The business of crime: music piracy

Finbarr Bermingham asks how illegal file-sharing works and who's making money from it

It's a question often wheeled out in the wee hours of a party and one that helps tell a lot about a person's character and their formative years. Soon, though, "What was the first CD you ever bought?" will be consigned to old men's pubs and bingo halls. People aren't purchasing physical music in the volumes they used to. As fans of steam trains, quill pens and VCRs will tell you, industry evolves.

The internet has revolutionised our relationships with music. As of June 2011, a total of 15 billion songs had been legally downloaded via iTunes. At Christmas 2009, Rage Against The Machine's Killing In The Name sold a staggering 502,569 downloads in one week alone. Nowadays, very few singles get a physical release at all. Albums, too, are now more likely to get a digital release only and it's easy to see why. According to the Recording Industry Association of America (RIAA), only 15 per cent of albums released in the US return a profit.

As well as making music easier to access, the internet has made it easier to share, legally and illegally. Musical piracy isn't a new thing - I recall being sold a dodgy cassette copy of Oasis's third album in the corridors of my secondary school. But now that the physical barriers have all but been removed, it's undoubtedly more prominent. And it's led to a debate over whether it's good or bad for the recording industry.

File-sharing sites like BitTorrent and Megaupload allow independent musicians to distribute their music for free and (if they're any good) increase their fan-bases. Social media allow them to promote their material and with tools like Garage Band, they can record in high quality without expensive recording equipment. A decade ago, it was difficult for a band to make even a ripple without being signed to a label. And since a relatively small portion of the average signed artist's income comes from record sales, many artists see greater access for the listener as a good thing as it will result in higher sales of gig tickets.

Changing landscape

In recent decades, major labels merged and hoovered up their smaller, independent rivals, creating a landscape dominated by behemoths. Now though, many have gone under. EMI - once home to the Beatles - was recently broken up and sold to a consortium led by Sony.

Labels have laid the blame for this decline squarely at the feet of illegal file-sharing. The figures, from their perspective, don't make for very encouraging reading. This year, Ed Sheeran's BRIT Award winning album + has been illegally downloaded 55,000 times per month in the UK. Between January and June this year, 42,263,582 albums were illegally downloaded (in the US, the total was 96,681,133).

Using figures older than these, a 2009 report by the Strategic Advisory Board for Intellectual Property (SABIR - a government body) suggested that every illegal download removes the intended value of the downloaded file from the UK economy (the report was leapt upon by the record industry and, subsequently, the tabloid press). The report "conservatively" estimated that illegal downloading cost Britain £10 billion a year and led to 4,000 job losses.

Ernesto Van Der Sar is the pseudonym of creator of TorrentFreak, a website charting developments in the file-sharing industry. He sits on the other side of the argument, saying: "Studies have shown that those who pirate actually spend more on music than the average buyer. Pirates are often the music industry's biggest customers and I believe that a big chunk of all piracy is complementary."

His belief is borne out by a study conducted by the North Carolina State University earlier this year, which showed that "more piracy leads to more album sales". A sample of 1,095 albums leaked on BitTorrent a month before their release sold, on average, 59.6 additional copies. It gives credence to the views of many involved in music that file-sharing could be a good thing, but it's a modest rise. So who exactly is making the big money out of the file-sharing revolution?

Who makes the money?

When we think of those making money from music, we think of mega-rich musicians - Beyonce Knowles and Jay Z stepping out of a new Bugatti, Lil Wayne and his diamond studded headphones - or skinny tied A&R guys, hanging around the back of a club, trying to spot the next big thing. But the flamboyance of Kim Schmitz, AKA Kim Dotcom, trumps them all.

Schmitz is the founder of Megaupload, once the largest file-hosting and sharing site in the world. In January of this year it was taken down by the US Justice Department on charges of copyright infringement. While many involved in the file-sharing business prefer to remain out of public view, German born Schmitz revels in the limelight.

A former computer hacker, he has a long history of felony and once made millions of dollars in an insider-trading scam. According to TorrentFreak, his PR stunts have included faking his own death and offering a $10 million reward for the capture of Osama Bin Laden. His expensive tastes have seen him acquire a fleet of planes and fast cars.

Now, though, he's in a New Zealand prison fighting extradition to the US, where he's accused of costing the entertainment industry $500 million (about £310 million). Megaupload had, at its peak, 180 million users worldwide. File-sharing sites have legitimate uses - many friends share photos and many businesses share files in this way. But many have been used to share pirated files, from movies, to software, to music.

Users upload files to the sites, which send them a unique link to download it in return - all for free. This link can be shared at the user's discretion and is often how albums are leaked in advance: someone trusted with a pre-release copy leaking it onto Megaupload. Megaupload provided a searchable directory to all of the files uploaded onto its servers (in order to accommodate such a volume of files, it had a storage capacity of 25 petabytes - one quadrillion bytes).

How do they make it?

While it was easy to work out how the guy selling counterfeit cassettes in the school corridor was making his money, with file-sharing it's a bit less obvious. But the explanation is straightforward. Most earn revenue in the same way as most other for-profit websites: through advertising. Even the most maligned sites are often full of adverts from reputable companies because of retargeted ad networks, which generate adverts on a website based on the users' previous internet history. In order to increase profits, clicking on one of the links on a site like Megaupload will usually take you to a secondary page, which allows the site to generate another page view for adverts, for which it can bill its advertisers. Furthermore, sites sell premium services which give users unlimited downloads and file storage space in exchange for a subscription fee.

Schmitz and his executive team did themselves few favours by driving round in cars with license plates emblazoned with "GUILTY". And their defense rests largely on a tenet of US law which states that there's no criminal liability for secondary copyright infringement. They merely host links, rather than uploading pirated content and have pointed to the likes of YouTube, which has also been used to host pirated material.

Megaupload may have grabbed the headlines and shaped people's opinions of file-sharing in the process, but the technological revolution needn't be the final nail in the music industry's coffin. With the likes of Spotify, Grooveshark and Pandora, listeners have plenty of legal ways to access music (though artists' returns from such platforms are minimal) from the comfort of their homes, without having to resort to illegal file-sharing. And by giving fresh artists access to new listeners, who's to say that file-sharing won't help spark music-centric party chats for years to come?

The expert: Ernesto Van Der Sar

Owner, (a website discussing developments in file-sharing)

How do file-hosting sites make money?

Most make money through adverts, which is sustainable as long as there are advertisement companies (such as retargeted ad networks) who are willing to work with them. Entertainment industry groups are lobbying hard to convince advertisers to come up with strict piracy guidelines, but sites such as Megaupload are not guilty until the court says so. Megaupload removed many files and had good relations with copyright holders.

Is musical piracy a problem or an opportunity for the music industry?

It's a bit of both. For the overwhelming majority of the artists file-sharing is a good thing. Thousands of artists share their work for free on BitTorrent, for instance, to expand their fan-base as the average musician makes only a fraction of their revenue from music sales. The major labels, on the other hand, make pretty much all their revenue from music sales so are more affected by piracy.

However the decline in record label sales could also be the effect of the technological revolution in general, not just file-sharing. Since the second world war the costs of producing and distributing music have decreased decade after decade, and this process accelerated in the file-sharing era. The effect of this shift is make record labels less crucial to the process and hence reduce the potential profits available to them. With a minimal investment, artists can make music and sell it themselves on iTunes, or even give it away for free.

What does the future hold for online file-sharing / downloading?

Piracy exists because legal alternatives are lacking. Repression can't stop piracy, only innovation can. If the legal option is more appealing than the pirated alternative why should people pirate in the first place? In Europe we've seen that hundreds of thousands of people stopped pirating music when Spotify came along and in the US the movie piracy rate dropped significantly in recent years thanks to Netflix.

The legal file-sharing website: Alexandra Zwinqli

CEO, (a file-hosting and sharing website)

How does RapidShare generate revenue?

RapidShare generates income from customers who upgrade to premium accounts. You can use RapidShare for free with limited functionality for as long as you like. But some features are only available for premium customers.

How far do you go to prevent piracy?

We have an anti-abuse team that identifies and deletes pirated material. In addition to doing what we are legally required to (such as responding to takedown notices) we actively search the internet for links to files that have been illegally made public on RapidShare and make them unavailable. Our eventual goal is to completely discourage the "piracy scene" from using RapidShare.

What benefits can sites like RapidShare offer the wider economy?

During the last decade or so, data availability has become essential. We don't only want to access the internet wherever we are, but want to be able to access our own digital data from everywhere and with any device. Cloud storage services such as RapidShare are the solution to this requirement. In a few years, people will no longer feel the need to constantly copy everything to all their devices. From a business perspective, people now often have to send extremely large files to colleagues or clients. Services such as RapidShare are the perfect solution.

What separates RapidShare from sites which have faced censure, like Megaupload?

I can't really judge which statements about Megaupload are true and which are not. I can only tell you that I can guarantee that RapidShare is doing the right thing. In addition to our anti-piracy measures, we've also been in contact with copyright holders for years.