4	Rights Management

Copyright owners continue to be ambivalent about the Internet. On the one hand, it represents a fantastic new medium for distribution; on the other, many in the publishing industry see it as one “giant, out of control copying machine.”

The traditional protections offered by intellectual property law seem powerless to deal with many of the issues raised by digital media. In a widely quoted article, John Perry Barlow asserted that “Intellectual property law cannot be patched, retrofitted, or expanded to contain digitized expression…. We will need to develop an entirely new set of methods as befits this entirely new set of circumstances.”¹

Is Barlow right? Is copyright law hopelessly outdated? We think not. As in the other cases we have examined in this book, many of the tried and true principles are still valid. What has changed is that the Internet, and information technology in general, offers new opportunities and challenges in applying these principles.

The very technological advances that make rights management more difficult—the dramatic reduction in costs of copying and distribution—also offer a fantastic opportunity for owners of intellectual content. Just as owners of mineral rights in the nineteenth century welcomed the arrival of the railroad, which allowed them to transport their precious ore to market, so should the owners and creators of intellectual property rights in the twenty-first century view the digital revolution as a great opportunity to broaden their reach and distribution by orders of magnitude. Every new reproduction technology, from the printing press to the VCR, has brought forth dire predictions that it would destroy an industry, but somehow this has never happened. We are confident that owners of intellectual property can overcome the threats raised by digital reproduction just as they have overcome the threats raised by other reproduction technologies in the past.

In this chapter we will examine how digital technology affects the management of intellectual property. We think today’s rights owners can learn some very important lessons from the history of intellectual property, so we examine some periods in which similar technological and institutional changes took place. Our message is an optimistic one: sure, some of the old business models are broken, but there are a lot of new models waiting to be discovered and implemented. The new opportunities offered by digital reproduction far outweigh the problems.

PRODUCTION AND DISTRIBUTION COSTS

Digital technology changes two significant costs faced by a publisher of content:

• Reproduction costs. Digital technology dramatically reduces the cost of making perfect reproductions.
• Distribution costs. Digital technology allows these reproductions to be distributed quickly, easily, and cheaply.

The impacts of these two cost changes often get confounded, but it is important to keep them separate. In other technological advances, the cost distinctions were more clear cut: some technologies made copying easier, and others made distribution easier. Consider the following two examples:

• A tape recorder offers a cheap way to copy music, but it is just as expensive to distribute a copy of a cassette as it is to distribute the original cassette. The tape recorder lowers the cost of copying, but not the cost of distribution.
• An AM broadcast of a classical recording is a cheaper way to distribute the music than a high-quality CD, but the sound fidelity is poor, and, even worse, listeners have no control over when they listen. Similarly, a black and white photocopy of an art book about the Sistine Chapel may be a cheaper method of distribution, but it is not nearly as valuable to potential users as the original full-color book. In these cases, the distribution costs are reduced, but the quality of the reproduction is much worse than the quality of the original.

Digital technology is uniquely potent precisely because it sharply lowers both copying and distribution costs. Each of these new capabilities offers a different set of challenges to rights management and requires a different set of responses.

MAKING LOWER DISTRIBUTION COSTS WORK FOR YOU

Don’t fight against lower distribution costs; take advantage of them. Reduced distribution costs offer you a significant advantage by allowing you to promote your products more effectively.

Giving Away Your Content

We said in Chapter 1 that one of the defining characteristics of an information good is that it qualifies as an “experience good”: consumers don’t know what it is worth to them until they experience it. This has always been the case for information goods, no matter how they are packaged or delivered, and sellers of information have always had to come up with ways to deal with this problem.

Bookstores typically allow their customers to browse through their collection. As authors, we have read a lot of books standing up, especially those written by our competitors. Nowadays, you don’t have to stand up. You can sit in a comfortable chair and sip a capuccino while absorbing the latest thought in business strategy. The book superstores have made it more comfortable to browse because they’ve discovered that it helps them sell more books. By “giving away” at least part of their content, they end up making a lot more money.

The Internet is a wonderful way to offer free samples of information content. People have debated the right advertising model for the Internet for several years, but the answer has been staring them in the face all along: the Internet is ideal for “infomercials.” You can tell people about your product, and even give them pieces of it, while they remain comfortably at home. But there is a problem with Internet infomercials. Producers of physical goods don’t worry about infomercials cutting into sales: an image of a shirt is quite different from a shirt. But an image of a photo is the photo, for most purposes, and owners of photo libraries are reluctant to post their photos on the Web for obvious reasons: how can they make money if they give away their product?

The obvious answer is: you give away only part of your product. This is like the old marketing tactic of offering free samples of consumer products, but updated for the digital age. The beauty of information is that it is particularly easy to give free samples of something that has zero marginal cost of distribution. The trick is to break your product up into components; some you give away, others you sell. The parts that are given away are the advertisements—the infomercials—for the parts you sell.

This rights management strategy is a twist on the versioning strategy described in Chapter 3. There we argued that you should offer a whole product line of information goods. The cheap versions (which can even be free) serve as advertisements for the high-priced versions.

Consider, for example, the case of books. No one wants to read a book, or even a long magazine article, on-line; it’s just too painful given the limitations of the current technology. Studies have shown that most Web users will read only about two screens of material before they click off.

The ergonomic costs associated with on-line reading mean that large amounts of content can be posted without cutting into sales of hardcopy. In fact, in many cases, posting the on-line content can increase the sales of the physical version of the information good. The National Academy of Sciences Press put more than a thousand of its books on-line and found that the availability of the electronic versions has boosted sales of hard copies by two or three times. The MIT Press had much the same experience; it claims that making electronic books available on its Web site approximately doubles their sales.

But watch out: if the on-line version is too easy to print out, then hardcopy sales could suffer. The best thing to do is to make the on-line version easy to browse—lots of short screens, lots of links—but hard to print out in its entirety.

Demand for Repeat Views

For some sorts of information—music, for instance—repeated plays are very important. If you hear a song on the radio that you like, you may want to hear it again right away. But if you read a novel—even one that you enjoy very much—you are unlikely to want to read it again in the near future. The radio broadcast of a song is an ad for itself—or, more accurately, it’s an ad for a more conveniently packaged version of itself. It’s a free sample, but presented in an inconvenient form: the sample is provided when the DJ wants to broadcast it, not necessarily when you want to hear it. The value added by the CD version of the song is that it can be played when, where, and how you want it to be played. The CD has what economists call option value: you can exercise the option to play it where and when you want, unlike the radio broadcast of the same music. This is much like the versioning strategy we advocated in Chapter 3: the inconvenient version offered by the DJ is given away for free, while the user must pay for the convenient CD version.

The desire for repetition is common among children. There is something very comforting to a child in reading the same story, or hearing the same song, or seeing the same video over and over and over again. This means that giving away a single view of the product is often an attractive marketing strategy for information goods targeted at the children’s market.

Take, for example, our old purple friend Barney the Dinosaur. Barney’s saccharine personality makes him a controversial character, at least in some circles. He made it to the Internet early on, in the form of a Usenet newsgroup called alt.barney.dinosaur.die.die.die, which was devoted to anti-Barney diatribes and explicit descriptions of how to dismember, torture, and mutilate the lovable purple thereopod. There are also numerous Web pages devoted to Barney, including one that purports to prove that Barney is Satan.

But Barney has a following: The Barney Web site claims that he has sold more than 35 million kid vids and has a fan club with more than a million members in the United States alone. Barney & Friends is the most watched show on TV by children under the age of six.

Barney wasn’t the creation of a media conglomerate; it was truly a grass-roots effort. Sheryl Leach, a former teacher, created Barney in the late 1980s. She found it relatively easy to make the shows, produce the tapes, and even get the tapes into the stores on consignment. The hard part was getting people to buy them. Then she had an inspiration: if the customers wouldn’t buy Barney, she would give him away. Ms. Leach started sending free videos to day care centers and preschools near the retail outlets that carried Barney tapes. In each video case was a note telling parents where they could buy copies of tapes for their children. Ms. Leach’s strategy is an example of the “multiplayer” strategy of bribing one party to lock in another party, which we discuss in Chapter 6: she offered Barney for free to the true decision makers, the kids, thus effectively locking in their agents, who (supposedly) control the money, the parents.

Leach’s strategy was phenomenally successful: Barney has become a cultural icon. Recently Microsoft and PBS announced that they are collaborating on a new Barney series that will include an encoded signal that operates a Barney robot.

The Barney marketing strategy should be contrasted with the behavior of another purveyor of children’s media, the Walt Disney Company. According to John J. Tormey, a Disney attorney based in New York, “We pursue all known infringements of our rights.” In their view, there’s no such thing as a Mickey Mouse lawsuit—or, more properly, a Mickey Mouse™ lawsuit. Disney has taken several day care centers to court for showing Disney videos without a proper license, and in the early 1990s the company threatened to sue three day care centers in Florida that had painted Disney characters on their walls.

Disney is perfectly within its legal rights to engage in such actions; indeed, it must actively defend its trademarks or risk losing them. It’s not the propriety of Disney’s actions that we question—it’s their profitability. And Disney is not alone. The American Society of Composers, Authors, and Publishers (ASCAP), which licenses rights for music performances, threatened to sue Girl Scout camps for singing songs written and published by ASCAP composers and publishers. This is despite the limited revenue potential from Girl Scout camps, the obvious negative public relations implications, and the prospect that singing an artist’s songs would spur demand for that artist’s CDs. The instinct to seek out and charge all those who use copyrighted material runs deep and can easily cause otherwise sensible executives to defend their rights past the point of economic return.

In our view, it would make a lot of sense for Disney to at least experiment with some marketing campaigns directed at the day care centers and preschools along the same lines that the Barney promoters used. For example, it could provide a special package of Disney videos, with a license allowing them to be exhibited for a limited period of time, as long as the day care center distributed coupons to the parents offering deals on purchasing their own copies of the videos from local retailers or direct from Disney. The videos shown at the preschool would be very effective at advertising themselves, creating a demand for home viewing.

There is also considerable demand for repeat viewing of videos among adults, sometimes for surprising reasons. Recall Good Morning Vietnam, discussed in Chapter 2, for which the demand for repeat viewing came from the fact that the audience did not catch all the jokes the first time through. Video rentals have been flat for the past seven years; all the industry growth has come on the video purchase side, reflecting, in part, the strong desire for repeat viewing of many kinds of videos.

Similar, but Not Identical, Products

A closely related strategy has to do with giving away samples to sell similar, but not identical, products. The images we see in various media—magazines, television, on-line—are a good example: customers don’t want repeat viewing of the same images, they want some variation—but not too much. Playboy magazine is a natural example: the audience would soon tire of seeing exactly the same images over and over again. They want variation, but variation on the same basic theme.

Like other content producers, the Playboy organization is worried about piracy of its “intellectual property” and is now adding “digital watermarks” to the centerfold pictures it posts on the Web. This is a technology that modifies brightness characteristics of the pixels that make up the image so as to encode copyright information. Other suppliers of non-erotic on-line images, such as Corbis, use similar technology.

DigiMarc, which provides the service that Playboy is using, adds a new twist. It also sells a software product called the MarcSpider that searches the Web for images marked with the DigiMarc watermarks. Not only does this allow DigiMarc to track the use of its own technology, it also provides customers with a valuable service by alerting them to unauthorized use of their images.

Although digital watermarks are a neat idea from a technological point of view, we think their most profitable use may be a bit different from that envisioned in the popular press. For example, just as with Barney, it is certainly in Playboy’s interest to give away some of its content to create demand for other items it sells. Indeed, the organization posts a “free” image of the Playmate of the Month without making much of a fuss about copyright. And why should it? Playboy certainly makes a profit on the photo by charging more than $10,000 per month for a banner ad on its Web site. But to charge the advertisers this kind of money, Playboy has to give them some idea of how many people will see their ads and, demographically, who these people are. Playboy can count the hits on its Web site, but can’t see who is making copies of the images posted. The MarcSpider gives Playboy a way to follow the image through the Web to find out “who’s doing what, where, and when to our stuff,” to use the words of a Playboy spokesperson.

Such market research can be very valuable. Remember the basic maxim of marketing: know thy customer? Technologies like MarcSpider will help you do this. It makes sense for Playboy to give away its Playmate of the Month picture, as long as people associate it with the Playboy brand. Logos, text, and embedded hyperlinks can be used to tell the viewers where the image comes from. And if the viewers know where the image comes from, they know where to go to get more. Playboy, in turn, realizes revenue from these viewers on their visits to Playboy’s site via advertising, subscription, and/or pay-per-view.

The strategy of giving away a sample isn’t limited to images. McAfee Associates sells computer security tools; its flagship product is Virus-Scan, a program that detects and deletes computer viruses. The company was started by engineer John McAfee, who handled virus problems for Lockheed. In 1989 he posted a virus fix on a computer bulletin board and asked those who downloaded it to send him whatever they thought it was worth. He made $5 million in his first year.

McAfee went public in 1992 and had a $3.2 billion market value by 1997, shipping more than half of the world’s antivirus software that year. The company continues to offer many of its products for free via the Web, making its revenues on upgrades and customer service. Companies purchase site licenses, and individuals pay $53 to $160 per year for additional services. In December 1997 McAfee merged with Network General, creating Network Associates, the largest independent network security company and the tenth largest independent software company. The new company’s pending merger with Trusted Information Systems will push it still higher on the list. Not bad for a company that “gives away” its products!

Ultimately, we believe that digital technology and the Internet offer great opportunities for the creative use of informational free samples, whether the content consists of images, news articles, databases, or stock quotes. Free samples of information are effective for two reasons: (1) consumers need samples to see what it is you are selling (the experience good effect) and (2) it costs you almost nothing to provide these extra bits (the zero marginal cost effect). But how, you ask, can you convince freeloaders to become revenue generators, if you offer extensive free samples? The answer is versioning: your low-end version is free, but limited in scope, convenience, quality, and/or quantity.

Complementary Products

The next strategy we examine is selling complementary products. This has been around as long as razors and blades, but takes a variety of new twists on the Internet.

One attractive idea is to give away an index or table of contents and to sell access to the main material. This exploits the obvious complementarity between the contents and the content. The scientific publishing house Elsevier now puts the table of contents for each of its journals on the Web and also provides a push service, Contents Alert, which sends out e-mail notifications of the contents of new issues. The Wall Street Journal and the Economist allow free full-text searching of their back issues archives and then charge a couple of dollars to download the retrieved articles. Each of these examples takes the same form: you offer the index or search service for free to increase demand for priced content.

Sometimes it’s the other way around: the content is free and the organization is what is valuable. Farcast is one of several companies that sell “current awareness” services. Farcast describes its service, Inquisit, as a “business intelligence service.” You can use “droids” to search a variety of information sources, which then report back to you with what they’ve found. Some (but not all) of the information sources the droids look at are already available for free on-line. The value that Farcast adds is not in providing the content itself but rather in providing a service that both searches for and organizes the content. Farcast sells this service for about $13 a month and (of course!) it offers a two-week subscription as a free trial.

Illicit Copying

All these tactics are very clever, you may say, but what about the product that you don’t give away for free? What about the stuff that you want to sell? If people can take your content without compensation, where do the revenues come from? “Bitlegging” can’t be ignored: there’s no doubt that it can be a significant drag on profits. Luckily, there are some compensating factors.

First, information that is timely, or that people tire of quickly, is less susceptible to illicit copying. Sports scores, financial information, and gossip—all three widely available on the Internet—are most valuable when fresh. How many illicit copies of last month’s sports scores have you seen?

Dated copies of this sort of material can serve as illustrations of the quality of the fresh material that you provide. However, there is a danger in providing too much of the “old” content. Giving away a few free samples from the archive is a fine idea; giving away unlimited access, including search capabilities, is quite another matter. This is why the Wall Street Journal gives away a couple of weeks of its archive but makes you pay for older material. Such an archive or library can be immensely valuable.

Second, bitleggers have the same problem that any other sellers of contraband material have: they have to let potential customers know how to find them. But if they advertise their location to potential customers, they also advertise their location to law enforcement authorities. In the contraband business it pays to advertise … but not too much. This puts a natural limit on the size of for-profit, illegal activities: the bigger they get, the more likely they are to get caught. Products such as MarcSpider can automate the search for contraband. Digital piracy can’t be eliminated, any more than any other kind of illegal activity, but it can be kept under control. All that is required is the political will to enforce intellectual property rights.

MAKING LOWER REPRODUCTION COSTS WORK FOR YOU

Let us turn now to the other significant cost factor charged by digital technology: reproduction. Digital copies are perfect copies of the original. For digital content, production is reproduction. Illicit CDs can be stamped out for well under a dollar apiece, and they’re all perfect copies of the master. These illicit perfect copies are perfect substitutes for the original. And if a perfect copy is available at a bargain basement price, who would want to buy the original?

It is easy to overstate this case. “Perfection” really isn’t as important as is sometimes thought. An analog copy of a heavy metal CD is just about as good as the original digital version—maybe even better. In one test, professional record producers could distinguish a second-generation analog copy from a twentieth-generation analog copy only 63 percent of the time—that is, only 13 percent better than they would have done by chance alone. And sometimes the experts preferred the twentieth generation!

The fact that a perfect digital copy can be made isn’t that much scarier than the fact that a very good analog copy can be made. We’ve learned to live with analog copies of documents, music, and video—we can learn to live with digital copies as well.

HISTORICAL EXAMPLES

It is important to recognize that the introduction of cheap production and distribution mechanisms isn’t really that new. In the Middle Ages, professors used a primitive form of intellectual property protection: they lectured in darkened rooms so that the students couldn’t take notes. Today, middle-aged professors still lecture in darkened rooms, but now it’s so the students can see the PowerPoint presentation.

History may not repeat itself, but it rhymes. Printing presses, xerography, and the Internet have made text reproduction progressively cheaper, and express mail and fax machines have reduced the costs of text distribution immensely. With each new reduction in cost, the amount of information being distributed has increased dramatically. There is more being published today, and more money being made in publishing, than ever before.

The photocopying machine was supposed to be the death knell for the publishing business. But, in fact, cheap photocopying has probably increased the demand for printed content. For example, the fact that photocopying is widely available allows producers of library materials (such as academic journals) to charge more for the content they produce. The fact that library materials can be copied easily makes them more valuable to their users.

The Rise of the Library

Libraries themselves are a wonderful example of an innovation that first appeared to threaten the publishing industry but ended up vastly expanding it.

In the eighteenth century only the wealthy could afford to buy books. A single book cost the equivalent of an average worker’s weekly wage. And because books were expensive, there was little reason to invest in becoming literate. At the start of the nineteenth century, there were only 80,000 frequent readers in all of England.

The big breakthrough came in 1741 with the publication of Pamela. Instead of the usual dull theological treatise, the public was offered a racy and entertaining tale of a young girl’s life. Pamela’s success spawned many imitators, and a whole new genre, the English novel, was born. Pamela begat Moll Flanders and Moll begat Tom Jones and so it went. These classic novels were denounced by the literati such as Samuel Coleridge: “As to the devotees of these [novels], I dare not compliment their pass-time or rather kill-time with the name of reading. Call it rather a sort of beggarly day-dreaming, during which the mind of the dreamer furnishes for itself nothing but laziness and a little mawkish sensibility.”² Sounds almost as bad as television, doesn’t it?

But the public paid little attention to the critics. People couldn’t get enough of these lurid tales. English bookstores were unable to keep up with the demand for novels and romances, so they started renting them out. These circulating libraries, as they were called, were denounced by the literate classes as “slop shops of literature.” What’s more, they were also denounced by the publishers and booksellers for an entirely different reason: the publishers and booksellers were afraid that the circulating libraries would cut into their business: “[W]hen circulating libraries were first opened, the booksellers were much alarmed; and their rapid increase added to their fears, and led them to think that the sale of books would be much diminished by such libraries.”³

In the long-run, however, there is no doubt that the circulating libraries were much to the benefit of the publishing industry. The availability of low-cost entertainment motivated many to learn to read. According to Charles Knight, author of The Old Printer and the Modern Press, the 80,000 frequent readers in 1800 grew to over 5 million by 1850. The publishers who served the new mass market for books thrived, while those who sold only to the elite disappeared.

As the market grew, people started to buy rather than rent their books. The passage cited above continues: “But experience has proved that the sale of books, so far from being diminished by them, has been greatly promoted; as from these repositories many thousand families have been cheaply supplied with books, by which the taste of reading has become more general, and thousand of books are purchased each year by such as have first borrowed them at those libraries, and after reading, approving of them, have become purchasers.”⁴

Note carefully the causality: it was the presence of the circulating libraries that killed the old publishing model, but at the same time it created a new business model of mass-market books. The for-profit circulating libraries continued to survive well into the 1950s. What killed them off was not a lack of interest in reading but rather the paperback book—an even cheaper way of providing literature to the masses.

The Rise of the Video

The same industry dynamics occurred in the market for prerecorded videos in the 1980s. In the early 1980s VCRs cost more than a thousand dollars and videotapes sold for $90. Videos were a medium for the rich—just as books had been in 1800.

Video rental stores changed all that. Like the circulating libraries 300 years earlier, they brought this new form of entertainment to the masses. The stores made it possible for an ordinary family to rent both the video machine and the cartridge. The additional revenue flowing to VCR manufacturers allowed them to exploit economies of scale. By the mid-1980s, the average middle-class family could afford a VCR and video rental stores were thriving.

Hollywood didn’t like the rental business. Studios tried to control the stores through various licensing arrangements, but the owners of these mom-and-pop stores wouldn’t cooperate. In the end, of course, despite its objections to video rentals, Hollywood made a lot of money off them. The availability of inexpensive content meant that people watched many more movies. By the late 1980s, video machines were selling for less than $200 and 85 percent of American families owned one. Video rental was a blockbuster business. (Or should we say a Blockbuster business?)

During the early 1980s there was little change in the sales price of videos; they continued to sell for about $90 retail and $60 to video stores, which rented them out for $2 or $3. But then Disney realized that people—ordinary people—would actually buy a video if the price was right. Its first video targeted for home purchase, Lady and the Tramp, sold 3.2 million copies at $29.95.

Pretty soon the market was flooded with cut-rate videos selling for $19.95, $14.95, even $9.95—and for movies that were just a few months old. Since 1990, the video rental market has been flat, and all the action has been in the sales market. In the last fifteen years, video purchase prices have dropped by more than 90 percent. And Hollywood is making money like never before.

The spread of the video machine is a beautiful example of positive feedback (which we mentioned in Chapter 1 and examine in depth in Chapter 7). The more VCRs there were, the greater the demand for prerecorded videos. And the more prerecorded videos there were, the greater the demand for VCRs. Home video, time shifting, and rental of VCRs got the market to critical mass. Once it was there, positive feedback took over.

Far from being Hollywood’s death knell, prerecorded video tapes have been its savior. Just as in the case of books, the rental market for videos created a huge new opportunity for both renting and buying the product. The companies that recognized the implications of the new technology succeeded beyond their wildest dreams, while those which stuck with the old model were consigned to the dustbins of history.

Growing the Market

Producers of digital content are in much the same position now that the producers of books were in 1800 or producers of film were in 1975. It’s easy to see the threats inherent in the new media; it’s hard to see the promise. The key issue is how to exploit economies of scale: a thousand consumers paying a dollar a piece to download a piece of software that costs pennies to produce and distribute is a lot more profitable than 100 consumers paying $10 a piece for software that costs $5 to produce and distribute.

The book producers in 1800 and the video producers in 1980 didn’t appreciate how dramatically the market could grow. Publishers used to dealing with a wealthy elite didn’t foresee that literacy would dramatically increase if there was something interesting to read. Hollywood producers didn’t recognize that VCRs would become a mass-market item if popular content was available for them. The publishers and movie producers understood their own industries, but they didn’t understand their complementors’ industries.

We think that the natural tendency is for producers to worry too much about protecting their intellectual property. The important thing is to maximize the value of your intellectual property, not to protect it for the sake of protection. If you lose a little of your property when you sell it or rent it, that’s just a cost of doing business, along with depreciation, inventory losses, and obsolescence.

CHOOSING TERMS AND CONDITIONS

But enough of the past; what about the present? Let us suppose that you are the owner of some intellectual property and have the legal right to market it as you will. How should you think about the terms and conditions under which you will make your product available?

The first thing to do is to recognize the fundamental trade-off between control and customer value. The more liberal you make the terms under which customers can have access to your product, the more valuable it is to them. A product that can be shared with friends, loaned out, rented, repeatedly accessed, or sold in a resale market is obviously more valuable to a potential user than one that can be accessed only once, under controlled conditions, by only a single party.

The fact that liberal terms and conditions increase the value of the product has two effects. First, you can charge a higher price, and second, more consumers will want to buy it. But there is a mitigating factor. More liberal terms and conditions also create competition for your product: rental markets and resale markets cut into the sales of the originals, which reduces revenues. And consumers are willing to pay less for your product if there are close substitutes available, such as used copies.

The challenge of intellectual property management lies in trading off these two effects: in choosing the terms and conditions that maximize the value of your property. The more generous the terms on which you offer your intellectual property, the more you can charge, but the less you sell.

The Analytics of Rights Management

We can examine this trade-off using a staple from the economist’s toolkit: the demand curve. Since unit costs are very low for most information goods, and negligible for purely digital goods, we will ignore production costs in what follows.

Your goal is to set a price that maximizes your revenue. The demand curve in Figure 4.1 illustrates the standard trade-off: a high price leads to low volume. With the help of a good marketing study, you should be able to choose the price that maximizes revenues, which are represented by the area of the revenue box, as shown in panel A, the baseline case.

But what about the terms and conditions under which the product is offered? Offering more liberal terms and conditions increases the value of the product to the consumers, which shifts the demand curve up. However, the more liberal the terms and conditions, the more copying and sharing, and the less the producer sells. In Figure 4.1, the demand curve in panel B is twice as steep as it is in panel A. This means that every consumer is willing to pay twice as much for the intellectual property offered under more liberal terms and conditions. But owing to the more liberal terms, the producer sells less; in this diagram, we’ve assumed that sales fall by 50 percent. This means that the new revenue box has twice the height and half the width, leaving revenue unchanged.

Figure 4.1. Balancing Terms and Conditions of Sale with Amount Sold

If more liberal terms and conditions reduced sales by more than 50 percent, this change would reduce producer revenue; if they reduced sales by less than 50 percent, this change would increase producer revenue. Making terms more liberal increases profit if the increased value to the consumers, which can be captured by the producer through higher prices, is larger than the decrease in sales.

This observation helps you understand the terms and conditions trade-off in practical ways. Consider, for example, Blockbuster’s recent experimentation with terms and conditions for its video rental. Our local store now has 1-day, 3-day, and 5-day rentals, along with free popcorn and discounts for early return. In choosing which titles fall under these various categories, Blockbuster thinks about how the terms will affect both consumer value and rentals. If consumers will pay twice as much for a 5-day rental as they will for a 1-day rental, but would rent only half as many videos, Blockbuster would make the same revenue from each rental period. If consumers find the longer period twice as valuable, but they rent only 40 percent of the videos they otherwise would have rented, Blockbuster would want to choose the shorter period.

Transaction Costs

As we saw in Chapter 2, one important influence on consumer value is transaction costs. These are the costs that the consumer or the producer pays to make the transaction happen. For example, to rent the latest video you must go to the store; if the video is very popular you may have to go many times. When you finally get the video, you have to take it home and view it, then return it the next day. The cost of travel and delay can be significant. For many consumers, buying a video at $12.95 is preferable to renting at $3 because they avoid the hassle of returning the video.

A new technology known as Digital Video Express, or Divx, offers pay-per-view DVDs. You purchase a movie on disk for $5, and when you’re done you can simply throw away the disk. By selling Divx disks at $5 the producers are guessing that consumers are willing to pay at least $2 to avoid the hassle of returning a video that rents for $3. Both sides of the transaction are potentially better off: the producers get the extra $2, and the users avoid a late night trip to the video store.

Another good example of the importance of transaction costs are site licenses for software. Site licenses are often priced at a low multiple of the software’s unit purchase price. Table 4.1 depicts the site license per seat for three different office suites.

It is attractive to sell these products via site license since transaction costs are reduced for both the buyer and the seller. It is much cheaper to load a program from a file server than it is to create, warehouse, and distribute a copy for each purchaser in the organization. This is especially true if user support costs are handled by the organization rather than the producer.

Table 4.1. Site Licenses for Software Office Suites

Suite	1,000 Seats	5,000 Seats	10,000 Seats
Lotus SmartSuite	$133 per seat	$125 per seat	$125 per seat
Corel WordPerfect	69	64	64
Microsoft Office	158	171	167

Source: InfoWorld, October 28, 1996, p. 14.

Site licenses are also an attractive strategy for pricing and selling information content. Members of a large investment bank, for example, would find it much more attractive to have an electronic site license to, say, the Wall Street Journal than to each manage his or her own purchase. With the site license they could redistribute articles within the organization with no liability; without it, there could well be heavy transaction costs in verifying and complying with terms and conditions. (See our earlier discussion of group pricing in Chapter 2 for more on the marketing advantages of this form of pricing.)

As an owner of an information good, you should ask yourself: “Is it cheaper for me to distribute my product directly to the end-user, or is it cheaper for the organization to distribute my product to the end-user?” If the distribution cost advantage lies with the organization, then you should be able to reach a bargain where both you and the organization share the gains from the more efficient distribution system.

In addition, organizations often realize significant savings by choosing particular products as standards, and, once they commit to a product, they may be very reluctant to switch. This loyal installed base can give you a steady stream of revenue from upgrades that can be well worth initial discounts you must extend to make the sale. In the next chapter we will discuss in detail strategies for dealing with switching costs.

LESSONS

• Digital technology poses two challenges for rights management. First, it reduces the cost of making copies. Second, it allows the copies to be distributed quickly, easily, and cheaply. These challenges also offer opportunities.
• Reduced distribution costs help to advertise your product by making it cheap to give away samples. This is useful when there is significant demand for repeated views or for closely related content. Giving away samples helps to sell more content.
• Reduced distribution costs are beneficial to those who sell illicit copies as well, but their need to advertise helps keep “bitlegging” under control. A bitlegger that gets too big and attracts too much attention will soon be caught.
• Copy protection schemes impose costs on users and are highly vulnerable to competitive forces. Trusted systems, cryptographic envelopes, and other copy protection schemes have their place but are unlikely to play a significant role in massmarket information goods because of standardization problems and competitive pressures.
• When choosing terms and conditions, recognize the basic trade-off: more liberal terms and conditions will tend to raise the value of your product to consumers but may reduce the number of units sold. The trick is to pick the terms and conditions to maximize the value of your intellectual property, not to maximize the protection.
• Site licenses and other group-pricing schemes are a valuable tool for managing terms and conditions. They economize on transaction costs for both the buyer and seller.