Introduction
Media managers are complaining heavily about piracy. Although the scale of losses claimed by their representative bodies should be accepted with caution, it can still be seen that the dimension of content piracy is substantial. The significant decrease in revenue cannot be explained in terms of ageing demographics, the excess revenues generated during the vinyl-to-CD conversion cycle and greater competition for the disposable income of young consumers, but rather is to a significant extent attributable to copyright infringements (C.S.a.T.B. 2000).

The techno-legal paradigm of strong protection
In a situation with extensive intellectual property piracy, where current legislation fails to provide the necessary security, media companies are developing self-help mechanisms in order to safeguard sustained sources of direct revenue. The content industry is determined to address this critical situation by seeking techno-legal means of preventing the uncontrolled redistribution of content. Technical strategies aim to protect the economic interests of media companies through the deployment of Technical Protection Measures based on key technologies such as encryption, watermarking and rights expression languages (Ünlü and Hess 2004). In this context, Charles Clark has stated that "The answer to the machine is in the machine" (Clark 1996); in other words, the survival of the media industries presupposes the development of suitable technical infrastructure. Technical strategies are effective only when accompanied by contract-based legal strategies (e.g. mass market licenses or technology licenses) and by an appropriate legal framework that supports the use of DRMS solutions by ensuring the protection of technical measures (Bechtold 2002). In fact, the technological and legal approaches provide mutual support for one another, thereby constituting a protective unity. Technology prevents infringements, while legal measures provide deterrents regarding circumvention of the technology.

In the quest to safeguard their means of existence, the media industries have been focusing on techno-legal content protection in an isolated and excessive manner and neglecting consumer interests in their profitability calculus. Numerous voices support the so called "Napsterization" threat model that assumes that one crack is sufficient to enable a pirate to inject the content into P2P networks, leading to the perfect public good problem, a phenomenon also referred to as "ROCE" (Rip Once, Copy Everywhere). Therefore, in accordance with the Napsterization model, the DRMS security design selected must be absolutely bullet-proof in order to prevent a single attack which threatens the entire economic value of the content.

A paradigm based on consumer needs
However, this would not make sense, either from a technical or from an economic perspective. From a technical viewpoint, it will never be possible to implement complete protection. Even if technological protection measures can remain a step ahead of the attack techniques and tools of the hacker community, the fundamental problem of the "analogue hole" will continue to exist. This refers to the possibility of digitising high-quality analogue copies and distributing at least one copy in media networks, with the resulting snowball effects (due to the problem of the "digital hole"). Thus, sooner or later, the availability of unauthorised copies must be expected.

In economic terms it is not necessary to increase protection levels excessively or to make technical installations bullet-proof. DRM systems have a substantial price attached to them. The costs of setting up, deploying and maintaining the technical infrastructure seriously erode revenue potentials (Ünlü and Hess 2005). Therefore, in some situations weaker protection may be preferable to stronger forms of content protection. Shapiro and Varian summarise this by stating, "The important thing is to maximise the value of your intellectual property, not to protect it for the sake of protection" (Shapiro and Varian 1999). The need to fine-tune the level of content protection is a well-investigated research issue. Empirical case studies show that liberal download sites with a low protection level, such as iTunes, have proven successful in the marketplace, while many strong content protection systems, such as Sony´s Key2Audio system, have been outright commercial flops (von Walter and Hess 2004).

Thus, economic reasoning shows that the reflection of consumer needs in the design of DRMS is of pivotal importance. Therefore, this contribution seeks to show that decision makers in the media industry must analyse and integrate the notion of consumer utility in their overall strategy. The technical design of DRMS and the scope of content protection must be aligned to consumer interest and the given competitive situation. For this purpose, more abstract industrial organization-models are helpful to determine this optimal level of protection and understand how this level depends on the given market structure (Yoon 2001).

The following arguments demonstrate that a lower level of technical content protection can both satisfy consumer needs and increase profits. Thus, consumer requirements are reconciled with the economic imperative. The corollary is that hurting consumer interests can lead to a depression of profits. Therefore, consumer-friendly technical installations should be desirable, not in order to demonstrate excessive civil responsibility on the part of the media industries and concede to consumers their well-deserved legal freedom. Instead, the idea is to selfishly maximize profits by accounting for the needs of honest and potentially illicit consumers.

Paradox of profitable piracy
The pirating of copyright materials is considered harmful to the interests of the copyright owner. However, some economists argue that the toleration of certain levels of piracy can enhance profits and accommodate consumer demand for more liberalized usage, a position which may appear counterintuitive at first sight. Three factors associated with "profitable piracy" have been identified in the economic literature: indirect appropriation, experience effects and network externalities (King and Lampe 2002).

In the case of indirect appropriation, the copyright owner is able to obtain revenue from unauthorised copies by charging a higher price for the original media products from which unauthorised copies are made. The logic behind this approach is straightforward: If the copyright owner knows which originals will be used to make copies, a higher price can be charged for these originals. This allows the copyright holder to capture some of the revenues that could have been appropriated through ordinary sales if unauthorised copying had been prevented (Liebowitz 1985).

Experience effects can also lead to profitable piracy. Information goods can be considered to be experience goods, since consumers are not perfectly informed about the characteristics of media products prior to consumption. Copies provide information concerning the value of a product, and this in turn promotes the purchasing decision. Network technologies, such as Peer-to-Peer (P2P) systems, can help copyright owners by making it easier for consumers to inspect the media products (e.g. by sampling songs), so as to facilitate the purchasing decision. If P2P systems were merely used to "try out" content, then their use would be complementary to retail purchasing, rather than a substitute for it. In addition, the exchange of media products stimulates demand by allowing consumers to sample content that is subsequently bought.

Finally, network externalities are highly relevant in markets for information goods in cases where consumer valuation of a good increases when more consumers have purchased it. For example, in the case of online games, network effects emerge from the liquidity of the player pool. Both legal and illegal copies of the game application can expand the "network" of consumers of that online game. Due to the existence of network effects, unauthorised copying and consumption provide value to legitimate buyers. It thus seems reasonable that illicit copying may benefit rights holders for information goods that exhibit network effects (Conner and Rumelt 1991).

Effects of content degradation
Media companies can also engage in content degradation activities, by focusing on ways to increase the utility difference between original and pirated products. An important parameter is the degradation factor that represents the utility discount of the media product vis-à-vis the original product. A low degradation factor means that the pirated product is only slightly degraded and provides almost the same utility to the consumer as the original product. Conversely, a high degradation factor reflects substantial degradation and consequently a significant loss of utility vis-à-vis the original product. The concept of content degradation can be interpreted in two ways:

First, it can be interpreted as the quality discount of the pirated product in relation to the original product. In the case of analogue reproduction, copies represent poor substitutes for originals (e.g. "screener" copies produced illicitly in cinemas). Although this does not apply to digital reproduction, original content often provides consumers with a higher level of utility, to the extent that it is bundled with valuable additional services, which are unobtainable or difficult to obtain from pirates. For instance, software products are often supplied with manuals and support services, such as technical support; and discounts on upgrades may be provided.

Alternatively, it can be interpreted as a transaction cost disadvantage incurred when purchasing the product from a pirated source. In this interpretation, a high degradation level means that the transaction cost is prohibitively high when purchasing from a pirate, with the result that the valuation of the original media product is reduced almost to zero. For example, in the case of highly degraded media product, a consumer who wishes to purchase from an original content provider can simply buy the content legally via a known (online) retailer. If instead the customer wishes to purchase from the pirate, it is first necessary to find the pirated product, which implies higher search costs and possibly greater download costs than in the case of purchasing the original product. Thus, the overall transaction costs of purchasing from a pirate may be much higher than are those for purchasing from a legal source. This reduces the level of utility of pirated products.

Content degradation strategies
Content degradation strategies assume that the media company can determine the level of degradation of competing pirated products. While network effects are inherent in a media product and therefore constitute a given exogenous parameter, it can be argued that the quality difference between a pirated product and the original is something that can be deliberately designed into the competing products. In fact there are at least three strategies which could cause customers to have a reduced willingness for pirated as opposed to original products (Ünlü 2005).

First, media companies can combine their information products with (physical) services that are difficult to copy. For example, this could take the form of more sophisticated (including individualised) artwork accompanying audio CDs, or bundling media products with promotional activities, such as sweepstakes.

Secondly, media companies could increase transaction costs for illegal purchases. One approach would be for legal companies to penetrate P2P networks and supply illegal downloaders with fake pirated goods. This would greatly increase the search costs involved in finding genuine pirated goods. This has occurred in the case of Madonna's "American Life" album, where fans seeking tracks from P2P networks have downloaded files which are blank except for Madonna delivering a message to those attempting to download her new songs. This could at least provide a fresh approach to the problem of music piracy and file-trading.

Thirdly, through fear campaigning, media companies could highlight the ethical and legal problems associated with piracy. This could result in a psychological devaluation of pirated media products.

It can be seen that there are various ways to deliberately increase the degradation level, which can also be used in combination. In all these cases, media companies have to incur additional costs in order to increase the utility difference between original and pirated products. Related costs include production costs for additional physical components, server and broadband capacity to infiltrate P2P networks, and advertising costs.

The benefit of "homemade" content degradation is that it reduces the need for technical protection. This means that content degradation is in some sense a substitute for a higher protection level. Therefore, with a bundle of degradation measures, the need for high-security, illiberal DRMS can be reduced. Honest consumers are not hurt but – instead – benefit from this downward adjusted level of protection. However, efforts to increase the quality difference between original and pirated products (e.g. by means of content individualisation) also imply costs which should not be unreasonably high (Ünlü 2005).

Bottom line
The aim of this article was to demonstrate that consumer and media industry interest must not diverge. On the contrary, optimised profits can only be achieved by accounting for consumer welfare. Specific characteristics of markets for information goods (which exhibit network effects) must be taken into account when deciding on an appropriate level of copyright protection. Besides, product design decisions can add value to products confronted with piracy, when such measures are a cost-effective alternative to technological protection measures. Based on theoretical evidence, there is reason to suggest that media managers should be careful not to implement excessively high levels of protection. Consumer interests have normative implications for the ideal design of a DRMS. In future, further research efforts should be made to investigate the interrelationship between consumer utility and the need for technical protection from an economic perspective.

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About the author: Dr. Vural Ünlü is Managing Partner of Cogitans Consulting GmbH that has been delivering consulting services to the top-management level of telecommunications, media and entertainment industries since 2001. He has investigated the domain of Digital Rights Management Systems from a multidisciplinary perspective in the Institute for Information Systems and New Media (WIM) at the Munich Graduate School of Management (LMU München) and is author of the book "Content Protection – Economic analysis and techno-legal implementation". Vural can be contacted at vural.uenlue@cogitans.de

Status: first posted 20/10/05; licensed under Creative Commons
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