Game developers have frequently lamented the drive for lower cost games on the iPhone.  “The push to 99 cents is the single most frustrating and terrible thing about App Store pricing,” says Nathan Vella, co-founder of Capybara, makers of Critter Crunch. “Since it became ‘expected’ by consumers, it forces a lot of developers, specifically indies, to devalue their game and significantly increase the number of sales needed for developers to get back their investment.”

But what Vella thinks as devaluing is really basic economics. Competition, the healthy and rewarding heart of capitalism, encourages makers of goods to try to one-up each other, whether by lowering prices or offering a more compelling product.

The App Store, with more than 100,000 applications, 13,000 of which are games, competition is pretty fierce. It is to be expected that price will be pushed down. Most game makers have stayed around 99 cents, so if someone really wanted to stand out, maybe they should sell at 98 cents. Or there’s lots of free games and that soon might become “expected”. Not even including truly free apps, estimates (which I strongly question) claim 75 percent of apps are pirated meaning Vella and game developers have more to fear from free than 99 cents. If Vella thinks 99 cents devalues his games, how will he feel when he’s forced to sell it for free?

iPhone developers, like many in the media industry, forget that price and value are two different things. Value is subjective. I, as a consumer, value a game a $10. As long as the price is less than $10, I will buy the game, even if it is $2. The developer chooses the price that will make them the most money, specifically by setting the price low enough as to attract the largest number of buyers. The $2 price in no way devalues the game. While I might have paid more, 10 other people might not have. Meaning the developer attracted more purchases and made more money over all. This is known as price elasticity.

We see evidence of this in many digital services. The PC game Left4Dead took 50 percent off its price and jumped 3,000 percent in sales. Variable pricing on iTunes led to lots of $1.29 songs and very few 69 cent songs. Those higher priced songs have seen enough of a drop in unit sales that overall revenue is lower. Maybe at 69 cents, they’d actually make more money.

For game developers, it seems the App Store just has too much competition to make it easy for anyone. There are so many games vying for attention, thanks to the low cost of entry (until traditional gaming consoles), that its a major challenge to get the attention of enough consumers willing to pay the 99 cents (or even pirate it). The benefits of the Long Tail in the App Store necessitates better search and organization to help people find the apps they want (the App Store does lack this robust a function). But game developers can look for their own solutions to stand out by using social media, pricing, and excellent games to build the buzz. It’s not Apple’s fault, it’s not consumers fault, piracy’s fault, or other developers faults. It is up to each developer to give consumers a reason to buy their game.  If consumers don’t pay, then change what you’re doing. That’s innovation and competition makes sure it happens.

…but movie companies certainly don’t see that. Paramount Pictures released its study of the five million IP addresses it tracked who downloaded camcorded copies of Star Trek.  Writing to the FCC, Paramount says:

Just five years ago, one had to be computer literate and exceedingly patient to pirate movies. Today, literally anyone with an internet connection can do it. Clunky websites are being replaced by legitimate looking and legitimate feeling pirate movie websites, a perception enhanced by the presence of premium advertisers and subscription fees processed by major financial institutions.

So after years of suing and spending millions in lobbying, spying, and prevention, Paramount agrees it is easier than ever to download movies. Downloading movies “has advanced from geek to sleek” they say.

I interpret this as a sign that the movie companies’ campaign against piracy has not worked. It is easier than ever to download any movie, song, or game you want and it will only get faster and easier. More people are doing it and aren’t embarrassed by it. For all the propaganda (see last Sunday’s 60 minutes), file-sharing is what the market wants.

Paramount, of course, sees the opposite.  The spreading of file-sharing means movie companies need more laws to stop file-sharing, while never showing how these laws, assuming they worked (which they won’t), would encourage customers to go back to their former purchasing practices.

That’s why Big Champagne, a company that tracks online piracy, is urging movie companies to rethink their piracy strategies, claiming their own practices are encouraging file-sharing, especially in European countries where they might wait weeks or months for a TV show or movie to air. CEO Eric Garland tells CNET:

In the digital world, we don’t want to wait three months, six months. We’re just not accepting that anymore…we want it all, we want it right now and even Mom and Pa Kettle are getting to the point where they say if it’s not on, let’s just fire up the computer and watch it. If they want me to wait six months, I’ve got other options. And people don’t really have a conscious [sic] or qualms about that.

So we know waiting hurts (why wait when you don’t have to). But instead of searching for alternatives, movie companies want more windows, or at least maintain the ones they have. This goes against what customers are demanding. Instead of offering customers a compelling product, movie companies just want the government to pass laws supporting their obsolete business models.

For all the increases in file-sharing, movie production and revenue has risen (ignore the blatant lies in the aformentioned 60 Minutes segment), from 567 movies released in 2004 to 1177 movies scheduled for release this year.  Total revenue rose by about $300 million from 2004-2008 (this year hasn’t ended, and for reference 1037 movies came out in 2008).  So more movies, more money. I wish file-sharing would hurt my industry the same way.

Value has revealed a great understanding for the way technology is changing the video game industry. Instead of getting mad about piracy and used game sales, the company recognizes it needs to give fans a reason to pay and support their products. Valve launched one of the first digital distribution systems for the PC and supports a thriving modding community and has played with a variety of game prices including special free weekends (which led to higher retail sales).

Valve managing director Gabe Newell thinks another future business model for video games can be fan-funded games:

One of the areas that I am super interested in right now is how we can do financing from the community. So right now, what typically happens is you have this budget - it needs to be huge, it has to be $10m - $30m, and it has to be all available at the beginning of the project. There’s a huge amount of risk associated with those dollars and decisions have to be incredibly conservative.

What I think would be much better would be if the community could finance the games. In other words, ‘Hey, I really like this idea you have. I’ll be an early investor in that and, as a result, at a later point I may make a return on that product, but I’ll also get a copy of that game.’

So move financing from something that occurs between a publisher and a developer… Instead have it be something where funding is coming out of community for games and game concepts they really like.

Several musicians and labels are showing this fan supported model can be quite successful, providing a business model that ensures the creators get paid and fans get something worth paying for.

Musicians like Jill Sobule found great success offering a tiered system of fan support where fans paid different amounts for different rewards including $10,000 to sing on the album (which someone paid). Game developers can offer many useful and scarce products to entice fan support from test early builds of the game, add their voice or likeness to a character, create a monster, access to design documents, art books, and creator Q&As.  All of these are already offered by many game developers after development.

The numbers are more than scalable, even for blockbuster games.  $50, less than the price of most console games, from 100,000 fans would raise $5,000,000, more than enough for a quality game.  More popular developers could easily raise more.  And developers might even keep costs down by getting rid of their retail marketing costs and allowing fans to contribute to the game’s development.  Valve itself released Counter-Strike, a fan-modification of Half-Life, at retail.  That fan modification, released for free online has sold more than 9 million copies.

A blockbuster game budgeted at $20 million could be built off $20 from 1 million fans.

The best part – since the game development is already paid for, piracy is no longer an issue.  The fans who paid received extra benefits and the ability to support the game’s creation. Anyone who downloads the game for free has the chance of becoming a fan and supporting the next game. This model encourages the game to be spread to as many people as possible. Not everyone will pay, but the more that play it, the more people who might contribute.

Controversy swirled last week on allegations that Last.fm’s parent company CBS gave the RIAA user data for possible use in civil and criminal cases. All those involved in the story have denied these allegations, though Techcrunch stands by the story.

It’s impossible to filter the he-said she-said right now, so instead let’s look at all the good that can come from the RIAA looking at Last.fm’s data. First, it’ll be almost impossible to make any case based on the data – Last.fm shows what music people listen to, but not the source (whether its legal or pirated). Instead, the RIAA could use this massive amount of data on real listening behavior to find new revenue streams and marketing opportunities. The RIAA could see exactly who likes one thing and then listens to another, helping to plan concert schedules and other events (like they already do with piracy data).

What would be even better is if the music industry took this data and used it to find new musicians and bands that fit the listening tastes of music fans (the ones listening). Using actual user actions can be much more efficient than focus groups or other market testing, but rarely is that data available. Of course, this is another benefit of the internet’s cheap and easy distribution – easy market testing. Post a new song to Last.fm or YouTube and see what happens. Do a little self promotion and you might have the next Susan Boyle on your label.

Of course, the RIAA won’t do any this. They’d much rather claim they’ve stopped suing people then continuing on suing. More money there than actually finding new business models.

I often get into arguments about why I don’t think piracy is wrong, but actually helpful to businesses.  The crux of many arguments, from newspapers to music to software, revolves around how people should be paid for their work rather than will people pay for that work.  This is a serious disconnect that explains much of the frustration many feel regarding new business models and free content.

Content creators argue they should be paid for their work. If they aren’t paid for their work, no one will make music, movies, investigative journalism, or video games. We’ll live in a silent, non-fun, corrupt world of animals on skateboards.

But this is not the economic reality.  In capitalism, people can try to make money, but there is no right to it.  600,000 small businesses are started each year and more than 50 percent will fail within the first five years.  No one should have to support these businesses. It’s up to each business to find a market need and fill that need.  While making money is obviously the goal, it is a side effect of effectively meeting a market need.

The content industry (I’m including newspapers and software) certainly filled important market needs – entertainment, productivity products, information and education, etc.  But they got used to a business model based on little competition and monopolies on distribution. The market has changed, but the market need is still there.  People will always want all these products.  But without the monopoly on distribution, consumers have more choice to market products.  More competition drives prices down, and this means for the content industry, the price of content is zero.  The value is still high, but there’s so much of it, you can’t price it higher.  It doesn’t matter if you should be paid for your content.  No one will pay you because another company will fill the market need at the lower price.  This is why you have to treat piracy like a competitor, not a threat, because it’s the market demanding change.

When a company says people should pay, it’s claiming a right and entitlement to compensation.  Obviously, if someone works hard, it’s good to be rewarded, but often hard work comes with the risk you won’t be properly compensated. That is business. It’s competition. It’s healthy for the economy overall.  If companies are guaranteed money, they don’t have to try as hard to earn consumer’s money by creating valuable products that feed market needs.

This is why Google chairman and CEO Eric Schmidt was so right when he told newspaper executives they shouldn’t piss off consumers.  Consumers decide how they want to consume news, not news executives.  If consumers won’t pay for newspapers, then newspapers will go out of business.  Nothing can change that.  You might think they should or even have to pay, but the economic reality is, they won’t.  Even if piracy is stealing, it’s the economic reality. It’s what the market wants. Nothing can change that.  The successful businesses of the future will learn how to capitalize on this market demand and find new, innovative ways to make money.  Everyone else will get left behind.

Clay Shirky has an excellent article about how the newspaper industry and how technology affects business models. Shocking to many newspaper and music executives, this is not the first time technology has upended business models. Just like before,  the old systems break before new systems are put in place because it takes so much experimentation to find new business models.  Shirky summarizes “If the old model is broken, what will work in its place? The answer is: Nothing will work, but everything might.”

Shirky opens with a great quote putting the newspaper predicament in perspective. He quotes Gordy Thompson talking about Usenet piracy of Dave Barry columns. “When a 14 year old kid can blow up your business in his spare time, not because he hates you but because he loves you, then you got a problem.”  The problem for newspapers is not a loss of interest in news, but a loss of interest in paper. Do we save newspapers or do we just redefine how get our news?

Shirky states wonderfully how newspapers seem to dwell on how we’ll replace newspapers – that without newspapers, there will be no watchdog for government or business (cause of the bang up job they’ve been doing). But with the fall of one business models leaves open experimentation for a new business model.  Automobiles make horse and buggies obsolete before we have an widespread, paved roads. Or as Shirky highlights, the printing press made for chaotic business models back in the day.

The Bible was translated into local languages; was this an educational boon or the work of the devil? Erotic novels appeared, prompting the same set of questions. Copies of Aristotle and Galen circulated widely, but direct encounter with the relevant texts revealed that the two sources clashed, tarnishing faith in the Ancients. As novelty spread, old institutions seemed exhausted while new ones seemed untrustworthy; as a result, people almost literally didn’t know what to think. If you can’t trust Aristotle, who can you trust?

During the wrenching transition to print, experiments were only revealed in retrospect to be turning points. Aldus Manutius, the Venetian printer and publisher, invented the smaller octavo volume along with italic type. What seemed like a minor change — take a book and shrink it — was in retrospect a key innovation in the democratization of the printed word. As books became cheaper, more portable, and therefore more desirable, they expanded the market for all publishers, heightening the value of literacy still further.

That is what real revolutions are like. The old stuff gets broken faster than the new stuff is put in its place.

While it seems we’re giving up newspapers for the hope something new will come along, the truth is newspapers need to fail for the new thing to be worth trying.  And as past transitions have shown, the new model is often more efficient and profitable and better for all parties.

The Guardian posts an interesting theory that for Amazon’s Kindle to be more successful, it needs more widespread piracy.  Unlike Apple’s iPod, Kindle users can’t transfer their book collections onto the hardware like CD-to-MP3s.  Every book must be purchased or downloaded. And while book piracy does exist, it relies on devoted fans copying every page – not as easy as an automated CD ripper.

The Kindle is selling quite well for Amazon, but hardly on the road to travel dominance like the iPod. This might show the market is not as ready for the iPod of books as it is for the iPod of music.  As I’ve (and others) have written, piracy shows what the market wants and at this point, digital books are not in high demand.

Book and content producers need to understand why this is the case. Right now, books are more valuable to consumers for any variety of reasons, like convenience, habit, and collecting.  We know reading online/on the computer is a preference for many for short features, like news articles, but books are still preferred in tangible form.  The Kindle isn’t going to change the habits of consumers, but it’s a forward looking option that knows paper’s days are numbered.

Unfortunately, the book industry is leaving clues they are more likely to follow the close-minded music industry approach.  Paul Aiken, the executive director of the Author’s Guild claimed the Kindle’s new text-to-speech feature was an act of copyright infringement by allowing any book to be read aloud saying literally: “They don’t have the right to read a book out loud…That’s an audio right, which is derivative under copyright law”. According to his logic, reading any book out loud, even a bedtime story for your kids, is a derivative work and thus copyright infringement.  Or, maybe, this feature is just a way to make the Kindle, and thus digital downloads, more valuable to consumers. It’s unlikely a computerized voice is going to replace emotional actors on audio tapes.

For book publishers, they need to plan for a future where books are digital and readily pirated. It’s already happening on a very small scale.  Instead of fighting the inevitable future, book publishers can embrace the change and profit from it. First, embrace the cheap distribution of digital goods and include digital downloads of books with the purchase of a hard copy. Even spread full, free downloads online – several examples of free eBooks show huge increases in tangible book sales.  These sales come because the hard copy is more valuable than the digital copy.  Book publishers need to increase the quality of the published books, recognizing why people buy them.  Small, soft cover travel copies are perfect for convenience customers (and should be cheap, impulse buys). For collectors, like everyone I know with huge bookshelves to fill, increase the value of hard covers with gorgeous art, author’s notes (the paper form of commentary tracks), and high-end binding.

These features give customers a reason to buy the hard copy.  This way, when book piracy explodes, book publishers are already offering compelling alternatives that give customers a reason to spend their money.

I will be speaking at the Flow Conference in Austin, Texas on October 9th at a round table about music and copy protection.  I’m posting here my position paper, though regular readers should be familiar with my opinion on the subject.  If anyone’s heading to the conference, please contact me in the comments, email or Twitter.

The other panelists will be (links go to panelist’s position papers).

Patrick Burkart, Texas A&M University (convener)

Danny Kimball, University of Wisconsin-Madison

Ali McMillan, University of Western Ontario

Moderators: Marnie Binfield and David Uskovich

This is the question the roundtable will be discussing:

More and more music fans, artists, and labels are rejecting DRMed file formats in favor of more lenient digital music sharing policies than what are available through most commercial music service providers. Under what conditions do music fans resist copy protections? When have music labels dropped copy protections? What is the disposition of digital music distributors towards DRMed formats?

My response

Thanks to technology, more people are creating and listening to music than ever before. With computers and the internet, it is cheaper and easier to produce and distribute music. Instead of embracing technology, music companies are using technology like DRM to stifle innovation and user value, trying to control their evolving industry.

DRM gives record companies the feeling of control over their music – control they no longer have. But the economics of music are changing. The cost of distributing music has dropped to almost nothing, making music infinitely reproducible by anyone. Music companies used to decades of controlling distribution need to adjust to a new marketplace where plastic discs don’t matter. This means radically changing music’s business models.

Musicians and publishers feared the first digital music device, the player piano, more than a century ago. In 1906, John Phillips Sousa and music publishers asked Congress to ban the player. Instead, Congress instituted the compulsory license system still used today. This took away control from publishers, but helped everyone make more money by embracing the benefits of the technology, selling piano rolls to make songs more popular and performers more valuable.

Computers and the internet can be just as profitable when embraced. Musicians like Trent Reznor, Radiohead, Jill Sobule, Kristin Hersh, and Maria Schneider are experimenting with new business models using infinite goods to sell scarce goods. Reznor posted his own music on file-sharing networks while selling premium editions of his album with a Blu-Ray slideshow, vinyl version, and signature. Reznor grossed $1.6 million in the first week even though his music was freely available online. Sobule and Hersh let fans support the creation of their albums by selling private performances, chances to sing on the album, or executive producer credits. Music companies study file-sharing networks to target advertising and decide tour locations based on the popularity of artists.

Most music companies treat new technology like the enemy, using DRM to limit what technology can do. DRM aims to prevent file-sharing, helping music companies control distribution of an infinite good, while taking away value from paying customers. Music companies expect customers to pay more dollars for less value.

But DRM does not stop file-sharing. Only one MP3 file is needed to spread to thousands of freeloading fans. Almost every form of DRM gets circumvented within days meaning one file always makes it onto file-sharing networks. EMI began selling DRM-free files on iTunes partly because DRM has no effect on piracy.

While DRM fails at its only purpose, it succeeds in making music less valuable, treating paying customers like criminals, and causing technical and public relations nightmares from installing malware (Sony rootkit) to failing devices (Blu-Ray players that don’t play all Blu-Ray discs). DRM-free stores like Amazon and Wal-Mart evolved out of necessity. Music companies forced Apple to lock iTunes with DRM limiting files to only play on iPods. As Apple sold more music, it sold more iPods. When Amazon and Wal-Mart launched their music stores, they had to offer them DRM-free so songs could play on iPods. The music industry handed Apple control over its digital future, from pricing to marketing, because of DRM.

Some DRM validation services get canceled, leaving companies with expensive public embarrassments and unhappy customers with useless music. Yahoo, Google, and Microsoft all canceled support for their DRM. Yahoo and Google offered refunds or DRM-free alternatives to all customers while Microsoft, due to public outcry, reinstated its DRM.

It’s up to the music industry to develop business models that embrace the promotional value of its music to sell more valuable scarce goods. Entertainment has used this model for decades: Television provides free shows supported by advertising and music uses the promotion of radio to increase album sales. There is more money to be made embracing technology rather than fighting it. People can listen to and share music, becoming bigger music fans, and increasing demand for scarce goods like concert tickets and collectibles. Thanks to computers and the internet, every MP3 is a promotional tool.

The music industry needs to adapt to the changing marketplace. Use technology to give customers more value: give people a reason to spend their money. DRM takes away value from customers, causes public relations nightmares, and provides no benefit except a false sense of control. Instead of fighting file-sharing, embrace it as a competitor and offer a more valuable customer experience, not try to control the experience. More value means more money. And that’s good business.

Work Cited

Doctorow, Cory. “Microsoft Research DRM talk.” Microsoft offices, Redmond. 17 June 2004. 1 Sept. 2008 <http://www.craphound.com/msftdrm.txt>.

Masnick, Mike. Techdirt. 1 Sept. 2008 <http://www.techdirt.com>.

You read that headline right. TorrentFreak reveals MediaDefender, the infamous anti-piracy firm working on behalf of Big Content, has been moonlighting as a porn pusher.

To disrupt online P2P networks, MediaDefender often floods searches with false files, many of which redirect users to these porn sites.  The redirects have been extremely effective, converting 1 in 2000 LimeWire users.  MediaDefender’s Ben Grodsky wrote in an email:

One of the theories I’ve had about why the LimeWire redirects sell so many porn subscriptions is because one basically can’t get porn on old versions of LimeWire because our popups and spoofs overwhelm the user.

MediaDefender makes $4,000 to protect an album, $2,000 for a single song, and almost a million dollars for a movie. Basically, MediaDefender is paid by these media companies to promote its other efforts.  That’s a pretty healthy business model, as long as morals aren’t an issue.

Seriously, MediaDefender is doing more to show P2P is a viable business model, something Big Content isn’t looking to admit.  Their tactics are mostly spam and obviously frustrate users, but work. Just think if a caring, responsible company used P2P for promotion, helping users find the content they were looking for or selling related scarce goods for the content users do find.

EA released the long-in-development Spore this weekend, packed with repressive DRM.  Gamers have responded by flooding Spore’s Amazon with one star reviews (more than 650).  EA limits Spore to only three installations.  Uninstalling the game does not increase that number, leaving paying customers to prove they legally purchased the game to EA for permission to play the game.

All this happens in the name of preventing piracy. But Spore has been available on Bittorrent sites for almost a week sans DRM. This leaves paying customers to deal with restrictive DRM.

EA knew a public relations nightmare was brewing when it announced the DRM back in the spring.  After public outcry, EA removed part of the DRM requiring a validation check every 10 days, but EA kept the three installs limit that is frustrating gamers.

So piracy is running free and paying customers are pissed off.  How is DRM supposed to work again?