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 @ 2:45pm

    Not so fast

    As much as I hate the MPAA and RIAA and would like to believe that there business model does not add value and is inevitably doomed, this is not the case. As an economist by training, I see a number of problems with your reasoning.

    Note that everything I say here applies to movies, too, but for simplicity’s sake, I’m just going to mention music.

    First, as someone else here mentioned, the recipes and other intellectual property involved in producing music is scarce in the sense that not everyone has the talent and/or creativity to create music that people want to hear. If you don’t believe me, then you haven’t heard as much non-talented “music” as I have (even though I have very broad taste in music).

    If talented musical artists cannot get compensated for their efforts, then they will spend more and more of their time doing other things to pay the bills, even if they like creating music, since they need to eat, have a roof over their heads, etc. In order for artists to get compensated, there needs to be a feedback mechanism where they get compensated if people like their music. If not such mechanism exists, then artists will underallocate the time they spend creating music and spend more time doing things that pay the bills. This is especially true as they get older and the cold hurt more, they need more medical care, etc.

    Second, unfortunate as it may be, the music labels do add some value. Not much, but some. As the entities that distribute music, they offer exposure for artists’ music, which can benefit artists and consumers alike. Now, IMHO, they charge many times too much for this service. However, it is hard to deny that the music they distribute is valued by at least some of those who listen to that music. If it didn’t, people wouldn’t buy that music and the music labels would go out of business very quickly. And don’t give me that “brainwashed masses” argument. It’s condescending to the “masses” and intellectually dishonest.

    Another argument that reinforces the idea that the music labels offer value to artists is that artists sign up with them. If the artists didn’t think that they would get any value out of the services music labels offer, then they wouldn’t sign up.

    Note that many artists don’t sign up with music labels. However, having known many musical artists (I lived in Austin, TX for 5 years, a GREAT city for almost every kind of music, including punk, alternative, psychobilly, etc.), I think that that most often this is not due to the choice of the artist. Most artists would LOVE to be distributed by a label, even ones that create music because they love doing it and don’t really do it for the money, since they know that their music, which they believe in, will reach more people by signing up with a label than by not signing up. Still, some would never sign with a label under any circumstances, and that’s their right.

    It seems to me that a business model that would work to get the maximum amount of music to the maximum number of receptive listeners would be an “expiring free listen license”. This would work on the same basic premise that the existing song segment approach uses (where you get to listen to part of a song for free, but if you want to listen to the whole song, you have to buy it). But I think it’s a bit more progressive.

    Basically, I would envision a musical website where users would have the opportunity to listen to any music on the site, and they would get to listen to the song a certain number of times (probably something less than 10 times), which might be determined by the artist or by an agreement between the artists and the website, for free. After the user had listened to the song the allocated number of times, the ability to listen to the song would expire, unless the user paid for the song. Ideally, the website would also have other services, such as providing musical suggestions to users, based on their ratings of music they listened to, and artist, song and keyword searches, etc. I think this kind of website would add value to both users and artists alike.

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