MEMORANDUM and ORDER

LOUIS L. STANDTON, U.S.D.J.

Defendant Broadcast Music Inc. ("BMI") applies to this court in its rate-setting capacity under Article XIV of the Amended Final Judgment entered in United States v. Broadcast Music, Inc., 1966 Trade Cases (CCH) ¶ 71,941 (S.D.N.Y. 1966), modified by 1996-1 Trade Cases (CCH) ¶ 71,378 (S.D.N.Y. 1994) (the "BMI Consent Decree"). It seeks an order setting reasonable final fees for a blanket license for applicant Music Choice's cable, satellite, and Internet services from October 1, 1994 through September 30, 2004.

For the reasons that follow, the fee for the blanket license for Music Choice's cable and satellite service is set at 1.75% of its gross revenues as that term is defined in the 1995 license agreement between BMI and DMX. The fee for its Internet service is set at 1.75% of its gross revenues as that term is defined in the standard BMI "Web Site Music Performance Agreement."

Background

The BMI Consent Decree requires BMI to make through-to-the-listener licenses available for public performances of its music, and to provide applicants with proposed license fees upon request. If BMI and the applicant cannot agree on a fee, either party may apply to the rate court for the determination of a reasonable fee. In the rate court proceeding, BMI bears the burden of proving that its proposed fee is reasonable. While the rate determination is pending, the parties may ask the court to set an interim fee, subject to later adjustment.

1. Prior history of this action

By letter dated January 31, 1997 Music Choice applied to BMI for a blanket license for its residential music services distributed to the home by cable, satellite and the Internet. After the parties were unable to agree on a license rate, BMI applied to this court for determination of reasonable license fees for the period from October 1, 1994 through September 30, 2004.

By order dated November 15, 1999, the court set an interim fee, subject to retroactive adjustment, of 3.0% of Music Choice's gross revenues for its cable and satellite services, and 1.75% of its gross revenues for its Internet service. The order warned that "the parties, and all concerned, must appreciate that the interim fee may bear little resemblance to the final fee."

During May 22-31, 2001, a six-day trial was held on the issues affecting the determination of a reasonable fee.

2. Music Choice

Applicant Music Choice, which commenced consumer operations in 1991, transmits an audio service consisting of 55 different channels of music to consumers' televisions sets via cable and satellite and to their computers via the Internet. It was the first entrant into the residential music service industry, which consists of companies offering music to cable and satellite subscribers in the home.

Music Choice's channels consist almost entirely of CD-quality music, transmitted continuously throughout the day without commercial interruption. Each channel is programmed with different musical compositions within a specific genre, such as rock, pop or classical. Information about each song, including title, author, and album appears in text format on the subscribers' television or computer screen at the beginning of each song.

For its programming transmitted by cable and satellite, Music Choice licenses a package of up to 45 music channels to cable and satellite operators, who in turn transmit the music service to their customers. To deliver its cable service, Music Choice first transmits its programming onto its own satellite, where it is received by cable operators, who then transmit the programming through their cable systems into the home. Similarly, Music Choice's satellite programming is transmitted from its own satellite to that of the satellite operator. Customers then receive the programming directly from the satellite operator through their own satellite receivers. The cable and satellite operators transmit Music Choice's service without addition, subtraction, or change to the programming, and they do not alter the signal in any way.

Music Choice's Internet programming, which provides up to 40 channels of music, is available directly to the consumer through its web site. Internet customers (also known as "Backstage Pass" subscribers) access the web site for a fee through an Internet service provider ("ISP"), such as America-On-Line or Netscape. In March 2001, Music Choice had approximately six million cable and wireless customers, about nine million satellite customers, and fifteen hundred "Backstage Pass" subscribers.

Initially, Music Choice's service was only available through cable, and cable operators offered it to customers as a "premium" or "à la carte" channel. Under that business plan, customers paid the cable operators separately for access to that service, and the operators remitted a portion of that payment to Music Choice. At that time the available technology required the cable operators to attach a separate "tuner" to their customers' cable boxes to decode the digital music signals, and the separate premium fee allowed the operators to cover those additional hardware costs.

By 1993, however, it was evident that fewer subscribers than expected were willing to pay separately for the service, and that selling Music Choice as a premium channel would never be profitable. Thus, when Music Choice began offering its service via satellite through a company called DirectTV, it did so as part of DirectTV's "basic" or "enhanced basic" service, rather than as a premium service requiring an additional fee. The change in pricing structure was facilitated by satellite digital technology which did not require an additional tuner for DirectTV's customers to listen to Music Choice.

Over time, the pricing of Music Choice's cable service also changed from that of a premium channel to basic service, and now cable operators only offer it to new cable customers as part of a basic, or enhanced basic, cable package. At the time of trial, only about 100,000 cable customers, who subscribed to the service before 1995, still paid for Music Choice as a premium channel, and that number is rapidly diminishing.

In contrast with the cable and satellite customers, Internet subscribers pay Music Choice directly for access to its "Backstage Pass" programming; they also pay their Internet service provider a separate fee for access to the Internet.

3. Music Choice's licensing history

A few years before starting its service, Music Choice began negotiating with BMI for a blanket license. In 1990, BMI and Music Choice signed a three-year agreement requiring Music Choice to pay a license fee equal to 2% of its gross revenue plus 2% of the cable operators' gross revenues from Music Choice's service (minus the operators' payment to Music Choice) for the first two years; both percentages increased to 2.1% for the third year. From BMI's standpoint, that allowed it to capture what it saw as the full value of what a customer was willing to pay to receive Music Choice's music programs. The license also had a "most favored nation" provision: that if a similarly situated licensee obtained more favorable terms from BMI, BMI would offer those terms to Music Choice as well.

At that time, because Music Choice's service was sold only as a premium channel, one easily identified the portion of cable operators' revenues attributable to Music Choice by the subscriber's payment to the operator for the premium channel. However, as the business changed and technology advanced so that a separate tuner was no longer needed and the cable operators increasingly included Music Choice's service in their basic cable packages, it became harder to separate the portion attributable to Music Choice's channels from the operators' general revenues, which the operators were slow and reluctant to disclose.

Ultimately the problem of timely ascertaining the operators' relevant revenues was resolved on terms which BMI reached with a similarly situated competitor, DMX, Inc. (discussed below): Music Choice's rates were adjusted to abolish the two-tier structure, and replace it with a single fee of 3.75% of Music Choice's adjusted gross revenues from October 1, 1994 to September 30, 1996, and then 4% until January 31, 1997. This effectively eliminated the operators from the procedure, and their revenues did not have to be ascertained, because the approximate doubling of the rate to be paid by Music Choice gave BMI equivalent license fee revenue.

4. DMX. Inc.

Currently, DMX is the only other company offering digital music to the home via both cable and satellite. Like Music Choice, DMX offers channels of continuous CD-quality music, programmed within a specific genre, with no commercial interruption. DMX transmits its service to its cable and satellite operators, which then transmit it to their customers. DMX was also originally offered exclusively as a premium channel, and over time has moved to distribution as part of a basic cable package, although not quite as quickly or completely as Music Choice.

DMX's first BMI blanket license, in 1991, was modeled on the 1990 Music Choice license: it required DMX to pay 2% of its gross revenues plus 2% of the cable operators' gross revenues from its service (minus its payments to DMX) for the first two years of the license, both increasing to 2.1% for the third year. At that time, DMX's customers (like Music Choice's) needed the separate tuner that the cable operator supplied to receive DMX's programming, and paid a separate fee to receive DMX's music service as a "premium" channel.

During the term of the 1991 license, the "hardware" dispute between BMI and DMX arose over operator revenues. BMI asserted that operator revenues included the cost of the tuner used to receive DMX's service. DMX interpreted the contract as excluding such costs, and deducted them when computing its payments under the license. BMI conducted an audit, and concluded that DMX owed approximately $445,231 on the "hardware" through December 1993.

Thus when DMX began negotiating its new license agreement in 1994, it was simultaneously contending with the hardware dispute. DMX's primary concern in negotiating the new license agreement was to change the fee structure to a single rate based on only its own revenues, rather than including 2% of the operators' revenues. It had experienced difficulties obtaining information from its operators concerning their DMX revenues, and it was concerned by the exposure posed by a rate component which it could not control and which might increase in the future. BMI agreed to the change, provided that the rate be adjusted to capture what BMI considered to be the full value of its music license (i.e., reflecting the total amount the subscriber was willing to pay).

Ultimately, DMX and BMI resolved the issues in separate agreements, signed simultaneously on August 7, 1995. The hardware dispute was settled for $222,625.22 (half of the disputed amount), to be paid by DMX over an 18-month period. The fee for the new license agreement (the "1995 DMX agreement") was 3.75% (a bit less than the total of DMX's plus the operators' prior percentages) of its gross revenues from October 11, 1994 to September 30, 1996, and 4% of its gross revenues from October 1, 1995 to September 30, 1999. The license agreement also contained a most favored nation provision.

4. The positions of the parties

BMI argues that the court should take the 1995 DMX agreement as an appropriate benchmark for setting a reasonable fee for Music Choice's cable and satellite programming. BMI contends it is appropriate because the agreement was a fairly negotiated arms-length transaction, DMX and Music Choice are engaged in the same business, and they program and distribute music in the same manner.

Music Choice argues that the 1995 agreement is unreasonable because its fees reflect BMI's monopolizing and superior bargaining power, are inflated to some decree by the settlement of the hardware dispute, and are derived from the two-tiered fee structure of DMX's 1991 agreement, which was negotiated before there was a rate court and under which BMI improperly included revenues received by the cable operators. Music Choice suggests that the 1.35% rate BMI charges radio broadcasters or the 1.75% rate BMI charges its Internet licensees are more appropriate.

Discussion

Although the BMI Consent Decree directs the court to set a "reasonable" fee, it provides no guidance for making that determination. Prior cases involving rate-setting under the American Society of Composers and Publishers ("ASCAP") Consent Decree, which also requires its rate court to set a reasonable fee, have viewed the court's task as defining a rate or range of rates reflecting the fair market value for a particular license, i.e., "the price that a willing buyer and a willing seller would agree to in an arm's length transaction." ASCAP v. Showtime/The Movie Channel, Inc., 912 F.2d 563, 569 (2d Cir. 1990) (hereinafter ASCAP v. Showtime).

The efficiencies and benefits of a blanket license imbue it with a value different than the sum of its constituent compositions. Moreover, because the music licensing industry is predominantly controlled by two competitors, BMI and ASCAP, the market for blanket licenses "appears to be one whose natural consequence is the lack of broad-based competition."United States v. ASCAP (Application of Capital Cities/ABC, Inc.), 831 F. Supp. 137, 144 (S.D.N.Y. 1993)

Thus, ASCAP rate decisions have considered "very imperfect surrogates, particularly agreements reached either by these parties or by others for the purchase of comparable rights," as a starting point for their analysis. ASCAP v. Showtime, 912 F.2d at 577 (App: Opinion of Trial Court). Whether such an agreement is an appropriate benchmark depends on "the degree of comparability of the negotiating parties to the parties contending in the rate proceeding, the comparability of the rights in question, and the similarity of the economic circumstances affecting the earlier negotiators and the current litigants", United States v. ASCAP (Application of Buffalo Broadcasting Co., Inc.), Civ. No. 13-95, 1993 WL 60687, at *18 (S.D.N.Y. Mar. 1, 1993), aff'd in part, vacated in part, United States v. ASCAP (Application of Capital Cities/ABC, Inc.), 157 F.R.D. 173 (S.D.N.Y. 1994), as well as the "degree to which the assertedly analogous market under examination reflects an adequate degree of competition to justify reliance on agreements that it has spawned."ASCAP v. Showtime, 912 F.2d at 577 (App: Opinion of Trial Court). See also United States v. ASCAP (Application of Capital Cities/ABC, Inc.), 157 F.R.D. at 198-99 (it is "necessary to examine those prior agreements so as to determine whether anomalous conditions impacted them or whether they were the product of a disparity in bargaining leverage so as to render them unreliable as benchmarks for subsequent periods.").

1. BMI's proposal

It is uncontroverted that Music Choice and DMX are similarly situated competitors in the residential music services industry, have similar business structures for the distribution of their product (although DMX still sells more of its programming on premium channels than Music Choice), and program and distribute music in a similar fashion.

The dispute in this application centers on whether the 1995 DMX agreement with BMI should be adopted as the basis for a reasonable fee. It was taken as "the best guide towards an interim fee" in the court's November 15, 1999 order, but with adjustments reflecting doubts which the May, 2001 trial has clarified.

a. Negotiation of the 1995 agreement

DMX had no palatable licensing alternatives to accepting a blanket license from BMI. Without such a license, it could use only ASCAP music (which would have unacceptably restricted its music inventory), negotiate piecemeal for licenses with individual songwriters or music publishing firms (which would have been totally impracticable), or resort to the rate court (at a time when DMX's serious cash flow problems left it not knowing if it could meet its payroll, and the idea of arbitrating the hardware dispute "was very distressing", Tr. at 231).

DMX's counsel Peter Laird testified that the "position became one of survival. In other words, we had to find a way out of this mess that we could live with on the short term because we were not going to be able to fight . . ." (Tr. 232).

Jerold Rubenstein, DMX's Chairman and CEO at the time of the negotiations, testified that the rate in the 1995 agreement was high, but affordable in light of his two more urgent concerns: that the rate be the same for both DMX and its competitor Music Choice, and that the cable operators' revenues be removed from the fee calculation, so that DMX would not be subject in the future to license fees based on cable operators' revenues from which it did not benefit, and which it could not control (see generally, tr. at 193-95).

On the basis of the trial evidence as a whole, one cannot say with confidence that the "hardware dispute" or its resolution had any particular effect on the license rate.

However, it is clear that in view of DMX's strained finances, the lack of feasible alternatives, and the special considerations affecting DMX's position in the negotiations, the 1995 DMX agreement should not be regarded as reflecting normal competitive market terms.

b. Reasonableness of 1995 DMX license fee

The basic premise on which BMI asserts the propriety of the 3.75-4% rate in the 1995 DMX agreement is that it includes both components for which the music subscriber is willing to pay: the music itself (approximately 2% of Music Choice's revenues) and the transmission by the operator to the home (approximately 2% of the operators' revenues from Music Choice's programs). The subscriber enjoys only the music, rather than the machinery of its delivery, but BMI argues that the combined rate is what the subscriber is willing to pay to receive the music, i.e., its fair value.

But the fair value of the total package is not necessarily the fair value of the music or the music license. The other components of the package for which the subscriber pays (the former tuner, the cable, the connections, the labor of installation, etc.) are not contributed by the author of the music, and there is no reason why the author should be compensated for their cost. Quite to the contrary, the true value of the music is expressed at the earlier stage where it is incorporated into Music Choice's programs. The blanket license authorizes the use of the music, and should have no regard to whether the mechanics of delivery are cheaper or costlier. Thus, the idea that to recover the full value of the music, the blanket license rate should include a component based on the cable or satellite operators' revenues, is misconceived.

The notion that the rate should rest on both the licensee's and the operators' revenues originated in 1990, when Music Choice's business was starting and it needed BMI's license before it could get commitments from cable operators, and before recourse to the rate court was available. It found support in the view that Music Choice's transmittals to the cable operators, and the cable operators' transmittals to the subscriber, each constituted "performances" which would infringe the music composer's copyright unless licensed by BMI.

That idea has since been rejected by the ASCAP rate court for license fee purposes, regardless of how the transmittals may be regarded as a matter of copyright-infringement law. See United States v. ASCAP (Application of Fox Broadcasting Company), 870 F. Supp. 1211, 1219 (S.D.N.Y. 1995) ("This is not a copyright case; our job is to set reasonable rates for Fox's use of ASCAP music and not to decide whether Fox has infringed the copyrights held by ASCAP members.").

The earlier facility with which the operators' revenues could be derived through the usage of premium channels has been eradicated with the passage of time and the change in the industry's business practices. To the extent that the 1995 DMX agreement contemplated distribution of music service substantially as premium channels, it does not serve as a useful benchmark for Music Choice, whose service will soon only be part of basic cable packages.

For all the above reasons, the concept on which the 1995 DMX rate agreement rests — that the license fees should capture a portion of the cable operators' revenues — is flawed, and should be disregarded in considering that agreement as a reference point. Removing the 2% initially allocated as the cable operator's portion from the initial total rate of 3.75% in the DMX agreement leaves a rate of 1.75%.

2. Music Choice's proposal

Music Choice proposes two rates as potential benchmarks: the 1.35% rate BMI charges radio broadcasters, and the 1.75% rate BMI charges its Internet licensees.

a. Broadcast radio licenses

Music Choice argues that the broadcast radio blanket license is an apt benchmark, because Music Choice competes with broadcast radio for listeners.

However, there are substantial differences between the residential music services industry and the radio broadcast industry. The broadcast radio license has a "blended" rate offered to radio stations that broadcast music, whether their programming consists of music interspersed with commercial, news and disc jockey interruptions, or almost no music at all. That rate has little relationship to the value of a blanket license to a service like Music Choice's or DMX's, which consists almost entirely of continuous music.

b. Internet licenses

Music Choice also argues for the 1.75% Internet license rate, because it is applied to web sites (like Music Choice's and DMX's) that have music programming identical in format, music usage and quality to Music Choice's cable and satellite service.

BMI disparages the Internet licenses as "experimental", and thus not establishing a reasonable fee.

Because Internet technology and business structures are constantly evolving, BMI states, it has attempted to keep its licensing agreements "as flexible as they can be and give the market an opportunity to experiment with different ways of putting music our there and also different ways of making money." (Tr. at 297).

However, during the six years since BMI began its licensing in 1995, the 1.75% license (first offered in 1997) has been applied consistently to revenue-generating music programming at web sites other than those belonging to radio and television stations or offering primarily visual texts and images.

BMI offers no reason why Music Choice's Internet rate should differ from its cable and satellite rate except that its cable and satellite distribution involves third-party operators.

Notably, when the misconception that the presence of an operator should affect the rate is removed, the resulting rate under the 1995 DMX agreement is almost the same as the Internet rate.

Conclusion

For the foregoing reasons, the fee for the blanket license for Music Choice's cable and satellite service from October 1, 1994 through September 30, 2004 is set at 1.75% of its gross revenues as that term is defined in the 1995 License Agreement between BMI and DMX. Without objection, the fee for its Internet service for the same period is 1.75% of its gross revenues as that term is defined in the standard BMI "Web Site Music Performance Agreement."

So ordered.