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. icon
    Mike (profile), 6 Mar 2007 @ 4:25pm

    Re: Re: Re: Re: Re: Re: Re: Re: Re: Re: Re:

    *Every* scientific theory has a non ambiguous test. Which is yours?

    Heh. I like how you ignored the data I did point you to, which is the entire history of the movie industry. But that's okay. When it comes to economic explanation, you don't set up tests like scientific experiments (for the most part), but you do look for proxy data, and there's plenty of that. Not, perhaps, for the movie industry, but I'll point you to another industry that has similar characteristics in terms of high upfront costs, huge risks, and a non-scarce good as the output: pharmaceuticals.

    Now, many people insist that the pharmaceutical industry cannot function without patents... and so I believe it offers a very interesting analog to the movie industry.

    So, to do a proper "test" as you want, you need to be able to compare two different cases. Economics is tricky, certainly, because there are numerous other variables that play into things, but you can clearly draw some conclusions.

    In the case of pharmaceutical patents, if you assume that, like the movie industry, it needs gov't protectionism, then I'd ask you to explain the situation in Italy. Prior to 1978, its patent law did not cover pharmaceuticals, and Italy had a thriving pharmaceutical industry, with many different players, and the industry produced many new drugs (i.e., they weren't just "copying" from elsewhere). In fact, it was one of the largest exporters of drugs. That shows pretty good evidence that you don't need a government protectionist policy on high fixed cost products that produce non-scarce goods. You just need a good business model.

    It's also somewhat (but not as) interesting to look at the Italian pharma industry post-1978. The domestic industry basically dried up. Big international pharma used patents to focus on monopolies and helped destroy what had been a thriving industry working on new drugs. Now there may have also been other factors involved in the post 1978 situation -- but the pre-1978 situation seems to work as an excellent example that these types of goods do not need protectionist policies.

    Either way, like any economic theory the proof is very much in the pudding. It's in what happens based on the theories going forward. You can complain all you want that there's no business model for the movie industry going forward, but someone will prove you wrong -- and it's going to make life more difficult for you because you won't be prepared for it.

    Oh, and one more question, just to see if at least you are honest with your own business: Companies whom you sell your personalized blogs with comments and analysis- are they freely allowed to republish and share them?

    Yes. Our customers are free to do what they want with our content. Some of the contracts have contractual stipulations, but we often encourage our customers to spread the data far and wide. It's why we don't charge on a per seat basis as well -- as we think that's damaging.

    You have to realize, our customers don't pay us for the content. They pay us to produce the content. It's an important distinction. Once we've produced the content, we really don't care what they do with it. But our contracts are for the ongoing production of that content. That is, they're paying us for what we're going to produce tomorrow, not what we produced yesterday.

    And it's also basic economics that just because your model can make a little profit (hell, even giving software for free and accepting donations makes monetary profit), this doesn't make it neither a better model, nor an inevitable one that everyone should adhere to.

    Well, that's not the economics I'm espousing. There are two points that I have made (and backed up, despite your claims that I have not). First is that the existing model is unsustainable -- and it's unsustainable for clearly obvious reasons, which is that there are ways to provide more value at lower costs, and the general nature of a competitive market will push your market to realize this truth. The second is that by recognizing how to bundle the scarce elements with non-scarce goods, there actually are ways to expand the pie. And for that, there are many historical examples. In just your own industry, the VCR is a perfect example of that very fact. Despite the industry's fear of the VCR (the "Boston Strangler to the movie industry"), what it did was increase value to customers by offering a new delivery mechanism. And the industry took the non-scarce content (movies) and wedded it to a scarce resource (VCR tapes, people's ability to go to the movies, desire to have entertainment in the home) and made money off of it.

    Oh great. So now tell me, how are Shakespearean book publishers differentiating among themselves? There is not one, but many many printed versions of Macbeth, all of them making profits. Many are printed on the very same paper and format, so certainly the fact that they are printed is not what is different. How's that?

    They tend to differentiate based on a variety of things, from the introductory text, to the footnotes, to the explanations, even to the versions of the play (some have cut out parts). On a superficial level, you could even claim that some differentiate based on cover art, completeness of the play, readability of the fonts, etc. etc. etc. The point is that there are nearly limitless ways to differentiate and sell one product over another. Some actually compete on name brand. People like buying a book from a certain publisher rather than another one -- and that right there is differentiation.

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