Flexibility as an Instrument in Digital…

             Flexibility as an Instrument
            in Digital Rights Management



                         joint with


 Thomas Eisenbach      Joan Feigenbaum    Scott Shenker
University of Munich    Yale University   UC Berkeley


                         WEIS '
                              05
Introduction

   digital goods (audio, video, software, etc.) promise transferability and
   portability across various media and devices


   exibility is often an essential aspect of consumer valuation


   exibility carries risk of circulation of unlicensed copies

    ­ undermine revenue generating sales
Digital Rights Management

  DRM controls how consumers can use the good

   ­ how long customer can use the good

   ­ how often she can use it

   ­ how many devices she can use it simultaneously

   ­ how to copy and alter it


  DRM: response by content providers to increase users'valuation without
  risking additional sales
Greynet, Security and Platform

   Internet is "greynet" without perfect security provisions


   challenge: how to design and sell without complete security provisions


   likelihood to receive unlicensed copy is increasing

    ­ in number of licensed copies, in permitted exibility


   trusted platform: hardware-based, cryptographic support for proof that
   receiver' machine is running approved software stack
            s
Flexibility and iTunes

   iTunes DRM rules

    ­ each music ...le can be played on ...ve devices authorized by the buyer
      of the ...le

    ­ individual ...les can be burned on CDs without restriction, but every
      playlist, i.e. speci...c arrangement of several ...les, can only be burned
      seven times


   high quality ...les bought from Apple and those extracted from a user' own
                                                                        s
   CDs using the iTunes software can be played by an iPod.
Platform and iPod - iTunes

   trusted platform: hardware-based, cryptographic support for proof that
   receiver' machine is running approved software stack
            s


   digital good runs on platform:

    ­ enhances the security of DRM system

    ­ restricts use of unlicensed copies
Complementary Products

  digital good and platform are complementary products


  conict between platform and content provider:


     "Our music is not something to be given away to sell iPods."

               Music Executive, Financial Times, 3/04
1. Model


2. Optimal Flexibility and the Greynet

      Identical Customers

      Heterogeneous Customers


3. Platform and Content O¤ered by Single Firm

      Constrained E¢ cient Solution


4. Platform and Contect O¤ered by Distinct Firms

      Ine¢ cient, yet Superior to Pure Content Provision
Model

  continuum of consumers

                                             h   i
  exibility in use of digital good:     2 0;


  utility of consumer i for digital good:

                                      iu (   )   p


  willingness to pay i


  u increasing and concave
Choices

  seller o¤ers price for digital good p


  seller o¤ers exibility


  number of sold licenses q


  marginal cost of digital good c = 0

   ­ ) e¢ cient solution      =
Greynet

  digital good can be obtained through two channels:

   ­ licensed product purchased at price p

   ­ unlicensed copy received with probability    q


  probability of receiving unlicensed copy proportional to:

   ­ sold licenses q; exibility , contact rate

   ­    represent permeability of the content-distribution environment
Permeability and Contact Rate

    inuenced by technical and economic factors

   ­ more lenient copyright law,

   ­ less vigilant enforcement of existing copyright law,

   ­ more easily circumventable DRM,

   ­ higher Internet bandwidth and contact frequency

        college students vs senior citizens

        di¤erent access to a variety of sharing technologies
Identical Customers

   willingness to pay:   i   =   > 0 for all i


   equilibrium segmentation

    ­ some buy digital good

    ­ some get digital good
Market Equilibrium

  value of licensed copy:
                                   u( )     p


  (expected) value of unlicensed copy with exibility c

                                    q u ( c)


  identical consumers, indi¤erent aross alternatives:

                            u( )   p=      q    u ( c)
Equilibrium Pricing

    increased circulation of copies through

     ­ higher exibility ; higher sales volume q


    critical level of contact rate


Proposition (Pricing with Identical Customers)
1. For          , all customers buy the product and price p and exibility
are decreasing in .

2. For > , the number q of paying customers is decreasing in         and p
and   stay constant.
Di¤erentiated Customers

  willingness to pay: i   F()


  gross utility: iu ( )


  market segmentation with critical customer

   ­ high willingness to pay       : purchase licensed copies

   ­ low willingness to pay    <   : wait for unlicensed copies
Proposition (Pricing with Di¤erentiated Customers)

The equilibrium price p , exibility    ; and sales q are decreasing in   .


    market for sales becomes smaller


    increasing focus on high end customers


    yet quality of product o¤ered decreases with increase in piracy


    socially ine¢ cient allocation
Platform

  provision of platform to use digital good


  platform enhances security

   ­ digital goods can transferred but only on the platform

   ­ additional features


  complementary products, separate pricing

   ­ ...nal utility from joint consumption
Integrated Provider

   price of software, hardware: pI ; pI ;     I
                                 s    h


   market segmentation:

    ­ hardware and software

                                   iu (   )       ps   ph

    ­ only hardware
                                     qs i u ( )        ph

    ­ neither
Proposition (Integrated Platform)
In an integrated platform market:

1.   I >       ;

2. I <     ;

3. pI < ps .
    s


     with a platform:

      ­ exibility is higher

      ­ market for software (and hardware) is larger
        than in pure digital goods market
Distinct Providers

   denote equilibrium choices by pD ; pD ; D ; :::
                                  s    h


   timing:

      pD ; D
       s   s             !      pD
                                 h               !   consumer decides


   aspects of double marginalization:

    ­ not quite...

    ­ content and platform provider have di¤erent market size
Proposition (Complementary Products)
In the platform/content market equilibrium:

1.   I >   D;


2. I < D ;

3. pI < pD , pI > pD .
    s    s    h    h


     with distinct providers:

      ­ exibility is lower

      ­ market for software (and hardware) is smaller
Conclusion

  role of competing platforms in the context of DRM


  role of competing distribution channels for content


  more sophisticated pricing strategies:

   ­ monthly fees for limited/unlimited transactions

   ­ varying exibility (nonlinear pricing)


  heterogeneous consumers with respect to contact rate
Strategies for Complementary Products

  Gillette makes money by selling blades not razors


  Cellular phone companies signing up cell-phone subscribers rather than
  selling phones


  conict between platform and content provider:



     "Our music is not something to be given away to sell iPods."

                Music Executive, Financial Times, 3/04
Literature

   Parker and Van Alstyne (2005)

    ­ pricing of complementary products in two-sided markets

        selling to software developers and end consumers

        selling to entertainment industry and households
Sundararajan (2004)

 ­ role of digital management to restrict digital piracy in optimal pricing
   model.

 ­ piracy acts as a constraint on the pricing policy

 ­ no interaction between exibility and the implicit cost of piracy in terms
   of foregone sales


Park and Scotchmer (2004)

 ­ cost of circumvention a¤ects pricing of digital goods
Platforms in Security Context

   Microsoft Trusted Computing Platform ("Palladium")

    ­ "hack-proof" by authorizing hardware

    ­ MPEG4 provides "hooks" for technical protection system


   Intel introduced serial number on Pentium III chips

    ­ identify computers for watermarking, encryption