Maximizing Value in the Digital World

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The information age has created a host of digitized products — in the realms of software, databases, music, videos and electronic books — that can be produced and distributed with low variable costs, resulting in high gross margins. The key to profitability for creators of these products is to generate enough unit sales to offset their high development costs. But the ability to produce and distribute these products quickly and cheaply is not limited to the original content creator, and the potential for piracy, defined as duplication and distribution of a product without the permission of or payment to the content owner, is extremely high. One of the greatest challenges to digital business is figuring out how to maintain a profitable model in the face of widespread unauthorized competition.

Up to now, efforts to control piracy have relied on the assumption that creators of digital products have absolute ownership rights to the digital content they create. For example, on the basis of that assumption, recording companies and their artists have pursued an aggressive, allegedly successful legal challenge against the file-sharing sites and Napster. Under the same assumption, several software firms have sought to limit piracy with contractual as well as technological safeguards such as click-wrap contracts, encryption, password-limited access to distribution sites and copy proofing.

However, because the belief in absolute ownership of digital content is incorrect from a legal standpoint, antipiracy tactics that rely upon it will ultimately prove ineffective. What’s more, these tactics can risk the profitability of the business model by actually reducing authorized usage by paying customers. A far better solution is to recognize the dynamics of the marketplace, segment that market into innovators (potential pirates) and the mainstream (potential paying customers), and address each segment differently to gather information and establish market leadership.

The Case Against Absolute Ownership

A single-minded emphasis on enforcing absolute ownership rights not only raises serious practical impediments to effective enforcement, but also the very assertion of those rights rests on a misunderstanding of the objectives of copyright law.

Even in 1789 the nation’s founders recognized intellectual products such as writings or inventions as “public goods,” products that take considerable time and resources to create, but can subsequently be cheaply and quickly appropriated in an unfettered free market. Consequently, the framers added the “intellectual property clause” to the U.S. Constitution, expressly authorizing the U.S.



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2. R.S.R. Ku, “The Creative Destruction of Copyright: Napster and the New Economics of Digital Technology,” University of Chicago Law Review, in press. A draft can be found at sol3/papers.cfm?abstract_id266964; and M.A. Lemley, “Beyond Preemption: The Law and Policy of Intellectual Property Licensing,” California Law Review 97 (January 1999): 111–172.

3. V. Chiappetta, “Defining the Proper Scope of Internet Patents,” 289–361.

4. D.S. Karjala, “A Coherent Theory for the Copyright Protection of Computer Software and Recent Judicial Interpretations,” University of Cincinnati Law Review 66 (fall 1997): 53–117; D.S. Karjala, “Misappropriation as a Third Intellectual Property Regime,” Columbia Law Review 94 (December 1994): 2,594–2,609; and J. Reichman, “Legal Hybrids Between the Patent and Copyright Paradigms,” Columbia Law Review 94 (December 1994): 2,432–2,558.

5. A. Sutin and W. Josel, “Napster’s Last Stand?” Computer and Internet Lawyer (October 2000): 20–21.

6. L. Gomes, “Renegade Gnutella May Become Web Standard,” Wall Street Journal, Tuesday, May 29, 2001, sec. B, p. 6.

7. See Association of Research Libraries: ucitapg.html.

8. M.A. Lemley, “Beyond Preemption,” 111–172; and J. E. Cohen, “Lochner in Cyberspace: The New Economic Orthodoxy of Rights Management,” Michigan Law Review 97 (November 1998): 462–563.

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10. L. Lessig, “Code and Other Laws of Cyberspace” (New York: Basic Books, 1999), 122–141 and 142–163; M.A. Lemley, “Beyond Preemption,” 111–172; and J.E. Cohen, “A Right to Read Anonymously: A Closer Look at ‘Copyright Management’ in Cyberspace,” Connecticut Law Review 28 (summer 1996): 981–1,039.

11. H. Gregory, “The Napster Online Music Controversy — Is the Battle Over or Just Beginning?” John Marshall Center for Intellectual Property Law News Source 3 (spring 2001): 4–9; and M.A. Lange, “Digital Music Distribution Technologies Challenge Copyright Law,” Boston Bar Journal (April 2001): 14–31.

12. F. Von Lohmann, “Hacker Heroes,” California Lawyer 43 (June 2001): 43–44.

13. F. Von Lohmann, “Hacker Heroes,” 43–44; J. Lee, “Cryptographer Held in E-Book Case Prefers Paper,” New York Times, Saturday, Aug. 11, 2001, sec. B, p.1.

14. E.M. Rogers, “Diffusion of Innovations” (New York: Free Press, 1983): 192; and V. Mahajan and E. Muller, “When Is It Worthwhile Targeting the Majority Instead of the Innovators in a New Product Launch?” Journal of Marketing Research (November 1998): 488–497.

15. G.M. Moore, “Crossing the Chasm” (New York: Harper Business, 1991), 17–21. Note that this gap or “chasm” using the Moore terminology is a definitional and a relative difference, not an absolute one. There are very few absolute innovators or members of the majority. Thus, managers attempting to utilize the suggestions must carefully assess the relative gaps in their particular circumstances as well as the size of innovator and majority populations.

16. J P. Barlow, “The Economy of Ideas,” Wired 2.03 (March 1994); H.J. Dossick and D. Halberstadter, “Facing the Music,” Los Angeles Lawyer 24 (April 2001): 34–40. For example, the DeCSS decryption of the DVD protection systems has been widely shared to demonstrate technical prowess, to ensure information could be as free as “free speech” itself. See the defendants’ arguments in Universal City Studios Inc. v. Reimerdes, 111 F. Supp. 2d 294 (S.D.N.Y. 2000) and Universal City Studios Inc. v. Corley, 273 F. 3d 429 (2d Cir. 2001).

17. C. Shapiro and H.R. Varian, “Information Rules” (Boston: Harvard Business School Press, 1999), 184.

18. Greg Milner, “Sound Scam,” Village Voice, Tuesday, July 8, 1997, pp. 64–65; and R. Guzman, “CD’s As Easy as MP3,” Wall Street Journal, Friday, Jan. 9, 1998, sec. A, p. 14.

19. H. Gregory, “The Napster Online Music Controversy,” 4–9.

20. As research in marketing has shown, the lowest price charged in a product category is an important anchor for the perceived value of similar products subsequently introduced. See J.G. Lynch, Jr., D. Chakravarti and A. Mitra, “Contrast Effects in Consumer Judgments: Changes in Mental Representations or in the Anchoring of Rating Scales,” Journal of Consumer Research 18 (December 1991): 284–297.

21. See M. Givon, V. Mahajan and E. Muller, “Software Piracy: Estimation of Lost Sales and the Impact on Software Diffusion,” Journal of Marketing 59 (January 1995): 29–37. Note also a March 2001 working paper titled “Piracy and the Legitimate Demand for Recorded Music” by authors Hui, Ping and Cui of the School of Computing, National Singapore University, which suggests that in some categories of digital products losses of up to 15% of the total may accrue due to piracy.

22. P. Keegan, “Lego: Intellectual Property Is Not a Toy,” Business 2.0 (October 2001): 90–99.

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