Memorandum submitted by British Phonographic
Industry Ltd |
The structure of the submission is as follows:
Sections 2 and 3 give industry background
relevant to the parallel imports issue.
Sections 4 and 5 assess the effects
of parallel trading on both producers and consumers.
Section 6 considers the various intellectual
property issues that are raised in the context of the parallel
2. BRITISH PHONOGRAPHIC
The British Phonographic Industry is the record
companies' trade association. The BPI represents more than 200
record companies in the UK and its members produce most of the
country's recorded music.
The BPI was founded in 1971 and has a democratically
elected Council existing of the managing directors of large and
small companies from a variety of musical backgrounds. The Council
meets on a regular basis to confront issues affecting the music
The BPI hosts the annual BRIT awards ceremony.
This honours the best of British and international music talent
and is broadcast throughout the world.
The BPI operates a Research and Information
Department which collects, collates and publishes statistical
information about the size and value of the market for recorded
music in the UK. The BPI also has an Anti-Piracy Unit which targets
pirated and counterfeit CDs and gives educational seminars to
public enforcement bodies and the record industry. The legal department
provides advice to members and negotiates on their behalf with
other music bodies.
The Events department supports BPI members by
arranging attendance at international trade fairs which promote
Through the British Record Industry Trust, whichis
funded by charitable events and indivdual donations, the BPI sponsors
a number of initiatives to promote education and employment in
the record industry and elsewhere. This ranges from the BRIT School
for Performing Arts and Technology to the Nordoff-Robbins Music
Therapy Centre which works to help disabled children communicate
UK RECORDING INDUSTRY
3.1 Contribution of the recording industry
to the UK economy.
The contribution of the recording industry to
the UK economy has to be seen in a broader context than merely
the production of recordings. The record industry generates high
value added and employment for composers, musicians, studios,
producers, manufacturers, music publishers, collection societies,
retailing and distribution, and managers, agents and promoters.
The best data currently available on the value
of the music industry to the UK economy relates to 1995 and is
provided by The Value of Music (a National Music Council Report
into the value of the UK Music Industry prepared by the University
of Westminster November 1996).
of the UK music industry was estimated by the report at £2.5
billion (including earnings generated overseas). This is broken
down in table 1.
|Total Value Added (£m)
|Live performance: rock and pop etc.||300.0
|Live performance: classical etc.||146.0
|Other artists' earnings||525.0
|Opera and musical theatre||120.0
|Recording (including manufacturing and distribution)
|Retailing and distribution||334.1
|Musical instruments: production, retailing and distribution
|Managers, agents, promoters||132.0
|Education and training||100.9
This value-added generates considerable employment. In 1995,
the music sector in the UK generated the equivalent of 115,200
full time jobs. When part-time workers are added, at least 160,000
people were actively involved in the creation and distribution
A BREAKDOWN OF
|Live performance: rock and pop etc.||42,000
|Live performance: classical etc.||6,383
|Other artists' earnings||3,888
|Opera and musical theatre||1,250
|Recording (including manufacturing and distribution)
|Retailing and distribution||18,898
|Musical instruments: production, retailing and distribution
|Managers, agents, promoters||15,562
|Education and training||1,072
3.2 The "Value of Music" report notes that
with value added of £2.5 billion, the music industry is of
similar size to industries such as water supply (£2.4 billion
in 1994) and larger than organic and inorganic chemicals (£2.1
billion), electric motors (£1.9 billion), electronic components
(£1.7 billion) and shipbuilding(£1.6 billion).
3.3 The nature of the recording industry.
The recording industry is a particularly high-risk industry.
The level of investment required is extremely high and there is
a good deal of uncertainty in the expected return. On average,
only 1 in 10 recordings are successful.
This is well summarised on page 73 of the Department for
Culture, Media & Sport's Creative Industries Mapping Document
(1998) ["DCMS Report"].
"The recording industry is high risk, requiring substantial
upfront investment in new artists and repertoire (A&R). Record
companies invest approximately 12-13 per cent of revenues in A&R,
one of the highest ratios of R&D expenditure of any industry.
The industry relies on a handful of "blockbuster" hits
to cover the losses from the majority of recordings that do not
sell enough copies to cover the initial investment."
Confirming the point on levels of investment, the Monopolies
and Mergers Commission report on the supply of recorded music
(June 1994) commented on the fact that the DTI had observed that
20 per cent of record industry turnover is devoted to A&R
expenditure, together with expenditure on fixed capital formation.
The DTI found that this compared well with 2.2 per cent R&D
in manufacturing generally and even compares well against electronics
with 10.2 per cent.
Despite this level of investment, many recordings are produced
at a loss or just a modest profit. That this is true is proven
by the rates of return received by investors in the recording
industry. A recent study by NERA
on behalf of DGXV of the European Commission showed the following
rates of return for the period 1992-1997:
NERA reportTable 2.1: Page 16 of Appendix C.2
|Operating Profit Margin (92-97)
|Majors||5.6 per cent
|Independents||-0.1 per cent
These profits are modest by general standards and, in the
case of the independent record industry, are negative. Of course,
within these aggregated figures are examples of recordings that
are extremely successful which earn a much higher return than
that shown above. On the other hand, it also includes recordings
for which the losses are very significant where the recording
is a complete failure.
3.4 THE "MAJORS"
The five major recording companies are BMG, EMI, Sony, Universal
and Warner. These are global companies with operations in markets
throughout the world. Notwithstanding the multinational nature
of these companies, each of the individual country offices is
typically a nationally based company. This means that they have
indepedent decision-making ability from the parent. Most importantly
for the debate on parallel imports, they have indendent budgets
to invest in local repertoire.
3.5 THE "INDEPENDENTS"
The DCMS 1998 report on the creative industries notes that
29 per cent of albums sold in the UK were supplied by 800 independent
record companies (based on 1991 data). This proportion has barely
changed in recent years and is higher than any of the individual
market shares of the majors.
A feature of independent companies is that they are too small
to have operations on a global scale. The domestic (UK) market
is the most important market due to the fact that it is here that
the company will have a selling infrastructure and can compete
head on with the majors. On export markets, however, it is impossible
for most independent companies to have own selling operations.
Thus there is a simple choice for export markets.
Either recordings are licensed to unrelated companies in
each export market or the finished product is exported through
Before considering the effect of parallel imports on the
independent record industry in section 4.3, it is important to
look at the income flows in the domestic and export markets in
a little more detail.
In the domestic market, the independent company is responsible
for the recording from the original recording, through manufacture
of the CD, to the sale to a dealer. The exact process varies according
to the genre. However, generally, high levels of investment are
made in promotion and advertising for sales on the domestic market.
Not every recording will be successful and therefore it is an
extremely risky business. Although particular recordings may make
substantial profits, often these merely cover the losses of other
recordings that have flopped. This is a highly competitive market
and, thus, the independent record companies have to be highly
efficient and dynamic economic operators. Because of this some
of them are able to make overall profits, but given the riskiness
of investment, many make losses even on the domestic market and
there are many company failures each year. Thus, for many recordings,
the domestic market is not sufficient to cover the high investment
The export market, on the other hand, is not viewed in the
same way. The independent record companies do not have the infrastructure
in each market to run their business in the way that they do in
the domestic market. Therefore, export markets are viewed very
much as marginal sales. If a record has made a profit at all on
the domestic market, export sales are profitable as long as they
cover marginal costs. Thus, although all companies would like
to receive as high a price as possible for export sales, they
accept the price that each market bears. In the case of licensing,
it is only royalty income that is received. It can be noted that
this means that the UK independent record company does not have
any control whatsoever on selling price (they merely receive a
royalty income based on a fixed percentage).
The key difference, therefore, is that for the domestic market,
UK independent record companies price on a full average cost basis.
For export markets, they price on a marginal cost basis if it
is necessary in order to be able to sell in the overseas market
These characteristics were reflected in the DCMS creative
"The indies play an important role in the industry, discovering
new sources of talent, and establishing new fashions. However,
as a result they bear a disproportionate risk of developing new
Given all of the above points, it is clear that both the
UK and export markets are crucial to the business of UK independent
record companies and loss of either market would raise serious
questions about the viability of many of these companies.
3.6 The industry does not only produce pop music
Pop and rock music clearly dominate the industry in value
terms. However, fewer than one quarter of BPI members are regarded
as pop music specialists and indeed there are just as many companies
whose output includes classical music. The range includes the
spoken word, jazz and brass band music. BPI's membership even
includes specialists in Christian and other religious recordings.
This reflects the diverse nature of the independent record companies.
4. HOW PARALLEL
UK RECORDING INDUSTRY
4.1 The general effects of international exhaustion
Currently, parallel imports are permitted when the first
sale has taken place inside the EEA (ie Community exhaustion).
When the original sale is made outside the EEA, the rights within
the EEA have currently not been exhausted. International exhaustion
would mean that rights were exhausted on the first, legitimate
sale anywhere in the world.
The general effect of this is that prices could not differ
according to different circumstances in different markets. The
implication of this will differ for the majors and independents.
We will consider each of these in turn.
The term "parallel import" implies that a product
is being imported "in parallel" to an original export
transaction. This is not always the case in the record industry.
Recordings can be licensed to, and manufactured by, different
companies in different countries. In such a situation, the parallel
import may be an identical product to the domestically produced
product but there is no original export transaction.
In the past, a common source of imports has been North America.
The dramatic fall in Asian currency values over the last 18 months
suggests that countries such as Thailand, Malaysia and Indonesia
are now more likely sources. Also, countries in Central and Eastern
Europe with less developed economies and where piracy levels are
rife, are another obvious source, as the industry develops its
operations in these territories. With the current strength of
sterling, such parallel importation is bound to occur on a very
4.2 The effect of international exhaustion on the majors
The introduction of international exhaustion would not necessarily
have a significant impact on the business of the major recording
companies in global terms. However, it would change the structure
of these companies' global business.
As noted in section 3.3, all of the majors in the UK have
independent artist and repertoire budgets. This is invested in
developing UK talent. The result of this is that an investment
might be made in a band that, initially at least, is only expected
to do well in the UK market. Although such a recording may be
sold in export markets, it is unlikely that the same level of
investment would occur.
If recordings can come back into the UK through parallel
traders from non-EEA markets, the higher price in the UK (required
to cover the investment costs) will be compromised. In effect,
the parallel trader will be free-riding on the original promotion
and advertising investment for the UK market.
Introducing international exhaustion risks losing this independent
function of the UK divisions of the majors. International exhaustion
will mean that prices cannot differ between markets. Thus, in
effect, companies' strategies will become more global as a global
price will have to be charged for each recording (the only differences
reflecting transport and other costs).
The risk for the UK economy is that the unfettered role of
the local office is lost as global strategy is decided by head
office in the biggest market (the US) and profits revert back
to the US, rather than remaining with the UK divisions as at present.
Such a situation would result in job losses for the UK as well
as a lower investment in UK talent.
4.3 The effect of international exhaustion on the UK independent
If parallel imports are permitted from all countries, the
UK independent record company has four possible responses:
Leave prices as they are.
Refuse to supply export markets where prices are
lower than domestic market.
We can look at the consequences of following each of these
choices in more detail.
Raise export prices
Firstly, it can be noted that increasing price in the export
market is not an option. Independent record companies are price
takers in export markets. The choice is to sell at the market
price or not sell at all.
It can also be noted that it would not be possible to increase
licence fees given that they are already set at the price the
particular market can bear.
Lower domestic prices
Reducing prices on the domestic market is also not a viable
option. The price cannot be lowered because many UK independent
record companies are already on the borderline of commercial viability.
Leave prices as they are
The principal effect of this will be that, where export sales
have been priced on a marginal cost basis and are then re-imported,
they will displace domestic sales priced on an average cost basis.
The effect will be an overall fall in profitability caused by
parallel traders free-riding on the investment of the independent
In additon there would be a fall in royalty income in two
ways. Firstly, even where royalties are payable at the same percentage
rate, the amount received will be reduced because it will have
been calculated on the basis of lower prices. Secondly, royalties
from low priced markets are likely to be at lower percentage rates.
Lastly, the profit associated with the manufacturing element
in the domestic market will be lost where products have been licensed
on the export market.
As explained above, considerable investment in A&R, advertising
and promotion take place in the domestic market. The same investment
has not taken place for marginal export sales. Thus, parallel
traders importing CDs from low price countries will be free-riding
on the expenditure of the UK independent record companies. This
is a classic case of market failure. The response to the free-riding
problem is that UK independent record companies will not make
investments because they can be too easily undermined. Thus, fewer
new recordings will be made. Given the importance of the independent
sector as highlighted in the UK Goverment Creative Industries
Report, this would have a negative impact on the UK music industry
as a whole.
Refuse to supply export markets where prices are lower than
This is a means by which parallel imports could be prevented.
However, it means that a crucially important source of income
(as highlighted above) is cut.
In all four scenarios above, the independent producers would
lose income and thus profitability would deteriorate.
It can be noted that, if the majors were to reduce their
discretionary UK A&R budgets as discussed in 4.2 above, this
would also have a negative effect on the independent companies.
The links between the independent companies and the majors are
strong and any weakening of the majors' independence in the UK
will have knock-on effects for the independent record companies.
This provides a unique infrastructure and environment for the
5. HOW PARALLEL
5.1 Effect on prices
Allowing parallel imports by introducing international exhaustion
is likely to have only modest effects on consumer prices.
The following points should be noted:
Price differences are over-estimated when appropriate
adjustments are made.
Price differences that exist are explainable by
reasons other than protection of intellectual property rights.
Where there is an opportunity to parallel imports,
traders will increase their profits rather than lower retail prices.
These points can be considered in more detail:
Price differences are over-estimated when appropriate adjustments
are madeThere is much pejorative media comment about the
price of recorded music, particularly CDs. Press articles often
run price comparisons to show how UK consumers are paying too
high prices for their CDs. However, these stories are often extremely
misleading for a number of reasons. For example, in the case of
comparisons between UK and US prices:
First, price comparisons often fail to take into account
differences in taxes.
Secondly, royalty rates are lower in the US than in
Thirdly, the UK market is a much smaller market than
the US market (most often used in the price comparisions). It
is not surprising that, given the average volume sale in the US
is much greater than a typical sale in the UK, prices are lower
in the US. Also, the cost of manufacturing does not differ significantly
between the US and UK. Therefore, US firms more quickly recoup
the fixed cost element of a recording.
Fourthly, a higher level of service is provided in
the UK than in the US and therefore UK distribution costs are
Fifthly, the cost of retailing is higher in the UK
than in the US, caused by such factors as cost of planning permission
and higher rates, rent etc and other associated costs.
Lastly, there is a much larger range of mid-price
and budget CDs available in the UK. The average price difference
across all types is much less than the full price pop CDs.
Price differences that exist are explainable by reasons other
than protection of intellectual property rightsThis was
confirmed in the MMC report. In announcing the reference to the
MMC, the Director General drew attention to high prices relative
to the USA. He expressed concern that use of copyright law to
restrict parallel imports may frustrate competition. However,
the MMC is clear in its conclusion:
"We do not ascribe the price differentials to the right
of a copyright owner to control parallel imports. It seems unlikely
that removing that right would lead to a reduction in the price
of recorded music generally."
Exchange rates are the principal cause of price differences
between both EU member states and with countries such as the US.
This was confirmed by the MMC report, which stated that "perceptions
are crucially influenced" by the exchange rate. Given the
prevailing exchange rate, price differences between the UK and
other countries may increase and decrease according to developments.
The fact that price differences can be explained by factors
other than parallel import restrictions was backed up by the MMC
study into prices of other products. The MMC studied prices of
goods relating to leisure activities and found that in almost
all product groups, average prices were higher in the UK than
USA and concluded that CD prices were not out of line with a range
of goods. More recently, as set out in the NERA Report of 8 February
1999 (Annex C, table 2.5, page 19) an international comparison
of international retail prices of sound recordings was made across
a range of formats and price levels. The average UK price was
10.47 and the average US price was
10.52, indicating lower average prices across the wide range of
recordings available in the UK. Indeed UK prices were lower than
the other EC countries surveyed, including Germany, Holland, Sweden,
Denmark and Belgium.
Where there is an opportunity to parallel import, traders
will increase their profits rather than lower retail pricesThe
points made above indicate that the opportunities for parallel
importing are perhaps less than is sometimes claimed. However,
it is clear that some opportunities for parallel importing would
exit if international exhaustion was introduced (due to marginal
cost pricing of exports).
Where importers parallel import products from overseas markets,
this is highly unlikely to have any effect on retail prices. More
likely, the parallel importers will increase their profits on
an unfair basis due to the fact that they are free riding on the
promotion and advertising expenditure of the UK companies.
5.2 Loss of choice
The choice of recordings for consumers is likely to be reduced
as less investment will be made in UK bands.
Parallel traders tend to "cherry-pick" the records
that are already successful. Therefore, there is likely to be
an increased emphasis on the best-selling hits.
There would be less diversity of music as investments would
have to be more certain of commercial success in order to be viable.
Many of the independent record companies whose existence would
be threatened by parallel imports are in niche markets. Parallel
traders would not be interested in providing a diverse range of
musicinstead, "free-riding" activity is likely
to be concentrated only on commercially successful titles.
6. INTELLECTUAL PROPERTY
6.1 Are trademarks sufficiently protected?
Trademarks are, in general, adequately protected in the UK
as the current legislation stands.
However, should international exhaustion be introduced for
trademarked goods, the level of protection would be inadequate
for the record industry. Although record companies are often able
to rely on copyright law to prevent parallel imports of their
recordings, in certain circumstances it is very difficult and
using trademark law is much more straightforward.
The distribution of recordings on-line via the internet will
become increasingly popular over the next few years. When dealing
with this type of distribution, it is much easier to use trademark
law than copyright law. To proceed successfully in relation to
copyright infringement on parallel importation via the internet,
it is necessary to show that the importer is not the consumer
(who has a defence because he is not importing in the course of
a business). In relation to trademarks, the same is not true.
Similarly, when dealing with the parallel importation of
physical goods, copyright law does not always provide an available
remedy; if a recording is made in a non-Rome Convention country,
such as the USA, and subsequently imported into an EEA Member-State
which does not protect such recordings, such as Sweden, the trademark
right will in principle be the only legal tool to stop parallel
imports. This means that if international exhaustion for trademark
rights was introduced, a significant number of important recordings
could be freely imported as there would be no ability to rely
on copyright law.
6.2 What are the main problems with existing measures to detect
and prevent counterfeiting and piracy? How can such measures be
made more effective?
In general, the experience of using the anti-counterfeit
regulation (Council Regulation 3295/94) has been very positive.
One reason for this is that national customs services in the EU
have gone beyond the strict requirements of the Regulation and
kept a general watch for CDs arriving from certain specified countries,
rather than taking action only when informed about the specific
shipments. For example, UK Customs seized 47,000 infringing CDs
bound for the Dutch market as a result of a request from the BPI
to be on the lookout for CDs coming in from Singapore.
The issue of piracy and counterfeiting is currently the subject
of an in-depth review in the EU under the EU Green Paper on combating
Counterfeiting and Piracy in the Single Market. The BPI has submitted
a response to this Green Paper as well as endorsing the very detailed
submission prepared by IFPI. In very general terms, measures under
UK law are satisfactory, although the BPI believes that enforcement
should be strengthened and that theft of intellectual property
should treated on a par with theft of real property. In addition,
there is often a failure of the part of law enforcement agencies
to prosecute intellectual property crimes due to a lack of resources.
Finally, the very low levels of fines and prison sentences handed
down by the courts, despite heavier penalties being available
under the law, do not provide an adequate deterrent.
We believe the situation would be improved if counterfeiting
and piracy was recognised as a serious crime and that CD piracy
would be greatly reduced if there was mandatory regulation of
CD plants and compulsory use of unique identification codes such
as the Source Identification (SID) Code.
The BPI supports international IP initiatives through WIPO
and the WTO. However, it vigorously opposes the introduction of
any form of international exhaustion for intellectual property
rights, for the reasons set out in this paper. The BPI urges the
UK Government to ensure that the WIPO Treaties on copyright protection
in the on-line environment are quickly implemented into EU legislation
through the Copyright Directive and the E-Commerce Directive in
order that the creative industries can do business on-line and
effectively fight internet piracy.
6.4 THE IMPACT
Sound recordings are particularly prone to pirating and counterfeit
activity and it is estimated that pirate sales of CDs and cassettes
worldwide in 1997 were worth £4.5 billion. Introducing international
exhaustion would have an extremely significant effect on the enforcement
of intellectual property rights in the UK.
Pirate recordings have become increasingly sophisticated
and today are often indistinguishable from authorised copies.
It should also be noted on a practical level that border controls
will necessarily become less effective against the importation
of pirate goods if they are also required to deal with the unfettered
flow of large numbers of parallel imports.
Given that there are good reasons to maintain the current
system of Community exhaustion with regard to trademarks and copyright
(as set out in sections 4 and 5) the benefit in terms of strong
protection against piracy is a massive bonus in maintaining the
existing regime that should be taken into account.
30 March 1999
The value added figure is that which remains after such costs
as management fees and recording costs are deducted from gross
The Economic Consequences of the Choice of Regime of Exhaustion
in the Area of Trademarks (February 1999). Back