Welfare Economics of FairPlay and DRM Lock-in

This week I got a veritable hit parade from my rant on Sony’s DRM and format lock-in.  There, I considered the lock-in in terms of whether it was good or bad for Sony; I’ve similarly examined Apple’s FairPlay DRM as well as whether the lock-in is good for the music industry.  These considerations are important, but, to really understand lock-in’s impact, we must put it in a broader normative perspective.  One can rather loosely do so under the label of “consumer perspective,” including harm to innovation and competition.  Drawing these and other considerations together, we can think more generally in terms of welfare economics.  After reading Ernest’s post on DRM last week, I wanted to bring this up for further discussion.

In iTunes: How Copyright, Contract, and Technology Shape the Business of Digital Media, the Berkman Center’s Digital Media Project considered the relation between iTunes, FairPlay, the iPod, and the DMCA in terms of social welfare as well as from Apple’s business perspective (see p. 33-47, 44-45 in particular).  As to the latter, the tying of the Music Store to the portable player may be wise. As to the former, our account is not favorable.  The fragmentation and barriers to entry caused by DRM will inhibit competition and innovation in the music store and portable player markets primarily as well as the market for compression standards (please forgive the typo “DRM compression standards” – copying to PDF missed a strike-thru; will update in next draft).  Compatibility would generate substantial network effects – “[j]ust like having different standards of incompatible fax machines would reduce the value of all fax machines, having incompatible portable players and DRM is likely to affect the value of the players.”

This analysis is relevant independent of the DMCA.  That is, had the market simply evolved this way without a DMCA, these harms could still raise some concerns.  However, it is doubtful that the market would have done so. The DMCA provides the necessary impediment to legitimate reverse engineering for interoperability.  The impact of fragmentation and DRM lock-in would be minimized as people could create products that play all formats.  Moreover, without the DMCA, the incentive to create these barriers in the first place would be greatly diminished, because compatible products would have a much easier time of getting to market.

The iTunes-iPod tie is just one example of the DMCA’s effect, of course.  Among many articles on the subject, Professor Dan Burk’s Anti-circumvention Misuse excellently covers how the DMCA’s enables copyright holders (and whoever else controls the DRM) to control secondary markets, inhibit competitors, and dictate innovation.  Rather than innovation flourishing in an environment of limited control, where all technologists can compete to bring the best products to market, the DMCA gives certain parties tight control over digital media use.  As Burk points out (and Ernest noted), this control can be particularly dangerous in the hands of powerful incumbents, who will reap enormous benefits from the technologies they choose to allow while not suffering the consequences of technologies that undermine their business model.

The best part of Burk’s article is how he sets this against legal background in patent and copyright.  We typically have a rather nuanced approach for this subject, including consideration of anti-trust (e.g., tying) as well as rules like misuse which take into account basic public policy considerations.  In misuse cases, a critical component is whether the actions of the IP holder allow them to appropriate rights beyond the scope of the IP grant.  Traditionally, we would allow the sort of interop that FairPlay and other DRM prevents.

In steps the DMCA, a blunt instrument, unchecked by any of the balances we have built into copyright. In Burk’s terms, it provides a “paracopyright” far beyond the scope of copyright’s intended bounds or even the DMCA’s stated purposes.  As Cory said, the copyright holder has gotten control of the record but never the record player; and the copyright holder’s control over the record has never given Apple or Sony and all the other involved vendors the right to dictate compatible technologies.  All this done in a law whose purpose was to stop piracy.  

This all leads to a final key point.  One can certainly point to ways in which reverse engineering and interop could in certain circumstances lead to some social harm (for instance, by reducing some incentive to innovate of those who would have had control).  But to justify the DMCA on these grounds is myopic.  I accept that standard setting and this control over secondary markets is a complex issue that could have differing consequences in different situations; however, the DMCA ignores those many complexities that we have traditionally examined when treating this issue, particularly in the IP context.  Also, it is oversimplified and misleading to call, for instance, the current digital music standards situation “the market at work.”  Indeed, given how the DMCA steps into the market to limit competition, this is hardly just the market functioning “normally”.  It is a market born out of a particular legal framework that rejects the careful balancing we would typically employ, and the balance we had struck to allow reverse engineering and decryption for interop.