Why Is Amazon Buying CDs?

| About: Amazon.com, Inc. (AMZN)
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Amazon (AMZN) recently expanded its trade-in program to cover CDs. On the surface, this doesn't seem like a very important development, as Amazon's trade-in program has been accepting various goods in exchange for Amazon credit for years. But unlike those programs, where Amazon primarily refurbished and/or resold the goods, I think that Amazon may have a different motive for buying decade-old CDs. If so, Pandora (P), Sirius XM (SIRI) and other companies should be concerned.

I think that it seems possible that Amazon may be readying an internet-based music service. The service could be similar to Pandora, which streams music based on a user's preference of artist or genre, or more like Spotify, which allows users to pick individual songs to listen to on-demand. Amazon could provide its service to Prime subscribers, which already enjoy the ability to stream some movies and television content, or it could even be offered more broadly. Clearly, this service would be a significant (if not mortal) threat to Pandora, but could also be a meaningful threat to Sirius XM and other music providers.

Amazon may attempt to provide this service in a way that no one has before - by utilizing physical CDs to provide internet listening. I'm not a legal expert, but my understanding of a relevant principle, the first sale doctrine, suggests that it may be possible. As explained by Fred Von Lohmann:

The "first sale" doctrine expresses one of the most important limitations on the reach of copyright law. The idea, set out in Section 109 of the Copyright Act, is simple: once you've acquired a lawfully-made CD or book or DVD, you can lend, sell, or give it away without having to get permission from the copyright owner. In simpler terms, "you bought it, you own it" (and because first sale also applies to gifts, "they gave it to you, you own it" is also true).

This doctrine explains why one can borrow books and CDs from libraries, but, up until now, digital content has required licensing that generally involves very limited and pay-per-use terms. However, I think that Amazon could change that.

For example, if Amazon were to buy a used N*SYNC CD from a user (currently the greatest hits version can be traded in for $1.40), it is clearly allowed to resell (or lend) that CD to another person. But I think that Amazon may also be able to utilize the rights entitled to that CD's owner to enable streaming of that music to another person. Amazon would have to institute policies that make this lending process legitimate - and I think that they have already begun to do so.

Amazon only pays buyers for CDs that are in working order and can actually play music - this is important, because Amazon would clearly not be allowed to let a thousand people simultaneously stream "Bye Bye Bye" if they only own one (working) physical copy of the N*SYNC CD that it comes from. However, if Amazon owns a thousand N*SYNC CDs, then they are really just temporarily lending a CD to a listener, because no other listener can access it at that point in time.

There may be additional requirements for this program to work legally (i.e. using the CD to actually the music on a semi-real time basis to the listener) that Amazon would have to figure out, but I do not think that such details are insurmountable in the establishment of such a program.

A startup service called Aereo is attempting to do something similar with broadcast television. Television signals are available to anyone with an antenna, but not many users are interested in actually harvesting that free TV themselves. Instead, Aereo will devote a unique antenna to a listener, and then pass that antenna's programming along to the user via the internet. To me, this seems very similar to the virtual CD lending program that Amazon could pioneer.

I believe that the concept of unique use by a unique user could allow Amazon to introduce services that are comparable to (or better) Pandora or Spotify, at a much lower cost; once Amazon acquires its library (for pennies per song), there are no licensing costs associated with each playback. This would eliminate the need to sell ads (like Pandora does) or charge a monthly fee (like Spotify does) and users would flock to Amazon's service. I don't necessarily believe that this would have a meaningful impact on Amazon financially, as few people are likely to buy a $80 Prime membership to stream some music; however, I think that it could be very damaging to competitors.

Pandora clearly has the most to lose if such a service was launched. I'm a satisfied, regular Pandora user (I use it for about an hour at the gym every day), but I'd be happy to switch to an Amazon service that might allow me to pick individual songs, create playlists, repeat a song that I want to hear again, and not bother me with occasional ads.

Sirius XM may be negatively affected, too. While Sirius differentiates itself in meaningful ways (unique content, sports, no cellular bandwidth required [though the monthly subscription fee is not dissimilar to what a user might pay to stream Pandora on a cell phone]), a new, competing music service (especially a free one) would surely not be a good thing. Terrestrial radio would also be threatened (and may fight alongside labels in preventing Amazon from launching a streaming service), as traditional radio must pay for the licensing to play music and must bother its listeners with advertisements to stay in business.

Maybe Amazon is just buying back copies of N*SYNC's Greatest Hits because the CDs can be resold at a marginally higher price. But I believe that Amazon may be trying something much bolder; if they are, competitors should start planning for a future with much tougher competition, and shareholders of those competing companies may need to reevaluate their positions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.