A Grand War for A Small Payment

A willingness to pay to use a copyrighted material creates a potential for copyright holder to reap financial benefits. The payments, however, sometimes could be so insignificant (de minimis), that the cost of collecting them dwarfs the payments themselves. Copyright holders have long relinquished such de minimis payments. However, as I will document in the first part of the blog, technology has enabled copyright holders to collect such de minimis payments with lower or negligible cost. In the second part of the blog, I will explain the apparent paradox that copyright holders are willing to wage a grand war for de minimis payments.

De Minimis is obsolete

One source of missing de minimis payments is small scale “infringement”. Some infringements, like distributing a chapter from a book for classroom usage, are allowed under fair use. Additionally, as a practical matter, copyright holders will not choose to pursue de minimis infringement, even if it is illegal---“the recovery might be de minimis, so that no one have any incentive to sue.”[1] Even if a user is willing to pursue a license, there is not enough money for the licensing agent to manage such requests.[2] Technology has made collection of such de minimis payments cheaper. Consider the case of YouTube, where Content ID automatically detects matching between User Generated Content (“UGC”) and copyrighted material, insignificant the copying might be. In the past, copyright holders will never discover small infringements, or even when they do discover, they would not go after such small infringements; now technology has allowed them to monetize, or block such de minimis infringement. (The fact that YouTube is able to take a large share of monetized value is a separate issue: it concerns Google’s unfair monopolistic behavior.)

Another source of missing de minimis payments is the limited commercial life of copyrighted material. Most books, for example, have a very limited commercial life. Though they are still in copyright 60 years after publication, it is most likely that they are out of print. Though there are still sporadic demands for such books, authors were never able to reap such benefits due to the high fixed cost of printing---it is economically infeasible to print a book for a small number of copies. Now consider the settlement of Author’s Guild vs. Google. Books that has reached its end of commercial life, are now infused with a new commercial life: readers can purchase digital access to out-of-print books; institutions can buy access to Databases containing out-of-print books; and advertisers can pay to place ads on Google Book Search. All these payments will be split between Google, publishers, and authors, with the majority (70% of net profit) goes to publishers and authors. In summary, technology has enabled publishers and authors to monetize in ways that were not possible in the past.

Why Fight a War over De Minimis 

It is revealing to note how much effort publishers and Authors’ Guild (AG) put into collecting such de minimis payments, every penny of it. First, the whole negotiation took two and a half years. Second, the ultimate settlement went into great lengths to insure that publishers and AG get every penny out of it: From the determination of optimal prices, to running “Google Tests” to choose the best preview modes. The goal is simply to maximize “sales and revenues”. They did leave some consumer surplus on the table, but this is not inconsistent with monopolistic profit maximizing behavior (except in the case of first degree price discrimination, which is only a theoretical curiosity, profit maximizing monopolies will not be able to extract all consumer surplus).

It is misleading to call such payments de minimis. It is not de minimis for big publishers and AG, who will benefit from a huge collection of books: though payment on each individual books is small, it adds up. However, it is de minimis for individual authors. How many digital access can an author of an out-of-print book realistically sell each year? When the advertising fee, after publishers and AG take a cut, is divided among so many copyrighted material, how many cents can an author realistically expect? This potential income is de minimis in another sense: from an ex ante point of view (before the author writes the book), such incomes, arriving so many years later, will be heavily discounted. Assuming a 5% discount rate, payment after 28 years (original term of copyright) will be discounted by 76.3% (one dollar is valued at 0.23). Thus, strengthening copyright protection to enable such de minimis payments to be extracted serves little to ex ante incentivize authors.

This mismatch between the insignificant ex ante incentivization and the whopping eagerness to extract the payments is not unprecedented. It was present when Congress extended the term of the copyright. Time inconsistency played a key role: Revenue from copyrighted material 70 years later might be a negligible 0.01% of the present value of a copyrighted material ex ante; from the perspective of 70 years later, it is a gigantic 100%. Owners of expiring copyrighted material have every incentive to extend their monopoly. Here in Google Book Search case, there is an additional problem. The key players shaping the policy, publishers and AG, not only fail to discount the revenue due to time inconsistency, but also benefit from aggregating de minimis payments. It is wealth from a thousand cuts.

---

[1] Goldstein, P. (1994). Copyright's highway: From Gutenberg to the celestial jukebox. Stanford: Stanford Law and Politics. P96

[2] http://zoekeating.tumblr.com/post/108898194009/what-should-i-do-about-youtube

Copyright Infringement and Type I/II error

 “It is more important that innocence be protected than it is that guilt be punished, for guilt and crimes are so frequent in this world that they cannot all be punished.”

--John Adams, defending British Soldiers involved in Boston “so-called Massacre”

 Motivation

When one thinks of copyright protection, one thinks of barring certain behaviors that violate copyright, like massively duplicating a movie and offer copies for sale. That view and impression is outdated. Starting with Universal City Studios Inc. v. Sony Corp. of America, copyright holders have increasingly used copyright protection as a vehicle for shaping product design, devices or platform. They exert influences in three ways: litigations (Universal City Studios v. Sony Corp. of America; Cahn v. Sony; Viacom v. YouTube.), regulations (Audio Home Recording Act; Digital Millennium Copyright Act), and agreements formed by private parties (User User Generated Content Principles). This shift in focus has shifted the power of determining and executing copyright disputes from the court to private parties. The result, so far, has been dire. This blog will focus on the agreement that shaped today's User Generated Content services, like YouTube.

User User Generated Content Principles(“UGC services”), agreed to by leading commercial copyright holders and UGC services, set the current framework for UGC services. Within this framework, copyright owners provide reference data (video footage or audio track) to which they “believe” to own copyright. Then UGC services then employ some matching technology to identify content that matches key elements of those reference data. Finally, UGC services will “block such matching content before that content would otherwise be made available”. The rest of the blog will focus on the problems of this framework, exemplified by YouTube’s Content ID system (“the System”).

Contrast this with a court handling a copyright case. The plaintiff has to prove two things: 1) that he has the right to the relevant portion of the work in question and 2) that the defendant has violated one of the “exclusive rights”. After that, 3) only if the defendant fails to come up with an affirmative defense, the court will issue injunction or grant damages. However, on YouTube, the System effectively becomes the “judge, jury, and executioner” of copyright disputes. In the rest of the blog, I will first point out the fallibilities of the System with respect to the three elements and the problems arising from that. Then I will propose a framework for thinking about this issue.1.

Fallibility of the System

Copyright ownership. 

This framework swaps the burden of proof with “good faith”.[1] This low standard of “proof” enabled fraudulent copyright claim. Additionally, even when one has a legitimate copyright claim to some content, he does not necessarily own every single part of the content. For example, when media companies broadcast some news, they will use some material in public domain, that is material with no copyright owner. The media companies have copyright to the overall news broadcast or comments, but not to those public domain footage. Everyone, should be free to use those footage. However, the System is not able to distinguish which part of the reference data is copyrightable, and when it finds other videos matches the portion of public domain material, it automatically makes the infringement judgement. This is exemplified by YouTube taking down NASA’s Mars landing clip and Lon Seidman’s video discussion of the landing.

Existence of infringement.

 The matching technology is, in the first place, imperfect. As any statistical procedure, it inevitably makes “spurious matching”. For example, a YouTube user called eeplox uploaded a video with only sounds of nature like bird calls. The System matches its audio track to a composition licensed by Rumblefish, a music licensing firm (Wired report).

Affirmative defense.

Whereas the System is fallible in the first two dimensions, it is incapable of respecting fair use. Works involving fair use, such as parody and critical review, usually remixes or resemble copyrighted material. However, the System does not understand fair use, and automatically finds infringement. A most ironic example concerns Prof. Larry Lessig, who posted a lecture video on the cultural importance of remixes. The system muted the lecture, because it uses excerpts of music owned by Warner Music (report on EFF).
Given the inadequacies discussed above, the power yielded by the System is huge. It can and often does automatically and block the content. One can dispute the block, but the accuser gets to block the video for 10 business days for free. This is in stark contrast to the way court handles copyright infringement—unless copyright ownership and infringement is proven, and fair use defense fails, the content would not be blocked for a single second.

A Framework

When making judgements, any system make both Type I errors (falsely classify legitimate material as infringement) and Type II errors (fails to catch infringing material). One trades off these two errors by making the system to be either more stringent (more type I errors and fewer type II errors) or less stringent. A rational decision maker should weigh the costs of making these two types error and adjust the stringency of the system accordingly.
What is the cost of type I error? Stifling creativity and censorship. What about type II error? Possibly loss of revenue to copyright holders. However, as is clear from the US constitution, the purpose of copyright protection is to give copyright holders some rewards to incentivize them to do creative work. Copyright protection is a means to an end (stimulate creativity) not an end in itself. Copyright holders are not categorically entitled to all possible rewards. Type II errors are a cost for copyright holders, but not necessarily to the society at large. The real cost of type II error emerges only if the erosion of reward fails to incentivize creative work. It is not obvious creator are primarily motivated by financial incentives (though intermediaries like media corporations certainly do): In fact, some musicians willingly give up their financial rewards: allow their fans to stream or download their works for free (see Zoe Keating's complaint of YouTube). Furthermore, psychology research has pointed out that financial incentive could demotivate creativity. Thus there are few arguments for tipping the balance in favor of over-vigilance, and creating a “copyright scare”. I will come back to this issue in a later blog.

Concluding thoughts

Can one expect private parties to sort out the issue? 

No. 

YouTube always adjusted their practice to serve their business priorities, not public interest. In the past, when it was optimal to attract infringing material to mobilize their service, it chose intentional negligence. Now, its business priorities have shifted. It want musicians to make all of their music available on YouTube first. To do this, YouTube bundled this commitment with the privilege of the System (of near perfect copyright protection) (see Zoe Keating's complaint of YouTube).This privilege, comes at society’s cost (over vigilance), but the profit it generated is reaped by YouTube.

Note:

This change in business priorities might seem strange at first sight, so it deserves a careful explanation. In the beginning, when YouTube started, big media companies were unwilling to to put their contents on YouTube or online in general. For one things, they fear increased piracy risks. Second, they are not willing to let some third-party be cut into the distribution business, interrupting their vertical integration (an anti-trust issue, but no time for it now). Third, YouTube was just a small start up then, and there is no way big media companies will want to sign any contract with YouTube. Given the three reasons, it will be impossible for YouTube to get those contents in any legitimate way. The only solution is to let users upload pirated material so that YouTube can attract users. In fact, one of YouTube founders himself uploaded such material.
Now, media companies take it as a given that many media contents will be distributed online by third parties. The business question becomes how to attract them onto my platform. Due to network effects, a platform with the best and most inclusive content will attract the most viewers, and this in turn make the platform more attractive. Google is a big players, but so is its competitors, like Amazon. As a result, Google has adopted carrot (over vigilance on copyright if you join us and have content ID) and stick (negligence if you do not join us) tactic.

[1] Paragraph 3(g) of Principles for User Generated Content Services.

E-Commerce ---Beneficial or Destructive?

Alibaba has got much attention and controversy since it IPO---luxury brands have been suing Alibaba for its tolerance of fakes (link 1, link 2); media has been bearish on Ali, and it has even encountered obstacle from Chinese regulators. Some of the controversy is more grass-root. An open-letter from a consumer finds fault with Alibaba, and criticizes almost everything Ali does. This open-letter has been shared mostly on social media like wechat and weibo (equivalent of twitter), and has gained pretty good number of readers. So does the criticism hold water?

First Look at Price competition

The main criticism directs itself at price competition that Alibaba is promoting. Not inconsistent with our intuition, online platform has made prices more transparent, easier to search and compare prices, putting downward pressure on markups. This pushes sellers to sell closer to cost. The author argues that if the economic growth is stimulated by lower prices, there is no value, because it represents a zero-sum game between manufacturers. I think this is a stupid argument. The ultimate concern is whether consumers benefit--and I think consumers do benefit from lower prices. The whole idea of promoting competition is to reduce prices, especially monopoly pricing, which we think is inefficient and induces dead-weight loss. More intense price competition, exposes the relative strengths and weaknesses of different manufactures, distributors and retailers, allowing consumers shift from less efficient producers to more efficient ones. Less efficient producers will be forced to shut down or improve their efficiency. This is a good thing. It is like evolution, selecting out fittest to serve the demand. It would be a waste if we still rely on hugely inefficient producers if there are more efficient ones out there, simply because we do not know about them. Also, it gives incentive for people to get more efficient. State monopolies during the early years' of China's founding deteriorated dramatically in terms of efficiency, mainly because they have no competitors. I think most Chinese people still remember that painful history. The same logic applies to distributors and retailers. If an item could be sold online without taking up physical space in a huge department store, then be it. It is much more efficient. The physical space could be released for something else, like a cafe, or barbers. Or at least it will decrease the demand for real estates, resulting in lower rents which is passed on to consumers as lower prices.

"Ruinous" Competition?

 Ruinous competition has been a favorite argument when one wants to criticize competition. Yes, we understand "some" competition is good, but we just have "too much competition". What is "too much"? They like to point to casualties, like those who lose their jobs or gets displaced. Unfortunately, that is how our progress comes. An over-quoted quote from Schumpeter concisely describes the process of "creative destruction":

The process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one"

Yes, destroying old ones. If we do not let go of the old ones, where can we find a place for new ones? There will be winners and losers. The fact that we have losers is not evidence that the competition is ruinous as a whole.
As a consequence, the anti-trust regulation in US is for“the protection of competition, not competitors", a point first made in the Supreme Court Case Brown Shoe vs. The United States, and recently emphasized again in United States vs. Apple Inc.   
It is no coincidence that the same debate takes place in US as well, where e-commerce giant Amazon.com has been vigorously reducing prices on its website, bringing down many physical retailers. Judge Cote noted "The birth of a new industry is always unsettling...It is not the place of the Court to protect bookstores and other stakeholders from the vicissitudes of a competitive market". It is probably no-one's place to protect old industries from the force of creative destruction.
Of course US congress could be much more populist or merely corrupt. Due to lobbyist power from cotton farmers, US subsidize US cotton farmers, a clear violation of WTO agreements. Instead of letting go of this industry (clearly not essential for national security) and moving on to its competitive advantage, US government started paying 148 million dollars per year to Brazilian farmers so that it can keep subsidizing the cotton farmers. How ridiculous! What a perfect example of incumbents trying to insulate itself from competition and hurt the general public.

 Innovation?

What about the argument that "unless the industry can make a decent profit, it will not want to innovate". That is perhaps the only argument with some merit. It has been a speculation for a long time, and recently there has been a study that seems to confirm this intuition. The study is about Intel.  I have not read the research carefully enough to make a final judgement, but my first impression is that it is quite convincing. However, this is one industry and to extrapolate it to online retail takes several leaps of faith. For one thing, microprocessor industry is very capital-intensive, and R&D intensive. In fact, that is the reason why Andy Grove believed that the computer industry will change from a vertically integrated industry to a horizontally segmented industry. But look at what is sold on online? Mostly it is small everyday essentials, socks, clothes, wallet, cookware, hardly the type of items we associates with heavy R&D spending.
It is also essential to realize that IP protection is a double-edged sword. It could encourage as well as block innovation. My sense is that unless we are talking about extremely capital-intensive R&D, strong IP protection hinders innovation. Most of the innovation with everyday items are more of tinkering. Those things build on each other. Innovators will have some lead time to make a profit, which is usually enough to cover the tinkering cost and encourage people to do so. I have no systematic study to prove my point, but some anecdotal evidence helps.

(Aside: Even in high-tech industries, lack of competition is not always a great thing. AT&T before Judge Greene's breakup, was a strong monopoly. Not coincidentally, it also argued that its monopoly would leads to a more "orderly and stable" market, allowing it to better serve "the greater good". While it did have some innovations, it did also stifle a lot of innovation for fear that those innovations would threaten its monopoly power)

Caveats--Information Asymmetry

A final point I want to address concerns those "fake items" or "pirated items". Everyone understands the LV or Gucci on Taobao is fake. But we buy them. because it satisfies our vanity, and they have nice designs. So the "pirating" is not to "confuse" consumers per se, but rather to freeride on brands in terms of design and popularity. Design is not copyright-able, so Alibaba is only infringing on the trademark value of those brands. If those brands are built on vanity and marketing ploys, do we think protecting brands will matter much for economic growth? Of course, it is a beg-thy-neighbor problem, as our gain probably comes from the loss of those brands. But gain and loss relative to what? I am not of the view that international regulations are completely fair in this regard. Protecting luxury brands not based on true quality differential but on marketing distortions, is hardly justifiable for me.
A related point is on quality. I think quality issue will resolve by itself. It is not a problem of the e-commerce. It is a problem of any starting retail channels. Back in the days when China first opened up, we get low-quality goods from physical stores and had no way telling them from good ones. As e-commerce platform evolves, it will solve this problem. The reason is simple. If a platform does not solve this problem and consumers suffers, they will leave the platform and moves on to another platform that does a better job at solving information asymmetry. Or they might just shop from physical stores entirely. Once again, free competition is the core of this process.

Conclusion

This is not a battle. This is a war between incumbents and disrupters empowered by internet. Whether it is fintec, Uber, AirBNB, or e-commerce platform, it is disrupting the old ways of doing things, taking someone else's cheese. Instead of moving on to find new cheese, incumbents are now increasing mobilizing popular sentiments (eg. taxi drivers assaulting Uber drivers) or its political clout (Uber in NYC and AirBnB in San Francisco). This is dangerous. It is blocking the creative destruction that benefits all, but destroys those fat cats.