Monday, December 28, 2009

Piracy and the Secondary Market

The idea behind a free market is that each participant fights for their own interests, and a good allocation of resources is discovered. While the battles tend to be minor adjustments in staffing, pricing and offerings, there are occasionally much larger shifts in the battlefront. Major companies go under, industries experience consolidation or pop into existence, and occasionally the rules of the game are changed.

In theory the market should generally be close to an equilibrium state, so there shouldn't be many opportunities to drastically alter the market. But it does happen. A company can make a particularly poor strategic decision. Or technology can change the field of play. And one of the best examples of that effect is the Internet.

While you can find examples all through society, I'm going to focus now on the pivot of piracy. Unauthorized distribution has existed as long as media has, but the Internet makes it easier, cheaper and more private. Yet contrary to claims by the entertainment industry, it isn't clear that its having any negative impact on revenue. The movie industry is having a record breaking year. Software revenue continues to explode. The music industry is the counterpoint, but given its many tactical blunders, its hard to pin the blame on piracy, particularly when the pirates also buy the most music.

Some effort is of course necessary to keep piracy from growing to the point it does harm profits. But given the lack of evidence piracy is doing much damage, why the intense focus on it by the entertainment industries? While you aren't likely to get the average Chinese citizen to spend two months gross income on Photoshop even if you do stamp out piracy, the point is that the battles against piracy are also shifting power away from consumers who do buy your product. Organized media corporations act as middlemen between consumers and artists. While some of that role is important, a lot of industry profit comes from acting as a gatekeeper, controlling what people can purchase. With the Internet replacing traditional gatekeepers, publishers need leverage.

And then there's the secondary market. The first sale doctrine is a legal concept in America that guarantees you the right to sell what you've purchased when you're done with it. Car companies could make a lot more money if you weren't allowed to buy used cars, but the government won't let them enforce such a rule. Free markets are only efficient in theory, but the more participants in a market, the closer that market will tend to be to efficiency. The secondary market is an important way to keep markets sufficiently large. Using the car example again, if you couldn't buy used cars, new cars might cost more, as car makers wouldn't be competing with cheap alternatives.

Most anti-piracy actions also encroach on your first sale rights. If Microsoft catches you pirating software, your XBox loses much of its functionality. This means that buying a used XBox is more risky than it should be: if the old owner was a pirate, you've bought a lemon (thus reducing the value of even legal XBoxes). Similiarly, EA came under fire with the DRM on its hit game Spore: Each key could only be used for a set number of installs, so too many resales(or going through too many computers in the course of your life) would prevent you from accessing the content. On the occasions I do buy a game, I tend to buy something a few years out of date for cheap, rather than a brand new $60 product. Without resales, those cheap old games would no longer be a competitor to the newest lineup.

And really, this is so important to digital industries because bits don't degrade. In fifty years my car will be scrap and my books all yellowed. You expect to pay less at a yard-sale because the products are used, and thus hold a lower value. But if I'm careful, I could sell a song I bought off ITunes in sixty years, and it'll be indistinguishable from a new copy. This is tough competition, and the fairness of it is open to debate. Maybe there do need to be controls on reselling digital media. But that's a harder argument for the entertainment industries to win then the debate over piracy. And returning to the opening concept of market dynamics, I expect there will be more than one signficant shift of power before a new equilibrium between consumers, artists and publishers is found.

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