How Copyright, Contract, and Technology Shape the Business of ...

iTunes
How Copyright, Contract, and Technology Shape
the Business of Digital Media – A Case Study
GREEN PAPER V. 1.0
Please send comments to digital-media@cyber.law.harvard.edu


















This Green Paper provides an initial analysis of Apple’s Online Music Store iTunes. The exploratory case study presented in this
document is research in progress. Comments and questions are encouraged. The paper analyzes relevant law to achieve deeper
understanding of current shifts in the digital media landscape, but does not provide legal advice.

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Research Team







This Green Paper is a case study developed by the Digital Media Project team at the Berkman Center
for Internet and Society at Harvard Law School. Gartner|G2 served as our research partner in this
venture. Particular thanks to Mike McGuire of Gartner|G2.






Digital Media Project Principal Investigator
William W. Fisher, III
Hale and Dorr Professor of Intellectual Property Law, Harvard Law School




Authors
Urs Gasser, Derek Bambauer, Jacqueline Harlow, Charles Hoffmann, Renny Hwang, Georg Krog,
Stephen Mohr, Ivan Reidel, Derek Slater, C. Lee Wilson, and John Palfrey




Communications Director
Mary Bridges







Draft as of March 30, 2004
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Contents



Contents ................................................................................................................................................. 2
Introduction ........................................................................................................................................... 6
Abstract ........................................................................................................................................................... 6
A. Background................................................................................................................................................ 6
B. Objectives and Scope ............................................................................................................................... 7
C. Overview of the iTunes Music Store ..................................................................................................... 8
1. Pricing..................................................................................................................................................... 9
2. Song Catalog........................................................................................................................................ 10
3. Ease of Use .......................................................................................................................................... 10
4. Digital Rights Management System.................................................................................................. 10
5. Extra Features ..................................................................................................................................... 11
Part I: Contract-Copyright Interplay..................................................................................................... 12
A. Summary: Where Copyright Permits, Contracts May Prohibit........................................................ 12
1. Copyright.............................................................................................................................................. 12
2. Contract................................................................................................................................................ 13
B. Effects of Contract versus Copyright Tension on iTunes................................................................ 14
C. Copyright versus Contract in the United States................................................................................. 15
D. Copyright versus Contract in Europe ................................................................................................. 18
1. European Union.................................................................................................................................. 18
a. Copyright Regulation by the European Union .......................................................................... 18
b. Contract Regulation by the European Union ............................................................................ 19
c. Contractual Modification of Copyright Entitlements in the European Union ..................... 21
d. Example: Copyright-Contract Interaction in Germany............................................................ 22
2. Summary of Business Impact............................................................................................................ 23
E. Copyright versus Contract in Asian Countries................................................................................... 23
1. Japan ..................................................................................................................................................... 23
a. Copyright in Japan.......................................................................................................................... 24
b. Contract in Japan............................................................................................................................ 25
c. Contractual Modification of Copyright Entitlements in Japan................................................ 26
d. Business Impact of Contract and Copyright on iTunes in Japan............................................ 27
2. China..................................................................................................................................................... 28
a. Copyright in China ......................................................................................................................... 28
b. Contract in China ........................................................................................................................... 29
c. Contractual Modification of Copyright Entitlements in China ............................................... 30
d. Business Impact of Contract and Copyright on iTunes in China........................................... 31
F. Conclusion ............................................................................................................................................... 32
Part II: Digital Rights Management .....................................................................................................33
A. Introduction ............................................................................................................................................ 33
B. How is DRM Protected by Law?.......................................................................................................... 33
1. United States........................................................................................................................................ 34
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2. European Union.................................................................................................................................. 35
3. Asia-Pacific............................................................................................................................................. 37
a. Japan ................................................................................................................................................. 37
b. China ................................................................................................................................................ 38
3. Future Implementers.......................................................................................................................... 38
B. The Interaction Between iTunes DRM and the DMCA .................................................................. 38
1. Preventing Piracy ................................................................................................................................ 39
2. Reverse Engineering and Interoperability ....................................................................................... 42
C. Conclusion ............................................................................................................................................... 45
Part III: Digital First Sale Doctrine ......................................................................................................47
A. Introduction ............................................................................................................................................ 47
1. “Double Dutch Bus”.......................................................................................................................... 47
2. The Exclusive Right of Distribution and its Limitation: First Sale Doctrine ............................ 48
B. Potential Effects of the First Sale Doctrine........................................................................................ 49
C. Digital First Sale Doctrine? ................................................................................................................... 52
1. Digital Works....................................................................................................................................... 52
2. Digital Dissemination of Works ....................................................................................................... 53
3. Further Limitations............................................................................................................................. 53
D. International Perspective ...................................................................................................................... 55
1. WIPO Treaties .................................................................................................................................... 55
2. European Union.................................................................................................................................. 56
3. Asia-Pacific........................................................................................................................................... 59
a. Japan ................................................................................................................................................. 59
b. China ................................................................................................................................................ 60
E. Summary and Outlook........................................................................................................................... 61
Part IV: Fair Use Doctrine ....................................................................................................................64
A. Introduction ............................................................................................................................................ 64
B. Brief Overview of Fair Use ................................................................................................................... 64
C. How Fair Use might Affect iTunes, its Users, and Copyright Holders.......................................... 66
D. Fair Use Laws in Several of the Premiere Global Marketplaces ..................................................... 68
1. United States........................................................................................................................................ 68
2. Countries of the European Union.................................................................................................... 71
a. United Kingdom............................................................................................................................. 72
b. Germany .......................................................................................................................................... 73
c. France............................................................................................................................................... 75
3. Canada .................................................................................................................................................. 75
4. Asia-Pacific........................................................................................................................................... 76
a. Japan ................................................................................................................................................. 76
b. China ................................................................................................................................................ 77
E. Conclusion............................................................................................................................................... 77
Part V: Findings and Tentative Assessment .........................................................................................79
A. Summary .................................................................................................................................................. 79
1. Critical Interactions ............................................................................................................................ 79
2. Comparative Law Perspective........................................................................................................... 80
B. Tentative Assessment............................................................................................................................. 83
1. Impacts on Consumers ...................................................................................................................... 84
2. Potential Impacts on Labels .............................................................................................................. 85
3. Potential Impacts on Artists.............................................................................................................. 86
C. Final Remarks.......................................................................................................................................... 87
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Appendix International Jurisdiction – The European Example...........................................................88
A. Introduction ............................................................................................................................................ 88
B. Why jurisdiction matters........................................................................................................................ 89
C. Brussels Jurisdiction Regulation: Overview and Areas of Uncertainty........................................... 91
1. Introduction......................................................................................................................................... 91
2. The Requirements of Art. 15.1 c) Brussels Jurisdiction Regulation ............................................ 93
a. What constitutes a “contract”? ..................................................................................................... 94
b. Who is a “consumer”?................................................................................................................... 94
c. Who pursues commercial and professional activities?.............................................................. 95
d. What does “pursue … in the Member State” actually mean?.................................................. 95
e. What does it mean to say “by any means, directs… to”?......................................................... 96
D. Conclusion .............................................................................................................................................. 99






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Introduction



Abstract
In this Green Paper, the Berkman Center’s Digital Media Project has conducted an exploratory case study on
Apple’s Online Music Store iTunes from a legal and business perspective. The objective of this analysis is
twofold: First, it seeks to gain advanced knowledge of the relationships among copyright law, contract law,
digital rights management schemes and business modeling processes in the Post-Napster world.
Understanding such interactions is crucial when attempting to balance the divergent interests of consumers,
artists, the entertainment industry, and technology manufacturers through regulatory mechanisms such as law,
code market mechanisms, and adjustment of social norms. Second, the Green Paper is intended as a further
step toward expanding the knowledge base of the Digital Media Project beyond U.S. law to include a more
detailed coverage of the legal and regulatory frameworks of other countries. The focus of the comparative law
analysis conducted in this initial study is on European jurisdictions and selected nations in the Asia-Pacific.
The Green Paper is research in progress; comments, critiques, and questions are encouraged.
A. Background
The Berkman Center for Internet & Society and GartnerG2 White Paper, “Copyright and Digital Media in a
Post-Napster World,”1 analyzed the shift from analog and physical media to digital and online media and
examined how the shift is altering the media industry and changing the way people use and enjoy consumer
electronic products, media, and entertainment. More specifically, the foundation paper identified today’s
critical technological issues in the digital media debate, explored key legal and regulatory developments
regarding copyright and related intellectual property issues, and discussed business models upset by digital
media distribution and new models made possible.
The second paper2 by the Digital Media Project at the Berkman Center set forth five scenarios for digital
media in a Post-Napster world that could emerge over the next few years. This second study also included an
initial analysis of the legal, business and economic impacts of these five scenarios. Since the release of the
second paper, these scenarios have been extensively discussed, reviewed, and further developed. Today, the
five scenarios include:3

1 See http://cyber.law.harvard.edu/home/2003-05.
2 See http://cyber.law.harvard.edu/home/2003-07.
3 See http://cyber.law.harvard.edu/media/scenarios.
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• The No-Change Scenario assumes that copyright law and the Digital Millennium Copyright Act
(DMCA) continue to guide digital media distribution.
• The Technology Speed-Bump Scenario forecasts that technological restrictions like encryption
will create modest barriers to users’ access and control of digital content.
• The Technology Lockdown Scenario projects that restrictive digital rights management (DRM)
schemes will effectively constrain the ways in which consumers make use of the content they
purchase.
• The Alternative Compensation System Scenario imagines that users gain access to digital content
through a state-run system that would tax
consumers
according to use and reward
creators according to the popularity of their work.
• The Entertainment Co-op Scenario envisions that voluntary associations emerge within the
existing copyright structure to allow distribution of digital content between creators and
subscribers.
B. Objectives and Scope
The present case study of Apple’s Online Music Store iTunes4 has been conducted against the backdrop of
these prior reports by the Digital Media Project at the Berkman Center. These reports have made clear that
any potential solution to the current media crisis must balance the potentially divergent interests of
consumers, artists, the entertainment industry, and technology manufacturers in order to create a viable
foundation for future growth. Regardless of which solution is envisioned, balancing of these interests through
the law, technology, market mechanisms, and adjustments of social norms requires an understanding of the
complex interplay between these basic regulatory modalities and their effects on business models, industry
structure, technology, and the normative and social environments.
This Green Paper, by analyzing iTunes, focuses on one particular aspect within this complex network of
interrelations and interdependencies—the interaction between doctrines of copyright and contract law, digital
rights management regimes, and business modeling processes. Such interactions and interrelationships are
assumed under all five scenarios, but have not yet been explored in detail. Moreover, the research paper aims
to expand the knowledge base of the Digital Media Project beyond the U.S. law by including an analysis of the
critical legal issues in the digital media debate in Europe, Japan, and China.
The following key legal issues and their interactions with the business model are discussed from both a U.S.
and international perspective:

4 We examine Apple’s Online Music Store iTunes because it is the pacesetter in the digital media marketplace. However, it is important to
note that iTunes provides only one example of an online media distribution system.
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• Copyright and Contract Law Interplay: Online media services such as Apple’s iTunes regularly
use two legal strategies to govern consumer’s actions with respect to purchased e-content such as
songs, movies or e-books: agreements through contracts and limitations through copyright
protections. Part I explores the interaction between these two doctrines and illustrates how
Apple’s ability to control iTunes depends on this interplay.
• Digital Rights Management (DRM): One key element of the iTunes online music store (and
digital media services in general) is the DRM system, which constrains by technological means
(“Code”) what users are able and allowed to do with digital content. Part II describes iTunes’
digital rights management system (called FairPlay) and discusses how the business model may
depend on the Digital Millennium Copyright Act (DMCA) and its counterparts in other
jurisdictions to provide a cause of action against users who bypass these restrictions.
• Digital First Sale Doctrine: Copyright law provides a set of exclusive control rights such as the
right of reproduction and the right of distribution. However, such exclusive rights are only
granted within certain limits. Part III discusses the limitation on the right of distribution through
the first sale doctrine (the principle of exhaustion), explores whether the doctrine—originally
created for tangible goods—applies to digital content distributed over the Internet, and illustrates
why these questions matter from the business perspective of digital media service providers such
as iTunes.
• Fair Use Doctrine: Part IV discusses another set of limitations on copyright law—the privilege of
users to use copyrighted materials such as songs downloaded from iTunes in a reasonable manner
without the permission of the copyright owner. It analyzes the potential effects of this doctrine
on the business models of digital media services like iTunes.
C. Overview of the iTunes Music Store
Apple’s iTunes Music Store lets customers search a catalog of over 500,000 tracks, including music from all
five major labels.5 With one click, users can purchase the songs and download them into their iTunes music
library for $0.99 cents per song and $9.99 per album, without any subscription fees. Songs are downloaded in
digital quality and can be burned onto CDs for personal use, played on up to three computers, and listened to
on an unlimited number of portable players such as Apple’s iPod. Access to the iTunes Music Store and its
song catalog is embedded in Apple’s iTunes software,6 which includes a music player, CD ripping and burning
tools, an interface to the iPod, free Internet radio stations, and a limited streaming audio feature called
Rendezvous. In October 2003, Apple released similar software for Windows, and announced product tie-ins

5 See http://www.prnewswire.com/cgi-bin/stories.pl?ACCT=SVBIZINK8.story&STORY=/www/story/10-16-
2003/0002037635&EDATE=THU+Oct+16+2003,+02:06+PM.
6 Available at http://www.itunes.com/.
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with America Online and Pepsi Cola.7 The service is currently (March 2004) only available in the United
States.8
Sixteen days and two million downloads after opening,9 Apple’s iTunes Music Store10 had become the
pacesetter in the digital music marketplace. Finally, there was a simple, inexpensive music service that could
satisfy consumers. With over 50 million downloads since its launch,11 the Store has elicited renewed interest in
the online music market. What makes the iTunes Music Store special? The following paragraphs sketch the
Store’s main characteristics and explain how it differs from previous services.
1. Pricing
Apple’s iTunes was the first service with content from all five major labels to sell songs à la carte with no
subscription fees. Unlike every prior music service, iTunes charges no subscription fee. The Store’s pricing
seems both revolutionary and obvious—the former because the prices are significantly lower than previous
services’ (including brick-and-mortar CD stores), and the latter because they come closer to projected price
points. Market research firm Jupiter Research projected last year that $0.99 per song would attract a
significant number of consumers.12
The à la carte pricing’s flexibility and convenience makes iTunes feel like P2P in certain ways. In a P2P service,
downloaders get what they want on a whim. Apple’s combination of à la carte purchases with fast searching,
one-click purchasing, and integrated software tools keep the consumer’s focus on short-term costs and his or
her immediate desire for a song. Thus, the low up-front price can lead to “impulse buys.” Though
subscription services might often be cheaper for high-volume downloaders, the initial fees they charge cause
consumers to focus on high up-front costs. Even forcing consumers to buy “packs” of downloads rather than
individual songs, like former music service Pressplay did, may seem too costly to many consumers. In the
meantime, some services are trying to cash in on both markets; Roxio’s Napster 2.0 music service, developed
from its purchase of Pressplay, includes both subscription and à la carte options, while RealNetworks operates
its à la carte Music Store separately from its subscription service, Rhapsody.
Apple’s iTunes is using the same prices across the board. In contrast, rival à la carte service BuyMusic.com is
varying prices. Pressplay only offered tiered bulk pricing to burn songs to CD or move them to portable
players.13 Though Rhapsody also charges for burning and Napster 2.0’s subscription model charges for
permanent downloads, they simplify the process by using one flat fee ($0.79 and $0.99, respectively).

7 See http://www.prnewswire.com/cgi-bin/stories.pl?ACCT=SVBIZINK8.story&STORY=/www/story/10-16-
2003/0002037635&EDATE=THU+Oct+16+2003,+02:06+PM.
8 [check Japan]
9 See http://news.com.com/2009-1027-1009538.html.
10 See http://www.apple.com/itunes/store/.
11 See http://www.apple.com/pr/library/2004/mar/15itunes.html.
12 See http://weblogs.jupiterresearch.com/analysts/gartenberg/archives/Jupiter%20Apple.pdf.
13 See http://www.digitalsongstream.com/reviews/pressplay20.htm. See also http://www.ecommercetimes.com/perl/story/18847.html.
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2. Song Catalog
Apple’s iTunes originally featured a 200,000 song catalog that did not represent a wide variety of labels,
particularly independent labels. With its expansion to Windows, Apple announced that it had a 500,000 song
catalog including 300 independents.14 Apple is expected to continue expanding its catalog to keep up with
newer offerings; BuyMusic.com offers 400,000 songs, and Napster 2.0 offers more than 500,000 songs
including many independent labels.15
3. Ease of Use
The Store has become well-known for its ease of use:16 After browsing the catalog for free, purchases can be
made immediately with “one-click technology” or can be progressively added to a shopping cart for later
purchase. Parents can also create special accounts for their children with individual spending limits.17
4. Digital Rights Management System
All tracks are encoded using the open standard, Advanced Audio Coding (AAC)18 at 128 kbps rather than the
ubiquitous, though marginally lower quality, standard, MP3 (MPEG Audio Layer-3). In addition, Apple
employs its own proprietary Digital Rights Management (DRM) system called FairPlay. This DRM system
restrains usage in two ways:
• First, users can only download a purchased song once and can only use the song on three
computers. However, they can move songs to a portable iPod an unlimited number of times.
Users also can make unlimited CD burns, but can only burn the same exact playlist 10 times (to
curb mass-production of copies for illicit sale). Unlike Napster 2.0’s subscription model,
Rhapsody, and Pressplay, Apple’s purchases are treated like sales, not rentals.19 As a consequence
and in contrast to subscription models, playing a song is not contingent on remaining a customer
of the Store. Perhaps because of Apple’s success, the newer à la carte services have negotiated
similar usage restrictions.20

14 See http://www.apple.com/pr/library/2004/mar/15itunes.html.
15 See Chris Marlowe, "Roxio Reloads Legal Napster," Hollywood Reporter (Oct. 13, 2003). As many as many as 200,000 from independent
labels, see http://msl1.mit.edu/furdlog/docs/nytimes/2003-07-28_nytimes_ap_napster.pdf.
16 See, e.g., http://www.earthv.com/Art.s.asp?Art.ID=2037.
17 See http://www.apple.com/itunes/store/.
18 See http://www.iis.fraunhofer.de/amm/download/mpeg_aac.pdf (describing audio format).
19 See Part II on Copyright and Contract Law and Part III on Digital First Sale Doctrine. Apple has at least been open to the possibility that
songs are owned inasmuch as they could be legally resold, although that would be technically difficult. http://news.com.com/2100-1027_3-
5072842.html. Though Apple reserves the right to modify the usage restrictions at any time, even if doing so means ”you may no longer be
able to use Products to the same extent as prior to such change or discontinuation,” it is highly unlikely that such changes will affect songs.
However, one customer has reported that, when re-initializing his domestically purchased songs outside of the country, the songs became
inoperable, see http://www.interesting-people.org/archives/interesting-people/200307/msg00150.html.
20 Slight differences are common, however. For instance, Musicmatch’s service only allows 5 burns of a given playlist, but the difference is
negligible. See http://news.com.com/2100-1027-5083282.html.
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