Critique of the ICC’s report on the digital economy in Europe

The International Chamber of Commerce has released a report entitled “Building a Digital Economy” (full report here). The report is getting a lot of press because it makes some spectacular claims about the creative industries in Europe. According to the study, by 2015 digital piracy will have cost the industry €32 billion EUR, and will have caused job losses of 611,300. If accurate, these are tremendous losses that would require immediate legislative action. But of course, that is a big IF. Is the study accurate? I do not think so. I will try to go through each of the assumptions it makes to build my critique.

Market share

This is the least controversial statement in the report, and I am willing to take the figures at face value. According to the study, the European creative industries generate almost €560 billion EUR to the total GDP, which translates to 4.5% total of the GDP in 2008 for the 27 EU member states. The industry also is responsible for 8.5 million jobs in the EU.

Drop in sales

This is where the study begins to get into shakier ground. The ICC claims that the music market has been in freefall throughout Europe, and they calculate that album sales have dropped from €10 billion EUR in 2004 to €6 billion EUR in 2008. The problem with these figures is that they completely fail to recognise that the industry is in a state of change, and look only at one part of the music business. For example, in the UK, PRS Music calculated that the entire music industry had been growing in 2008; this includes merchandise and concerts. Also, single sales have sky-rocketed in the last couple of years. What is happening is that the music industry has been late in finding a replacement for CDs, as they did with many other technological changes. Take for example this recent chart from Forrester Research, which describes better than anything else that the industry has been the cause of its own demise:

This is an astounding visual representation of what the problem is. Vinyl sales peaked in 1980, but the cassette was already a viable replacement. Cassette sales peaked in 1990, and already CD sales were growing. CD sales peaked in 2002 (long after Napster), yet no replacement has come forward. This is quite simply, the main reason for the drops we see, file sharing might be affecting sales, but the effect is nowhere near what the ICC report makes out to be.

The same narrow interpretation of facts can be seen in other reported drops in sales. The ICC claims that DVD sales have dropped, but their data does not match the reported trends by other experts. According to Screen Digest, sales in DVD peaked in 2006, and the market has indeed been shrinking. However, this is because there is currently a technology substitution taking place, with Blue-Ray sales expected to increase this year, which will normalise the market. This would respond to the technology substitution chart by Forrester.

Most telling is the fact that the ICC report states that cinema ticket sales are also dropping, and seems to blame piracy for that. However, the MPAA has recently reported that global ticket sales are at an all-time high, with a global increase of 30% since 2005! More importantly, there is a lot of investment going into the industry, which indicates that it is very healthy. The MPAA reports that the number of digital 3D screens in Europe has grown from 0 in 2005, to 3,495 in 2009. That is hardly an industry affected by piracy.

More indicative is the fact that the ICC study does not report software sales, both for enterprise software and the video games industry. There is probably a good reason for that, as it would completely throw off their claims. For example, in 2009 Gartner Research did report a slight drop in enterprise software sales, but this is blamed on the recession, and not on piracy. This is of course offset by the amazing growth in games sales. For example, games sales in Europe rose 25% from 2007 to 2008 alone! No wonder these were left out of the Building Digital Economy document, they are good news and would destroy the doom-and-gloom scenario it is trying to paint. This is remarkable, because the omission would lead one to believe that the creative industries are suffering greatly in this environment. If one leaves out games, concert tickets, and merchandise, then one is presented with depressing overall drops (13% overall drop in the UK alone). But this is ignoring the sectors in the market that are growing, so the ICC report cannot really be trusted.

Substitution

Another controversial part of the report is that it tries to calculate lost sales due to piracy. This has always been a very difficult area of study. The copyright industries sometimes exaggerate the level of substitution that occurs from digital piracy. There is no doubt that physical piracy does appear to have a stronger effect on sales, as people are buying an infringing physical copy. But does this translate in the digital environment? The ICC report makes an assumption that there is always going to be a negative effect on sales based on the literature. The problem is that the literature does not agree in this respect. The report claims that the substitution rate is between 10% and 30%, and decides to go for the lowest percentage of 10%. I have no problem in principle with this, although it has to be pointed out that the figures are not at all clear.

The problem I have is that there is growing evidence that substitution rates should be offset by other factors. For example, it has been widely reported that those who file share the most, are more likely to buy more music than those who do not, which would clearly have to offset the calculation of losses occurring due to digital piracy.

Nonetheless, the worst offence in the ICC report for me is that it brings together physical piracy and digital piracy to calculate lost sales. This is such a big methodological problem that I simply cannot see how it was done unintentionally. The report is trying to sell us a set of figures related to digital piracy, but then halfway includes physical piracy.

Lost jobs

The worst part of the report is the huge assumption it makes with regards to job losses. Once the report has calculated losses due to piracy (which is a huge assumption in itself), the report makes the following assumption:

“Based on the revenue losses assessed at European level, the loss of jobs is obtained by dividing the revenue losses by the average revenue in sales per person employed in each sector, from production up to the retail distribution level. […] Thus, we assume that:
– The music industry employs one person for every €70,000 in sales.
– The film/TV industry employs one person for every €85,000 in sales. […]
–  the British IT industry employed around one person for every €170,000 in sales.”

These are huge assumptions. By some sleight of hand, the ICC report seems to assume that these are quantifiable, and therefore give us the astounding figure of 186,400 accumulated job losses up to 2008. I can see how they make their assumptions, but these seem to be based entirely on their own mathematical assessment, with little or no understanding of the markets. Similarly, by leaving the publishing and games industries out, the reported loss in jobs are highly skewed.

Extrapolating to 2015

The last part of the report that made me think was that it makes even more assumptions about the rise of piracy due to current trends. By assuming that piracy will continue to grow responding to larger broadband take-up, and particularly because of mobile internet growth, the report makes the astounding assumptions on job losses by 2015. The problem is that linear modelling is wrong-headed to say the least. It makes assumptions based on current trends which might be reversed.

For example, surveys are showing that legal streaming services can seriously curb piracy rates. Similarly, broadband penetration may not be followed by more piracy, as the report assumes, it is possible that with new services and faster connections file sharing will stall.

Conclusion

It is disappointing that the copyright industries continue to spend money and resources trying to scare policy-makers into action, instead of making sure that they offer viable alternatives. With reports showing that UK consumers are not aware of legal alternatives to file sharing, it seems like the industry could do a better job of getting their message across.

Update: There is an excellent debunking of the report at Tumbled Logic, and Glyn Moody makes some other interesting points.