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), 4 Mar 2007 @ 11:15am

    Re: Do you actually know any economics?

    Are you familiar with the distinction between public goods and private goods?

    Very much so. I'm also aware that many economists are starting to question earlier assumptions about public goods. Also, you really should look at the difference between positive and negative externalities... because throughout this post you treat them as if they're the same, when they're absolutely not.

    Public goods are terribly inefficient, economically.

    That is not necessarily true. It all depends on the incentive structure that is set up. Also, you make a very bad assumption here, that the government intervention can't make things worse -- and there are plenty of examples wehre that is true.

    Part of the reason why economists are starting to rethink the distinction between public and private goods is that they're finally recognizing how bundles play a role in the market -- and the fact that non-scarce goods can be "bundled" in some way with scarce goods to keep the market efficient, without government intervention.

    DRM is fundamentally an attempt to be able to turn content from a public good into a private good. It will act more like a pencil, something that can be controlled and limited and charged for, than lie clean air, which everyone gets automatically without paying for it. And this is a GOOD THING. It means that the levels of production will be optimal even without government regulation.

    No. It's not a good thing. It's limiting an infinite resource -- which is bad economically. Content is a resource that can be used to create many more resources. Trying to artificially limit it is reducing your pool of resources unnecessarily, which is BAD.

    Without workable DRM, we will have too little content produced, and the only solution will be some kind of government action, lie a tax on downloads which gets fed back to content creators.

    You make a huge assumption here that is easily provably false. Almost every CD sold today has no DRM. So, uh, yeah, it hasn't stopped production there.

    You are thinking way too narrowly about business models, and assuming that it's the music, rather than complementary products that need to be sold. If you focus on selling the complementary products, and using the music as a promotional resource, your outlook will change quite a bit.

    It's no different from pollution control, public safety or other public goods.

    Again, I suggest you look at the difference between positive and negative externalities.

    Sooner or later the government will take over responsibility for them, if the market can't find a way to privatize them and ensure that the creators and distributors reap the profits from what they create.

    Only if the government can't understand how a market with infinite resources works. I agree that may be a problem, but they don't need to get involved. The market will take care of the situation without a problem.

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