Competing with Free: The Impact of Movie Broadcasts on DVD Sales and Internet Piracy

1. Competing with Free:The Impact of Movie Broadcasts on DVD Sales and Internet Piracy Michael D. Smith (with Rahul Telang) Heinz School of Public Policy and Management Carnegie Mellon University Workshop on Information Security Economics DIMACS January 19, 2007 Title, co- with Rahul Early work in progress. Comments welcome. For me, some of the most exciting research questions in electronic commerce revolve around how technology can create new products and change the nature of competition with existing products. We have seen the questions addressed in the literature usually in the context of competition between undifferentiated physical products, or products with some differentiation like cannibalization of new product sales by used product markets. One area where these sorts of questions have become particularly important recently is in the debate about High Definition Television Broadcast standards and the broadcast flag. The broadcast flag was proposed by the movie and television industries, ostensibly as a protection against cannibalization of DVD sales from digital piracy. The studios� are concerned that the combination of the increased integration of the computer and television demodulators will allow consumers to easily store, edit, and share high quality copies of movies on P2P networks. And, that without some form of Federally mandated copy protection, when a movie is broadcast in high definition over television it will significantly increase the supply of pirated copies of that movie and that, as a result, this will significantly cannibalize DVD sales and sales of other media. Essentially that they can�t compete with free digital copies of their content. The studios have gone so far as to say that without Federally mandated copy protection it will no longer be profitable for them to broadcast their movies and other high value content in over-the-air High Definition formats, and that instead they will choose to broadcast them solely on cable and satellite channels where some forms of copy protection are already in place. When these arguments were presented to the FCC, the Commissioners, possibly out of fear that a lack of high value content would slow the Nation�s transition to digital television, more-or-less accepted the industry�s statements about the risk of piracy and mandated copy protection technology, commonly known as the Broadcast Flag. The broadcast flag mandate was subsequently overturned by the courts on the grounds that the FCC did not have Congressional authority to enact the Broadcast Flag � and this authority is currently being debated in Congress. What Rahul and I found striking about this whole debate was that nowhere in has anyone empirically analyzed what happens to piracy or DVD sales after a movie is broadcast in High Definition or on cable. So that is what we set out to do. Specifically, we collect data from Amazon.com and two prominent BitTorrent trackers to analyze the impact of a movie broadcasts on both DVD sales and piracy. And, at the risk of spoiling the punchline for you, we find that while the movie industry is concerned about an increase in piracy and a decrease in DVD sales � exactly the opposite occurs in the data. When a movie is shown on television it significantly stimulates DVD sales, without having a statistically significant increase on either the supply of or demand for pirated copies of that movie. Very early research. Results preliminary. Trying to push this because it�s an ongoing policy debate. However, there are a lot of regressions and analysis that we would like to run but haven�t had a chance to. So we will beg your indulgence on that point. There are also probably many more analyses that we should be doing that we haven�t thought of, so we will beg your participation and interaction. If you have any suggestions or feedback, just stop me. Questions and comments welcome. So, with that as background, let me get to the agenda� Title, co- with Rahul Early work in progress. Comments welcome. For me, some of the most exciting research questions in electronic commerce revolve around how technology can create new products and change the nature of competition with existing products. We have seen the questions addressed in the literature usually in the context of competition between undifferentiated physical products, or products with some differentiation like cannibalization of new product sales by used product markets. One area where these sorts of questions have become particularly important recently is in the debate about High Definition Television Broadcast standards and the broadcast flag. The broadcast flag was proposed by the movie and television industries, ostensibly as a protection against cannibalization of DVD sales from digital piracy. The studios� are concerned that the combination of the increased integration of the computer and television demodulators will allow consumers to easily store, edit, and share high quality copies of movies on P2P networks. And, that without some form of Federally mandated copy protection, when a movie is broadcast in high definition over television it will significantly increase the supply of pirated copies of that movie and that, as a result, this will significantly cannibalize DVD sales and sales of other media. Essentially that they can�t compete with free digital copies of their content. The studios have gone so far as to say that without Federally mandated copy protection it will no longer be profitable for them to broadcast their movies and other high value content in over-the-air High Definition formats, and that instead they will choose to broadcast them solely on cable and satellite channels where some forms of copy protection are already in place. When these arguments were presented to the FCC, the Commissioners, possibly out of fear that a lack of high value content would slow the Nation�s transition to digital television, more-or-less accepted the industry�s statements about the risk of piracy and mandated copy protection technology, commonly known as the Broadcast Flag. The broadcast flag mandate was subsequently overturned by the courts on the grounds that the FCC did not have Congressional authority to enact the Broadcast Flag � and this authority is currently being debated in Congress. What Rahul and I found striking about this whole debate was that nowhere in has anyone empirically analyzed what happens to piracy or DVD sales after a movie is broadcast in High Definition or on cable. So that is what we set out to do. Specifically, we collect data from Amazon.com and two prominent BitTorrent trackers to analyze the impact of a movie broadcasts on both DVD sales and piracy. And, at the risk of spoiling the punchline for you, we find that while the movie industry is concerned about an increase in piracy and a decrease in DVD sales � exactly the opposite occurs in the data. When a movie is shown on television it significantly stimulates DVD sales, without having a statistically significant increase on either the supply of or demand for pirated copies of that movie. Very early research. Results preliminary. Trying to push this because it�s an ongoing policy debate. However, there are a lot of regressions and analysis that we would like to run but haven�t had a chance to. So we will beg your indulgence on that point. There are also probably many more analyses that we should be doing that we haven�t thought of, so we will beg your participation and interaction. If you have any suggestions or feedback, just stop me. Questions and comments welcome. So, with that as background, let me get to the agenda�

2. Competing with Free: DIMACS - Jan. 19, 2007 2 Motivation Movie industry has long believed that TV broadcasts substitute for media sales Universal v. Sony �Betamax� (H)DTV & Computers Movie industry more recently has argued (H)DTV broadcasts may serve as source of pirated material �Broadcast Flag� copy protection in DTV

3. Competing with Free: DIMACS - Jan. 19, 2007 3 Hines Ward Touchdown (NTSC) Hines Ward scoring the game winning touchdown at the Super Bowl. Pretty nice.Hines Ward scoring the game winning touchdown at the Super Bowl. Pretty nice.

4. Competing with Free: DIMACS - Jan. 19, 2007 4 Hines Ward Touchdown (HDTV) Hines Ward in HD. You don�t have to be a Pittsburgh Steelers fan to appreciate the differenceHines Ward in HD. You don�t have to be a Pittsburgh Steelers fan to appreciate the difference

5. Competing with Free: DIMACS - Jan. 19, 2007 5 Industry Concerns [***TRANSITION: Industry worried that its not only academics who will have an easy time of copying pieces of broadcasts � but that pirates will also be able to easily make copies***] Viacom of course owns CBS Disney/ABC & MPAA make similar comments before Commission Note that Viacom was arguing that they would move their content to Cable � that would be more profitable to them.[***TRANSITION: Industry worried that its not only academics who will have an easy time of copying pieces of broadcasts � but that pirates will also be able to easily make copies***] Viacom of course owns CBS Disney/ABC & MPAA make similar comments before Commission Note that Viacom was arguing that they would move their content to Cable � that would be more profitable to them.

6. Competing with Free: DIMACS - Jan. 19, 2007 6 Movie Industry Business Model DVD Sales make up 46% of studio revenue from movies ($18.9B). 2.5 times greater than revenue from theater (18%) 80% of revenue goes directly to studio (Unions take 20%) Studio exec: �Un<bleep>ing believable deal� DVD introduced in 1996, 2004 penetration 80% Time Warner�s movie library appreciated by $7 billion from 1996-2004 (Epstein 2005) Licensing makes up 28% (free TV) and 8% (Pay TV) of revenue Movies licensed to networks for ~ $3-15 million Emerging digital download market (e.g., iTunes Movie Store) Surprised to learn DVD dominates all studio revenue. And this revenue translates into profit because the studios negotiated a sweetheart deal with the various unions early in the development of the DVD standard. To quote a studio exec I spoke to�well to paraphrase�an un-bleeping-ing believable deal. Emerging Digital download market. Also important to point out that the remainder of the studio�s revenue � 36% � comes from licensing to free TV (28%) and pay TV (8%). Theater revenue 18% In 1950, theater revenue was 100% of movie revenue. Now it is 18%Surprised to learn DVD dominates all studio revenue. And this revenue translates into profit because the studios negotiated a sweetheart deal with the various unions early in the development of the DVD standard. To quote a studio exec I spoke to�well to paraphrase�an un-bleeping-ing believable deal. Emerging Digital download market. Also important to point out that the remainder of the studio�s revenue � 36% � comes from licensing to free TV (28%) and pay TV (8%). Theater revenue 18% In 1950, theater revenue was 100% of movie revenue. Now it is 18%

7. Competing with Free: DIMACS - Jan. 19, 2007 7 Arguments Against Broadcast Flag Could curtail consumer�s fair use rights Potential to stifle innovation Potential to confuse consumers Potential to increase equipment cost Difficulties in incorporating �not user modifiable� requirement into open source community Broadcasters given free access to public spectrum (in exchanges for using it in the public interest) Unlikely to reduce piracy MAKE POINT: FIRST 5 ALL LIKELY TO DELAY CONSUMER ADOPTION Won�t spend too much time on this slide. The main point is that the broadcast flag might not accomplish the goals of anyone. There are some strong arguments that the BF won�t in any meaningful way reduce piracy � which would mean it wouldn�t solve the problems the industry wants it to solve. There are some arguments that it will significantly curtail consumers� fair use rights � their ability to use the content in ways that they can today � which would be bad for consumers and there are arguments that if it confuses consumers, stifles innovation, and increases equipment cost, it could delay adoption of DTV, which would be bad for government. One can reasonably ask whether BF protections represent a local minima instead of an optimal point � and maybe we should check the second derivative before imposing it. I�m not advancing any of these arguments. I�m just making the more simple point that this might not be an entirely benign solution � and could very well end up hurting both consumers and government, which not helping industry in the way it was intended to help.MAKE POINT: FIRST 5 ALL LIKELY TO DELAY CONSUMER ADOPTION Won�t spend too much time on this slide. The main point is that the broadcast flag might not accomplish the goals of anyone. There are some strong arguments that the BF won�t in any meaningful way reduce piracy � which would mean it wouldn�t solve the problems the industry wants it to solve. There are some arguments that it will significantly curtail consumers� fair use rights � their ability to use the content in ways that they can today � which would be bad for consumers and there are arguments that if it confuses consumers, stifles innovation, and increases equipment cost, it could delay adoption of DTV, which would be bad for government. One can reasonably ask whether BF protections represent a local minima instead of an optimal point � and maybe we should check the second derivative before imposing it. I�m not advancing any of these arguments. I�m just making the more simple point that this might not be an entirely benign solution � and could very well end up hurting both consumers and government, which not helping industry in the way it was intended to help.

8. Competing with Free: DIMACS - Jan. 19, 2007 8 Potential to Confuse Consumers

9. Competing with Free: DIMACS - Jan. 19, 2007 9 Piracy Impact? Doesn�t cover legacy equipment Broadcast Flag DRM easily broken Software HDTV decoders available today HDTV unlikely to be only source of HD content at time of broadcast Studio leaks (Byers et al. 2003) Weaknesses with HDMI interface Weaknesses with AACS copy protection (Blu Ray, HD-DVD) (Perry 2005) �Break once, break everywhere� Old decoders will still output unprotected stream. New equipment will output protected stream.Old decoders will still output unprotected stream. New equipment will output protected stream.

10. Competing with Free: DIMACS - Jan. 19, 2007 10 FCC Response Commissioner Adelstein: �They say without protection, high value content will not be made available on the broadcast medium. Given the circumstances and the potential harm to creators, it is appropriate to offer some baseline protection.� Commissioner Copps: �Given digital media�s susceptibility to indiscriminate mass online distribution, content producers may have significantly greater incentives to broadcast high-value content if there are in place at least basic protection technologies. Similar comments by other commissioners and various FCC documents

11. Competing with Free: DIMACS - Jan. 19, 2007 11 Empirical Evidence?

12. Competing with Free: DIMACS - Jan. 19, 2007 12 Research Questions What impact do movie broadcasts have on DVD sales? How does this differ across cable and OTA? What impact do movie broadcasts have on the supply of and demand for pirated copies of movies? How does piracy impact DVD demand? Why are these important questions? If OTA broadcasts serve as a substitute for later purchases, many of the movie studios plans to monetize their content through digital downloads and DVD season releases are put into question. However, if OTA broadcasts complement purchases, then these might be profitable lines of business. Also, the impact on the later marketability for a copyrighted product is one of the four key determinants of �fair use� in copyright law. If the market isn�t damaged by a use, much more likely that it will be found to be fair. Also note that DVD sales might simply decline from fair use time-shifting or space-shifting of movies � which is an allowed fair use of copyright from Sony v Universal. [***There are only two problems with getting answers to these questions: (1) how do you measure sales, and (2) how do you measure piracy***]Why are these important questions? If OTA broadcasts serve as a substitute for later purchases, many of the movie studios plans to monetize their content through digital downloads and DVD season releases are put into question. However, if OTA broadcasts complement purchases, then these might be profitable lines of business. Also, the impact on the later marketability for a copyrighted product is one of the four key determinants of �fair use� in copyright law. If the market isn�t damaged by a use, much more likely that it will be found to be fair. Also note that DVD sales might simply decline from fair use time-shifting or space-shifting of movies � which is an allowed fair use of copyright from Sony v Universal. [***There are only two problems with getting answers to these questions: (1) how do you measure sales, and (2) how do you measure piracy***]

13. Competing with Free: DIMACS - Jan. 19, 2007 13 Data All national movie broadcasts on over-the-air networks (ABC, CBS, NBC, FOX, WB/UPN) All movies broadcast on 4 most popular ad-supported cable networks (LIF, TBS, TNT, USA) Broadcast characteristics, Movie characteristics, DVD characteristics & sales, piracy supply & demand Nielsen Media Research viewership data July 12, 2005 to Nov 23, 2006 Excludes Christmas Holiday (Nov 23, 2005 - Jan 1, 2006) 638 broadcast movies, 779 DVDs Cut data in November to avoid any peculiarities associated with the Christmas season.Cut data in November to avoid any peculiarities associated with the Christmas season.

14. Competing with Free: DIMACS - Jan. 19, 2007 14 Data: Sales & Piracy Sales: Amazon sales rank (hourly 14 days before & after) Q = a*Rankb (Brynjolfsson, Hu, Smith 2003) Piracy: piratebay.org, mininova.org, (spytorrent, torrentspy) Current �seeds� (sharers) Current �leechers� (downloaders) Current cumulative downloads Category (e.g., DVD Rip) and date posted

15. Competing with Free: DIMACS - Jan. 19, 2007 15 Estimation Models Impact on DVD Sales X: time periods before and after release (interacted with viewers) Product Level (ASIN) Fixed Effects ? Impact on Piracy {seeds,leechers,downloads}ij= ?Xij+?ln(tracker age) + ?ij X: time periods after release Tracker Fixed Effects No production function: both new and used quantity available for sale are fixed at the time of the sale. This follows Goolsbee and Chevalier. The number of books printed is fixed at the time of the sale. We see no evidence that Amazon is trying to jigger their prices based on used prices. Random effects assumption is that the individual effects that are incorporated into the error term are uncorrelated with the explanatory variables. This assumption (that the errors are uncorrelated with the explanatory variables) can be tested with a Hausman specification test to compare the parameters estimated using the fixed-effects model to the parameters obtained using the GLS estimates from the random-effects model.No production function: both new and used quantity available for sale are fixed at the time of the sale. This follows Goolsbee and Chevalier. The number of books printed is fixed at the time of the sale. We see no evidence that Amazon is trying to jigger their prices based on used prices. Random effects assumption is that the individual effects that are incorporated into the error term are uncorrelated with the explanatory variables. This assumption (that the errors are uncorrelated with the explanatory variables) can be tested with a Hausman specification test to compare the parameters estimated using the fixed-effects model to the parameters obtained using the GLS estimates from the random-effects model.

16. Competing with Free: DIMACS - Jan. 19, 2007 16 OTA HDTV Sales Gains Explain how X-axis is coded Highest: Monsters Inc, Pirates of the Caribbean Black Pearl, Harry Potter For smallest sellers this is on the order of a sales increase of 10-20 units For largest sellers it is 2500-4000 Explain how X-axis is coded Highest: Monsters Inc, Pirates of the Caribbean Black Pearl, Harry Potter For smallest sellers this is on the order of a sales increase of 10-20 units For largest sellers it is 2500-4000

17. Competing with Free: DIMACS - Jan. 19, 2007 17 OTA HD vs. non-HD Gains

18. Competing with Free: DIMACS - Jan. 19, 2007 18 OTA HD vs. Cable Gains 5.4 times larger sales gain! 411% vs. 90% for cable5.4 times larger sales gain! 411% vs. 90% for cable

19. Competing with Free: DIMACS - Jan. 19, 2007 19 Extension: Random Effects Add movie, DVD-level effects to price & time dummies DVD: Amazon rating, num disks Movie: Duration, minutes edited, ln(gross rev.), IMDB rating Assumes random errors uncorrelated with RHS variables Hausman specification test on baseline model fails to reject Enhances promotion effect Controls have expected signs Higher sales gain if� �higher Amazon/IMDB rating, �more time edited from TV broadcast, �widescreen format, �more disks (insignificant)

20. Competing with Free: DIMACS - Jan. 19, 2007 20 Piracy Results: Daily Downloads

21. Competing with Free: DIMACS - Jan. 19, 2007 21 DVD Sales Gain with & w/o Tracker Percent gain per 100,000 viewers 4.7 million viewers on average for broadcast 1.3 million viewers on average for ad cablePercent gain per 100,000 viewers 4.7 million viewers on average for broadcast 1.3 million viewers on average for ad cable

22. Competing with Free: DIMACS - Jan. 19, 2007 22 Caveats and Limitations Not a policy impact study Does not preclude possibility that lack of broadcast flag causes some cannibalization (but not due to piracy) Increase in HDTV computer cards / broadband Internet penetration may change results Most serious if other HD piracy avenues blocked (industry, HDMI, AACS in Blu Ray/HD-DVD) Impact of piracy may be different for new(er) releases