7. Music Compact Discs
7.1 Market Structure
In many ways the structure of the Compact Disc (CD) market is similar to that for books. Most of the mainstream products are produced overseas with distribution controlled in New Zealand by a domestic agent. There are a number of separate copyrights in each work and thus different royalties payable.
7.2 Expected Impacts
The discussion of the expected impacts focuses on how the theoretical arguments presented in section 3 fit into the specific market of musical compact discs. The arguments are developed from those presented in section 3 , with further detail provided by interviews with market participants, overseas literature and a search for data in New Zealand. The key source of international literature comes from the Prices Surveillance Authority (PSA) in Australia which undertook an extensive analysis in support of its view that parallel importing would be beneficial for consumers of sound recordings. A summary of the arguments presented for and against parallel importing in Australia are provided at appropriate points from an article by Davison (1992).
The culmination of the analysis of the Australian market for sound recordings is the Copyright Amendment Bill (No.2) 1997 which gives effect to the decision of the Australian Government to allow parallel importing of sound recordings. The explanatory memorandum to the Bill states the impact of the amendment will be high and will result in:
- "Increased competition between local and overseas suppliers of sound recordings.
- Larger number of titles and suppliers available to local retailers.
- Lower wholesale prices for sound recordings.
- Retailers will be more able to compete with sales of sound recordings over the Internet.
- No increase in compliance costs."
In acknowledgement of the potential for increased access of pirated products, the Bill also contains a revision of the penalties for selling or trading in pirated goods as an additional deterrent.
7.2.1 Innovator
The return to the innovator of the music is unlikely to be significantly affected any change in the parallel importing restrictions in New Zealand. As with books the major impact is likely to be on the decision as to whether to introduce new products into the New Zealand market.
International Conventions
The system of copyright protection for sound recordings is more complicated than that for books. Different international conventions provide protection for the musical works and the sound recording itself. Some countries have not adopted the conventions covering both musical works and sound recordings and this can result in different treatments for titles in different countries and different returns to the innovators. Parallel importation from countries that have not signed up to the international conventions could result in lower returns to the innovator and may lead to a reduced incentive to innovate.
Royalties
There are a number of different royalties payable on CDs. In New Zealand, the composers' interest (i.e. recording and writing) accounts for about 8% of the price. There are concerns that parallel importation will lead to a reduction in royalty payments to artists. This could occur if the source of the parallel imported material is South East Asia, where royalty rates have been described as "artificially low". An increase the importation of titles from this region could reduce the overall return to innovators.
There are two issues that arise from this argument. Firstly, is a parallel importing restriction the best way to deal with the acknowledged problem of a low return to innovation from the sale of material in these countries? A parallel importing restriction is a second best solution and allows companies to maximise their returns in other parts of the world. Unfortunately, the first best solution appears to be very difficult to achieve. The lack of success in this area has not been for lack of trying.
Secondly, the question that has to be asked is whether such a reduction in return would impact on the incentive to innovate. This is a much more difficult problem. New Zealand is such a small market that any reduction in royalties payable from the sale of music here would be very small and is unlikely to impact on the decision to innovate by international artists or record companies.
The PSA analysis included a recommendation for "the government to reconsider the creation of a performers' copyright comparable to that provided for the makers of sound recordings." They felt that the current royalty system did not properly reward performers.
New Zealand Music
There is a great deal of uncertainty about the likely impact on the New Zealand music industry. One view was that the removal of the ban would reduce or eliminate the investment by the major record companies in the New Zealand music scene. However, other interviewees disputed that the level of investment was significant even with the ban in place. It was suggested that the small local record labels had a higher commitment to the New Zealand industry than the international agents. The influence of NZ on Air was also thought to be significant and would not be affected by the removal of the restriction.
Further to this argument is that if the investment is currently profitable, then changing the parallel importing restriction is unlikely to significantly change that. And if it is not currently profitable, then the local record companies are cross-subsidising local music to the detriment of the majority of consumers.
If the development of New Zealand music is a worthwhile goal in itself, is the parallel importing restriction the best way to provide this?
The local music arguments were dismissed by the PSA because they believed that (Davison, 1992, p.35):
- the increased quantity sold as a result of the price fall induced by parallel importing may increase the profits of local distributors;
- increasing demand for Australian recordings would justify continued investment in the local industry; and
- the commercial return to Australian music depends on international licensing agreements which would not be affected by the type of parallel importing restriction provided in the domestic market.
However, it must be noted that the PSA did also recommend the development of a levy based on sales of sound recordings to be used to fund the development of Australian music.
The Australian analysis also identified that royalties to domestic performers could fall if parallel importation occurred from the US, as the US has the lowest mechanical royalty rate in the world (Parliament, 1997, p.7). So New Zealand artists that are able to sell music internationally could face lower returns.
Piracy
One of the major concerns of the industry is that the distribution of parallel imports in the New Zealand market may hide the importation of pirated copies of the work. It is almost universally agreed that piracy undermines innovators' right to control the reproduction their work, and this is the view taken in this report.
The view expressed to us during the interviews was that pirated copies of original works were of such high quality that it was almost impossible to detect the difference between the pirated version and the genuine article. At present the New Zealand market is relatively free of pirated products because of the degree of control held by the local record companies over the distribution of the genuine product and the relatively unit high cost of producing the copies for such a small market.
If parallel imports were permitted, the industry believes it would not be able to distinguish between a parallel imported and therefore genuine copy, and a pirated version. The incidence of pirating is likely to increase under these circumstances, to the detriment of innovators and eventually consumers, as the incentive to innovate decreases.
The PSA in Australia dismissed this argument by observing that even under the current system of restriction it is difficult to detect pirated or parallel imported copies. Only where the retailer has never been supplied a legitimate copy of the work can the record companies identify infringing copies. Once the infringing copies are put alongside the legitimate copies, the ability of the record companies to detect them is negligible. So the PSA concludes "it is difficult to see why detection of pirate imports from legitimate records within Australia would be much more difficult under an open market than detection of pirate/parallel imports under a closed market" (Davison, 1992, p.37-38). For a large market such as Australia, this argument is relatively sound because pirated products could be domestically produced. In New Zealand, the vast majority of CDs are currently imported. If a CD is being imported by someone other than the legitimate distributor, then it is either pirated or parallel imported. Thus the PSA argument may be somewhat weaker in New Zealand as it is easier to detect pirate copies in a small market where the high unit cost makes domestic pirating unattractive.
Increasing the penalties for piracy are seen as an integral part of ensuring the success of parallel importing in Australia.
7.2.2 Domestic Agent
With the present restriction, most orders for musical CDs must go through the domestic agent of the international record company. Some parallel importing is tolerated by the domestic agents but if the order is for more than about 5 CDs the record company would tend to step in and threaten legal action under the Copyright Act.
As with the book market, the speed of distribution is an important element. The industry claims that most CDs can be "indented"15 within 7 days. However, other interviewees indicated that the time taken by domestic agents could be significantly greater than 7 days to fill some orders.
The industry is dominated by the "big 5" but there are a large number of other distributors that are the sole agents for a wide range of smaller record labels. One of these distributors suggested they would only enter into a contract with an international record label is they could get exclusive distribution rights. However, it is not worth the legal costs to enforce that exclusive right against parallel importers.
The Australian analysis indicated that the profits of the music companies could decline as a result of parallel imports, as they faced increased competition from overseas suppliers. A similar result would be expected in New Zealand.
7.2.3 Retailer
Retailers in New Zealand have little choice but to use the domestic agent as their distributor for CDs. Although some parallel importing is tolerated, importation on the scale necessary for retailers to benefit is not permitted.
Large retailers with international connections may be able to make use of economies of scale in purchasing to parallel import products at a lower price than they can get from the New Zealand distributor. However, small retailers without those connections may be forced to pay more for their stock as they lack the market power to extract discounts from the international distributors.
Lower wholesale prices, easier access to titles released overseas and increased choice of suppliers were seen by the Australian Government as the main effects on retailers as a result of allowing parallel imports. Allowing retailers to compete effectively with the Internet was also seen as an important benefits of the changes.
7.2.4 Consumer
As described in the book market, there will be a range of users of CDs in the market. Each of the users will have different characteristics and subsequently different preferences. Radio stations are large consumers of CDs but they rarely pay for these, so price is not often an issue. Most retail consumers are much more price conscious, though for some availability is more important.
Price
As with the book market, we undertook a brief international price comparison using the Internet. We took the prices quoted on the Internet and converted them to New Zealand dollars at the current exchange rate. This gives us a crude comparison of the difference between the retail prices paid by consumers in other countries relative to New Zealand consumers. A full comparison is provided in Appendix G.
Table 4 International Price Comparison - CDs: Exchange Rates Taken from Week Ending 16/1/98 |
| Store | No of titles | Average price difference | Percent of NZ price |
|---|
| AB CDs (US) | 3 | 4.73 | 84% |
| CD World (US) | 11 | (4.45) | 115% |
| CDNOW (US) | 9 | 6.08 | 80% |
| Tower (US) | 10 | 4.78 | 84% |
| Reddog (Aust) | 9 | (2.72) | 109% |
| Music Stop (UK) | 6 | (9.07) | 131% |
| TeleCD (Ger) | 10 | (2.45) | 108% |
| Notes: | (1) Exchange rate assumptions: NZ/Aus 0.89; NZ/UK 0.34; NZ/US 0.57. |
| Source: | NZIER Internet search |
The price of CDs in New Zealand appears to be relatively competitive with the prices in some countries around the world but not others. They are cheaper, for example, than comparable products in Australia and the UK but significantly more expensive than the same product in Germany and some US retail outlets. At least some of this difference will be attributable local taxes and other factors. If a lifting of the parallel importing ban led to an equalisation of prices across countries, it is possible that prices in New Zealand could rise.
The exchange rate has a significant impact on the outcome of this analysis. To illustrate this we have presented the same price comparisons using a stronger New Zealand dollar.
Table 5 International Price Comparison - CDs :Exchange Rate Assumptions as Given |
| Store | No of titles | Average price difference | Percent of NZ price |
|---|
| AB CDs (US) | 3 | 6.79 | 77% |
| CD World (US) | 11 | (1.65) | 105% |
| CDNOW (US) | 9 | 8.04 | 73% |
| Tower (US) | 10 | 6.85 | 77% |
| Reddog (Aust) | 9 | (2.35) | 108% |
| Music Stop (UK) | 6 | (3.12) | 111% |
| TeleCD (Ger) | 10 | 0.19 | 99% |
| Notes: | (1) Exchange rate assumptions: NZ/Aus 0.9; NZ/UK 0.40; NZ/US 0.62. |
| Source: | NZIER Internet search |
With the stronger New Zealand dollar the price differentials increase. If transport costs of around $NZ8-$NZ10 for a single CD are added, the average difference is almost significant enough for consumers to justify purchasing CDs through this mechanism. For bulk purchasers, the transport costs per CD are considerably lower, making the Internet a viable and cheaper alternative to purchasing the same CDs in New Zealand.
However, we must highlight the caveats that are associated with this analysis. It is a simple comparison of the prices offered to consumers. It does not necessarily suggest that these prices would be prevail if parallel importing were permitted. There are a number of other factors which have to be taken into account when identifying the possible price with parallel importing. For instance, it is the wholesale price, not the retail price, that is the important indicator for a parallel importing scenario. Local taxes and customs duties must also be adjusted for. Transport costs and a margin for each party to the transaction must be built in.
Volume is a key ingredient to getting discounts on CDs. An organisation like The Warehouse which services a significant proportion of the market can demand a substantial discount from the distributors. Unconfirmed reports suggested that some retailers can buy titles cheaper from The Warehouse than they can from the New Zealand distributors. The volume discount is one reason why some local record labels believe that non-exclusive distribution networks would splinter orders and would result in lower discounts and therefore higher prices to consumers.
The Australian PSA analysis concluded that the returns on shareholders' funds in the recording industry were significantly higher than in all other industries with which those return were compared. It also showed that the prices for sound recordings in Australia were higher than in comparable countries such as the UK, the US, Canada and New Zealand (Davison, 1992, p.34). The estimates of the retail savings that consumers can expect range from $A1.60 to $A10 on the current price of $A30 (Parliament, 1997, p.9).
These conclusions were different to those presented by the Copyright Law Review Committee (CLRC) after its analysis of the market for sound recordings. It concluded that the prices paid by Australian consumers were not significantly above the prices paid in other countries, though they further claimed that removing the restriction would have severe detrimental effects on the industry. It was the PSA that pointed out the inconsistency of this statement as parallel importing would not occur if the prices paid by Australian consumers under the restriction were competitive with the prices of landed goods (Davison, 1992, p.34).
Different segments of the CD market will have differing sensitivities to price changes. As with books, consumers/users with different tastes and different requirements will react differently. For example, radio stations will be less price sensitive than consumers.
Availability
As with the book market, different segments may be affected differently. There was a wide variation in the estimates of the difference between the time material was released overseas and when it was distributed in New Zealand. One estimate suggested a 30 day delay while another interviewee suggested that with the trend of world wide release dates, New Zealand technically received some material the day before other parts of the world due to time differences.
However, for less main stream material it can be difficult to get access simply because the New Zealand distributor doesn't stock it. The distributors have dramatically improved their service in this regard and the indent service is quite efficient. Some retailers will still parallel import titles to fill customer orders and consumers with specific preferences for music still have the option of parallel importing for their personal use. Radio stations source the majority of their material from the local distributors but there is a small quantity that they have to search for themselves.
It was suggested that the range of CDs currently available would fall if parallel importing were permitted as parallel importers would focus solely on popular titles, and New Zealand based distributors reduced their holdings of other material to compete on price. One interviewee suggested that this scenario was unlikely given the diversification that has occurred in the radio market. The high number of radio stations have had to find their own niche and it is unlikely that a change in the parallel import restrictions would change listeners' tastes.
At present the main concern is the ability of users to source titles from small record labels. It was not clear that changing the restriction would impact on the availability of these titles.
The Internet was seen as a good source for information and for accessing hard to find material by most interviewees but some considered it was not a viable option for purchasing main stream CDs for most consumers. We would agree with this finding as most New Zealand households do not have access to the Internet. For the majority of CD purchasers it is currently not a viable alternative to purchasing from the retail network.
Pre-Sales Service
Without the sole right to distribute a CD in New Zealand, the investment in promotional activity is likely to fall. However, the degree to which domestic record labels currently invest in promotional activity is not clear. Also, the extent to which retailers would pick up this role if they were parallel importing the product is also not clear. It will be in the retailers interest to ensure that the products they are importing are promoted to ensure that there is sufficient demand to sell the stock they have purchased.
One interviewee suggested that radio is the major source of promotion for CDs and this was unlikely to be affected by a change in the parallel importing restriction.
7.3 Welfare Analysis
The main detriment is the potential deadweight loss associated with prices charged by sole distributors. From the selective price comparison we have undertaken we can conclude that, New Zealand consumers are paying relatively more for their CDs than consumers in some other countries but relatively less than others.
Other aspects of the sole distributors' service can also be poor, especially in terms of filling orders for material that is not in stock, though this has improved in recent years.
Using a method similar to the approach taken in the book market, we can estimate the size of the potential welfare gain from lifting the parallel import restriction. From the price analysis above we know that the average price of a CD in New Zealand is $30. Other consumers are paying approximately $6 less than this. We will conservatively assume that they can sell in New Zealand at $3 less than the current price.
Total household expenditure on Records and Tapes as shown in BERL (1997) is $155.9m. We assume that these are all likely to be CDs or at least the same price savings could be achieved for other music formats. Thus the volume of CDs purchased in New Zealand is estimated to be 5.2 million per annum. If we assume that half of these will fall in price as a result of the change in the restriction and that the price elasticity is 0.5, the deadweight loss is approximately $195,000.
Again, the same caveats apply to this estimate as to the estimate of the deadweight loss in the book market. It should be noted again that this is likely to be a conservative estimate as it does not take into account that the transfer to consumer surplus is not offset by a reduction in local producers' surplus.
Benefits of the restriction allowing exclusive distribution networks:
- dynamic efficiency - encouraging innovation, particularly in New Zealand music.
As highlighted above, this investment comes at the cost of cross-subsidisation from the importation of other material. If the investment in New Zealand music is not profitable per se, then resources would be more appropriately used for other purposes. - reducing free riding in pre or after sales services
Promotional activity in New Zealand by exclusive agents does not appear to be substantial. Other information sources apart from this promotional activity are available to the consumer. The reduction of such expenditure may thus enhance efficiency if it is not desired by consumers.
There does not appear to be a substantial investment in after sales service required. - easier detection of pirated goods
If a parallel importing restriction is in place than any CD that is not sold through the authorised channel is either a pirated copy or a parallel import. If both are prohibited it makes it easier to prevent the unwanted pirated goods from entering the market. However, this will only impact on the New Zealand market if the additional returns to the innovator encourage further investment in CDs. As the New Zealand market is small, any change in the returns is unlikely to influence the investment decision of an innovator. - increasing the range of CDs available
The impact on the availability of CDs in New Zealand was uncertain. Mainstream material is easy to get hold of now and that is unlikely to change if parallel importing is permitted. At present, titles from small labels are difficult to get hold of but this is also unlikely to change.
Summary
There are some legitimate concerns for record labels about the lifting of the parallel importing restriction in New Zealand. If wholesale parallel importing was sourced from countries which do not observe the international conventions on intellectual property rights, their returns could fall as more of their legitimate goods are sourced through non-royalty paying countries. This may also occur if parallel importing encourages pirated products as well.
However, in terms of net New Zealand welfare, the changes are likely to be positive. Prices are expected to fall and the availability of CDs is unlikely to get any worse. The degree of pre and after sales service is not significant, so consumers would not lose if this was curtailed.
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