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
    BIllyG, 6 Mar 2007 @ 11:09am

    Re: Re: Profits

    Hi Alexander,
    1) Do you agree with copyright law? I'm not asking about DRMs, but just about the notion of intellectual property and copyright.

    IP is an artificially state mandated monopoly whose purpose is to foster the creation and dissemination of ideas. Since it is a monopoly the laws need to be balanced between the creator and the public. Hence fair use provisions and limited terms. The goals are good but if the laws are not balanced, can't achieve their stated goals, or are no longer needed then the laws need to be changed.

    For example, does a term of the author's life + 70 years make sense (How is Elvis gonna create more works)? Are software patents the driving force between innovation in the software industry or a tool to be used against competitors. Here's a quote from Bill Gates himself on the matter:
    "If people had understood how patents would be granted when most of today's ideas were invented and had taken out patents, the industry would be at a complete stand-still today."

    2) if breaking a law becomes almost trivial and costless, does this mean that the law should be dropped?

    Laws are made to serve a society. If a law doesn't do so then it should be rejected. In the case of downloading, millions of people are saying that they don't think they should pay for something who's marginal cost is close to zero.

    3) These ideas you provide, are you willing to risk your own money and time on them?

    This is an odd way to frame the problem. If you're in an industry you do what you need to do to survive. If movies, like any other industry, start making less money then they work on ways to return to profitability. Be it by lowering costs, delivering more competitive products, or adjust their market strategy. If you want an example of one of my ideas in action here it is: http://ibtimes.com/articles/20070305/instant-films.htm

    Most of the comments on this blog have been very intelligent but I'm dissapointed by the pro-DRM gang's pessimism. The internet has allowed any digitizable good to be instantly and freely available around the globe. This is an incredible achievement. Of course business models dependant on the old distribution methods are dead. Just as business models based on monks hand copying books where finished once the printing press came out. A business model is dead but and new ones will emerge. But the need to create art as has been the case throughout human history will continue.

    P.S. Check out "Piracy is Good" for an example of a new business model for TV shows in the new internet age: http://video.google.com/videoplay?docid=-1720068211869162779&q=piracy+is+good

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