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Accepting Reality In China:

James P. ChesserProWorld

® Consulting Group

P.O. Box 50890Nashville, TN 37205

(615) 500-9599prc@proworld.com

Alternative Business Models for the Entertainment Industry

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Unpopular Premises:

China is what it is: It is not a U.S. state, possession, or territory; it has sovereignty over its own domestic and foreign affairs

We work as guests in China, at the pleasure of its people and government

To succeed in China we must be willing to listen, understand, and adapt

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Accepting Reality In China. . . . a Roadmap

I. Admit our bias: we’re comfortable with western copyright laws under which traditional business models & legal protection have developed

II. Acknowledge that the 21st Century western entertainment industry is one of looming Chaos; and the fate of the industry may be dependant on new models developed in China

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Accepting Reality In China. . . . a Roadmap cont’d

III. Understand the unique backdrop of China’s copyright system

IV. Know why China’s enforcement system fails to prevent physical piracy of entertainment

products

V. Know why China’s legal system (and perhaps our own) fails to prevent internet piracy of entertainment products

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Accepting Reality In China. . . . a Roadmap cont’d

VI. Fight Piracy with Alternative Business Models, initiated both Privately and Publicly

VII. Take the high road; use guanxi; use diplomacy & law but do not be dependent upon them; constantly reassess; be flexible, innovative, and profitable in serving China, as it is

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I. Western Copyright Laws under which entertainment business models & legal protections have developed

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I. Western Copyright Laws under which entertainment business models & legal protections have developed

In Article I, Section 8 of the U.S. Constitution, the Founding Fathers gave Congress the controversial power: “To promote the Progress of Science and the Useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.”

Monopolies, even for limited usage, were highly suspect in early America--it was, after all, a tea monopoly which sparked the American revolution. The 1790 U.S. copyright law best balanced, however, individual rights against the young Republic’s need to promote knowledge (i.e. science)

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I. Western Copyright Laws under which entertainment business models & legal protections have developed cont’d

Coupled with the First Amendment Right of Free Speech, an economy which emphasized commerce, private rights, individual liberty, and intellectual creation for mass consumption, ‘writings’ flourished in the U.S.

Copyright protection required no review for non-obviousness, novelty, or usefulness—only originality and ‘fixation’. But copyright could not apply to useful articles.

Simple definition of “writings” expanded to include new problematic technologies such as records & films, software, firmware, and semi-conductor chips

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• U.S. music copyright slowly adapted to include not only copying and transcriptions, but also performances (except for singers or artists), T.V. and radio broadcasts, synchronizations to video, mechanical reproduction (LPs, tapes, CDs), jukebox play, and digital downloads

• A complex infrastructure developed to protect statutory and common law copyrights in music; private collection agencies arose such as ASCAP, BMI, Harry Fox, etc to protect composers’ and publishers’ rights; strict civil and criminal penalties were enforced against infringers

I. Western Copyright Laws under which entertainment business models & legal protections have developed cont’d

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II. The looming Chaos of the Entertainment Industry in the 21st Century

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II. The looming Chaos of the Entertainment Industry in the 21st Century

Piracy—physical and internet—is the single greatest threat to the world’s entertainment industries

--See “The Recording Industry 2006 Piracy Report”, IFPI (2006)

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II. The looming Chaos of the Entertainment Industry in the 21st Century cont’d

Record companies have filed over 26,000 lawsuits since 2003 over file-sharing alone

--See, e.g. Virgin v. Thomas; MGM Studios, Inc. v. Grokster etc.

Piracy to films cost to L.A. County duplicating firms alone amount to over $5.2 Billion in 2005, and “potential for additional damage is enormous”

--”A False Bargain: L.A. County Consequences of Pirated Products”, LAEDC (2007)

source -- IFPI 2006 Piracy Rep.13

II. The looming Chaos of the Entertainment Industry in the 21st Century cont’d

Piracy has diversified into many different forms

• CD-R Piracy: Dominant fake disc format—40,000 burners seized in 2006

• Pressed CD Piracy--78 disc manufacturing lines seized in 2006

• Internet Piracy--Nearly 20 billion songs illegally swapped or downloaded

in 2005

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II. The looming Chaos of the Entertainment Industry in the 21st Century cont’d

And New Forms of Piracy Are Constantly Emerging

LAN FILE SHARING

DIGITAL STREAM RIPPING

MOBILE PIRACY

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II. The looming Chaos of the Entertainment Industry in the 21st Century cont’d

Piracy dissuades labels from using in-store and radio promo to reach customers; prevents budget recoupment; chills marketing

Record Label annual sales dropped $5 Billion and falling

losses to music publishers greater still

Losses to Artists are uncertain; due to superior bargaining power of labels, few artistsreceive regular royalties

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III. The unique backdrop of China’s copyright system

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III. The unique backdrop of China’s copyright system

No notion of intellectual property every developed indigenously in China

Economic system stressed agriculture and de-emphasized commerce

Ancient China was among the world’s most technologically and culturally advanced civilizations; but literary works were limited to small class of educated elites

No demand for inexpensive mass production and distribution of creative works

Copying did not occur on a broad scale as might be expected

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III. The unique backdrop of China’s copyright system cont’d

Confucianism which permeated life in China for two millennia was antithetical to the moral rights and economic values underlying copyright

Law maintained social order and protected the state, not western style individual rights that could be enforced against others or the state

Artistic works were a common heritage of all Chinese, and creative expression was an exercise in moral refinement and edification; it was not to be sullied by commerce in which people pitted moral development against immediate financial gain

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III. The unique backdrop of China’s copyright system cont’d

Foreign investment followed the Opium War (1839-42) and copying of foreign brands occurred for tax and marketing reasons

Literacy rates and printing technologies improved; copying abounded due to unique legal, cultural, or historical conditions

In 1949 Communist Party attempted to stimulate creation and reassure intellectuals, but pirating continued

Following 1966-76 Cultural Revolution intellectual debate and creative works atrophied; the legal system was all but obliterated

Piracy flourished

slogan of the Cultural Revolution20

Is it Necessary for a Steel Worker to Put His Name on a Steel Ingot that he Produces?

If not, why should a member of the intelligentsia enjoythe privileges of putting his name on his intellectual product?

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III. The unique backdrop of China’s copyright system cont’d

Following the Cultural Revolution China needed to modernize and open itself both culturally and economically to the world

It had no functioning legal system, intellectual property regime, or basis for foreign investment

It struggled, and still struggles, with massive competing interests: AIDs, unemployment, crime, divorce, disparity between rich and poor, pollution, agriculture…

Government needs the West; but fears unstable change; hunger; revolution

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III. The unique backdrop of China’s copyright system cont’d

As China attempts its colossal IP undertaking, Chinese demand for pirated products has never been stronger

China is home to the largest pirating problem in human history; and sits on a powder keg of an internet piracy explosion

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IV. Why China’s enforcement system fails to prevent physical piracy of entertainment products

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IV. Why China’s enforcement system fails to prevent physical piracy of entertainment products

1979—China signed the Agreement of Trade Relations with the United States

1980—China joined WIPO 1990—China enacted its first Copyright Law 1992—China enters MOU with U.S.A. Thereafter China signs Berne Convention, ratifies Geneva

Convention for Protection of Phonograms, and amends the 1990 Copyright law

2001—China enacts 2001 Copyright Law Amendment to bring it into compliance with TRIPS and WTO

2004—Chinese Constitution amended to provide citizens “inviolate right” to own private property

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IV. Why China’s enforcement system fails to prevent physical piracy of entertainment products

Article 1 of the 2001 Chinese Copyright law states that its purpose is to protect:

“ the copyright of authors in their literary, artistic, scientific works and the rights and interests related to copyright, of encouraging the creation and dissemination of works conducive to the building of a socialist society that is advanced ethically and materially, and of promoting the progress and flourishing of a socialist culture and sciences.”

This language reflects the very unstable tension between a collectivist socialist society, and a utilitarian private property economy

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IV. Why China’s enforcement system fails to prevent physical piracy of entertainment products cont’d

Is it realistic to expect that China can attain a level of copyright enforcement in less than two decades akin to that developed by the West over centuries?

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IV. Why China’s enforcement system fails to prevent internet piracy of entertainment products

A. Barriers To Effective Copyright Enforcement1. Battling Bureaucrats & Admin. vs. Judicial Issues2. Lack of Judicial Competence3. Local Protectionism, Bias, & Corruption4. Centralism5. Ineffective Criminal Penalties6. Economic Conditions7. Ideological Opposition to Copyrights by Public8. Other Competing Matters of State

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IV. Why China’s enforcement system fails to prevent physical piracy of entertainment products cont’d

B. Other Barriers Which Encourage Piracy

1. Censorship

2. State control of venues and production technology

3. Quotas

4. Tax policies

5. Currency exchange

6. Cultural Norms

7. Visa restrictions & Government Clearances

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V. Why China’s enforcement system fails to prevent internet piracy of entertainment products

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V. Why China’s enforcement system fails to prevent internet piracy of entertainment products

Resources spent on physical piracy diminishes gov’t capacity to fight more pernicious internet piracy

Broadband users are growing exponentially (approx. 100M to date)

Chinese online community adapts and persists even when major global peer-to-peer networks such as KaZaa and Grokster are terminated; sneakernets, FTP file sharing on closed-access servers are also used at universities

All barriers relevant to physical piracy enforcement also apply

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly

The integrity of western copyright laws have been threatened by new technology on an ever more frequent basis; but time, federal preemption, treaties, and our common economic and cultural values have helped resolve these assaults.

China, the world’s most populous and rapidly advancing country, cannot be marginalized or ignored. But economic cooperation with China presents formidable challenges never before faced by the West which copyright or IP laws can not alone overcome

Legal challenges, and diplomacy pressure is valuable but ultimately not enough; other more innovative approaches which do not rely on copyright are required

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly cont’d

Due to rampant, inexorable piracy, the Chinese record industry has had to pioneer more flexible business models which are less reliant on retail sales receipts.

Chinese entertainment companies have re-positioned themselves at the cutting edge of an internet driven shift from old, product-oriented music business models to service-oriented business models.

Our experience in China warns us that we may no longer be able to apply 20th century entertainment business models to 21st century internet technology

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly cont’d

Prospects for effective, sustained enforcement of copyright laws in China within the near future appear slim.

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly cont’d

Companies generally have adopted one of three approaches to the Chinese marketplace:

a) Develop alternative business models that reflect reality but are not dependent on IP laws

b) Build the cost of piracy into their models

c) Utilize sufficient private enforcement to keep problem from worsening

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly cont’d

A. Private Business Models for Entertainment:

1. Partner with Chinese internet company which will police piracy in return for share of legitimate internet market (e.g. Universal Music w/ R2G startup)

2. Lower product prices to gain market share and control (e.g. Warner Bros. 1995 decision to lower DVDs to 22 – 28 Yuan; Han Hong etc)

3. Switch to a talent-management business model—tapping into new revenues such as touring, merchandise, personal appearances, music sales, sponsorships (e.g. Warner Music Asia Pacific Records w/ Pu Shu; and now progressing westward, to EMI U.K. artist, Robbie Williams)

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly cont’d

4. Use record sales as a promotional loss-leader by giving away to university student pirates; avoid album compilations altogether (e.g. Newsboys model); use DVDs as promo to lure customers into high-tech theaters (Warner Bros. model may generate new revenues with Chinese theater partnerships)

5. Pre-selling of specific corporate promo songs to finance album or tour production costs (e.g. “Out of Your Window” model btw Pu Shu and Microsoft); and film costs (e.g. “A Sunny Day” subopera by Starbucks/PepsiCo venture in Shanghai subway)

6. Selling bulk CDs to high profile entities and businesses to give away to customers or clients (e.g. CCM model in which CDs are sold to churches)

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly cont’d

7. Assign exclusive license rights to self-interested government organizations (e.g. Thomas Nelson model cut through censorship also)

8. Target private enforcement against high profile search engines who may later seek entry into U.S. market (e.g. Baidu.com sought IPO in U.S. in 1995)

9. Develop private restricted access networks such as mobile phone downloads such as encryption protocols; on-line video/music rentals (but cf. Nokia-Warner Mosh Music dispute )

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly cont’d

B. Public Supported Business Models for Entertainment

1. Create government protected “safe havens” for copyrights in key urban centers such as Shanghai and Beijing where piracy abounds; work outward gradually to remote areas

2. Explore public protection models outside copyright laws such as Alternative Compensation Systems (“ACS”) which could assess a tax on all copying, broadcasting, and performance electronics and divide funds pro rata (e.g. variant of ASCAP/BMI ?); this system could be administered by NCA/MCSC etc.)

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly cont’d

3. Provide int’l assistance to Chinese government agencies or businesses so that they can develop and protect their own IP

4. Provide exchange scholarships to students studying IP law

5. Exert diplomatic pressure for a higher Yuan exchange rate

6. Develop new western laws which perhaps better balance the public’s interest in assessing rich varieties of reasonably priced works against a copyright owners’ fair compensation for creative efforts

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly cont’d

C. Controversies with Private Business Models

1. Business models that rely on corporate endorsements can stifle diversity by favoring commercial, uncontroversial artists

2. Although power is presently with consumers and pirates, private models and the desire for tighter product controls may undermine copyright law’s basic principles: to promote knowledge.

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VI. Fighting Piracy with Alternative Business Models—Privately and Publicly cont’d

D. Controversies with Public Business Models

1. Film and Record Companies resist loosing control of the distribution of their products (e.g. as in an ACS environment)

2. Even if public models resolve some or all of the piracy problems currently, these models will take significant time to implement; technology, and the new problems associated with it, however, change at lightning speed

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VII. Conclusion

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VII. Conclusion

China is the most difficult entertainment market in which to survive because of conflict between the old and new; collectivism and individual liberty; socialism and free-market economics; and between east and west culture, politics, and laws

As guests in a foreign nation we must take the high road to better listen, learn, and understand reality in China before we can adapt to the most profitable path of service

In this market where traditional entertainment industries are dysfunctional, executives and artists are developing state-of-the-art business models because viable law-based solutions are unavailable

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VII. Conclusion

Unhindered by old-media lobbying, and complex legal precedents applied to old technology, China is free to explore new ways to exploit the internet’s limitless promise, and perhaps in so doing, the copyright principles originally enshrined in our own Constitution

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VII. Conclusion

“We are here not to curse the darkness, but to light a candle”

--old Chinese proverb

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The Earth is Flat--but only in economics theory

Selected Reference Materials: Thomas L. Friedman, The World is Flat (2005)

William W. Fisher, III, Promises to Keep: Technology, Law, and the Future of Entertainment (2004)

Eric Priest, The Future of Music and Film Piracy in China, 21 Berk. Tech. L.J. 795 (2006)

William P. Alford, To Steal a Book Is an Elegant Offense: Intellectual Property Law in Chinese Civilization (1995)

James Chesser, Semiconductor Chip Protection: Changing Roles for Copyright and Competition, 71 Va. L. Rev. 249 (1985)