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Tuesday, July 12, 2005

Grokster vs MGM - an analysis

On 27th June, 2005, the US Supreme Court made a historic ruling that Peer-to-Peer (P2P) technology developing companies are legally responsible for the illegal acts of their users. This landmark ruling stems from the legal action brought against two US software firms, Grokster and StreamCast, in 2001, by 28 entertainment companies, including MGM, Walt Disney, EMI and Time Warner. Two lower courts had previously ruled that the Grokster and StreamCast could not be held responsible for copyright infringement carried out using their software. That decision was based on a precedent set by another Supreme Court decision in 1984, which absolved Sony from liability for copyright infringement carried out using Betamax video tapes, because the tapes also had legitimate uses. Although P2P networks could also have legitimate uses, the Supreme Court ruled that Grokster or StreamCast made no effort to stem illicit use of their software. Although this ruling definitely marks a victory for the music and movie industry and will boost the bottom line of legitimate song download sites such as ITunes, Rhapsody etc, I believe that this will be harmful to technology businesses in general because it will have a negative impact on commercial innovation by deterring companies from creating products that might potentially be used for copyright infringement and also because of the legal uncertainties involved.

The music and the movie industry are the biggest beneficiaries from this decision and so are the legal music download sites such as Apple’s iTunes and Real Networks’ Rhapsody. The music industry can now hope that consumers who have been sharing music illegally will now revert to legal means of downloading songs e.g download a song for 99 cents from Apple’s iTunes store. The movie industry, on the other hand will be hoping that this will give them a shot in arm for the next generation of movie going experience such as Internet downloads, legal on-demand-downloads etc.

I, however believe, that this decision will be a big blow not only for consumers but also for many small and promising startups currently developing some fantastic software for file-sharing. The current ruling by the Supreme Court extends the Sony Betamax ruling of 1984 by saying that a company could lose its copyright protection if it actively encourages copyright infringement. In other words, a company that is developing software for legal file-sharing purposes now has to be concerned whether the users of its software are using it for legal purposes or not. Although this might sound a very good idea, it is a very difficult thing to do - it raises the possibility of startup companies having to defend their new technologies against expensive litigation. Also, the VCs will be now be a little wary of investing in such firms – although they might still like the technology being developed, however the fact that the company will be under the strict jurisdiction of the law might make them a little nervous. While it might take courts years to define the precise boundaries of the ruling, many entrepreneurs don't have the luxury of waiting. The next generation of peer-to-peer services, such as BitTorrent, which allows the rapid transfer of large files, will have to be developed under the shadow of the court's new "active inducement" standard. So will innovations such as podcasting -- the creation of radio shows for downloading onto digital listening devices such as iPods. Almost all of these nascent technologies have two things in common. First, their widespread commercial implementation is still far in the future. Second, they can be used for both legal and illegal purposes. As such, at this point the only thing that's clear is that these technology companies will have to watch their step more carefully in every phase of business development, from funding fresh ventures and designing products to communicating with customers. Also, startups may have to invite lawyers in on product-development discussions from the beginning to help draw up plans and work with engineers on research and development.

Secondly, another tricky concern for innovators and entrepreneurs now is how to respond once they become aware that their technology may be being used for rampant piracy. In the past, companies were safest when they didn't admit to knowing about the thievery. The ruling states that mere knowledge of copyright violations isn't illegal. But such awareness, when combined with other actions, such as ads or statements by employees or executives, could leave a company vulnerable to lawsuits if it doesn't take action after receiving a warning from a music label or studio that illegal copying was occurring. According to Larry Lessig, an intellectual-property professor at Stanford Law School, "It might take 10 years of litigation to get a clear sense of this (liability issue)”. In Internet time, 10 years of chilled innovation will prove costly.

Thirdly, the ruling opens up some tricky questions for us to answer - email and IM can be used and often are used for illegal purposes – so, are companies such as Microsoft, AOL and other mainstream companies at risk because of this ruling? – Yes, because their software is used for illegal purposes; No, because these companies do not encourage users from using their software for such purposes. The point that I am making here is that the ruling leaves the door open to more litigation with a vague standard for liability. The Grokster decision has created "a gray area in which lawyers will thrive," says Gary Little, a general partner at venture firm Morgenthaler Ventures in Menlo Park, Calif. As a result of this ruling, my guess is that ads such as Apple Computer Inc.'s "Rip. Mix. Burn" or Microsoft Corp.'s "Swap Pictures, Music, Video and More" pitch for its instant-messaging service won't be imitated!

Lastly, I believe that this blow against Internet piracy may not be the magic bullet that the music/movie industry hopes will end its problems. A survey by Pew Internet & American Life Project suggests that the swapping of music and film files doesn't just happen over file-sharing networks. Some 19 per cent of downloads now happen through someone else's iPod or MP3 player, around 28 per cent take place via e-mail and instant messages. Also, quite apart from file-sharing, one in three CDs sold worldwide is pirated, according to the International Federation of Phonographic Industry. Copyright theft through DVD piracy is equally worrying for the film industry, especially in countries like China, Indonesia and Mexico.

In conclusion, this decision will definitely drive many existing commercial file-swapping companies out of business. Also, this may ultimately make it more difficult to get any kind of file-swapping software. On the other hand, the entertainment companies probably will face a long, slow fight to persuade consumers to alter their habits. An estimated six million people in the United States are using file-sharing networks at any one time and a total of tens of millions of people use such file-sharing networks overall, according to estimates from BigChampagne, which studies online activity. Young music fans have had five years or more to become accustomed to the easy acquisition of free music files that can be easily burned to CDs, transferred to portable music players like Apple's iPod and shared without restriction. Holding technology companies liable for truthful marketing will only encourage disingenuousness. Business models based on customers' vices may be cynical, but they won't go away because the law frowns on them. Consider the effectiveness of alcohol prohibition in the United States. The Supreme Court's decision is understandable, given the law's reliance on precedent. But it fails to account for the unprecedented development of the Internet and computer technology in recent years. Computers are designed to copy and manipulate digital content. Remove that ability and they're no better than televisions. The right to copy needs to be thoroughly reevaluated in light of what technology has made possible and what market demand suggests could be profitable for all involved--if only content owners weren't intent on overvaluing their assets.

So, what would a better system look like? A model such as Apple's iTunes, at a price point that makes sense in an era of instantaneous global distribution, with micropayment-based peer-to-peer file sharing. For example, users would get, say, 5% of the $0.50 sale price of every song downloaded from their computer. Content owners and artists would get paid, as would marketing and infrastructure providers such as Apple. When everyone gets paid, everyone is happy. Just look at Google. It has violated the copyright of every Web site out there by copying and indexing its content. But in return, it offers traffic, which can be monetized. The entertainment industry would do well to realize that sharing could be more profitable than suing.

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