NBA 600: Session 16Newly Vulnerable Digital Goods

13 March 2003

Daniel Huttenlocher

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Announcements

Group assignments– Due Friday at 5pm

• Hand in hardcopy to 346 Sage and email to me (dph2)

– Will contact by email if want brief in-class presentation 3/27

Change in due dates for remaining two short papers– #4 from 3/27 to 4/1 (handed out 3/25)– #5 from 4/8 to 4/10 (handed out 4/3)

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Today’s Class

Finish discussion of darknets– Likely evolution of darknets based on current

legal, social and political environment (in US)

Clemons paper on newly vulnerable markets for information goods– Competitive strategy theories– Application to music and newspaper industries

Your analysis – Applying theories of newly vulnerable markets

and co-specialized assets to music industry

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Likely Evolution of Darknets

Large-scale file sharing will be limited– For music, RIAA and labels will identify hosts

that share lots of data• Shut down through legal means

– File sharing will become more subject to viruses and corrupted files• As more mainstream will become larger target

However small-scale sharing hard to stop– Sharing only with friends

• Can’t prohibit without alienating users• Less problem with trusting content

– But harder for users to find new things

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Leaves Room for Online Sales

Make it easy for friends to share music, while still encouraging purchase– Systems such as Threedegrees do this by

enabling shared listening but not copying– Perhaps leading to reduced costs for

radio/video promotion

Supplement with easy means of making online purchases– Many purchasers of music under age 18 and

don’t have credit cards• Could be good for Paypal and other prepaid

payment services

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Large Opportunity

Safe, secure, easy purchase online a viable alternative to illegal downloads– Make easy to find music

• Search, sample, online community, reviews

– Can be provided by industry or retailers– Value more than being easy and safe

• “Tipping point” phenomenon, people willing to pay for perceived value

Not just to avoid other costs such as viruses and corrupted files

Offering wide variety of pricing models– Per song, per “album”, per listen, subscription

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Information Goods Strategy

Clemons identifies theory of newly vulnerable (contestable) markets– Newly easy to enter– Attractive to attack– Difficult for incumbents to defend

Considers two information industries– Music and newspapers

Also draws on Teece’s theory of resource-based value retention– Other required resources make entry difficult

• Co-specialized assets

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Market Vulnerability

Newly easy to enter – due to changes in– Regulatory rules– Technology– Consumer preferences

Attractive to attack– Cross subsidies

• Some customers subsidizing others; pricing not reflective of costs

E.g., credit card industry

• Some products or services subsidizing others

– Also: decoupling of co-specialized assets• Clemons views this as a kind of cross subsidy

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Market Vulnerability

Difficult (for incumbents) to defend– If incumbents can respond in-kind then profits

competed away– Regulation can be stricter for incumbents

• E.g., landline vs. cellular telephony• E.g., banks offering credit cards

– Channel conflict issue for incumbents

Similar problems if too easy for new entrants– Many entrants will compete away (at least

their own) profits

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Digital Goods Industry Players

Content creators– Composers, writers, artists, performers, actors

• Often contractors not employees

Content producers – packaging, promotion– Record labels, newspapers, studios

Reproduction facilities– Printers, CD/DVD/tape duplication

• Often owned by content producers

Distributors– Wholesalers, retailers, broadcasters

• Close relations with content producers

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Roles of Digital Content Producers

Identify and develop individuals and works Certify “value” or credibility of work

– More important for information than entertainment (e.g., news vs. music)

Control or have relationships with distribution channels

Promote and advertise work– Including branding, promotional copies, etc.

Control sale and reproduction of work– Including defending copyright of the work

• Most important for items of long term value

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Music Industry Vulnerability

Cross-subsidies of talent– Different products (artists) provide large

differences in profitability– In principle subject to pick-off of talent,

traditionally combat with• Long-term contracts• Not many record labels to turn to

All providing similar services at similar costs

– Internet provides potential for successful artists to distribute content on their own• Bypass the record labels once contracts expire• Leaving only less profitable acts to labels

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Music Industry Structure

Value creation and revenue production are co-specialized assets in music industry

Value creation– Done by artists – Realized by labels

• Finding acts, producing recordings, promotion

Revenue production– Largely through selling physical copies

• Reproduction and distribution of those copies controlled by labels

Internet threatens decoupling

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Challenges for Incumbents

Where to find revenue with changes in control of reproduction and distribution– Fight to maximize life of current model

• Challenge online services

– Try to control reproduction and distribution over internet• Copy protection technologies and strict laws

– Investigate new revenue models

How to keep most profitable acts– Demonstrate value of services other than

reproduction and distribution• Probably share more revenue with best talent

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Several Industry Scenarios

Clemons models various cases– Base case of late 1990’s structure– Defection of big groups from labels

• Defecting groups enjoy more profit but labels become less profitable

• Depending on degree, labels become unprofitable and decrease promotion

Fewer new bands and lower consumer choice

– Rapid proliferation of pirated copies• 75% of top acts content stolen, 25% of others

Artists and labels lose money, fewer new bands, lower choice

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Will We See Reduced Choice?

Clemons’ simulations illustrate current structure doesn’t adapt well to Internet

Do consumers value choice– If so business opportunities in identifying and

promoting new bands• Labels that become known for exciting new

artists in some genre Value in reducing search costs

Simulations also don’t consider large scale adoption of online distribution by labels– As predicted by Forrester study

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Newspaper Industry

Reporters don’t have star power of musical acts– Not much cross-subsidy of talent like music– Newspapers play larger brand and certification

role than music labels

News a very different experience from entertainment– Likely to want to experience once rather than

many times• Less desire to make a copy

– Care more about credibility, viewpoint – brand

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Newspaper Industry Revenue

Again presence of co-specialized assets– Value creation done by reporters and editors– Revenue production from printed copies

• Mainly circulation-based advertising not sales According to Newspaper Assoc. of America

81.5% of revenue from advertising

Printed copies less important than packaging of advertising with content– Consumers unwilling to view ads alone– Consumers want news but generally not willing

to pay costs– Advertisers want to reach these consumers

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Newspaper Industry Vulnerability

Widespread defection of content creators not viable– Value of newspaper brand, news gathering

ability and lack of star power

New entrants such as weblogs may over time provide brand competition– Editorial and viewpoint value

Advertising bundled with content adapts well to the Web– As long as content not widely pirated

• Seems likely to be the case given time sensitivity

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Newspaper Industry Vulnerability

Substitute sources of information that reduce newspaper readership– Reducing advertising revenue– Recent Web news sites compete with papers

Substitute advertising channels– Ways of reaching desirable audience not

through news• Recent Web sites provide substitutes for

classified ads (e.g., eBay, monster.com)

Risk of death spiral if such revenue reductions cause reduced value creation

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Possible Defenses

News businesses not easy to enter– Brand is important to get viewers/readers

• And thus advertising revenue

– Quality news product not easy to create

Easier for incumbent to go online than for new online news service to arise– Largely bringing together competitors from

different branches of news• Television, newspaper, magazine

Using new technologies for more targeted and thus valuable advertising

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Strategies for Music Industry

Newly vulnerable markets theory– How important is cross subsidy– What barriers are there to widespread new

entrants– How applicable is this to illicit copying– What predictions relative to Forrester report– What defensive or offensive actions should

incumbents take– Will artists go it alone and why

Other strategic models and applicability to this industry