use information. Consequently, information that is available is more valuable. Second, that same technology makes it easy to circumvent the constraints that the suppliers of information use to keep information from you that you did not pay for (“piracy”). As a result, traditional purveyors of information should be able to profit from the new technology but, instead, find that their business models are threatened.
This dire scenario is best illustrated by the music industry, the poster child for the effects of piracy. Music was one of the first products digitized for mass consumption. Technological change made compact discs burnable and then redundant, leaving music in its digital form, disembodied from a means of carrying it physically. Consequently, on a number of dimensions, seemingly all at once, music could be easily copied. And so it was.
The desire to copy music has always existed. [3] Recordable cassette tapes were a threat to vinyl albums. I remember, as a ten-year-old, spending countless hours listening to the radio with two fingers ready to press “play and record” simultaneously on our family’s cassette deck so as to capture a desired song. (Yes, I do remember what songs, and, no, I’m not telling.) I did this because I couldn’t afford to purchase music (at least not often) and happily sacrificed time and quality to free it from broadcast radio. The current technologies for doing the same thing were a dream for those of my generation, but by the time they rolled around, I was too busy and comparatively too rich to live the fantasy.
From this perspective, digitization should have wiped out the music industry. A decade ago, many predicted it would. Compact discs and physical music stores have pretty much disappeared. Even in the absence of piracy, this likely would have happened, as downloadable music was even more efficient to distribute and more valuable to consumers than CDs. Of course, consumers were well aware of this and took matters into their own hands.
This is not the place to rehash the missteps of the music industry (both in its own digital ventures and in disproportionate legal responses to consumers), which, let’s face it, was well aware change was coming but it wasn’t sure where the competition was. A CD in 2000 sold for around $12. Given that a consumer’s purchases were typically driven by around four songs on the album, this would suggest a single song price of around $3. But a $3 single would have competed with the CD. It took Steve Jobs to convince the music industry that it was not competing with the $12 CD but rather with “free,” which suggested a much lower price point (as it turned out, $0.99). Moreover, the actual purchase had to be transactionally easier than illegal downloading. As learning how to download stuff illegally took some investment on the part of consumers (and risked infecting your PC with a nasty virus), a simple alternative (iTunes) convinced many consumers to not make that investment.
In the end, the music industry worked out—probably quicker than it would have liked—how to price music when the costs of distribution had fallen to zero. While revenue has fallen, the long-term outlook for profits is no longer their complete disappearance. Indeed, some evidence suggests that artists have not curtailed their creative activities at all. [4] What did change is the way in which music is sold: the market has moved away from the album as a generator of sales to the single.
Now, in fact, music publishers are no longer compelled to offer singles. Instead, they have the option to sell only albums, although they often choose to offer singles as well. Moreover, the singles on an album no longer have one price, but range from $0.99 upward, depending on demand factors. [5] This suggests that what drove the bundling of songs into albums previously was that it did not cost much more to produce and distribute an album CD than a single CD. This, alongside the fact that different consumers might desire a different subset of songs, led stores to shy away from wanting to stock singles. [6] Digital distribution changed the inventory problem and, with it, the returns to pure bundling. To be sure, albums cost less than the sum of singles, but, overall, consumers have more options to buy less if they want.
Free and Business Models
In less than a decade since the introduction of the iTunes Music Store, music publishers have abandoned digital rights management (DRM) entirely. One of the features that Apple offered the music industry in 2003 was its FairPlay system, which made copying music difficult. If you purchased a song on iTunes, you could transfer it to any iPod in your household, but it was harder to transfer it between computers and certainly beyond, although you could burn songs to a CD and then reimport them, DRM free. The overall rationale here was that use would be limited, as much as possible, to the individuals who made a purchase, just as it would be with physical media where some copying was possible.
But consider consumers who legitimately purchased music. At some point, they would purchase a new computer and have to reauthorize their account. They would acquire new family members who they couldn’t transfer songs to. Simplicity would then turn to effort. [7] Thinking of the long term, some consumers might make investments to download music just to be free of the later hassles and annoyances caused by DRM. [8] Was DRM itself harming the very paying customers the music industry wanted to attract?
The answer is likely yes, precisely because music on iTunes is no longer shackled with DRM constraints. This migration happened as part of a compromise. Apple introduced a second pricing tier ($1.29) for songs without DRM and with a higher quality. Within a relatively short time, all the music on iTunes migrated to that form. Moreover, while the 30 percent price increase stuck in some cases, sometimes music publishers lowered prices. In 2011, Apple even offered iTunes Match, which allowed consumers who had not purchased music from iTunes (perhaps music they had downloaded illegally) to turn their collections into iTunes-quality versions.
These changes reflect a third viewpoint of “information wants to be free”: use. When consumers acquire information, they want to be free to use it in a form they choose. This might mean transferring music between computers, but it also may mean editing a song to use in a home movie. This also makes information (in this case, music) more valuable, which is why, when constraints were lifted, the price of music could increase.
This notion of free has important implications for the business models of information goods. From a consumer perspective, putting restrictions on the use of information increases the cost or decreases its value. Effectively, the producers are increasing the price without gaining any revenue. Indirectly, producers may be making piracy more costly, but, at the same time, these restrictions give consumers an incentive to avoid monetary payment if only to also avoid the hassle.
Any price or restriction that does not reflect a seller’s costs of getting the marginal unit to market causes a corresponding loss in value created—what economists refer to as a deadweight loss. A deadweight loss occurs when a seller, in order to extract more from some consumers, either prices to exclude other consumers or to reduce overall use of the product. When the seller genuinely incurs costs, prices can play a role in getting consumers to share in the efforts to economize on those costs. However, for information goods, digitization reduces the need for such economizing and, correspondingly, increases the size and potential for deadweight losses.
Traditional information businesses, when confronted with digital distribution, tend to start by replicating the same restrictions that consumers face in a physical world. They institute a system that maximizes deadweight losses. Instead, the “freedom to use” perspective suggests that sellers of information goods ought to start by envisaging their business as one where products are offered to consumers without restrictions on use—either through pricing or otherwise. Can they make a world without deadweight losses work? If
