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All the Interested Parties? Not Quite.

June 14, 2007 by

Here’s a quick quiz to detect whether you’re stuck in Washington groupthink.

There’s a patent reform bill under consideration in Congress. According to a blog entry by Andrew Noyes at the National Journal, a group of Republican senators sent a letter to Rep. Howard Berman, the chair of the relevant House subcommittee, asking that the patent bill be given more consideration before the committee votes on it. Senator Berman responded:

“There have been a number of hearings, briefings, and meetings about these issues over the past four years,” said Berman, who introduced a companion bill, H.R.1908. “We’ve heard from representatives of all the interested parties – from independent inventors, universities, bio-technology, pharmaceutical, software and financial services industries.”

Here’s the quiz: who did Rep. Berman leave off his list of “all the interested parties”?

Rep. Berman’s omission is a common one in Washington. Start listening for this omission, and you’ll be surprised how often you hear it.

I don’t mean to pick on Rep. Berman personally. Okay, maybe I do, just a tiny bit, given some of his past actions such as co-sponsoring the ill-advised Berman-Coble bill that would have legalized denial-of-service attacks against people suspected of sharing infringing content. If this was just one congressman, once, it wouldn’t be worth noting. But given the frequency of this mistake, I think it does reveal something about the standard Washington mindset.

In the case of patent reform, there are complex issues at stake. Changes to patent law can affect innovation and competition in subtle ways. That affects all of the parties Rep. Berman mentioned, as well as the one notable group he left out. Which is …

Ordinary citizens.

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EMI To Sell DRM-Free Music

April 3, 2007 by

EMI, the world’s third largest record company, announced yesterday that it will sell its music without DRM (copy protection) on Apple’s iTunes Music Store. Songs will be available in two formats: the original DRMed format for the original $0.99 price, or a higher-fidelity DRM-free format for $1.29.

This is a huge step forward for EMI and the industry. Given the consumer demand for DRM-free music, and the inability of DRM to stop infringement, it was only a matter of time before the industry made this move. But there was considerable reluctance to take the first step, partly because a generation of industry executives had backed DRM-based strategies. The industry orthodoxy has been that DRM (a) reduces infringement a lot, and (b) doesn’t lower customer demand much. But EMI must disbelieve at least one of these two propositions; if not, its new strategy is irrational. (If removing DRM increases piracy a lot but doesn’t create many new customers, then it will cost EMI money.) Now that EMI has broken the ice, the migration to DRM-free music can proceed, to the ultimate benefit of record companies and law-abiding customers alike.

Still, it’s interesting how EMI and Apple decided to do this. The simple step would have been to sell only DRM-free music, at the familiar $0.99 price point, or perhaps at a higher price point. Instead, the companies chose to offer two versions, and to bundle DRM-freedom with higher fidelity, with a differentiated price 30% above the still-available original.

Why bundle higher fidelity with DRM-freedom? It seems unlikely that the customers who want higher fidelity are the same ones who want DRM-freedom. (Cory Doctorow argues that customers who want one are probably less likely to want the other.) Given the importance of the DRM issue to the industry, you’d think they would want good data on customer preferences, such as how many customers will pay thirty cents more to get DRM-freedom. By bundling DRM-freedom with another feature, the new offering will obscure that experiment.

Another possibility is that it’s Apple that wants to obscure the experiment. Apple has taken heat from European antitrust authorities for using DRM to lock customers in to the iTunes/iPod product line; the Euro-authorities would like Apple to open its system. If DRM-free tracks cost thirty cents extra, Apple would in effect be selling freedom from lockin for thirty cents a song – not something Apple wants to do while trying to convince the authorities that lockin isn’t a real problem. By bundling the lockin-freedom with something else (higher fidelity) Apple might obscure the fact that it is charging a premium for lockin-free music.

One effect of selling DRM-free music will be to increase the market for complementary products that make other (lawful) uses of music. Examples include non-Apple music players, jukebox software, collaborative recommendation systems, and so on. (DRM frustrates the use of such complements.) Complements will multiply and improve, which over time will make DRM-free music even more attractive to consumers. This process will take some time, so the full benefits of the new strategy to EMI won’t be evident immediately. Even if the switch to DRM-free music is only a break-even proposition of EMI in the short run, it will look better and better in the long run as complements create customer value, some of which will be capturable by EMI through higher prices or increased sales.

The growth of complements will also increase other companies’ incentives to sell DRM-free music. And each company that switches to DRM-free sales will only intensify this effect, boosting complements more and making DRM-free sales even more attractive to the remaining holdout companies. Expect a kind of tipping effect among the major record companies. This may not happen immediately, but over time it seems pretty much inevitable.

In the meantime, EMI will look like the most customer-friendly and tech-savvy major record company.

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FreeConference Suit: Neutrality Fight or Regulatory Squabble?

March 28, 2007 by

Last week FreeConference, a company that offers “free” teleconferencing services, sued AT&T for blocking access by AT&T/Cingular customers to FreeConference’s services. FreeConference’s complaint says the blocking is anticompetitive and violates the Communications Act.

FreeConference’s service sets up conference calls that connect a group of callers. Users are given an ordinary long-distance phone number to call. When they call the assigned number, they are connected to their conference call. Users pay nothing beyond the cost of the ordinary long-distance call they’re making.

As of last week, AT&T/Cingular started blocking access to FreeConference’s long-distance numbers from AT&T/Cingular mobile phones. Instead of getting connected to their conference calls, AT&T/Cingular users are getting an error message. AT&T/Cingular has reportedly admitted doing this.

At first glance, this looks like an unfair practice, with AT&T trying to shut down a cheaper competitor that is undercutting AT&T’s lucrative conference-call business. This is the kind of thing net neutrality advocates worry about – though strictly speaking this is happening on the phone network, not the Internet.

The full story is a bit more complicated, and it starts with FreeConference’s mysterious ability to provide conference calls for free. These days many companies provide free services, but they all have some way of generating revenue. FreeConference appears to generate revenue by exploiting the structure of telecom regulation.

When you make a long-distance call, you pay your long-distance provider for the call. The long-distance provider is required to pay connection fees to the local phone companies (or mobile companies) at both ends of the call, to offset the cost of connecting the call to the endpoints. This regulatory framework is a legacy of the AT&T breakup and was justified by the desire to have a competitive long-distance market coexist with local phone carriers that were near-monopolies.

FreeConference gets revenue from these connection fees. It has apparently cut a deal with a local phone carrier under which the carrier accepts calls for FreeConference, and FreeConference gets a cut of the carrier’s connection fees from those calls. If the connection fees are large enough – and apparently they are – this can be a win-win deal for FreeConference and the local carrier.

But of course somebody has to pay the fees. When an AT&T/Cingular customer calls FreeConference, AT&T/Cingular has to pay. They can pass on these fees to their customers, but this hardly seems fair. If I were an AT&T/Cingular customer, I wouldn’t be happy about paying more to subsidize the conference calls of other users.

To add another layer of complexity, it turns out that connection fees vary widely from place to place, ranging roughly from one cent to seven cents per minute. FreeConnection, predictably, has allied itself with a local carrier that gets a high connection fee. By routing its calls to this local carrier, FreeConnection is able to extract more revenue from AT&T/Cingular.

For me, this story illustrates everything that is frustrating about telecom. We start with intricately structured regulation, leading companies to adopt business models shaped by regulation rather than the needs of customers. The result is bewildering to consumers, who end up not knowing which services will work, or having to pay higher prices for mysterious reasons. This leads a techno-legal battle between companies that would, in an ideal world, be spending their time and effort developing better, cheaper products. And ultimately we end up in court, or creating more regulation.

We know a better end state is possible. But how do we get there from here?

[Clarification (2:20 PM): Added the “To add another layer …” paragraph. Thanks to Nathan Williams for pointing out my initial failure to mention the variation in connection fees.]

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Apple Offers to Sell DRM-Free Music

February 7, 2007 by

The Net is buzzing with talk about the open letter posted by Apple CEO Steve Jobs yesterday. In an apparent reversal, Jobs offers to sell MP3 files, free of anti-copying DRM technology, on the iTunes Music Store if the major record companies allow it.

Much as I would like to see Apple renounce DRM entirely, that’s not quite what Jobs is saying. The letter describes three possible futures for Apple’s music technology: (1) continue the current path with a closed Apple-only DRM system; (2) license Apple’s DRM technology to other companies to build compatible systems; and (3) sell DRM-free music.

Apple’s preferred outcome, Jobs says, is outcome (3), selling DRM-free music. This is notable, and somewhat surprising, as the consensus has been that Apple strategy has been to seek outcome (1), using its proprietary DRM to lock customers in to its iTunes-iPod world. If Apple really prefers to eliminate DRM, that is news.

But this part of the letter might just be cheap talk. As Jobs points out in the letter, Apple sells music at the pleasure of the record companies. And if the record companies announce tomorrow that they don’t want Apple to use DRM, then Apple will have little choice but to smile and go along.

So there is little downside to Apple saying that they they willing to get rid of DRM. In this respect, Apple is like the kid who says he is willing to go to the dentist, because he knows that no matter what he says he’s going to see the dentist whenever his parents want him to.

The least-discussed aspect of the letter is its praise for the status quo (outcome (1)). Jobs says that the current system is working well:

The first alternative is to continue on the current course, with each manufacturer competing freely with their own “top to bottom” proprietary systems for selling, playing and protecting music. It is a very competitive market, with major global companies making large investments to develop new music players and online music stores. Apple, Microsoft and Sony all compete with proprietary systems. Music purchased from Microsoft’s Zune store will only play on Zune players; music purchased from Sony’s Connect store will only play on Sony’s players; and music purchased from Apple’s iTunes store will only play on iPods. This is the current state of affairs in the industry, and customers are being well served with a continuing stream of innovative products and a wide variety of choices.

His real scorn is for outcome (2), where Apple licenses its DRM technology to other companies. It’s easy to see why this is the worst outcome for Apple – the company loses its ability to lock in customers, but everybody still has to put up with the cost and hassle of using DRM.

What the letter really does, in typical Jobsian fashion, is frame the debate. It does this in two respects. First, it sets up a choice between two alternatives: stay the course, or get rid of DRM entirely. Second, it points the finger at the major record companies as the ones making the choice.

This is both a clever PR move and a proactive defense against European antitrust scrutiny. Mandatory licensing is a typical antitrust remedy in situations like this, so Apple wants to take licensing off the table as an option. Most of all, Apple wants to deflect the blame for the current situation onto the record companies. Steve Jobs is a genius at this sort of thing, and it looks like he will succeed again.

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Sharecropping 2.0? Not Likely

December 20, 2006 by

Nick Carr has an interesting post arguing that sites like MySpace and Facebook are essentially high-tech sharecropping, exploiting the labor of the many to enrich the few. He’s wrong, I think, but in an instructive way.

Here’s the core of his argument:

What’s being concentrated, in other words, is not content but the economic value of content. MySpace, Facebook, and many other businesses have realized that they can give away the tools of production but maintain ownership over the resulting products. One of the fundamental economic characteristics of Web 2.0 is the distribution of production into the hands of the many and the concentration of the economic rewards into the hands of the few. It’s a sharecropping system, but the sharecroppers are generally happy because their interest lies in self-expression or socializing, not in making money, and, besides, the economic value of each of their individual contributions is trivial. It’s only by aggregating those contributions on a massive scale – on a web scale – that the business becomes lucrative. To put it a different way, the sharecroppers operate happily in an attention economy while their overseers operate happily in a cash economy. In this view, the attention economy does not operate separately from the cash economy; it’s simply a means of creating cheap inputs for the cash economy.

As Mike at Techdirt observes, it’s a mistake to think of the attention economy and the cash economy as separate. Attention can be converted into cash – that’s what advertising does – and vice versa. Often it’s hard to distinguish attention-seekers from cash-seekers: is that guy eating bugs on Survivor doing it for attention or money?

It’s a mistake, too, to think that MySpace provides nothing of real value to its users. I think of MySpace as a low-end Web hosting service. Most sites, including this blog, pay a hosting company to manage servers, store content, serve out pages, and so on. If all you want is to put up a few pages, full-on hosting service is overkill. What you want instead is a simple system optimized for ease of use, and that’s basically what MySpace provides. Because it provides less than a real hosting service, MySpace can offer a more attractive price point – zero – which has the additional advantage of lowering transaction costs.

The most interesting assumption Carr makes is that MySpace is capturing most of the value created by its users’ contributions. Isn’t it possible that MySpace’s profit is small, compared to the value that its users get from using the site?

Underlying all of this, perhaps, is a common but irrational discomfort with transactions where no cash changes hands. It’s the same discomfort we see in some weak critiques of open-source, which look at a free-market transaction involving copyright licenses and somehow see a telltale tinge of socialism, just because no cash changes hands in the transaction. MySpace makes a deal with its users. Based on the users’ behavior, they seem to like the deal.

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