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
    Alexander, 10 Mar 2007 @ 4:03am

    Re: DRM

    I'd like to know if you think DRM technology will ever actually succeed in controlling all digital media or will rampant piracy continue unabated.

    Unlike the trend here, I'll provide a clear answer: I do not think DRM will succeed. I do not think it is necessary, either. But I do not think free content will be the model, either. What do I think? Three things :

    1) That content will have a cost so low that pirating it won't be worth the risk of getting caught. You buy the "right to view the movie" for $2 to $6 for example. And you can execute this right as many times as you want, in any format you want : streamed to your computer, wified to your portable console, in a theatre (for a much reduced additional cost, if any. Just present the proof of purchase. They'll sort revenue distribution among themselves afterwards), downloadable as a burnable DVD with cover art, etc.

    2) More content will be produced for display technologies that are not accessible to home users: IMAX, 3D, Motion cinema, Hemispheric cinema, Interactive cinema, Immersive Virtual Reality, and new technologies yet to arrive (project Brainstorm, anyone?). Which was long due.

    3) More emphasis will be put on non-copiable, physical sutff : merchandising, posters, clothes, etc.

    BTW, I'd like also a clear-cut answer to the 2nd and 3rd question I aksed you :-).

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

    You answered about what the role of laws is, but I didn't ask about how laws are made or whom they serve. I asked ...(paste (2) here )...

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

    You didn't provide an answer. It was a question related to you yourself personally.

    BTW, I saw the presentation of this guy, but I'm afraid he's got quite a few things messed up:

    I'm surprised is that noone asked him a very basic question: A cable network ad costs what it costs not because the show is funny according to someone's subjective oppinion, but because of the measurable audience it has. It's easy to say a posteriori that an Ad on Star Wars is worth so an so. How are you going to know the audience size some free content will have, in order to make the advertiser pay for a tiny logo on it?

    Also, comparing a logo with a 30 sec ad is nonsense, and that's another thing noone asked. Even if the 30 sec ad costs the same and reaches only 1/10th of the audience, it is still better. The aim of an advertisment is not "to reach audience". It is, basically, to make sales. Everything else (call it brand identity, brand awareness, etc. revolves around the ultimate aim of sellig you something).

    Thus, conversion rate times audience is the important factor, not audience alone. An ad with a conversion rate of 0 will drive its company to bakrpucy even if every single critter in the universe saw it.

    And what's the conversion rate of a logo? How many kids are going to ask their dads for a McDonalds when seeing a 30' McDonalds ad in the middle of a movie on Disney TV? I can bet any amount that they will be orders of magnitude more than the kids asking for a McDonalds just because of some tiny logo on a movie, which by the way the brain will filter after a while, just as we don't notice cable TV logos either. This is not hypothesis. It's a proven psychological fact. Or brains are trained by evolution to pay attention to changing things, not to constant impulses.

    So there cannot be any sort of comparison between a 30', or a 15' ad and a wimpy logo.

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