An Economic Explanation For Why DRM Cannot Open Up New Business Model Opportunities

from the shrinking,-not-expanding,-the-pie dept

Continuing my increasingly lengthy series of posts on the economics of non-scarce goods, I wanted to take a look at an issue that I mentioned in passing earlier this week concerning the ongoing insistence among the entertainment industry (and the DRM industry) that DRM somehow will open up new business models. I'd like to explain why, economically, that doesn't make sense.

First, to clarify, I should point out that, technically, I mean that it doesn't make sense that DRM could ever open up feasible or successful business models. Anyone can create a new unsuccessful business model. For example, I'm now selling $1 bills for $1,000. It's a new business model (well, perhaps not to the dot coms of the original dot com boom), but it's unlikely to be a successful one (if you disagree, and would like to pay me $1,000 for $1, please use the feedback form above to make arrangements). However, for a new business model to make sense, it needs to provide more value. Providing more value than people can get elsewhere is the reason why a business model succeeds. So, any new business model must be based on adding additional value.

The good news is that value is not a scarce concept. Unfortunately, there are too many in this world who view value and growth as a zero-sum game. They believe that there's some fundamental limit on the possibility of adding value, and therefore, business models are about moving around a limited amount of value, rather than expanding it. It's the same fallacy facing those who have trouble understanding zero and infinity in economics. The economist Paul Romer's discussion on Economic Growth offers a concise explanation for this:
Economic growth occurs whenever people take resources and rearrange them in ways that are more valuable. A useful metaphor for production in an economy comes from the kitchen. To create valuable final products, we mix inexpensive ingredients together according to a recipe. The cooking one can do is limited by the supply of ingredients, and most cooking in the economy produces undesirable side effects. If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer from unacceptable levels of pollution and nuisance. Human history teaches us, however, that economic growth springs from better recipes, not just from more cooking. New recipes generally produce fewer unpleasant side effects and generate more economic value per unit of raw material.

Every generation has perceived the limits to growth that finite resources and undesirable side effects would pose if no new recipes or ideas were discovered. And every generation has underestimated the potential for finding new recipes and ideas. We consistently fail to grasp how many ideas remain to be discovered. The difficulty is the same one we have with compounding. Possibilities do not add up. They multiply.
Note that it's the non-scarce products, the recipes and the ideas, that helps expand the value of the limited resources, the ingredients. You expand value by creating new non-scarce goods that make scarce goods more valuable -- and you can keep on doing so, indefinitely. Successful new business models are about creating those non-scarce goods and helping them increase value. Any new business model must be based around increasing the overall pie. It's about recognizing that creating value isn't about shifting around pieces of a limited economic pie -- but making the overall pie bigger.

DRM is fundamentally opposed to this concept. It is not increasing value for the consumer in any way, but about limiting it. It takes the non-scarce goods, the very thing that helps increase value, and constrains them. Those non-scarce goods are what increase the pie and open up new opportunities for those who know where to capture the monetary rewards of that value (within other limited resources). DRM, on the other hand, holds back that value and prevents it from being realized. It shrinks the pie -- and no successful business models come out of providing less value and shrinking the overall pie. Fundamentally, DRM cannot create a successful new business model. It can only contain one.

If you're looking to catch up on the posts in the series, I've listed them out below:

Economics Of Abundance Getting Some Well Deserved Attention
The Importance Of Zero In Destroying The Scarcity Myth Of Economics
The Economics Of Abundance Is Not A Moral Issue
A Lack Of Scarcity Has (Almost) Nothing To Do With Piracy
A Lack Of Scarcity Feeds The Long Tail By Increasing The Pie
Why The Lack Of Scarcity In Economics Is Getting More Important Now
History Repeats Itself: How The RIAA Is Like 17th Century French Button-Makers
Infinity Is Your Friend In Economics
Step One To Embracing A Lack Of Scarcity: Recognize What Market You're Really In
Why I Hope The RIAA Succeeds
Saying You Can't Compete With Free Is Saying You Can't Compete Period
Perhaps It's Not The Entertainment Industry's Business Model That's Outdated

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  1. identicon
    Isaac, 5 Mar 2007 @ 5:54am

    Re: Make people actually *want* to buy it!

    I thought of the lottery model as well for raising money (it seems to have worked for The Great Wall of China). What I had in mind, is a big money jackpot - which should make it irresistible not to enter the lottery, so this is to attract a lot of participants - and all the other prices in the form of non-scarce goods, instead of scarce money.

    This should not be started with movies first, music is best suited to start such a model. Once it gains in popularity and more tickets are sold, then other non-scarce goods can be given as prizes as well, like: e-Books, movies, games and software. At some point the non-scarce prizes that all the participants are guaranteed to win, could become the dominant reason to enter the lottery.

    Take this simplified example: let's say that you sell $10 tickets online, and you are going to sell 20 million tickets worldwide. You use half for the money jackpot of $100 million, the other half you use to fund the recording of albums ($50k each, consisting of $30k cost and $20k profit for artists and producers). That comes down to 2,000 music albums. All the participants win the prize of downloading those 2,000 albums for free. If you sell 200 million tickets worldwide, that would be 20,000 albums that everyone wins. That might be a bit much, so you could lose 200 albums and instead of those do one movie (at $10 million). Or 200 e-Books, or a computer game, or a piece of software. This lottery, instead of having a fixed draw date, it could have a fixed target, like 20 million tickets. So only once all those tickets have been sold there will be draw. This approach is used by SellaBand to raise the $50k to record a music CD. So there is no risk that you won't sell enough tickets. The participants can get a refund at any time before all the 20 million tickets have been sold. So there is also no risk in it for the participants.

    Because it is difficult to predict human behavior we could simply make small modifications to the model and test them in practice. For example money from the jackpot could be shifted to the non-scarce prizes, and see if people will still buy tickets then. Also instead of giving just the participants free access to the non-scarce prizes, a part of those prizes could be made available to everyone (so not only to those that entered the lottery). Maybe it would be possible to successfully move to a lottery with no money jackpot, but only non-scarce prizes that can be freely downloaded by everyone. At that point it can't be classified as a lottery anymore, it would be voluntary cooperation in the form of $10 donations. This way people could experience the great things that are possible when we cooperate, and then they might not try to get a free ride, because of the risk that it would collapse this venture, and that could result in a loss of millions of dollars worth of non-scarce prizes in the future.

    I think such a lottery model with non-scarce prizes can become very successful very fast.

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