O’SCANNLAIN, Circuit Judge:
In this case involving the intersection of computer technology, the Internet, and music listening, we must decide whether the Rio portable music player is a digital audio recording device subject to the restrictions of the Audio Home Recording Act of 1992.
This appeal arises from the efforts of the Recording Industry Association of America and the Alliance of Artists and Recording Companies (collectively, "RIAA") to enjoin the manufacture and distribution by Diamond Multimedia Systems ("Diamond") of the Rio portable music player. The Rio is a small device (roughly the size of an audio cassette) with headphones that allows a user to download MP3 audio files from a computer and to listen to them elsewhere. The dispute over the Rio’s design and function is difficult to comprehend without an understanding of the revolutionary new method of music distribution made possible by digital recording and the Internet; thus, we will explain in some detail the brave new world of Internet music distribution.
The introduction of digital audio recording to the consumer electronics market in the 1980’s is at the root of this litigation. Before then, a person wishing to copy an original music recording -- e.g., wishing to make a cassette tape of a record or compact disc -- was limited to analog, rather than digital, recording technology. With analog recording, each successive generation of copies suffers from an increasingly pronounced degradation in sound quality. For example, when an analog cassette copy of a record or compact disc is itself copied by analog technology, the resulting "second-generation" copy of the original will most likely suffer from the hiss and lack of clarity characteristic of older recordings. With digital recording, by contrast, there is almost no degradation in sound quality, no matter how many generations of copies are made.
Digital copying thus allows thousands of perfect or near perfect copies (and copies of copies) to be made from a single original recording. Music "pirates" use digital recording technology to make and to distribute near perfect copies of commercially prepared recordings for which they have not licensed the copyrights.
Until recently, the Internet was of little use for the distribution of music because the average music computer file was simply too big: the digital information on a single compact disc of music required hundreds of computer floppy discs to store, and downloading even a single song from the Internet took hours. However, various compression algorithms (which make an audio file "smaller" by limiting the audio bandwidth) now allow digital audio files to be transferred more quickly and stored more efficiently. MPEG-1 Audio Layer 3 (commonly known as "MP3") is the most popular digital audio compression algorithm in use on the Internet, and the compression it provides makes an audio file "smaller " by a factor of twelve to one without significantly reducing sound quality.
MP3’s popularity is due in large part to the fact that it is a standard, non-proprietary compression algorithm freely available for use by anyone, unlike various proprietary (and copyright-secure) competitor algorithms. Coupled with the use of cable modems, compression algorithms like MP3 may soon allow an hour of music to be downloaded from the Internet to a personal computer in just a few minutes.
These technological advances have occurred, at least in part, to the traditional music industry’s disadvantage. By most accounts, the predominant use of MP3 is the trafficking in illicit audio recordings, presumably because MP3 files do not contain codes identifying whether the compressed audio material is copyright protected. Various pirate websites offer free downloads of copyrighted material, and a single pirate site on the Internet may contain thousands of pirated audio computer files.
RIAA represents the roughly half-dozen major record companies (and the artists on their labels) that control approximately ninety percent of the distribution of recorded music in the United States. RIAA asserts that Internet distribution of serial digital copies of pirated copyrighted material will discourage the purchase of legitimate recordings, and predicts that losses to digital Internet piracy will soon surpass the $300 million that is allegedly lost annually to other more traditional forms of piracy.1 RIAA fights a well-nigh constant battle against Internet piracy, monitoring the Internet daily, and routinely shutting down pirate websites by sending cease-and-desist letters and bringing lawsuits. There are conflicting views on RIAA’s success -- RIAA asserts that it can barely keep up with the pirate traffic, while others assert that few, if any, pirate sites remain in operation in the United States and illicit files are difficult to find and download from anywhere online.
In contrast to piracy, the Internet also supports a burgeoning traffic in legitimate audio computer files. Independent and wholly Internet record labels routinely sell and provide free samples of their artists’ work online, while many unsigned artists distribute their own material from their own websites.
Some free samples are provided for marketing purposes or for simple exposure, while others are teasers intended to entice listeners to purchase either mail order recordings or recordings available for direct download (along with album cover art, lyrics, and artist biographies). Diamond cites a 1998 "Music Industry and the Internet" report by Jupiter Communications which predicts that online sales for pre-recorded music will exceed $1.4 billion by 2002 in the United States alone.
Prior to the invention of devices like the Rio, MP3 users had little option other than to listen to their downloaded digital audio files through headphones or speakers at their computers, playing them from their hard drives. The Rio renders these files portable. More precisely, once an audio file has been downloaded onto a computer hard drive from the Internet or some other source (such as a compact disc player or digital audio tape machine), separate computer software pro vided with the Rio (called "Rio Manager") allows the user further to download the file to the Rio itself via a parallel port cable that plugs the Rio into the computer. The Rio device is incapable of effecting such a transfer, and is incapable of receiving audio files from anything other than a personal computer equipped with Rio Manager.
Generally, the Rio can store approximately one hour of music, or sixteen hours of spoken material (e.g., downloaded newscasts or books on tape). With the addition of flash memory cards, the Rio can store an additional half-hour or hour of music. The Rio’s sole output is an analog audio signal sent to the user via headphones. The Rio cannot make duplicates of any digital audio file it stores, nor can it transfer or upload such a file to a computer, to another device, or to the Internet. However, a flash memory card to which a digital audio file has been downloaded can be removed from one Rio and played back in another.
RIAA brought suit to enjoin the manufacture and distribution of the Rio, alleging that the Rio does not meet the requirements for digital audio recording devices under the Audio Home Recording Act of 1992, 17 U.S.C. S 1001 et seq. (the "Act"), because it does not employ a Serial Copyright Management System ("SCMS") that sends, receives, and acts upon information about the generation and copyright status of the files that it plays. See id. S 1002(a)(2).2 RIAA also sought payment of the royalties owed by Diamond as the manufacturer and distributor of a digital audio recording device. See id. S 1003.
The district court denied RIAA’s motion for a preliminary injunction, holding that RIAA’s likelihood of success on the merits was mixed and the balance of hardships did not tip in RIAA’s favor. See generally Recording Indus. Ass’n of America, Inc. v. Diamond Multimedia Sys., Inc., 29 F. Supp. 2d 624 (C.D. Cal. 1998) ("RIAA I"). RIAA brought this appeal.