Recursos necesarios por la microempresa para la implementación de estrategias

The Judges agree with SoundExchange’s critique that the “incremental approach” advanced by iHeart is an inappropriate method for determining rates under section 114. There are a number of reasons why the “incremental approach” is improper.

First, the basic premise of the approach is erroneous. In an effort to avoid the so-called “shadow” of the statutory rate, Drs. Fischel and Lichtman essentially substitute a rate of zero for

173

SoundExchange does not provide a citation to the record for these statistics, referring only to “iHeart’s data.” SX PFF ¶ 863. By contrast, Drs. Fischel and Lichtman stated in their written testimony that “[a]s of July 2014, these 27 labels accounted for approximately % of webcast performances on iHeart,” but it was unclear from their

testimony whether that percentage combined custom and simulcast performances. See Fischel/Lichtman AWDT ¶ 57 & n.51. Thus, the record is unclear what percentage of plays on iHeart’s custom noninteractive service is comprised of these 27 Indies’ recordings.

174

SoundExchange also points out that Drs. Fischel and Lichtman only had performance data for of the 27 Indies, so they extrapolated the data that they had. Id. at 5548; see also SX Ex. 2347.

175

As noted in the Judges’ analysis of the Pandora/Merlin Agreement, Mr. Barros did not indicate that Concord, or anyone on its behalf, established a monetary value for these other contractual items.

Determination of Rates and Terms 2016-2020 (Web IV) - 155

the number of sound recordings played under the existing statutory rate. Then, they conceptually divide the expected total of performances under the direct license (the iHeart/Warner Agreement) into two value-bundles. The first conceptual value-bundle (Scenario 1) consists of the lower number of performances (without steering) that iHeart expected to be played under the higher existing statutory rate. The second conceptual value-bundle (Scenario 2) consists of the number of performances (with steering, from % to % market share) that iHeart expected to be played under the lower direct deal rate. Drs. Fischel and Lichtman then consider the expected difference between the higher revenues arising from the direct deal. Finally, they divide the incremental revenue by the number of incremental plays to determine their “incremental rate.”

This methodology intentionally attributes no market value to the rate and revenue paid for the pre-incremental performances. Although, as noted above, Drs. Fischel and Lichtman engage in this process in order to remove the alleged impact of the “shadow” of the statutory rate, they merely replace one supposed problem with a very real and more serious problem. That is, they replace the statutory rate with an effective rate of zero for the pre-incremental

performances. There was no evidence presented in this proceeding – and indeed no logical evidence could be presented – to support an assertion that the bulk of the pre-incremental performances under iHeart’s “two bundle” concept would be priced at zero in an actual market. To state the obvious, the creation of sound recordings is not costless, and prices are positive because costs must be recovered.176

Relatedly, although iHeart would like the Judges to focus only on the incremental number of performances and the incremental revenue, those incremental values cannot exist without iHeart first paying for the pre-incremental performances at pre-incremental rates. To put the point colloquially, “you cannot get there from here.” That tautological point is not avoided by arbitrarily attributing a zero value to the pre-incremental performances.

SoundExchange makes this point well by analogizing to a “buy one, get one free” offer. If a vendor offered an ice cream cone (to adopt SoundExchange’s demonstrative example at the hearing) for $1.00, but offered two ice cream cones for $1.06, it would be absurd to conclude that the true market price of an ice cream cone is the incremental six cents. Rather, this offer indicates a market price of $0.53 – the average price for the two ice cream cones. Or, to take a common example, tire sellers will often advertise a special where the buyer can pay for three tires and get the fourth tire free. This is economically (and mathematically) equivalent to a 25% reduction in the price of four tires. No one could go to the automotive store and receive only the “free” fourth tire!

iHeart attempts to distinguish the ice cream cone example by noting that, in the present case, Drs. Fischel and Lichtman are not eliminating a market-based price for the pre-incremental bundle, but rather are eliminating a government-set rate that casts a “shadow” on the market. There are several errors in this reasoning. First, the statutory rates were set after market

176

It is also unsupported by the evidence that record companies would forego all royalties in the hypothetical market merely to obtain a promotional value from the playing of their recordings on a noninteractive service.

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participants provided the Judges in the prior proceeding with market evidence. There is no a priori reason to conclude that the rates set in that earlier proceeding failed to reflect or

approximate market forces, and iHeart does not provide evidence as to why the Judges should re- litigate its prior rates and reach such a conclusion.177 Second, to use a zero rate in order to remove the alleged shadow of the Judges’ statutory rate or a settlement rate would be, to put the matter colloquially, throwing out the baby with the bathwater.” A functionally zero rate for the pre-incremental performances is no mere potential “shadow;” it is an ink blot that obliterates any economic value inherent in the majority of the performances for which the rates must be

established.178

Accordingly, the Judges reject iHeart’s incremental approach and they reject the $0.0005 rate its experts derived by using the incremental approach. To be clear, that incremental

$0.0005 proposed rate does not constitute a benchmark or a guidepost which the Judges have relied for any purpose, and that incremental rate and the analysis from which it was derived has not influenced the Judges in their determination of the statutory rate in this proceeding.179

177

Similarly, iHeart has not proffered evidence sufficient to show why the rates set in settlements between parties, that both parties agree may be evidence of a market rate, fail to reflect, or at least approximate, market rates as of the time they were set.

178

On a less colloquial and more economic basis, iHeart has confused an elasticity-type concept with price. iHeart calculates the change in total revenue divided by the change in quantity. Such a proportionate change is not equivalent to a unit price.

179

iHeart attempts to support its “incremental” analysis with three arguments that it claims are confirmatory of the $0.0005 rate. See iHeart PFF ¶¶ 236-260 (and citations to the record therein). The Judges note that their rejection of this “incremental” analysis moots the relevance of any attempt to confirm its purported contextual reasonableness. Further, the fact that iHeart did not propose these approaches as benchmarks or as other independent bases to set the rates makes them unhelpful and inappropriate as evidence to support iHeart’s rate proposal. However, in the interest of completeness, the Judges note the following with regard to those arguments. First, Drs. Fischel and Lichtman undertook what they called a “thought experiment,” whereby they attempted to estimate a rate necessary for sound recording copyright holders to maintain revenue at current levels if 100% of all listening to recorded music migrated to noninteractive webcasting. (They concluded that the rate would be $0. per play.) They also did the same analysis on the assumption that only 25% migrated to noninteractive service. (They concluded that the rate would be $0. per play.) However, Drs. Fischel and Lichtman acknowledge that this “thought experiment” is “not evidence of what a willing buyer and willing seller would negotiate.” Fischel/Lichtman AWDT ¶ 128 (emphasis added). Therefore, such speculation is irrelevant to the Judges. Second, Drs. Fischel and Lichtman performed an “Economic Value Added (“EVA”) analysis of the costs, revenues and necessary ROI of a “hypothetical simulcaster” to determine the rate necessary for it to remain in business in the long-run, which they determined to be between $0. and $0. per play. However, as the Judges have repeatedly held, rate proceedings under section 114 are not public utility style proceedings whereby parties are guaranteed a rate of return. See, e.g.,Web III Remand, 79 Fed. Reg. at 23107. Further, their EVA model was based on a sample of terrestrial radio firms that is not necessarily representative of simulcasters. Additionally, their EVA analysis fails to consider the rates necessary for record companies to obtain a sufficient rate of return, so they have simply focused on the demand side of the market and ignored the “willing sellers” on the supply side. Third, Drs. Fischel and Lichtman compare the statutory rate for satellite digital audio radio services (SDARS) and find that it suggests a per-play rate of $0. to $0. . However, rates set by the Judges in other types of proceedings are not probative of rates that should be set in this proceeding, especially when the standards in the two proceedings are different. The rate standard in SDARS proceedings is different from the standard in section 114(f)(2)(B) for noninteractive services. See 17 U.S.C § 801(b)(1)(A)-(D) (setting forth particular objectives that the rates must achieve).

Determination of Rates and Terms 2016-2020 (Web IV) - 157 b. The Judges Find the Average per-Play Rate Indicated by the iHeart/Warner

Agreement to be a Useful Benchmark

Unlike the incremental rate derived by iHeart’s experts, the “average rate,” i.e., the stated per-play rate contained in the iHeart/Warner Agreement, is a useful benchmark that, after

adjustment, is probative of the rate that would be paid by a Major, as a willing seller/licensor, to a noninteractive service, as a willing buyer/licensee.180

i. The Benchmark Passes the “Four-Part Test” derived from the Judges’ Prior Decisions

First, the iHeart/Warner Agreement satisfies the sub-tests implicit in the Judges’ prior determinations, as outlined by Dr. Rubinfeld:

Willing buyer and seller test: the rates are intended to be those that would have been negotiated in a hypothetical marketplace between a willing buyer and a willing seller.

There is no dispute that Warner was a willing seller in connection with the iHeart/Warner Agreement. As one of the three Majors, Warner is a sophisticated entity capable of negotiating direct agreements in a manner that it understands will advance its economic interests. Likewise, iHeart is a leading noninteractive webcaster – not to mention one of the largest transmitters of music across various platforms. iHeart thus without dispute is also clearly capable of

representing its economic interests in negotiating direct agreements.

In the present case, the record is replete with voluminous submissions and substantial testimony indicating the diligence of both iHeart and Warner in negotiating this direct

agreement. Clearly, each party was a willing participant in the legal sense; that is, each party was under no compulsion to enter into the iHeart/Warner Agreement, and each party had the opportunity to avail itself fully of all facts that it deemed pertinent before executing that

agreement. See, e.g., Amerada Hess Corp. v. Comm’r, 517 F.2d 75, 83 (3d Cir. 1975) (defining a “willing buyer” and a “willing seller” as parties not “being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.’”).

Same parties test: the buyers in this hypothetical marketplace are the statutory webcasting services and the sellers are record companies.

In the iHeart/Warner Agreement, the buyer/licensee, iHeart, is a statutory webcasting service. The seller/licensor, Warner, is a record company. Clearly, this aspect of the statutory test is satisfied.

Statutory license test: the hypothetical marketplace is one in which there is no statutory license.

180

In discussing the reasons why this average rate is a useful benchmark, the Judges find it helpful to organize their finding by adopting Dr. Rubinfeld’s characterization of the elements of the statutory test implicitly set forth in section 114. See Rubinfeld CWDT ¶ 122(a)-(d).

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The iHeart/Warner Agreement is a direct agreement between the parties. The rates established in this agreement are not statutory rates. More particularly, at the time the iHeart/Warner Agreement was executed, iHeart was obligated to pay royalties to Warner according to the schedule of rates set forth in the SoundExchange/NAB settlement.181

SoundExchange asserts that, nonetheless, the rates in the iHeart/Warner Agreement are too heavily influenced by the “shadow” of the statutory rates to satisfy this “statutory license test.” The Judges disagree. As with regard to the Pandora/Merlin Agreement, it is crucial to appreciate that the adjusted effective rate182 in the direct license is less than the default rate that would otherwise control (the SoundExchange/NAB settlement rates for iHeart, and the Pureplay rates for Pandora). Accordingly, Warner was under no compulsion to accept the lower rate (compared to the SoundExchange/NAB settlement rate) set forth in the iHeart/Warner Agreement; it could have rejected that rate and defaulted to the higher SoundExchange/NAB settlement rate. Instead, Warner agreed to the lower rate, in exchange for the anticipated steering by iHeart of additional webcast performances of Warner sound recordings (from approximately

% to % of total sound recordings). Accordingly, the Judges find that the “statutory license test” has also been satisfied by the iHeart/Warner Agreement.

Further, and as discussed in connection with the Pandora/Merlin Agreement, the steering aspects of the iHeart/Warner Agreement also satisfy a statutory “test” omitted from Dr.

Rubinfeld’s four-part approach: the “effective competition” test. The steering aspect of the iHeart/Warner Agreement reflects price competition – an increase in quantity (more

performances) in exchange for a lower price (a lower rate). All of the reasons set forth in this determination in the analysis of the Pandora/Merlin Agreement regarding the pro-competitive aspects of such steering, including the dynamic effect of a threat of steering, apply with equal force to the iHeart/Warner Agreement.183

Same rights test: the products sold consist of a blanket license for digital transmission of the record companies’ complete repertoire of sound recordings, in compliance with the DMCA requirements.

It is not disputed that the iHeart/Warner Agreement provides in pertinent part for a license from Warner to iHeart to play Warner sound recordings on iHeart’s noninteractive

webcasting service. See SX Ex. 33 at 8 ¶ 1(y) (defining “ ”); 11, ¶

2(a)(1) (granting right to play “ ” on “ ”). Pursuant to the

181

See footnote 28, supra.

182

The Judges’ determination of the adjusted effective rate under the iHeart/Warner Agreement is discussed infra.

183

iHeart notes that the threat of steering could cause steering to occur in a number of differentiated ways, e.g., with one service making steering deals with several licensors, several licensees making similar deals with the same licensor(s), or a licensee making different deals with different licensors over time. See iHeart RPFF at 6, n. 15. However, the Judges need not rely on such specific predictions. In whatever ways in which the reality of steering and the concomitant threat of steering-induced price competition develop, it is clear to the Judges that, as Dr. Shapiro explained, steering is the mechanism by which the complementary oligopoly power of the Majors is offset, allowing the Majors to realize only their considerable (non-complementary) oligopolistic power generated by their repertoires and their organizational acumen.

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iHeart/Warner Agreement, a “ ” must

. Id. at p. 8, ¶ 1(y). In turn, Exhibit A to the iHeart/Warner Agreement

permits ; requires

iHeart to ; and allows a listener to

. Id., Ex. A.

Accordingly, the Judges find that iHeart/Warner Agreement satisfies the core of the “same rights test.”

ii. The Average Rate in the iHeart/Warner Agreement

The Judges agree with SoundExchange that any use of the iHeart/Warner Agreement as a benchmark must apply the effective average rate contained in that agreement.184 See SX RPFF ¶ 844 (“The average effective rate approach … is the proper analytical method ….”) (emphasis in original). The iHeart/Warner Agreement sets forth different per-play rates for

. The record does not reflect the reason(s) why iHeart and Warner negotiated an increase in the rates from a low of $0. in to a high of $0. in (and for any renewal term thereafter). In any event, the parties’ inclusion of specific per-play rates paid to Warner in exchange for the right granted to iHeart to play Warner’s sound recordings reflects the parties’ WTA and WTP for the particular years. In the absence of relevant evidence

necessitating adjustments or legal conditions extrinsic to the parties’ agreement, the Judges cannot second-guess the rates to which the parties have agreed in a benchmark contract that otherwise satisfies the statutory test for a usable benchmark.

By applying the average rate explicitly set forth in the iHeart/Warner Agreement (subject to potential adjustments), the Judges have obviated the protracted dispute between the parties regarding the probative value of different models and projections of future growth of

performances and royalties. That is, in the absence of a “two-bundle” theory, the parties’ expectations and projections are baked into the single explicit annual rate contained in the iHeart/Warner Agreement. Regardless of whether actual performance eventually resembles the “Today’s Growth Model” relied upon by the iHeart Board, or some more pessimistic or

optimistic model of projections considered by iHeart or Warner, iHeart was contractually bound to pay a fixed royalty per year, and Warner had the duty to provide iHeart with access to

Warner’s sound recordings if those fixed per-play payments were made. Accordingly, the Judges look to the average rate agreed to by the parties in the iHeart/Warner Agreement for 2016, which coincides with the first year of the statutory 2016-2020 period. That agreed-upon rate is $0. per play.

184

The stated per-play rate is the equivalent of the “average” rate because it is the same rate paid for each

performance. That is, to use iHeart’s parlance, there is only one “bundle” of rights, with each performance priced at the same rate. The issue of how to adjust, if at all, that “average” rate into the average “effective” rate is discussed

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However, that average, stated per-play rate is not necessarily applicable, standing alone, as a benchmark, if it is subject to necessary adjustments – upward or downward – to account for other forms of consideration or to more accurately account for probative evidence related to the rights available under the statutory license. The Judges turn to these issues in the next section of this determination.

iii. Potential Adjustments to the Rate Derived from the iHeart/Warner