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), 8 Mar 2007 @ 10:30am

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


    You've gone back to:

    1) Alexander demands Mike shows A
    2) Mike shows A
    3) Alexander says "That doesn't prove B!!"
    4) Mikes shows B
    5) Alexander says "That doesn't prove A!"

    Why should i? Is there any relationship between what they two did and what you are saying? If there was data, would this prove anything? No. If there wasn't data, would this prove anything? No.

    The point is simple. In describing economic business models, there isn't data before the business model has been put in place.

    People take risks (with or without data) and either fail or succeed. Some succeed (Ford, Bill Gates) some (the majority) don't. And this is so obvious that it is a tautology. And it doesn't prove neither that your model or that any particular model will work.

    Yikes. I didn't say it proved my model (here's that "it doesn't prove B!!!" again). I simply pointed out why it's silly to demand data on a specific instance of a business model that hasn't been used yet.

    Based on your reasoning, no one should ever try a new business model, because there's no proof.

    But, let me explain a little economics here. Because economics involves a huge number of variables, economists don't do "proofs" in the typical scientific sense like you're discussing. What they do is work out the basic rules of economics, looking at the different variables. From that, however, it is often possible to see why certain models work and others don't. It's not about the data, but about the economics -- and the economics is solid. So stop worrying about the data and start looking at the economics.

    Except that Italy wasn't producing new drugs, it was producing new molecular entities. Which is not quite the same.

    You're really stretching here. You do understand what proxy data is, right? You do understand why it's used, right? I'm not going to explain that to you from scratch.

    Sarcastic as we both can be, it remains a fact that you are not doing or willing to do what you are preaching about.

    Er. That's not true. As I pointed out, I am doing exactly what I'm preaching about -- just not yet in the movie industry.

    Market drives prices to MC, but not unconditionally. If you undust your basic economics books, this only happens under some circumstances : in a free market that does not have price-control systems and when there are no significant entry barriers (If you think
    because in the absence of price-control systems and entry barriers, any competitor can sell the same thing that I sell, accepting less profit and therefore charging less.

    Yeah, I think you might need to dust off a slightly more advanced economics text, because yours is a bit out-dated and not really accurate. It does not need price-control or significant barriers to entry. What it needs is constant differentiation -- which some people call "competitive monopolies" or others call "constant innovation." Basically, you keep on differentiating, and that can include both real and perceived differences, such as brand or that "it looks pretty" or whatever.

    Look at the example of the 9/11 commission report. It was a huge best seller, but it wasn't under copyright. Anyone could publish it, but the first company that the gov't agreed to let publish it was the overwehlming leader in the market. There were no barriers to entry. There were no price controls. There was only a brand differentiation held by being first.

    But obviously book sellers are making a profit, and since Macbeth has existed for about 400 years, it's certainly not that the market hasn't had time to drive prices to MC. So how's that? Obviously one of the premises is violated.

    Again, you need to brush up on your economics. It's not copyright that's the issue here. You seem to have misunderstood the time factor in economics. What keeps products from matching marginal cost is that you keep innovating and building up that differntiation (again, real or perceived), and it's that continual change and innovation that helps you keep your price above marginal cost. That has nothing to do with copyright

    So take your choice: Either accept copyright is the price control system that allows Shakespearean book sellers to continue to sell at a profit OR reject the theory that market drives prices to MC.

    Again, you need to go back to the economics books again, because you've left out the option of what's really happening.

    So help me with this one: Is MPAA data valid or not?

    MPAA data on things like attendance and box office take is valid data. MPAA data on things like "losses due to piracy" are what I was talking about as being bogus.

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