Introduction
This article stems from a study on the economic analysis of DRMs (Bomsel and Geffroy 2004) carried out within the FP6 IST project MediaNet. The objective of this project is to remove the obstacles to end-to-end digital communications and content exchange, from content/service providers to customers and between persons. In the MediaNet open architecture model it is crucial to examine the conditions under which Digital Rights Management systems could emerge and be reliable enough to ensure the compatibility of circulation of both copyrighted and non copyrighted material.

Digital Rights Management systems are means of assigning access to digital contents. This paper deals with the economic characteristics of DRMs. First, it aims at defining their economic functions, that is to say content protection and versioning. We then analyze the mechanisms of DRMs adoption over the Internet. Emphasis is put on the importance of network effects on complementary goods within dynamic vertical relations. We underline the difficulty of DRMs roll-out over two-way communication networks and draw the comparison with traditional one-way distribution networks. The final question is the overall competition between broadcast, physical, free and DRMs-based Internet distribution of digital contents.

DRMs: Protecting and versioning contents in the digital era
DRMs: Protecting content in the digital era
The first goal of DRMs is to protect the exclusive rights of content owners. On the one hand – comparably to physical supports or entrance tickets – they exclude consumers from the consumption of the cultural good if they don’t pay the price for it. On the other hand, they determine the range of uses granted to the consumers like other copying control mechanisms.

DRMs and all other private protection tools supplement copyright laws. Yet they follow different objectives. While private protection measures are designed to maximize rights owners’ benefits, copyright law seeks for optimal social welfare. It therefore makes a trade-off between excludability, which provides incentives to creation, and the social benefits of diffusion. That is why the exclusive rights granted to the content owners are limited both in length and in scope by exemptions, like fair use and first sale doctrines.

Digitization has changed the terms of copyright laws’ trade-off. By dramatically reducing the costs of copying, storing and transmitting digital files, it has increased diffusion possibilities together with threats to content owners’ revenues and incentives to create. The DMCA (1998) and the EUCD (2001) made a relatively clear choice towards strengthening the ownership rules. While the first sale doctrine or principle of exhaustion cannot apply to digital files, anti-circumvention rules enable DRMs to override the traditional fair use limitations of copyright laws.

DRMs: Versioning content in the digital era
The second function of DRMs is the versioning of contents. Contents address markets through a form of price discrimination called quality pricing or versioning. The idea is to offer different qualities of the good at different prices to get consumers select themselves from among these versions, according to their different willingness to pay. Think, for instance, of hardback and paperback versions of a good.

DRMs enable content owners to make further versions of a digital file with respect to the liberalities of uses attached to it. They allow copyright owners to charge a price that varies according to the particular uses authorized. To be more concrete, digital files with embedded DRMs may offer various rights to modify or excerpt, time of possession, number of accesses, of copies on different devices or of people one can share with.

DRMs' enhanced versioning possibilities not only mean that content owners will better extract consumers’ willingness to pay and increase their profits. Although it seems at first unfair to make people pay different prices, it may improve consumers’ overall welfare. By enlarging the range of prices, versioning can allow more people to access the good, more consumers to be served. For instance, if audio digital file versions with restricted uses are sold at far lower prices than digital files with more liberal uses or than physical supports, new consumers may be able to enjoy songs.

DRMs roll-out and distribution networks competition
DRMs, network effects and standardization
Contents can’t be taken apart from their distribution networks and encryption standards have to be accepted by the entire vertical media chain.

Networks effects are attached to products for which users’ benefits increase with the number of users. Rolfs (1974) showed that there is a critical mass of subscribers below which a network cannot be sustainable. Once it is reached, every new consumer brings additional utility to all the others and the roll-out speeds up. A general rule to reach the critical mass is to subsidize the early adopters.

Distribution networks roll-out may be subsidized by piracy or circumvention of copyrighted media contents: the utility of the distribution industry is increased by the availability of free contents. This situation existed well before digitization. Yu (2003) and Varian (2004) refer both to the American delay of the International Copyright Act in the 19th century, that enabled the expansion of the domestic publishing industry thanks to pirated English novels until the rise of domestic authors at the end of the century (Hawthorne, Poe, Twain, etc.). As for content owners, they need their content to be protected against circumvention and benefit from its compatibility with the largest range of equipment. They have to make equipment and delivery networks industries accept a protection standard. But it is a different burden in two-way communication networks and in traditional one-way distribution ones.

In the case of one-way networks, like physical or broadcast distribution, content owners control the availability of contents and the indirect network effects. Equipment manufacturers have to accept their protection standard. An illustration of this idea is the recent broadcast flag agreement for the US over-the-air digital TV.

Over two-way communication networks like the Internet, everyone can technically broadcast contents. Moreover, circumvented contents are made available by individuals and not by professional pirates that could be located and prosecuted relatively easily. These contents are widely compatible thanks to free encoding formats like MP3 or DivX. As of today, the broadband Internet roll-out is largely subsidized by circumvented contents available through P2P applications. Circumvention benefits all complementary equipment as PCs, microprocessors, operating systems, printers, Internet modems, media players… . While DRMs oppose these Internet network effects, equipment and networks industries are not enforced to accept any encryption standard.

Nevertheless, some actors consider that DRMs roll-out is likely to happen in the future and are positioning themselves to have their proprietary solution accepted as the standard. That is for instance the game of Microsoft, Apple and Sony in the digital music market. This game results in a standards war bringing incompatibility between DRMs. It delays DRMs adoption by consumers and extends over time the cross-subsidy of equipment and networks through copyright circumvention.

DRMs and the overall competition between distribution networks
The standards war on DRMs penalizes legal digital content distribution over the Internet and therefore benefits alternative diffusion systems: circumvention through P2P sharing, broadcast on dedicated networks and physical distribution. The overall competition between these different distribution networks depends also on price, quality, novelty and liberalities of uses.

  • Physical versions could last for more than forecasted. They can increase their utility through quality and information density, decrease its prices or innovate in distribution like in the Netflix model (online DVD rental choice combined with postal delivery and return). Finally it can benefit from a valuable equipment legacy (the large base of DVD players).

  • Content owners should push dedicated distribution networks like television or mobile phones. From an economic perspective, mobile phones are very comparable to broadcast networks because they distribute communication services according to a pay-for-service model. These distribution networks benefit from a stronger content protection and are easier to standardize. They could therefore benefit durably from a larger range of contents.

  • As for free contents on P2P networks, their total liberty of use contrasts with DRMs-files opaque restrictions and the advantage of DRMs-files is not systematic on quality and novelty. The on-going circumvention dynamics may have irreversible effects on broadband pricing and equipment. Being used to pay for capacity only (storage, processing, bandwidth) and to get always more value for his money, the broadband consumer may be reluctant to pay for services or contents. This behavior may orient future investment in broadband networks.

Bottom line
DRMs are necessary to bring exclusion to digital IP goods. They are the only means to enable the exclusiveness of intellectual property rights and consequently, the sufficient incentives to create. While they restrict the short term consumers’ benefits of cultural goods free diffusion, they insure their long term welfare by enabling these cultural goods to be financed and produced in the future.

The success and the pace of DRMs adoption will determine the format of the future digital libraries, whether encrypted or not. Two kinds of networks are presently competing to diffuse digital contents. One, the descending distribution model, in which the content owner masters the utility of the network, is DRM friendly. The other, the Internet open communication network, carries major circumvention incentives. A crucial stake in this competition is the roll-out of the home network equipment, i.e. the investment made by the consumer to equip his home with connected digital devices. This process will be shaping the access, the uses and the willingness-to-pay of the consumer for contents.

Sources

About the authors: Olivier Bomsel is senior researcher and professor of industrial economics at CERNA, Ecole des Mines de Paris. Contact: bomsel@ensmp.fr.

Anne-Gaëlle Geffroy is Ph.D. Student on the economics of digital contents at CERNA, Ecole des Mines de Paris. She works currently on digital copyright and vertical contracting issues in the media chain. Contact: ageffroy@ensmp.fr.

Status: first posted 09/03/05; licensed under Creative Commons
URL: http://www.indicare.org/tiki-read_article.php?articleId=84