12.\297\ Thus, applying his five potential benchmark
ratios, Dr. Eisenach determined that the mechanical works royalty rate
to be set in this proceeding ranged from $[REDACTED] per play to
$[REDACTED] per play (dividing the figure in column (5) by 100 to
reduce the rate from ``per 100'' to ``per play'').
---------------------------------------------------------------------------
\297\ Dr. Eisenach testified that [REDACTED].
---------------------------------------------------------------------------
ii. Method #2
Dr. Eisenach describes his Method #2 as an alternative method of
deriving a market-derived mechanical royalty. His Method #2 ``derive[s]
an all-in musical works value based on the relative value of sound
recordings to musical works and then remove[s] the amount of public
performance rights paid for musical works, leaving just the mechanical-
only rate.'' Id. ] 142. The algebraic expression for Method #2 is as
follows:
MRMW = (SRIS/RVSR/MW)-PRMW,
where PRMW is the public performance royalty rate for musical works,
and the other variables are as defined and described in Method #1.
Id.
Dr. Eisenach calculates PRMW, as an average of
$[REDACTED] per 100 plays for the licensees that he included in his
data analysis. Id. ] 156, Table 13. Applying all the inputs across the
various benchmark ratios, the results from Dr. Eisenach's Method #2 can
also be depicted in tabular form, as set forth below:
Musical Works Mechanical per 100 Plays Rate Calculation
[Method 2]
----------------------------------------------------------------------------------------------------------------
(3) = (2) \298\ x
(1) (2) (1) (4) (5)
SRIS RVSR/MW........... Ratio Adj......... (Avg.) PRMW....... MRMW
----------------------------------------------------------------------------------------------------------------
[REDACTED]...................... 1:1............... [REDACTED]........ [REDACTED]........ [REDACTED]
[REDACTED]...................... [REDACTED]........ [REDACTED]........ [REDACTED]........ [REDACTED]
[REDACTED]...................... [REDACTED]........ [REDACTED]........ [REDACTED]........ [REDACTED]
[REDACTED]...................... [REDACTED]........ [REDACTED]........ [REDACTED]........ [REDACTED]
[[Page 2005]]
[REDACTED]...................... 4.76:1............ [REDACTED]........ [REDACTED]........ [REDACTED]
----------------------------------------------------------------------------------------------------------------
See id., Table 14.
In sum, after applying all of his potential benchmarks in both of
his methods, Dr. Eisenach opined that ``the YouTube and Pandora [Opt
Out] agreements represent the most comparable and reliable benchmarks,
implying ratios of [REDACTED] and [REDACTED], respectively, with a mid-
point of [REDACTED].'' Id. ] 130 (I note that converting these end-
points and mid-point of his range to TCC percentages results in a range
from [REDACTED]% to [REDACTED]% and a mid-point of [REDACTED]%.) \299\
---------------------------------------------------------------------------
\298\ The ratio in column (2) is converted into its reciprocal
percentage and the percentage is multiplied by the corresponding
figure in column (1). For example, in the third row, the [REDACTED]
ratio equals [REDACTED]%. When $[REDACTED] is multiplied by
[REDACTED], the product is $[REDACTED] (rounded).
\299\ Dr. Eisenach found these results to confirm the
reasonableness of Copyright Owners' per play rate proposal. However,
because I reject a per-play rate structure, that point is not
relevant to my Dissent. I further note that Dr. Eisenach also
calculates a per user rate, using his Method #2. As he explains,
``this is accomplished by calculating all-in publisher royalties on
a per user basis and subtracting the average effective per-user
performance royalties to publishers, leaving an appropriate rate for
mechanical royalties.'' Id. ] 159. He finds that the sound recording
rate per user is $[REDACTED] (the per user analog to [REDACTED] per
100 plays in his per play analysis). Applying the same ratios and
utilizing similar market data as in his per play approach, Dr.
Eisenach concludes that a ``mechanical rate of between $[REDACTED]
and $[REDACTED] per user reflects the range of relative values for
sound recordings and musical works . . . .'' Id. ] 165. Finally, he
notes that, at the [REDACTED] ratio (his mid-point of the YouTube
and Pandora benchmarks), the ``mechanical only'' rate would be
$[REDACTED] per user (even greater than the $1.06 per user rate
proposed by Copyright Owners.) Id. Because I do not agree that
Copyright Owners' per-user proposal is appropriate (for the reasons
discussed supra), this asserted confirmation of the reasonableness
of Copyright Owners' per-user proposal is unhelpful in the context
of this Dissent.
---------------------------------------------------------------------------
e. Criticisms and Analysis of Dr. Eisenach's Benchmark Methods
i. Dr. Eisenach's Ratio of Sound Recordings: Musical Works
Dr. Eisenach's attempt to identify comparable benchmarks and
corresponding ratios of sound recording rates to musical works rates
appears to me to be a reasonable first step in seeking to identify
usable benchmarks. That is, I find his basic conceptual approach--
relying on empirics over abstract theory, viz., assuming that a tightly
clustered set of ratios across several markets and discerning a central
tendency from among them--could aid in the identification of the
statutory rates. (As noted supra, Dr. Eisenach eschewed unnecessary
``assumptions, complexities and uncertainties associated with
theoretical debates'' as to why the particular existing market ratios
existed. Id. ] 79.) In this regard, I understand that Dr. Eisenach was
following a well-acknowledged principle of economic analysis,
articulated by the Nobel laureate economist Milton Friedman, who
famously eschewed excessive theorizing that failed to match the
predictive power of empirical analysis. See M. Friedman, The
Methodology of Positive Economics, reprinted in D. Hausman, The
Philosophy of Economics at 145, 148-149 (3d ed. 2008).
However, the data available to Dr. Eisenach did not demonstrate a
sufficient cluster of similar ratios to establish a predictive ratio
across the data set. That is, the problem does not lie in the analysis,
but rather in the implications from the data regarding ratios of sound
recording royalties to musical works royalties. The Services make this
very criticism, noting the instability of the ratio across the several
markets in which Dr. Eisenach identified potential benchmarks. See
SJRPFF-CO at 182 (and record citations therein). Apple finds that the
wide range of ratios is unsurprising, because Dr. Eisenach's benchmarks
do not relate to the same products and same uses of the two rights.
Indeed, Apple's [REDACTED], confirming, according to Apple, that there
is no fundamental market ratio that can be applied in this proceeding.
Dorn WRT ] ] 6, 24, 28-29.
To be sure, this point does not go unnoticed by Dr. Eisenach, who
focuses more on the royalty ratios arising from two potential
benchmarks in the middle of his range--the Pandora ``Opt-Out''
agreements and the YouTube Agreements, discussed infra.
The Services assert an additional and fundamental criticism of Dr.
Eisenach's approach. They note that his use of sound recording
royalties paid by interactive services embeds within his analysis the
inefficiently high rates that arise in that unregulated market through
the complementary oligopoly structure of the sound recording industry
and the Cournot Complements inefficiencies that arise in such a market.
See Katz CWRT ] 56; Marx WRT ] ] 137-141. I agree with this criticism.
Indeed, the Judges explained at length in Web IV how the complementary
oligopoly nature of the sound recording market compromises the value of
rates set therein as useful benchmarks for a market that is
``effectively competitive.'' \300\ In Web IV, the Judges were provided
with evidence of the ability of noninteractive services to steer some
performances toward recordings licensed by record companies that agreed
to lower rates in exchange for increased plays. Here, the Judges were
not presented with such evidence, likely because an interactive
streaming service needs to play any particular song whenever the
listener seeks to access that song (that is the essence of an
interactive service compared with a noninteractive service). Thus, the
Judges have no direct evidence sufficient to apply a discount on the
interactive sound recording rate to adjust that potential benchmark in
order to fashion an effectively competitive rate.\301\
---------------------------------------------------------------------------
\300\ In Web IV, the Judges noted that, even in the willing
buyer/willing seller context of 17 U.S.C. 114(f)(2(B), all relevant
authority required that those rates be reasonable, that is, they
must reflect a market that is ``effectively competitive'' (i.e.,
``workably'' competitive, the economic analog to ``effectively''
competitive.). See Web IV, supra, at 26331-34 (noting the legal
bases for an equivalence between effectively competitive and
reasonable rates). (However, the rates in this proceeding are
further subject to potential adjustment by application of the four
itemized factors in section 801(b)(1).). As the Judges noted in Web
IV, ``[a]n effectively competitive market is one in which
supercompetitive prices or below-market prices cannot be extracted
by sellers or buyers . . . .'' Id. at 26331 (citation omitted).
Because Dr. Eisenach's approach intentionally incorporates sound
recording market-based royalty rates into his ratios, those rates
and the ratios in which they are inputs must be reduced to eliminate
the supercompetitive effect of complementary oligopoly that is
inconsistent with effective competition.
\301\ Dr. Eisenach suggests that the entry of large
``ecosystem'' firms, Amazon, Apple and Google into the interactive
streaming market has tended to add ``bargaining power'' to the
licensee side of the market, obviating any concern over undue
licensor power. Eisenach WRT ] 77. However, as indicated by the
Shapley value analyses of Copyright Owners' other economic expert
witnesses, Professors Gans and Watt, bargaining power is a function
of how many participants exist on one side of the market versus the
other. See Gans WRT ] 55 (noting, without making any exception for
these large entities, that ``[s]ervices are substitutes for one
another, providing rightsholders with a wide array of choices in
their licensing decisions [and] this competition reduces individual
services' bargaining power.''); Watt WRT ] 25 (``[T]he different
interactive streaming companies--Spotify, Apple Music, Rhapsody/
Napster, Google Play Music, Amazon, etc.--do all compete (and rather
fiercely) among themselves, offering very (perhaps perfectly)
substitutable services.''). That is, despite the overall size of
Apple, Amazon and Google, in a market transaction, all licensors
providing complementary ``must have'' inputs will have a bargaining
advantage, and they can refuse to license even to these large
entities if the latter insist on too low a royalty, licensing
instead to other interactive streaming services who can satisfy
downstream market demand. In this regard, there is no evidence that
[REDACTED].
---------------------------------------------------------------------------
[[Page 2006]]
Thus, the sound recording royalties relied upon by Dr. Eisenach
likely are too high and would need to be adjusted to reflect reasonable
rates derived from a market that is effectively competitive. However,
because there is no record evidence in this proceeding allowing for an
estimate of the adjustment, I can find only that Dr. Eisenach's ratios
are too high to the extent they incorporate the royalty rates derived
from the sound recording market.
ii. Dr. Eisenach's Specific Benchmarks
Section 115 Benchmark
The Services assert that Dr. Eisenach's calculation of a section
115 ``valuation ratio'' of 4.76:1 is incomplete, because he limited
this statutory ratio to the 21% and 22% TCC prongs. They note that
under the percentage-of-revenue prong of section 115 (10.5%), this
statutorily-derived ratio would have ranged between 5:1 and 6:1, see 4/
5/17 Tr. 5152 (Leonard), implying a musical works rate equal to only
16.67% to 20% of sound recording royalty rates. I agree that Dr.
Eisenach's statutory benchmarks would have been more comprehensive if
he had included the ``valuation ratios'' derived from this headline
prong of the present royalty rate structure. However, the Services'
focus on that lower implied TCC fails to recognize the greater-of rate
structure (with a lesser-of second prong) to which the parties agree.
The purpose of the explicit TCC levels was that they could trigger if
greater than the 10.5% rate and the implicit TCC that could be derived
from that rate. Accordingly, I find that the fact that the existing
rate structure, on which the Services rely in this proceeding, includes
the potential use of the 21% and 22% prongs, demonstrates the
usefulness of this benchmark as a representation of a rate that the
licensors have agreed to accept, given the provisions of section 115.
Direct Licenses
The Services disagree with Dr. Eisenach's minimization of the
relevance of this benchmark category. They argue that the direct
licenses between interactive services and music publishers ``are by far
the most directly apposite benchmarks used in Dr. Eisenach's
analysis,'' because they, like the section 115 rates and terms
themselves, possess the characteristics of a useful benchmark in that
they are: (1) voluntary; (2) concern the same licensors/publisher; (3)
negotiated in the same market; and (4) pertain to the same rights. See
Katz WDT ] ] 97-113; Leonard AWDT ] ] 51-76.
I find that direct licenses that meet the foregoing criteria are at
as least as useful as the section 115 benchmark itself, provided those
licenses do not include additional rights whose values have not been
adequately isolated from the particular mechanical license at issue in
this proceeding.\302\ The so-called ``shadow'' of section 115 provides
a default rate for the licensing parties, so direct licenses that
deviate in some manner from the rates in the statutory license reveal a
preference for other rates and terms that, at least marginally, are
below the statutory rate. (If in the direct negotiations the licensors
insisted on rates above the statutory rates, a licensee would simply
reject the demand and default to the statutory rate.) Thus, as the
services note, these benchmarks are useful, because ``these agreements
. . . were voluntarily entered both in 2008 and 2012, by the very same
publishers in the same markets and for the same rights . . . .'' SJPFF
] 261 (and record citations therein). More generally, as described
supra, I find that the so-called ``shadow'' of the statutory license on
a benchmark not only does not disqualify that benchmark as useful
evidence, but rather serves to eliminate licensor ``hold out'' power,
making the resulting rate more reasonable and more reflective of an
effectively competitive rate
---------------------------------------------------------------------------
\302\ See the discussion infra regarding the importance of this
qualifier in connection with Pandora's Direct Licenses.
---------------------------------------------------------------------------
Synchronization Licenses
The Services also take issue with Dr. Eisenach's inclusion of
synchronization licenses in his collection of benchmarks. See, e.g.,
Leonard WRT ] ] 37-40 (testifying that synchronization licenses are not
comparable for interactive streaming licenses because synchronization
differs in important economic respects from streaming); Hubbard WRT ] ]
6.31-6.32 (testifying on various ``economic characteristics of synch
licenses, that render the ratio between sound recording royalties and
musical works royalties different between synch and interactive
streaming services''); Marx WRT ] ] 148-151 (``Synch royalty rates are
a poor benchmark for streaming royalty rates''). Indeed, even Dr.
Eisenach acknowledged that, at best, the low ratio in the synch
licenses indicates an unusually high musical works royalty rate among
his collection of benchmarks. 4/4/17 Tr. 4671, 4799 (Eisenach);
Eisenach WDT App. A-9.
In a prior proceeding, the Judges rejected the synch license
benchmark as useful ``[b]ecause of the large degree of its
incomparability.'' See Phonorecords I, 74 FR at 4519. I find that
nothing in the present record supports a departure from that prior
finding. The lack of comparability remains present because the
synchronization market differs in important economic respects from the
streaming market. See Leonard WRT ] 39. Because synch rights pertain to
media such as music used in films or in television episodes,\303\ the
historically equal valuation of publishing rights and sound recording
rights arises from the particular conditions faced in those industries.
Id. Movie and television producers may have a certain musical work in
mind as a good fit for a particular scene in the film. Id. However,
these producers have the option of making their own sound recording of
that musical work, and for this reason, ``cover'' songs are quite
common in films. Id.; see also Marx WRT ] 149 (``Both film and
television production companies have the option of recording their own
versions of songs, rather than paying royalties to use a pre-recorded
song. . . . . This option gives the users of synch rights, such as
movie producers, more bargaining power relative to the labels than
would be the case with streaming services.''). Thus, the contribution
to value of the sound recording is less vis-[agrave]-vis the musical
work in the synch market. Leonard WRT ] 39.
---------------------------------------------------------------------------
\303\ The Copyright Owners also rely on blanket (``microsynch'')
licenses by which publishers grant their entire catalogs for use in
synchronized audio-video productions, and they also rely on synch
licenses for mobile and video game applications. The Judges'
critique of synch licenses as benchmarks is equally applicable to
these licenses.
---------------------------------------------------------------------------
Additionally, in the case of synchronization rights, the
marketplace for sound recording rights is more competitive than other
music licensing contexts because individual sound
[[Page 2007]]
recordings (and thus the musical works within them) compete against one
another for inclusion in the final product (e.g., a movie or television
episode). By contrast, in the interactive streaming market, services
must build a catalog of sound recordings and their included musical
works, so that many works can be streamed to listeners. Id. That is, in
the interactive streaming market, the sound recordings (and their
embodied musical works) are ``must have'' complements, not in
competition with each other. However, in the synch market the potential
sound recordings of any given musical work identified by the movie or
television producer is a substitute good, in competition with any other
existing or future cover sound recording of the same musical work for
inclusion in the movie or television show.
YouTube Agreements
I agree with Copyright Owners that YouTube is a competitor vis-a-
vis the interactive streaming services. Indeed, the Services
acknowledge this point. [REDACTED]. Page WDT ] ] 47, 53, 55; see also
(Eisenach) WRT ] 59. In like fashion, Professor Marx testified that
[REDACTED]. Marx WDT ] 44 n.54. Accordingly, at least one form of
YouTube Agreement would likely be somewhat comparable to the
interactive streaming market.
As noted supra, Dr. Eisenach selected for input into his ratio the
YouTube agreements and rates pertaining to [REDACTED]. See SJRPFF-CO at
187-89 (and record citations therein).
I agree that the inclusion of a video component in the YouTube
product renders less useful as a benchmark the agreements relating to
``User Videos with Commercial Sound Recordings.'' Further, as Dr.
Eisenach acknowledges, these YouTube audio/video combinations also
provide for synchronization rights, see Eisenach WDT ] 100, and this
addition of yet another right in the licenses further muddies the
comparability of a YouTube benchmark.
The Services further maintain that--assuming arguendo any YouTube
licenses are appropriate benchmarks--Dr. Eisenach should have relied on
a different category of YouTube licenses for his benchmark analysis.
Specifically, they maintain that the more appropriate YouTube benchmark
ratio would compare the contractual provisions between YouTube and
publishers, and YouTube and record companies, for [REDACTED].
I agree with the Services in this regard. [REDACTED].\304\
---------------------------------------------------------------------------
\304\ I take note of Dr. Eisenach's criticism of the [REDACTED]
publishing rates as constrained by the ``shadow'' of the section 115
license. However, as explained elsewhere in this Dissent, I find the
``shadow'' of the section 115 statutory license to be beneficial in
establishing rates that reflect the workings of an effectively
competitive market.
---------------------------------------------------------------------------
Under the [REDACTED] contract provisions (i.e., the [REDACTED]
provisions) governing YouTube's agreements with [REDACTED]. See
Professor Katz's Supplemental Written Rebuttal (Katz SWRT) ] ] 13(b)
n.26 and 13(e) n. 29 (and contracts referenced therein). [REDACTED],
the sound recording copyright owner receives a royalty of [REDACTED]%
of revenue, compared with the [REDACTED] received by music publishers.
Id. ] ] 13(h) n. 32 and (k) n.35 (and contracts referenced therein).
Thus, under the [REDACTED] deals, the royalty ratio is [REDACTED],
which equals 4.76:1. In turn, that ratio implies a TCC musical works
rate of [REDACTED]%. Under the [REDACTED] deals, the royalty ratio is
[REDACTED], which equals [REDACTED], which implies a TCC musical works
rate of [REDACTED]%. I find that these ratios and implied percentages
derived from YouTube's [REDACTED] royalty rates to be usable benchmarks
in this proceeding.
Pandora ``Opt-Out'' Agreements
Together with his YouTube benchmark, Dr. Eisenach finds the Pandora
``Opt-Out'' agreements to be the most useful among the several
potential benchmarks he examined. I agree with Dr. Eisenach that the
Pandora ``Opt-Out'' agreements have a degree of comparability
sufficient to render them usable as benchmarks.
However, I do not agree with Dr. Eisenach's attempt to extrapolate
into the future from the actual rates in those Opt-Out Agreements.
Rather, I find that the [REDACTED] ratio that Dr. Eisenach identified
for the year 2018 derived from existing agreements is the most useful
benchmark derived from the ``Opt-Out'' data. See Eisenach WDT ] 104.
The Services concur with Dr. Eisenach with regard to the existence of
this [REDACTED] ratio, and they further note that Pandora's most recent
direct license agreements during the ``Opt-Out'' period with the
publishers (who control many of the works underlying sound recordings
performed by Pandora) provide that publisher royalties will be
determined as [REDACTED].\305\ Specifically, these agreements resulted
in a shift of the sound recording: musical works ratio to [REDACTED],
implying a musical works TCC percentage of [REDACTED]%. See Katz CWRT ]
] 101-104; Herring WRT ] ] 28-29.
---------------------------------------------------------------------------
\305\ Pandora's status as a purely noninteractive service prior
to 2018 does not impact the relevancy of this benchmark, because:
(1) noninteractive and interactive services both pay performance
royalties; (2) noninteractive services do not pay mechanical
royalties; and (3) the performance license and the mechanical
license are perfect complements.
---------------------------------------------------------------------------
I reject Dr. Eisenach's identification of a trend in the
[REDACTED]. His change in the ratio to [REDACTED] was driven by
expectations regarding the likelihood of an uncertain change in the
legal landscape regarding publisher withdrawals from performing rights
organizations. However, changes in such uncertainties are not well-
captured by mapping them over a time horizon. Moreover, as the Services
note, and as Dr. Eisenach concurs, even assuming arguendo such a change
in relative uncertainty could be captured in a regression, other
regression forms, such as a quadratic form, could have been used to
demonstrate not a [REDACTED], but rather a return of the ratio to its
prior level (an equally plausible future event). See 4/5/17 Tr. 495963
(Katz); Katz CWRT ] ] 104-107, Table 1,F; 4/4/17 Tr. 4807-08 (Eisenach)
(noting his linear form of regression was not ``material'').
Moreover, the assumption behind Dr. Eisenach's regression was not
borne out. In 2015, the Second Circuit Court of Appeals affirmed a 2014
decision by the Southern District of New York, prohibiting such partial
withdrawals. In re Pandora Media, Inc. v. ASCAP, 785 F.3d 73, 77-78 (2d
Cir. 2015), aff'g In re Pandora Media, 6 F. Supp. 3d 317, 322 (S.D.N.Y.
2014). Subsequently, in August, 2016, the Department of Justice issued
a statement announcing that, consistent with these judicial decisions,
it would not permit such partial withdrawals under the existing consent
decrees. See Eisenach WDT ] 114 & n. 109 therein. In fact, as indicated
supra, there were actual Pandora ``Opt-Out'' agreements that set rates
through 2018 that established a sound recording:musical works ratio of
[REDACTED], that Dr. Eisenach chose to disregard in favor of his
extrapolated lower ratio. See Katz CWRT ] 103; Herring WRT ] 28.
iii. Dr. Eisenach's Per Play Sound Recording Rate
I also have difficulty relying on the data set which Dr. Eisenach
developed for his estimation of a $[REDACTED] per play sound recording
royalty rate, to which he applied the several benchmark ratios. The
principal problems with this
[[Page 2008]]
data is that it covered a non-random sample of only approximately 15%
of all interactive plays, excluding in particular plays on [REDACTED]
ad-supported services and Apple's interactive streaming service.
Inclusion of [REDACTED] would have [REDACTED] his per play rate from
$[REDACTED] to $[REDACTED] (Inclusion of [REDACTED] would have
[REDACTED] the $[REDACTED] estimate to $[REDACTED].) SJRPFF-CO at 158-
59 (and record citations therein).
Dr. Eisenach explained that he restricted his data sample
purposefully. He decided to omit several sound recording labels because
they [REDACTED], which he asserted [REDACTED]. Eisenach WDT ] 150. I
acknowledge Dr. Eisenach's assertion that this fact could have an
impact, on the margin, of driving [REDACTED] the royalties paid by
[REDACTED] to those labels. However, the evidence does not bear that
out, because [REDACTED]. More particularly, the [REDACTED] contract
with record labels that Dr. Eisenach reviewed show [REDACTED]. 4/4/17
Tr. 4739-53 (Eisenach); see also, e.g. Trial Ex. 2760 ([REDACTED]);
Trial Ex. 2765 ([REDACTED]). [REDACTED].
With regard to Dr. Eisenach's specific omission of data from
Spotify's ad-supported service, Copyright Owners make additional
arguments. They claim that the ad-supported service does not reflect
the actual value of the sound recordings, because that tier acts as a
funnel to draw listeners to the subscription service. Therefore,
Copyright Owners maintain, the ad-supported service is essentially a
loss-leader, with the difference between the higher effective per play
rates for subscription services and the lower effective per play rates
for the ad-supported services more in the nature of a marketing expense
that should not be deducted from Dr. Eisenach's royalty calculations.
See Eisenach WDT ] 148 n.127.
However, that analysis omits several important facts. First, as Mr.
McCarthy, Spotify's CFO testified, [REDACTED]. 3/21/17 Tr. 2058-59
(McCarthy) ([REDACTED]). Second, he notes that [REDACTED]% of Spotify's
paid subscribers in the United States were previously such engaged
users of the ad-supported service. McCarthy WRT ] 22; see also 3/21/17
Tr. 2059 (McCarthy). Third, Mr. McCarthy testified that the ad-
supported tier [REDACTED]. See 3/21/17 Tr. 2059 (McCarthy)
([REDACTED]).
Notwithstanding the marketing value of the freemium model, it must
be remembered that [REDACTED]. These listeners, and the advertising
revenue they generate, are real and reflect the WTP of a large swath of
interactive listeners.\306\ See Marx WRT ] 115-16 & Fig. 9 (``While I
agree that one aspect of the ad-supported service is to provide an on-
ramp to paid services, it also has another important aspect, namely to
serve low WTP customers . . . . Copyright Owners' economists err in not
calculating the impact of the Copyright Owners' proposal on ad-
supported services. Ad-supported services currently make up [REDACTED]
in the industry.'') I agree with this point, and I therefore agree with
the Services that Copyright Owners erred in their decision to exclude
Spotify data from their analyses.\307\
---------------------------------------------------------------------------
\306\ In the parlance of platform economics, and as noted supra,
Spotify's ad-supported service provides a multi-platform approach,
in which listeners, advertisers, sound recording rights holders and
musical works holders all combine to obtain revenue based on the
mutual values each brings to that platform. See 3/21/17 Tr. 2013
(Marx).
\307\ Copyright Owners belatedly propose that--if the Judges
intend to include the Spotify ad-supported service in the rate
structure and rate calculations--that they establish (1) separate
rates for ad-supported services that are not incorporated into the
calculation of rates set for other services; and (2) separate terms
for an ad-supported service that limit the functionality of such a
service to avoid potential cannibalization of services paying higher
royalties. COPCOL ] 228 & n.34. This argument is a tacit
acknowledgement by Copyright Owners that a segmented market may
require a differentiated rate structure (even as they strenuously
dispute the appropriateness of such a structure). Such a post-
hearing argument is ``too little, too late.'' If Copyright Owners
wanted to argue in the alternative in this manner, they needed to do
so during the hearing, and support their arguments for limited ad-
supported functionality and segmented rates with testimony and
evidence. As I noted supra, the Judges `choices were limited to the
rate structures proffered by the parties, or reasonably suggested by
the evidence; a different structure, if proffered or suggested by
the evidence, might have been preferable, but it had to be supported
by record evidence. In any event, the rate structure I adopt in this
Dissent does not simply average Spotify's lower effective per-unit
rate into an overall rate, because the I am adopting a
differentiated rate structure that continues to treat the ad-
supported market segment separately, reflecting the presence of a
market segment with a lower WTP. Startlingly, the majority adopts
this reasoning wholesale in the Majority Opinion, foreclosing
Copyright Owners' argument. So, although the majority agrees that
Copyright Owners could not propose a new rate structure post-
hearing, the majority gives itself a free pass to do the same, even
though the harm to the parties is identical in either case--they are
deprived of the opportunity to challenge the post-hearing creation.
---------------------------------------------------------------------------
I also disagree with Copyright Owners' suggestion that the ad-
supported service deprives them of higher royalties from subscribers.
Although ad-supported services identify future subscribers, until those
subscribers are identified, they are not subscribers. In that sense,
ad-supported services indeed are marketing tools, but they do not
reduce present royalties because the future subscribers have not yet
been identified. By using ad-supported services, Spotify certainly does
avoid hard marketing costs that would be incurred through, for example,
paid advertising to convince non-subscribers to subscribe. However,
there is no record evidence that this hard cost saving translates
directly into lost royalty revenue to Copyright Owners. Apparently,
Copyright Owners argue that their loss is in the form of an opportunity
cost, losing the opportunity to obtain subscription-level royalties
from the ad-supported listeners. But if Spotify paid subscription-level
royalties for all ad-supported listeners, it would be paying an
implicit marketing cost that inefficiently was wasted on the
[REDACTED].\308\
---------------------------------------------------------------------------
\308\ Another alternative marketing approach would be the
offering of free trial subscriptions. However, there was no
testimony as to whether free trials would better monetize listening
than the freemium model used by Spotify. In fact, Spotify's CFO, Mr.
McCarthy testified that, [REDACTED]. 3/21/17 Tr. 2113-2115
(McCarthy). See also COPFF ] 369.
---------------------------------------------------------------------------
In this regard, it is important to remember that, as discussed
supra, music is an ``experiential'' good. See Byun, supra, at 23. Thus,
provision of a monetarily ``free-to-the user'' service is a reasonable
marketing tool, and the Judges are loath to second-guess the business
model incorporating that marketing approach, especially after it has
proven successful while still providing royalties to rights owners. See
Page WDT ] 27 (Spotify's freemium model monetizes through subscriptions
more successfully than the sale of downloads and CDs, as well as
terrestrial radio and, of course, piracy).
d. Service's Criticisms and Judicial Analysis of Dr. Eisenach's Method
#1
The Services criticize Dr. Eisenach's Method #1 calculation as
being based upon the incorrect assumption that the entire difference
between interactive and noninteractive rates must be attributed to the
mechanical license right. As the Services properly note, there are
several reasons, all unrelated to the mechanical right and license, why
interactive rates are higher than noninteractive rates for musical
works performance rights. Leonard WRT ] 55; Katz CWRT ] ] 117-118;
Hubbard WRT ] 6.4; 4/5/17 Tr. 4972-74 (Katz). First, Dr. Eisenach's
Method #1 did not account for the presence of the ephemeral right in
licensing noninteractive streaming (discussed supra), which accounts
for 5% of the noninteractive rate. 4/4/17 Tr. 4851-52 (Eisenach); see
also 4/5/17 Tr. 5159-5161 (Leonard) (discussing how Dr. Eisenach's
analysis does not consider
[[Page 2009]]
the ephemeral right); Leonard WRT ] ] 55-56. Second, there is a
difference in the performance rights royalty rates charged by PROs to
interactive and noninteractive services that is not captured by Method
#1. See, e.g., In re Petition of Pandora Media, Inc., 6 F. Supp. 3d at
330 (ASCAP charges different royalty rates for performance rights
depending on whether the service is non-interactive or interactive).
Had Dr. Eisenach considered these factors, he might well have estimated
a mechanical rate significantly less than the rates he derived, even
using his ``valuation ratios.'' See Katz CWRT ] 122.
The Services also note the impact in Method #1 of Dr. Eisenach's
decision to [REDACTED] from his modeling. As the Services note, adding
[REDACTED] to Dr. Eisenach's effective per play rate for sound
recording results in a per rate of $[REDACTED]. See 4/4/17 Tr. 4771-74
(Eisenach). Further, the Services note that, by introducing the
unregulated sound recording rates in his ratio, Dr. Eisenach has
imported the complementary oligopoly (Cournot Complements) power
associated with those rates, as noted in Web IV. See Katz CWRT ] 56;
Marx WRT ] ] 137, 141.
Combining all of the foregoing criticisms, the Services conclude as
follows:
If one were to use $[REDACTED] per hundred plays for the sound
recording rate ([REDACTED]) (id. at 4771:10-4774:5), reduce that by
12% as the Board did in Web IV for complementary oligopoly power,
increase the $0.20 per hundred plays Dr. Eisenach uses for musical
works performance rights by 60% to account for the difference in
ASCAP rates identified by Judge Cote [in the rate court], and then
apply Dr. Eisenach's invalid ``valuation ratio'' of [REDACTED], the
result would be $[REDACTED] per hundred plays [$[REDACTED] per
play], way below the $0.15 per hundred plays rate [$0.0015 per play]
that Dr. Eisenach attempts to validate.
SJPFF ] 279 (and record citations therein). Thus, the foregoing
criticisms would reduce Copyright Owners' benchmark by 80%.
I agree with the Services that Method #1 does not provide a useful
benchmark in this proceeding. As noted supra, and most importantly, the
absence of interactive streaming data from Spotify is a critical
omission. The fact that much of that data relates to ad-supported
services with a limited functionality does not justify removing that
data from a market analysis, because that service is a part of the
market. In fact, Copyright Owners argument proves too much. That is,
their willingness to distinguish and isolate the Spotify ad-supported
service and related data in this manner only underscores the need for a
differentiated/price discriminatory rate structure, such as proposed by
this Dissent.
Also, I agree that Dr. Eisenach's analysis imports the
complementary oligopoly power of the sound recording companies.
Although (as also noted supra) I do not think that the Judges could
simply import the 12% steering adjustment from Web IV to calculate this
effect (because the 12% was a function of evidence specific to that
proceeding), it is clear that any benchmark approach should adjust
downward a rate inflated by the presence of complementary oligopoly in
the benchmark market.
And to reiterate, although the Services utilize Dr. Eisenach's
[REDACTED] ratio (implying a TCC of [REDACTED]%) to illustrate the
impact of their other criticisms, I find that ratio to be much lower
than what can reasonably be gleaned from Dr. Eisenach's benchmarks. As
indicate supra, the most usable benchmark information from Dr.
Eisenach's approach are the YouTube [REDACTED] ratio, and the Pandora
``Opt-Out'' ratio from actual agreements, which imply a TCC between
[REDACTED]% and [REDACTED]%.
e. Services' Criticisms and Judicial Analysis of Dr. Eisenach's Method
#2
The Services criticize Dr. Eisenach's Method #2 principally for the
same reason they criticize his Method #1, viz., his use of a ratio that
embodies inapposite sound recording data. They also emphasize the
import of his decision to omit Spotify's sound recording data from his
Method #2 calculations. At the hearing, Dr. Eisenach acknowledged the
significance impact of this omission, but he defended the omission as
virtue rather than vice, because of the starkly different manner in
which Spotify monetizes its ad-supported service. He testified that,
had he incorporated all of Spotify's sound recording data in estimating
a current industrywide monthly per user charge, he would have
calculated a monthly per user sound recording rate of $[REDACTED] per
month, rather than the $[REDACTED] rate he determined when excluding
[REDACTED] data. 4/4/17 Tr. 4825-28 (Eisenach).
In addition, the Services assert that Method #2 is faulty because
of Dr. Eisenach's use of the rate court performance royalty rates that
he subtracts from his ratio-derived musical works rate to identify an
implied mechanical works rate. More specifically, the Services assert
that Dr. Eisenach's willingness to use the rate courts' performance
rates is inconsistent with his broader claim that musical works rates
have been artificially reduced below market rates. For example, when
identifying benchmarks, Dr. Eisenach relies on the non-rate court
performance rights paid by Pandora in the Opt-Out agreements precisely
because they represent, in his opinion, market-based rates untainted by
the depressing effects of the rate court. See Eisenach WDT ] ] 106-110,
4/4/17 Tr. 4805, 4821-23. (Eisenach). According to the Services, to be
consistent, Dr. Eisenach should have increased the rate court levels to
reflect what he understood to be market rates. Such consistency, they
assert, would make the subtracted rate in the Method #2 formula larger,
and the difference--which is Dr. Eisenach's mechanical rate--smaller.
Finally, the Services criticize Dr. Eisenach's Method #2
calculations because they exclude not only significant sound recording
data, but also the performance royalty data for Amazon, Apple, Google,
and Spotify. Accordingly, Method #2 accounts for only 13 percent of
total interactive service revenues in 2015. See Katz CWRT ] 124.
I agree with the Services that Method #2 does not contain
sufficient industrywide performance royalty and sound recording data to
provide a meaningful analysis for determining a per-user monthly
mechanical works royalty. I am also troubled by the apparent
inconsistent use of rate court established rates in Method #2, when Dr.
Eisenach had indicated in other contexts that rates unshackled from
rate court decisions provide a truer indication of market rates.
More broadly, I understand that Dr. Eisenach omitted [REDACTED]
because of [REDACTED], which is [REDACTED]. I recognize that combining
[REDACTED] user data with other interactive streaming services' data
[REDACTED]. See CORPFF-JS at pp. 183-184 (noting what Copyright owners
describe as ``[t]he profound impropriety of [REDACTED] into Copyright
Owners' benchmarking and calculations.)
Once again, though, that seeming anomaly actually underscores why I
find the differentiated rate structure in the 2012 benchmark to be
appropriate. The royalty rates paid by all services should be
reflective of the differentiated WTP of their listeners (for the
reasons discussed supra). That is, the same reason why Dr. Eisenach
elected not to lump Spotify with other services in his calculations
incorporated into Copyright
[[Page 2010]]
Owners' ``one size fits all'' rate structure. Indeed, the anomalous
nature of Spotify's monetization of the downstream market underscores
why ``one size does not fit all,'' and why the 2012 rate structure
therefore is preferable (and why Copyright Owners made the post-hearing
argument for a separate rate structure, with separate terms, for ad-
supported services, as discussed supra).
f. Conclusion
For the reasons set forth above, I would not adopt Dr. Eisenach's
proposed benchmark rates as the mechanical rates for the upcoming rate
period. However, as explained supra, I find that the actual Pandora
Opt-Out Agreements, the [REDACTED] YouTube Agreements [REDACTED] rates
provide useful benchmark information (albeit not the same information
that Dr. Eisenach identifies as useful from those agreements). Thus,
usable ratios from Dr. Eisenach's analysis consist of the [REDACTED]
and [REDACTED] ratios derived from the YouTube [REDACTED] agreements
and the [REDACTED] ratio derived from the Pandora Opt-Out Agreements.
These ratios, respectively convert to percentages (i.e., a TCC
percentages) of [REDACTED]%, [REDACTED]%, and {REDACTED]%. Also useful
are the 21%-22% TCC values in the existing rate structure, which, as
Dr. Eisenach indicated, [REDACTED]. See Eisenach WDT ] ] 84-92.
2. The Services' Benchmark Rates \309\
---------------------------------------------------------------------------
\309\ The following analysis does not address the direct deals
entered into by Pandora, cited by Professor Katz in his testimony.
He candidly acknowledged that the probative value of these
agreements was weakened by the fact that they included rates for
other tiers of service, including noninteractive service, and he had
not given consideration to how the bargaining and setting of each
rate in each tier might be interrelated. See Katz WDT ] 105 (``The
simultaneous agreement with respect to multiple services can cloud
the interpretation of any given number in a contract because the
rates are negotiated as a package.''). I agree with Professor Katz
and, for this reason, I place no weight on those direct Pandora
agreements.
---------------------------------------------------------------------------
a. The Present Section 115 Rates
The Services do not examine in detail the particular rates within
the existing rate structure. Rather, they treat the rates within that
structure as benchmarks are generally treated--considerations in
arriving at an agreement. Thus, just as Dr. Eisenach did not analyze
why the rates and ratios on which he relied as benchmarks were set at
the levels he identified, or consider the subjective understandings of
the parties who negotiated his benchmarks, the Services' economists
elect to rely on the 2012 rates as objectively useful evidence of the
parties' revealed preferences.\310\
---------------------------------------------------------------------------
\310\ This point is not made to be critical of Dr. Eisenach's
approach, but rather to show that the Services' reliance on the 2012
settlement as a benchmark shares this similar analytical
characteristic, typical and appropriate for the benchmarking method
in general.
---------------------------------------------------------------------------
Copyright Owners disagree with this use of the 2012 rate structure.
As with regard to the structure of the rates, they take the Services to
task for failing to present evidence of the negotiations that led to
the prior settlements, including the present 2012 benchmark. They argue
that, without such supporting evidence or testimony, the Services
cannot provide support for their proposed rates. See CORPFF-JS at p. 61
(noting the lack of evidence for the ``computations for different types
of potential services'' in the 20212 benchmark).
The Services take a broad approach in their attempt to support the
usefulness of the rate levels within the 2012 benchmark. They note that
music publishers have consistently realized profits under these rates,
including profits from musical works royalties. However, Copyright
Owners note that mechanical royalties have not created a profit for
Copyright Owners, and the Services' assertion of overall publisher
profitability is based on their lumping of performance royalties
together with performance royalties. As I have noted supra, in
considering Professor Zmijewski's analysis, the combination of
mechanical and performance royalties earned by the music publishers is
the more important metric, because: (1) performance and mechanical
royalties are perfect complements; and (2) the mechanical royalty has
been calculated in an ``All-In'' fashion, subtracting the performance
royalty from the mechanical royalty, which of course has the effect of
inflating the performance royalty portion relative to the mechanical
royalty portion.
The Services also maintain that they relied on the continuation of
the rates that now exist to develop their business models. For example,
Pandora, the latest entrant into the interactive streaming market,
asserts that its decision to enter this market was based on its
assumption that there would be no increase in the mechanical royalty
rates. Herring WRT ] 3. I categorically reject this argument. The
applicable regulations provide that ``[i]n any future proceedings the
royalty rates payable for a compulsory license shall be established de
novo.'' 37 CFR 385.17; see also 37 CFR 385.26 (same). A party may feel
confident that past is prologue and the parties will agree to roll over
the extant rates for another period; a party could be sanguine as to
its ability to make persuasive arguments as to why the rates should
remain unchanged; a party might even conclude that the mechanical rate
is such a small proportion of the total royalty obligation that its
increase would be unlikely to alter long-term business plans. But for
sophisticated commercial entities to claim that they simply assumed the
rates would roll over without the possibility of adjustment strikes me
as so absurd and reckless as to raise serious doubts about the
credibility of that position.
At least one of the Services, Spotify, further suggests that the
present rates should not be increased because an increase in the rates
might affect different interactive streaming services in different
ways. In particular, there might be a dichotomous effect as between
essentially pure play streaming services (such as Spotify and Pandora)
and the larger new entrants with a wider commercial ``ecosystem'' (such
as Amazon, Apple and Google). As Spotify's CFO testified:
The Copyright Owners argue that ``a change in market-wide
royalty rates such as this would affect all participants in a
similar way,'' suggesting that the industry as a whole could
increase prices without affecting their relative price points.
Rysman WDT ] 94. [REDACTED]. See, e.g., Rysman WDT ] 29 . . . .
[REDACTED].
McCarthy WRT ] 38 (emphasis added); see also McCarthy WDT ] ] 50-51
([REDACTED]); McCarthy WRT ] 36 ([REDACTED]).
I construe this argument as an iteration of the ``business model''
argument that the Judges have consistently rejected, viz., that the
Judges will not set rates in order to protect any particular streaming
service business model. Final Rule and Order, Digital Performance Right
in Sound Recordings and Ephemeral Recordings, 72 FR 24084, 24088 n.8
(May 1, 2007) (Web II). That is, I distinguish between: (1) business
models that are necessary reflections of the fundamental nature of
market demand, particularly, the varied WTP among listeners; and (2)
business models that may simply be unable to meet dynamic competition
within the market or a given market segment. If pure play interactive
streaming services are unable to match the pricing power of businesses
imbued with the self-financing power of a large commercial ecosystem,
nothing in section 801(b)(1) permits--let alone requires--that the
Judges protect those pure play
[[Page 2011]]
interactive streaming services from the forces of horizontal
competition.\311\
---------------------------------------------------------------------------
\311\ Moreover, any disruption arising from the disparate impact
of a rate increase among interactive streaming services would not
constitute ``disruption'' under Factor D of section 801(b)(1),
because such disruption would not impact the structure of the
industry or generally prevailing industry practices, but rather
would impact particular business models. The irrelevancy, for
disruption purposes, of a rate increase under the existing structure
must be distinguished from a rate increase caused, as in the
Majority Opinion, by a radical change in the rate structure that
cedes control of rates to private third-parties, i.e., the record
companies, who have economic interests adverse to both the services
and Copyright Owners, as discussed supra.
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On balance, I do not find that the Services' status quo and
business model arguments for maintaining the section 115 rates are
themselves persuasive reasons to maintain those rates. If those rates
should be maintained, support for such a result would need to be found
elsewhere in the record.
b. The Services' Subpart A Benchmark
The Services propose the rate set forth in Subpart A as a benchmark
for the Subpart B rates to be determined in this proceeding. As noted
supra, Subpart A reflects the rates paid by record companies, as
licensees, to Copyright Owners for the mechanical license, i.e., the
right to reproduce musical works in digital or physical formats. The
particular Subpart A benchmark rate on which the Services' rely is the
existing rate, which the Subpart A participants have also agreed to
continue through the forthcoming rate period through the settlement
noted supra.
In support of this benchmark, the Services emphasize that the total
revenue created by the sale of digital phonorecord downloads and CDs is
essentially commensurate with the revenues created through interactive
streaming, indicative of an equivalent financial importance to
publishers when negotiating rates when negotiating rates with licensees
in Subparts A and B respectively. See 3/20/17 Tr. 1845 (Marx)
(``downloads, in particular, are comparable to interactive
streaming.''). Also, although the Subpart A rate is the product of a
settlement, the Services argue that the rate is a useful benchmark
because it reflects both the industry's sense of the market rate and
the industry's sense of the how the Judges would apply the section
801(b)(1) considerations to those market rates. 3/15/17 Tr. 1184, 1186
(Leonard); 3/20/17 Tr. 1842-43 (Marx).
In opposition, Copyright Owners argue, for several reasons, that
the Subpart A rates are not proper benchmarks. First, they emphasize
that revenue from the sale of DPRs and CDs has been declining over the
past several years. See COPFF ] ] 196, 583, 611, 736 (and record
citations therein). Second, they note that, as the Services
acknowledge, the parties are not identical; specifically, the licensees
in Subpart A are the record companies whereas in Subpart B the
licensees are the interactive streaming services. See, e.g., 3/15/17
Tr. 1193 (Leonard). Third, they emphasize that the existing Subpart A
rate is itself the product of a settlement, rather than a market rate.
More importantly, Copyright Owners also note that the subpart A
settlement establishes a per-unit royalty rate of $.091 per physical or
digital download delivery (with higher per-unit rates for longer
songs), rendering that rate inapposite as a benchmark for the Services'
present subpart B proposal. In support of the conclusion that this
makes for an inapposite comparison, Copyright Owners argue that because
the subpart A rate is expressed as a monetary unit price, the Copyright
Owners have eliminated the risk that the retailers' downstream pricing
decisions will impact Copyright Owners. More specifically, they note
that, ``[u]nder the Subpart A rate structure, the label (as licensee)
pays the same [penny rate] amount in mechanical royalties regardless of
the price at which the sound recording is ultimately sold [within the]
range of price points for individual tracks in the market ranging from
$0.49 to $1.29 and the mechanical penny rate binds regardless of the
price of the track. COPFF ] 727 (citing Ramaprasad WDT ] 28 & Table 1).
Of equal importance, Copyright Owners distinguish Subpart A from
Subpart B based on the fact that downstream listeners to DPDs and CDs
(and any other physical embodiment of a sound recording) become owners
of the sound recording and the musical work embodied within it, whereas
under Subpart B the listeners only obtain access to these songs and
musical works for as long as they remain subscribers or registered
listeners (to a non-subscription service).
In reply to this argument, Dr. Leonard, asserted that the legal
``ownership vs. access'' distinction does not reflect as fundamental an
economic difference as might appear on the surface. Leonard WRT ] 27
(``[T]here are certain conceptual similarities between streaming and a
download.''). Having paid for a track download, a user can listen to it
as often as desired without further charge. Similarly, having paid the
subscription fee, a streaming user can listen to a track as often as
desired without further charge''); 3/15/17 Tr. 1098, 1113 (Leonard)
(``in the case of a PDD, and streaming, in both cases you're getting--
it's really about on-demand listening . . . . I think it's . . . a
very, very useful benchmark.'').
I disagree with Dr. Leonard, and agree with Copyright Owners that
the ``ownership vs. access'' dichotomy diminished the usefulness of the
subpart A rate as a benchmark. Although Dr. Leonard is correct in
noting that ownership is in essence a more comprehensive and
unconditional form of access, a downstream purchaser acquires ownership
of only the digital or physical embodiment of a sound recording (and
the embodied musical work) in exchange for an up-front charge (the
purchase price), and then has unlimited free access to that single
sound recording/musical work going forward. By contrast, a subscriber
to an interactive streaming service pays an up-front charge (usually
monthly), and then likewise has unlimited access to the entire catalog
of sound recordings (and the embodied musical works) for each such
period.
Thus, the dissimilarities between the products regulated in subpart
A and subpart B outweigh their similarities. An interactive streaming
service provides an access (option) value to entire repertoires of
music. A purchased download or CD provides unlimited access for only a
single sound recording/musical work.
In other respects, though, I recognize that the subpart A market
and settlement are somewhat comparable to the subpart B market. The
licensed right in question is identical--the right to license copies of
musical works for listening in a downstream market. Further, the
licensors--i.e., the music publishers and songwriters--are
identical.\312\ Finally, the time period is reasonably recent, and the
Copyright Owners have not explained whether or how the particular
market forces in the Subpart A market sectors have changed since 2012
to make the rate obsolete.
---------------------------------------------------------------------------
\312\ However, the licensees in the benchmark market are not the
same. Moreover, as Copyright Owners note, there is an important
economic difference in the identities of the licensees. In subpart
A, the licensees are record companies, who use the licensed musical
works as inputs to create a new product, the sound recording. In
subpart B, the interactive streaming services use the musical work
through their use of the finished product (the sound recording).
This basic difference suggests that the different values are a
consequence of a difference in kind.
---------------------------------------------------------------------------
Notwithstanding these similarities though, I find that the facially
different access value in subpart A constitutes a fatal flaw in its
usefulness as a benchmark in this proceeding. However, the Services,
and Apple, have presented
[[Page 2012]]
evidence which they assert provides two different ways of rendering
subpart A rates compatible. Accordingly, I consider those approaches
below.
c. The Services' and Apple's Subpart A Benchmarking Approaches
To convert the per-unit rate in subpart A into a subpart B percent-
of-revenue rate, the Services and Apple identify several alleged third-
party conversion ratios between a given number of interactive streams
and a single play of a purchased DPD that they allege are applicable in
this proceeding.
Professor Marx first applies a conversion ratio of PDDs to streams
of 1:150, which she noted had been established by the RIAA. Second, she
(as well as Professor Katz) takes note of an academic study which
estimated that, in the marketplace, 137 interactive streams was
equivalent to the sale of one DPD. Marx WDT ] 108 & n.21 (citing L.
Aguiar and J. Waldfogel, Streaming Reaches Flood Stage: Does Spotify
Stimulate or Depress Music Sales? (working paper, National Bureau of
Economic Research, 2015)); Katz WDT ] 110 (same). Apple's economic
expert, Professor Ramaprasad, also relied on the Aguiar/Waldfogel
article to support Apple's benchmark per play proposal. Ramaprasad WDT
] 56, n.102.\313\
---------------------------------------------------------------------------
\313\ Professor Ramaprasad also relied on two other equivalency
ratios, the first from Billboard magazine, and the second from
another entity, UK Charts Company (UK Charts). However, she
acknowledges that the Billboard ratio combines video streaming
royalty data with audio streaming royalty data, which results in an
overestimation of the ratio of streams to track sales relative to an
audio-stream-only analysis. 3/23/17 Tr. 2760-61 (Ramaprasad). She
also acknowledges that UK Charts changed its ratio from 1:100 to
1:150 without explanation, rendering uncertain that purported
industry standard. See COPFF ] 683 (and record citations therein).
Also, there was no evidence indicating that streaming and download
activity in the United Kingdom would be comparable to U.S. activity.
---------------------------------------------------------------------------
To apply the 1:150 conversion ratio, Professor Marx first
calculated the subpart A mechanical license fee as the weighted average
of the PDD/CD mechanical license fee for songs five minutes or less and
songs greater than five minutes: $[REDACTED] per copy for the former
and $[REDACTED] per minute or a fraction thereof (conservatively
assuming that songs longer than five minutes have an average length of
eight minutes). Based on this assumption, she estimated a PDD/CD
mechanical license fee of $[REDACTED] per song. Marx WDT ] 108. Next,
Professor Marx obtained a per-play streaming royalty equivalent by
dividing the $[REDACTED] per song amount (derived supra) by the number
of streams, 150, yielding a value for the per-play total streaming
royalty of $[REDACTED]. Id. ] ] 109-110. The resulting per-play royalty
rate for the sum of mechanical and performance royalty translates to
[REDACTED]% of Spotify's revenue. Id. ] 111. Subtracting out the
performance royalty of [REDACTED]% as in an ``All-In'' calculation, she
derived a mechanical royalty rate equivalent from Subpart A of
approximately [REDACTED]% to [REDACTED]% of revenue. Id. ] 112, Fig.
22.
Professor Marx engaged in the same calculation methodology when
applying the 1:137 conversion ratio from the Aguiar/Waldfogel article,
and she determined a percent-of-revenue royalty for Spotify of
[REDACTED]% (``All-In''), higher than the [REDACTED]% when applying the
1:150 conversion ratio. Id. ] 111 n.123.
On behalf of Pandora, Professor Katz used the same 1:150 conversion
ratio as Professor Marx. He calculated a mechanical rate implied by the
subpart A rate of 4.25%, higher than Professor Marx's implied rate, but
still lower than the existing headline rate of 10.5% in subpart B. Katz
WDT ] 111. On behalf of Apple, Professor Ramaprasad utilizes the 1:150
ratio, which she adopted from Billboard magazine's ``Stream Equivalent
Albums'' approach. Ramaprasad WDT ] 84. Because Apple has advocated for
a per stream rate, her conversion was expressed on a per stream basis,
at $0.00061 per stream. Professor Ramaprasad noted that this rate was
not only lower than the $0.0015 per stream rate proposed by Copyright
Owners, but also significantly lower than Apple's own proposed per-
stream rate of $0.00091. Ramaprasad WDT ] 86. When Professor Ramaprasad
applied the Waldfogel/Aguiar 1:137 ratio, expressed on a per-play
basis, she calculated a rate of $0.00066 per-stream for interactive
streaming, which she noted also was even lower than the per-stream rate
of $0.00091 Apple had proposed.
I do not place any weight on this ``conversion'' approach.
Copyright Owners levy numerous criticisms of the ratio approach, and
those criticisms, each on its own merit, serve to discredit the ratio
approach. First, the Services and Apple simply adopted the equivalence
ratios without defining what ``equivalence'' means. For example, the
RIAA used the concept to identify albums that were sufficiently popular
to garner ``gold'' or ``platinum'' awards. That use, absent other
evidence, does not indicate that the conversion ratio is appropriate
for rate-setting purposes. See generally Rysman WRT ] 96. Second, and
relatedly, the experts who relied on the Aguiar/Waldfogel article did
not verify that the input data used by the authors was appropriate for
the purposes for which it has been relied upon in this proceeding. See
3/20/17 Tr. 1945-46 (Marx); 3/23/17 Tr. 2789-90 (Ramaprasad). Third,
the Aguiar/Waldfogel article appears not to specifically address two
issues that would make an equivalency ratio meaningful: (a) what
happens to the download behavior of an individual who adopts streaming;
and (b) how the availability of streaming alters the consumption of a
particular song. See Rysman WRT ] 97. Fourth, the experts for the
Services and Apple ignore that Aguiar and Waldfogel conducted an
additional analysis described in the same article on which they rely.
In that second analysis, the authors compared the weekly data from
Spotify for the period April to December 2013 with weekly data from
Nielson on digital download sales for the same exact songs during the
same overlapping time period. That approach, which Aguiar and Waldfogel
called their ``matched aggregate sales'' analysis, yielded a ratio of
1:43, implying a much higher mechanical rate for streaming. See COPFF ]
] 663-64 (and record citations therein).
The Services and Apple offer no sufficient evidence to overcome
these criticisms of their ``equivalence'' approach for applying the
Subpart A rates in this proceeding. Accordingly, I do not rely on such
``equivalence' approaches in this determination.
By contrast, the Services' second Subpart A benchmarking approach,
utilized by both Professor Marx and Dr. Leonard, is more
straightforward, and does not require a conversion of downloads into
stream-equivalents. Rather, under this approach, Professor Marx simply
divides the effective per-unit download royalty of $[REDACTED] by the
average retail price of a download, $1.10, to calculate an ``All-In''
musical works royalty percent of [REDACTED]%. Subtracting Spotify's
[REDACTED]% performance rate nets a mechanical works rate of
[REDACTED]%. In similar fashion, given an average CD price of $1.24 per
song, she finds that the ``All-In'' musical works rate equals
[REDACTED]%. Subtracting Spotify's [REDACTED]% performance rate nets an
``effective'' mechanical royalty rate of [REDACTED]% under this
approach. Thus, she concludes that the Services' proposal in general,
and Spotify's proposal in particular, are conservative and reasonable,
because those proposals provide for substantially higher royalty
[[Page 2013]]
rates than suggested by this subpart A benchmark analysis. Marx WDT ] ]
113-114 & Fig. 23.
Dr. Leonard did a similar calculation. He found that, applying the
subpart A rates, expressed as a percentage of revenue, interactive
streaming services would pay an ``All-In'' rate to Copyright Owners of
8.7% of revenue, based on the average retail price of digital downloads
in 2015. Leonard AWDT ] 42. Dr. Leonard further calculated that,
expressed as a percentage of payments to the record labels (rather than
total downstream revenues) the subpart A settlement reflects a payment
of 14.2% of ``All-In'' sound recording royalties, when compared to
payments to record labels in 2015. Leonard AWDT ] 46.
Using updated 2016 data, which lowered the DPD retail price to
$.99, Dr. Leonard calculates an ``effective'' percentage royalty rate
of 9.6%. 3/15/17 Tr. 1108-09 (Leonard). Dr. Leonard then adjusts this
result to make it comparable to Google's proposal, which seeks a 15%
reduction of up to 15% in certain costs incurred to acquire revenues.
Adjusting for this cost reduction, Dr. Leonard concludes that the
equivalent percent of revenue (after deducting similar costs) in
Subpart A is 10.2% in 2015 and 11.3% in 2016. Id. at 1109.
Copyright Owners do not dispute the calculations made by Professor
Marx and Dr. Leonard in these regards. However, they emphasize that
this approach nonetheless is not useful because it fails to fails even
to attempt to explain the significant differences in access value
between the purchase of a download or CD, on the one hand, and a
subscription to (or free use of) an interactive streaming service, on
the other. That is, whereas the Services and Apples' first approach is
deficient because its conversion ratios are not applicable, Services'
second approach fails because it simply bypasses altogether the problem
of access value differences.
Finally, I take note of a point made by Professor Marx, that
Copyright Owners, like any seller/licensor, would rationally seek to
equalize the rate of return from each distribution channel i.e., from
licensing rights to sell DPDs/CDs under subpart A and from licensing to
interactive streaming services under subpart B. As she explains:
This principle of equalizing rates of return across different
platforms has some similarities with that underlying the approach of
W. Baumol and G. Sidak, ``The Pricing of Inputs Sold to
Competitors,'' . . . . They propose an efficient component pricing
rule whose purpose is to ensure that the bottleneck owner (in our
case, the copyright holder) should get compensation for access from
all downstream market participants, whether existing or new
entrants, that leaves him as well off as he would have been absent
entry.
Marx WDT ] 104, n.118. The Judges first identified this principle
in Web IV, through a colloquy with an economic witness. See Web IV, 81
FR at 26344 (SoundExchange's economic expert, Professor Daniel
Rubinfeld, acknowledging that, generally, licensors, as ``a fundamental
economic process of profit maximization . . . would want to make sure
that the marginal return that they could get in each sector would be
equal, because if the marginal return was greater in the interactive
space than the noninteractive . . . you would want to continue to pour
resources, recordings in this case, into the [interactive] space until
that marginal return was equivalent to the return in the noninteractive
space.'').
However, that argument is dependent upon a usable conversion ratio
to equalize access value per unit. Professor Marx does not explain how,
absent such conversions, it would be possible to equalize rates of
return across platforms. Accordingly, I find that the principle of
``equalized returns'' relied upon by Professor Marx cannot be applied.
3. Apple's Proposed Rate
Apple proposes a per-play rate of $0.00091 per unit. However, that
rate is premised on two analytical factors that I have rejected, as
discussed supra. First, as a single, per-play rate, it fails to reflect
the variable WTP in the market, rendering it a less efficient upstream
royalty rate. Second, Apple's proposed $0.00091 rate is derived from
the subpart A conversion ratio approach that I have rejected, for the
reasons discussed supra. I incorporate herein my analysis rejecting a
per-unit approach, and my analysis rejecting the subpart A conversion
ratio approach.
4. Findings Regarding the Reasonable Rate (before consideration of the
four itemized factors)
There are several rates, as discussed supra, that I find to be
supported by sufficient evidence to be relevant to the setting of rates
in the present proceeding.
First, Dr. Eisenach's Pandora Opt-Out Agreement benchmarks, as
contained in those agreements (i.e., without extrapolation), reflect a
ratio of [REDACTED] of sound recordings:musical works in a comparable
benchmark setting. This ratio, as noted supra, translates to a TCC
percent of [REDACTED]%. With sound recording royalty rates of
approximately [REDACTED]% to [REDACTED]%, this TCC reflects a royalty
equal to an effective percent of total \314\ revenue equal to
[REDACTED]% to [REDACTED]%.
---------------------------------------------------------------------------
\314\ In the context of this section, ``total'' revenue is
intended to distinguish from the percent of royalties paid by
interactive streaming services to record companies as sound
recording royalties (i.e., TCC).
---------------------------------------------------------------------------
Second, the YouTube agreements with music publishers identified by
Dr. Eisenach--that relate to [REDACTED]. That [REDACTED]% royalty is a
denominator in the ratio concept utilized by Dr. Eisenach,\315\ and the
numerator is the [REDACTED] sound recording royalty paid to the record
companies. As explained supra, YouTube has agreed to pay [REDACTED],
and has agreed to pay [REDACTED]. The [REDACTED] ratio reduces to
[REDACTED], implying a TCC ([REDACTED]) of [REDACTED]%. The [REDACTED]
ratio reduces to [REDACTED], implying a TCC ([REDACTED]) of
[REDACTED]%.
---------------------------------------------------------------------------
\315\ To repeat for the sake of clarity, Dr. Eisenach does not
rely on the ``static image'' agreements for his ultimate opinion.
But the text accompanying this footnote expresses how the ``static
image'' rate is being applied based on Dr. Eisenach's ratio
approach.
---------------------------------------------------------------------------
Third, I look at the effective rates paid by Spotify, the largest
interactive streaming service in terms of in terms of the number of
subscriber-months and the number of plays. See Marx WRT ] ] 37-38 &
Figs. 8 & 9. Under the current rate structure, as noted supra,
[REDACTED] \316\ [REDACTED].
---------------------------------------------------------------------------
\316\ The record in some places records this figure as
[REDACTED]% and [REDACTED]%. I understand these differences reflect
rounding of figures and some discrepancy as to the time period
covered. In any event, these differences do not impact my findings.
---------------------------------------------------------------------------
Continuing with a consideration of Spotify's rates paid under the
existing rate structure, [REDACTED].
[REDACTED]. The average rate is relevant in this proceeding
because, as discussed supra, Spotify's two tiers are interrelated, in
that the ``freemium'' model construes ad-supported listeners as a pool
of potential converts to the subscription tier, even as they generate
(indirectly) advertising revenue that converts to royalties for the
Copyright Owners under the TCC prong.
Fourth, leaving the Spotify rates, I note that direct deals
identified in the record reflect rates in the present regulations (as
Dr. Eisenach noted, albeit he minimized the importance of those direct
agreements). Also, the direct agreements contain additional terms that
make them relatively uncertain benchmarks. For example, although
Google's direct deals include rates that reflect the statutory rate--
[[Page 2014]]
[REDACTED]. Leonard AWDT ] ] 53-54.\317\ Also, its direct deals omit
the Mechanical Floor, id., which, as noted supra, [REDACTED].
---------------------------------------------------------------------------
\317\ [REDACTED].
---------------------------------------------------------------------------
[REDACTED] pays [REDACTED] royalties equal to [REDACTED] for its
bundled subscription services which, after subtracting an [REDACTED]%
performance royalty, equals a mechanical royalty of [REDACTED] % of
[REDACTED]. Leonard AWDT ] 64. [REDACTED].
Apple pays [REDACTED]. Wheeler WDT ] 10. [REDACTED]. See Eisenach
WDT ] 10 (``[A]s a matter of economics the Section 115 license operates
as a ceiling but not a floor on Section 115 royalties.'').
Based on the foregoing evidence regarding rates, I find that the
existing rate structure is generating effective percent-of-revenue
rates in the manner in which it was intended. The 10.5% headline rate
is exceeded by the rates paid by [REDACTED], even as the effective per
play rates that generate those percentages are lower. The rates
actually paid and the rates under the 2012 benchmark are also
consistent with the benchmark rates arising from the benchmark analyses
undertaken by Dr. Eisenach that I find to be sufficiently comparable,
particularly with regard to the TCC prong. The clustering of the
effective percent of revenue rates in this regard indicates that the
price discriminatory aspects of the existing structure allow for the
growth of revenue, as the interactive streaming services ``exploit the
demand curve'' by offering tiers of service that appeal to the budget
constraints and the preferences of the segmented marketplace. The fact
that a wide array of products with different characteristics at
different price points has monetized usage, such that some effective
actual rates exceed the 10.5% ``headline'' rate, is testament to the
mutual benefits of the existing rates.
As noted supra, this finding does not mean that there might not be
better ways to monetize demand, and I do not suggest that the record
permits me (or the majority) to identify appropriate rates with
mathematical precision. However, as the D.C. Circuit has held, and as
noted supra, our rate-setting is an intensely practical affair, and
mathematical precision is not possible. Nat'l Cable Television Ass'n,
724 F.2d at 182. Moreover, the Judges are constrained: We must choose
among the rates and structures proposed by the parties, or reasonably
ascertainable from the evidence, through an evidentiary process that
the parties were permitted to consider, challenge and rebut at the
hearing. What the Judges cannot do is attempt to cobble together
elements of different proposals (the majority's ``Frankenstein's
Monster'' approach, as characterized by Copyright Owners) without
evidence as to how those combined elements would impact the industry
and its participants.
VI. SUBPART C: APPLYING THE 2012 BENCHMARK
The parties' negotiations in Phonorecords II that culminated in the
2012 settlement focused more intensely on the rates that would apply to
new service types, including cloud locker services, that would
ultimately be embodied in subpart C of 37 CFR part 385. Parness WDT ]
13; Levine WDT ] ] 38-39; Israelite WDT ] ] 28-30. In fact, the subpart
C negotiations that created five new service categories were quite
protracted, the subject of a negotiation over more than one year. 3/29/
17 Tr. 3652-55 (Israelite). Moreover, in this protracted give-and-take,
the NMPA rejected some categories proposed by the services, while
others were accepted and became part of subpart C. Id. at 3654- 56.
In setting these rates--rather than developing a new royalty
structure for these service types--the parties ultimately agreed on a
structure for subpart C that resembled the subpart B structure,
adopting a headline percentage of revenue royalty rate and per-
subscriber and TCC minima. Parness WDT ] 14; see also 37 CFR 385.22. As
with the bundling negotiations relating to subpart B, the parties
negotiated and created a bundled service category under subpart C (with
certain adjustments to the definition of ``revenue.'') 3/8/17 Tr. 161-
64 (Levine); 37 CFR 385.21. Not only are these provisions the default
statutory terms, but publishers and service also incorporate these
rates and terms in their direct licenses. See Leonard AWDT ] ] 54, 58,
67, 69.
Copyright Owners now urge the elimination of these subpart C
provisions. They note that, although the Services had been very
interested in locker services (a large focus of subpart C) during the
2012 negotiations, locker services have decreased in popularity and
significance, and have largely disappeared. They explain this
phenomenon as linked to the transition by listeners from ownership to
access models, rendering functionally unimportant a listener's access
to his or her own libraries as stored in a cloud locker. In fact,
Copyright Owners point out that the Services' own witnesses have
acknowledged this decrease in the popularity of lockers. 3/8/17 Tr.
159-160 (Levine); 3/16/17 Tr. 1458-1461 (Mirchandani) ([REDACTED]);
Mirchandani WDT ] 33 ([REDACTED]), Copyright Owners further note that
this fall in popularity is reflected in the fact that neither Spotify
nor Pandora offers either a purchased content or a paid locker service.
They note that Apple, which at one time offered a paid locker service,
has abandoned that product, but still offers a purchased content locker
service (perhaps a function of its market share of previous listener
purchases of digital downloads from its iTunes Store). 3/22/17 Tr. 2523
(Dorn).
Copyright Owners also note that the Services' subpart C arguments
suffer from the same defect as their subpart B arguments: they have not
provided any evidence explaining the basis for any of the rates or
terms contained in . . . subpart C . . . . of the statute. CORPFF-JS at
p.2.
In opposition, the Services argue that Copyright Owners do not
point to any evidence to show that locker services have completely
``disappeared.'' Rather, they note that Apple and Amazon continue to
offer locker services. Joyce WDT ] 5; Mirchandani WDT ] ] 16-17. In
this regard, Apple notes that each service in this proceeding that
sells downloads also offers locker services. See 3/22/17 Tr. 2523-25
(Dorn); Ramaprasad WDT, Table 3. The Services also note that Copyright
Owners are seeking rates for subpart C products that are substantially
higher than present rates. See Joyce WDT ] 19.
More generally, the Services urge the Judges to use the subpart C
rate structure as the benchmark for rates in the forthcoming period for
the same reasons as they urge the use of the subpart B benchmarks a an
appropriate benchmark. That is, the 2012 subpart C benchmarks were
negotiated by the same parties, covering the same rights over a
relatively contemporaneous period, and the economic circumstances are
sufficiently similar. Amazon characterizes the ``[t]he existing . . .
Subpart C service categories and rate structures [as] represent[ing]
the collective efforts of industry participants . . ., including [a]
proceeding[] before the [Judges] which were resolved by a negotiated
settlement agreement among the participants many of whom are also
participants in this proceeding.'' Mirchandani WDT ] ] 58-62. Moreover,
several of the listed services already provided (or had plans to
provide) subpart C services in 2012, underscoring the relevance of the
negotiated settlement. See 3/18/17 Tr. 157-158 (Levine) (discussing
Google's plans to launch a . . . locker service in
[[Page 2015]]
the period of Phonorecords II negotiations); Mirchandani WDT ] 16
(discussing launch of Amazon locker service in mid-2012).
The Services also criticize the application of Copyright Owners'
greater-of approach in the subpart C context as absurd. They claim that
under Copyright Owners' proposal, licensors would receive $0.091 for
each download of a copy from a purchased content locker, and at least
$1.06 per-month for each month that a listener facilitates a copy in
order to accesses the track via that locker, because. This would be
absurd, according to the Services, because the separate copy is the
basis for the royalty payments that Copyright Owners had already
received when the listener originally purchased the product.
Mirchandani WRT ] 47. Adding to this criticism, Apple emphasizes that
Copyright Owners fail to mention that: (1) all purchased content locker
services are free by definition, pursuant 37 CFR 385.21; and (2) some
locker service streams originate from private copies of songs that are
not streamed content from a central service (see 3/13/17 Tr. 829-830
(Joyce).
On balance, I find that the subpart C rate structure has the same
attributes of a useful benchmark as does the subpart B rate structure.
The categories of parties were the same, the rights are the same and
the agreement is relatively contemporaneous. I do not find that the
lack of popularity of the subpart C configurations cuts against the use
of the 2012 rate structure as a benchmark. If the subpart C categories
wither in the marketplace, the impact of this rate structure will be of
little importance. But if these lockers, bundles and other offerings
grow in popularity, the relative strength of this benchmark will be
preferable to the ``greater of'' formulation proposed by Copyright
Owners.
In that regard, Copyright Owners' rate structure proposal for
subpart C (identical to its proposal for subpart B) is rejected for the
same reasons as it was rejected for subpart B, and those criticisms are
incorporated into this section. Further, locker services are
distinguishable from other products. Musical works embodied in the
sound recordings that have already been purchased have a value that is
reflected in the sale through another distribution channel. It would be
anomalous to apply the same rate structure to the right of a service to
obtain a copy so that the downstream customer could store or access
that which he or she already owns. I find that the parties' prior arm's
length negotiations of the subpart C structure better reflects their
understanding of the different use values implicated by subpart B and
the locker services identified in subpart C.\318\
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\318\ Once again, separate and apart from the usefulness of the
2012 benchmark structure and rates as benchmark evidence, the
existing rate structure and rates, which embody the 2012 settlement,
serve as a default rate structure and set of rates, because the
other evidence in the record does not support an alternative
approach. See Music Choice, supra.
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VII. THE FOUR ITEMIZED FACTORS IN SECTION 801(b)
The four itemized factors set forth in section 801(b)(1) require
the Judges to exercise ``legislative discretion'' in making independent
policy determinations that balance the interests of copyright owners
and users.'' SoundExchange, Inc. v. Librarian of Cong., 571 F.3d 1220,
1224 (DC Cir. 2009); see also RIAA v. CRT, 662 F.2d 1, 8-9 (D.C. Cir.
1981) (analyzing identical factors applied by predecessor rate-setting
body and holding that the statutory policy objectives of 801(b)(1)
``invite the [Board] to exercise a legislative discretion in
determining copyright policy in order to achieve an equitable division
of music industry profits between the copyright owners and users'').
The four factors ``pull in opposing directions,'' leading to a
``range of reasonable royalty rates that would serve all these
objectives adequately but to differing degrees.'' Recording Indus.
Ass'n of Am. v. Copyright Royalty Tribunal, 662 F.2d 1, 9 (D.C. Cir.
1981) (``Phonorecords 1981 Appeal'') (citations omitted). Certain
factors require determinations ``of a judgmental or predictive
nature,'' while others call for a broad fairness inquiry. Id. at 8
(citations & quotations omitted). Accordingly, the Judges are ``free to
choose'' within the range of reasonable rates . . . within a `zone of
reasonableness.' '' Id. at 9 (citations omitted).
Further, as explained at note 205 (and the accompanying text)
supra, the ``reasonableness'' analysis can be undertaken as an initial
step, followed by consideration of the four itemized factors, or the
four-factor analysis can be undertaken as part of the
``reasonableness'' analysis. I have followed what I understand to be
the more conventional approach in proceedings applying the section
801(b)(1) standards by essentially undertaking the former approach.
However, my following consideration of the four itemized section
801(b)(1) factors also provides further support for the findings
identifying the reasonable rate structure and rates.
A. The Relationship of the Four Itemized Factors to the Market Rate
The D.C. Circuit recently reiterated the relationship between the
801(b) standard and market-based rates by contrasting that standard
with the willing buyer/willing-seller standard set forth in 17 U.S.C.
114(f)(2)(B). The court noted that the two standards are
distinguishable by the fact that, unlike section 114(f)(2)(B), section
801(b)(1) does not focus in the same manner as rates that would be set
in a marketplace. SoundExchange, Inc. v. Muzak LLC, 854 F.3d 713, 715
(D.C. Cir. 2017).
However, to the extent that market factors may implicitly address
any (or all) of the four itemized factors, the reasonable, market-based
rates may remain unadjusted, And, if the evidence suggest that the
market-based rates fail to account for any (or all) of these four
itemized factors, the Judges will adjust the reasonable, market-based
rate appropriately. See SDARS I, supra at 4094 (applying the same
itemized factors and holding that ``[t]he ultimate question is whether
it is necessary to adjust the result indicated by marketplace evidence
in order to achieve th[e] policy objective.'').\319\
---------------------------------------------------------------------------
\319\ Thus, the Judges reject Copyright Owners' argument that
the first three itemized section 801(b)(1) factors per se reflect
the same forces that shape the rate set in the marketplace. See 4/4/
17 Tr. 4589, 4666 (Eisenach). The Services also challenge Dr.
Eisenach's assertion that he believes that the first three itemized
factors reflect market forces, based on his prior writings and
testimony, a charge that he persuasively denies. Compare SJRCOPFF at
p.5 with 4/4/17 Tr. 4676-79 (Eisenach). I find this dustup to be
irrelevant to their objective analysis of the itemized 801(b)(1)
factors.
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B. Factor A: Maximizing the Availability of Creative Works to the
Public
1. Introduction
Factor A provides that rates and terms should be determined to
``maximize the availability of creative works to the public.'' 17
U.S.C. 801(b)(1)(A). Of particular importance, this provision
unambiguously links the upstream rates and terms that the Judges are
setting with the downstream market, in which ``the public'' is
listening to sound recordings that embody musical works.
In a prior Determination, the Judges made a general statement,
attributed to an expert economic witness, Dr. Janusz Ordover, in SDARS
I, that ``[w]e agree with Dr. Ordover that `voluntary transactions
between buyers and sellers as mediated by the market are the most
effective way to implement efficient allocations of societal
resources.'
[[Page 2016]]
Ordover WDT at 11.'' SDARS I, 73 FR at 4094. However, as the discussion
of the economics of this market, supra, should make plain, I do not
agree that such a broad statement captures all the economic realities
of the market. In fact, Professor Ordover's full testimony in SDARS I
clearly demonstrates that he fully appreciates the particular aspects
of the economics of the markets at issue, including the aspects
relevant to Factor A. More fully, Professor Ordover testified as
follows in SDARS I: \320\
---------------------------------------------------------------------------
\320\ I recount Professor Ordover's testimony to provide the
context for the snapshot of his testimony excerpted and relied on in
SDARS I. I do not rely on Professor Ordover's testimony in deciding
any factual issues in this proceeding.
Unimpeded market transactions promote economic efficiency and
lead to supply and demand decisions that maximize society's economic
welfare. [I]n the special case of markets for sound recordings and
other intellectual property . . . the incremental cost of serving
any single user is very low relative to the initial cost of
creation, and use by any single user does not diminish the
availability of the content to others. . . . [T]o account for these
differences, pricing in these markets should be based on the
underlying value of the product to the buyer.
. . .
The solutions to this policy problem focus on an oft-noted
tension in the pricing of intellectual property between static and
dynamic efficiency. . . . [E]conomists have . . . a clear answer . .
. provided by so called second-best . . . pricing.'' . . . The rule
is that those customers--be they final users or intermediate
customers (such as the SDARS, for example)--whose demand for the
product (content) is inelastic should pay a higher markup above the
marginal cost of serving them, and those whose demands are elastic
should pay a lower markup. . . . Since elasticity of demand is
related to ``willingness to pay'' [WTP] [so] users or usages with a
high [WTP] . . . should be required to contribute the most (per unit
of usage). . . . [T]his principle assures that the greatest number
of consumers will be able to benefit from use of a product . . . .
[``V]alue-based pricing'' . . . provides the correct incentives for
producers of content insofar as it ensures that overall revenues
from all sources recoup the costs of creating the content in the
first place.
Ordover WDT at 4, 16-18 (emphasis added). Professor Ordover then
noted the same upstream/downstream link that I have identified in this
proceeding:
[I]t is important to note that demand for music content by the SDARS
[or any distribution channel] is a ``derived demand'' in the sense
that it flows from consumers' demand for the service as a
distribution channel for music. . . . [T]he SDARS' [or any
distribution channel's] [WTP] content owner is inextricably linked
to consumers' [WTP] for the . . . service . . . .
Id. at 18-19 (emphasis added).\321\
---------------------------------------------------------------------------
\321\ To estimate the different values (elasticities) within a
distribution channel, Professor Ordover found ``highly informative''
the ``survey data and results'' obtained by a testifying survey
expert, id. at 23--just as I find informative the results of the
Klein Survey.
---------------------------------------------------------------------------
2. The Services' Position
On behalf of the Services, Professor Marx approaches Factor A in a
manner that is at once novel (for these proceedings) yet consistent
with fundamental and relevant economic principles. Specifically, she
asserts that maximization of the availability of musical works
(embodied in sound recordings) to the public, through interactive
streaming, requires that the combined ``producer surplus'' and
``consumer surplus'' be maximized, because that leads to listening by
all segments of the public regardless of their WTP. To understand
Professor Marx's analysis, the economic terminology on which she relies
needs a brief explanation.
The ``producer surplus'' is ``the amount by which the total revenue
received by a firm for units of its product exceeds the total marginal
cost. . . .'' A Schotter, Microeconomics: A Modern Approach at 389
(2009). The ``consumer' surplus'' is ``[t]he difference between what
the consumer would be willing [and able] to pay and what the consumer
actually has to pay.'' Mansfield & Yohe, supra, at 93. When a perfectly
competitive market is in equilibrium (or tending that way) ``the sum of
consumer surplus . . . and producer surplus . . . is maximized.''
Schotter, supra, at 420. By contrast, if a market is not perfectly
competitive because the sellers have some degree of market power, and
the level of output is somewhat restricted, producer surplus increases
relative to consumer surplus--with a portion of the overall surplus
redistributed to producers/sellers. Another portion is lost as ``a pure
`deadweight' loss . . . the principal measure of the allocation of
harm'' arising from the exercise of market power. Mansfield & Yohe,
supra, at 499. See also Schotter, supra, at 398 (setting forth the
accepted definition of ``deadweight loss'' as ``[t]he dollar measure of
the loss that society suffers when units of a good whose marginal
social benefits exceed the marginal social cost of providing them are
not produced because of the profit-maximizing motives of the firm
involved.'').\322\
---------------------------------------------------------------------------
\322\ To be clear, this static ``harm'' is hardly conclusive
evidence that such market power is actually harmful, or even
inefficient, on balance, in a dynamic sense. A monopoly may be more
efficient in reducing unit costs because of, inter alia, necessary
scale (such as a natural monopoly) or because of superior production
techniques.
---------------------------------------------------------------------------
As the foregoing definitions imply, the two surpluses may be
measured by reference to a single equilibrium price. However, when
sellers are able to price discriminate, they enlarge the total value of
the combined surpluses, diminish the ``deadweight loss'' and
appropriate for themselves the larger, combined surplus. See Varian,
supra at 465 (With price discrimination, ``[j]ust as in the case of a
competitive market, the sum of producer's and consumer's surplus is
maximized [but with] the producer . . . getting the entire surplus
generated in the market. . . .''). In fact, price discrimination is
ubiquitous in the marketplace. See Baumol, Regulation Misread by
Misread Theory, supra.
Professor Marx marshals these microeconomic principles, Marx WDT ]
] 119-122, to explain why the 2012 rate structure tends to incentivize
and support the maximization of musical works available to the public
under Factor A. Id. ] ] 123-133. As she testified:
[H]aving different means of price discrimination is going to
allow greater efficiency to be achieved [i]f we have a way for low
willingness to pay consumers to access music, for example, student
discounts, family discounts or ad-supported streaming, where low-
willingness-to-pay consumers can still access music in a way that
still allows some monetization of that provision of that service.
3/20/17 Tr. 1894-95 (Marx) (emphasis added). See also Marx WDT ] 12
(``An economic interpretation of [F]actor A is that the royalty
structure should ``maximize the pie'' of total producer and consumer
surplus. . . .'').
More granularly, Professor Marx explained why the price
discriminatory rate structure is superior to a per play model in
maximizing the availability of musical works to the public:
The subscription model provides an efficiency benefit because
the price of a play is equal to the marginal cost of roughly zero--a
subscriber faces the true marginal cost of playing a song over the
internet and thus consumes music at the efficient level. When
subscribers face a per-play royalty cost of zero, interactive
streaming services have the appropriate incentive to encourage music
listening at the margin.
In contrast, if interactive streaming services faced a positive
per-play royalty cost, they would have a diminished incentive to
attract and retain high-use consumers, the very type of consumers
who create the most social surplus through their listening. They
would also have an incentive to discourage music listening among the
high-use consumers they retain. The higher the level of per-play
royalties is, the more this incentive might affect the behavior of
interactive streaming services.
[[Page 2017]]
Id. ] ] 130-131 and n.135 (emphasis added) \323\
---------------------------------------------------------------------------
\323\ With regard to Factor A as it relates to Copyright Owners'
proposal, Professor Hubbard also notes the supply-side ``Cournot
Complements'' problem created by Copyright Owners' reliance on the
unregulated sound recording market. This is a problem because rates
in such a ``must have'' unregulated market can be even higher than
monopoly rates, thereby depressing the quantity supplied--contrary
to a goal of maximizing the availability of musical works. See 4/7/
17 Tr. 5532 (Hubbard).
---------------------------------------------------------------------------
Although Professor Marx's analysis is based on an understanding
that maximizing the availability of musical works is a function of
incentives to distributors and a function of downstream demand
characteristics, she notes that the variable, percent-of-rate based
rate structure is consistent with agreements in the unregulated
upstream market, where record companies license sound recordings to
these same interactive streaming services. In that regard, she notes:
Ironically, given the preference of . . . Copyright Owners'
economists for market outcomes in this context, they support a
proposal that would tend to [REDACTED], which the unregulated sound
recording side of the market has facilitated. Their proposal would
also completely do away with percentage-of-revenue rates that form a
key part of unregulated rates negotiated between music labels and
interactive streaming services.
Marx WRT ] 84 (emphasis added).
Beyond these theoretical arguments, Dr. Leonard notes that this is
the basic rate structure that has existed for two rate periods, and
there is no evidence that the songwriters as a group have diminished
their supply of musical works to the public. In fact, he notes that the
music publishing sector has been profitable throughout the present rate
period. 3/15/17 Tr. 1120 (Leonard). I understand this point--
particularly in the context of Factor A--to indicate that there has
been and will continue to be a growing supply of musical works
available to the public, because profitability is a market signal for
the entry of new resources and supply. See generally Varian, supra at
416 (``[I]f a firm is making profits we would expect entry to
occur.'').
3. Copyright Owners' Position
Copyright Owners, principally through the rebuttal testimony of
Professor Watt, argue that Professor Marx has made a fundamental error
in equating the maximizing of availability of musical works with a
maximization of the sum of the producer and consumer surplus. Watt WRT
] 10. According to Professor Watt: ``A better understanding of
criterion A is that the royalty payments should ensure that a plentiful
supply of works is forthcoming into the future. . . .'' Id. To
accomplish that end, Professor Watt argues the rates should be set so
as to ensure that ``creators are given the correct incentives to
continue to create and make available valuable works.'' Id.
Further, Professor Watt argues that even if the rates and rate
structure are designed to maximize the consumer and producer surplus,
such maximization would not inform the Judges as to whether that result
satisfies Factor A. Rather, according to Professor Watt:
In effect, a royalty structure is simply a way in which producer
surplus, once created, is shared between the interactive streaming
firms and the copyright holders, but in and of itself, the structure
does not determine the size of either producer or consumer surplus.
Consumer surplus and producer surplus are both entirely determined
by the interplay of the demand curve for the product in question
(here, interactive music streaming) and the way the product is
priced by the interactive streaming industry to its consumers. That
is, regardless of the structure of the royalty payments, the ``size
of the pie'' is determined by the unilateral decisions made by
interactive streaming firms about their pricing to consumers.
Watt WRT ] 11.
Professor Watt also attempts to de-couple the upstream and
downstream rate structures by analogizing interactive streaming to a
retail restaurant offering of an ``all you can eat buffet.'' There,
restaurants pay a positive per unit price for inputs of food offered at
the buffet, yet still--according to Professor Watt--charge a single
price for unlimited access to the buffet. (Professor Watt does not
provide any evidence of how buffet restaurants in fact make pricing
decisions.) Thus, he concludes that a retailer, such as an interactive
streaming service or a buffet restaurant, can pay for inputs (musical
works or food) per-unit while still charging an up-front access fee
($9.99 per monthly subscription or $9.99 for a buffet meal). By this
analogy, Professor Watt purports to demonstrate that interactive
streaming services do not require non-unit royalty rates to serve their
downstream listeners. Id. ] 12.
Professor Watt further notes that Spotify is not accurate when it
claims that listeners to its ad-supported service do not pay a marginal
positive price. He notes that listening to advertising that interrupts
the music imposes a time-related/annoyance cost that the listeners must
accept. This suggests to Professor Watt that per-unit pricing (at least
in a non-monetary manner) indeed is possible downstream. Id. ] 13.
(However, to the extent the advertising is informative, especially when
it is targeted to specific listeners, it is not clear from the record
that such ``interruptions'' would constitute a pure cost. See Phillips
WDT ] 33 (noting the ability of streaming services to ``deliver
extremely targeted advertising to particular audiences.'')).
Further, Professor Watt opines that any positive marginal cost
pricing of songs by interactive streaming services on subscription
plans necessarily would be offset by a reduction in the up-front
subscription price. He further suggests that this consequence would not
necessarily be deleterious for the streaming service because ``[w]ith
the reduction in the fixed fee (along with the positive per-unit
price), it becomes entirely possible that consumers who were not
initially in the market now find it to be in their interests to join
the market, consuming positive amounts of streamed music where
previously they consumed none.'' Id. ] 15.
In their affirmative case regarding Factor A, Copyright Owners
argue that ``availability maximization'' should be considered through
the lens of the creators, who seek high rates as a signal to spur
creation, and would see low rates as a disincentive. In particular,
another of Copyright Owners' expert economic witnesses, Professor
Rysman, testified, in colloquy with the Judges, that the importance of
price-signaling was so paramount that even a hypothetical outlandish
royalty would induce creators to maximize availability:
THE JUDGES: So if all the available music was available on
streaming services and the subscription price was $10,000 a month,
that would be equally available as it would on an ad-supported
service?
PROFESSOR RYSMAN: That's how I read availability. . . . I think
that would raise questions in the other factors, but as I read
availability, that would still satisfy availability.
4/3/17 Tr. 4397 (Rysman).
4. Analysis and Findings
For several reasons, I find that Professor Marx's analysis of how a
price discriminatory model maximizes availability is correct.
First, the rationale for price discrimination is two-fold; not only
does it serve low WTP listeners, but it also serves copyright owners,
by incentivizing interactive streaming services to increase the total
revenue that the price discriminating licensor can obtain. Any seller
or licensor would prefer to maximize its revenue, and a rate structure
that will effect such maximization thus would be the best structural
inducement. Moreover, for
[[Page 2018]]
purposes of applying Factor A, a rate structure that better increases
revenues, ceteris paribus, would induce more production of musical
works, a result that Copyright Owners should desire.\324\
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\324\ This point appears to raise a question: How could
Copyright Owners and their economic experts argue against a rate
structure that inures to their benefit as well? The answer is: They
do not. As stated supra, they advocate for a rate set under the
bargaining room theory, through which mutually beneficial rate
structures can still be negotiated, but not subject to the
``reasonable rate'' and itemized factor analysis required by law. In
those negotiations, as Dr. Eisenach candidly acknowledged, Copyright
Owners would have a different threat point to use in order to obtain
better rates and terms. 4/4/17 Tr.4845-46 (Eisenach).
---------------------------------------------------------------------------
Second, and by contrast, it would be less profitable simply to
equate ``availability'' with a higher rate. As noted supra, any product
that is priced beyond the WTP of a significant portion of the public is
unavailable to that segment. In this regard, Copyright Owners have
taken a cramped and unrealistic view of such incentives. In particular,
I disagree with Professor Rysman's assertion that even a $10,000 per
month subscription price would increase ``availability.'' I find that
he misapprehends the nature of a price signal. If the price is so high
as to eliminate or reduce total revenue to creators, in no way will
higher rates simply induce the supply of creative works over time.\325\
Indeed, even monopolists do not seek the highest price possible, but
rather seek to maximize profits. See Mansfield & Yohe, supra, at 362-63
(``Monopolies maximize profits by producing where marginal cost equals
marginal revenue.''). Thus, even monopolists--who have the most market
power--are constrained in their pricing by the demand curve and the
marginal revenue it creates.\326\ Although a higher royalty rate might
have an immediate superficial appeal, if the consequence will be lower
revenues, the high per-play rate would reveal itself as a form of
fool's gold.\327\
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\325\ This point is reminiscent of an old joke from the era of
the Great Depression. A poor boy is selling Apples on the street
corner for a price of $1 million per apple. A man approaches and
asks the boy: ``How many apples do you expect to sell at that
price?'' To which the boy responds: ``Well, I only have to sell
one!''
\326\ On a technical economic level, perhaps beyond the material
in a prototypical ``Economics 101'' course, a party with market
power, whether a monopolist or otherwise, is not subject to a supply
curve, because a supply curve depicts how much supply would be
forthcoming at given prices, whereas a firm with any pricing power
can influence both price and quantity. See Krugman & Wells, supra,
at 368 (``[M]onopolists don't have supply curves . . . [A]
monopolist . . . does not take the price as a given; it chooses a
profit maximizing quantity, taking into account its own ability to
influence the price.''). Oligopolists act similarly, but their
influence on price is complicated by their predictions of, and
reactions to, the pricing and production decisions of their
oligopolistic competitors. See Nicholson & Snyder, supra, at 521
(``[I]n an oligopoly . . . prices depend on how aggressively firms
compete, which in turn depends on which strategic variables firms
choose, how much information firms have about rivals, and how often
firms interact with each other in the market.'') In similar fashion,
Professor Watt acknowledged the presence of a supply curve in
competitive markets but declined to conclude that one exists in the
markets at issue here. 3/27/17 Tr. 3035-36 ([JUDGES]: ``Is there a
supply curve in the market?'' [PROFESSOR WATT]: ``[T]hat's a hard
question to answer. . . . [C]learly . . . economic theory points to
certain markets where there is no supply curve, per se, and other
markets in which there would be. Like a perfectly competitive
market, it's acceptable that there's a supply curve. . . . [O]once
you get into non-perfectly competitive output markets . . . it
becomes really debatable.'').
\327\ And, again, Copyright Owners are not economic naifs. Once
more, the bargaining room approach is relevant, in connection with
the foregoing price discrimination analysis. A licensor who could
segment the market via WTP could exploit the demand curve and
increase revenues above the revenues available in a single-price
market. Copyright Owners appear to understand this point--
acknowledging they would bargain with licensees if the single-price
rate set by the Judges was too high.
---------------------------------------------------------------------------
Third, I find that the objective of maximizing the availability of
musical works downstream to the public is furthered by an upstream rate
structure that contains price discriminatory characteristics that
enhance the ability of the interactive streaming services to engage in
downstream price discrimination (``down the demand curve,'' increasing
revenue for both Copyright Owners and the interactive streaming
services). That is, as recognized by both Professor Marx in this
proceeding--and Professor Ordover in SDARS I--upstream pricing is a
function of derived demand, and should be ``value-based,'' i.e.,
discriminating among the different values placed on streamed music by
different segments of listeners.
Fourth, I find that Professors Watt and Marx are talking past each
other regarding price discrimination. Professor Watt argues that a
percent-of-revenue based upstream royalty structure is not necessary in
order for the streaming services to price discriminate downstream.
However, I understand Professor Marx to be asserting not that a
percent-of-revenue royalty structure is a necessary condition for
downstream price discrimination, but rather that some form of price
discrimination is appropriate, and that a discriminatory percent-of-
revenue royalty structure will better align the upstream and downstream
incentives, thus maximizing the availability of musical works
downstream. A single upstream price for musical works would tend to
make price discrimination downstream more difficult, because (as noted
by Professor Marx and Professor Ordover in SDARS I) upstream demand is
derived from downstream demand.
To be clear, I do agree with Professor Watt that percent-of-revenue
pricing is not necessary to facilitate price discrimination downstream.
Indeed, in Web IV, the Judges adopted multi-tier upstream per-play
pricing, not percent-of-revenue pricing, to reflect variable WTP
downstream. But here, Copyright Owners have not proposed multiple-tier
per unit pricing, and nothing in the record indicates how the Judges
could mold Copyright Owners' per- play rate into multiple,
discriminatory rates. The only rate structure proposed in this
proceeding that promotes such efficiencies is the existing rate
structure. Because the Judges remain subject to (and bounded by) the
evidence adduced at the hearing, they have before them only one rate
structure that promotes and reflects the downstream market's need for
price discrimination to promote the availability of musical works to
the public.\328\
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\328\ More particularly, in Web IV, the Judges set multiple per-
stream noninteractive royalty rates on a per-play basis,
differentiating among subscription services, ad-supported services
and educational webcasters. These decisions were based on the
Judges' understanding of the evidence at the hearing. If the parties
had presented the Judges with evidence in this proceeding that would
have permitted them to fashion price-discriminatory per-play or per
user rates, those would have been an options for consideration.
However, there was insufficient evidence to permit me to depart from
the parties' proposals in that regard.
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In this regard, Pandora notes the challenges of operating a
business that has fixed revenues per customer but variable cost.
Herring WRT ] 17. Copyright Owners did not provide sufficient evidence
that their proposed per unit royalty rate would better accommodate such
risks. Instead, as noted supra, Copyright Owners rely on an analogy;
Professor Watt's comparison of the streaming industry to the buffet
restaurant industry, in which he assumed input suppliers did not charge
based on a percent of revenue. However, Professor Watt admitted that
his testimony in this regard was ``pure observation,'' and that he has
never consulted for a buffet restaurant and has never performed any
economic analysis of the business strategies of buffet restaurants. 3/
27/17 Tr. 3173-74 (Watt). I note one particular difference between a
foodstuff input to a buffet restaurant and a musical stream input to an
interactive service: the foodstuff is a private good, rivalrous in
consumption, i.e., with a positive marginal cost, whereas the copy of
the musical work is non-rivalrous, i.e., with a zero
[[Page 2019]]
marginal production cost. Because this difference is a critical aspect
of the economics of intellectual property, Copyright Owners' failure to
explore this distinction precludes judicial reliance on their proffered
analogy.
Fifth, I find that Professors Watt and Marx are also talking past
each other with regard to the usefulness of the consumer surplus/
producer surplus approach. Professor Watt claims that the development
of the surplus is relevant only to determine how the surplus will be
split, as noted supra. See Watt WRT ] 11. Professor Marx takes issue
with the assertion that the rate structure does not determine the size
of either producer or consumer surplus. I understand Professor Marx's
point to be that a royalty structure that efficiently incentivizes
price discrimination will enlarge the producer surplus by appropriating
consumer surplus and eliminating deadweight loss,\329\ resulting in
more surplus that can then be allocated between the licensors and
licensees. Indeed, a close reading of Professor Watt's testimony is not
inconsistent with this understanding. He testified that the rate
structure ``in and of itself'' does not determine the size of the
producer surplus. Rather, he testified that producer (and consumer)
surplus are ``entirely determined by the interplay of the [downstream]
demand curve and the way the product is priced [downstream].'' Id. But
Professor Marx's point is that (1) upstream price discrimination makes
downstream price discrimination more efficient; and (2) downstream
price discrimination (a) increases the producer surplus (by
appropriating consumer surplus and eliminating the ``deadweight loss);
and (b) increases the quantity of musical works listened to downstream,
i.e., that are available to the public at prices approximating their
WTP. She does not state that the rate structure ``in and of itself''
will impact the consumer surplus; in fact, her point is that the rate
structure interacts with the demand curve, via price discrimination, to
affect the size of the producer surplus.\330\
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\329\ And shift some consumer surplus to the producers, which is
the point of price discrimination from the perspective of the
seller.
\330\ Indeed, the enhancement of efficiency and the increase in
profits (with the attendant signal to producers) is at the essence
of price discrimination. See Nicholson & Snyder, supra, at 507 (when
sellers' price discrimination leads to an increase in total output
it is ``allocatively superior'').
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Sixth, I am unpersuaded by Professor Watt's argument that a
positive per-play charge levied downstream would likely necessitate a
lower subscription price that would maximize availability of music to
the public. Although the point is economically logical, the services
are the market actors who interact with listeners and are in the better
position to gauge consumer demand. It would be inappropriate to rely on
the opinion of Copyright Owners' expert as to what is theoretically
possible if the business model was changed, or the impact of that
change on the availability of musical works. Indeed, Professor Watt
could testify only that if the interactive streaming services attempted
to pass through to listeners a per-unit royalty via a per-unit
downstream charge, it would become ``possible'' that consumers who were
not initially in the market would be induced by the lower subscription
price to join the market, preferring the combination of the lower
subscription price and the positive per play rate to a higher
subscription price and a lower per play rate. Watt WRT ] 15. However,
the net effect of such a change is simply speculative. What can be said
with some assurance is that such a change would impose a positive
marginal cost on the listener for a product (the copy of streamed
music) that has a zero production cost, which is inconsistent with
static allocative efficiency. Also, if the services could obtain more
revenue by lowering the subscription price and charging a per-play
rate, there is nothing in the record to explain why they have not
engaged in such a strategy on a widespread basis.\331\
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\331\ Professor Watt notes that Spotify has engaged in a non-
monetary version of this strategy, offering an ad-supported service
with no up-front subscription price but a non-monetary ``fee'' in
the form of burdensome advertising. Watt WRT ] 15. However, as noted
supra, it is not necessarily correct to equate listening to
advertising with a monetary cost, because some advertising is
valuable, especially more targeted advertising (why else would
advertisers pay to advertise?) and non-monetary costs may be quite
de minimis for an appreciable segment of the public. In any event,
the business of identifying consumer preferences in order to
establish the appropriate mix of up-front fees and per-play
``costs'' is the specialized business activity of the interactive
streaming services, so any change in rate structure that is premised
on an assumption that market demand and the availability of musical
works can be equally or better served via a different rate structure
needs to be supported by additional record evidence.
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Seventh, although I acknowledge that, in response to per-play
pricing, the services could implement downstream usage restrictions,
such as listening caps, usage-based tiers and overage charges (see
Rysman WRT 75) such steps would not align with the price discriminatory
model that would best serve a listening market with a variable WTP.
Again, a price discriminatory upstream rate structure is appropriate
not because it is either necessary or the only way in which this market
can be structured, but rather because the record indicates it is a rate
structure (among all the ``second best'' economic options) that has
aligned well the characteristics of both the upstream and downstream
markets in a manner that increases the availability of musical works
``down the demand curve.'' And once again, I note that Copyright Owners
and their experts are not in the business of attempting to market
interactive streaming services in the downstream market, so their
``advice'' as to the beneficial use of listening caps, overages and
tiered subscriptions is simply speculative. See [REDACTED].
In sum, I am persuaded that Professor Marx's analysis of Factor A
is consistent with the purpose of that statutory objective and sound
economic theory. An upstream rate structure that contains multiple
royalties reflective of and derived by downstream variable WTP will
facilitate beneficial price discrimination. In turn, such price
discrimination allows for access to be afforded ``down the demand
curve,'' making musical works available to more members of the public.
Accordingly, I would not make any adjustment pursuant to Factor A.\332\
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\332\ The Majority Opinion finds that its significant increase
in rates is necessary to provide sufficient income to songwriters
and, thereby incentivize songwriting which will make more musical
works ``available'' to the public. In this regard, the majority has
made the same mistake as Professor Rysman, confusing higher prices
with increased revenues. The majority has collapsed the existing
price discriminatory rate structure into a single greater-of
structure, based on two revenue prongs. (which I acknowledge to be a
``blunt'' price discriminatory tool, compared with the richer price
discrimination in the 2012 rate structure that has worked
successfully).The majority's approach fails to address two problems:
(1) what is the evidence as to the elasticity of demand that makes
them confidence that their 44% increase in rates will bring forth
additional revenue to songwriters? (That is, what would be the
corresponding decrease in quantity demanded?); and (2) with the TCC
rate uncapped, how can the majority conclude that sound recording
companies will not seek to preserve their share of royalties even as
mechanical royalties rise under the majority's approach, leading to
a spiraling of royalties and a reduction of overall quantity
demanded that offsets the rate increases? (This second problem is a
reprise of my broader criticism of the majority's assumption that
the sound recording companies will docilely accept a ``Shapley
Surrender'' (to coin a phrase) and accept the transfer of tens of
millions of dollars of royalties from them to music publishers/
songwriters, rather than attempt to preserve their revenues and take
that preservation out of the hides of the services, Copyright
Owners, or both.
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C. Factors B and C: Fair Income and Returns and Consideration of the
Parties' Relative Roles
Factor B directs the Judges to set rates that ``afford the
copyright owner a fair return for his or her creative work and the
copyright user a fair income under existing economic conditions.''
Factor C instructs the Judges to weigh ``the
[[Page 2020]]
relative roles of the copyright owner and copyright user in the product
made available to the public,'' across several dimensions.\333\
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\333\ These dimensions are: ``creative contribution,
technological contribution, capital investment, cost, risk, and
contribution to the opening of new markets for creative expression
and media for their communication.'' Id.
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As explained supra, Factor B, and, implicitly, Factor C, were
included in section 801(b)(1) to establish a legal standard that would
pass constitutional muster, yet the statutory language paralleled
public utility-style regulatory principles.\334\ According to Mr.
Nathan in his 1967 congressional testimony, these principles were ill-
suited for setting rates that ``equitably divided compensation for the
``relative roles'' of licensors and licensees in order to provide a
``fair'' outcome.\335\ However, as the parties' economic experts make
clear in their approaches to Factors B and C, economics has evolved
since Mr. Nathan's 1967 testimony in which he criticized as
economically impossible any regulatory attempt to equitably divide
creative contributions.
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\334\ Public utility-style regulation--especially in 1967 when
Mr. Nathan was testifying--was classic ``rate-of-return''
regulation. Essentially, the regulator would identify the utility's
costs, determine the value of invested capital, ascertain an
appropriate rate of return on such capital, and, then, establish the
rate (or rates) charged to customers (or to different customers), in
order to provide the utility with revenue that covers its costs and
provides a ``reasonable rate of return.'' See generally C. Decker,
Modern Economic Regulation at 104 (2014).
\335\ The economic experts for Copyright Owners and the Services
acknowledge that microeconomic principles (pre-Shapley values) do
not provide insights as to what constitutes ``fairness.'' See, e.g.,
3/30/17 Tr. 3991 (Gans) (``fairness . . . is not a topic that is
sitting in an economics textbook somewhere.''); 3/20/17 Tr. 1830
(Marx) (``Fairness is not a notion that has a unique definition
within economics.''); 1128-29 (Leonard) (``economists . . .
typically don't do `fair' ''); 4/13/17 Tr. 5919 (Hubbard)
(Economists aren't philosophers. I can't go to the biggest picture
meaning of ``fair''. . . .). Rather, economists attempt to identify
ex ante ``fairness'' by identifying fair processes in the workings
of and structure of markets and bargaining, and in the efficiency of
outcomes generated by these processes, although their understanding
of what constitutes a fair ``process'' varies. See, e.g. 3/13/17 Tr.
555 (Katz) (``[T]he most useful or practical way of thinking about
it here was really to focus on whether the process is fair'' . . .
[and] a conception that's often used in economics is that a process
is fair if it's . . . competitive or the outcome of a competitive
market. A competitive bargaining process is fair. And so that's
the--the central notion of fairness that I used here.''); 3/15/17
Tr. 1129 (Leonard) (``My concept of fair . . . and what I think a
lot of economists would say is that if you have . . . a negotiation
between two parties and there are no . . . constraints such as
holdup . . . and there's no market power . . . again I hesitate to
use the word, so maybe I'll put it in quotes, would be
[`]fair['].''); Eisenach WDT ] 24 (``a rate set at the fair market
value by definition provides fair returns and incomes to both the
licensee and licensor.'')
---------------------------------------------------------------------------
The parties' economic experts have addressed the Factor B and C
issues through either a Shapley value analysis or an analysis
``inspired'' by the Shapley valuation approach.\336\ The Judges defined
and described the Shapley value in a prior distribution proceeding:
``[T]the Shapley value gives each player his `average marginal
contribution to the players that precede him,' where averages are taken
with respect to all potential orders of the players.'' Distribution of
1998 and 1999 Cable Royalty Funds, 80 FR 13423, 13429 (Docket No. 2008-
1) (March 13, 2015) (citing U. Rothblum, Combinatorial Representations
of the Shapley Value Based on Average Relative Payoffs, in The Shapley
Value: Essays in Honor of Lloyd S. Shapley 121 (A. Roth ed.
1988)).\337\ See also Gans WDT ] 64 (``The Shapley value approach . . .
models bargaining processes in a free market by considering all the
ways each party to a bargain would add value by agreeing to the bargain
and then assigns to each party their average contribution to the
cooperative bargain.''); Marx WDT ] 144 (``The idea of the Shapley
value is that each party should pay according to its average
contribution to cost or be paid according to its average contribution
to value. It embodies a notion of fairness.''); Watt WRT ] 23 (``The
Shapley model is a game theory model that is ultimately designed to
model the outcome in a hypothetical ``fair'' market environment. It is
closely aligned to bargaining models, when all bargainers are on an
equal footing in the process.'').
---------------------------------------------------------------------------
\336\ Dr. Lloyd Shapley won a Nobel Memorial Prize in economics
for this work. The Shapley approach represents a method for
identifying fair outcomes, previously unaddressed in microeconomics.
Mr. Nathan did not reference the potential use of the Shapley value
approach in his 1967 testimony, perhaps because this methodology,
although developed by Lloyd Shapley in 1953, was not yet widespread
in the economic literature.
\337\ The parties' economic expert witnesses find that these
Factors B and C are properly considered jointly in the present
proceeding, and I agree. See Marx WDT ] ] 11-2 (the Shapley value .
. . operationalizes the concept of fair return based on relative
contributions.''); Watt WRT ] 22 (``the Shapley model is a very
appropriate methodology for finding a rate that satisfies factors B
and C of 801(b)''); see also Gans WDT ] ] 65 n. 35, 67 (noting the
Shapley approach provides for a ``fair allocation'' as among input
suppliers to reflect ``the contributions made by each party.'')
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In the parties' direct cases, on behalf of the Services, Professor
Marx constructed a Shapley model. On behalf of Copyright Owners,
Professor Gans developed what he described as a ``Shapley-inspired''
approach. In rebuttal to Professor Marx's Shapley value model,
Copyright Owners, through the testimony of Professor Watt, criticized
Professor Marx's analysis, and made adjustments to her model.
1. The Parties' Shapley Value Evidence and Testimony
a. Shapley Values
A Shapley value approach requires the economic modeler to identify
downstream revenues available for division among the parties. The
economic modeler must also input each provider's costs, which each must
recover out of downstream revenues, in order to identify the residue,
i.e., the Shapley ``surplus,'' available for division among the
parties. As such, the Shapley approach is cost-based, in the same
general manner as a public utility-style rate-setting process
identifies a utility's costs that must be recovered before an
appropriate rate of return can be set.\338\ In the present case,
Copyright Owners and the Services have applied this general approach in
different ways, and each challenges the appropriateness of the other's
model.
---------------------------------------------------------------------------
\338\ Unlike in public utility regulation, the Shapley value
method considers the costs of all input providers whose returns will
be determined. In traditional public utility rate regulation, the
utility is a monopoly and thus the only provider of a regulated
service.
---------------------------------------------------------------------------
To summarize the differences in their approaches, Professor Marx
utilizes a Shapley value approach that purposely alters the actual
market structure in order to obtain results that intentionally deviate
from the market-based distribution of profits--in order to determine
rates she identifies as reflecting a ``fair'' division of the surplus
(Factor B) and recompense for the parties' relative roles (Factor C).
By contrast, Professor Watt's ``correction'' of Professor Marx's
model rejects her alteration of the market structure to achieve such a
result. Rather, he maintains that the incorporation of ``all potential
orders of the players'' in her model--as in all Shapley models--already
adjusts for the hold-out power of any input provider who might threaten
to walk away from a transaction.
Professor Gans, like Professor Watt, does not attempt to alter the
market structure. However, Professor Gans also does not attempt to
construct Shapley values from the ground up. Rather, he takes as a
given Dr. Eisenach's estimation that record companies receive a royalty
of $[REDACTED] per play from interactive streaming services. Because
Professor Gans identifies musical works and sound recordings as perfect
complements, he assumes that the musical works licensors would receive
the same profit as the record companies (but not the same royalty rate,
given their different costs). Because this is not a Shapley value
ground-up
[[Page 2021]]
approach (which would entail estimating the input costs of all three
input providers--the record companies, the music publishers and the
interactive streaming services--Professor Gans candidly acknowledged on
cross-examination that he did not perform a full-fledged Shapley value
analysis; hence he describes his methodology as a ``Shapley-inspired''
approach. 3/30/17 Tr. 4109 (Gans) ([Q]: ``[Y]ou do, is it fair to say,
a Shapley-inspired analysis, if it wasn't a Shapley model?'' [PROFESSOR
GANS]: ``That's fair enough.'').
b. Professor Marx's Shapley Value Approach
Professor Marx testified that, as an initial matter ``[t]he Shapley
value depends upon how [the modeler] delineate[s] the entities
contributing to a particular outcome.'' Marx WDT ] 145. More
particularly, Professor Marx delineated the entities in a manner that
was ``not putting in market power into the model.'' 3/20/17 Tr. 1862-63
(Marx). That is, she modeled the downstream interactive streaming
services as a combined single service (and she added to her model
``other distribution types as another form of downstream distribution
to account for the potential opportunity cost (``cannibalization'') of
interactive streaming). By modeling the downstream market in this
manner, Professor Marx artificially--but intentionally--treated the
multiple interactive streaming services as a single service, a
treatment used as a device (or artifact) to countervail the allegedly
real market power of the collectives (the music publishers and the
record companies respectively) that owned the other inputs--a market
power that Professor Marx concluded must be removed (i.e., offset) to
establish a fair division of the surplus and a fair rate. See 3/20/17
Tr. 1865, 1907 (Marx) (``[M]y goal is to model a fair market, where
there [are] no obvious asymmetries in market power upstream versus
down. So I viewed it as appropriate to view interactive streaming as
one player.'').
With regard to the upstream market of copyright holders, Professor
Marx utilized two separate approaches. In her self-described
``baseline'' approach, she ``treat[ed] rights holders as one upstream
entity, reflecting the broad overlap in ownership between publishers
and record labels.'' Marx WDT ] ] 146, 162. In her ``alternative''
approach, she ungrouped the two collectivized copyright holders--the
songwriters/publishers, on the one hand, and the recording artists/
record companies, on the other. Id. The two purposes of her alternative
approach were: (1) to separately allocate surplus and indicate rates
for musical works (the subject of this proceeding); and (2) to
illuminate the additional ``bargaining power'' of each category of
copyright holder when these two categories of necessary complements
arrive separately in the input market under the Shapley methodology. 3/
20/17 Tr. 1883-84 (Marx). Each of Professor Marx's Shapley value
approached is considered in more detail infra.
i. Professor Marx's Baseline Approach
Professor Marx noted the undisputed principle that ``[t]he
calculation of the Shapley value depends on the total value created by
all the entities together and the values created by each possible
subset of entities.'' Marx WDT ] 147. Equally undisputed is the
understanding that ``[t]hese values are functions of the associated
revenue and costs.'' Id.
The surplus to be divided (from which rates can be derived) is
realized at the downstream end of the distribution chain when revenues
are received from retail consumers. That surplus can be measured as the
profits of the downstream streaming services (and the alternative
services in her model), i.e., their ``revenue minus . . . non-content
costs.'' \339\ The total combined value created by the delivery of the
sound recordings through the interactive (and substitutional) streaming
services consists of: (1) the aforementioned profits downstream (i.e.,
service revenue - non-content cost) minus (2) ``the copyright owners'
non-content costs. Simply put, ``surplus'' reflects the amount of
retail revenue that the input providers can split among themselves
after their non-content costs (i.e., the costs they do not simply pay
to each other) have been recovered.
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\339\ Content costs, as opposed to non-content costs, are not
deducted because the content costs comprise the surplus to be
allocated in terms of royalties paid and residual (if any) that
remains with the interactive streaming (and substitute) services.
The non-content costs, as discussed infra, must be recovered by each
input provider as part of its Shapley value, because entities must
recover costs.
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Thus, any Shapley value calculation requires data to estimate costs
and revenues. In her Shapley analysis, Professor Marx relied on 2015
data from Warner/Chappell for her music publisher non-content cost data
and its ownership-affiliated record company, Warner Music Group, for
record company non-content costs. She was limited to this data set for
non-content costs because among all major holders of musical works and
sound recording copyrights ``only Warner . . . breaks down its cost by
geographic region and by source in enough detail to estimate the
amounts needed.'' Marx WDT ] ] 149-50. Utilizing this Warner cost data
and extrapolating to the entire industry, Professor Marx estimated that
``Musical Work Copyright Holders' Total Non-Content Costs'' equaled
$424 million; and ``Sound Recording Copyright Holders' Total non-
content costs equaled $2.605 billion (more than six times copyright
Holders' non-content costs), summing to total upstream non-content
costs of $3.028 billion. Id. ] 150, Fig. 26.
Turning to the downstream distribution outlets, Professor Marx
identified and relied on Spotify's 2015 revenue and cost data from for
interactive streaming services, and for the alternative distribution
modes, she relied on Pandora's and Sirius XM's revenue and cost data.
Id. ] 152 and nn.149-152. Using that data, Professor Marx estimated
interactive streaming revenue of $[REDACTED]; and (2) interactive
streaming profit of $[REDACTED]. For the alternative distributors
(Pandora and Sirius XM), she estimated (1) revenues of $8.514 billion;
and (2) profits of $3.576 billion. The total downstream revenue,
according to Professor Marx, equaled an estimated $10.118 billion. Id.
] 153 & Fig. 27.
Professor Marx noted that there would be some degree of
substitution between interactive streaming services and alternative
distribution channels (e.g., non-interactive internet radio and
satellite radio). Id. ] 154. She opined that ``it is difficult to
determine the exact value of this substitution effect,'' so she
reported a range of Shapley value calculations that corresponded to ``a
range of possible substitution effects.'' Id.
These data were all inputs into the Shapley algorithm, i.e.,
assigning value to each input provider for each potential order of
arrival among these categories of providers to the market. The multiple
values were summed and averaged as required by the Shapley methodology
to arrive at the ``Shapley value,'' which as explained supra, accounts
for each entity's revenues and (non-content) costs under each possible
ordering of market-arrivals.
Based on the foregoing, Professor Marx estimated that the total
royalty payment due from the interactive streaming services to the
Copyright Owners would range from $[REDACTED] to $[REDACTED], based on
varying assumptions as to the substitution between interactive services
and substitute delivery
[[Page 2022]]
channels. This range of dollar-based revenues reflected a ``percentage
of revenue'' paid by interactive streaming services to all copyright
holders (musical works and sound recordings) ranging from [REDACTED]%
to [REDACTED]%. Id. ] ] 159-160. Professor Marx then noted that this is
well below the combined royalty rate of [REDACTED]% paid by Spotify for
musical works and sound recording rights, indicating that the actual
combined royalty payments are clearly too high. Id. ] 161.\340\
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\340\ Because her baseline approach combines sound recording and
musical works licensors into a single entity, Professor Marx does
not break out separate royalties for musical works or mechanical
licenses. However, she recommends that the mechanical rate should be
lowered based on this finding. Professor Marx does specifically
estimate the musical works rate under her Alternative approach, as
discussed infra.
---------------------------------------------------------------------------
ii. Professor Marx's Alternative Approach
As noted supra, Professor Marx also performed an ``alternative''
Shapley value in which (as opposed to her baseline approach) she
modeled the upstream market as two entities: ``a representative
copyright holder for musical works and a representative copyright
holder for sound recordings.'' Id. ] 163. (That change enlarged the
number of ``arrival'' orderings to 24 (four factorial) but, in all
other respects, Professor Marx's methodology was the same as her
methodology in her initial approach. See id. ] 199, App. B).
Under this alternative approach with two owners of collective
copyrights upstream (musical works owners and sound recording owners),
interactive streaming's total royalty payments range from [REDACTED]%
to [REDACTED]% of streaming revenue. Id. (Sound recording copyright
holders' total royalty income under this alternative approach ranged
from [REDACTED]% to [REDACTED]% of revenue. Id. Professor Marx
explained that this higher range of combined royalties (as a
percentage) in her alternative approach arose from the fact that
splitting the copyright holders into two creates two ``must-haves''
providing each upstream entity with more ``market power and
consequently higher payoffs than the baseline calculation.'' Id. ] 164,
n.153. By splitting the upstream licensors into two categories (record
companies and musical works licensors), Professor Marx calculated that
``musical work copyright holders' total royalty income as a percentage
of revenue ranges from [REDACTED]% to [REDACTED]%.'' Id. ] 163. By way
of comparison, Spotify actually pays [REDACTED]% of its revenue for
musical works royalties (i.e., ``All-In'' royalties). Accordingly,
Professor Marx concludes that ``[b]ecause this proceeding is about
mechanical rates, the fairness component of 801(b) factors suggests
that interactive streaming's mechanical rates should be reduced from
their current level.'' Id. ] 161.
iii. Discussion of Professor Marx's Shapley Value Approach and the
Criticisms of the Copyright Owners' Witnesses
Copyright Owners criticize Professor Marx's model for ``failing to
accurately reflect realities of the market, where current observed
market rates for sound recording royalties alone are approximately
[REDACTED]% of service revenue. See Watt WRT ] 23; Written Rebuttal
Testimony of Joshua Gans on Behalf of Copyright Owners ] ] 19, 28 (Gans
WRT); see also COPFF ] 741. More technically, Copyright Owners object
to Professor Marx's joinder of the sound recording and musical works
rightsholders as a single upstream entity in her ``baseline'' model,
which had the undisputed effect of lowering Shapley values, and hence
royalties, available to be divided between the two categories of
rightsholders. Gans WRT ] 21; Watt WRT App. 3 at 2) (noting that in the
real world, as opposed to the stylized Shapley-world, the institutional
structure is such that the two would not jointly negotiate with
licensees); see also COPFF ] 742. Even more particularly, Professor
Gans questions Professor Marx's rationale for her joint negotiation
assumption, viz., the' overlapping ownership interests of record
companies and music publishers. Gans WRT ] 21.
I find this criticism of Professor Marx's baseline approach to be
appropriate, in that it was not necessary to combine the two
rightsholders in a Shapley analysis. As Professor Watt explained in his
separate criticism, there is no need to collapse the rightsholders into
a single bargaining entity to eliminate holdout power by the respective
rightsholders, because the ``heart and soul'' of the Shapley value
excludes the holdout value that any input supplier could exploit in an
actual bargain. 3/27/17 Tr. 3073 (Watt). More particularly, Professor
Watt explains:
The model . . . allows us to capture a player's necessity [and]
bargaining power, including vetoes, holdouts, everything . . .
that's actually in the market. It allows us to import all of that
into a model that generates a fair reflection upon each player of
what they actually do without any abuse of . . . any power that they
may have.
Id. at 3058-59. He emphasizes that, because the Shapley approach
incorporates all possible ``arrivals'' of input suppliers, it
eliminates from the valuation and allocation exercise the effect of an
essential input supplier holding out every time or arriving
simultaneously with another input supplier (or apparently creating
Cournot Complement inefficiencies). Id. at 3069-70.
However, the foregoing criticism does not pertain to Professor
Marx's second Shapley value model--her ``Alternative'' model--in which
she maintains the two separate rightsholders for musical works and
sound recordings. Marx WDT ] 146, n.153; 3/20/17 Tr. 1871-72 (Marx).
With regard to this Alternative model, Copyright Owners level a more
general criticism of Professor Marx's approach that does pertain to
this model (as well as her Baseline model). They assert, through both
Professors Gans and Watt, that Professor Marx wrongly distorted the
actual market in yet another manner--by assuming the existence of only
one interactive streaming service--rather than the presence of
competing interactive streaming services. Watt WRT ] ] 25, 32 n.19, 17;
Gans WRT ] ] 55-56; see also COPFF ] 755. By this change, they argue,
Professor Marx inflated the Shapley surplus attributable to the
interactive streaming services compared to the actual proportion they
would receive in the market.
According to Professor Gans, this simplified assumption belies the
fact that the market is replete with many substitutable interactive
streaming services, whose competition inter se reduces each service's
bargaining power. The problem, he opines, is that to the extent the
entities being combined are substitutes for one another--such as
alternative music services--then combining them ignores the effects of
competition between them, thereby inflating their combined share of
surplus from the joint enterprise (i.e. their Shapley value). Gans WRT
] 21.
Professor Marx does not deny that she intentionally elevated the
market power of the services by combining them in the model as a single
represent agent. However, as noted supra, she explained that she made
this adjustment to offset the concentrated market power that the
rightsholders possess--separate and apart from any holdout power they
might have (which, as noted by Professor Watt, is addressed by the
Shapley ordering algorithm). Thus, her alteration of market power
apparently was designed to address an issue--market power--that the
Shapley value approach does not address. 3/20/17 Tr.
[[Page 2023]]
1863 (Marx) (``I want a model that represents a fair outcome in the
absence of market power, so I am going to have to be careful about how
I construct the model that I am not putting in market power into the
model.'').
Although at first blush it would seem more appropriate for
Professor Marx to have directly adjusted the copyright holders' market
power by breaking them up into several entities each with less
bargaining power, such an approach would have made Shapley modeling
less tractable (by increasing the number of arrival alternatives in the
algorithm), compared with the practicality of equalizing market power
by inflating the power of the streaming services (by reducing them to a
single representative agent).\341\
---------------------------------------------------------------------------
\341\ For example, in Professor Marx's ``alternative'' Shapley
model, she models four entities, two upstream (musical works holders
and sound recording holders), and two downstream (the representative
single streaming service and a single alternate distribution
outlet). With these four entities, the number of different arrival
orders is 4!, or 24. If Professor Marx instead had broken the
musical works copyright holders and the sound recording copyright
holders respectively into two entities, the number of total entities
would have increased from 4 to 6. The number of arrival orders would
then have increased from 24 to 720.
---------------------------------------------------------------------------
Professor Gans testified that (regardless of how Professor Marx
sought to equalize market power) her approach was erroneous because
Shapley values are meant to incorporate market power asymmetries, not
to eliminate them. Gans WRT ] 31 (noting Shapley values incorporate
market power asymmetries). However, I note that Professor Gans
acknowledged that in an Australian legal proceeding, he too combined
multiple downstream entities into a single entity in his Shapley value
approach in ``comparison'' to two upstream rightsholders. 3/30/17 Tr.
4179 (Gans). Additionally, Professor Watt has authored and published an
article (cited at Gans WDT ] 65, n.36) in which he too ``artificially''
equalized market power between rightsholders and licenses (radio
stations) in the same manner. See R. Watt, Fair Copyright Remuneration:
The Case of Music Radio, 7, 25, 35 (2010) 7 Rev. of Econ. Res. on
Copyright Issues 21, 25, 35 (2010) (``artificially'' modeling the
``demand side of the market as a single unit, rather than individual
radio stations . . . thereby . . . add[ing] (notionally) monopsony
power to the demand side'' to offset the monopoly power of the input
supplier).
In essence, the import of this criticism is actually not about the
faithfulness of Professor Marx's approach to the Shapley Value model.
Rather, the salience of this critique pertains to her decision to
include within her ``fair income/return'' and ``relative contribution''
analysis of Factors B and C an adjustment for market power asymmetry
that seeks to equalize market power as between Copyright Owners and the
streaming services. In this regard, her adjustment is consistent with
testimony by Professor Katz, who cautioned that the Shapley value
approach takes the parties' market power as a given, locking-in
whatever disparities exist. 4/15/15 Tr. 4992-93 (Katz).
I agree with Professor Watt and find that the Shapley value
approach inherently eliminates the ``hold-out'' problem that would
otherwise cause a rate to be unreasonable, in that it would fail to
reflect effective (or workable) competition. However, Professor Marx's
Shapley value approach attempts to eliminate a separate factor--market
power--that she asserts renders a market-based Shapley approach
incompatible with the objectives of Factors Band C of section
801(b)(1). Strictly speaking, this issue does not raise the question of
which approach is more consistent with the traditional Shapley value
approach, but rather, as Professor Marx noted, whether the modeler
should equalize market power in this particular context in order to
satisfy these two statutory objectives. See also 3/27/17 Tr. 3126-27
(Watt) (indicating that a market rate ``might reflect'' both existing
market power and ``abuse of monopoly power,'' the latter in the form of
``hold-out'' behavior, but the Shapley Value approach will eliminate
the ``abuse of monopoly power.'').\342\
---------------------------------------------------------------------------
\342\ At the hearing, Professor Watt was confronted on cross-
examination with his published article stating that the Shapley
value eliminates ``market power.'' As the foregoing analysis
indicates, though, the Shapley value incorporates whatever market
power exists (unless otherwise adjusted). Professor Watt testified
that his language in this regard was ``poorly worded'' and that he
intended to state that the Shapley value eliminates the ``abuse of
market power,'' by which he meant the ability of ``must have''
suppliers to ``hold out'' and refuse (or threaten to refuse) to
negotiate. 3/27/17 Tr. 3131-33, 3148 (Watt). The Judges find,
considering the totality of Professor Watt's testimony and writings,
that he indeed intended to refer to ``abuse of market power'' in his
prior writing. This seems clear because he has consistently
expressed the opinion that the Shapley value does prevent the
exploitation of complementary oligopoly (must have/hold out) power,
through its inclusion of all ``arrival orderings'' in its algorithm.
However, his writings (like Professor Gans's prior work with which
he was confronted on cross-examination) demonstrate that the Shapley
value approach may be applied by adjusting the number of licensors
or licensees to change any existing market power disparities. This
is fully consistent with Professor Marx's testimony that the extent
of market power remains a choice for the Shapley modeler, and
Professor Katz's testimony that a Shapley value that makes no such
adjustment simply takes as given any disparity in market power that
actually exists.
---------------------------------------------------------------------------
In the present case, the issue of market power, as it relates to
the fairness of the rates and their reflection of the parties' relative
roles and contributions, pertains in large measure to the power of the
rightsholders derived from their status as collectives. As noted supra,
music publishing is highly concentrated among a few large publishers.
(As also noted supra, the major record companies likewise control
significant percentages of the market.) These large entities provide
the efficiencies of a collective, performing the salutary service of
minimizing licensing transaction costs. However, a by-product of
collectives is the concentration of pricing power. This is why, for
example, the performing rights societies, ASCAP and BMI, operate under
consent decrees that limit their receipt of royalty rates reflective of
their market power. See R. Epstein, Antitrust Consent Decrees at
31(2007) (noting that a collective representing numerous musical works
can be understood as ``all potential competitors in the market banded
together . . . who will sell their goods--at above-competitive
prices.'').
Professor Marx's adjustment for market power, like Professor Watt's
adjustment as noted in his article (and like Professor Gans's
adjustment in his Shapley approach in the aforementioned Australian
proceeding), ameliorates this collective pricing power. In that sense,
the adjustment renders the Shapley value more representative of
``fairness'' and ``relative contributions.'' In the process, the baby
is not thrown out with the bathwater, so to speak, because the lower
transaction costs achieved by the collectives are inputs in the Shapley
model, thereby enlarging the surplus available for sharing among all
input suppliers. (That is, if the songwriters were disaggregated
(``uncollectivized'') and required to bargain separately with each
interactive streaming service, transaction costs would be higher, if
not disabling.)
Professor Marx's adjustment thus mitigates the collective market
power of music publishers, yet retains the lower transaction costs
incurred by rightsholders. In this approach, I detect a clear and
modern echo of the ``public utility'' rate regulation history that was
the foundation for Factors B and C of section 801(b)(1). The goal of
such rate regulation has been to maintain the efficient cost structure
of the utility (i.e., its low average costs), while ameliorating the
ability of sellers to use their concentrated market power to earn
[[Page 2024]]
supranormal profits. See Decker, supra, (public utility rate of return
regulation is intended to allow the regulated entity to recover its
costs and a ``fair rate of return''). Professor Marx's market power
adjustment provides a form of market power mitigation, while still
incorporating the higher surplus emanating from the more efficient cost
structure of collectivized licenses.\343\
---------------------------------------------------------------------------
\343\ To be clear, although I find such a market power
adjustment a relevant consideration in a section 801(b)(1) Factor B
and C analysis, it is not a consideration when determining only a
rate that reflects ``effective competition.'' An effectively
competitive rate need not adjust for such market power, because such
a rate (as also set under the willing buyer/willing seller standard
of 17 U.S.C. 14(f)(2)(B)) does not include consideration of these
two factors or their public utility style legislative history
antecedents. Alternately stated, the Shapley value approach, without
any adjustments for market power, eliminates only the complementary
oligopoly (``must have'') effect, through its use of all ``arrival
orderings,'' indicating the outcome of an effectively competitive
market, but does not necessarily address the Factor B and C
objectives.
---------------------------------------------------------------------------
iv. Application of Professor Marx's Shapley Value Analysis in this
Proceeding
Consideration of whether to apply Professor Marx's Shapley value
model requires the placement of her modeling in the proper context of
other evidence in this proceeding. More particularly, her Shapley value
methodology must be compared with the process that led to the creation
of the 2012 rate structure. This comparison demonstrates that the
Judges should not make any adjustment to the reasonable rates they have
determined in this proceeding through an application of the Shapley
value analyses.\344\
---------------------------------------------------------------------------
\344\ Professor Marx estimated a Shapley-derived rate of
[REDACTED]% to [REDACTED]%. Marx WDT ] 163 & App. B. This rate range
brackets the ``headline'' 10.5% rate in the 2012 benchmark but is
[REDACTED] pursuant to the 2012 benchmark structure. However, I note
that Professor Marx testified that the mechanical rate she derived
in her Alternate Shapley approach was not intended to be precise,
but rather indicative of a range and direction for the Judges to
consider. 4/7/17 Tr. 5576 (Marx) (the Factor B and C Shapley Value
analysis points in the ``direction'' of rates ``moving slightly
lower'' within the existing rate structure).
---------------------------------------------------------------------------
The 2012 rate structure (for subparts B and C) was the product of
an industrywide negotiation, with the music publishers represented by
the NMPA and the interactive streaming services represented by DiMA,
their respective trade associations, continuing the 2008 industrywide
settlement rate structure for subpart B. (Although individual entities
also participated, the settlement was industrywide.) When such a
settlement occurs, it contains the same benefits with regard to the
avoidance of the ``hold-out'' effect and the equalizing of bargaining
power as produced by Professor Marx's Shapley value modeling. See 3/13/
17 Tr. 577 (Katz) (``I think of the shadow as balancing the bargaining
power between the two parties.''); Katz CWRT 136, n.236 (``there are
market forces that promote the achievement of the statutory objectives
in private agreements, such as the 2012 Settlement, when the parties
are equally matched (it was an industry-wide negotiation) and the
negotiations are conducted in the shadow of a pending rate-setting
proceeding that can be expected to set reasonable rates in the event
that the private parties do not reach agreement.''). Accordingly, any
attempt by me to use Professor Marx's Shapley modeling approach, after
I have accepted the appropriateness of the present rate structure and
rates as benchmarks, would constitute an inappropriate form of double-
counting.
The Judges came to a similar analytical conclusion with regard to
analogous private agreements in Web III (on remand), where they adopted
as benchmarks two settlements between SoundExchange (as the negotiating
and settling agent for the record company licensors), and respectively,
the National Association of Broadcasters (NAB) and Sirius XM.
Determination of Royalty Rates for Digital Performance Right in Sound
Recordings and Ephemeral Recordings, 79 FR 23102 (Apr. 25, 2014). There
(although Shapley values were not in evidence), the Judges found that
SoundExchange, as a collective, would internalize the impact of
the complementary nature of the repertoires on industry revenue and
thus seek to maximize that overall revenue. This would result in
lower overall rates compared to the situation in which the
individual record companies negotiated separately. . . .
The . . . power of SoundExchange was compromised by the fact
that the NAB . . . could have chosen instead to be subject to the
rates to be set by the Judges . . . which would be free of any
potential cartel effects--rather than voluntarily agree to pay
above-market rates.
Id. at 23114 (emphasis added). In those settlements, the licensees
likely were represented by, respectively, a trade association (NAB),
and the entire licensee-side of the relevant market (Sirius XM). Thus,
the Judges have previously acknowledged a similar removal of the
``abuse of market power'' (arising from complementarity) as in a
Shapley value analysis, when the licensors are jointly represented in
negotiations by a common agent.
Further, because the 2012 settlement was industrywide, with both
sides represented by (inter alia) their respective trade associations;
there was no apparent imbalance of market power in the negotiating
process (such as the imbalance that Professor Marx attempted to
eliminate by equalizing the number of Shapley-participants on each side
of the bargain). In this regard, in Web III (on remand), the Judges
also found that these settlement agreements--with the ``shadow'' of a
statutory license looming over the negotiations--avoided the same
market power imbalance that Professor Marx seeks to eliminate in her
Shapley modeling equalizing the number of licensors and interactive
streaming services. Specifically, in Web III (on remand), the Judges
held:
[T]he NAB, which negotiated on behalf of a group of
broadcasters, enjoyed a degree of bargaining power on the buyers'
side during its negotiations with SoundExchange. . . . . [S]uch
added market power on the buyer side tends to mitigate, if not fully
offset, additional leverage that SoundExchange might bring to the
negotiations. . . . The question of competition is not confined to
an examination of the seller's side of the market alone. Rather, it
is concerned with whether market prices can be unduly influenced by
sellers' power or buyers' power in the market.
Id. Thus, the Judges have previously recognized that a negotiated
agreement between industrywide representatives--when a failure to agree
will trigger a statutory rate proceeding--will: (1) ameliorate the
complementary oligopolists' ``abuse of power'' arising from the threat
to withhold a ``must have'' license; and (2) reflect countervailing
licensee power that neutralizes the monopoly power of a licensor-
collective.
Web III, as a prior determination by this body, thus underscores
the redundancy of a Shapley value adjustment in such a context.\345\
\346\ Further, absent any valid reason to the contrary, the Judges have
a statutory
[[Page 2025]]
duty to act in accordance with their prior determinations. 17 U.S.C.
803(a)(1).\347\
---------------------------------------------------------------------------
\345\ Of course, the parties in the present proceeding could not
know in advance that the Judges would determine a rate structure
incorporating these principles, and their Shapley analyses thus were
proffered given that uncertainty.
\346\ Professors Watt and Gans also criticize Professor Marx's
selection of data as inputs in her Shapley model. In fact, Professor
Gans testified that his re-working of Professor Marx's model through
the use of different data alone accounted for the bulk of his
increase (``the lion's share'') of the surplus attributable to
rights holders. However, in his written testimony, he did not
separately quantify the impact of Professor Marx's attempts to
equalize market power by reducing the number of streaming services.
3/30/17 Tr. 4057, 4119 (Gans). Because I find that Professor Marx's
Shapley value model would be redundant given the rate structure
analysis undertaken, for the reasons stated in the text, supra,
these data input disputes are moot. Of course, if one were to apply
the Shapley values in this proceeding (as the majority does), each
party's criticisms of the sufficiency of the other's data sets would
need to be carefully scrutinized.
\347\ If the Judges had considered the impact of the Shapley
value analyses in the context of setting a reasonable rate--rather
than as a separate consideration under Factors B and C--they would
have reached the same result, given the countervailing power that
exists between the settling parties.
---------------------------------------------------------------------------
c. Professor Gans's ``Shapley-Inspired Approach''
On behalf of Copyright Owners, Professor Gans presented a model
that he described as ``inspired'' by the Shapley value approach, and
thus not per se a Shapley value approach. 3/30/17 Tr. 4109 (Gans). At a
high level, his Shapley-inspired approach attempted to determine the
ratio of sound recording royalties to musical works royalties that
would prevail in an unconstrained market. After calculating that ratio,
he estimated what publisher mechanical royalty rates would be in a
market without compulsory licensing by multiplying the benchmark sound
recording rates by this ratio. Gans WDT ] 63.
Professor Gans begins his analysis by making two critical
assumptions: (1) publishers and record companies must have equal
Shapley values (i.e., they must each recover from total surplus equal
profits), because musical compositions and sound recording performances
are perfect complements and essential components of the streamed
performance; and (2) the label profits from interactive streaming
services are used as benchmark Shapley values. Gans WDT ] 77. The
royalties that result will differ, given the different level of costs
incurred by music publishers and record companies respectively. Gans
WDT ] ] 23, 71, 74, 76; Gans WRT ] ] 15-17; see also 3/30/17 Tr. 3989
(Gans).
Echoing Dr. Eisenach, Professor Gans found these assumptions
critical because agreements between record companies and interactive
streaming services are freely negotiated, i.e., they are not set by any
regulatory body or formally subject to an ongoing judicial consent
decree and, accordingly, are also not subject to any regulatory or
judicial ``shadow'' that arguably might be cast from such governmental
regulation in the market. Professor Gans therefore uses the profits
arising from these unregulated market transactions to estimate what the
mechanical rate for publishers would be if they too were also able to
freely negotiate the rates for the licensing of their works. Gans WDT ]
75.
In light of his decision to assume this equality in upstream
Shapley values, Professor Gans also coined the phrase ``top-down''
approach to describe his approach, as distinguished from Professor
Marx's approach which--again coining a phrase--he labeled a '``bottom-
up'' approach. Gans WDT ] 77. Moreover, as Professor Gans noted, an
important distinction between the two approaches is that the bottom-up
approach was ``really an exercise . . . in modeling the royalty rate as
the result of a hypothetical bargain [whereas] [t]he top-down approach
was to actually calculate this [b]enchmark I was worried about. Is this
price [i.e., the Copyright Owner's proposed rate] too high or not?'' 3/
30/17 Tr. 4013-14 (Gans).
Professor Gans utilized data from projections in a Goldman Sachs
analysis to identify the aggregate profits of the record companies and
the music publishers, respectively. 3/30/17 Tr. 4017 (Gans). Given his
assumption that sound recordings and musical works were both
``essential'' inputs and thus able to claim an equal share of the
profits, Professor Gans posed the question: ``[H]ow much revenue do we
need to hand to the publishers so that they end up earning the same
profits as the labels?'' Id. at 4018.
He found that, for the music publishers to recover their costs and
achieve profits commensurate with those of the record companies under
his ``top down'' approach, the ratio of sound recording royalties to
musical works royalties derived from his Shapley-inspired analysis was
2.5:1. (which attributes equal profits to both classes of rights
holders and acknowledges the higher costs incurred by record companies
compared to music publishers). Gans WDT ] 77, Table 3.
As noted, Professor Gans made a key assumption, treating as
accurate Dr. Eisenach's calculation of an effective per play rate for
sound recordings of $[REDACTED]. Given those two inputs (the 2.5:1
ratio and the $[REDACTED] per play rate), Professor Gans's approach
indicated a market-derived musical works royalty rate of $[REDACTED]
(rounded). Id. ] 78, Table 3. However, because the musical works
royalty is comprised of the mechanical rate and the performance rate
paid to PROs (not to publishers), this $[REDACTED] rate needed to be
adjusted down. Accordingly, he subtracted the performance rate and
determined that the percent of revenues attributable to mechanical
royalties was 81% of the total musical works royalties, under his
Shapley-inspired approach. Thus, he estimated a mechanical royalty rate
of $[REDACTED] (rounded) (i.e., [REDACTED] x [REDACTED]), Gans WDT ]
78, confirming, in his opinion, the reasonableness of Copyright Owners'
proposed $0.0015 statutory per play rate.
On this basis, Professor Gans also concluded that his Shapley-
inspired approach supports the Copyright Owners' per-user rate
proposal. Applying the Shapley value based ratio of 2.5 to 1 to the
benchmark per-user rate negotiated by the labels of %[REDACTED] per
user per month, and after subtracting the value of the performance
rights royalty, Professor Gans obtained an equivalent publisher
mechanical rate of $[REDACTED] (rounded) per user per month. (i.e.,
([REDACTED]/2.5) x 80%).\348\ Gans WDT ] 85.
---------------------------------------------------------------------------
\348\ Professor Gans multiplies the per play rate by 81% but the
per user rate by 80%. Compare Gans WDT ] 78 with Gans WDT ] 85. The
rate derived by Professor Gans was the 80% figure. Gans WDT ] 77,
Table 3, line 17. This discrepancy does not impact the relevance of
his analysis or my findings.
---------------------------------------------------------------------------
i. Services' Criticisms and Dissent's Analysis of Professor Gans's
Approach
I do not credit Professor Gans's Shapley-inspired model, because of
its assumption and use of the $[REDACTED] per play sound recording
interactive rate. As found supra, Dr. Eisenach's $[REDACTED] per play
sound recording rate is not supported by the weight of the evidence.
Therefore, Professor Gans's Shapley-inspired analysis is unpersuasive
for that reason alone. More particularly, the record company profits
are inflated by the inefficient rates created through the Cournot
Complements ``hold out'' problem that impacts the agreements between
record companies and streaming services, as noted by the Services'
experts in this proceeding, and as the Judges noted in Web IV.
Professor Gans's model is also troubling because it begs two broad
questions: (1) whether the model produces a ``reasonable'' rate as
required by Sec. 801(b)(1); and (2) whether the model produces a rate
that also adequately satisfies Factors B and C of section 801(b)(1). He
testified as follows as to why he understands a Shapley-based
methodology generally will provide an economic approach that satisfies
the objectives of section 801(b)(1):
[O]ne of the reasons why the Shapley analysis is useful is
because these regulations have a fairness objective. I wasn't the
only one--every economist I think you've asked about what they meant
by fairness. It's--it's not a topic that is sitting in an economic
[[Page 2026]]
textbook somewhere. But the way in which, you know, I viewed it
turned out to be similar to others in that it means that if you
contribute something of economic value that is very similar to what
somebody else does in terms of economic value, you should be
expecting them to get the same out of it in terms of what they get
to take home.
Tr. 3/30/17 3991 (Gans). Thus, if (as Dr. Eisenach opines), there is an
identity between a market rate and a reasonable (effectively
competitive) rate that takes into account Factors B and C of section
801(b)(1), then Professor Gans's Shapley-inspired analysis would be
useful (absent any other defects). Conversely, if there is no identity
between a purely market-based rate and a reasonable (effectively
competitive) rate that explicitly takes into account Factors B and C,
then Professor Gans's model is not helpful in applying those statutory
factors.
I find that Professor Gans's model fails to incorporate
sufficiently the reasonableness requirements and the ``fairness'' and
``relative roles'' elements of section 801(b)(1). As explained supra,
the concept of a ``reasonable'' rate reflects a market rate that is not
distorted by a lack of effective competition. Here again, a key
assumption made by Professor Gans, by his own admission, is that the
$[REDACTED] per play rate estimated by Dr. Eisenach satisfies the
statutory requirement of reasonableness. But, as discussed supra, Dr.
Eisenach's calculation of the $[REDACTED] per play rate sound recording
rate reflects the unregulated ``must have'' hold out power of the
record companies. Thus, Professor Gans's Shapley-inspired approach has
imported the record companies' ``must have'' hold out power, and
therefore inserted the ``abuse of power'' that Professor Watt rightly
identified as necessarily excluded from a full-fledged Shapley value
approach. Although Professor Gans chose to describe his approach by
coining the phrases ``Shapley-inspired'' and a ```top-down' Shapley,''
I find his borrowing of the Shapley moniker in this context to be
somewhat Orwellian, and find his approach to be too dissimilar from a
full-fledged Shapley approach to be of assistance in establishing a
reasonable (effectively competitive) rate. See 3/30/17 Tr. 4107-09
(Gans) (acknowledging that the top down/bottom up dichotomy is of his
own making and that the original work by Dr. Shapley ``is closer to a
bottom-up approach'').
Professor Gans's Shapley-inspired approach also does not attempt to
eliminate any other market power that may be possessed by the music
publishers. As explained supra with regard to Professor Marx's model
and the critiques thereto, a model that does not address the market
power asymmetries of the parties (as Professor Gans expressly
acknowledges his model does not) thus fails to address the concepts of
fairness and relative roles/contributions required by Factors B and C.
Thus, while Professor Marx's analysis is redundant of the market power
adjustments reflected in the 2012 settlement, Professor Gans's Shapley-
inspired approach omits such adjustments.
I also agree with Professor Marx's further criticism that Professor
Gans's Shapley-inspired model is lacking in certain other important
respects. Perhaps most importantly, he intentionally omits the
streaming services from his model, because he is interested only in
equating Copyright Owners' profits with those of the record companies.
Professor Gans did not provide any convincing evidence to explain why
the Judges should rely on a model that omits from consideration the
very licensees who would be paying the royalties pursuant to a rate the
model is intended to confirm. (I understand this omission by Professor
Gans to be one reason why he described his model a ``top-down,''
Shapley ``inspired'' approach, as opposed to a full-fledged Shapley
value model.). Consequently, Professor Gans's results provide for the
streaming services to pay total royalties (sound recording and musical
works) greater than their total revenue, leading to losses despite
their undisputed contribution to the total surplus available for
distribution. Marx WRT ] 184 (Professor Gans's Shapley-inspired
calculation of a per-play musical works royalty rate of $0.0031,
combined with the existing sound recording royalty rate, would cause
Spotify to pay [REDACTED]% of its revenue in royalties).
Professor Gans apparently explains away these losses by the fact
that the Services have been engaging in below market pricing to
increase market share and such pricing shows up in their lower
revenues. I address that issue elsewhere in this Determination.
However, to the extent Professor Gans is correct in this regard, it
shows the limits of a Shapley-inspired approach that, by definition,
treats accounting costs and revenue inputs as relevant parameters.
Further in that regard, it is important to note ``[t]hat the main
problem with the Shapley approach . . . a particularly pressing problem
[is] that of data availability.'' R. Watt, Fair Copyright Remuneration:
The Case of Music Radio, 7 Rev. Econ. Rsch Copyright. Issues at 21, 27
(2010).\349\
---------------------------------------------------------------------------
\349\ Because I do not apply the Shapley approaches to adjust
the rates or to determine reasonableness, the parties' attacks on
the usefulness of the other's data sets are moot. However, as noted
supra, to the extent the Majority Opinion applies any of the Shapley
approaches, it needed to address and resolve the issues of data
reliability.
---------------------------------------------------------------------------
Finally, one of the assumptions behind Professor Gans's approach is
that musical works are as indispensable as sound recordings for
purposes of a Shapley value approach. However, that assumption is
subject to challenge. More particularly, I find merit in a further
critique made by Dr. Leonard. He questioned the underlying assumption
that musical works are ``essential inputs,'' or ``must haves,'' in the
same way in which sound recordings are essential inputs/''must haves.''
As he explained, at the time a recording artist and a record
company decide upon which song to record, they have numerous songs from
which to choose. No one song therefore is essential at the time in
which the recording artist and the record company must select the song.
(The essentiality of the song may exist, as Copyright Owners note, in
those instances when the songwriter himself or herself is of sufficient
acclaim and notoriety.). It is only after a song has been incorporated
into a recording that it has become essential. As Dr. Leonard notes,
this point is analogous to the problem of ``hold up'' in the setting of
royalties for patented inputs within a larger complex device. At an
early stage of production, the device manufacturer has the opportunity
to select among several competing patented inputs, but once one of them
is selected, its uniqueness allows the owner of the input to demand a
disproportionate share of the revenue in royalties, because, ex post
selection, it has become ``essential.'' However, ex ante selection, it
was not ``essential.'' Thus, the existing spread between musical works
royalties and sound recording royalties, according to Dr. Leonard, may
reflect this phenomenon, rather than simply an artificial regulatory
diminution in the mechanical royalty rate. 4/5/17 Tr. 5185-87
(Leonard).
d. Professor Watt's Shapley Approach and the ``See-Saw'' Effect
As noted supra, Professor Watt appeared solely as a rebuttal
witness. In that capacity, he testified as to purported defects in
Professor Marx's Shapley modeling. In addition, he presented
alternative modeling intended
[[Page 2027]]
to apply an adjusted version of Professor Marx's Shapley value model.
Professor Watt agreed that the Shapley model is extremely well-
suited to address Factors B and C within section 801(b)(1). 3/27/17 Tr.
3057 (Watt). He characterizes the Shapley model as an approach ``for
analyzing complex strategic behavior in a very simple way.'' Id. at
3058. However, he found that Professor Marx's approaches contained
several flaws and methodological issues. Id. at 3057. Accordingly, he,
like Professor Gans, attempted to adjust her modeling in a manner that,
in his opinion, generated ``decent, believable results.'' Id. at 3058.
Professor Watt criticized Professor Marx's alternative Shapley
model, in which she treated sound recording and musical works as being
owned by two distinct entities. 3/20/17 Tr. 1885 (Marx). In that
alternative model, Professor Marx found that Spotify's total royalties
for musical works and sound recordings combined would range from
{REDACTED]% to [REDACTED]% of total royalties. Id.\350\ That total
indicated a payment of approximately [REDACTED]% to [REDACTED]% of
total revenue for sound recording royalties. Although she understood
that Spotify actually pays [REDACTED]% of its revenue in total for
these royalties (see id. at 1860-61), she was not concerned by the
difference, or by the reduction of royalties paid to record companies
under her alternative Shapley model, because she ``wasn't trying to
construct a model of the market as it is,'' but rather . . . a model
that represents the allocation of surplus in a way that is fair and
respects the relative contributions of the parties''. Id. at 188.
---------------------------------------------------------------------------
\350\ Under her baseline Shapley value model, Professor Marx
estimated combined royalty payments equaling [REDACTED]% to
[REDACTED]% of total Spotify revenue. Id. at 1888. She could not
break that range down into musical works and sound recording
royalties because her baseline model treated both types of royalties
as if they were paid to a single rightsholder.
---------------------------------------------------------------------------
In his Shapley modeling adjusting Professor Marx's analysis,
Professor Watt reached conclusions that were broadly consistent with
her finding that the ratio of sound recording:musical works royalty
rates should decline. Specifically, Professor Watt found that at least
[REDACTED]% of interactive streaming revenue should be allocated to the
rightsholders, and, of this [REDACTED] should be retained by the
Musical Works copyright holders, which equals [REDACTED]% (i.e.,
[REDACTED]) of total interactive streaming revenue. As these
calculations imply, the record companies would receive [REDACTED]%
([REDACTED]) of the [REDACTED]% of interactive streaming revenues
allocated to the rightsholders. Thus, the record companies would
receive [REDACTED]% of total interactive streaming revenues
([REDACTED]). Watt WRT ] 35; 3/27/17 Tr. 3083, 3115-16 (Watt).\351\
---------------------------------------------------------------------------
\351\ At present, record companies receive approximately 55% to
60% of total interactive streaming revenue, substantially higher
than the 37.9% calculated by Professor Watt.
---------------------------------------------------------------------------
Professor Watt's ratio of 37.9%:29.1% equals 1.3:1, whereas
Professor Marx's ratio (given the range she estimated) is [REDACTED], a
ratio of [REDACTED]. Moreover, both of their ratios are well below the
current ratio of approximately [REDACTED] for Spotify, and
approximately [REDACTED] comparing the 10.5% headline rate to an
average sound recording rate of approximately [REDACTED]% of revenue.
Accordingly, under their Shapley value models, Professors Watt and Marx
appear to be in general agreement that the ratio of sound
recording:musical works royalties should decline. However, Professor
Watt's model indicates that this ratio reduction should occur via a
significant increase in musical works royalties and an even greater
precipitous decline in the sound recording royalties set in an
unregulated market. On the other hand, Professor Marx's model indicates
that the ratio should narrow essentially through a dramatic reduction
in sound recording royalties and an essentially stable musical works
rate.
Professor Watt explains that the cause of the dramatically lower
sound recording rates in his Shapley model is the existing regulation
of musical works rates. Specifically, he opines:
[The reason] my predicted fraction of revenues for sound
recording royalties is significantly less than what is observed in
the market [is] simple. The statutory rate for mechanical royalties
in the United States is significantly below the predicted fair rate,
and the statutory rate effectively removes the musical works
rightsholders from the bargaining table with the services. Since
this leaves the sound recording rightsholders as the only remaining
essential input, bargaining theory tells us that they will
successfully obtain most of the available surplus.
Watt WRT ] 36.\352\ Professor Watt opines that, because the
mechanical rate should rise, the sound recording rate therefore should
fall--a phenomenon the parties have summarized as a ``see-saw'' effect.
See, e.g., 4/5//17 Tr. 5079-80:10 (Katz).\353\
---------------------------------------------------------------------------
\352\ More specifically, Professor Watt calculates that, for
each dollar that the statutory rate holds down fair market musical
works royalties, 95 cents is captured by the record companies (and 5
cents is captured by the streaming services). Watt WRT ] 23, n.13 &
App. 3.
\353\ Although it is noteworthy that Professor Gans does not
anticipate such an effect, and instead speculates that the Services
might simply pay the same sound recording royalty rate and the
higher mechanical rate out of existing profits or through an
increase in downstream prices. Gans WRT ] 32. The Judges find no
evidence to support the speculation that the Services could engage
in such substantial adjustments in the market.
---------------------------------------------------------------------------
However, no witness explained how this seesaw effect would occur,
and there were no witnesses from the record companies who testified
that the record companies would impotently acquiesce to a significant
loss in royalties to accommodate the diversion of a huge economic
surplus away from them and to the Copyright Owners.\354\ Indeed, when
the Judges inquired of Professor Watt how such an adjustment might
occur, given existing contractual rates between the Services and record
companies, he acknowledged that he had not thought of that problem
until he was questioned by the Judges at the hearing, and he
acknowledged that the timing of any adjustment might be disruptive. 3/
27/17 Tr. 3091-92 (Watt).\355\
---------------------------------------------------------------------------
\354\ According to the RIAA, interactive streaming revenues for
2015 totaled $1.604 billion. See Marx WDT ] 153 & App. B.1.b (citing
RIAA figures). The assumption that the see-saw effect would induce
record companies to surrender a significant amount of this revenue
(which has been growing year-over-year as streaming becomes more
popular), absent any evidence, makes the assumption of the see-saw
effect speculative and unreasonable.
\355\ Copyright Owners argue that Professor Watt (as a non-
lawyer) did not appreciate that contracts between record companies
and interactive streaming services could be renegotiated at any time
upon mutual agreement of those parties. See CORPFF-JS at 221-22 (and
citations therein). While this legal point of course is correct, it
does not address the economic uncertainty as to whether the record
companies would be willing to renegotiate rates in a manner by which
they concede a loss of royalty revenue as indicated by Professor
Watt's anticipated see-saw effect.
---------------------------------------------------------------------------
[[Page 2028]]
I am loath to adopt the hypothetically plausible idea of a ``see-
saw'' effect impacting the division of this surplus, when there is
simply no evidence that such an adjustment would occur.\356\ Given at
least $[REDACTED] in interactive streaming revenue, if the record
companies were to passively accept a reduction of royalties from
approximately [REDACTED]% of that revenue, $[REDACTED], to Professor
Watt's proposed 37.9%, i.e., to $[REDACTED], they would lose (assuming
no further growth in streaming) approximately $[REDACTED] annually, or
$[REDACTED] over five years. The Judges cannot merely assume that the
record companies would ``go quietly into that good night,'' rather than
seek some other market structure in which to protect this revenue, such
as, for example, resurrecting the idea of establishing or otherwise
integrating their own streaming services. The Services' experts, and
Apple's expert, testified that any purported see-saw effect was
indeterminate with regard to its impact on the interactive streaming
services. See 4/5/17 Tr. 4944-45 (Katz) (acknowledging the possibility
that a mechanical royalty rate increase would affect sound recording
royalties in the future but not immediately, and that there is no
reliable estimate of the size of any such adjustment); 4/7/17 Tr. 5515-
5516(Marx) ([REDACTED]); 4/5/17 Tr. 5704-05 (Ghose) (``[I]t's quite
likely that the streaming service will want to maintain their royalties
and their revenues at the current levels. And so, you know, to me it
seems like an extreme statement that the entire increase in publisher
profits will come at the expense of the streaming services.'').
---------------------------------------------------------------------------
\356\ As a matter of economic theory, given the present
interactive streaming market structure, the record companies already
have the economic power to put streaming services out of business,
because the market in which record companies and interactive
streaming services negotiate is unregulated. So, I recognize that--
given the present interactive streaming market structure--the record
companies apparently find it in their self-interest to maintain the
presence of interactive licensees. Indeed, the evidence in Web IV
revealed that the record companies' strategy has been to
``[REDACTED].'' Web IV, supra, at 63 (restricted version). However,
if mechanical royalty rates were to increase to a level that
significantly reduced the profits of the record companies from
streaming, there is no evidence in the record in this proceeding
that indicates whether the record companies would decide to maintain
the current vertical structure of the market and docilely accept
such a revenue loss. For example, they could create their own
streaming services (perhaps learning the lessons from the failed
Pressplay and MusicNet attempts of the past). Or, they could
maintain the sound recording royalty rates, thereby hastening a more
immediate exit of streaming services from the market. Although such
an acceleration of exit might be the consequence in an unregulated
market (fostering Schumpeterian competition for the holy grail of
market scale), such a change would not only be inconsistent with
affording the services a fair income, but also would clearly be
disruptive pursuant to Factor D of section 801(b)(1).
---------------------------------------------------------------------------
In any event, from an evidentiary perspective, there is no need to
indulge in such speculation. There is absolutely no evidence that such
a significant shift in royalty distribution would occur, nor is there
sufficient evidence as to the potential consequences of such a
draconian reallocation of revenue.
In sum, my analysis of the Shapley approaches with regard to the
elements of Factors B and C demonstrates (whether that analysis was
undertaken as part of the ``reasonable rate'' analysis or as a separate
``factor'' analysis) that there is no basis to apply those elements to
adjust the reasonable rates as set forth in the 2012 benchmark.
D. Factor D
The last itemized factor of section 801(b)(1), Factor D, directs
the Judges ``to minimize any disruptive impact on the structure of the
industries involved and on generally prevailing industry practices.''
17 U.S.C. 801(b)(1)(D). In Phonorecords I, 74 FR at 4525, the Judges
reiterated their understanding of Factor D, concluding that a rate
would need adjustment under Factor D if that rate
directly produces an adverse impact that is substantial, immediate
and irreversible in the short-run because there is insufficient time
for either [party] to adequately adapt to the changed circumstance
produced by the rate change and, as a consequence, such adverse
impacts threaten the viability of the music delivery service
currently offered to consumers under this license.
Id. I adopt and apply in this Determination the same Factor D test as
set forth above.
The Services are advocating broadly for essentially the same rate
structure that now exists, except for the elimination of the Mechanical
Floor. See SJPFF at 1. My proposed rate structure is consistent with
that position, except that I would maintain the Mechanical Floor. I
would also maintain the existing rates. Because this result would
continue the existing structure and rates, neither the services nor
Copyright Owners can reasonably complain of disruption under the
standard quoted above. Indeed, a continuation of the present rate
structure and rates reflects constancy rather than disruption.
More particularly, the fact that interactive streaming services are
failing to realize an accounting profit under this structure does not
demonstrate that the rate structure proposed would threaten their
viability. As noted supra, such year-over-year accounting losses are
consistent with a long-run competition for the market, during which
losses can be endured as a cost of doing business. Indeed, the services
remain in business despite the existence of chronic losses. In that
regard, a financial expert engaged jointly by the Services testified
that he was ``not aware of a single standalone digital music service
that has sustained profitability to date,'' Testimony of David B.
Pakman ] 23 (Pakman WDT), yet that lack of sustained profitability has
not materially diminished the ranks of interactive streaming services
nor dampened competition from new entrants into the market.
Moreover, the record indicates that the services are not as
concerned with short-term rates as they are with long-term market
share, or what the services call ``scaling,'' in their Schumpeterian
competition for the market. This point was made clearly by [REDACTED]
(emphasis added). Of course, [REDACTED]. Katz CWRT ] 204.
The point is well-recognized by Google as well. See Joyce WDT ] 20
([REDACTED]) (emphasis added). This acknowledgement was echoed by one
of Copyright Owners' economic expert witnesses, who explained that the
services' competitive posture was typical of internet-based entities
that accept short-term losses to build economies of scale through, for
example, investing in customer loyalty. Rysman WDT ] 32.
Moreover, another expert economic witness for the Services, Dr.
Leonard, candidly acknowledged that ``[a]n argument may be made that
the services expect to be profitable eventually, otherwise they would
go out of business and Spotify, for example, would not have positive
market value.'' Leonard AWDT 101, n.153. Likewise, Pandora notes that
it can ``achieve the growth it projects . . . under a continuation of
existing rates and terms . . . .'' Pandora's Introductory Rebuttal
Memorandum at 3 (emphasis added).
This inability of the services to become profitable will persist
based on the record, under existing competitive conditions. As Mr.
Pakman testified: [N]o current music subscription service--including
marquee brands like Pandora, Spotify and Rhapsody--can ever be
profitable, even if they execute perfectly . . . .'' Pakman WDT 23 n.5
(citation omitted). Although Mr. Pakman blames the lack of
profitability (in part) on the level of mechanical royalties, id., I
find, based on the Services' own acknowledgement, that the lack of
profitability is a function of
[[Page 2029]]
a lack of scale (which is another way of indicating that market share
is divided among too many competing interactive streaming services). In
fact, Mr. Pakman himself recognizes the importance of scale to long-run
profitability. Pakman WDT ] 26 n.11 (``Scale is a magic word for so
many cloud-based companies and services. . . . It may be that Spotify
will gain some power over the royalties it pays once it has a critical
mass of customers . . . .''). Pakman WDT ] 26 n.11 (emphasis added).
Given the paramount importance of scaling to the long-term success
of interactive streaming, lowering mechanical royalties in this
proceeding--simply to mitigate or prevent shorter-term losses by
interactive streaming services--would constitute an unwarranted subsidy
to these services at the expense of Copyright Owners.\357\
---------------------------------------------------------------------------
\357\ In this regard, Copyright Owners argue that the services
could attempt to cut their non-content costs in order to remain
sustainable. They suggest that the services emulate Sirius XM, which
successfully reduced its non-content costs as a percent of revenue.
See Rysman WDT ] ] 98-100. However, as Spotify's CFO, Mr. McCarthy
notes, Sirius and XM (the pre-merger predecessors to Sirius XM)
``nearly bankrupted themselves and merged in order to survive.''
McCarthy WRT ] 42. Moreover, not only were Sirius XM's content costs
lower as a percent of revenue, but also its ``costs declined as a
percentage of revenue as they grew their subscriber base. . . . .
Their costs declined as they achieved scale.'' Id. Once again, the
necessity of scale remains paramount.
---------------------------------------------------------------------------
Also, although the services have indicated their ability to
withstand short-term losses as they compete for scale/market share, the
record also indicates that there is a limit to such losses--however
imprecise and unknown--beyond which services will be unable to attract
capital and survive until the long run market d[eacute]nouement. In
this regard, Mr. Joyce noted that, [REDACTED], at some point
[REDACTED]. Joyce WDT ] 18. As Dr. Leonard testified, ``[REDACTED].''
Leonard AWDT ] 101 n.151. This testimony reflects the well-understood
principle that ``[t]here is no specific time period . . . that
separates the short run from the long run.'' R. Pindyck & D. Rubinfeld,
Microeconomics at 190 (6th ed. 2005). Thus, although the services
appear able to withstand current rates, a rate increase of the
magnitude sought by Copyright Owners would run the very real risk of
preventing the services from surviving the ``short-run,'' threatening
the type of disruption Factor D is intended to prevent.\358\
---------------------------------------------------------------------------
\358\ That is, the potentially profitable long-run cost curve,
from scaling, may never be attainable if the interactive streaming
services remain on perpetual loss-inducing short-run cost curves.
---------------------------------------------------------------------------
Moreover, the 44% rate increase adopted by the majority likewise
places the services in quite unchartered waters regarding the
disruptive impact of that increase. The majority actually recognizes
that the increase is so draconian that it cannot be implemented
immediately. See Majority Opinion, supra. Instead, the majority leaches
the increase into the rates year-by-year, as if one can simply assume
that the disruptive impact of such a rate increase is ameliorated in
this manner. Without a record to consider the impact of that rate
increase, the majority may simply be substituting a slow bleed for a
fatal blow.\359\
---------------------------------------------------------------------------
\359\ Of course, it is possible that the majority may be correct
that rolling out this rate increase over five years will ameliorate
its disruptive impact. But it is equally possible that the rate and
structure remain disruptive even when introduced in this extended
manner. The salient point, again, is that the fact this rate
structure and these rates were adopted post-hearing with the absence
of a record to support them makes the analysis too speculative. The
parties deserve an opportunity, and are entitled to one under the
statute, to challenge the rates and rate structure, whether as
inconsistent with Factor D or as inconsistent with any other
requisite set forth in section 801(b)(1).
---------------------------------------------------------------------------
With regard to the Mechanical Floor, I do not find that the
continuation of this element of the existing rate structure would be
disruptive under the applicable standard. As discussed supra, the risks
of fractionalized licenses and publisher withdrawals have receded,
belying any reasonable assertion that such events are on the
``immediate'' horizon. Further, given that musical works royalties are
a fraction of the total royalties paid by interactive streaming
services, the triggering of the Mechanical Floor would be unlikely to
``threaten the viability'' of the interactive market.'' Further,
because the Mechanical Floor was a bargained-for feature of the
benchmark structure on which the Services rely, and because that
provision protects the funds available to provide liquidity to
songwriters in the form of advances, removal of the Mechanical Floor
would more likely disrupt ``prevailing industry practices.'' The
continuation of the Mechanical Floor avoids that disruption.
With regard to the impact on Copyright Owners, I find that the
adoption of a rate structure based on the 2012 benchmark would not be
disruptive under the standard quoted above. The record indicates that
music publishers have been profitable while this standard has been in
effect, and that interactive streaming has contributed to that
profitability. Although that profitability is generated by a
combination of mechanical and performance royalties paid by interactive
streaming services, the fact that those two rights are--without
dispute--perfect complements, means that the profitability of Copyright
Owners must be viewed economically in the context of royalties realized
from both rights (especially given the ``All-In'' aspect of the
mechanical royalty).
Indeed, Copyright Owners' principal complaint is that, although
their mechanical royalty revenue has increased, it has not increased as
fast as the increase in the number of musical works streamed via sound
recordings performed on interactive services. However, as noted, supra,
the record reflects that the increase in streams is itself a function
of the price discriminatory rate structure that incentivizes downstream
services that can move ``down the demand curve'' and offer streaming
services to listeners with a low WTP. 3/13/17 Tr. 701 (Katz). Such a
structure will produce an increase in royalties, even as it may produce
a lower effective royalty per stream but, as Professor Hubbard
explained, that comparison misses the salient economic point. 4/13/17
Tr. 5971-73 (Hubbard).
Further, the current rate structure has allowed for rates to exceed
the 10.5% headline rate. For example, [REDACTED]. Accord, 3/29/17 Tr.
3637 (Israelite (``I don't even think we thought of them as minima. We
thought of them as alternate rates. And we would get the greatest of
three different rates.''). In this regard, the existing ``greater of''
structure incorporates the benefits that the Copyright Board of Canada
identified (as discussed supra) as tilted in favor of rights holders,
although the existing structure, established via settlement,
ameliorates that impact by providing a ``lesser-of'' approach in the
second rate prong.)
In sum, I find no evidentiary basis to support a Factor D
adjustment to the rates I have otherwise proposed in this Dissent.
Because I have rejected Copyright Owners' rate proposal, the
potential disruptive impact of their proposal is moot, given my
decision to consider the ``reasonable'' rate structure and rate issues
before considering the four itemized factor of section 801(b)(1).
However, if I had incorporated this disruption consideration within the
``reasonable rate'' analysis, my finding would be the same, i.e., that
Copyright Owners' rate proposal would be unreasonable because it would
be disruptive under the Factor D standards.
That disruptive effect is captured by the following summary of the
rate changes for the several services if Copyright Owners' proposal
were to be implemented:
[[Page 2030]]
Figure 3--Impact of Copyright Owners' Proposal on Spotify's Royalties
[In thousands except percentages, 2H2015-1H2016]
[REDACTED]
Figure 4--Estimated Impact of the Copyright Owners' Proposal on Other Streaming Services, 2015
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Current Copyright Owner's proposal Impact of Copyright Owners' proposal
--------------------------------------------------------------------------------------------------------------------------------------------------------------
Service name % increase in % increase in musical
Mechanical royalties Musical works royalties Mechanical royalties Musical works royalties mechanical royalties works royalties
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Google........................... [REDACTED]............... [REDACTED]............... [REDACTED]............... [REDACTED].............. [REDACTED].............. [REDACTED]
Amazon Prime..................... [REDACTED]............... [REDACTED]............... [REDACTED]............... [REDACTED].............. [REDACTED].............. [REDACTED]
Rhapsody......................... $7,323,476............... $10,253,216.............. $11,230,793.............. $14,160,533............. 53%..................... 38%
Apple Music...................... [REDACTED]............... [REDACTED]............... [REDACTED]............... [REDACTED].............. [REDACTED].............. [REDACTED]
TIDAL............................ $755,522................. $1,754,546............... $1,600,723............... $2,599,747.............. 112%.................... 48%
Deezer........................... $438,412................. $563,412................. $822,541................. $947,540................ 88%..................... 68%
Other............................ $4,478,824............... $11,255,046.............. $16,709,012.............. $23,485,234............. 273%.................... 109%
Average.......................... $5,277,869............... $8,311,074............... $16,098,189.............. $19,131,394............. 194%.................... 109%
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Marx WRT at 8-9.
These increases are on an order of magnitude that indicates to me that
such increase would clearly implicate the applicable disruption
standard.
The knock-on effects of this proposal would be disruptive under the
applicable standard. Pandora indicates it would have little choice but
to eliminate its limited offering Pandora Plus product. See Herring WRT
] 10. Under Copyright Owners' proposed per user rate, it would pay
[REDACTED] the amount it now pays for both mechanical and performance
royalties, and royalties would be even higher on the other prong--based
on the number of songs played, Herring WRT ] 7, even though the
overwhelming majority of streams on Pandora Plus are noninteractive and
do not implicate the mechanical right. See Herring WRT ] 16. Mr.
Herring further testified that, under Copyright Owners' proposal,
[REDACTED]. Consequently, he notes that Pandora would lack any
resources to invest in its burgeoning interactive streaming service
offerings. Herring WDT ] 58.
[REDACTED]. Marx WRT ] 16 & Fig. 1.
In similar fashion, Google claims that Copyright Owners' rate
proposal would [REDACTED] rates it pays for interactive streaming on
its Google Play Music service. More particularly, if Google had paid
Copyright Owners' proposed rates from June 2013 to June 2016,
[REDACTED], Leonard WRT ] 9. On dollar terms, Google estimates that it
would have paid $[REDACTED] for musical works rights under Copyright
Owners' proposal, compared with [REDACTED] it paid during that period
under existing rates. Id. ] ] 8, 9.
Apple also claims that Copyright Owners' proposal would lead to a
shutdown of one of its services. Specifically, Apple asserts that it
would not continue to offer its purchased content locker service if it
were subject to Copyright Owners' per-user proposal and that Apple
would never offer a paid content locker again if the Copyright Owners'
rates were in place. 3/22/17 Tr. 2526 (Dorn).
Copyright Owners argue that the services could ameliorate any
disruptive impact from these rates by estimating the number of plays
per user, raising rates and/or limiting functionality (e.g., by capping
listening). See Rysman WRT ] 75. However, there is no sufficient
evidence in the record that the services could engage in such
modifications and estimations in order to offset the draconian rate
increases that would result from Copyright Owners' proposal.
Copyright Owners argue that the current status of the interactive
streaming market indicates that neither their proposed rate structure
nor their proposed higher rates would be disruptive pursuant to Factor
D or the Judges' application of that factor. In that regard, Copyright
Owners make three points with regard to ongoing market developments:
1. Ongoing entry of new interactive streaming services indicates
that the market is healthy and expanding;
2. The entry in particular of large entities with comprehensive
product ``ecosysems'' (i.e., Amazon, Apple and Google) specifically
demonstrates the opportunity for profitable interactive streaming;
and
3. [REDACTED].
4/4/17 Tr. 4647-49 (Eisenach).
I find these three points inapposite with regard to the issue of
whether Copyright Owners' proposed rate structure and rate increase
would minimize disruption. Simply put, Copyright Owners' proposed
changes are not yet in existence, so any evidence of changes that have
occurred previously cannot reflect the potential impact of Copyright
Owners' proposals. Of particular note, Copyright Owners' proposal would
eliminate the ``All-In'' feature of the mechanical rate, resulting in
the disruption from ``double-counting'' the value of perfect
complements that the ``All-In'' feature is designed to avoid.
And again, I return to Copyright Owners' endorsement of the
bargaining room theory and their concomitant acknowledgement that they
might well engage in bargaining, by which they would agree to lower
rates to accommodate different services catering to differing listener
segments. That argument at least implicitly acknowledges that Copyright
Owners' ``one-size-fits-all'' rate is a misnomer, and that their
proposal is designed to handle potential disruptive impacts through
negotiation that were not subject to an application of any of the
section 801(b)(1) factors.
In sum, even if I had integrated my disruption analysis into my
reasonable rate analysis (as opposed to treating it separately), I
would have rejected Copyright Owners' rate structure and rate proposal
as inconsistent with Factor D.
I also find that Apple's per play rate structure would be
disruptive,
[[Page 2031]]
essentially for the same reason that Copyright Owners' proposed
structure would be disruptive. For example, Apple's proposed per-play
rate would increase Spotify's royalty payments on its ad-supported
service to [REDACTED]% of revenue, threatening the continuation of that
service--the only one to provide a monetarily free service. See Written
Rebuttal Testimony of Paul Vogel (on behalf of Spotify USA Inc.) ] 48.
In this regard, the senior director of Apple Music, David Dorn,
indicated in colloquy with the Judges, that [REDACTED]. See 3/22/17 Tr.
2538 (Dorn) ([REDACTED]). Of course, the ad-supported Spotify service,
and the [REDACTED], for example, are designed to [REDACTED], so Apple's
proposed rate structure and rates would disincentivize such
distribution channels, impeding the ``future'' listener conversion Mr.
Dorn anticipates. Moreover, such low WTP listeners on an ad-supported
or other free-to-the-listener service generate royalties that would
otherwise not be paid. See Written Rebuttal Testimony of Will Page (On
behalf of Spotify USA Inc.) ] 48 ([REDACTED]); see also 4/7/17 Tr. 5503
(Marx) ([REDACTED]).
4. Conclusion
For the foregoing reasons, I respectfully dissent.
Issue Date: November 5, 2018.
David R. Strickler,
Copyright Royalty Judge.
List of Subjects in 37 CFR Part 385
Copyright, Phonorecords, Recordings.
Final Regulations
0
For the reasons set forth in the preamble, the Copyright Royalty Judges
revise 37 CFR part 385 to read as follows.
PART 385--RATES AND TERMS FOR USE OF NONDRAMATIC MUSICAL WORKS IN
THE MAKING AND DISTRIBUTING OF PHYSICAL AND DIGITAL PHONORECORDS
Subpart A--Regulations of General Application
Sec.
385.1 General.
385.2 Definitions.
385.3 Late payments.
385.4 Recordkeeping for promotional or free trial non-royalty-
bearing uses.
Subpart B--Physical Phonorecord Deliveries, Permanent Digital
Downloads, Ringtones, and Music Bundles
385.10 Scope.
385.11 Royalty rates.
Subpart C--Interactive Streaming, Limited Downloads, Limited Offerings,
Mixed Service Bundles, Bundled Subscription Offerings, Locker Services,
and Other Delivery Configurations
385.20 Scope.
385.21 Royalty rates and calculations.
385.22 Royalty floors for specific types of offerings.
Subpart D--Promotional and Free-to-the-User Offerings
385.30 Scope.
385.31 Royalty rates.
Authority: 17 U.S.C. 115, 801(b)(1), 804(b)(4).
PART 385--RATES AND TERMS FOR USE OF NONDRAMATIC MUSICAL WORKS IN
THE MAKING AND DISTRIBUTING OF PHYSICAL AND DIGITAL PHONORECORDS
Subpart A--Regulations of General Application
Sec. 385.1 General.
(a) Scope. This part establishes rates and terms of royalty
payments for the use of nondramatic musical works in making and
distributing of physical and digital phonorecords in accordance with
the provisions of 17 U.S.C. 115. This subpart contains regulations of
general application to the making and distributing of phonorecords
subject to the section 115 license.
(b) Legal compliance. Licensees relying on the compulsory license
detailed in 17 U.S.C. 115 shall comply with the requirements of that
section, the rates and terms of this part, and any other applicable
regulations. This part describes rates and terms for the compulsory
license only.
(c) Interpretation. This part is intended only to set rates and
terms for situations in which the exclusive rights of a Copyright Owner
are implicated and a compulsory license pursuant to 17 U.S.C. 115 is
obtained. Neither the part nor the act of obtaining a license under 17
U.S.C. 115 is intended to express or imply any conclusion as to the
circumstances in which a user must obtain a compulsory license pursuant
to 17 U.S.C. 115.
(d) Relationship to voluntary agreements. The rates and terms of
any license agreements entered into by Copyright Owners and Licensees
relating to use of musical works within the scope of those license
agreements shall apply in lieu of the rates and terms of this part.
Sec. 385.2 Definitions.
Accounting Period means the monthly period specified in 17 U.S.C.
115(c)(5) and any related regulations.
Affiliate means an entity controlling, controlled by, or under
common control with another entity, except that an affiliate of a
record company shall not include a Copyright Owner to the extent it is
engaging in business as to musical works.
Bundled Subscription Offering means a Subscription Offering
providing Licensed Activity consisting of Streams or Limited Downloads
that is made available to End Users with one or more other products or
services (including products or services subject to other subparts) as
part of a single transaction without pricing for the subscription
service providing Licensed Activity separate from the product(s) or
service(s) with which it is made available (e.g., a case in which a
user can buy a portable device and one-year access to a subscription
service providing Licensed Activity for a single price),
Copyright Owner(s) are nondramatic musical works copyright owners
who are entitled to royalty payments made under this part pursuant to
the compulsory license under 17 U.S.C. 115.
Digital Phonorecord Delivery or DPD has the same meaning as in 17
U.S.C. 115(d).
End User means each unique person that:
(1) Pays a subscription fee for an Offering during the relevant
Accounting Period; or
(2) Makes at least one Play during the relevant Accounting Period.
Family Plan means a discounted subscription to be shared by two or
more family members for a single subscription price.
Free Trial Offering means a subscription to a Service's
transmissions of sound recordings embodying musical works when:
(1) Neither the Service, the Record Company, the Copyright Owner,
nor any person or entity acting on behalf of or in lieu of any of them
receives any monetary consideration for the Offering;
(2) The free usage does not exceed 30 consecutive days per
subscriber per two-year period;
(3) In connection with the Offering, the Service is operating with
appropriate musical license authority and complies with the
recordkeeping requirements in Sec. 385.4;
(4) Upon receipt by the Service of written notice from the
Copyright Owner or its agent stating in good faith that the Service is
in a material manner operating without appropriate license authority
from the Copyright Owner under 17 U.S.C. 115, the Service shall within
5 business days cease
[[Page 2032]]
transmission of the sound recording embodying that musical work and
withdraw it from the repertoire available as part of a Free Trial
Offering;
(5) The Free Trial Offering is made available to the End User free
of any charge; and
(6) The Service offers the End User periodically during the free
usage an opportunity to subscribe to a non-free Offering of the
Service.
GAAP means U.S. Generally Accepted Accounting Principles in effect
at the relevant time, except that if the U.S. Securities and Exchange
Commission permits or requires entities with securities that are
publicly traded in the U.S. to employ International Financial Reporting
Standards in lieu of Generally Accepted Accounting Principles, then
that entity may employ International Financial Reporting Standards as
``GAAP'' for purposes of this subpart.
Interactive Stream means a Stream, where the performance of the
sound recording by means of the Stream is not exempt from the sound
recording performance royalty under 17 U.S.C. 114(d)(1) and does not in
itself, or as a result of a program in which it is included, qualify
for statutory licensing under 17 U.S.C. 114(d)(2).
Licensee means any entity availing itself of the compulsory license
under 17 U.S.C. 115 to use copyrighted musical works in the making or
distributing of physical or digital phonorecords.
Licensed Activity, as the term is used in subpart B of this part,
means delivery of musical works, under voluntary or statutory license,
via physical phonorecords and Digital Phonorecord Deliveries in
connection with Permanent Digital Downloads, Ringtones, and Music
Bundles; and, as the term is used in subparts C and D of this part,
means delivery of musical works, under voluntary or statutory license,
via Digital Phonorecord Deliveries in connection with Interactive
Streams, Limited Downloads, Limited Offerings, mixed Bundles, and
Locker Services.
Limited Download means a transmission of a sound recording
embodying a musical work to an End User of a digital phonorecord under
17 U.S.C. 115(c)(3)(C) and (D) that results in a Digital Phonorecord
Delivery of that sound recording that is only accessible for listening
for--
(1) An amount of time not to exceed one month from the time of the
transmission (unless the Licensee, in lieu of retransmitting the same
sound recording as another limited download, separately and upon
specific request of the End User made through a live network
connection, reauthorizes use for another time period not to exceed one
month), or in the case of a subscription plan, a period of time
following the end of the applicable subscription no longer than a
subscription renewal period or three months, whichever is shorter; or
(2) A number of times not to exceed 12 (unless the Licensee, in
lieu of retransmitting the same sound recording as another Limited
Download, separately and upon specific request of the End User made
through a live network connection, reauthorizes use of another series
of 12 or fewer plays), or in the case of a subscription transmission,
12 times after the end of the applicable subscription.
Limited Offering means a subscription plan providing Interactive
Streams or Limited Downloads for which--
(1) An End User cannot choose to listen to a particular sound
recording (i.e., the Service does not provide Interactive Streams of
individual recordings that are on-demand, and Limited Downloads are
rendered only as part of programs rather than as individual recordings
that are on-demand); or
(2) The particular sound recordings available to the End User over
a period of time are substantially limited relative to Services in the
marketplace providing access to a comprehensive catalog of recordings
(e.g., a product limited to a particular genre or permitting
Interactive Streaming only from a monthly playlist consisting of a
limited set of recordings).
Locker Service means an Offering providing digital access to sound
recordings of musical works in the form of Interactive Streams,
Permanent Digital Downloads, Restricted Downloads or Ringtones where
the Service has reasonably determined that the End User has purchased
or is otherwise in possession of the subject phonorecords of the
applicable sound recording prior to the End User's first request to use
the sound recording via the Locker Service. The term Locker Service
does not mean any part of a Service's products otherwise meeting this
definition, but as to which the Service has not obtained a section 115
license.
Mixed Service Bundle means one or more of Permanent Digital
Downloads, Ringtones, Locker Services, or Limited Offerings a Service
delivers to End Users together with one or more non-music services
(e.g., internet access service, mobile phone service) or non-music
products (e.g., a telephone device) of more than token value and
provided to users as part of one transaction without pricing for the
music services or music products separate from the whole Offering.
Music Bundle means two or more of physical phonorecords, Permanent
Digital Downloads or Ringtones delivered as part of one transaction
(e.g., download plus ringtone, CD plus downloads). In the case of Music
Bundles containing one or more physical phonorecords, the Service must
sell the physical phonorecord component of the Music Bundle under a
single catalog number, and the musical works embodied in the Digital
Phonorecord Delivery configurations in the Music Bundle must be the
same as, or a subset of, the musical works embodied in the physical
phonorecords; provided that when the Music Bundle contains a set of
Digital Phonorecord Deliveries sold by the same Record Company under
substantially the same title as the physical phonorecord (e.g., a
corresponding digital album), the Service may include in the same
bundle up to 5 sound recordings of musical works that are included in
the stand-alone version of the set of digital phonorecord deliveries
but not included on the physical phonorecord. In addition, the Service
must permanently part with possession of the physical phonorecord or
phonorecords it sells as part of the Music Bundle. In the case of Music
Bundles composed solely of digital phonorecord deliveries, the number
of digital phonorecord deliveries in either configuration cannot exceed
20, and the musical works embodied in each configuration in the Music
Bundle must be the same as, or a subset of, the musical works embodied
in the configuration containing the most musical works.
Offering means a Service's engagement in Licensed Activity covered
by subparts C and D of this part.
Paid Locker Service means a Locker Service for which the End User
pays a fee to the Service.
Performance Royalty means the license fee payable for the right to
perform publicly musical works in any of the forms covered by subparts
C and D this part.
Permanent Digital Download or PDD means a Digital Phonorecord
Delivery in a form that the End User may retain on a permanent basis
and replay at any time.
Play means an Interactive Stream, or play of a Limited Download,
lasting 30 seconds or more and, if a track lasts in its entirety under
30 seconds, an Interactive Stream or play of a Limited Download of the
entire duration of the track. A Play excludes an Interactive Stream or
play of a Limited Download
[[Page 2033]]
that has not been initiated or requested by a human user. If a single
End User plays the same track more than 50 straight times, all plays
after play 50 shall be deemed not to have been initiated or requested
by a human user.
Promotional Offering means a digital transmission of a sound
recording, in the form of an Interactive Stream or Limited Download,
embodying a musical work, the primary purpose of which is to promote
the sale or other paid use of that sound recording or to promote the
artist performing on that sound recording and not to promote or suggest
promotion or endorsement of any other good or service and:
(1) A Record Company is lawfully distributing the sound recording
through established retail channels or, if the sound recording is not
yet released, the Record Company has a good faith intention to lawfully
distribute the sound recording or a different version of the sound
recording embodying the same musical work;
(2) For Interactive Streaming or Limited Downloads, the Record
Company requires a writing signed by an authorized representative of
the Service representing that the Service is operating with appropriate
musical works license authority and that the Service is in compliance
with the recordkeeping requirements of Sec. 385.4;
(3) For Interactive Streaming of segments of sound recordings not
exceeding 90 seconds, the Record Company delivers or authorizes
delivery of the segments for promotional purposes and neither the
Service nor the Record Company creates or uses a segment of a sound
recording in violation of 17 U.S.C. 106(2) or 115(a)(2);
(4) The Promotional Offering is made available to an End User free
of any charge; and
(5) The Service provides to the End User at the same time as the
Promotional Offering stream an opportunity to purchase the sound
recording or the Service periodically offers End Users the opportunity
to subscribe to a paid Offering of the Service.
Purchased Content Locker Service means a Locker Service made
available to End User purchasers of Permanent Digital Downloads,
Ringtones, or physical phonorecords at no incremental charge above the
otherwise applicable purchase price of the PDDs, Ringtones, or physical
phonorecords acquired from a qualifying seller. With a Purchased
Content Locker Service, an End User may receive one or more additional
phonorecords of the purchased sound recordings of musical works in the
form of Permanent Digital Downloads or Ringtones at the time of
purchase, or subsequently have digital access to the purchased sound
recordings of musical works in the form of Interactive Streams,
additional Permanent Digital Downloads, Restricted Downloads, or
Ringtones.
(1) A qualifying seller for purposes of this definition is the
entity operating the Service, including affiliates, predecessors, or
successors in interest, or--
(i) In the case of Permanent Digital Downloads or Ringtones, a
seller having a legitimate connection to the locker service provider
pursuant to one or more written agreements (including that the
Purchased Content Locker Service and Permanent Digital Downloads or
Ringtones are offered through the same third party); or
(ii) In the case of physical phonorecords:
(A) The seller of the physical phonorecord has an agreement with
the Purchased Content Locker Service provider establishing an
integrated offer that creates a consumer experience commensurate with
having the same Service both sell the physical phonorecord and offer
the integrated locker service; or
(B) The Service has an agreement with the entity offering the
Purchased Content Locker Service establishing an integrated offer that
creates a consumer experience commensurate with having the same Service
both sell the physical phonorecord and offer the integrated locker
service.
(2) [Reserved]
Record Company means a person or entity that:
(1) Is a copyright owner of a sound recording embodying a musical
work;
(2) In the case of a sound recording of a musical work fixed before
February 15, 1972, has rights to the sound recording, under the common
law or statutes of any State, that are equivalent to the rights of a
copyright owner of a sound recording of a musical work under title 17,
United States Code;
(3) Is an exclusive Licensee of the rights to reproduce and
distribute a sound recording of a musical work; or
(4) Performs the functions of marketing and authorizing the
distribution of a sound recording of a musical work under its own
label, under the authority of the Copyright Owner of the sound
recording.
Relevant Page means an electronic display (for example, a web page
or screen) from which a Service's Offering consisting of Streams or
Limited Downloads is directly available to End Users, but only when the
Offering and content directly relating to the Offering (e.g., an image
of the artist, information about the artist or album, reviews, credits,
and music player controls) comprises 75% or more of the space on that
display, excluding any space occupied by advertising. An Offering is
directly available to End Users from a page if End Users can receive
sound recordings of musical works (in most cases this will be the page
on which the Limited Download or Interactive Stream takes place).
Restricted Download means a Digital Phonorecord Delivery in a form
that cannot be retained and replayed on a permanent basis. The term
Restricted Download includes a Limited Download.
Ringtone means a phonorecord of a part of a musical work
distributed as a Digital Phonorecord Delivery in a format to be made
resident on a telecommunications device for use to announce the
reception of an incoming telephone call or other communication or
message or to alert the receiver to the fact that there is a
communication or message.
Service means that entity governed by subparts C and D of this
part, which might or might not be the Licensee, that with respect to
the section 115 license:
(1) Contracts with or has a direct relationship with End Users or
otherwise controls the content made available to End Users;
(2) Is able to report fully on Service Revenue from the provision
of musical works embodied in phonorecords to the public, and to the
extent applicable, verify Service Revenue through an audit; and
(3) Is able to report fully on its usage of musical works, or
procure such reporting and, to the extent applicable, verify usage
through an audit.
Service Revenue. (1) Subject to paragraphs (2) through (5) of this
definition and subject to GAAP, Service Revenue shall mean:
(i) All revenue from End Users recognized by a Service for the
provision of any Offering;
(ii) All revenue recognized by a Service by way of sponsorship and
commissions as a result of the inclusion of third-party ``in-stream''
or ``in-download'' advertising as part of any Offering, i.e.,
advertising placed immediately at the start or end of, or during the
actual delivery of, a musical work, by way of Interactive Streaming or
Limited Downloads; and
(iii) All revenue recognized by the Service, including by way of
sponsorship and commissions, as a result of the placement of third-
party advertising on a Relevant Page of the
[[Page 2034]]
Service or on any page that directly follows a Relevant Page leading up
to and including the Limited Download or Interactive Stream of a
musical work; provided that, in case more than one Offering is
available to End Users from a Relevant Page, any advertising revenue
shall be allocated between or among the Services on the basis of the
relative amounts of the page they occupy.
(2) Service Revenue shall:
(i) Include revenue recognized by the Service, or by any associate,
affiliate, agent, or representative of the Service in lieu of its being
recognized by the Service; and
(ii) Include the value of any barter or other nonmonetary
consideration; and
(iii) Except as expressly detailed in this part, not be subject to
any other deduction or set-off other than refunds to End Users for
Offerings that the End Users were unable to use because of technical
faults in the Offering or other bona fide refunds or credits issued to
End Users in the ordinary course of business.
(3) Service Revenue shall exclude revenue derived by the Service
solely in connection with activities other than Offering(s), whereas
advertising or sponsorship revenue derived in connection with any
Offering(s) shall be treated as provided in paragraphs (2) and (4) of
this definition.
(4) For purposes of paragraph (1) of this definition, advertising
or sponsorship revenue shall be reduced by the actual cost of obtaining
that revenue, not to exceed 15%.
(5) In instances in which a Service provides an Offering to End
Users as part of the same transaction with one or more other products
or services that are not Licensed Activities, then the revenue from End
Users deemed to be recognized by the Service for the Offering for the
purpose of paragraph (1) of this definition shall be the lesser of the
revenue recognized from End Users for the bundle and the aggregate
standalone published prices for End Users for each of the component(s)
of the bundle that are Licensed Activities; provided that, if there is
no standalone published price for a component of the bundle, then the
Service shall use the average standalone published price for End Users
for the most closely comparable product or service in the U.S. or, if
more than one comparable exists, the average of standalone prices for
comparables.
Stream means the digital transmission of a sound recording of a
musical work to an End User--
(1) To allow the End User to listen to the sound recording, while
maintaining a live network connection to the transmitting service,
substantially at the time of transmission, except to the extent that
the sound recording remains accessible for future listening from a
Streaming Cache Reproduction;
(2) Using technology that is designed such that the sound recording
does not remain accessible for future listening, except to the extent
that the sound recording remains accessible for future listening from a
Streaming Cache Reproduction; and
(3) That is subject to licensing as a public performance of the
musical work.
Streaming Cache Reproduction means a reproduction of a sound
recording embodying a musical work made on a computer or other
receiving device by a Service solely for the purpose of permitting an
End User who has previously received a Stream of that sound recording
to play the sound recording again from local storage on the computer or
other device rather than by means of a transmission; provided that the
End User is only able to do so while maintaining a live network
connection to the Service, and the reproduction is encrypted or
otherwise protected consistent with prevailing industry standards to
prevent it from being played in any other manner or on any device other
than the computer or other device on which it was originally made.
Student Plan means a discounted Subscription to an Offering
available on a limited basis to students.
Subscription means an Offering for which End Users are required to
pay a fee to have access to the Offering for defined subscription
periods of 3 years or less (in contrast to, for example, a service
where the basic charge to users is a payment per download or per play),
whether the End User makes payment for access to the Offering on a
standalone basis or as part of a Bundle with one or more other products
or services.
Total Cost of Content or TCC means the total amount expensed by a
Service or any of its affiliates in accordance with GAAP for rights to
make interactive streams or limited downloads of a musical work
embodied in a sound recording through the Service for the accounting
period, which amount shall equal the applicable consideration for those
rights at the time the applicable consideration is properly recognized
as an expense under GAAP. As used in this definition, ``applicable
consideration'' means anything of value given for the identified rights
to undertake the Licensed Activity, including, without limitation,
ownership equity, monetary advances, barter or any other monetary and/
or nonmonetary consideration, whether that consideration is conveyed
via a single agreement, multiple agreements and/or agreements that do
not themselves authorize the Licensed Activity but nevertheless provide
consideration for the identified rights to undertake the Licensed
Activity, and including any value given to an affiliate of a record
company for the rights to undertake the Licensed Activity. Value given
to a Copyright Owner of musical works that is controlling, controlled
by, or under common control with a Record Company for rights to
undertake the Licensed Activity shall not be considered value given to
the Record Company. Notwithstanding the foregoing, applicable
consideration shall not include in-kind promotional consideration given
to a Record Company (or affiliate thereof) that is used to promote the
sale or paid use of sound recordings embodying musical works or the
paid use of music services through which sound recordings embodying
musical works are available where the in-kind promotional consideration
is given in connection with a use that qualifies for licensing under 17
U.S.C. 115.
Sec. 385.3 Late payments.
A Licensee shall pay a late fee of 1.5% per month, or the highest
lawful rate, whichever is lower, for any payment owed to a Copyright
Owner and remaining unpaid after the due date established in 17 U.S.C.
115(c)(5) and detailed in part 210 of this title. Late fees shall
accrue from the due date until the Copyright Owner receives payment.
Sec. 385.4 Recordkeeping for promotional or free trial non-royalty-
bearing uses.
(a) General. A Licensee transmitting a sound recording embodying a
musical work subject to section 115 and subparts C and D of this part
and claiming a Promotional or Free Trial zero royalty rate shall keep
complete and accurate contemporaneous written records of making or
authorizing Interactive Streams or Limited Downloads, including the
sound recordings and musical works involved, the artists, the release
dates of the sound recordings, a brief statement of the promotional
activities authorized, the identity of the Offering or Offerings for
which the zero-rate is authorized (including the internet address if
applicable), and the beginning and end date of each zero rate Offering.
(b) Retention of records. A Service claiming zero rates shall
maintain the records required by this section for no less time than the
Service maintains records of royalty-bearing uses
[[Page 2035]]
involving the same types of Offerings in the ordinary course of
business, but in no event for fewer than five years from the conclusion
of the zero rate Offerings to which they pertain.
(c) Availability of records. If a Copyright Owner or agent requests
information concerning zero rate Offerings, the Licensee shall respond
to the request within an agreed, reasonable time.
Subpart B--Physical Phonorecord Deliveries, Permanent Digital
Downloads, Ringtones, and Music Bundles
Sec. 385.10 Scope.
This subpart establishes rates and terms of royalty payments for
making and distributing phonorecords, including by means of Digital
Phonorecord Deliveries, in accordance with the provisions of 17 U.S.C.
115.
Sec. 385.11 Royalty rates.
(a) Physical phonorecord deliveries and Permanent Digital
Downloads. For every physical phonorecord and Permanent Digital
Download the Licensee makes and distributes or authorizes to be made
and distributed, the royalty rate payable for each work embodied in the
phonorecord or PDD shall be either 9.1 cents or 1.75 cents per minute
of playing time or fraction thereof, whichever amount is larger.
(b) Ringtones. For every Ringtone the Licensee makes and
distributes or authorizes to be made and distributed, the royalty rate
payable for each work embodied therein shall be 24 cents.
(c) Music Bundles. For a Music Bundle, the royalty rate for each
element of the Music Bundle shall be the rate required under paragraph
(a) or (b) of this section, as appropriate.
Subpart C--Interactive Streaming, Limited Downloads, Limited
Offerings, Mixed Service Bundles, Bundled Subscription Offerings,
Locker Services, and Other Delivery Configurations
Sec. 385.20 Scope.
This subpart establishes rates and terms of royalty payments for
Interactive Streams and Limited Downloads of musical works, and other
reproductions or distributions of musical works through Limited
Offerings, Mixed Service Bundles, Bundled Subscription Offerings, Paid
Locker Services, and Purchased Content Locker Services provided through
subscription and nonsubscription digital music Services in accordance
with the provisions of 17 U.S.C. 115, exclusive of Offerings subject to
subpart D of this part.
Sec. 385.21 Royalty rates and calculations.
(a) Applicable royalty. Licensees that engage in Licensed Activity
covered by this subpart pursuant to 17 U.S.C. 115 shall pay royalties
therefor that are calculated as provided in this section, subject to
the royalty floors for specific types of services described in Sec.
385.22.
(b) Rate calculation. Royalty payments for Licensed Activity in
this subpart shall be calculated as provided in paragraph (b) of this
section. If a Service includes different Offerings, royalties must be
calculated separately with respect to each Offering taking into
consideration Service Revenue and expenses associated with each
Offering.
(1) Step 1: Calculate the all-In royalty for the Offering. For each
Accounting Period, the all-in royalty shall be the greater of the
applicable percent of Service Revenue and the applicable percent of TCC
set forth in the following table.
Table 1 to Paragraph (b)(1)--2018-2022 All-In Royalty Rates
----------------------------------------------------------------------------------------------------------------
Royalty year 2018 (%) 2019 (%) 2020 (%) 2021 (%) 2022 (%)
----------------------------------------------------------------------------------------------------------------
Percent of Revenue.............. 11.4 12.3 13.3 14.2 15.1
Percent of TCC.................. 22.0 23.1 24.1 25.2 26.2
----------------------------------------------------------------------------------------------------------------
(2) Step 2: Subtract applicable Performance Royalties. From the
amount determined in step 1 in paragraph (b)(1) of this section, for
each Offering of the Service, subtract the total amount of Performance
Royalty that the Service has expensed or will expense pursuant to
public performance licenses in connection with uses of musical works
through that Offering during the Accounting Period that constitute
Licensed Activity. Although this amount may be the total of the
Service's payments for that Offering for the Accounting Period, it will
be less than the total of the Performance Royalties if the Service is
also engaging in public performance of musical works that does not
constitute Licensed Activity. In the case in which the Service is also
engaging in the public performance of musical works that does not
constitute Licensed Activity, the amount to be subtracted for
Performance Royalties shall be the amount allocable to Licensed
Activity uses through the relevant Offering as determined in relation
to all uses of musical works for which the Service pays Performance
Royalties for the Accounting Period. The Service shall make this
allocation on the basis of Plays of musical works or, where per-play
information is unavailable because of bona fide technical limitations
as described in step 3 in paragraph (b)(3) of this section, using the
same alternative methodology as provided in step 4 in paragraph (b)(4)
of this section.
(3) Step 3: Determine the payable royalty pool. The payable royalty
pool is the amount payable for the reproduction and distribution of all
musical works used by the Service by virtue of its Licensed Activity
for a particular Offering during the Accounting Period. This amount is
the greater of:
(i) The result determined in step 2 in paragraph (b)(2) of this
section; and
(ii) The royalty floor (if any) resulting from the calculations
described in Sec. 385.22.
(4) Step 4: Calculate the per-work royalty allocation. This is the
amount payable for the reproduction and distribution of each musical
work used by the Service by virtue of its Licensed Activity through a
particular Offering during the Accounting Period. To determine this
amount, the Service must allocate the result determined in step 3 in
paragraph (b)(3) of this section to each musical work used through the
Offering. The allocation shall be accomplished by dividing the payable
royalty pool determined in step 3 for the Offering by the total number
of Plays of all musical works through the Offering during the
Accounting Period (other than Plays subject to subpart D of this part)
to yield a per-Play allocation, and multiplying that result by the
number of Plays of each musical work (other than Plays subject to
subpart D of this part)) through the Offering during the Accounting
Period. For purposes of determining the per-work royalty allocation in
all calculations under step 4 in this paragraph (b)(4) only (i.e.,
after the payable royalty pool has been determined), for sound
recordings of musical works with a playing time of
[[Page 2036]]
over 5 minutes, each Play shall be counted as provided in paragraph (c)
of this section. Notwithstanding the foregoing, if the Service is not
capable of tracking Play information because of bona fide limitations
of the available technology for Offerings of that nature or of devices
useable with the Offering, the per-work royalty allocation may instead
be accomplished in a manner consistent with the methodology used by the
Service for making royalty payment allocations for the use of
individual sound recordings.
(c) Overtime adjustment. For purposes of the calculations in step 4
in paragraph (b)(4) of this section only, for sound recordings of
musical works with a playing time of over 5 minutes, adjust the number
of Plays as follows.
(1) 5:01 to 6:00 minutes--Each play = 1.2 plays.
(2) 6:01 to 7:00 minutes--Each play = 1.4 plays.
(3) 7:01 to 8:00 minutes--Each play = 1.6 plays.
(4) 8:01 to 9:00 minutes--Each play = 1.8 plays.
(5) 9:01 to 10:00 minutes--Each play = 2.0 plays.
(6) For playing times of greater than 10 minutes, continue to add
0.2 plays for each additional minute or fraction thereof.
(d) Accounting. The calculations required by paragraph (b) of this
section shall be made in good faith and on the basis of the best
knowledge, information, and belief of the Licensee at the time payment
is due, and subject to the additional accounting and certification
requirements of 17 U.S.C. 115(c)(5) and part 210 of this title. Without
limitation, a Licensee's statements of account shall set forth each
step of its calculations with sufficient information to allow the
Copyright Owner to assess the accuracy and manner in which the Licensee
determined the payable royalty pool and per-play allocations (including
information sufficient to demonstrate whether and how a royalty floor
pursuant to Sec. 385.22 does or does not apply) and, for each Offering
the Licensee reports, also indicate the type of Licensed Activity
involved and the number of Plays of each musical work (including an
indication of any overtime adjustment applied) that is the basis of the
per-work royalty allocation being paid.
Sec. 385.22 Royalty floors for specific types of offerings.
(a) In general. The following royalty floors for use in step 3 of
Sec. 385.21(b)(3)(ii) shall apply to the respective types of
Offerings.
(1) Standalone non-portable Subscription--streaming only. Except as
provided in paragraph (a)(4) of this section, in the case of a
Subscription Offering through which an End User can listen to sound
recordings only in the form of Interactive Streams and only from a non-
portable device to which those Streams are originally transmitted while
the device has a live network connection, the royalty floor is the
aggregate amount of 15 cents per subscriber per month.
(2) Standalone non-portable Subscription--mixed. Except as provided
in paragraph (a)(4) of this section, in the case of a Subscription
Offering through which an End User can listen to sound recordings
either in the form of Interactive Streams or Limited Downloads but only
from a non-portable device to which those Streams or Limited Downloads
are originally transmitted, the royalty floor for use in step 3 of
Sec. 385.21(b)(3)(ii) is the aggregate amount of 30 cents per
subscriber per month.
(3) Standalone portable Subscription Offering. Except as provided
in paragraph (a)(4) of this section, in the case of a Subscription
Offering through which an End User can listen to sound recordings in
the form of Interactive Streams or Limited Downloads from a portable
device, the royalty floor for use in step 3 of Sec. 385.21(b)(3)(ii)
is the aggregate amount of 50 cents per subscriber per month.
(4) Bundled Subscription Offerings. In the case of a Bundled
Subscription Offering, the royalty floor for use in step 3 of Sec.
385.21(b)(3)(ii) is the royalty floor that would apply to the music
component of the bundle if it were offered on a standalone basis for
each End User who has made at least one Play of a licensed work during
that month (each such End User to be considered an ``active
subscriber'').
(b) Computation of royalty rates. For purposes of paragraph (a) of
this section, to determine the royalty floor, as applicable to any
particular Offering, the total number of subscriber-months for the
Accounting Period, shall be calculated by taking all End Users who were
subscribers for complete calendar months, prorating in the case of End
Users who were subscribers for only part of a calendar month, and
deducting on a prorated basis for End Users covered by an Offering
subject to subpart D of this part, except in the case of a Bundled
Subscription Offering, subscriber-months shall be determined with
respect to active subscribers as defined in paragraph (a)(4) of this
section. The product of the total number of subscriber-months for the
Accounting Period and the specified number of cents per subscriber (or
active subscriber, as the case may be) shall be used as the subscriber-
based component of the royalty floor for the Accounting Period. A
Family Plan shall be treated as 1.5 subscribers per month, prorated in
the case of a Family Plan Subscription in effect for only part of a
calendar month. A Student Plan shall be treated as 0.50 subscribers per
month, prorated in the case of a Student Plan End User who subscribed
for only part of a calendar month.
Subpart D--Promotional and Free-to-the-User Offerings
Sec. 385.30 Scope.
This subpart establishes rates and terms of royalty payments for
Promotional Offerings, Free Trial Offerings, and Certain Purchased
Content Locker Services provided by subscription and nonsubscription
digital music Services in accordance with the provisions of 17 U.S.C.
115.
Sec. 385.31 Royalty rates.
(a) Promotional Offerings. For Promotional Offerings of audio-only
Interactive Streaming and Limited Downloads of sound recordings
embodying musical works that the Record Company authorizes royalty-free
to the Service, the royalty rate is zero.
(b) Free Trial Offerings. For Free Trial Offerings for which the
Service receives no monetary consideration, the royalty rate is zero.
(c) Certain Purchased Content Locker Services. For every Purchased
Content Locker Service for which the Service receives no monetary
consideration, the royalty rate is zero.
(d) Unauthorized use. If a Copyright Owner or agent of the
Copyright Owner sends written notice to a Licensee stating in good
faith that a particular Offering subject to this subpart differs in a
material manner from the terms governing that Offering, the Licensee
must within 5 business days cease Streaming or otherwise making
available that Copyright Owner's musical works and shall withdraw from
the identified Offering any End User's access to the subject musical
work.
Dated: December 18, 2018.
Suzanne M. Barnett,
Chief Copyright Royalty Judge.
Approved by:
Carla D. Hayden,
Librarian of Congress.
[FR Doc. 2019-00249 Filed 2-4-19; 8:45 am]
BILLING CODE 1410-72-P