Building A Brighter Future –Making AND Selling Great Music

August 12, 2005San Diego, California

Mitch BainwolCEO, RIAA

Retailers And Labels Are In The Same Boat

Touring MerchandisingPublic

PerformanceSales

Labels $$$

Publishers $$$ $$$

Songwriters $$$ $$$

Artists $$$ $$$ $$$

PRO's $$$ $$$

Retailers $$$

Big TakeawaysWe're finally on offense against illegal P2P. Grokster case provides moraland legal clarity. Even so, more work needs to be done.

Eliminating piracy - physical or digital - is not our goal. But we can containpiracy - and thereby foster an environment for retail to flourish.

Players in the music community need to pull together to sharply pivot into the new world. We all must bend, adapt and experiment.

User lawsuits are working. We will maintain our resolve and enhance deterrence.

Burning is becoming a bigger problem than P2P. The root challenge though is identical.

Our future isn’t binary. It isn’t physical or digital; it's both. Consumption will rise - we need to find ways to monetize it.

Record stores are at the center of the fight. You are in closest contact with the consumers. You can make a difference.

Where Were We In The Fall Of 2003?• Image

• Sales Pattern

• Digital Prospects

• Positioning

How Did We Respond?What’s Our Present Status?How Do We Build A Brighter Future?

The 4 Questions

Where Were We?

Only Good News Was Our Image Wasn’t In The Tank

Source: VCR, Survey 9/29 – 10/4 2003 among Voters

Favorable Unfavorable

Congress 55% 41%

Movies 52% 39%

Music 50% 39%

National News Media 50% 42%

Pharmaceuticals 44% 51%

Tobacco 21% 74%

Kazaa, Grokster 18% 12%

Under Pressure

Where Is The Bottom?

For 2005, As of the first week of August, SoundScan reports album sales down 7.8% compared with 2004

600

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Mill

ions

of U

nits

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004Year

Total Units Shipped 1994 - 2004

Down 31%

Digital Prospects?

Promising but SpeculativeMajor Impediments to Pivoting Into Digital Space• Complex law / rights ownership• Artist reluctance (disaggregation / timing)• Interoperability• Existence / Awareness of legal alternatives• Fair use “theology” run amok• Absence of deterrence

Industry Positioned Poorly…

Bad Guys Instead of Victims

Dinosaurs / Business Model Problem

Culture Instead of Business

Piracy Cool, Stigma Free – Even Costless

All the Clichés Were Against Us

• “Music Wants To Be Free”

• “Anything Goes”

• “Genie Is Out of the Bottle”

Was There Harm?

Downloading Is Not Harmful"The Effect of File Sharing on Record Sales, An Empirical Analysis“ Oberholzer & Strumpf 2004

Downloading Is Harmful

"Pitfalls in Measuring the Impact of File-sharing” Liebowitz 2005"The Effect of Digital Technology on the Sales of Copyrighted Goods: Evidence from Napster" Hong 2005"Peer-to-peer Networks: Creative Destruction

or Just Plain Destruction?" Liebowitz 2005"On-line Piracy and Recorded Music Sales" Blackburn 2004"Piracy on the High Cs" Rob & Waldfogel 2004"The Effect of Internet Piracy on Music Sales: Cross-Section Evidence“ Pietz & Waelbroeck 2004"Measuring the Effect of Music Downloads on Music Purchases“ Zentner 2003

Which Study Enjoyed National Pub?

Oberholzer & Strumpf 2004“Study: File-Sharing No Threat to Music Sales” (Washington Post)

“Study: File downloads don't affect sales of CDs” (Boston Globe)

“Internet not to blame for slow music sales” (SF Chronicle)

“Music sharing doesn't kill CD sales, study says” (CNET)

“Happy Medium” Music and the Internet (ABC News, Nightline)

Perfect Storm

Generation of Kids• Love Music• Cool to Collect• Facile with Technology• No Money• NO Rules• A Million Excuses to Steal• Parents Happy They’re Home / Computer Safe• Broadband Coming of Age

How Did We Respond?

Lawsuits (Users)EducationPhysical Anti-PiracyGrokster (P2Ps)Messaging

Why User Lawsuits?

• Kids and Parents Didn’t Know the Law35% Illegal25% Legal40% Don’t Know / Refuse

• No Risk – No Deterrence

]_ 65%

10. "Be honest...have you ever seen a nicer spider hole than this?"

9. "Who's got a coat hanger -- this beard itches like a son of a bitch!"

8. "Anyone have a mint?"

7. "Is this about the illegal music downloads?"

6. "Am I going to be on 'Cops'?"

5. "Which describes me better right now -- 'haggard' or 'grizzled'?"

4. "How did you get past my impenetrable styrofoam brick?"

3. "Do I get the 25-million-dollar reward?"

2. "How's the war going?"

1. "Will you go easy on me if I tell you where Martha Stewart is hiding?“

Letterman’s Top 10 Questions Asked by Saddam Hussein When He Was Captured 12/15/03

Lawsuits

Education Worked: 35% - 25% before

65% - 10% almost overnight

Attitudes Shifted: “Should be Illegal” Improved 40 Net Points

Most People Thought Lawsuits OK

Deterrence Established

No Free Zone for Next Generation - Reoriented Expectations

P2P as share of broadband declined and is only up modestly during a period of phenomenal broadband growth

Bottom Line: Containment

P2P Share Of BroadbandHouseholds

Source: Pew Internet Project, NPD MusicWatch Digital

Broadband User Growth Compared With P2P Usage

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Education

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Government

ISPs

Universities

Artists

Government

November 6, 2003Dear Mssrs. Falco, Rosso, Yagan, Bildson, and Weiss, and Ms. Hemming,

We are writing to encourage you to voluntarily take the following three common-sense steps to reverse this troubling trend and help educate and protect P2P users.1. Provide a Clear, Conspicuous, and Meaningful Notice & Warning to Users about the Legal Risks of Using P2P Software 2. Incorporate Effective Copyright and Pornography Filters3. Change the “Sharing” Default Setting

Letter signed by: Senators Lindsey Graham (R-South Carolina), Dianne Feinstein (D-California), Gordon Smith (R-Oregon), Dick Durbin (D-Illinois), John Cornyn (R-Texas), and Barbara Boxer (D-California)

FTC

Congress

StatesGovernor Schwarzenegger Prohibits Use of State Resources for Illegal Downloading of Copyrighted Material"So many of the entertainment industry's talented musicians, actors, writers and programmers devote their careers to creating products that enrich our society. We need to do our part to protect the creative and intellectual property they work so hard to create for the rest of us." said Governor Schwarzenegger. "Today California is taking a stand against use of state resources for illegal downloading of this material and standing in support of the work of these talented Californians."

FBI

ISP Sensitivity Enhanced:Then…

“Exactly where and how to find the good stuff”

… And Now

“ * Copyright infringement liability: Using popular file sharing software like KaZaa, Limewire, Morpheus, Grokster or BitTorrent to download and share copyrighted music, videos, software and other materials, without the permission of the copyright owner is illegal, and the financial penalties and potential criminal liabilities can be significant. The fines for illegally downloading copyrighted material can be up to $150,000 per work-that is, for every song, movie or game-in addition to legal expenses in processing your case. The copyright law may also subject you to criminal liability in certain instances. “

Universities

Legal Options at Universities (‘03)

Today…

Cornell University

Middlebury College

The GeorgeWashingtonUniversity

University of Miami

Rochester Institute of Technology

University of Southern California

Wright StateUniversityDePauw University

Duke University

MariettaCollege

Ohio University

Purdue University

Tulane University

University of Colorado at Boulder

University of Denver

Wake Forest University

YaleNorthern Illinois University

University of Minnesota Penn State University Baruch College

Vanderbilt University

University ofNorth Carolina

University of RochesterUniversity of Wisconsin- Eau Claire

Trinity University

Texas A & M

Purdue University- Calumet

Eastern Michigan University

University of Tennessee

Western Carolina UniversityUNC, Wilmington

N.C. State University

Virginia Tech U. of Maryland

Drexel Rutgers U.

U. Of Delaware

Tufts

Purdue U-Ft. Wayne

*Adelphi University*Goucher College*North Carolina A & T State University

Lyon College

Henderson State University

Thomas College

University of California campuses:•Berkeley•Davis•Irvine•Los Angeles•Merced

•Riverside•San Diego•San Francisco•Santa Barbara•Santa Cruz

•Long Beach•Pomona•San Marcos•San Diego•Bakersfield

•Sacramento•Stanislaus•East Bay•San Jose•Monterey Bay

California State University campuses:•Humboldt•Chico•Sonoma•Maritime•San Francisco

•Fresno•San Luis Obispo•Channel Islands•Los Angeles•Dominguez Hills

•Northridge•San Bernardino•Fullerton

University of California*

California State University*

University of Missouri

Hofstra

Yellow stars denote campuses covered in the recently announced Cdigix opt-in partnership with UC and Cal State.

University of Washington at Seattle

Dirty Deeds Done Dirt Cheap

Physical Piracy

Challenge: Pirates Have Become More Sophisticated,

Even as “Barriers to Entry” Decline

Mass production of high quality counterfeit CDs

Links to organized criminal syndicates

Multiple venues for distribution:• Retail Locations

• Flea-markets

• Street Vendors

RIAA’s Response

Devote More Resources• Opened More Offices

Strengthen Leadership• New Director of Anti-Piracy Operations - Brad

Buckles (Former Head of ATF)• New Director of Investigations - Patti Galupo

Increased Searches / Warrants• Up 23% to 1649 in 2004

Collaboration with MPAA

One Way or Another

Anti-Piracy Highlights

Increased Seizure of Raw Materials for Counterfeiting

Seizures of Manufacturing Equipment Such As Computers, Burners, Scanners, and Copiers Up Over 50% for 2004

Renewal of the Retail Blitz campaigned aimed at retail establishments selling pirate product

Focus on major flea markets with 61 active investigations.

ResultsCounterfeit/Pirate Seizures (Cassettes, CDs, CD-Rs, Labels)

9.6 Million

5.8 Million6.9 Million

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Grokster Decision

More Than A CaseShatters the Complexities • “Garden Variety Theft” (Justice Breyer)• Sony doesn’t obviate secondary liability where

infringement actively encouraged

Speaks to Culture As Much As LawAudience: Downloaders / Elites / Parents9-0 Especially Powerful

I Think I Smell A Rat

Grokster – Supreme Thought:

“The unlawful objective is unmistakable.”or…

We can smell a rat when we see one!

Pre-Ruling, The Majority of Consumers Sided With Our Position…

Adults 18 - 54

Neither3%

MGM43%

Lean MGM7%

Lean Grokster8%

Don’t Know8%

Grokster31%

MGM – 50Grokster - 39

Source: Public Opinion Strategies

The Unanimous Decision Had A Big Impact on Attitudes

Age 18-54

June 2005 - After Hearing Both Sides

50%

39%

0%

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20%

30%

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50%

60%

70%

80%

MGM Grokster

+11%

July 2005 - After Hearing Court Decision

70%

20%

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70%

80%

MGM Grokster

+50%

Source: Public Opinion Strategies

Consumers See More Lawsuits As Both A Likely & Positive Outcome Of The Decision

Perceptual Map of Adults 18 - 54

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70%

3 4 5 6 7 8Perception of Outcome (1 Worst - 10 Best Scale)

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Industry more aggressive going after file sharing companies

More consumers will pay to download

Industry more aggressive going after file sharing individuals

Record industry more likely to invest in new and more artistsInnovation will be slowed

Kids will learn the right lesson

Positive Outcome, Low Likelihood

Positive Outcome, High Likelihood

Negative Outcome, Low Likelihood

Negative Outcome, High Likelihood

Source: Public Opinion Strategies

All Good, But…

For Broad Public, No Matter How Compelling the Story, It Hasn’t Been Heard Nearly Enough

56% Haven’t Seen, Read, or Heard About the Case

…Most Consumers Support Suing Illegal Downloaders, File Sharing Companies, or Both

34%

Sue Neither25%

Sue Both36%

Adults 18-54

Sue File Sharing Companies

4% Sue P2P Users

1% Don’t Know/ Refused

Source: Public Opinion Strategies

Consumers Make Little Distinction Based on Number of Files Downloaded

Adults 18 - 54

68% 65%

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70%

1000 Files 100 Files

Perc

ent A

gree

Source: Public Opinion Strategies

Over and Over

So What Does All Of This Mean?

We Need To Tell Our Story Over and Over AgainMessage Heard Loud and Clear by P2PsPublic Approval For User Suits• Ramp Up Numbers• Lower Threshold

Messaging

Rather than Old vs New, Tech vs Content, Plastic vs Digital…• Real Issue is Legal vs Illegal

Property Rights – Property Rights – Property Rights!We Are Morally Right; They Are Morally Wrong – Bad ActorsThey Cause Real Harm

• Economic

• Jobs

• Culture

What’s Our Present Status?

Cultural Signals

New Product Explosion

Leno

My Generation

But Have We Lost A Generation?

“If I told you I wanted a song, I could get it in three seconds. Not even having to download it myself – I could get it in three seconds from any number of sources.”

“I think it should be illegal, but I download because it’s something I do.”

“I’ll be downloading when I’m 50”

“…you can’t charge me $20.00 for a crappy CD that lasts 45 minutes long…”

“It’s not our responsibility to just stop downloading”

Quotes from college and recent grads during focus group June ‘05

Click Click Boom!

Digital Consumption Exploding…

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1Q '03 2Q '03 3Q '03 4Q '03 1Q '04 2Q '04 3Q '04 4Q '04 1Q '05 2Q '05Period

Cumulative Tracks Sold

Tracks Sold In Quarter

iTunes, Napster 2.0, and WalMart Music Downloads Launched

Rhapsody Launched

Launch of Yahoo Music Service & Grokster Decision

…Yet Remains A Fraction Of The Market

Consumer Spending On Recorded Music 2004

97.5% Other Distribution

1.7% Downloads 0.8% Subscription

It’s Not An Either / Or World!

Future Is A HybridDigital Consumers Are Big Physical Consumers

Digital Consumers Are Big Physical Consumers

Source: NPD

$95

$53

$92

$81

$78

$9

$48

$0

$0$20$40$60$80

$100$120$140$160$180$200

PaidDownloaders(past 2 years)

DigitalSubscribers

(past 2 years)

P2P Users (past2 years)

Buy CD's Only(13 years & up)

Estimated Music Spending (Last 12 Months)

Other Spending

Spending On CDs Only$148

$173

$87

$48

The Lines Are Crossing

June 2004 – Net Illegal

June 2005 – Net Legal

Age 18 - 54

More Adults Now Say They Have Downloaded Using Legal Services Than Free P2P

6%

13%

12%

10%

4%

5%

6%

7%

8%

9%

10%

11%

12%

13%

14%

June '04 June '05

Ever Used P2P

Ever Paid to Download

Source: Public Opinion Strategies

What Do We Know About the Habits of Today’s Fans?

Emerging Challenges?

Some Buy More, But Most People Are Buying Fewer CDs…

Source: The Taylor Research & Consulting Group, Inc.

28%

42%

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10%

20%

30%

40%

50%

More Less

All Ages Purchasing pattern

…With The Most Significant Decline Among The 16 – 24 Year Old Age Group

Source: The Taylor Research & Consulting Group, Inc.

28%

47%

0%

10%

20%

30%

40%

50%

More Less

16 - 24 Year Old Purchasing pattern

Music Acquisition Is Only AboutHalf Through CD Purchases

Source: NPD

}29% Burning / Ripping

How Music Was Acquired In The Past 12 Months (Dec 2004)

Paid Downloads

4%

P2P16%

Ripped (from others)

11%

Burned (from others)

18%

CD's51%

Key Point

Burning and Ripping Are Becoming A Greater Threat Than P2P

Burning Down The House

Burning Is A Real Problem

About 12% of Households Burn CDs

63% Burned 1 to 5 CDs In A Month

20% Burned 6 to 10 CDs

17% Burned More Than 10 CDs!

Source: NPD

•We have no objection to personal use burning

Top Burned Artists in April

Source: NPD

(MusicWatch Digital Apr.‘05)

# Songs Burned 50 CENT 7,144,000 MARIAH CAREY 2,829,000 GREEN DAY 2,593,000 METALLICA 2,568,000 THE GAME 2,426,000 THE BEATLES 2,069,000 EMINEM 2,019,000 LINKIN PARK 1,782,000 LUDACRIS 1,744,000 NELLY 1,561,000

How Do We Build a Brighter Future?

Specifics…

Pivot to New Products and Services

• DualDisc

• Kiosks

• Copy Protected CDs

Win The Message War

DualDisc

Combined CD / DVD On A Single Disc

Major Labels All Developing DualDiscs

Tremendous Consumer Acceptance and Interest

Releases include Bruce Springsteen, Rob Thomas, Kelly Clarkson, John Mayer and many others

Kiosks

Allow consumers to create their own mix CDs

Can be used to expand in store catalog offerings

Standardization Initiatives• Packaging• Media• Security• Reporting

Copy Protected CDs

Includes copy protection, secure burning capability

Capable for use with both Windows media and iTunes

Proven in Europe past two years, significant US rollout 2005 (Sony BMG)

Technology evolving to address consumer expectations

Win The Message War

We all need to be message ambassadors to win this culture war.

The Court has given us a gift - moral clarity has been established. Seize the moment.

We need to demonstrate adaptability to move debate beyond issues of “models” to the core questions of property and right versus wrong.

The Solution Depends on Everyone Doing Their Part

Music FansAppreciate and respect copyright lawEnjoy Music

ISPsEducate: what’s legal & illegal; advertise responsiblyCooperate with copyright owners

The Solution Depends on Everyone Doing Their Part

Recording IndustryMeet legitimate consumer demands; Foster legitimate online systemsWork with technology community; Educate

Congress / GovernmentHighlight and enforce the law; Protect U.S. Intellectual PropertyEducate and protect consumers

The Solution Depends on Everyone Doing Their Part

Artists & PublishersAllow for digital distribution of works

Technology CompaniesManage interoperability issuesEnable seamless consumer experiences

The Solution Depends on Everyone Doing Their Part

ParentsTalk to your children about what is legal activity onlineBe aware of kids’ online activity

File Sharing NetworksGo legitFilters for illegal material

The Solution Depends onEveryone Doing Their PartEducators

Teach importance of copyright; Basics of the law and Right v. WrongAcademic institutions should value “thought”

RetailersGet the message outSell only legitimate productsListen and respond to customers

I’m Optimistic About The Future

• Labels and retailers are experimenting to meet consumer expectations

• Kids increasingly are getting the right signals from their parents, ISPs and their schools

• Government is assuming a bigger role in enforcement and education

• Technology is making music more ubiquitous than ever –fostering demand

• Lawsuits and the Grokster decision, have clarified the law and affirmed the significance of our “property”

• Our music family has pulled together well to fight for our future