"The Long Tail" on DRM, downloading and digital media

(Updated Aug 25 pm)

The Long Tail (Chris Anderson) has great insight on the digital media, and in fact, the insight applies to many internet businesses, and business in general as well.

His has a new post about DRM, basically explaining why Movielink and CinemaNow have so far failed. While I do not fully agree with his argument, he made a few interesting points worth discussing

  1. "Any protection technology that is really difficult to crack is probably too cumbersome to be accepted by consumers
  2. Instead, efficient software and entertainment markets should exhibit just enough piracy to suggest that the industry has got the balance of control about right: not too loose and not too tight. That number is not zero percent (which requires protection methods so invasive they kill demand), and it's not 100% (which kills the business). It's somewhere in-between
  3. piracy can actually let you raise your prices: The usual price-setting method is to look at the entire potential market, from the many at the economic lower end to the few at the top, and set a price somewhere in between the top and bottom that will maximize total revenues. But if you cede the bottom to piracy, you can set a price between the top and the middle. The result: higher revenues per copy, and potentially higher revenues overall."

His point #1 is intuitive and is supported by his other points.

I have another good example for his point #2, it proves the "could" but not his "should" assertion. See for example the encryption of DVD, CSS. Free DeCSS softwares such as DVD Decrypter and DVD Shrink are available across the internet (e.g., here). Does this damaged the $15bn DVD market? No. Does the ridiculous region code prevented decrypters at work? No. Those who went to length at DeCSS are not going to buy the legitimate products if pirated copies are not available. The only difference is that the region code has greatly reduced efficiency and increased the cost of manufacturing and distribution. In this case CSS is appealling to consumers, because it is not as cumblesone as DRM. The fact that CSS is cracked does not damage the key areas of its target market.

His point #3 is not really right, and it requires some elaboration and discussion.

  • In making this point Anderson has implicitly assumed price uniformity across the world (for software, or media content products), which is fine. Unlike that of pharmaceuticals, it is easy for software and media content to surf cross national coundaries, thanks to the internet (and the small size/weight of the DVD which facilitates shipping). Therefore, we can assume that parallel import has will effectively equalize price, roughly, as we have observed in reality.
  • The second assumption he has made is that the long tail (the yellow portion in the chart above) is not very sensitive to price. (i.e stiff price elasticity). This is where I do not agree. The x-axis of the graph is price, the y-axis the volume. Price is the line that separates the two areas. Total revenue is the yellow area times price (the cut-off). Therefore, if the revenue loss of the portion above the cut-off is not compensated by the increase in volume, Total revenue will decrease. (In pharmaceutical, it was possible to apply differential pricing to different markets (Canada and France, vs US) up to this moment, so the argument here does not really work. However, more and more people are importing drugs from Canada.) This is where his logic falls apart. As Brad at Panopticologist correctly pointed out, "When a firm with market power sets their price they are always making a trade-off between receiving a higher price from a few and a lower price from many. The rational firm looks at the entire market and chooses a price which maximises profit. If a portion of that market leaves, revenue will either decrease (if the price was sufficiently low to sell to that portion) or stay the same (if the price was too high for them anyway)." Brad's argument asserts that for a monotonic function volume(price), the revenue function (P * V) has only one maximum. The simple form of his proof assumes uniform pricing, but one can construct a more elaborated proof for tiered pricing as well.

However, what we have observed is that some degreee of piracy is associated with the successful marketed product (e.g., DVD), while none of the fully protected products make any success in the market (e.g., movielink), especially for software and media content products.

Now let me argue in defense of Mr Anderson, that there is an optimum point for tolerating piracy, and that optimum point is not zero piracy.

  • There are two choices, 1) abandon the red portion (low end segment) and forbid them to use without purchase (they can't afford to), or 2) cede the low end to piracy. Microsoft's example has proven that ceded it to piracy (hence the total revenue decreased a tiny amount in the short term) will trap the market and train the potential customers, hence helping them the grow of the yellow part much faster when income level increases
  • To prove Mr Anderson's hypothesis one needs to assume that the volume curve (the chart above) would expand, which is not difficult to show. Such volume increase due are found in the examples of LD vs VCD vs DVD, in Asia and US. The VCD market in Asia flourished largely as a result of the wide-spread of piracy (also see below). One could even argue that the Hollywood studios made more money over VCD than LD, for which piracy technology was too expensive. In short, the media industry has mistaken that it is a zero sum game, but it is not.
  • Or alternatively, to maximize sum of revenue over time, instead of the static sum at current time. This is analogous to the free trial promotion for shampoo from P&G, except that the cost is zero for such promo. Bill Gates cleverly used piracy to accomplish his promotion campaign. The DVD Forum got their free promotion passively (see below).

In addition to Anderson's illustration with Windows OS, we could
also look at the DVD machine market, from
DVD Consortium's perspective. It was the Chinese manufacturers
(assemblers) who have commoditized DVD machine, and in turn drived the DVD
market upward. Without the Chinese players, we will still have to pay for
$350-500 per DVD machine. It would not be surprising that DVD suffer the same
fate as LD in North America. And we may still be watching VHS today.

But how did the Chinese managed to cut the cost so much? A few

  1. During the mid-1980s and mid-1990, Chinese companies have
    competed fiercely with each other on the home appliances, from refrigerator to
    microwave machine, to TV set and VCD players. The huge domestic market of 10-40M
    unit is great playground to move on the
    experience curve when they entered the DVD player
    market around 1999. As we can all see in Wal-marts and Best-buys
  2. The learning curve on DVD players is boosted by the learning
    from VCD player assembling (which is entirely absent in the US market, like the
  3. Most importantly, before these Chinese players export en mass
    to the US, they perfected their skills within China, where they did not have to
    pay loyalty to the DVD consortium

The results are that the DVD consortium made a lot more money
from licensing to these Chinese factories than they could have otherwise.
Additional sales were also made in the DVD drivers, the chip and other stuffs.
Without some "piracy", Toshiba and Philip would not have profited so much in the
DVD market. This is in support of the Microsoft experience.

The problem of DRM, and that of Movielink and all the pre-iPod online music stores, in my view, lies in their business models. More precisely, the product itself. The restriction DRM imposed on the products just make them repulsive to consumers. There is no "ownership" under DRM, and the pricing for DRM content is totally wrong. If they call it "rental" instead of "sales" it might fare better. But then DRM cannot compete with streaming media. It is caught in the middle of no-man's land.

We learn from the above discussions

  1. Highly successful products are often correlated with certain degree of piracy
  2. Ceding the lowest segment to piracy might help nurture for future growth
  3. Cumblesome anti-piracy measure such as DRM will drive away potential customer, simplifying the technology and making it more user-firendly will help boost volume significantly, even though that might mean losing a portion of potential volume to piracy, as that would be more than compensated by the volume gain in the other segments
  4. The failure of DRM related products such as Movielinks are due to their business models, which is in part dictated by the inflexibility of the DRM technology itself

When it comes to new technology, one just has to bear in mind that this is not a zero sum game. Opportunity rewards the risk-takers.

1 comment:

Anonymous said...

It’s not right to consider digital piracy as marketing advantage. Firstly it contradicts to most international laws. Secondly it brings companies to lost revenues. However an “enough piracy” can help in a digital product PR and distribution. But it mostly depends on digital product type. For example it might be useful for such a things like CD/DVD containing music, films, e-books, but not for PC software. If we talk about potential entertainment products customers in this case we can imagine that by example some music album having unbeatable DRM will not reach all its target audience and risks to remain relatively unknown. But with more accessibility it will come to all potential customers and among them can be many people who will bye its licensed version for full price having known and fully tried it from unofficial sources like pirates. But software cracks and piracy can bring developers and vendors only for lost revenues by the next reasons:
- Most software products have specialized direction and limited target audience. In this case marketing people of such a companies set the reasonable prices for their users that need this solution and ready to pay for it. Otherwise if the application cracked and available to free use the big part of these potential customers will prefer to use free or low cost illegal copies to save their money.
- Where an application has wide targeted audience and many competitor products its cracking and piracy is the shortest way to large volume lost revenues. And in this case we cannot consider free application availability through cracked versions and piracy channels as a promotion opportunity. The best marketing solution for such a products is a wide range of free evaluation versions with flexible limitations legally available, additional freeware distribution, differentiation on light, Std and Pro versions. And it gives possibility to all real potential users to try software before bye it. Then to avoid illegal use and make a large part of users to pay the software has to be strongly protected. As a result all who need the program and ready to pay for it will buy it for full price that really will raise revenues of application vendor. An ‘uncrackable’ software protection cannot negatively influence to sales because it will differentiate people who cannot and in all cases won’t buy an application copy from target customers who really need the solution.

As a software developer and vendor I can say my opinion is based in practice. Having weak protection I found my program cracks and keygens in several days after software release. And among users who really needed my software solution paid for it only most honest people and a large part of ready-to pay people used its illegal copies. Having found and using in my product one of today’s strongest software protection tool EXECryptor from strongbit.com made my application new updates uncracked during about 2 years. I have significant sales raise. In addition to supply most possible customers with solution they need by cannot to pay full price my company has flexible pricing such as great discounts for educational and non-profit organizations and all people who is able to contribute a reason to get discount so they pay money they can.