"The more I find out, the less I know."

Monday - November 21, 2005 at 03:09 PM in

DRM and Price Discrimination

Digital Rights Management (DRM) is not, and never has been, about fighting piracy. DRM does nothing to stop the true pirates in China cranking out millions of DVDs and CDs for pennies a pop, and isn't even all that effective at keeping unauthorized copies of movies and music off of online services.
Instead, DRM is about price discrimination for movies, music, and similar intellectual property. Of course, the RIAA and MPAA won't acknowledge that fact, probably because price discrimination tends to be extremely unpopular, while fighting piracy at least sounds fair. But the reality is that while DRM is nearly useless for stopping piracy, it is very effective at allowing the distributors of content to charge different prices to different people for the same product.

I wrote a pretty lengthy article on price discrimination a couple years ago, and the capsule summary is this: different people are often willing to pay different prices for the same product. A company can maximize its profits (and often offer lower prices to a wider market) by figuring out how to charge as much as possible to each person. However, price discrimination violates most people's sense of fair play, and is deeply unpopular. Dramatic price discrimination (such as used to exist in airplane ticket prices) is often an indicator of price collusion or a de-facto monopoly.

Price discrimination in content is as old as the paperback: popular books are released first in expensive hardcover editions, and people eager to read it are forced to pay $25 or $30 for a copy of a novel. Some months later, when demand for the expensive edition has dropped, a paperback edition is released, and everyone who is willing to pay $6 (but wouldn't pay $30) for the book buys a copy. And while a hardcover is more expensive to produce than a paperback, the bulk of the price difference between the paperback and the hardcover is pure profit.

The same thing happens with DVDs: after a few months, the price to own a movie tends to drop dramatically. Recently Costco was selling a complete set of Lord of the Rings DVDs for $30, about half the price you would have paid if you bought the movies when they first came out. And in music, if you like a song you may pay $0.99 for a copy through iTunes. But if you really like a song, you may pay an additional $2.49 to buy it as a ringtone (even though the ringtone is a short version which isn't really suitable for anything other than letting you know your girlfriend is calling).

(And you probably won't be happy about paying twice for the same song, even if you felt it was worth it, which is more proof of how people hate price discrimination.)

And let's be perfectly clear that every business in the world practices some form of price discrimination. Things like sales, volume discounts, senior-citizen discounts, etc., are all ways to set different prices for different customers. But nobody likes feeling like they paid too much, and some of the more dramatic price discrimination schemes leave a company's best customers feeling like chumps.

But the function of DRM schemes is to create barriers for customers to do certain things they might reasonably want to do. Nobody would pay $2.49 for a ringtone if they could just copy the song they already own onto their cellphone. But the existence of this barrier allows the rightsholder to charge come customers $0.99, and other customers $3.48 for the same song. Some customers will figure out how to copy the $0.99 song into their cellphones, but those aren't the people who would pay the extra $2.49 anyway.

I don't believe that there is anything inherently wrong with modest price discrimination. Indeed, it is necessary for the proper functioning of business, since it allows a company to figure out what customers are willing to pay.

The problem with most DRM schemes is that they try to limit a customers' use of a product (and charge more to remove those limits). They break the model of I-bought-it-so-I-own-it. And that's going to make customers upset. Worse, some of those schemes (like Sony's various ham-handed music DRM attempts) can actually cause damage when they try to prevent customers from doing things they expect to be able to do.

If content companies want to enable price discrimination, they should stop focusing on subtracting value from the customer's experience so they can sell it back. Instead, they should look for ways to add value that customers will be willing to pay more for.

Posted at 03:09 PM | Permalink | | |

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