This paper is concerned with the basic question whether any CCS option would simultaneously increase the user and rights holder welfare. For this purpose, we adopt a conservative approach: For several parameters for which there is no precise measure available, we deliberately pick values that will not result in overestimation of welfare gains through a CCS. By concentrating on recorded music, we do not address the desirable scope of a CCS across different types of copyright works. Nor do we address the fine-tuning of the CCS in terms of product differentiation or price discrimination, both of which would be costly to implement but might increase aggregate user welfare and in particular the position of rights holders.

One of the fundamental decisions regarding a CCS is whether it is mandatory or voluntary on the user side. “Mandatory” refers to a CCS where user payment/participation is bundled with Internet subscription; the two are not available separately. “Voluntary” refers to a CCS where user participation is voluntary in the sense that Internet subscribers get to choose whether they want to buy a CCS license. A mandatory CCS is an effective way to inhibit free-riding and thus improve the provision of quasi-public goods. The disadvantage is that a mandatory CCS offsets the market coordination between supply and demand. This has been the main criticism of CCS raised in the economics literature so far (Merges 2004; Liebowitz 2005). A voluntary CCS provides users with greater flexibility. When users can opt out of the CCS, rights holder income from the CCS depends on the demand for such a license and thus on the utility of licensed works for users. A voluntary CCS is less effective in inhibiting free-riding, however, when coupled with limited copyright enforcement. Due to these differences, it is not certain whether rational users would prefer mandatory or voluntary CCS. The calculation of the welfare implications of mandatory and voluntary CCS is distinct, and we present them separately.

A mandatory compensation system

No mandatory CCS will be generally welfare increasing. Among users, WTP is too varied, many users have a WTP of zero, and price discrimination and/or product differentiation will be restricted in practice.Footnote 15 Median user WTP for any CCS option covered is to reject it (WTP < €5). Mean WTP marks the maximum price at which the CCS option would pass the Kaldor–Hicks compensation test regarding only users, leaving users at large no worse off than under the status quo. We first calculate the aggregate user value and the potential revenues that could be generated by the CCS option. Then, we deduct estimated costs of operating the CCS, to gauge the amount distributed among rights holders. We compare estimated CCS revenues to rights holder revenues under the status quo, in order to establish whether the CCS would increase rights holder profits. We can thus establish whether a CCS would provide a Pareto improvement in the broad sense of simultaneously making users and rights holders at large better off.

Later on, we discuss a number of extensions regarding the substitution of a CCS for conventional purchasing of recorded music; the potential for product differentiation and price discrimination; long-term effects; and the position of other stakeholders, including the effect on demand for Internet subscriptions, which could affect the impact of a CCS on social welfare.

Under a CCS that is mandatory on the user side, there will be two types of participating usersFootnote 16: those with a WTP greater than the price being charged and those with a WTP lower than the price being charged.Footnote 17 The price of a CCS charged among users establishes the division of any surplus among users and rights holders. The net welfare effect of a mandatory CCS for users is

$$\pi_{UAm} = (\bar{w}(A) - p) N(p, A,X)$$ (1)

where \(\pi_{UAm}\) is the accumulated welfare of users, U, of a compensation system with the attributes A, and the additional subscript m denominating mandatory participation on the user side. The mean WTP reported in the discrete choice experiment is \(\bar{w}\), which depends on the characteristics of a CCS, A. The price of the CCS license for users is p. The number of households with Internet subscription in the Netherlands is N. The number of Internet subscriptions is used—rather than the number of individuals aged 15 or older—to avoid overestimation: The payment mechanism described in the discrete choice experiment was a surcharge coupled with the payment for Internet subscription. In multi-person households, one Internet subscription is typically shared by all members of the household, so that respondents may have considered the WTP for a CCS for all household members rather than their individual valuation of a CCS. N depends on the price and attributes of the CCS, as well as the price and attributes of Internet services associated with the CCS, X. We assume X is unaffected by the CCS, and we relegate the discussion of demand for Internet subscription for later.

Users with a lower WTP than the price will suffer under a mandatory CCS, whereas those with a higher WTP will benefit. To prepare for a comparison with a voluntary CCS, a separate assessment of users who gain and users who lose is of interest. Equation 1 can be extended to

$$\pi_{UAm} = (\bar{w}_{h} (A) - p)n_{h} (p, A,X) - (\bar{w}_{l} (A) - p) n_{l} (p, A,X)$$ (2)

where subscript h denominates users with a WTP higher than p, and subscript l denominates users with a WTP lower than p.

To establish the welfare effect of a CCS on rights holders, the relevant comparison is that between total rights holder profits under the status quo and prospective profits under a CCS. Our focus is on estimating monetary rewards from sales of copies to users rather than non-monetary rewards or rights holder profits from markets for related goods and services. This partial measure of welfare of rational rights holders, \(\pi_{R}\), is the difference between total revenues/income of rights holders, I, and total costs suffered by rights holders, C, that is \(\pi_{R} = I - C.\)

The effect of a CCS on rights holder welfare compared to the status quo is

$$\pi_{RA} = (I_{A} - C_{A} ) - (I_{S} - C_{S} ) - B = I_{A} - I_{S} - C_{A} + C_{S} - B$$ (3)

where subscript S stands for status quo, subscript A for a specific combination of CCS attributes, and B stands for the operating costs of the CMO, assuming that the CMO covers its costs by a deduction from collected royalties. This is the predominant way of financing existing CMO so that the operating costs of that organization reduce rights holder revenues rather than increase their costs. For simplicity and since B is probably small, we assume B to be a constant share of the collection amount independent of the number of rights holders, users, and thus of the price charged.Footnote 18 A CCS will not decrease rights holder profits if

$$I_{A} - C_{A} - B \ge I_{S} - C_{S}$$ (4)

Data on rights holder revenues are accessible, whereas information on costs and thus profits is not. We focus on estimating revenues for now and will discuss costs separately below. Rights holder revenues with a mandatory CCS on the user side associated with Internet subscription are

$$I_{Am} = pN\left( {p,A,X} \right) - B$$ (5)

Overall, the short-run effect of a mandatory CCS on the welfare of both types of stakeholders, \(\varPi_{Am}\), is

$$\varPi_{Am} = \pi_{UAm} + \pi_{RAm}$$ (6)

Substituting \(\pi_{UAm}\) and \(\pi_{RAm}\) for their specifications in Eqs. 1, 3, and 5 results in

$$\varPi_{Am} = (\bar{w}(A) - p)N(p, A) + pN(p,A,X) - I_{S} - C_{Am} + C_{S} - B$$ (7)

We adopt a conservative approach in estimating mean WTP, given that we only have information on a limited number of price points and no empirical estimates of the shape of the demand curve between and beyond these points (Bateman et al. 2002). We assume that the probability of an individual’s WTP being no lower than a price point covered in the survey is equal to the probability of WTP being equal to the next highest price point covered, and we count reported WTP of the maximum price covered in the survey as equal to that amount. We thus estimate users’ mean WTP through the following step function

$$\bar{w}_{Am} = \mathop \sum \limits_{p \in P} \theta_{w \ge p} \left( {p - p_{j - 1} } \right)\quad {\text{for}}\quad p \in P = \left\{ {5,10, \ldots ,30} \right\}$$ (8)

with \(\theta_{w \ge p}\) denominating the probability of WTP being at least equal to a price, that is, the ratio of the number of respondents accepting the CCS option at a price and the total number of respondents, which ranges between 0 and 1.

This estimate of mean average WTP, \(\bar{w}_{Am}\), in our sample of the Dutch population is €9.25 per month. That amount is the cautious estimation of the maximum price for a license at which a CCS would pass the Kaldor–Hicks compensation criterion among users, if all individuals were to participate and pay. At this price, aggregate user surplus is zero. Below this price, users are on average better off than under the status quo.

The population of the Netherlands in 2013 was 16.78 million, and average household size was 2.2 according to Eurostat (2014a, b), so that the number of households in the country is about 7.63 million. In 2013, 95 % of the Dutch population aged between 16 and 74 years had Internet access at home. Assuming that all households are equally likely to have Internet access, the relevant number of households with Internet connection is 7.25 million.Footnote 19 Multiplied by average WTP of €9.25 per month and 12 months per year, the aggregate WTP of users for the CCS is €804.8 million per year.

The main CMO concerned with recorded music in the Netherlands, Buma/Stemra, has had a net distribution ratio of ca. 95 % in 2012, including allocations for social and cultural purposes. This is high by international standards, but it is probable that CMO’s monitoring and enforcement costs of a CCS would be low compared to royalties from mechanical reproduction or public performance rights, for example.Footnote 20 Overall, the estimated amount that could be distributed among rights holders would thus be in the order of €764.6 million.

Industry statistics provide us with a reasonable indication of rights holder income under the status quo, I S . For the year 2012, the most recent report of the IFPI (2013) estimates rights holder revenues in the market for recorded music in the Netherlands at €143.6 million.Footnote 21 For lack of better data, we assume that a CCS substitutes for all conventional purchases of recorded music.

An adequate CCS that is mandatory on the user side could thus increase rights holder revenues by up to ca. €621 million, without making users at large worse off.

A mandatory CCS would be most acceptable if neither users nor rights holders were worse off in the short run. So far, we have discussed the upper bound of this range of the price for a mandatory CCS, where the price is equal to mean user WTP so that there is no effect on aggregate user welfare. The lower bound is found at the monthly price, p e , at which a mandatory CCS would generate annual rights holder revenues equal to current rights holder revenues from selling recorded music to private households in the NetherlandsFootnote 22

$$p_{e} \equiv pNd = \frac{{I_{S} }}{12}$$ (9)

where \(I_{S}\) current rights holder revenues reported on an annual basis, and d is the proportion of the collected CCS fees distributed after covering CCS operating costs, assumed to be 95 %. Assuming the number of Internet subscriptions, N, is unaffected, a CCS fee of ca. €1.74 per household with Internet subscription would generate the same revenues to rights holders as current revenues in the Dutch market for recorded music.

Overall, there is a wide range of mandatory CCS fees between €1.74 and €9.25 in which both users and rights holders would be better off compared to the status quo.

Table 2 provides an overview of the effects of the mandatory CCS option for various prices. Since we assume the operating costs of the CCS increase in the collection sum, the total effect on social welfare decreases with revenues to rights holders (and thus price). Prices higher than average WTP would not be desirable, since they would lead to excessive allocation of resources to the creation of recorded music.

Table 2 Summary of results for a mandatory compensation system Full size table

A voluntary compensation system

With a voluntary CCS, there is no negative effect on user welfare, as low-WTP users do not participate. The total effect on user welfare is then

$$\pi_{UAv} = \left( {\bar{w}_{h} (A) - p} \right)D_{v} \left( {p, A} \right)$$ (10)

where subscript v stands for voluntary and D v for the demand for a voluntary CCS license, which is equivalent to the number of rights holders with a WTP greater than the price of this license, n h . For simplicity, we present this as Eq. 2 without the low-WTP users. Of course, at any given price and CCS option, the number of voluntarily participating users and their mean WTP will not be the same as in a mandatory system, due to any effect of the mandatory/voluntary attribute on WTP, for instance if users value the option of cancelling the CCS in principle or in case their preferences change.

The number of participating users with a voluntary CCS will be lower than with a mandatory CCS, since low-WTP users can opt out. Rights holder revenues with a voluntary CCS on the user side associated with Internet subscription are

$$I_{Av} = pD_{\text{v}} \left( {p,A, X} \right) - B$$ (11)

Here, Internet subscription and the CCS are not necessarily bundled, so that X affects the maximum number of users participating in the CCS and is otherwise irrelevant for the number of CCS participants. A voluntary CCS can only increase demand for Internet subscription, if the CCS does not adversely affect the supply of creative works in the long run.

The overall effect of a voluntary CCS on social welfare, \(\varPi_{Av}\), is

$$\begin{aligned} \varPi_{Av} & = \pi_{UAv} + \varDelta \pi_{RAv} \\ & = (\bar{w}_{h} (A) - p)D_{v} (p, A, X) + pn_{h} (p,A) - I_{S} - C_{Av} + C_{S} - B \\ \end{aligned}$$ (12)

A monopolistic CMO administering a CCS would set the profit-maximizing price of the online license for recorded music. We continue focussing on the short run, over which the costs of creating new copyright works is irrelevant. The operating costs of a CCS are uncertain. We thus estimate the revenue-maximizing price of a CCS charged among voluntary users.

The discrete choice experiment produced probabilities of a respondents’ WTP exceeding, \(\theta_{w \ge p} \left| { \theta \in 0, \ldots ,1} \right.\), for six price points. We use linear OLS regression of these probabilities and price to describe the relationship of voluntary participation in a CCS and price as \(\theta_{w \ge p} = \alpha - \beta p\). Multiplying by the size of the relevant population, we get a linear demand function within the range of prices covered in the choice experiment of the shapeFootnote 23

$$D_{Av} = \left( {\alpha - \beta p} \right)N$$ (13)

With this linear model of demand, the revenue-maximizing price, p*, for a voluntary CCS license is found at

$$p* = \frac{ - \alpha }{2\beta }$$ (14)

The monthly price at which a voluntary CCS would fully compensate rights holders for complete substitution of conventional purchases by CCS users, \(p_{e}\), is

$$p_{e} \equiv p\theta_{w \ge p} Nd = \frac{{I_{S} }}{12}$$ (15)

As in Eq. 9, we include a measure of \(I_{S}\) per year as this tends to be the only data that are reliably available. Assuming that there is no correlation between WTP for a CCS and conventional purchasing, \(p_{e}\) is a constant across all CCS options covered in this paper at ca. €1.74.Footnote 24

The revenue-maximizing price, \(p*\), falls between prices for which we have empirical estimates. To estimate \(p*\), we use the linear regression of price points covered in the choice experiment and the respective probabilities of participation, \(\theta_{w \ge p}\); see the documentation in notes (2) of Table 3. We estimate the average WTP, \(\bar{w}_{hAv}\), of users with a WTP greater than \(p*\) through the following step function

Table 3 Summary of results for a voluntary compensation system with no changes to copyright enforcement Full size table

$$\bar{w}_{hAv} = \mathop \sum \limits_{p \in P} \theta_{w > p} \left( {p - p_{j - 1} } \right)\quad {\text{for}}\quad p \in P = \left\{ {5,10, \ldots ,p*, \ldots ,30} \right\} \ge p*$$ (16)

For a voluntary CCS with a flat monthly fee and no changes to the strength of copyright enforcement, the revenue-maximizing price, p*, is €23.43, at which 24.53 % of the sample would purchase. If this amount were collected per voluntarily participating household with Internet subscription, total revenues would be €500.2 million.

Deducting 5 % operating costs of the CCS, the amount distributed among rights holders would be €475.2 million. This is more than three times current revenues to the recorded music industry of €143.6 million, not all of which would be substituted by a voluntary CCS in which only a minority of households participates. Assuming conservatively that the CCS would substitute for all conventional music purchases among participating users and that WTP for a CCS and music purchasing are uncorrelated, this voluntary CCS would increase rights holder revenues by €439.9 million.

At the “fully compensating” price, \(p_{e}\), CCS revenues for rights holders would be equal to current revenues in the market for sound recordings (assuming complete substitution for conventional purchases among all CCS users and no correlation between the probability to participate in a CCS and conventional purchasing). Results for this price point as reported in Table 3 for the voluntary CCS option require some explanation. The price \(p_{e}\) falls below the range of price points covered in the survey. We thus assume conservatively that the participation rate is equal to the lowest price point covered, €5, and that the mean WTP of users with a WTP greater than \(p_{e}\) is equal to the mean of the entire sample, including low-WTP users. This explains the low estimates of user welfare and combined welfare at \(p_{e}\). Assuming the approximately linear, inverse relationship between price and participation rate we find for the empirically assessed price points were to hold between \(p_{e}\) and €5, aggregate user welfare would be much larger and combined welfare would exceed that for any other price point. The results for the mandatory CCS option illustrate this: There, no estimate of the probability of acceptance is required, and combined welfare at \(p_{e}\) exceeds the value for all other price points.

At a CCS fee of €5 per month, 44.6 % of the respondents would voluntarily participate in a CCS without greater copyright enforcement. Except for our conservative estimate of the values at \(p_{e}\)—see above—the combined welfare effect of a CCS strictly decreases with price. That could be offset by any supply effect in the long run, which is not included in the analysis, except in the sense that respondents may have incorporated their own expectations of long-term consequences into their evaluation of the CCS proposals. Another way to put this is that our data from the discrete choice experiment may not fully reflect the costs of creating new copyright works and the depreciation of the existing stock of copyright works.

The desirable range of prices for a voluntary CCS is ca. €1.74–€23.43 per month. Even at the upper bound that maximizes the collection amount of the CCS for rights holders, some user surplus remains, but the participation rate is low (24.5 %).

Table 2 and Fig. 2 display the participation probabilities for the voluntary CCS option under two treatments: one with and one without greater copyright enforcement. There are no significant differences. Therefore, we do not present separate estimates of the CCS option with greater copyright enforcement. With an affordable voluntary CCS available, there would be stronger moral justification for copyright enforcement among users opting out. Our results do indicate, however, that investments in stronger enforcement are not essential to make a voluntary CCS “work” in the sense that rights holder revenues are increased without making users worse off.Footnote 25 In any case, the operationalization of the concept of “stronger copyright enforcement” in the choice experiment was challenging and the instructions to respondents eventually left relatively great scope for varied interpretation.

Comparing the voluntary with the mandatory CCS options, the greater flexibility and adaptability of a voluntary CCS comes at a price for rights holders: Prospective CCS revenues to rights holders are lower with the voluntary option. Nevertheless, the voluntary CCS could increase rights holder revenues up to a factor of three. User welfare and combined welfare tend to be greater with a voluntary option, at least up to a price of €15. These results also suggest that the main long-run problem identified with CCS by economists so far—the offsetting of the coordination of supply and demand through prices—can be mitigated through a voluntary CS.

With a voluntary CCS and revenue-maximizing pricing, about three quarters of the population of users would not participate in the CCS, and the prospective participation rate never exceeds 50 % for any price point empirically assessed. A voluntary CCS would thus have the disadvantage that illegitimate use would very probably still occur frequently, which could be costly to society.