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), 16 Mar 2007 @ 6:12pm

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

    I think it's very difficult to twist someone else's words by quoting him literally :-)

    You said trademark was the same as copyright. That's simply not true. Trademark is a consumer protection issue, which is very different from intellectual property. I'll note that you don't bother to actually respond to the ways in which trademark is different from copyright and patents and why that matters...

    The fact that something is happening does not imply it happens for the reasons you say, and even if this were the case, it doesn't mean that a scientifc theory is not falsifiable. Euclid had a falsifiable test about his geometry axioms for about 2 millenia, and reality was showing him to be correct until Lobachevsky came and showed that he was wrong in the general case and then Einstein showed that there was more reality than Euclid was seeing.

    And we're back to Mike says A, Alexander says "that doesn't prove B!" Mike says "well here's something that proves B" and Alexander says "but that doesn't prove A!"

    I'll try once again: either you believe what economics proves or you don't. Do you believe in free market efficiencies or not? What "scientific proof" do you set up to disprove free market economics? Or what scientific proof do you set up to prove free market economics?

    Henry Ford did something for what there was no data and succeeded, while Joe Bankrupt did something for which there was no data and went bankrupt. Conclusions? None.

    Ah, but that's not true. What we ARE able to do is look at the basic economics again (I know you hate to do so, but it's how things work). Ford succeeded, in part, because the assembly line allowed him to be more efficient, producing decent automobiles at lower prices and getting much greater economies of scale. On top of that, he used excellent marketing techniques to build up additional brand value.

    That's an economic lesson that's pretty clear. If you can make something more efficiently economically, while using something else (such as brand) to increase value, you can do quite well against the competition.

    So, to return to the point: Your business model is .... (Check one)
    (..) New. There's no data
    (..) Not (favourite weasel adjective here) new.


    It's not new at all. I've said so from the beginning. If you want to look at the movie industry, just look at Marcus Loew's famous statement: "We sell tickets to theaters, not movies." He got it. From the very beginning the movie industry has never sold "movies". It's always sold something else bundled with the movies. And that's all I've been saying from the beginning, is that they now seem to think that they're actually selling the movies, and that's a problem, because they've forgotten about all the things bundled with it.

    Economics is predictive. All this is saying is that the business models put forth make it clear where the pressure is going to come from. Someone will adopt this model (some already are getting close) and when it succeeds, the old guard will have to rush to catch up.

    And the problem with that analogy is that Henry Ford did it himself, while you are preaching to others to do it. Preach when you make a couple of movies.

    I already made it clear that I am doing the same thing in other industries. I'm sorry that you want to stick your head in the sand and pretend it doesn't apply to other industries, but the economics go across the board.

    You failed (three times now) to answer my question about why did you dismiss as "not worthy of comment" my MPAA data which didn't bear any relation to piracy, while you yourself pointed to MPAA data.

    Actually, I did answer that question, but once again, you keep switching which question you want people to answer so you can pretend I don't answer it. Scroll up, you'll find your answer (or, seeing as how you ignore it, I guess you won't). Doesn't change the fact that I answered it already.

    And you failed to answer (two times now) to the issue of the Italian pharmaceutal industry or to any of the research studies I provided. You can accept the example is wrong and stop using it, or act like a crackpot and dismiss all evidence and keep dragging it along, much to your discredit.

    Well, there wasn't much to respond to in your critique of the Italian pharmacy study. You just insisted it couldn't be right because it used new molecular entities rather than drugs -- and made some ridiculous comment about how you could come up with an "incredible number" of new molecular compounds yourself. Considering the fact that in a 20 year period the entire world only came up with a little over 1000 such entities, I find that difficult to believe.

    Do you believe the Italian drug companies were coming up with NMEs for the hell of it? Especially considering that there was no patent protection, they were doing so solely for one reason: to make drugs that could be sold in the market.

    And then you point to a second piece of "research" that uses tautological proof to make it's point. It defines "innovation" as the number of patents issued. If you're going to complain that NMEs are not a decent proxy, you can hardly use the number of patents as a better proxy -- especially given the change in patent law!

    The point remains clear and supports my position. There *was* plenty of effort put into drug discovery without patents. By your own reasoning, without such artificial scarcity, there should have been NO research at all being done. Yet, there were 464 drug companies in Italy in 1976. They weren't just sitting there having fun. They were there for a reason -- knowing they could produce drugs and make money in the market, and they could do so without patent protection.

    That pretty clearly supports my point. You can nitpick about the data, but there's no nitpicking around the basic facts that there was a thriving pharmaceutical industry there.

    If you want additional examples, I'd suggest you look at the history of the Netherlands during the time it banned patents, as well as the industrial growth of Switzerland during the period that it had no (or very limited) patents. Both countries showed tremendous innovation and development (often more than other countries), despite the lack of such artificial controls.

    The point remains true: monopolies tend to be inefficient and bad for the marketplace. This is just as true with monopolies on non-scarce products. Limiting the ability to use a non-scarce good as a resource to increase the value of other goods is simply a bad business decision. It is, by definition, shrinking your potential market size.

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