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The Digital Content Marketplace

VIEWS: 57 PAGES: 28

									                                                            Progress on Point
Release 11.5 January 2004                                  Periodic Commentaries on the Policy Debate


       THE DIGITAL CONTENT MARKETPLACE:
 PROSPECTS & CHALLENGES FOR ONLINE DISTRIBUTION*
                                           MODERATOR:
                                      William F. Adkinson, Jr.

                                          PARTICIPANTS:
                                          Doug Lowenstein
                                          Shira Perlmutter
                                          Marybeth Peters
                                            Jerry Pierce
                                             Jim Ramo
                                             John Rose


William F. Adkinson, Jr., The Progress & Freedom Foundation: I'd like to start by
welcoming you to this Digital Content Marketplace Panel, where we will discuss the
prospects and challenges for online distribution of content

We're very excited about this issue at PFF. This is the second year here at our Aspen
Summit that a panel on Online Content has followed one on the economic recovery of
the Tech Sector Recovery. This is no accident, because these matters are closely
related. As Jeff Eisenach emphasized in his keynote speech last year, a vibrant online
market for rich digital content is critical to IT sector recovery.

But building this vibrant, online marketplace has proved elusive. This may seem
paradoxical. The Internet is an extremely efficient way to disseminate content, and we
should be able to turn it into a wonderful distribution mechanism. But economic
exchange is inherently reciprocal: Commercial distribution requires getting products to
consumers and getting payment back from the consumers to the producers.

As is well known, a number of firms have adopted half of this formula. So-called file-
sharing systems can provide consumers with unauthorized access to wide selections of
material at no charge, with no limitations on use, and without payments to content
providers.



* This is a lightly edited transcript of a panel that took place on August 19, 2003, at The Progress &
Freedom Foundation’s annual Aspen Summit. Speaker biographies are at the end.
Page 2                                                                 Progress on Point 11.5


Half a loaf is not better than none, because these systems don't promote marketplaces.
Quite the opposite. They obstruct the development of marketplaces for digital content
because they undermine the ability of producers to earn adequate returns. They even
threaten distribution of content through other media, like CDs. And they drastically
diminish incentives to invest in new works.

At PFF, we start from the premise that producers' rights in valuable content must be
recognized and protected. Reining in Internet piracy is essential to building markets for
digital content. We need practical means by which content providers can limit access to
paying customers. Copyright, like any other right, is empty if it cannot be practically
enforced.

Of course, the difficult problem is finding a way to protect that content without unduly
interfering with other values, including customers’ desire to take advantage of the
Internet. For consumers to be won over and a marketplace to flourish, content
providers must offer attractive alternatives for obtaining content online legitimately.

So today, we will hear about the diverse types of rich, digital content that some key
market participants are offering now and planning to offer in the future. In part, the
panelists will discuss the obstacles they face and the strategies they are developing to
overcome them. We're also going to hear more about the legal and policy issues that
impact these efforts.

It's our good fortune to have an exceptionally capable group to address these matters.
Their full bios are in the program, so in the interest of time I will very briefly introduce
each panelist before he or she speaks. We're going to start with John Rose. John is
the Executive Vice President of EMI Group, and since December 2001 he has managed
EMI's Recorded Music business.

John Rose, EMI Group: I'll just take a few minutes of your time to address a couple of
issues involved in the evolution of this digital marketplace.

The first point I want to make is that the music industry is one of a series of content
industries that are facing massive technological discontinuities, ones no less significant
than the kinds of discontinuities that disrupted the mainframe industry with the
introduction of the minicomputer, and the minicomputer with the introduction of the PC.

These discontinuities are affecting not just the content-creating industries. They are
affecting a whole swirl of industries that include both equipment providers and
distributors of content.

What do I mean by that? If you go back just to 1995 – not very long ago – content was
essentially format and device specific. You took a piece of music or film. You pressed
it onto some individual piece of medium, like a cassette tape or a CD. And you listened
on a purpose-specific device like a tape deck or a CD player or a phonograph. Or you
broadcast it and you listened to it over radio.
Progress on Point 11.6                                                              Page 3


If you look at what technology has enabled us to do today, first of all, there are a ton
more formats, but what is more important is that almost any device is capable of
accessing almost all content, regardless of what format it was originally encoded into.
As a consequence, all formats fit pretty much all devices and that simple and linear
world defined by “we take a piece of content, we code it into a format and it's heard on a
purpose-specific device,” has been blown up.

Something else has happened since 1995. Back in my days as a consultant, if you
looked at the industries that surrounded the content industries, they were basically
separate. They were beginning to touch, as cable systems and telcos were going to
war over distribution of content over DSL versus cable broadband. And there was the
beginnings of the push between PC manufacturers and consumer electronics
manufacturers about overlapping functionality. But they were still basically separate.

If you look at where we are today, that battle between the telcos and the cable systems
for new markets and existing markets has been extended to the wireless operators and
the ISPs. The nature of the overlap between consumer electronics manufacturers and
PC manufacturers has increased. They've added the wireless device manufacturers as
well as the PDA manufacturers. All of them are using content as a key part of defining
their consumer functionality and getting it out into the marketplace.

So you've got two parallel sets of discontinuities occurring simultaneously. First, the
breakdown of the format-specific, device-specific world. Second, a high degree of
overlapping competition between industries that are concerned with transporting and
accessing the content created by the content companies.

Now a lot of the debate over content focuses on issues of economics and piracy. And if
you look at the economics of piracy, you come to some pretty interesting conclusions.
(The numbers that follow are not mine; they were pulled together by an independent
third party consulting firm that was doing a little work for me.) The entire music industry
on a global basis (including publishing) in a good year earns about $1.6 billion. Last
year was not a good year. If you look at the elements of economic value created on an
incremental basis by the movement of files through networks to devices that were built
to access those files, there's somewhere between $3 and $4 billion of incremental profit
that accrues to the telcos. Those are backbone charges. (It's a little bit higher in Europe
than U.S. where they have limited Internet service provision.) If you look at the
incremental value to the consumer PC OEMs, there's another $1 to $2 billion. If you
look at the CE manufacturers, it’s another $1 to $2 billion.

You can argue the specifics of the numbers, and I've had this argument with telcos –
and PC manufacturers and consumer electronics manufacturers – until the cows come
home. But the general point is correct. The profit stream from consumers who are
paying money to access content does not flow back to the providers of content. The
money that flows to the providers of access and equipment dwarfs the profits of the
content businesses by a multiple of three to six times, depending on what assumptions
you believe.
Page 4                                                                    Progress on Point 11.5


That creates a need for us to all recognize, regardless of what element of this business
system we occupy, that our value chains, which had historically been pretty
independent from each other, are now highly interdependent. This move over the last
five to eight years from independence to interdependence is underlying a lot of the
debate that you see presently about who has what rights. Because what's really at
stake is multiple billions of dollars of profits that accrue, but not necessarily evenly in the
short term.

Now part of what must happen and, fortunately, is starting to happen is that some of
these industries are coming together to start developing interesting and robust rule sets
and business models. Just last year the Business Software Alliance (BSA), Computer
Systems Policy Project (CSPP), and Recording Industry Association of America (RIAA)
came together to define a set of principles around which this new set of digital
businesses and services could evolve. And following on that, somewhat simultaneously,
an important set of players across a broad range of these industries have started to
come forward with, interesting consumer-friendly business models that are economically
fair across the value chain.

For example, some of the more interesting ones are Real acquiring Listen. And
Rhapsody is doing a very interesting promotion with Best Buy to push legitimate
download music services on the back of some exclusive content that they got from us
for the Stones. What's important and interesting about that deal was that three
members of the value chain shared in it. It was good for Best Buy as a bricks and
mortar retailer. It's going to be good for Listen/Rhapsody, and it was good for us.

Similarly, we're going to see some interesting announcements – and everybody has
talked about iTunes – but we're going to see more interesting business model
announcements over next couple of months. MusicMatch, for example, which has one
of the leading radio streaming services, is going to introduce a click-to-buy opportunity
behind the streaming of their radio products. So if you're listening to a track on the web,
you'll be able to do a one-click purchase of the album or one click purchase of the track
while you're listening to it. This brings into one moment what the record industry has
been struggling with for years, which is creating a buzz by getting people to listen to
radio and then walk into stores. They will bring that into one single experience.

Music Choice is working hard with the cable operators and some of the telcos to provide
on-demand purchases and subscription to music videos. And that doesn't speak to the
wireless world where folks like AT&T Wireless and others are starting to bridge the gap
between where you find out about a piece of music and where you buy it.

We are starting to see the evolution of a whole bunch of interesting consumer-friendly
business models: Digital retail, purchase by stream (that I spoke of), and marketing or
ad-supported sales. And an obvious place for KaZaA and the peer-to-peer world to go
is to create a robust advertising model around which they can sell discounted content.
Progress on Point 11.6                                                                   Page 5


We, as a company, have moved down a path focusing on what is a fair wholesale value
for our content, not trying to constrain the consumer price. If you think about
newspapers, magazines, broadcast television, cable network television – those are very
attractive media models that are supported by advertising, and the advertising
subsidizes the creation of a content. I think the P2P networks provide an interesting
opportunity for us to explore and experiment with those kinds of models, presuming
we're able to solve the legal issues along the way.

And then, finally, secure distribution. All of the DRM technologies are starting to come
together to protect content and with the protection of content comes the unlocking of
some feature functionalities that we feel are quite cool. For example, the ability of me
as a consumer having bought a piece of music to send it to you, have you listen to it
once or twice and if you like it, click to buy it, because the rule set will allow for that kind
of viral distribution of content.

Again, starting to model how consumers really interact with content, but providing, as
you described, reciprocal transaction capability that makes some kind of sense.

But my final point is that in this new world of content there need to be rules. Society
does run by rules. I wish I could walk into a Ferrari dealer and drive out with a Ferrari or
I wish I could walk into a clothing store and walk out with the clothes without paying for
them. In reality, there must be rules that govern commerce. The question is: What are
the right rules?

There's been so much debate about things like burn limits, portable devices and
technology. Those debates missed the point. The point is: First, what are we trying to
achieve? Second, how will the technology enable it? So I want to start with what are
we trying to achieve.

What we're trying to achieve as a content company is the principle that when an
individual buys a piece of music, they ought to be able to listen to that music that they've
legitimately acquired for their own enjoyment, within their own personal domain,
irrespective of the device or the format that they prefer. And they shouldn't have to pay
for a second time to listen to that music. But if they give it to a friend, that friend
shouldn't have the ability to actually do the same thing without a transaction. Not that
they can't share that music with a friend, but when they go away, that friend can't have
captured that music unless the first person has given up in some way the right to play
that music himself. Just as if I go to your house and bring a CD with me, if I leave the
CD behind in the old world you had the CD and I didn't. But the point is if a consumer
buys a piece of music, they ought to be able to use it for their own personal enjoyment
any way they want, as long as they don't set up a little mini-manufacturing plant and
give it to all of their friends.

Now these rules of ownership should apply regardless of how the consumer acquired
the music. It should be no different if you downloaded it through the Net or you bought
a CD. What we have to do is bring that concept together so that the underlying rule
Page 6                                                                Progress on Point 11.5


sets are the same regardless of the vehicle by which you acquired the content. And if
you start from that principle, you could start very different kinds of conversations about
what you'll allow today and where the technology needs to be 12 or 24 months from
now, so that this becomes more and more seamless over time to consumers.

William Adkinson: Thanks very much, John. Next, we're going to hear from Doug
Lowenstein. Doug has been President of the Entertainment Software Association since
its founding as the Interactive Digital Software Association in 1994. He represents the
relatively young computer and video game software industry, which you may know as
the medium through which adults are humiliated by their children. I'm sure Doug can
tell us a lot more about it.

Doug Lowenstein, Entertainment Software Association: I want to thank PFF
actually for including me in this panel, because all too often the debate over online
content and digital content starts and ends with the music and the film industries. One
of the messages I want to leave with you today is that the entertainment software
industry is a key part of this dialogue.

And I think that's the case for a couple of reasons. One is purely economic. Video
games now are an increasingly large slice of the total American entertainment pie, with
annual revenue growth consistently outpacing that of any other entertainment industry.
In 2002, the videogame industry generated $7 billion in retail software sales in North
America alone, which is about a 10 percent year-on-year growth. Analysts are
forecasting more growth over the next two to three years.

Now of special relevance to this panel is the fact that revenue from online games and
various forms of Internet content is estimated to hit $1.5 billion by 2005-06. It's about
$500 million today. And none of this includes the revenue generated by games that are
increasingly appearing on cell phones and other wireless platforms.

A second reason I think it's important that we're part of this debate is that all content
industries are not made alike. There are some key differences when it comes to our
products – in our use of technology and the expectations of our consumers. I want to
focus on those differences in the balance of my remarks.

One problem is the one I mentioned a second ago. The words "entertainment software"
are seldom mentioned in discussions of the issues of online distribution of content. And
when all of the issues are viewed solely through the prism of what the record industry
has done or not done, or what the film industry has done and not done, it provides a
very distorted perspective. It leads to a debate that fails to understand, I think, some
important issues.

To shed some light on why I think the omission of entertainment software is important, I
am going to start with something about how our industry has approached the Internet.
Progress on Point 11.6                                                                Page 7


The gaming industry’s core audience, contrary to what a lot of people think, is 18 to 35
years old. It's not teenage boys. The majority of people who play games are adults, not
kids. The average game player is in his or her mid-20s. Many of them – in fact, most of
them – have grown up with technology in the home and at work. For them, video
games are uniquely appealing precisely because they're interactive and technology-
based, and not passive. And unlike any other form of entertainment, they tend to draw
an audience that is inherently comfortable with technology.

The nexus between the technology bent of many game consumers and the technology
heritage of many game software companies is a major reason that our industry
recognized in the mid-1990s that many of our core consumers were going to be early
Internet adopters. Game publishers didn't view the Internet as a threat to existing
business models, but as an opportunity to make existing business models work even
better. So from the very early years of the Internet, this industry has proactively sought
to use it, both as a marketing device and as a distribution tool.

And even more significantly, the industry understood that the Internet offered an
opportunity, a way to create entirely original content that capitalized on the unique
attributes of the online environment. I think this last point again is a critical distinction
that I want to make because the prevailing view in the game industry has been that the
internet is a way to expand and broaden the interactive entertainment experience. To
us, the internet is much more than a way to do marketing and distribution. It is a
platform on which to create both new intellectual property and to draw additional
revenue from existing intellectual property.

Put another way, from the very early days of the Internet, the game industry has actually
been out in front of our consumers, and as a result we've been able to shape their
expectations regarding access to content and the nature of the content itself. And I'm
going to take just a minute to touch on a few of the ways that we've done that. On the
marketing front, the game companies use the Internet to distribute free demos of current
and upcoming titles. We offer basic game levels for free to consumers on a kind of try-
before-you-buy model. On the distribution side, companies have licensed current and
catalog titles to portals such as Yahoo!, where users can pay monthly fees for full-game
downloads or game rentals. We even have some members who are starting to license
content to KaZaA as an experiment to see whether they can use that platform as a way
to distribute content to the peer-to-peer community.

And most importantly, there's been an explosion of games and businesses based on
creating original online content. For example, you have so-called casual gaming sites
such as Pogo (owned by Electronic Arts (EA)) and Zone.com (a Microsoft site). These
sites pull in 8 to 13 million unique users per month. The Pogo/EA site is the third most
visited site on the web and the average time spent on it is 51 minutes, making it also
one of the stickiest sites on the web. Similar numbers are available if you look at
Zone.com. Another interesting variable here is that about 65 percent of the users of
Zone.com are women.
Page 8                                                                 Progress on Point 11.5


In the new content space, we also have massively multiplayer online games such as
Everquest, where you have players purchasing a boxed CD at retail for $39, typically,
and then paying $10 a month to be in the game over an extended period of time. These
games typically have anywhere from 200,000 to 500,000 users at any given time.

There's also a large online game culture built around games like Counter Strike and
Battlefield 1942, where consumers purchase the CD and compete against other game
players and competitors. These games also are enormously successful. They actually
represent a pretty interesting example of where the game industries continue to look for
ways to stay ahead of consumer demand, because, frankly, if you make a PC game
today, and you don't have online functionality, it won't sell. The industry recognized that
and moved out to create that functionality.

And the last place that I think you see tremendous vibrancy in the game industry is in
the console world, where you have Xbox and PlayStation, both of whom now are
offering online game services. In the first eight months that Microsoft’s Xbox Live,
which is a broadband online gaming service, went live, Microsoft registered 500,000
users. Sony has been generating significant numbers with the PlayStation as well.

So I hope that the overview here of how we've approached the business suggests how
creative and innovative has been exploiting the platform in trying to redefine the
experience.

That's the good news. The bad news is it's almost impossible right now for anybody in
the game industry to have a profitable business around online games. Now there are a
lot of reasons for that and I'm not going to go into all of them because a lot of them
having nothing to do with the issues that concern this panel, but I will touch very briefly
on piracy and how it fits into this equation.

Here again, I think there are some differences between our industry and some of our
sister content industries. For example, console systems have access controls that are
built into the hardware. So even if one could easily share a console game through a
P2P network, the illegal copy is useless unless you first purchase and use a device to
circumvent the hardware access controls. Now this does occur, but it's frankly far more
common in Asia right now, thankfully, than it is in the United States.

But part of that also goes back to consumer expectations. While I think even highly
educated consumers have managed to convince themselves in a sort of twisted form of
logic that it's legal to download a music file, the vast majority of game consumers based
on our contact with them and our companies’ contacts, don't really come to the table
with an expectation that copying a game is a right. There is general acceptance of
console access controls and the software copy protection that is typically built into PC
games.

So our piracy problem exists, but it's very different. We've taken now well over 200,000
sites using DMCA notice-and-take-down provisions, but most of them offer illegal
Progress on Point 11.6                                                                   Page 9


circumvention devices, pirate games or copyright protection cracks. Unlike the music
and film industry, our peer-to-peer problem right now is less of an immediate threat.
That's again for several reasons. One is the access control issue I mentioned. Second
is that a typical game file, particularly PC game file, is one gigabyte or larger. With
broadband still not being very prevalent, that is a pretty good protection against game
downloading.

I don't want to sound smug about the peer-to-peer problem because I think we may well
face it sooner rather than later, but at least at this point it's not looking us squarely in the
eyes. But because we do have piracy problems, we are completely in accord with the
notion that some of the regulatory and legislative proposals on the Hill – designed to
surgically address the perceived issues associated with music file-sharing – are going to
legalize some circumvention devices and create digital first sale rules and so forth that
from our perspective are going to open the doors to massive game piracy.

This is all interconnected. And that's part of my point. The notion that you can talk
about this issue and say: We have a problem in the music area, we have a problem in
the film industry area, and we can fix those and not have collateral damages – is just
dead wrong. This all works together.

The final point I want to make here is that I would suggest to you that the game industry
for the most part -- and heaven knows there's plenty of things to criticize about the
industry – but in many of the key areas we've gotten it right. We've met consumer
expectations. We've helped shape those consumer expectations. We're meeting
demand. We're leading demand, but even with all of that, one, it's very hard to make
money with on-line games still, and two, we still have a piracy problem and I would
leave you with the thought that those who would suggest that this is all about the failure
of content industries to create viable business models to meet consumer demand and
that's why we have a peer to peer piracy problem, that's nonsense. This is in large part
a behavioral problem and a cultural problem. It is not a business model problem.

William Adkinson: Thanks, Doug. Now we're going to hear from Jerry Pierce. Jerry is
the Senior Vice President of Technology at Universal Pictures, where he's responsible
for a variety of digital initiatives, including recently forming the Motion Picture
Technology Office. Jerry's Electrical Engineering degrees confirm that sometimes
technical aspects of these issues predominate.

Jerry Pierce, Universal Pictures: Good morning. I want to thank Bill for the
opportunity to come today to PFF. Just as a note, this does feel like a meeting of
Californians Anonymous. Hello, my name is Jerry, I'm a native Californian. I'm a
member of the Lunatic Fringe.

(Laughter.)

But it's fun coming from L.A. and visiting with all of you and having discussions from a
slightly different perspective.
Page 10                                                                Progress on Point 11.5


New distribution channels must be analyzed in a lot of contexts:              consumer
expectations, contractual encumbrances, piracy and profit calculations, as we just heard
about for the gaming industry.

My plan in the next few minutes is to give an overview, a tip of the iceberg view of some
of the issues to be considered from the perspective of a movie distributor.

Our business is making entertaining content, distributing it to consumers, receiving
appropriate compensation. Piracy is certainly part of the landscape, but it is not the
focus of our landscape. We need to maintain good, existing models and adapt to
changing consumer trends with new business models. That is a focus of our strategic
planning.

Piracy has helped identify new consumer trends and desires and we need to pay
attention. We need to continue to design new distribution channels that meet the needs
of the new consumer, but not at the alienation of our current customer. One thing for
sure is that new distribution channels will be established, but none of the prior channels
will disappear. That's what we heard from the music industry, that's for sure.

So to understand it, let me start back and say; what do we think the new home is going
to be? In our opinion, the new home is changing and it's changing very fast. We see
that there will not be an average consumer any more. Much like in the music area, we
see that we're going to move from a home with a set of rabbit ears and a single TV, to
the now-more-common cable TV and a DVD, to a very sophisticated home.

We see the expansion of the home server, including the personal video recorder like
TiVo or ReplayTV, into a home network that connects the entire home, car and portable
device to the central home service. Either dial up or broadband will give us a back
channel for business negotiations behind the scenes; this is how pay-per-view works on
most satellite systems – the customer orders via a telephone connection with the
satellite company. We see multiple home viewing areas connected by either wire or
wireless in the home and we see portable devices as part of the landscape.

The same architecture that opens up the home to the peer-to-peer threat also opens up
the home to many new opportunities. Ultimately, consumers will have more choices,
more flexibility, better quality, all customized for their needs. The Internet can be our
friend.

We need to have a carrot and stick approach to the new services. We will enable new
capabilities in exchange for some help with piracy. So let me spend a few minutes on
the opportunities and then address piracy.

In our opinion, the two biggest enablers of new capabilities are the availability of a back
channel and the availability of hard disk based video storage, the PVR (personal video
recorder) or DVR (digital video recorder). The PVR hard disk allows new places to
store content as the PVR obtains common encryption technologies. We'll have more
Progress on Point 11.6                                                                Page 11


delivery options for our content. We see a growth of options such as DVDR (DVD
recordable) and HD-DVD (high definition DVD), both of which are going to be
recordable, as fitting into the opportunities as well. The back channel allows for a rich
set of usage rules and new business propositions.

Our vision is to provide content in an encrypted package, what we call DRM control, and
the consumer will be allowed more flexibility with their content. The back channel
allows us to authorize these activities and monitor these new transactions. We see our
business partners participating with us in these new models.

So, some examples of what we see coming. Well, the first thing that comes to mind is
exactly what we've done with MovieLink and has been done in iTunes, basically
electronic rental and sell-through. They are first examples. We know we are going to
see others come, and become better. We're considering and weighing the different
options for electronic delivery.

It's not just Internet delivery, by the way. There are many other options of moving this to
the home, including cable, over-the-air and satellite, assuming things settle down
properly in Washington. They'll all require a back channel to make them work and a
place to store the content. There are lots of commodity pipes that will deliver to the
home, including physical media. We see physical media with a back channel as also
giving us options.

We can also change existing products, like the DVD, and make them more valuable.
Delivery of content to portable devices. A rental DVD may become a purchase by an
authorized transfer to a PVR. Many options. Perhaps a way to organize is in a jukebox.
We see having a large number of DVDs that fit into the home system and we can have
box art, additional subtitle tracks, after the fact information.

But what happens when our legitimate product must fight for space against free? Well,
we have a set of threats that exist against us and the biggest threat from piracy is
changing consumer expectations. We've talked about consumer expectations, so let
me repeat that the biggest threat from piracy is changing consumer expectations. Look
at the huge change that occurred when DVDs changed consumer behavior to purchase
movies and shift away from rental, a huge positive influence. The same thing can
happen in this area.

Let me step back and look at the overall threats from unauthorized release of our
content. This is a list of our threats, not necessarily in any particular order. The biggest
threat to our business is during the theatrical window (and before the theatrical window,
since International tends to be a later theatrical window than U.S.) when we make our
product available only in the theaters and during that time, perhaps only in a region.

In many parts of the Eastern Block and Asia we don't have a theatrical business. That's
over a billion people we can't sell to, a real loss of potential revenue, in large part due to
piracy. As we look at this list on approaches to piracy, we are very insistent that any
Page 12                                                               Progress on Point 11.5


approach to solve piracy takes into account the theatrical window. So this is what we're
doing about these threats at this time.

Our goal is to work on new peer-to-peer piracies and the way it's taking new directions.
This is where we need the most help. Our goal is to make pirated content inconsistent
and inconvenient whether delivered peer-to-peer or on plastic. Making it hard to get,
making it not play well, keeping the quality low. We're also assisting by getting higher
quality legitimate product in the home. If consumer expectations are for high quality,
pirated content becomes less appealing.

Universal is actively pushing for an audio watermark for all of our content. Let me repeat
that one too. Universal is pushing for an audio watermark for our content, including
theatrical product. We feel this is our best chance of making a difference in technical
means addressing peer-to-peer piracy and also professional piracy.

At this point, we're working with hardware companies and consumers to develop a
jointly acceptable set of rules and technology. We plan to enable new business
opportunities to those platforms that help us control peer-to-peer.

So we have two kinds of content coming into the home and within the home. First,
content protected under DRM that has a built-in set of usage rules. Second, in the clear
content, including pirated content, without usage rules. So what do we think some of
these usage rules might be? Well, many proposals for copy control states have been
put forward. From the original CGMS (three states – never copy, copy once, no copy
control asserted) to the proposal included in, say, the 5C plan. We believe there could
be a richer set of copy control states. How the state is conveyed is secondary to the
states themselves. As I said, Universal thinks audio is a good choice.

The five states that we envisage would include:

   No home use;
   No copy;
   Pause/Time Shift;
   Permanent home copy;
   No redistribution

The biggest difference from the existing state and the states that I'm proposing here is
the introduction of a theatrical state - "no home use." Content marked with this state
shouldn't be found in the home, period, end of song, shouldn't play, shouldn't record. It
was not intended for delivery to the home.

We also see a richer pause/time shift state.

Now, how do we make devices respond to the markers of these states, and how do we
make the system into a compelling consumer proposition? This is difficult. It needs
cooperation among content providers as well as 5C companies and consumers,
Progress on Point 11.6                                                              Page 13


cooperatively working together. There are many options and we're leaving all of our
options open.

In summary, the devices that enable piracy are the same devices that offer us new
product opportunities and new business opportunities. The home server, the back
channel, the new digital delivery pipes that are unfolding can be a new opportunity for
us. Piracy can help us identify new consumer trends. We can provide a carrot and
stick approach to controlling piracy. We must remember that our best customers want
movies.

William Adkinson: Thanks very much. We're now going to hear from Jim Ramo who
is the CEO of Movielink. He took over Movielink last year and oversees its launch. I
would start to describe the business, but he can do that a lot better than I can. Jim?

Jim Ramo, Movielink: Thank you, Bill. Let me begin with a quick overview. Movielink
is a joint venture by Sony Pictures, Warner Bros., Paramount, MGM, and Universal.
They have three goals in mind. The first is to create a business, initially based on the
video-on-demand (VOD) paradigm of viewing. A second is to build an IP backbone and
use the Internet as a channel of distribution. And the third is to help drive DRM into the
marketplace.

The initial video on demand business is potentially very attractive. This is, basically, the
opportunity for consumers to get what they want, when they want it. It is part of the
evolution from broadcasting, to narrowcasting, and to individualizing or personalizing
distribution. We believe that the Internet is the ideal distribution vehicle for that
paradigm, given its packet-switched nature. In addition, we wanted to launch Movielink
with high value content and to do that we wanted to make sure, in the general
windowing of films as they come from the studios, that we had sufficient interest. The
timing of video-on-demand product release is ahead of pay television and ahead of
broadcast television, so it has significantly higher value.

Also, there was an existing video-on-demand model, and we could launch into that
model. That helped take care of some of the back licensing issues that are, frankly,
very difficult and one of the challenges of creating the business. It also meant that the
consumers would have some knowledge about what it is that they were going to get.

Basically, a film comes out. It's released in theaters and then about six months later it
goes to home video. In 45 to 60 days, it then becomes available to what's called pay-
per-view or video-on-demand, which are, in effect, transaction-oriented services. After
about 90 days it goes on to pay television, which is HBO, Starz, Showtime, and then,
lastly, it goes to broadcast or basic cable.

So we wanted to deliver a sufficiently high value piece of content that matched the
trustworthiness of the DRM that is in the market. After all, today's DRM is turning out to
be, we think, very good, very strong, but it is software only. It is not, as Doug was
saying, linked to the hardware, as might be the case in a PlayStation terminal.
Page 14                                                                  Progress on Point 11.5


So we launched the business, and today, you can go to www.movielink.com. You can
surf the site. We think we have a tremendous merchandising advantage that goes with
the Internet, and an up-close “two-foot” interactive experience, as compared to browsing
from your sofa with a remote control on a TV set. You choose a particular movie you
want, you register, you give your credit card number, you hit a button for download, and
the movie is downloaded. It lands on your hard drive and stays there for up to 30 days.
Any time during that 30-day period, you can hit play and watch the movie. You can
watch it as many times as you want, pause it, rewind it, etc., for a 24-hour period. Then,
because of the DRM, it disappears off the hard drive. You rent this movie for
somewhere between $2.50 and $5.00, depending on whether it's a new release, video-
on-demand, pay-per-view or a library product.

We launched the business in November of last year with about 175 titles. We have
about 600 titles today. We thought we were going to be delivering to 18 to 24 year olds.
We found out that we're delivering primarily to 25 to 49 year olds. About 60 percent of
our customers are men. About 15 percent connect the PC to their TV set, using an S-
video card and RCA analog jacks out to the TV. About 25 percent of our customers are
using movies downloaded onto their laptops and traveling with them, whether that's
business travel or just vacations.

Let me spend a second on something that Doug also spent some time on – the
difference between movies and music with respect to the Internet. With respect to
piracy and the Internet, music is to movies as the Spanish Civil War was to World War
II. It is an earlier version and we get the benefits of lots of learning.

Having said that, there are some real differences and the differences are both good and
bad for the film side of the business. Today, the PC is just made for music. It ships with
speakers. It ships with subwoofers. It ships with a burnable DVD or CD player. The
files are very small, so that you can download using low speed or broadband. It has a
very easy to index user interface. It’s got to be difficult having what was in the music
business pretty much a shrink-wrap retail-only packaged model being attacked
significantly now by the Internet.

That's not yet the case with movies. Films generally, as I mentioned, have multiple
windows, multiple business models, multiple venues. You can see a movie in a theater.
You can buy it off a transaction. You can get it as part of a subscription. You can get it
for free on broadcast television. On pretty much any Sunday night on broadcast
television there is a big major movie delivered to millions of consumers.

The files are very big. A movie file downloaded from Movielink is about a half a
gigabyte and download time depends on your last mile connection. File sizes depend on
the kind of compression used and other factors, and can vary from 2-3 gigabytes down
to sizes smaller than ours. The trade-off is resolution, or picture clarity, which suffers the
more the file is compressed. If you're on a cable modem in the middle of the night and
nobody else in the neighborhood is on, you can probably download a Movielink movie in
15 minutes. If you have a lower speed DSL, it probably could take two to 2.5 hours. If
Progress on Point 11.6                                                             Page 15


you are doing downloading off a pirate site and it is in MPEG2 format with much bigger
files, that can take four, six, ten hours to deliver. So again, we have an advantage on
the movie side in defending against piracy over the Internet. The longer download times
for movies are an advantage with respect to piracy – pirates download far fewer movie
files because it takes so long – but it’s actually a disadvantage in building a business to
deliver those bigger files, because it costs more and is less consumer friendly.

Having said that, I think there is a commonality and that is the potential for video-on-
demand – on demand programming generally, in our case, video-on-demand. One of
the things that we just have to wait out with respect to the delivery of movies over the
Internet is the chicken and egg problem. As I mentioned, we deliver in broadband only.
Today broadband is in about 20 million homes out of a little over a 100 million television
households, so we have a niche market with niche programming. But as the broadband
footprint approaches 100% of total television households, broadband offers the potential
to deliver all movies ever made at any time to all people. Getting from here to there is
just going to take some time. It is uneconomic, for example, to incur the cost to clear
and encode all of Bob Hope’s movies and make them available on the Internet to just a
small segment of the potential audience, which may want the "Road to Morocco" but not
the "Road to Zanzibar" or whatever. With broadband penetration to an audience of
most televisions households, that kind of investment makes a lot more sense.

It will take a fully robust and developed Internet to cover the back end encoding costs
and the legal costs to get the rights to fully exploit this medium. As I mentioned we
deliver in broadband only and broadband is in a small segment of the market. That has
to change and that's changing rapidly. Broadband from both the cable industry and the
telcos is probably their fastest growing product offering, growing at 50 percent a year.
So we think the signs are right for that.

Lastly, today we deliver to a PC, and people want to watch movies on a bigger device,
on a couch or in bed or wherever in a relaxed situation. So the home network,
connecting the TV to the Internet, is necessary for the success our business.

Having said that, we're running a 5-year business plan. We like the start. We're
developing a customer base that we've been able to understand, to educate, find it easy
to use. We see the opportunities for growth and we're very excited about this business.

William Adkinson: Thanks, Jim. We've now heard from four business people about
the various product offerings and problems that they face in making those offerings
available. Now we're going to hear from two people who are very well situated to talk
about some of the legal and policy issues.

Shira Perlmutter, AOL Time Warner: Thank you. At these PFF Aspen Summits over
the last few years, when we have had discussions of content protection issues, we have
heard over and over again the message that content owners need to develop legitimate
online business models. That's a great improvement from the first conference nine or
Page 16                                                                Progress on Point 11.5


ten years ago where the question was: Does copyright law apply on the Internet? So
we have made progress.

And I think, as you can sense from the speakers before me as well as from reading the
paper every day, that we are making tremendous progress on the business model front.
New offerings are available today and coming up on the horizon very quickly. There are
a lot of interesting collaborative efforts underway. So this is a very exciting moment for
all participants – for creators, for owners, for distributors and, of course, ultimately for
consumers.

My point on this panel is that the prerequisite for the continuation and success of these
efforts is an adequate legal and policy framework, an infrastructure. These efforts
cannot survive, cannot thrive, in a vacuum. As has often been pointed out, they can't
compete with free. We're talking about free offerings of our own products, rather than
tap water competing with Evian, as was discussed yesterday.

So what are the necessary elements of this infrastructure? I would identify at least four
elements.

One is law. We need laws that grant and define the scope of our property rights.

Second, enforcement mechanisms that really work, that can make the property rights
meaningful and control piracy.

Third, the ability to use digital rights management successfully, that is, effectively and
flexibly. It is through the use of DRM that we can maximize consumer choice – offering
different formats, different delivery mechanisms and different prices. So, for example,
consumers can choose to have access for 24 hours to a movie for a lower price than to
buy a permanent physical copy. Without effective DRM, that would just not be possible.

Fourth, education. We need to make sure that the public understands something about
what copyright is, and even more importantly, why it is. There's some reason for it,
there's some public benefit to it, and morality is involved in respecting property and
creativity.

I want to stress that no one is under the illusion that any single element of these four is
in itself sufficient. We need a combination, what is sometimes referred to as a multi-
prong approach. Litigation alone won't do it. Technology alone won't do it. Education
alone won't do it. We need all of it combined. And these elements all tend to interrelate
with each other.

What I want to spend the rest of my time talking about is whether we do have those
elements today, and what work is still needed on each of them.

Law: This is the area in which we need to do the least, because we do have a legal
structure, certainly in the United States, that is adequate. We have rights, balanced by
Progress on Point 11.6                                                             Page 17


exceptions, that are adequately defined. That legal structure has been updated and
refined periodically, and recently through the DMCA and judicial application of law to the
digital environment.

Enforcement: The essential tools exist, but there are some issues of how those tools
are being used and can be used. Particular issues that I've been thinking about are,
first, how do we ensure appropriate criminal enforcement by the government to
supplement civil litigation? And there, we see within the government an increasing
awareness of the importance of this issue to the U.S. economy.

Second, how do we deal with the growing and persistent problem of consumer
empowerment by devices and services that enable infringement by individuals at a level
that was never possible in the past? The question is: Who is responsible for those
undeniable acts of infringement and how do we make that responsibility real in some
way?

The major focus of all of us these days tends to be the peer-to-peer services, where
there has been a tremendous amount of litigation. And I'm talking about services that
operate without authorization, rather than the technology itself, which may have very
positive uses.

Here's the difficulty. There is a tremendous amount of infringement going on. It is
causing an undeniable negative impact today on the music business and will soon do
this to the movie business. Who is responsible and to whom do we look to stop it?
Where do we go to court to look for a remedy?

The service providers are generally not going to be liable, because of the safe harbors
that were negotiated in the DMCA. The people who are creating and providing the
services that enable this massive infringement may be liable under principles of
secondary liability. Napster was certainly stopped through those principles. But the law
is evolving and the recent decision in the Grokster case shows that there may be limits
to the ability to impose legal responsibility. We'll see; that case is on appeal.

So then the question is: What about the individuals who are clearly and blatantly
infringing? It is no one's first choice to sue individuals. That should be made clear.
And that has never been the industry's choice in the past. The decision has not been
made lightly that suits against individuals are an alternative to consider. But if there is
no one else out there who can be held responsible for massive infringement that is
taking place and causing real harm, suits against individuals must be considered
seriously.

It's important to recognize that individuals are now causing much more damage than
they have in the past. The kinds of things someone could do as an individual infringer
used to not be terribly detrimental, taken one by one. But now, when you're talking
about what individuals do on peer-to-peer services, they're not just making a personal
Page 18                                                                Progress on Point 11.5


copy at home. They're acting as online publishers, sending hundreds of millions of
copies of works around the world. And that is a real threat.

So what do we do, if lawsuits will be brought against individuals? Despite all the press
about it, this has not happened a lot yet. Doing it requires the ability to identify who is
uploading these massive numbers of files. And then the decision has to be made
whether to send a cease and desist letter, whether to notify them, whether to sue them.
That's another step.

There is a subpoena provision in the DMCA that enables content owners to ask service
providers to identify the infringers, and I want to say a few words about it. That
subpoena process in the DMCA was part of a negotiated trade-off in which
intermediaries were given safe harbors for infringements taking place using their
services, in return for assistance in locating the primary infringers who are putting the
content up there in the first place. Now, it is true that the possibility of peer-to-peer
services didn't occur to anyone. Napster was probably not yet a gleam in Shawn
Fanning's eye. But nevertheless, the concept was that that was the tradeoff.
Intermediaries wouldn't be held responsible; it was better to go after the primary
infringers.

Now we have the question of whether the DMCA subpoena applies in the peer-to-peer
context. So far the Courts have said: Yes, it does. We've heard a number of
complaints about this. I have to say that it is hard to see why there are more serious
privacy problems with applying the DMCA subpoena procedure to the peer-to-peer
context than to other contexts where it's been used in the past, given that peer-to-peer
users are essentially opening their computers to the world.

I also find it difficult to understand why there should be a strong preference for the use
of clearly available John Doe lawsuits, which allow for subpoenas, given that they place
a much greater burden on the judicial system and do not include some of the
safeguards for users that, in fact, the DMCA includes. For example, the DMCA requires
a sworn declaration that the purpose of the subpoena is to identify an infringer and the
information will only be used to protect copyright rights. That's not necessary for a John
Doe lawsuit. And while a John Doe lawsuit does involve a court looking at the
subpoena request, it's generally granted as a matter of course.

Now, there are cost and burden issues involved for service providers in responding to a
massive number of subpoenas that are likely to come up when you think about the
massive number of peer-to-peer users. Those issues are real and they can and should
be worked out.

Digital Rights Management: This is in some ways the newest issue and the most in
flux. To a large extent, the development and implementation of DRM is the province of
technologists and deal negotiators. But there are two areas where legal support is
clearly needed.
Progress on Point 11.6                                                             Page 19


One concerns prohibitions on the circumvention of technology. DRM is useless if it can
be circumvented with impunity. It will not do us any good, and that is why Congress
enacted Section 1201 of the DMCA in 1998. That was a hard-fought compromise and
it's a very complex law, but so far it has worked well. The borders are still being tested
in courts – that's part of the normal legal process – but it's held up pretty well. It does
continue to be controversial, so we're seeing court challenges to its constitutionality,
bills in Congress to change the compromise that was struck in 1998, and the on-going
Copyright Office rulemaking that is considering possible new exceptions from
prohibition. But it is absolutely critical that the legal protections for technology not be
weakened if new online distribution models are going to evolve and succeed.

The second area where legal support is needed is the implementation of DRM
solutions. Some types of DRM work, as we've already heard, by communicating
information – that is rules about how content can be used, such as no copying, one
copy, or unlimited copying, but no redistribution outside the home. Those kinds of rules,
to be effective, require detection and response. That detection and response needs to
be implemented in devices that receive and pass on content.

Where the content is only made available through conditional access, this can largely
be dealt with through private licensing. You can't get access to the content unless you
agree to follow the rules and handle it in certain ways. But that's not always the case.
Some content is delivered in the clear, or at some point is perceived in the clear. And in
those situations we need some sort of legislative or regulatory requirements for
implementation.

It should also be mentioned that this ensures a level playing field. For example, you
don't have device makers from other countries looking to achieve a competitive
advantage by selling devices that don't play by the rules everyone else has agreed to
here.

In our view, the ideal approach to this complex set of issues is to have private sector
cross-industry development of technological solutions, including the best means of
implementing those technologies, and then a limited government role in enforcing those
solutions through regulation as needed. The idea is to have the private sector and
government work together, with the private sector doing what it does best on the
technology side, relying on regulation only where it is needed in the specific
circumstances and only to the extent that it is needed. So we're not talking about broad
government mandates. We're not talking about the government deciding what
technology works. And we're not talking about one-size-fits-all-solutions.

There are precedents for this. For example, rules on implementation of Macrovision in
the DMCA. The good news again is that, as many have noted, there are on-going
discussions taking place among the IP, CE and IT industries to try to find some of these
solutions.
Page 20                                                                  Progress on Point 11.5


Education:      I do want to stress that the copyright industries are well aware of how
important this is and they are trying to work on it. It is not a simple task. There is no
one way that you can reach everyone and explain to them what they need to know. But
there's a lot going on, including public relations efforts. You'll see very soon, if it hasn't
started already, public service announcements on television and in the movie theaters
about who is affected by copyright infringement and what the problem is. There's a lot
of press coverage of the issue – the famous instant message sent by the RIAA on
KaZaA, hearings in Congress. Even litigation itself is a form of public education. One
of the things that litigation does is establish rules of the road and tell people what the
law is.

But it is important to end with the point that education should not be just the
responsibility of copyright owners. This is an issue for everyone. It's an issue for other
industries that rely on content and it's an issue for society as a whole. There are
repercussions for future innovation and creativity and for cultural development in this
country and other countries. And there are repercussions for the moral fabric of society
and ideas of individual responsibility. So this is something that we should all be aware
of – another issue for cooperation and discussion together.

William Adkinson: Now we are going to hear from Marybeth Peters who is the U.S.
Register of Copyrights. She's the head of the Copyright Office and she's held that
position for nearly 10 years and served the prior 10 years as Policy Planning Advisor to
the Register. She's the author of the General Guide to the Copyright Act of 1976 and is
responsible for implementing key aspects of the DMCA and also for promoting the
policies of the copyright laws generally.

Marybeth Peters, U.S. Copyright Office: Thank you very much. I was very pleased
to be invited by you to share the Office’s views on this matter. Many of you may not
know the Copyright Office. It's a small Government agency – about 550 people – with
about 20 lawyers who are involved in policy and regulatory work. The Office is part of
the Library of Congress; so it is part of the legislative branch rather than the
administration, even though it has executive functions.

The good news about this is the Office works very closely with the Congress. It has a
lot of independence, in the sense that there is no clearance of the Office’s position,
which allows the Office to procrastinate when preparing material for a hearing. You
have no idea what a benefit that is.

(Laughter.)

A long-standing premise of the Copyright Office is that emerging markets should be
permitted to develop with minimal government regulation. When changes in technology
lead to development of new markets or call for new business models for copyrighted
works, I strongly believe that copyright owners and users must have the opportunity to
establish mutually satisfactory relationships. And that means tolerating a degree of
Progress on Point 11.6                                                             Page 21


growing pains, if Government is not to step in prematurely. And Government has, in
fact, occasionally stepped in prematurely.

Market mechanisms must have a chance to evolve in an acceptable direction. At some
point, though, existing but dysfunctional markets may require adjustments to the law.
That is when timing is absolutely critical, and I'm going to talk a little bit more about
timing. Before I do that, I'm going to step back to discuss an important point.
Something I hear continually, and I have been in the Copyright Office now for almost 39
years, is that everyone who talks about copyright goes back to the Constitution. Each
person may interpret it a little bit differently, but we all go back and talk about how the
Constitution recognized copyright by giving Congress the power to promote the
progress of learning – the Constitution actually uses the word “Science” – by giving
authors exclusive rights. Not limited rights, exclusive rights – limited times, but
exclusive rights in their creative products. And since 1790, Congress has been
exercising that power by granting exclusive rights. In 1790 it was very clear that
exclusive rights were considered property. We can debate that, but this concept was
clear then.

Congress wasn't just granting exclusive rights. People talk about balance and societal
needs, and Congress has created a large number of exceptions to those exclusive
rights in order to achieve the "delicate" balance that we all believe the Constitution
requires.

Many of these exceptions are very specific. Certainly, the most important and certainly
the most cited is fair use. The most recent exception – actually Shira was very involved
in the Office’s study on it – dealt with distance education in a digital environment. And,
the Office was involved in the process of drafting the amendments. The timing is
interesting because we made our recommendations to Congress in May 1999 and at
that time copyright owners collectively opposed our recommendations. What a
difference a few years make. In November 2002, the digital distance education
amendments were enacted.

You have already heard that the Copyright Office does a lot of studies. The most recent
one dealt with a topic that Doug referred to – “first sale” in a digital environment. How
does it work, or does it work at all?

Additionally, the Office testifies on legislative proposals, and not infrequently. Congress
asks us assist and facilitate in the crafting of exceptions. I’ve talked about exclusive
rights and exceptions, but there's another major limitation on copyright owners' rights,
one that people sometimes see as a panacea, the answer to some difficult problems.
It’s known as a statutory or compulsory license. Here the copyright owner has his
exclusivity taken away from him. Use may be made of his work; the copyright owner
cannot say no. Of course, there are specified terms and conditions of use and generally
a reasonable royalty.
Page 22                                                                Progress on Point 11.5


Let me make it clear – the Copyright Office, based on principle, is opposed to
compulsory licenses. There are, of course, a number of compulsory licenses in our law.
But a compulsory license is a last resort in a dysfunctional market.

I find that compulsory licenses are very complicated. They create numerous problems.
They result in more regulatory action than one would imagine. They are more
expensive, and there is substantial litigation. They are perceived to be the solution for a
lot of academics. A lot of users say, “just provide a compulsory license and everything
will be fine.”

The Copyright Office administers a number of compulsory licenses, including some that
have been added since 1978. We collect royalties in three of the licenses. Copyright
owners whose works have been used make claims for a share of those royalty pools.
We administer a copyright arbitration royalty panel system – this is used when voluntary
agreements cannot be reached with respect to distribution, and with regard to the
setting of rates, terms, and conditions of the licenses. This is not an ideal solution.

The Office will continue to oppose compulsory licenses. For those of you who have any
doubts about what I’ve said, I suggest that you visit our website, www.copyright.gov,
and look at the CARP webcasting proceeding for transmissions of sound recordings.
That was concluded in July 2002, there are many appeals. The issues are extremely
complex, and nobody is happy.

Another statutory license deals with music. Since 1909 there has been a longstanding
compulsory license for the delivery of recorded music known as the “mechanical”
compulsory license. In a world of physical products, where a record company sought
the ability to make a phonorecords (disks, tapes), it worked well.

When the record companies got limited performance rights in sound recordings, music
publishers said well, we've got to be able to deal with what's going to happen to music.
So, in 1995 Congress amended section 115; it added “digital phonorecord deliveries,”
both general and incidental. In 1995, no one knew what an incidental phonorecord
delivery was. And, in 2003, we still don't know what an incidental phonorecord delivery
is. Additionally, there are unresolved issues related to on-demand streams and “limited
downloads.” Compulsory licenses are not the answer.

In this case, the parties got together and agreed on definitions and the scope of the
license. They presented their agreement to the Office and asked us to adopt it. In
effect, they said: “Make this the compulsory license.” It's not quite that easy. So, I'm
just basically saying I don’t think compulsory licenses are the way to go.

I'm going to conclude with what Shira referred to – the Copyright Office’s triennial
rulemaking under the DMCA.

The DMCA protects technological measures used by copyright owners to protect their
works. This rulemaking deals with the provision that prohibits circumventing access
Progress on Point 11.6                                                             Page 23


controls. As Shira mentioned, the anti-circumvention provisions were extremely
controversial. In fact, that part of the DMCA didn't go into effect for two years. Many
exceptions were created. One of the exceptions is known as the “fail-safe” exception –
an administrative rulemaking which gives the Librarian of Congress, on the
recommendation of the Register, the ability to evaluate the effect of the prohibition on
circumvention on non-infringing uses and to actually craft exceptions for a three-year
period of time.

The first rulemaking concluded the day before section 1201(a)(1) went into effect, on
October 27, 2000. There were two categories of works for which exceptions were
granted. We are now in the final stages of the second rulemaking. This is a highly
complex, multi-faceted rulemaking. The way we did it this time was we asked people to
recommend categories for exception. There were 83 categories recommended for
exception. And then in the second round, we essentially said to people: Support those
recommendations or oppose them. What we sought was verifiable evidence of the
impact or, if in fact impact hasn't occurred but is expected to occur in the next three
years, proof that it's more likely to occur than not occur.

I will list a few of the proposed exceptions. Filtering software, ebooks, literary works in
digital form for persons with disabilities, DVDs that are tethered to equipment, or DVDs
that are region coded, DVDs with advertising, video games with region coding,
protected music CDs, and broadcast news.

A late request came from Static Control Components (SCC) that had been sued for
copyright infringement by Lexmark International. SCC makes computer chips that third
party manufacturers can use to enter the toner cartridge replacement business.
Lexmark alleged that SCC circumvented its computer program, which included a secret
handshake between a Lexmark toner cartridge and a Lexmark printer, in violation of the
DMCA, and SCC sought an exemption to allow such circumvention. SCC did not want
to circumvent a technological measure to gain access to a copyrighted program it
wished to enjoy but to seek access to a work that controlled the operation of a product.
This clearly is a novel issue.

The DMCA requires consultation with NTIA, part of the Department of Commerce, and
we have done that. NTIA’s letter to us is posted on its website and ours. It's been
covered in the press. I will just tell you the NTIA response is not as bad as it has been
made out to be. NTIA takes issue with our stated standard of proof and offers some
suggestions. NTIA does not disagree with our interpretation of a particular class of
works.

The Office is in the process of wrapping up its deliberations. The decisions are based
on a balancing of the factors. One factor is whether access control measures are
increasing or restricting, the availability of copyrighted works for the general public?
That is, do technological controls encourage distribution or do they inhibit it?
Page 24                                                                Progress on Point 11.5


Another factor, of course, is the availability of use of copyrighted works for preservation
and fair use. To what extent have access controls prevented these activities? Another
factor is the extent to which circumvention is affecting the market for or value of
copyrighted works. In making our recommendations, we have to look at what's been
presented to us.

My goal is to get the recommendation to the Librarian early, late September, so that the
Librarian’s decision can be published well before the October 27th deadline.

I'm going to leave you with a couple of final thoughts on this rulemaking. The
rulemaking is not a process for changing the law. Some of the comments we received
said, for example: “This law sucks, change it.” This is a very narrow rulemaking. This
rulemaking is remedial. It doesn't change any normative rules. The legislative history
shows that Congress basically believed that the market would resolve most of the
issues without resorting to excesses dealt with in the rulemaking. The rulemaking is
mostly to look at unforeseen changes in the digital marketplace.

In the last rulemaking, although there were only two exceptions, the copyright owners
said they were not happy, and the users were, to say the least, extremely unhappy with
the rulemaking. But the truth of the matter is that a lack of exceptions or a limited
number of exceptions does not mean that the process isn't working or that it's not
functioning as it was intended to. It is exactly the opposite. It proves that the law is
working the way that Congress intended and that the market on its own is resolving the
problems. This is interesting because, as someone who headed an agency that was
getting this administrative rulemaking, I looked at it with concern and trepidation, and I
wasn't sure that administratively created exceptions were really a good idea.

I am not saying it’s a joyous task. I am not saying it’s one we look forward to. But I do
think it's an important check on the balance of the copyright law and it does monitor the
market. It can curb excesses and the three-year period does allow for changes,
including corrections. So I'm not opposed to the rulemaking, and I think it’s important.

Finally, I agree with everybody who said education is important. The Copyright Office
has limited resources, so our efforts in this area are limited. We're focusing on
education geared towards creativity – that copyright exists to encourage creativity and
the importance of distribution of copyrighted works. We're working with the Music
Educators National Conference trying to get copyright education into the schools. All
students are potential creators, and they need to see how these issues could affect
them as creators; they need to understand that there are laws in place to protect
creators.

So, if we each do our part, I think collectively we can get the message out. Thank you.

William Adkinson: Thanks, Marybeth. I want to thank our panel for giving us a
wonderful overview of what's going on in the marketplace.
Progress on Point 11.6                                                              Page 25


(Applause.)

I'm now going to ask our panel to cede the usual right to make responsive comments, if
I could, so that we could get a few questions in from the audience. Great. Any
questions? Jim?

Audience Member: Jim Burger. I have to take some exceptions to Mr. Rose's
numbers. It reminds me of the old – there are white lies, lies, bold face lies and then
statistics. The WiFi is very helpful because in the period when there's been all this
rampant piracy, PC shipments have dropped and I've got the data quest numbers up
here if you want to see them. So I don't see how there could be profit indeed. The only
bright start on the PC sale side has been portable computers. This is like Ted Cohen
taking exception to people last night saying: Oh yeah, the artists don't get any money,
there's all these numbers out there. I think we have to be very, very careful with these
numbers because they imply something and I think the implication is wrong.

The second piece is I was hoping I could argue with Shira a lot, but I can't. The only
thing I want – because I agree with just about 99 percent of what she said – I just want
to put a cautionary note on the Macrovision statute provision because I was involved
with a lot of other people in that. Macrovision applies to a dying old technology, which
was mature. I'm not disagreeing that there may at the end of the day be some role for
government, but one wants to be very careful when we're just evolving the business
models. The very flexibility Shira talks about gets taken away when you put something
into a statute. So I just think we need to be a little bit careful.

John Rose: I have to respond to the comment about PC shipments. First of all, they're
not my numbers, but you wouldn't expect that they would be. Second of all, if you peel
underneath the PC shipments and look at the mix and look at the margins and look at
the underlying marketing messages of a number of the consumer-driven PC
manufacturers, you can come up with the numbers I've come up with. If you want I'd be
happy to take you through them off-line.

However, any single number I presented can be nitpicked, and the issue really isn't any
specific single number in the analysis. I think I was very wide in my range of numbers
regarding the profitability impact of P2P file sharing. In aggregate, across the PC
manufacturers, CE companies, telcos, ISPs, looking just at the hard incremental
revenues and margins created by P2P file sharing, there is a fairly hefty bump. We can
argue about whether it's a $3 billion incremental profit number or a $6 to $8 billion profit
number, but there's no question when you look at the incremental traffic on the
backbone, the incremental minutes generated on the networks, and a bunch of other
incremental activity created by this file sharing, that it drives profitability.

You can argue about any specific assumption and I've had PC manufacturers, CE
manufacturers and telcos argue them out. But at the end of the day I'll guarantee you
that if we spent the four or five hours to go through the analysis, you would agree with
half of it and you would disagree with half of it. And you would be drawn to a conclusion
Page 26                                                                Progress on Point 11.5


that the incremental profitability is somewhere between three and six-to-seven times the
profitability of the content part of the value chain.

William Adkinson: Another question?

Audience Member: What are the differences in the social norms and mores that make
it okay to steal songs, but not software, movies? Or is it? I don't know if you can
quantify that, but I find it very curious.

Doug Lowenstein: There's probably a profound sociological discussion there that I'm
not qualified to undertake, but I'll give you my kind of pop response, which hopefully will
be somewhat helpful.

I think if you go back over many, many years, the whole set of consumers, the whole
notion of being able to copy a song has been something that has been with us for a long
time. Taping something off the radio, for example. Whether it was legal or not is not the
point. The point is people always felt that you could copy this. You could copy
something to a tape. People aren't making the distinction between personal use and
distribution and so forth. There has just built up over many, many decades, I think, in a
lot of normally law abiding people, some set of expectations that they can do that.

When you translate that into this sort of peer-to-peer online environment, it's a fairly
easy leap for a lot of people to make, in terms of their own mindset. Oh well, this is just
doing what I think I've been able to do for many, many years. It doesn't feel any
different; I just have to push a button. And so my own sense of it at least in the music
space (and there are other people here who have probably spent a lot more time trying
to understand that behavior than I have), is that that's a part of it.

In the game space, part of the point I was trying to make is that, as an industry, I think
there are some really fundamental distinctions between how what people have
expected and how people have used the product. And so they don't come to the table
with the same set of cultural expectations. There isn't a history of people being able to
copy a game on to different media and use it in different ways. It's always been
something where you came to the table, you knew that you could only play your X-box
game on your X-box, your Nintendo game on your Nintendo. People have never
questioned that set of assumptions. And so I think they have, over time, developed a
sort of different mindset.
Progress on Point 11.6                                                          Page 27


                              Speaker Biographies
William F. Adkinson, Jr. is senior policy counsel at The Progress & Freedom
Foundation. He focuses primarily on intellectual property, competition and regulatory
issues, authoring articles, reports and commentaries from legal and economic
perspectives. Previously, Adkinson was an associate at Wilmer, Cutler & Pickering,
where he practiced law in the antitrust and e-commerce groups. Earlier, Adkinson
served as an attorney with the Office of Policy and Planning at the FTC and as an
economist with the Council on Wage and Price Stability. He serves as vice president
for programs of the National Economists Club and assistant editor of the Antitrust Law
Journal. Adkinson graduated from Amherst College and received his law degree from
Yale. He completed course work and oral examinations towards a Ph.D. at Yale's
Economics Department.

Doug Lowenstein is president of the Entertainment Software Association, formerly
named the Interactive Digital Software Association. He became IDSA’s first president in
1994 and built IDSA into an influential trade body representing the computer and video
game software industry. Prior to joining IDSA, Lowenstein was an executive vice
president in the Washington and New York strategic communications firm Robinson
Lake Sawyer Miller, Inc. He also worked as legislative director for U.S. Senator Howard
Metzenbaum from 1982-1987. Lowenstein received his B.A. in political science from
Washington University.

Shira Perlmutter is vice president and associate general counsel for intellectual
property policy at AOL Time Warner. Previously, she was a consultant on the copyright
issues involved in electronic commerce at the World Intellectual Property Organization
in Geneva, Switzerland. From 1995 to 1999, she was Associate Register for Policy and
International Affairs at the U.S. Copyright Office. In that capacity, she advised
Congress on, and drafted portions of, the Digital Millennium Copyright Act of 1998.
Perlmutter received her A.B. from Harvard University and her J.D. from the University of
Pennsylvania.

Marybeth Peters has served as the U.S. Register of Copyrights since August 7, 1994.
From 1983 to 1994, she held the position of policy planning advisor to the Register.
Peters also served as acting general counsel of the Copyright Office and as chief of
both the Examining and the Information and Reference divisions. She is the author of
The General Guide to the Copyright Act of 1976 and is an adjunct professor of copyright
law at the University of Miami School of Law and at the Georgetown University Law
Center. Peters received her B.A. from Rhode Island College and her J.D. from the
George Washington University Law Center.

Jerry Pierce is senior vice president of technology at Universal Pictures. He recently
formed the Motion Picture Technology Office for Universal Pictures and established the
joint project with Matsushita Electric Industries (Panasonic) for DVD disc authoring and
High Definition Telecine Transfers. Before joining Universal Studios in 1995, Pierce
was vice president of Eidesign Technologies, an innovator in the design of MPEG-1
Page 28                                                                                                  Progress on Point 11.5


video encoder systems and services. He was a member of the Stanford Research
Institute for over 13 years and was director of the Electronics Technology Center.
Pierce holds a MSEE degree from Stanford University and a BSEE from UC Berkeley.

Jim Ramo serves as CEO of Movielink. He has over 25 years of experience in the
delivery of entertainment and related services. From 1985 to 1990, he was vice
president of Hughes Communications (the forerunner of PanAm Sat) and was
responsible for sales to the cable and broadcast industry. He also served as COO of
TVN Entertainment and CEO of Geocast Network Systems from 1997. From 1990-
1997, he was a primary founder and executive vice president of DIRECTV. Ramo
received his B.A. from the University of California at Berkeley and a M.S. degree from
the London School of Economics.

John Rose became executive vice president of EMI Group in December 2001. In his
position, he manages the operations review of EMI’s recorded music business and
helps to drive the growth strategy process for EMI Group. Previously, Rose served as a
senior partner of McKinsey and Company in New York, where he co-led the firm’s
global media and entertainment practice and was a founder of its e-commerce practice
and its broadband special initiative. Rose holds a B.A. in mathematics from Wesleyan
University and a M.A. from the Yale School of Management.




The Progress & Freedom Foundation is a market-oriented think tank that studies the digital revolution and its implications for public
policy. Its mission is to educate policymakers, opinion leaders and the public about issues associated with technological change,
based on a philosophy of limited government, free markets and civil liberties. The Foundation disseminates the results of its work
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partisan organization supported by tax-deductible donations from corporations, foundations and individuals. PFF does not engage
in lobbying activities or take positions on legislation. The views expressed here are those of the authors, and do not necessarily
represent the views of the Foundation, its Board of Directors, officers or staff.

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