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
    John B, 1 Mar 2007 @ 4:17pm

    Re: Re: Not so fast

    This post is so off-point in so many dimensions I really don't know where to start.

    Economics is really at its core primarily about incentives to use resources efficiently. While "efficiently" can be and is defined in many ways, depending on where you want to end up, I am assuming that when we discuss music we want as much "good music" (another subjective term that I would be inclined to let an "efficient" market define) to get into as many hands as possible over the long run.

    Saying that once content is created it is no longer scarce is like saying, "Well, you've already built the car, so why not just give it away?" Now, if you want to say that the marginal cost of reproducing digital music is very small, I buy that. But you're artificially breaking apart the necessary processes to get the digital music into the hands of those who want it. You're completely ignoring the incentive effect to create more new music. In the physical world, your logic would lead to completely depleting a natural resource that was limited, but easy to extract. Then it's gone. Your logic does nto lead to a sustainable system.

    I'm explaining why DRM does not add value, but limits it.

    Properly functioning DRM is a mechanism for recovering value. And that is its value. I was making the case why it is valuable to society in the long run if properly implemented.

    Yeah, see that doesn't add value. It takes away value from the competition -- which remains free file sharing. You don't build new business models by taking away value.

    Actually, it does create value. For artists, it: (1) offers them exposure and a facility that permits potential listeners to access their music and (2) creates a system for a feedback loop of rewards to artists so that they can make a decent living using their talents so that they continue to make new music. For users, it provides the opportunity to (1) find music they want to find; (2) find out about new music that they haven't heard yet; (3) listen to new (or not new) music for free; and (4) buy it if they want to continue using it indefinitely, which I woudl think would be valuable (otherwise, they wouldn't value it).

    Providing "free" music as the primary method of music distribution in the world isn't sustainable unless some rich guy decides to spend billion of dollars per year to design and host a site for free. And even then, if artists are not compensated, they will eventually stop producing their art, or at least produce much less of it than they would if they were able to make a decent living off of it.

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