Steve Jobs and the iTunes DRM Threat to Microsoft
Steve Job's recent comments about DRM and the music industry have drawn cautious praise from foes of DRM and quick criticism from those who prefer to believe that his comments were only made to diffuse pressure from the European regulators complaining about Apple's proprietary FairPlay DRM on iTunes purchases.
Anyone who hasn't read the article, should. It provides some interesting insights into Job's efforts to sell music and why Apple has been able to make money in online downloads while other companies--that were both larger and ahead of Apple in the online music business--have been unable to make any progress at all.
DRM as a Business Model
Before Apple released its FairPlay DRM at the unveiling of the originally Mac-only iTunes Store, DRM systems developed by Sony, Microsoft, and others were already established.
The Danger of DRM recounted how Sony and Phillips had tried to introduce DRM-laden digital music formats throughout the 90s, but ended up destroying any market for new digital players.
The Danger of DRM recounted how Sony and Phillips had tried to introduce DRM-laden digital music formats throughout the 90s, but ended up destroying any market for new digital players. Sony's MiniDisc, Phillip's DCC, and the two companies' collaboration on DAT all ended in failure as consumers largely ignored the new digital products rather than quickly leaving their recordable analog cassettes behind. When the technology to burn CDs was released, the game was over; MP3s and mix CDs--devoid of any DRM--became the new way to listen to music.
At the beginning of the next decade, Microsoft began releasing a new DRM effort referred to as Windows Media. Ignoring Sony's previous blunders, Microsoft developed a complex array of DRM security to allow providers to sell any kind of digital media under what ever set of DRM rules suited their fancy.
The result was the failure of the PlaysForSure partnership, followed by a bang-up solo effort in Microsoft's Zune, which used the same technology but introduced artificial restrictions that prevented the two versions of the same Janus DRM from playing each other's content.
If we could thaw out some Neanderthals, reanimate them, and teach them our language, they would no doubt quickly grasp why Microsoft failed back to back by repeating a strategy that had failed earlier for Sony.
Apple's Threat to DRM
It has been no secret that Jobs struggled to convince music executives to sign up with the iTunes store. Even after several years of rapidly escalating sales, Apple ran into the same difficulties in getting movie executives to add their content. So far, while iTunes has all the major music labels, it has only signed up Disney and Paramount for movies.
The reason for all the guarded hesitancy by content producers is the fear that Apple would be too liberal in use rights; once Apple were established as the only company able to successfully sell mass market content online, they worried it would have too much market power and could force content owners to lower prices, give up profits, and relax user restrictions.
That's a valid concern for producers, because Apple is not really interested in pushing DRM. It's not because Apple is holy and righteous, but because Apple makes little money from selling content; it makes its money selling hardware. For Apple, being able to sell its hardware requires available content; that content is a means to an end, not a business plan.
It's Not Blades and Razors
Analysts have long tried to describe Apple as selling blades and razors, an allusion to Gillette, the razor maker that got rich losing money on razors but made it all back in selling replacement blades. In the case of Apple, analysts imagine that the same thing is going on, except that Apple makes money on both the razor and the blade because it sells both the player and the music.
Of course, that's not really a good analogy at all. Apple makes a lot of money on the iPod, and only breaks even selling songs in the iTunes Store. That's not a guess, nor is it a secret. Apple's earning reports show quite obviously where the company makes its money.
"Blades and razors" is not just a flawed analogy, but really a completely unrelated business model. Apple's iPod business is far closer to how it sells Macs. In both cases, Apple makes the majority of its money selling hardware, and barely anything selling software. However, that mostly profitless software is essential to making sure that its hardware actually sells.
It's Cars and Roads
Apple's model is closer to the plight of car makers, who are dependent upon the availability of roads. Making roads is a huge waste of money to an enterprising capitalist. The only companies in the road making business are either being paid by governments or have some special bit of land that can support a toll road.
In general however, nobody could afford to build networks of roads and sell access to them. While there is a huge demand for roads, there are no profits, because nobody wants to pay for the roads they use.
So like the equally unprofitable businesses of healthcare, water, and defense, society hands it over to the public sector to maintain. Yes, there is money to be made in all those industries, but not by taking money directly from consumers to provide them.
In Apple's case, its cars will sell only if enough roads are available. Apple ran into difficulty with the Mac in the mid 90s because it wasn't paving its own software roads; it relied upon third party developers to build them. Once Windows became ubiquitous, many of the roads stopped supporting Macs. Without enough roads, Apple couldn't sell its car.
Apple bounced back by building its own set of roads, which offered a more pleasant drive. They also were only available to Mac drivers. Apple has also recently done more to encourage and support third party Mac road construction. The more software roads to drive upon, the more Macs sell.
Everyone is excited to buy a sexy car, but nobody wants to pay for the use of roads. Just like road construction, it's difficult to make money selling software, because while everyone is excited to buy a sexy computer, nobody wants to pay for software licensing.
Free software advocates have worked to build free, public roads available to anyone. Apple has worked to make sure its Macs support and leverage the variety of free software already available, and is encouraging its use. It has contributed back its own technology as well.
High Cost, Low Profit Content
The cars and roads analogy also applies the iPod. While iPods sell at an easy profit, there simply isn't a lot of money to be made in selling content for it. There are two main reasons:
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•high quality, desirable content--like software and roads--is difficult and expensive to produce.
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•owners of existing content want money for use of their content, because it cost them a lot of money to make.
Some of the highest regarded content worldwide is government supported: the BBC, and other nationally supported movies and TV offer many examples. Left to the private sector, content commonly boils down into whatever is cheapest to produce. American daytime TV turned to soaps, then the much cheaper talk shows, then the even cheaper reality shows in search of a profit. The BBC isn’t profit motivated to produce trash.
The high cost of content explains why Apple simply can't really churn out its own music and movies for the iPod, just so users can have somewhere interesting to drive. Apple has to license rights from existing content holders.
That's why the iTunes Store makes so little money, despite selling hundreds of millions of songs. The vast majority of that revenue is going to the labels and studios. Apple is investing the rest back into the iTunes Store so that potential iPod buyers have as many new places to go as possible.
That's why Apple got behind the entirely profitless podcasting business in iTunes as well. If there were huge amounts of cash to be made in reselling content online, Apple would be stupid to be pointing people toward free content. As it is, Apple is smart to be offering alternative content so users will have yet another reason to want to buy iPods. The fact that the average iPod user only has around 25 tracks--many none, some a lot--indicates that online media sales are an accessory business, not a key moneymaker for Apple.
That also explains why Apple has little interest in making sure music and movies are managed by DRM. The only reason FairPlay is around is to make sure there is content for the iPod.
Had Apple left things to Sony and Microsoft, all the labels would still be struggling to sell their music in WMA and ATRAC formats, which only run on Windows PCs and devices licensed by Sony or Microsoft. The Mac and iPod would both be left out of the loop on downloadable commercial content.
Apple's Vendor Lock Is A Better Product
From that perspective, it's obvious why Jobs announced that Apple would drop its DRM efforts in a hot minute if only it were allowed to by content providers. As pointed out earlier, it's a myth that the small proportion of iTunes content on iPods is being used to lock users to the iPod. Apple is locking in sales by offering a better product.
The fact that Xbox games only work on the Xbox does not prevent Xbox users from also buying a Wii on the side to play Wii games. The half million additional Macs being sold every quarter to former PC users was not prevented by those PC users having PC software that couldn't make the transition. The DVD wasn't held back by the inability of customers to shove VHS tapes into them for playback.
Apple doesn't have to force users to buy Macs and iPods with exclusive OEM contracts; people go out of their way to buy them. That means Apple isn't afraid of losing its vendor lock, because the only way it can lose sales is by failing to innovate.
Imagine There's No DRM
So what would happen if labels allowed Apple to sell music and movies without DRM? Previous articles have stated that DRM makes viable markets.
If music from iTunes were unrestricted, there would be far more sharing of that music. However, given that CDs comprise the vast majority of music actually sold, and the triviality of ripping CDs from iTunes and distributing songs without authorization, it's hard to understand why labels are worried about DRM in iTunes.
If Apple were freed from having to devote its resources to managing and policing DRM, it could focus its efforts on offering a variety of formats, including high definition lossless downloads. That would expand the demand for online music. Currently, the only reason why some users don't buy from iTunes is the limited bitrate.
In an iTunes Store without DRM, would the increase in the amount of stolen music be offset by expanding the market for digital downloads to premium users who want higher quality recordings?
Given how easy it currently is to defeat FairPlay by simply burning a CD, it's not hard to imagine that sales might skyrocket if DRM went away, the selection expanded, and other device makers started bundling iTunes for access to an online store for their players.
How No-DRM Would Affect Apple
The main beneficiary to increased iTunes sales wouldn't be Apple--which only makes a few cents on every sale--but rather the record companies themselves, who rake in the majority of iTunes Store revenues.
Further, what would happen to iPod sales if any player could play music obtained from the iTunes Store? It could only help the struggling Creative to have access to a store that works. It might help the Zune, which is currently saddled with a byzantine store supported by an inconvenient points currency. It certainly wouldn't benefit sales of the iPod in the least.
So why is Apple describing itself as being behind the defusing of DRM? Analysts who accuse the company of vendor lock in, monopolistic behavior, and collapsing sales must all be very confused, because their theories don't support Apple's willingness to abandon DRM at all.
How No-DRM Would Affect MicrosoftThe world's leading proponent of DRM, Bill Gates, was credited as the software architect behind Palladium, an ultra secure system for enforcing access controls and DRM in hardware.
A Palladium PC would tell users where they could go, rather than just asking them where they wanted to go.
After being harshly criticized by user rights advocates, Microsoft dialed back its plans for Palladium, but still incorporated strong DRM controls into Vista that seek to clamp down every potential vector for extracting high quality video or audio that is not expressly authorized. Windows Media similarly strives to maintain its lead as the tightest ship in the DRM armada.
If Apple were allowed by studios and labels to offer music and movies without DRM, Microsoft's DRM would completely run aground. Its huge investments in courting the favors of the content industry would be worthless, and its architectures for deploying ultra secure payloads of entertainment would be unsalable.
That suddenly makes it crystal clear why Jobs is disinterested in DRM. If studios and labels allowed Apple to dump DRM in the iTunes Store, Apple might lose a handful of diehard Creative fans and Zune lovers and face slightly more competition in the music player arena, but that would be a very cheap price to pay for ridding the online music and media industry of the looming 800 lb gorilla.
Microsoft has the billions to hand out free Zunes to everyone in America and cram Zune-branded DRM down everyone's throat. So far, the only thing that has held the company back is the hubris that it could beat Apple in the marketplace. Having failed miserably for two years with PlaysForSure, and then even more spectacularly with its own Zune, Microsoft is now a desperate and angry loose cannon.
The Last Angry Dash
When Microsoft fails in the market, it has a long and documented history of turning to anticompetitive, and even criminal behavior. The company has tight political ties to the far right and the Bush administration, and is rumored to be pushing the dismissal of state Attorneys General in order to engage Apple in a political imbroglio over its highly hyped options backdating.
Never mind that Microsoft itself danced through its own options backdating during the same era; Microsoft also skidded through a Federal Monopoly trial and several state cases that all have resulted in nothing more than a few inconsequential fines and done little to prevent further misconduct.
What would happen if Microsoft could marshal the political capital it has paid mightily to accumulate and fire it along with all its rage toward the only company that's really getting in its way and making it look foolish?
There are few other weapons for Microsoft to pull out: Vista is being compared to Tiger from two years ago; its star PC hardware maker Dell has fallen down and can't get up; and the media has become wise to its FUD and is increasingly difficult to charm with vaporware promises.
But Wait, There Is One More Thing
The threat to DRM is not the only thing that has Microsoft upset. The next articles show how Apple is targeting another Microsoft mainstay with a missile that may cause far more damage than the iPod and iTunes together.
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Wednesday, February 7, 2007
