Intellectual Property: Economic Arrangments Among Small 	 
Webcasters and Third Parties and Their Effect on Royalties	 
(01-JUN-04, GAO-04-700).					 
                                                                 
The emergence of webcasting as a means of transmitting audio and 
video content over the Internet has led to concerns about	 
copyright protection and the payment of royalties to those who	 
own the recording copyrights. Arriving at an acceptable rate for 
calculating royalties has been particularly challenging. Under	 
the Small Webcaster Settlement Act of 2002, small commercial	 
webcasters reached an agreement with copyright owners that	 
included the option of paying royalties for the period of October
28, 1998, to December 31, 2004, on the basis of a percentage of  
their revenues, expenses, a combination of both, or a minimum fee
rather than paying the royalty rates set by the Librarian of	 
Congress. During debate on the act, copyright owners raised	 
concerns that small webcasters might have arrangements with other
parties, such as advertisers, that could produce revenues or	 
expenses that might not be included in their royalty		 
calculations. In this context, the Congress mandated that GAO, in
consultation with the Register of Copyrights, prepare a report on
the (1) economic arrangements between small webcasters and third 
parties and (2) effect of those arrangements on the royalties	 
that small webcasters might owe copyright owners.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-700 					        
    ACCNO:   A10266						        
  TITLE:     Intellectual Property: Economic Arrangments Among Small  
Webcasters and Third Parties and Their Effect on Royalties	 
     DATE:   06/01/2004 
  SUBJECT:   Copyrights 					 
	     Economic analysis					 
	     Internet						 
	     License agreements 				 
	     Profits						 
	     Reporting requirements				 
	     Royalty payments					 
	     Small business					 
	     Broadcasting					 
	     Web sites						 
	     Webcasting 					 

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GAO-04-700

Report to Congressional Committees

June 2004

INTELLECTUAL PROPERTY

Economic Arrangements among Small Webcasters and Third Parties and Their
Effect on Royalties

Contents

Tables

Figures

Abbreviations

June 1, 2004Letter

The Honorable Orrin G. Hatch Chairman The Honorable Patrick Leahy Ranking
Minority Member Committee on the Judiciary United States Senate

The Honorable F. James Sensenbrenner, Jr. Chairman The Honorable John
Conyers, Jr. Ranking Minority Member Committee on the Judiciary House of
Representatives

The Internet has led to a new generation of content providers, commonly
known as "webcasters," who transmit digitized audio or video works over
the World Wide Web.1 The emergence of this new industry raised concerns
among record companies and performers because their works could be widely
disseminated, which might result in diminished sales of their copyrighted
works through record albums, compact discs, and other prerecorded formats.
To address these concerns and to support the emergence of new digital
technologies, the Congress extended limited copyright protection to
performances of sound recordings being digitally transmitted.

Webcasting consists of several steps: assembling the recordings to be
digitally transmitted over the Internet, translating them into digital
format, and then delivering performances of the recordings to listeners
through an Internet connection. The audio quality of recordings that are
webcast depends on the bandwidth used-the number of bits of information
transmitted per second. Higher bandwidth results in better audio quality
and also allows a greater number of simultaneous listeners. Webcasters
typically contract with other entities (commonly referred to as third
parties), such as bandwidth providers, to supply different webcasting
services. In addition, webcasters may contract with other third parties,
such as companies who wish to advertise products on a webcaster's Web
site, to obtain revenue that can help offset the costs associated with
webcasting and return a profit to the webcaster.

A copyright is a form of legal protection provided to the authors of
creative works, such as music and literature, that generally gives the
owner certain exclusive rights.2 These rights give the copyright owners
control over their works-usually in exchange for compensation, known as a
royalty. Generally, copyright owners and parties seeking to use
copyrighted works voluntarily negotiate the rates at which royalties will
be paid. However, the Congress has, in some cases, established a process
under which the Librarian of Congress sets the royalty rates.

In 1995 and 1998, two key pieces of legislation gave copyright owners the
right to control performances of sound recordings when they are digitally
transmitted and gave webcasters the automatic right to use the recordings
in certain circumstances in exchange for the payment of royalties under a
statutory license.3 The royalties were to be set at either a voluntarily
negotiated rate or at a rate set by the Librarian of Congress, based upon
hearings before a Copyright Arbitration Royalty Panel and the
recommendation of the Register of Copyrights. However, arriving at the
specific royalty rates that small commercial webcasters4 should pay to
owners for the use of their copyrighted recordings has been challenging.
In 2002, the panel recommended royalty rates for webcasters that the
Librarian subsequently rejected. The Librarian established lower rates
that proved controversial to both copyright owners and to small
webcasters. Copyright owners believed that the new rates were too low,
while small webcasters believed that they were still too high, and small
webcasters sought legislative relief to lower the rates further. In
response, the Congress enacted the Small Webcaster Settlement Act of 2002,
which allowed small webcasters and copyright owners to enter into an
agreement that provides for the payment of royalties based on a percentage
of revenues, expenses, both revenue and expenses, or a minimum fee, for
two time periods-the historical period, which began on October 28, 1998,
and ended on December 31, 2002, and 2003 through 2004.

During the debate on the Small Webcaster Settlement Act, copyright owners
also raised concerns about the economic arrangements that small webcasters
have with third parties, arguing that these arrangements could produce
revenues or expenses that might not be included in the calculation of
royalties that the small webcasters owed to them. To provide more
information on such arrangements, the Congress mandated that GAO, in
consultation with the Register of Copyrights, prepare a report on (1) the
economic arrangements between small webcasters and third parties and (2)
the effect of those arrangements on royalties that are based on a
percentage of the webcaster's revenues or expenses.

As required by the act, we coordinated with officials from the U.S.
Copyright Office throughout the course of our work and incorporated their
technical and other comments into the report as appropriate. To respond to
the objectives of this study, we met with officials from organizations
that represent small webcasters, the Recording Industry Association of
America,5 and SoundExchange.6 We interviewed advertising agency staff, a
bandwidth provider, and industry analysts. We also reviewed relevant
copyright laws, regulations, and articles. In addition, we conducted
structured telephone interviews with 58 small webcasters located
throughout the country-30 that had agreed to the terms of the agreement
reached under the Small Webcaster Settlement Act and 28 that had not.7 In
conducting our interviews, we requested the same revenue and expense data
that these small webcasters were required to submit to copyright owners
under the small webcaster agreement. Twenty-seven of the 30 small
webcasters that had agreed to the terms of the small webcaster agreement
provided us with estimates of their revenues and expenses.

Because the U.S. Copyright Office does not enforce copyrights or collect
financial data, we did not have access to the financial records of the
small webcasters that we interviewed and thus could not verify the
accuracy of the revenue and expense data they provided to us. Nor did we
attempt to determine whether these small webcasters had paid the royalties
based on those estimates. Appendix I provides additional details on our
scope and methodology.

We conducted our work from May 2003 through May 2004 in accordance with
generally accepted government auditing standards.

Results in Brief

Small webcasters have a variety of economic arrangements with third
parties, such as bandwidth providers, businesses seeking or selling
advertising space, and merchandise providers. Virtually all of the
webcasters that we interviewed-the 30 that had agreed to the royalty terms
in the small webcaster agreement and the 28 that had not-reported having
arrangements with bandwidth providers from 1998 through 2003. Forty
webcasters reported arrangements for selling advertising space either
directly or through advertising firms. However, advertising sales have
remained low, according to industry analysts, in part because of the
collapse of the high technology business sector since 2000 and the
relative novelty of the Internet as an advertising medium. Twenty-five, or
44 percent, of the small webcasters that we contacted also reported
arrangements with businesses to sell merchandise, such as T-shirts and
coffee mugs, through their Web sites. Less commonly reported arrangements
included those with  companies that help small webcasters manage or obtain
advertising for their Web sites such as by inserting ads on the Web site
or into the webcast itself or selling advertising based on the aggregate
audiences of multiple webcasters.

Data obtained from the small webcasters that agreed to the terms of the
small webcaster agreement suggest that the overall effect of economic
arrangements between small webcasters and third parties on royalties owed
to copyright owners has been minimal to date. Of the 30 small webcasters
we interviewed that had agreed to the terms of the small webcaster
agreement, 27 provided us with financial data. Nineteen of the 27 reported
revenue and expense estimates that were below the levels that would result
in royalty payments at an amount greater than the minimum fee for either
or both of the time periods for which payments were to be made. The
remaining 8 owed royalties that exceeded the minimum fee. In addition, 2
of the 13 small webcasters that reported receiving free or reduced-price
goods or services did not report the free service they received as revenue
in their calculations of royalties. However, these data may not be
reflective of conditions that may develop as the industry matures.
Specifically, revenues and expenses of small webcasters might increase as
they attract more listeners, and advertising opportunities and rates may
also increase as the webcasting industry matures and advertisers rely more
on the Internet as part of their advertising efforts, according to
industry analysts.

Background

The advent of the Internet and digital transmission of sound recordings
through personal computers has revolutionized the music industry and
created a new way to transmit music directly to listeners. Although
personal computers have been available since the late 1970s and music in
digital form since the early 1980s, it was opening up the Internet to
commercial activity in 1992 that set the stage for webcasting. In
webcasts, sound recordings, such as records and compact discs, and live
performances can be transmitted to listeners over the Internet. The
popularity of webcasting is growing, with the number of listeners tripling
over the past 3 years.

Webcasting and traditional radio broadcasting follow essentially the same
steps to deliver music to listeners (see figs. 1 and 2). Many webcasters
and traditional radio stations deliver music to listeners at no charge.8 A
key difference, however, concerns the number of potential listeners. In
traditional radio broadcasting, a station's signal is available to any
number of listeners within range of the transmitter. In contrast, the
potential audience for a webcast is anyone in the world whose computer is
equipped with a media player.

Figure 1: Webcasting Transmission Process

Figure 2: Traditional Radio Broadcasting Transmission Process

Webcasting, also called Internet streaming, is the process of transmitting
digitized audio or video content over the Internet. The content can
originate from live performances, records, compact discs, or other
prerecorded formats. A webcast consists of several steps. The webcasters
must first assemble the music that will be transmitted and then translate
it into one or more digital formats. Music that is not streamed "live"
must be stored so that it is available to individuals who use their
personal computers to access the Web site created by the webcaster. The
final step is delivering the music through an Internet connection.

Choices about the audio quality of the transmitted music and the size of
the audience affect the webcaster's operation costs. The quality of the
resulting music depends on the bandwidth-the number of bits of information
transmitted per second-used by the webcaster. Higher bandwidth results in
better sound quality of the transmitted music and allows a greater number
of simultaneous listeners. The size of the Internet connection to the
webcaster's server and the choice of bandwidth determine the potential
size of the audience. Although in its most basic form webcasting can be a
relatively inexpensive "do-it-yourself" operation using a minimum of two
computers and an Internet connection, the trade-off is lower sound quality
and smaller audience size. Alternatively, webcasters that hope to reach a
large audience with high-quality music frequently contract with one or
more third parties to provide the different steps. Such third parties can
provide a single service or some combination of services, including
translating the music into digital form and adjusting bandwidth needs to
accommodate the number of simultaneous listeners. Some may also provide
data on the number and location of listeners. Because webcasters
frequently deliver their music at no charge to listeners, webcasters may
contract with other third parties, such as companies that wish to
advertise products on the webcaster's Web site, to obtain revenue that can
help offset the costs associated with webcasting and return a profit to
the webcaster.

The Internet and the ability to digitally transmit sound recordings have
created opportunities for the recording companies that typically own the
copyrights in sound recordings to reach an unprecedented number of
listeners. Accompanying these opportunities are challenges for copyright
owners to maintain control over, and be compensated for, the use of their
copyrighted recordings. In the United States, the owners of copyrights in
sound recordings have not historically enjoyed the exclusive right to
control or authorize public performances of their recordings.
Traditionally these copyright owners generated royalties by selling copies
of the recordings in the form of albums, cassette tapes, and compact
discs. Although radio broadcasters pay royalties to publishers and writers
for use

of a musical work, they were not obligated to pay record companies for the
use of sound recordings.9

Two key pieces of legislation gave copyright owners the right to control
performances of sound recordings when they are digitally transmitted and
gave webcasters the automatic right to use the recordings under certain
circumstances in exchange for the payment of royalties under a statutory
license. The Digital Performance Right in Sound Recordings Act, enacted in
1995, granted copyright owners the exclusive right to control or authorize
the use of recordings when they are digitally transmitted but not, for
example, when they are transmitted for use as background music in a
restaurant.10 In the Digital Millennium Copyright Act (DMCA), the Congress
expanded the scope of this digital transmission right.11 Among other
things, the DMCA specifies that webcasters may operate under an automatic
license to use copyrighted works at either a voluntarily negotiated rate
or at a rate recommended by a panel known as a Copyright Arbitration
Royalty Panel (CARP), subject to review by the Librarian of Congress.12
These rates, retroactive to October 1998, were to apply through December
2002. The act called for this procedure to be repeated every 2 years as
the webcasting industry developed, though it could be extended by
agreement between the copyright owners and webcasters.

However, the legislation created conflict between record companies and
webcasters. The DMCA provided the opportunity to negotiate royalty rates
independently. But after negotiations between owners and webcasters broke
down, the Library of Congress convened a CARP to resolve the issue and
determine the appropriate rates. The CARP held hearings for 6 months,
during which both the copyright owners and webcasters presented their
cases. In February 2002, the CARP issued a royalty rate recommendation.

In June 2002, the Librarian rejected some of the webcasting rates
recommended by the CARP and issued a regulation that set royalty rates for
Internet transmissions. Both record companies and webcasters contested the
Librarian's rates and sought relief in the courts. Some small webcasters
believed that the rates set by the Librarian were too high, arguing that
they would have to close their operations because they could not pay the
rates set by the Librarian and that these rates would put an end to the
promise of webcasting. Copyright owners believed the rates were too low
and did not reflect the true market value of their music, causing them to,
in essence, subsidize the webcasters. Moreover, they argued that royalties
are simply another cost of doing business, like buying bandwidth, and
webcasters that could not afford to pay them should not be operating.

In response to these concerns, the Congress passed the Small Webcaster
Settlement Act of 2002.13 The act did not set new royalty rates but
instead allowed small webcasters and copyright owners another opportunity
to negotiate an agreement on royalty rates for the period beginning
October 28, 1998, through December 31, 2004.14 These negotiated rates were
to be based on a percentage of revenue or expenses, or a combination of
both; were to include a minimum fee; and were to apply in lieu of rates
set by the Librarian of Congress (see table 1). This option was available
to any small webcaster that met the agreed-upon eligibility requirements.
In December 2002 the U.S. Copyright Office published the resulting
agreement under the act.15 The agreement contained specific guidance for
webcasters to follow in determining the specific revenue and expense
categories that were to be included in the calculation of royalties due to
copyright owners. The guidance defines revenues and expenses in ways
compatible with generally accepted accounting principles and income tax
reporting.

Table 1: Summary of the Royalty Rates and Fees for Small Webcasters

Time period        Revenue rate        Expense rate Minimum annual fee     
October 28, 1998 - 8% of gross         5%           $500                   
December 31, 1998  revenues                         
January 01,1999 -  8% of gross         5%           $2,000                 
December 31, 2002  revenues                         
                                                       $2,000 for webcasters  
                                                       with gross revenues    
                                                       that were not in       
                                                       excess of $50,000 the  
                                                       previous or year or    
                      10% of the first                 expected to exceed     
                      $250,000 of gross                $50,000 during the     
January 01, 2003 - revenues and 12% of 7%           current license period 
December 31, 2004  any gross revenues                                      
                      in excess of                     $5,000 for webcasters  
                      $250,000                         with gross revenues    
                                                       that exceeded $50,000  
                                                       the previous year or   
                                                       are expected to exceed 
                                                       $50,000 during the     
                                                       current license period 

Source: GAO.

Note: Small webcasters owe royalties based on a percentage of revenue or
expenses or a minimum fee, whichever is greater.

As of October 2003, 35 small webcasters that had elected to follow the
royalty rates and terms set out in the agreement were in operation. As
shown in figure 3, these webcasters were located throughout the United
States, with one in Canada. We interviewed 30 of these webcasters. Rock
and pop are the types of music they most often delivered to listeners,
although they also webcast rhythm and blues, jazz, "oldies," and
electronic dance music. For 17 of these small webcasters, the targeted
audience includes both men and women, while the audience for the remaining
11 is predominately men. Almost all of these small webcasters target
listeners between the ages of 25 and 34.

Figure 3: Location of Small Webcasters That Signed the Small Webcaster
Agreement

Small Webcasters Enter into a Variety of Economic Arrangements with Third
Parties

Small webcasters have economic arrangements with various third parties,
including bandwidth providers, advertisers, and merchandise providers.
Other less commonly reported arrangements with third parties included
those with  companies that help small webcasters manage or obtain
advertising, such as companies that insert ads either on the Web site or
into the webcast, and companies that sell advertising based on the
aggregate audience of multiple webcasters. We determined that the economic
arrangements of the small webcasters that elected to follow the terms in
the small webcaster agreement and those that elected not to do so were not
substantially different.

Arrangements with Bandwidth Providers and Advertisers are Most Common

Fifty-two, or 91 percent, of the small webcasters that we interviewed
reported having had arrangements with bandwidth providers during the year
2003. In addition, 24 small webcasters said that they had received free
bandwidth. However, only 16 of them had received free bandwidth in 2003.
Fifteen small webcasters reported that they had received bandwidth at a
reduced price at some point, while 14 were receiving it at a reduced price
in 2003. Although bandwidth is the dominant cost component for most
webcasters, some bandwidth providers offer these incentives as a means to
gain business for themselves and to promote the small webcaster market in
general.

Over half of the small webcasters interviewed had attempted to sell
advertising space, either directly or through advertising firms. Of the 40
small webcasters that reported having attempted to sell advertising space,
38 said they were currently running advertising on their stations and 2
stated that they had run advertising in the past, but were no longer doing
so. As shown in figure 4, these small webcasters had various methods of
selling advertising space. Most reported that the owners or employees of
their stations sold advertising space. Other arrangements to sell
advertising space, such as through advertising firms or coalitions of
webcasters, were less common.

Figure 4: Methods of Selling Advertising Space

Note: Thirty-eight of the 40 small webcasters that had sold advertising
space responded to this survey question. Webcasters could report using
more than one method.

Small webcasters use various types of advertising on their sites. Banner
ads, which are graphic images that typically appear toward the top of Web
pages, were the most common type of advertising used by small webcasters
(see fig. 5). Thirty-three of the small webcasters reported that they use
banner ads on their sites, and another 2 reported that they used banner
ads in the past, but no longer do so. Audio ads, which play at the
beginning or during a small webcaster's stream, were currently being used
by 29 of the small webcasters, and another 3 reported having used them in
the past. Video ads, which are either shown on the computer screen
whenever the listener tunes to the station or during the stream, were less
common. Only 9 of the small webcasters reported using video ads, and
another 4 said they had used them in the past. Some of the small
webcasters reported using some other type of advertising on their sites.

Figure 5: Types of Advertising Currently Used by Webcasters

Note: Forty small webcasters responded to this survey question. Webcasters
could report using more than one type.

Advertising is a primary source of revenue for the small webcasters we
interviewed. Twenty-seven of the 58 small webcasters interviewed reported
that advertising had provided at least 10 percent of their station's gross
revenue in 2003 (see fig. 6). According to industry analysts and
representatives, advertising sales have remained low, in part due to the
collapse of the high technology business sector since 2000 and because of
the relative novelty of the Internet as an advertising medium. Twelve of
the small webcasters interviewed reported that they had received free or
reduced-price advertising since 1998. In addition to advertising, other
sources of revenue for the small webcasters included donations and
merchandise sales.

Figure 6: Sources Providing at Least 10 Percent of Webcasting Revenue

Note: Fifty-six webcasters responded to this survey question.

Arrangements with Merchandisers and Other Third Parties Are Less Prevalent

Small webcasters generally did not have arrangements with other third
parties, such as merchandisers and ad insertion companies. Twenty-five, or
44 percent, of the small webcasters that we interviewed reported that they
had economic arrangements with suppliers of merchandise, such as T-shirts
or coffee mugs in 2003 (see fig. 7). This represented an increase of 4
percent from the 1998 through 2002 time period. In addition to selling
merchandise on their sites, 15 small webcasters reported that they had
received merchandise, such as compact discs and T-shirts, for free or at a
reduced price.

Thirteen, or 23 percent, of the small webcasters reported that they had
economic arrangements in 2003 with ad insertion companies, which sell
either the technology for inserting ads into a webcaster's audio stream or
the service of inserting the ads. This technology can help small
webcasters target their advertisements to the profiles of their listening
audiences as well as provide links to their advertisers' Web sites. Other
types of economic arrangements that were even less common involved
coalitions of webcasters and arrangements with aggregators. Twelve, or 21
percent, of the small webcasters reported that they had economic
arrangements in 2003 with a coalition of webcasters. Such coalitions have
formed to help webcasters market themselves to advertisers. Seven percent
of the small webcasters reported that in 2003 they had economic
arrangements with companies that sell advertising based on the aggregate
audience of multiple webcasters. When an advertiser purchases advertising
space from a webcaster, the advertiser is purchasing the chance to present
a message to as many listeners as possible. While some webcasters are
small and may not have enough listeners to attract advertisers on their
own, they have entered into arrangements with companies that sell
advertising space based on an aggregate audience of multiple webcasters.
Other arrangements included those with parent and sister companies and
with corporate sponsors.

Figure 7: Types of Economic Arrangements with Third Parties

Note: Forty-seven of the 48 small webcasters that were operating between
December 28, 1998, and December 31, 2002, responded to this survey
question for both time periods. Ten additional small webcasters that began
operating in 2003 responded to this survey question for 2003.

Available Data Suggest the Effects of Economic Relationships between Small
Webcasters and Third Parties on Royalties Have Been Minimal to Date

Data obtained from small webcasters that agreed to the terms of the small
webcaster agreement suggest that to date the overall effect of their
economic arrangements with third parties on royalties owed to copyright
owners has been minimal. Most of these small webcasters owed the minimum
royalty fee for either or both of the time periods for which payments were
to be made. Because royalty obligations for these webcasters are based on
a percentage of their revenues or expenses, or a minimum fee, whichever is
greater, accurate reporting is essential to ensure the appropriate payment
of royalties. We found only limited evidence to suggest small webcasters
might not be doing so.

Royalties for Most Small Webcasters Equal the Minimum Fee

The majority of small webcasters we interviewed that had agreed to the
royalty terms in the small webcaster agreement owed royalties equal to the
minimum fee because they  did not generate revenue or incur expenses
sufficient to exceed the thresholds for owing royalties above the minimum
fee. Nineteen, or 70 percent, of the 27 small webcasters that provided us
with financial information reported revenue and expense estimates that
were below the levels that would result in royalty payments above the
minimum fee for one or both of the time periods for which payments were to
be made-the historical period, which began on October 28, 1998, and ended
on December 31, 2002, and 2003 (see table 2). The specific revenue and
expense thresholds vary, in part, depending on when the webcaster began
operating. The revenue threshold ranged from $25,000 for those that began
operating in 2002 to more than $100,000 for those that began in 1998,
while the expense threshold ranged from $40,000 to $170,000. For the
period 2003 to 2004, the revenue threshold varied in relation to
anticipated revenue, with the threshold at $20,000 for those earning less
than $50,000 and at $50,000 for those earning more. During the same time
period, the expense threshold was $28,571 for those earning less than
$50,000 and $71,429 for those earning more. Most small webcasters reported
revenues or expenses that were less than half the thresholds required for
royalty payments to exceed the minimum fee.

Table 2: Basis for Royalty Obligations for Two Time Periods

Basis                                           Number of small webcasters 
Owed the minimum fee for one or both time                               19 
periods                                         
Owed royalties based on revenues for one or                              5 
both time periods                               
Owed royalties based on expenses for both time                           3 
periods                                         
Total                                                                   27 

Source: GAO's survey of small webcasters.

Note: Three of the 30 small webcasters that agreed to the terms of the
small webcaster agreement did not provide us with financial information.

Eight small webcasters owed royalties that were based on either revenues
or expenses and exceeded the minimum fee. Five owed $3,000 or less above
the minimum fee and one owed $5,000 above the minimum fee. The remaining
two small webcasters owed more than three times the amount of the minimum
fee. These two owed royalties based on their revenues in both time
periods. One webcaster attributed much of its revenue to a relationship
with an online retailer, while the other received revenue from an Internet
service provider that offered its customers the option of including the
webcast as an additional service. The specific minimum fee applicable to
any individual small webcaster varied in the first period in relation to
when it began transmitting, ranging from a low of $500 for a webcaster
that operated only in 1998 to $8,500 for one that was operating for all or
part of each year from October 28, 1998, through December 2002. The
minimum fee for the period 2003 to 2004 varied in relation to anticipated
revenue and was $2,000 for small webcasters earning $50,000 or less and
$5,000 for those earning more.

Reporting revenue and expenses in accordance with the small webcaster
agreement is important to help ensure the proper payment of royalties.
Under the agreement, all money earned and all expenses incurred, with
certain exceptions, are to be reported for purposes of calculating
royalties. For example, small webcasters may exclude revenues from the
sale of recordings or assets such as land or buildings and such expenses
as royalties paid, the cost of recordings used in the webcast, and the
value of residential space used in the operation of the webcasting
service.

Transactions that do not involve the exchange of money but result in the
webcaster receiving something of value are to be included in statements of
revenues or expenses. The value of the goods or services received is to be
included in the small webcaster's revenue, and any goods or services the
small webcaster offered in exchange are to be reported as expenses. For
example, if a small webcaster received free bandwidth, the value of that
service should be included as revenue. In some cases, small webcasters
contract with an advertising firm that forwards a portion of the
advertising sales to the small webcaster and retains a portion as
commission. In these cases, the small webcaster is to report the money it
received as revenue and the portion retained by the advertising firm as an
expense.

Although the extent to which small webcasters comply with the agreed-upon
guidance for reporting revenues and expenses could not be determined
without a detailed review of their financial records, small webcasters
that elect to follow the terms of the small webcaster agreement
subsequently certify that the figures they report to copyright owners are
accurate under penalty of law. Copyright owners have the right to initiate
a detailed review of financial records to verify the accuracy of the
reported figures. However, an attorney representing copyright owners said
that, to his knowledge, no such reviews have been conducted.

We found limited evidence to suggest that small webcasters might not be
reporting revenues and expenses as agreed. Specifically, while 13 of the
small webcasters interviewed said they had received goods or services at
no charge, 2 reported having no revenue, although they had received free
bandwidth. In each case, however, these small webcasters reported revenue
and expense estimates that were well below the revenue and expense
threshold, and both were subject to the minimum fee for both the period
from 1998 to 2002 and for 2003.

Effect of Economic Arrangements May Change As Industry Evolves

Although the majority of small webcasters that we interviewed reported
revenues and expenses that were substantially below the levels required to
pay a royalty above the minimum fee, this may change as the industry
matures.16  Revenues and expenses of small webcasters might increase as
they attract more listeners, and advertising opportunities and rates may
also increase as the webcasting industry matures and advertisers rely more
on the Internet as part of their advertising efforts. Two trends that may
affect the amount of royalties that small webcasters may have to pay in
the future include growth in audience size and growth in advertising. The
number of Americans listening to Internet transmissions nearly tripled
between 2000 and 2003, and about 40 percent of Americans have listened to
webcasts, including Internet transmissions of over-the-air radio
programming, at least once, according to recent reports by an
international media and marketing research firm.17 Industry analysts
expect this growth to continue. Small webcasters that we interviewed also
reported growth in the sizes of their audiences.  Thirty-six, or 76
percent, of the small webcasters that we interviewed that started
webcasting before January 2002 said their audience size had increased,
although they could not quantify the extent of the increase (see fig. 8).

Figure 8: Change in Audience Size among Webcasters

Note: Forty-seven of the 48 small webcasters that were in operation on or
before January 2002 responded to this survey question.

As mentioned earlier, the small webcasters that we interviewed indicated
that they depend upon advertising as a primary source of revenue. 
According to an estimate from one of the reports cited above, if the
aggregate webcast audience could be "sold" to advertisers as if it were an
over-the-air radio network, it could generate up to $54 million per year
in advertising revenue.  However, according to industry analysts,
webcasters have the potential to increase their advertising revenues over
current levels, in part because they have the ability to provide
demographic information about their listeners, which allows advertisers to
more accurately target advertisements to potential consumers.

We will send copies of this report to the appropriate House and Senate
committees; interested Members of Congress; the Librarian of Congress; and
to the Director, Office of Management and Budget. We will also make copies
available to others upon request. In addition, the report will be
available at no charge on the GAO Web site at http://www.gao.gov.

If you have any questions about this report, please contact me at (202)
512-3841. Other major contributors to this report are listed in appendix
III.

Anu K. Mittal Director, Natural Resources and Environment

Scope and MethodologyAppendix I

As required by the Small Webcaster Settlement Act of 2002, we conducted a
study in consultation with officials from the U.S. Copyright Office in the
Library of Congress to determine (1) the economic arrangements between
small commercial webcasters and third parties1 and (2) how those
arrangements affect royalties due to copyright owners and performers. We
consulted officials from the U.S. Copyright Office throughout the course
of our work and incorporated the suggestions and comments we obtained into
our report as appropriate.

To respond to the objectives set out in the act, we met with officials
from the U.S. Copyright Office, the Library of Congress, and
representatives of organizations that represent copyright owners. In
addition, we interviewed staff from businesses that provide advertising
and other services to small webcasters and industry analysts. We also
reviewed relevant copyright laws, regulations, and articles.

To obtain information from small webcasters, we developed a structured
interview. We pretested the content and format of this interview with 6
webcasters. During these pretests we asked the small webcasters to assess
whether the questions were clear and unbiased and whether the terms were
accurate and precise. We made changes to the interview protocol based on
pretest results. We conducted the interview via telephone with 58 small
webcasters located throughout the country-30 who had agreed to the terms
of the agreement reached by copyright owners and small webcasters under
the Small Webcaster Settlement Act and 28 who had not.2

The U.S. Copyright Office is not required to and does not maintain a list
of small webcasters. As a result, to identify the universe of small
webcasters, we obtained a list from SoundExchange of 35 small webcasters
that had elected to follow the terms of the small webcaster agreement.3 We
subsequently learned that one of the webcasters had determined that it was
not eligible to follow the terms of the agreement because the station made
too much revenue, and a second webcaster operated only as a subscription
service. A third webcaster informed us that it had ceased operating in
December 2000. SoundExchange later sent us an updated list that included 3
additional small webcasters. Thus, the number of eligible small webcasters
that were operating as of October 2003 and had agreed to follow the terms
of the agreement was 35. We completed interviews with 30 of these small
webcasters for a response rate of 85.7 percent.

We also interviewed small webcasters that did not elect to follow the
terms of the small webcaster agreement. We obtained a list of 121 names of
small webcasters from BRS Media (a private firm that maintains a list of
Internet broadcasting firms). To the best of our knowledge, this
encompassed all small webcasters operating in the United States. Of these
121 webcasters, 28 were no longer operating or did not appear to meet the
definition of an eligible small commercial webcaster, and 4 had signed the
small webcaster agreement (and thus were on the list of "signers"). We
attempted to reach the remaining 89 small webcasters. Forty-two small
webcasters were contacted. Interviews were completed with 28 that met the
criteria of "small webcaster." Fourteen webcasters refused to be
interviewed. We were not able to contact the remaining 47 webcasters,
although we made repeated attempts and left messages when we could. We did
not calculate the response rate for the group of small webcasters that did
not sign the agreement because we did not know how many of those not
interviewed were eligible small webcasters, and we did not have enough
information to reasonably estimate the percentage that might be eligible.

To protect the confidentiality of the small webcasters we interviewed, we
randomly assigned each an identification number and documented their
responses to our interview questions with the identification number.
During the interviews, we asked the 58 small webcasters about economic
arrangements they had with third parties, whether they were currently
receiving or had previously received any free or reduced-price goods or
services, and requested estimates of their revenues, expenses, and third
party revenues. For those small webcasters that had signed the election
form to follow the terms of the small webcaster agreement, we asked for
their reasons for doing so. For those that had not signed the election
form, we asked for their reasons for not doing so. For many of the
questions, we asked small webcasters to provide separate responses for two
different periods to correspond with the reporting periods contained in
the agreement-the historical period, which began on October 28, 1998, and
ended on December 31, 2002, and 2003 to 2004. We asked small webcasters to
provide information through the date of our interviews, which were
conducted in November and December 2003.

We also asked each of the 30 small webcasters we interviewed who had
elected to follow the terms of the small webcaster agreement to sign a
release form allowing us to obtain access to the financial records they
had submitted to SoundExchange. We obtained signed release forms from 25
of the 30 (83.3 percent) small webcasters. A representative of
SoundExchange subsequently informed us that it had no financial
information for 9 of these 25 small webcasters. We reviewed the
information the 16 remaining small webcasters had provided to
SoundExchange to determine whether it was comparable to the information
they had provided to us.

To assess the effect that economic arrangements between small webcasters
and third parties have on the royalties due to copyright owners and
performers, we used financial information obtained during our interviews
with 27 of the 30 small webcasters that elected to follow the terms of the
agreement. Three of the 30 small webcasters declined to provide any
financial information. We calculated the threshold revenue amounts that
each of the 27 small webcasters would have had to exceed to owe more than
the minimum royalty fee. These revenue amounts were calculated for both
time periods-October 28, 1998 through December 31, 2002, and for 2003-and
were based on the length of time the small webcaster had been in
operation. We then estimated the amount that each small webcaster owed in
royalties for each of the two time periods based on the revenue and
expense data that they provided to us. For small webcasters that did not
report revenue or expense estimates for the entire year, we used their
average monthly revenues to project their yearly gross revenue and/or
expenses. These estimated values were compared to the threshold amounts
and allowed us to determine whether the small webcasters were subject to
royalty payments above the minimum fee.

Results of GAO's Survey of Small WebcastersAppendix II

GAO Contacts and Staff AcknowledgmentsAppendix III

GAO Contacts

Anu K. Mittal, (202) 512-3841 Cheryl Williams, (404) 679-1991

Acknowledgments

Stephen M. Brown, Jason Jackson, Jonathan McMurray, Lynn Musser, Deborah
Ortega, Janice Turner, and Mindi Weisenbloom made key contributions to
this report.

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