The Cato paper argues that market competition will blunt the possible negative effects of DRM on consumers. The theory is that a variety of competing DRM systems will emerge for online music. These systems will offer differing levels of flexibility to consumers. They will face market pressure to meet consumers’ needs, because consumers can choose which one to buy. Record companies will face competitive pressure to license their music via the DRM systems that consumers want to buy. If the DRM market is competitive, and the music market is competitive, then market forces will foster a reasonable DRM technology.
This theory has much to recommend it. But the theory works, of course, only if the music business really is competitive. If the record companies act as a cartel, they can use the resulting monopoly power to dictate the design of DRM systems, regardless of consumer preferences. Tellingly, the Cato paper does not bother to argue that the major record companies behave competitively in this respect. Instead, the section on record company competition (p. 6) talks almost exclusively about indie labels, which account for only a small piece of the overall market.
How can we tell whether the record industry is responding competitively to DRM? An interesting natural experiment is about to start. MP3Tunes, a new startup headed by serial entrepreneur Michael Robertson, is launching a new music service that sells songs in MP3 format. Will the major record companies license their catalogs for sale on MP3Tunes?
In a competitive market, they would license to MP3Tunes. There are surely some customers who are willing to pay for music but don’t want to accept the hassles of other online music services. MP3Tunes will extract revenue from these customers.
You may object that the record companies won’t sell their content in an unprotected format. But of course they already do so, and in fact most of their revenue comes from sales in the unprotected CD format. And they can’t rationally be worried that their existing catalogs will leak to the P2P networks – that already happened, long ago. It’s hard to see how licensing their existing catalogs to MP3Tunes would make the P2P infringement problem any worse.
The record companies may feel that other music services meet their needs better, for example by increasing the likelihood that consumers will have to repurchase the same song later. These factors might affect the price they offer MP3Tunes, but they shouldn’t preclude negotiations altogether. In a competitive market, producers have to offer the products that consumers want, not the products the producers like.
It’s hard to see any economically rational reason for a major record company to refuse, categorically, to deal with MP3Tunes – unless we assume that the major record companies act as a cartel. That’s why the record industry’s response to MP3Tunes will tell us how competitive that industry really is.
(Let me preempt some rebuttals by pointing out that if you want to argue about what would happen in a competitive market, your argument cannot be based on assertions about what the record industry, as a whole, wants or needs. Assuming that “the record industry” is an actor whose needs, desires, or plans matter is tantamount to assuming that the industry is in fact a cartel. Nor can you assume that any individual company in a competitive market cares about the fortunes of the industry as a whole, as opposed to its own selfish interests. Much of the discourse about the record industry assumes, implicitly, that it is a cartel. If you want to rebut my argument about how a competitive industry would behave, be very careful to avoid adopting that assumption.)