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 @ 2:47pm

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

    "it seems to have worked for The Great Wall of China"
    This I don't understand. Are you referring to reconstruction work or to the initial building?

    The initial construction is said to have been financed by funds raised with lotteries, but I can only give you Wikipedia and this source and I don't know if their information is accurate. But the point was that throughout the ages lotteries have shown to be very successful in raising funds.

    "All the participants win the prize of downloading those 2,000 albums for free"
    Do you agree with the 'free-content- theory? I mean can I copy this album?

    Yes and you can. Getting the attention of 200 million people is very valuable, you can get revenue from selling advertisement space on your download portal. Artists can reach a large audience which can be beneficial for their CD sales, t-shirts and concert tickets. It can be done sustainable.

    "Because it is difficult to predict human behavior we could simply make small modifications to the model and test them in practice"
    When you say we, are you willing to experiment with your own money?

    I would love to get the chance to invest some money in SellaBand, but like most other startups they are not open to small investors. But if for example Google with their huge worldwide audience would try such a venture then I would buy shares in Google.
    As for investing in the production of free content, I already do that on SellaBand by investing in the recording of albums. $50k needs to be raised for a professional recording. For every $10 part that I buy, I get a limited edition CD, which also could become a collectors item and thus more valuable. I also get a share of the profits from advertisements and CD sales. But if you buy just one part in a band, then the profits might not be important to you at all. It's the same for the artists, because due to the increased publicity they might increase their revenue from their gigs and they now posses a professional recording which is good for promoting their performances. And they probably haven't invested a lot of their own money in the recording. For SellaBand it is also not needed as they didn't put their own money in and they can cover the costs with revenue from ads and the interest on the money deposited in the escrow account. Profit of course would be desirable as it can be fed back into the system and make it grow faster. The bigger it gets, the better it works.

    I think there are many more who would like to invest, but they don't have the money to start a new business, so they will need to convince a couple of venture capitalists to invest their money which is difficult. Also because I think there is a chance that an established company (or lottery) that already has a huge audience, could see your success and copy your model and immediately have the upper hand because they already have a huge number of users (or a lot of content to attract them). Imagine what would happen if Google or a big lottery would copy what SellaBand does.

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