heated public debate started when the original "file-sharing"
service, Napster, went on-line in 1999. Napster was shut down in
2001, but the debate raged on as other file-sharing
services -- commonly referred to as peer-to-peer (P2P) networks -- took
its place. Advocates of file sharing argue passionately that the
practice has not harmed album sales, and opponents argue with equal
vehemence that it has.
Despite both sides' positions, the
research thus far does not show a clear effect on record sales from
file sharing. Does this mean that P2P is harmless? Not necessarily.
There are many reasons why P2P's impact may not have appeared in
empirical data, and there are valid reasons why P2P remains a
threat to the music industry. This paper provides a brief
discussion of these issues and explains why the music industry's
long-term viability is endangered by P2P file sharing.
What Is P2P File Sharing?
Peer-to-peer is now the common term used
to describe Internet file-sharing services. The name derives from
the underlying structure of the Internet, in which various
computers store information and other computers retrieve it through
interconnected networks. With P2P, all computers sharing
information over the Internet are "peers" because they both store
and retrieve information.
use a P2P service, such as KaZaA, users download software that
enables them to "join" a particular "club." Joining allows each
individual to search other members' computers for specific files,
such as a digital copy of the newest song by Galactic. Once the
file is found, the member who initiated the search can download his
or her own copy of the file directly from another member's
computer -- at no cost. Typically, members of the group make their
own digital files available for others to share, thus increasing
the number of files that are available for everyone in the group.
The overall size of the group, of course, is bounded only by the
number of people connected to the Internet.
majority of P2P services' users trade digital copies of songs and,
to a lesser extent, movies. Though there is nothing inherently
illegal about the technology itself (it can be used to share any
type of digital file, such as personal photos or text files), many
of the files traded through P2P networks are copyrighted. It is the
unauthorized "sharing" of these copyrighted materials that has
stirred the P2P controversy.
Economic Theory on File Sharing
of the theoretical literature about copying intellectual property
materials (such as music, books, and movies) was developed before
the introduction of the Internet. Consequently, this area of
economic theory cannot be used to defend P2P. For example, much of
the existing literature bolsters the idea that small-scale sharing
can make both consumers and producers better off. Because producers know
certain groups of consumers will buy rather than copy, those who
will buy can be charged a higher price. In contrast, the
large-scale nature of P2P copying and the downward pressure that
P2P copying exerts on music prices invalidate this "beneficial for
Additionally, the economic theory often
cited by P2P proponents has been misused to defend Internet file
sharing. P2P advocates argue (1) that file sharing increases album
sales (known as the sampling effect) and (2) that individuals who
use P2P to download music would not have purchased the music in the
J. Liebowitz provides an extensive analysis of why the first
idea -- the sampling effect -- does not hold up to scrutiny. The sampling story
holds that consumers use P2P to "sample" songs from full-length
albums. Because consumers could not sample prior to P2P, they were
less likely to buy the full-length album. Therefore, the story
goes, consumers who sample on P2P are now more likely to buy
main problem with the sampling story is that consumers who sample
may find that they dislike the music. These consumers will not
purchase the album. For sampling to increase music sales
unambiguously, individuals would have to sample the music, like the
music, and then purchase the music they had already acquired free
of charge (all with no downward pressure on music prices). Although
this process may hold true for some music consumers, a complete
market analysis suggests that the sampling effect will decrease
overall music sales.
Similarly, P2P proponents' second defense
describes the behavior of only some music consumers. The author's
research points out that because P2P makes it easier to get a
low-cost, high-quality copy, some individuals enter the market only
to download free music. These consumers can be thought of as
having a low preference for music, meaning that they probably do
not buy significant amounts of music. This is a theoretical
justification for the idea that some file sharers would not have
bought music in the first place, but it says nothing about
consumers with higher preferences for music.
instance, there surely are consumers with higher preferences for
music who copy some music and buy other music. For these consumers,
the introduction of P2P services increases the likelihood that they
will choose to copy rather than buy. The low-preference consumers
do not significantly affect music sales; therefore, the
introduction of P2P leads us to predict fewer music sales. The size
of this decrease, however, depends on other factors such as
Internet and high-speed Internet use. The current evidence about
P2P's impact on music sales is not perfect (as with all empirical
work), but most recent studies do support the theoretical
prediction that P2P will decrease album sales.
The Evidence on File Sharing
Because of econometric and data issues,
studies thus far have produced disparate estimates of file
sharing's impact on album sales. For example, it was widely
reported that a Harvard professor's research found that file
sharing had virtually no impact on overall album sales and seemed
to increase sales of some albums. However, Liebowitz both details several
econometric problems with that paper and estimates that file
sharing reduced album sales between 2000 and 2003 by as much as 30
Another study found that cross-country
aggregate data support a 20 percent reduction in compact disc sales
from file sharing,
but that researcher's individual-level (or micro-level) data tests
support a much smaller negative impact (8 percent) on sales. Using
a different econometric approach, this same research estimates that
file sharing reduces the likelihood of buying music by 30 percent.
The author's research also uses micro-level data and finds that
file sharing decreased CD sales in the U.S. by approximately 4
percent between 1999 and 2001.
Why the Evidence May Not Matter
of the above-mentioned studies has its own strengths and
weaknesses. None of the results, however, supports the contention
that P2P does not threaten the long-term viability of the music
industry. The reasons that the current evidence is only a small
piece of the puzzle can be summarized as follows:
- Relatively Few
Studies. The Internet and P2P downloading are both
relatively new phenomena, and collecting sufficient data for
empirical studies is difficult. This task is made cumbersome
because data that identify P2P users, their downloads, music
purchases, and demographics are not readily available. The number
of studies that investigate file sharing is growing, but the
overall number of studies is still small.
- Shortcomings of
Aggregate Data. Using aggregate-level data, such as total
industry sales, to study the impact of file sharing restricts the
number of observations and "control" variables for regression
analysis. As a result, it is difficult to generalize
aggregate-level test results to the behavior of individual
- Shortcomings of
Micro Data. Using micro-level data, such as individuals'
downloads and music purchases, makes it difficult to generalize
test results to the entire music industry. In other words, even if
it can be shown that a given set of albums was not adversely
affected by P2P downloading, it may be too much of a leap to
suggest that the entire music industry will not be affected by
Problem for Regressions. Another individual-level data
problem is that people who download music on P2P systems may be
more likely than other individuals to buy music. This issue
presents a problem for regression analysis because it can
artificially skew test results. Thus, regressions could "falsely"
indicate that the impact on music purchases is higher or lower than
it really is.
- Prior-Year Sales
vs. Future Sales. Studies that estimate the impact of P2P
on album sales use data that reflect current market conditions.
These studies do not have clear implications for the future of the
music industry because the future market is likely to be vastly
different from today's market. In today's market, most music
consumers do not make their purchases on-line -- a fact that is
likely to change over time.
The Future Market for Music
last bullet point -- that the future market for music is likely to be
quite different from today's market -- is vital to understanding the
P2P debate. In 2003, the U.S. music industry reported annual sales
of almost $12 billion. Nearly all of those sales (about 90 percent)
occurred in stores. Sales through mail order record clubs currently
represent only about 4 percent of annual sales. Internet sales,
though growing, still account for only 5 percent of the total. (See
Chart 1.) Music sales over the Internet are likely to be more
plentiful in the coming years, but Internet commerce for all types
of goods is still in its early stages.
U.S. Department of Commerce reports that, at the start of 2002,
approximately 143 million people (54 percent of the U.S.
population) were Internet users. Commerce also reports that most
individuals (80 percent) still use the slower "dial-up" connections
rather than the faster "broadband" connections -- a finding that is
particularly relevant in explaining the pervasiveness of music and
movie downloads. Among all Internet users, 45 percent report that
their main on-line activity is e-mailing and/or instant messaging,
and 21 percent report making on-line purchases. This report also
shows that Internet use is higher among younger people and that
younger individuals who use the Internet are likely to continue to
do so as they age.
current trends continue, most music consumers (in, say, 2020) are
likely to make their purchases on-line. Consequently, not only is
the delivery of the product likely to change, but the product
itself is likely to transform. The full-length CD format has been
the overwhelming favorite of music consumers for many years, rising
from 58 percent of total music sales in 1994 to almost 90 percent
by 2003. (See Table 1.) To sell these CDs, physical copies are
made, packaged, and shipped to stores.
the other hand, to sell a digital file over the Internet, one
original has to be placed on a hard drive. There is no additional
copying, packaging, or shipping because the original serves as the
"master" copy for all customers. Consumers can simply access the
Internet and download their own copies of the song to their hard
drives -- without leaving the comfort of their favorite computer
Still, until most consumers use the
Internet to make purchases, it is unlikely that the digital format
will overtake the full-length CD format. Instead, in the
environment that is likely to exist for several more years, most
music consumers will choose between buying a full-length CD or
downloading individual songs. This choice is very different from
the one that future consumers will have to make, and this
difference is central to why Internet file sharing poses a serious
threat to the music industry's future.
threatens artists' ability to sell their music through digital
downloading because the digital files available from sellers are
virtually indistinguishable from those available on the
file-sharing services. Economists refer to these types of goods as
perfect substitutes, reflecting the fact that one digital file (the
copy made available by the seller on the Internet) is a nearly
perfect replacement for the other (the copy made available by the
file sharer). It is a basic tenet of economic theory that, when
choosing between two such goods, consumers will choose the one that
the future, if most music consumers choose between for-sale
downloads and those available through file-sharing services, it is
difficult to argue that many will choose to pay for their digital
copy. Surprisingly, file-sharing proponents often claim that the
music industry has to "change its business model" to adapt to the
new P2P environment. When the new environment forces a business to
compete with perfect-substitute goods that are being given away,
the best way to adapt is probably to exit the industry.
Currently, the long-term profit of a
downloading Web site depends on the ability to outsell competitors
that do not charge for their product. The case can easily be made that
digital downloading will never become the preferred method of
selling music if file sharing is allowed to continue unabated.
What, if anything, should be done about
Internet file sharing? Can a compromise be reached that maintains
the important balance between artists' incentive to create and the
public's access to these goods?
What Should Be Done?
Copyright owners should be able to protect
their intellectual property against digital theft. There have
already been a number of lawsuits against heavy users of P2P
systems. These lawsuits can and should be pursued vigorously.
Existing laws also provide remedies for those who contribute to
infringement, such as P2P operators -- although there is considerable
litigation about how and when such contributory liability can be
Policymakers can help to clarify rights by
amending the law so that making copyrighted work available to the
general public on the Internet is clearly an infringement and by
allowing the Department of Justice to bring civil suits. Any
changes in the law should be narrowly targeted, however, and should
focus only on those who actually misappropriate protected works.
Some current proposals, while perhaps well-intended, appear to
swing too broadly.
bill -- S. 2560, introduced by Senator Orrin Hatch (R-UT) -- would make
liable anyone who "intentionally aids, abets, or procures" a
copyright violation. This language could cover a huge range of
legitimate activities. Intel pioneer Les Vadasz argues that these
prohibited "activities" could even cover the production of
microprocessors used to power PCs.
Similarly, regulation of devices and
software should also be rejected. While technology mandates could
reduce unauthorized copying, such rules would also stifle
innovation. Whatever happens in Washington, the ultimate solution
may be a private one, with copyright owners using new technologies
to make unauthorized copying of works more difficult.
Economic theory suggests that P2P file
sharing will decrease album sales, and several new studies show
various levels of support for this prediction. Isolating the impact
of P2P on previous album sales, however, says very little about the
music industry's long-term viability if Internet file sharing
continues unabated. Internet file sharing threatens artists'
ability to sell their music through digital downloading because the
digital files available from artists are virtually
indistinguishable from those available on P2P services.
substitutable nature of the two products is decidedly more
important for the future of the industry, when most consumers are
likely to make their purchases on-line. Consequently, the case can
easily be made that digital downloading will never become the
preferred method of selling music if file sharing is allowed to
Making copyrighted material instantly
available to the world without the owner's permission is stealing.
The challenge for policymakers is to curtail this theft of
intellectual property without limiting legitimate activity or
chilling technological innovation through regulation.
Norbert J. Michel, Ph.D., is a Policy Analyst
in the Center for Data Analysis at The Heritage