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
    Anonymous Coward, 1 Mar 2007 @ 6:25pm

    Re: archaic thinking

    With all due respect, MH, I think I understand this far better than you do. I have been studying these kinds of issues in both academia and the business world since I was in graduate school 16 years ago. I have founded and owned two internet-related businesses (the current one is earning me a nice income), and one of which was music-related (oh, and it was "free").

    I understand value, but I think you have too narrow a definition. DRM helps recover investment. It recovers money. If you don't think money is valuable, please send me all of yours. I am sure I can find something valuable to do with it.

    "For artists, it: (1) offers them exposure and a facility that permits potential listeners to access their music"

    It offers no such advantage, in fact it restricts that process. They already have that mechanism which does not require DRM.
    It's called the internet, a system of interconnected servers and routers that provides dissemination of material for practically zero cost.

    I don't think you understand the interrelated points I am making. But first I think I need to clarify something. Time is valuable. To everyone. Without exception. The search costs of finding music that one likes on the wide open internet, in terms of time, have become enormous. And, when you find the music you like, I'm betting that it's on a website somewhere, where someone has to pay for it. And program it. And maintain it. Etc. Web sites don't just happen. Web servers don't just appear. Eventually, they have to be paid for. That's one reason (not the only one) why the free music model isn't sustainable.

    Don't get me wrong. I know there will always be "free" music. "Free" music existed long before the computer was invented. People sang and played instruments in their houses for family and friends and didn’t charge a penny for it. But the range of songs was very limited, quality was highly variable and it required a fair amount of effort to produce each time it was heard.

    Now, the costs of reproducing the music are much lower. It's the search costs and the background infrastructure costs that are more important. Organizing the songs, "match-making" (between interested listeners with songs they like) and reducing search time is the advantage of having them on one or more related structured websites. And that doesn't happen for free for long.

    Firstly, they already have that. See above. There is simply no incentive for an artists to cripple their work and reduce its interoperability with commonly used standard playback systems.

    You completely fail to understand the motivation of artists, which is not primarily financial. Musicians whos primary motivation is money tend to make shit music. The old system to which you allude is one which selects only a few artists to be the privillaged benefactors of a system that rewards them at the expense of all other musicans, it is exclusive, devisive and an attempt to perpetuate the zero-sum fallacy that we are arguing against here

    Money is an incentive. Like it or not, it is. Money is a means. It is the liquid asset that reduced the need for bartering, which was a very cumbersome way of doing business. And I do understand that artists do what they do for reasons other than money, as I have specifically indicated in my previous posts. I like to write. I write poetry and have even won some national awards for it. I do understand the artist motivation very well. I wish I could make a living at it. But, realistically, I can't. And so, like many other people who like to create, my art is relegated to being a small hobby, since I can't make a living at it. People will only spend so much time doing something that doesn't make them a living when there are bills to pay. I've lost count of the artist friends that I have had who were talented and did not do their art for the money, but who have either stopped doing their art or do it very rarely because of the pressures of everyday life. Now, if they could make a decent living at it (and I'm not talking riches here, I mean even $20-$40K per year), they would still be doing it. By the way, I do agree with your last sentence in the paragraph above.

    No. That is a search and refinement problem, it has nothing whatsoever to do with DRM.

    So, who pays for developing and maintaining it? That's where DRM comes in. It's a means of financing the necessary infrastructure. I know that sounds like the rationale for the old record labels, and there are some similarities in the logic. But what I am proposing is much closer to the peer-to-peer situation you espouse than I think you realize. Bandwidth and server hosting costs have gotten quite reasonable, but they are not as close to zero as you seem to think. But, to the extent there is competition in the market, which I think there is, these costs will work their way into the business model I am proposing.

    Let me clarify something. The system I am envisioning would not charge $1 per song, like iTunes, but probably closer to 10 cents per song, or whatever would cover the costs of establishing and maintaining the system.

    Let me ask you this: Which is more efficient, both in terms of IT resources and in terms of user and artists cost in terms of time: 3 million websites on 500,000 servers spread around the globe with no organized connection OR one or a handful of competing sites that actually help organize and track the stuff? Which do you think will have lower search and transaction costs? Now, which do you think is the most likely to be the dominant model?

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