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
    Robert Krawitz, 3 Mar 2007 @ 2:49pm

    Re: Re: archaic thinking

    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.
    This makes no sense at all. The cost of the bandwidth and hosting is completely independent of the content; it's the same per gigabyte whether the data being served is music, movies, or Knoppix. In addition, there's no cost to the original host site in any event if the content is shared peer-to-peer over a different network.
    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.
    Maintaining what system? The distribution system? In that case, remove the DRM and allow people to develop other distribution systems that are cheaper. If the bandwidth is really more expensive than most people think, the costs of peer to peer sharing will be high enough to compete with people selling unencumbered music off their websites. If it's as low as most of us think, then for-pay distribution systems won't be a viable business. Evidently ISP's are able to make a profit at $20/month for essentially unlimited service (much of which is P2P traffic). If a typical song is a 3 MB Ogg or MP3, 10 cents would work out to $33/GB, and I don't think we're seeing retail bandwidth charges anything like that.
    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?
    If that is really the case, then a viable model might be to sell subscriptions to the search engine that matched musical tastes up with new music. If it really is the case that people would prefer to pay than to spend the time scouring the net, then there shouldn't really need to be any DRM, since even if people share their music out it's going to cost other people more to search the shared music themselves than to pay the search engine. Artists who aren't well known should be thrilled to receive this kind of exposure, because it would match them up with people really interested in their music (even though they don't know it yet!).

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