Monday, August 07, 2006

Digital Music Biospheres?

I have been torn about Apple's dominance in the digital music industry for some time now. On the one hand, I like how it aggregates consumer demand to bargain down the price of desired recordings. On the other hand, it seems like Apple is beginning to behave as anticompetitively as the recording industry it's trying to tame. If you have an iPod, you have to use iTunes. A norm of "consumer choice" would seem to dictate that I be able to use whatever software service I want to buy and organize my music, regardless of my MP3 player.

Recently, a French effort originally designed to "open up" Apple's iTunes software to rival MP3 players went into effect. Because of an intervention from the Conseil Constitutionnel, and some aggressive lobbying, the law's impact is in doubt. Rather than promoting interoperability, it may well end up thwarting it by hampering reverse engineering.

There has been some smart legal commentary on these developments already (here, here, and here). . . and I hope someone is thinking about whether the French court's angle on IP "takings" might create a constitutionalized "ratchet effect" of IP expansion here. But for now, I'd like to focus a bit on the policy here...particularly on Professor Wright's and Hazlett's argument that government intervention is unnecessary because rival services are likely to develop without it. I just want to challenge their rationale for diversity in services here, evoking hermeneutical economics (a narrative approach which their George Mason colleague Tyler Cowen has used in several enlightening and important works).

The Phenomenology of Digital Music Consumption

Let's stipulate that, in Hazlett's words, "rival field[s] of dreams [are] now being built by the Microsofts, Sonys, Dells, Amazons and T-Mobiles" to displace the iTunes/iPod juggernaut. Let's say each of them develops proprietary DRMs that prevent interoperability, and runs off to negotiate deals with the major labels. Do you really relish a world where you'll be trying to figure out which digital music player a) has the best software and b) has negotiated the best deals with the major labels? What if your preferred player is all of a sudden cut off by its label? (Echoes of Medicare Part D, anyone?). And what if one major hardware player bought up one or two of the major labels as subsidiaries? In other words, how far can vertical integration go before some alarm bells start going off?

Frankly, rather than rival fields of dreams, I can foresee rival "Biosphere 2" projects arising out of this type of no-holds-barred, verticalized competition...rather like the decay of pressPlay and musicNet. Just as one ought to doubt the ability of any team of scientists to figure out how life should play out in a "closed system," I doubt any one business's ability to plan out perfectly all my aural needs once I buy into its system. I just can't see why the competitive strategy of Apple (or any dominant player) should hinge on this type of hardware-software integration. I hope to research the situation in some Asian countries (where I believe another brand is dominant) to see what's happening there (particularly in S. Korea, which is way ahead of us re all sorts of electronics).


Blogger Josh said...

Frank, you misstate my argument. Allow me a few corrections. My argument is not that, as you put it, "government intervention is unnecessary because rival services are likely to develop without it." Rather, it is the government intervention is not necessary because there are not losses to consumer welfare.

There is long literature on efficiency explanations for bundling, tying, vertical integration, etc. We should not intervene without significant evidence of anticompetitive effect. We don't have it here. The only relevance of entry of rivals in my post was addressing the possibility that IF Apple abuses its dominant position to the detriment of consumers in the future, it appears from Microsoft's pending entry that rivals will be near to dissipate supracompetitive profits. That is an afterthought to the primary point that antitrust intervention is about consumer welfare.

One should note also that consumer choice is not the same as consumer welfare. In some industries consumers do not have a high demand for variety, i.e. I really only care that my grocery store sells a full line of spices and not that they carry 6 different lines whereas I care about the variety of soda.

Exclusive dealing contracts illustrate the point. These contracts obviously and necessarily reduce consumer choice. Yet, they are dealt with by the rule of reason in US antitrust law? Why, because they might provide other benefits for consumers. The same applies for vertical integration, which is precisely why vertical mergers do not typically raise antitrust concerns. The empirical industrial organization literature is pretty clear that vertical restraints are generally efficient and do not harm consumers.

So, the answer to your question: "In other words, how far can vertical integration go before some alarm bells start going off?" Until it threatens to harm consumer welfare. No doubt, you have more confidence in your ability to predict market outcomes than I do, but I suggest that you need not worry about the ability of a single business firm to perfectly plan your aural needs. Rather, should Apple fail to compete by satisfying consumer prefences, firms like Microsoft and others stand ready to appropriate these profit opportunities. Perhaps the much vaunted network barriers to entry are not as significant as we might have thought?

But that leads me to my last point/ question. On what basis to you believe that the competitive consequences of forced interoperability/prohibited vertical integration would be will make consumers worse off? What is the mechanism to which you attribute this harm? Are you accounting for the possible efficiencies of these practices resulting in lower costs and prices which must be traded off against whatever anticompetitive harm you are contemplating?

8/07/2006 5:33 PM  
Anonymous Anonymous said...

Frank, in keeping with other posts on this blog, I think instead of Biosphere 2 what you foresee is a series of music-player kipukas. Of course, kipukas are quite revered among the botanists in Hawaii, so maybe that wouldn't have the right ring to it.

Josh, I think the harm to consumer welfare that Frank is worried about (or one of them, anyway) is the harm that would result if Apple collapses, or stops selling iPods, or something, and all of a sudden the consumer's months or years of collecting iTunes music becomes unusable because it won't run on any other player. Of course, that's an argument in favor of an industry-standard encryption scheme like CSS, but the music industry so far hasn't been able to arrive at a single standard like that. I think there is undoubtedly a risk for iPod/iTunes consumers, which is why I don't plan on buying one. But my question for Frank is, how is that any different from the risk faced by any early adopters? There's a lot of people who got stuck with large collections of 8-tracks that they couldn't listen to when their 8-track players broke. There's people out there with expensive Iridium phones which no longer work, at least for ordinary consumers. So now those consumers must go about re-distributing a new phone number, and they have an expensive brick they can't use.

If you're worried about iPods/Fairplay fading into obsolescence, go with Rhapsody or Napster instead and get a player compatible with Helix or Windows Media 10. Apple has competitors on both the distribution and the hardware fronts. Correct me if I'm wrong -- I've only tinkered a little with this stuff (I'm an extremely late adopter) -- but in the case of Helix and WM10, you are not tied to a particular manufacturer's hardware, so I think you face less of a risk of having an unusable music collection due to one manufacturer's problems. If the service goes under you won't be able to get new music, but your existing collection should work as long as compatible players are manufactured.

8/08/2006 12:04 AM  
Blogger Josh said...

Bruce, I appreciate your point about the harm that Frank is trying to get at here. My basic point was that actual anticompetitive effects (or a high likelihood thereof in some instances) are a necessary condition for antitrust intervention and that in the case of IPod/iTunes the condition is not satisfied. One must demonstrate these effects to justify intervention, and my reference to Hazlett's analysis in the original post was for his discussion of the benefits consumers have derived from Apple's bundling.

To be sure, one could argue that "reduction in choice" is a per se anticompetitive effect. But the exclusive dealing example I give demonstrates that antitrust policy, fortunately for consumers, does not adopt such a backwards position with respect to both exclusive contracts and vertical integration. Taken to its logically required conclusion, such an antitrust policy would lead to absurd results.

The harm that you suggest is another possibility. But again, and as your comment quite correctly suggests, this harm derives from the competitive process and not from anticompetitive practices, e.g. if Apple collapses as a result of competition, or because some new technology makes the iPod/iTunes obsolete and gains favor with a critical mass of consumers, there exists no antitrust injury.

Perhaps the most important point that I wished to make (other than clarifying my position) was that a consumer welfare analysis of bundling or vertical integration while assuming away the potential efficiency explanations for the practices does not get us anywhere.

8/08/2006 12:26 AM  
Anonymous Anonymous said...

iTunes isn't the only thing that works with iPods...on Linux, anoraK (gotta love all the creative capitalizations) can also manage iPods. There are probably other third party s/w candidates out there, now or in the future. I think iPod's too popular for it to turn into paperweights if iTunes somehow collapsed.

8/08/2006 11:45 AM  
Anonymous Anonymous said...

Forgive the typo in the last post. Amarok has ipod support, and there's also gtkpod, though it's a little kludgy and also yamIpod, Crossover Office...they're starting to multiply. I've no doubt some of these open source apps would/could become available on windows/macs.

8/08/2006 11:52 AM  
Blogger Frank said...

Josh, thank you for this extensive response. I have two surreplies, which I hope are not too oblique.

1) Our colloquy here reminds me of a visit philosopher Charles Taylor paid to the Harvard political theory grad student group back in the mid-90's. Taylor gave a talk, and almost immediately afterward a group of Rawlsian graduate students started asking him "what role do the primary goods have in your theory? Are you adequately taking into account the nature of public reason, and the political, non-metaphysical nature of justice?"

Rather than answer the questions, Taylor simply said "I'm not translating my ideas into Rawls's terms, because too much would be lost in translation. Rawls has spawned one school of political theory, and a very powerful and interesting one. But his theory does not exhaust the field."

In other words: I have no doubt that the Chicago School of economic analysis has made fundamental contributions to our understanding of "brick and mortar" goods, coffee and coffemakers, M&M's and toothpaste. But in the realm of culture, we need a richer, more humanistic analysis. We cannot simply try to maximize "consumer welfare."

A simple example can show the fallacy here. Imagine two societies with two different record industries. In the first, a wealthy elite buys lots of music, and industry revenues are in the billions. In the second, very little is spent on music, but there are still thousands of songs created (say, via peer production). Does society 1 automatically "win out" as welfare maximizing? If the measure is so crude as to permit that possibility, what guidance can it give us?

Pace an early FCC chairman, TV is not a toaster with pictures. Diversity and quality in our cultural life are key values, not just maximization of the amount spent on music.

2) You also state that "should Apple fail to compete by satisfying consumer prefences, firms like Microsoft and others stand ready to appropriate these profit opportunities." But how can they when my iPod won't work with the other software? Are you assuming that I'll just go out and buy another one?

Again, I think that, given the decline in average disposable income over the past few years for middle class families, that's not a really good option for them. (See the chart here:

3) Finally, to comment on our "talking past each other:" I think your antitrust analysis is most likely impeccable. But I am trying to give reasons why we should change antitrust policy.

In other words, to use the categories developed in Charles Tully's fascinating book Why?, you are giving "codes" as reasons, and I am giving "stories" as reasons. Here's an account of the difference:

"As Tilly writes, [stories] circumscribe time and space, limit the number of actors and actions, situate all causes 'in the consciousness of the actors,' and elevate the personal over the institutional. . . Then there are codes, which are high-level conventions, formulas that invoke sometimes recondite procedural rules and categories."

You can give all manner of "scientific" rationales for nonintervention here (though I think your argument ultimately hinges on the rather arbitrary assignment of the burden of proof on me!). But consumers' nagging sense that they are the victims of sharp commercial practices will persist until we have a better sense of the efficiencies the major players' lock-in strategies really bring us.

8/08/2006 6:31 PM  
Blogger Josh said...

Frank, I appreciate your response. I offer this reply:

1) The assignment of the burden proof is not arbitrary. It is properly assigned to you. As you recognize, antitrust law currently operates largely within a consumer welfare framework. You would like to change antitrust law. As you are arguing for the change in policy, I suggest that this is one reason the burden is yours.

A second reason is that it is you that assert that the consumer welfare metric is "too constrained" to capture the cultural effects you are concerned about. I don't know why? Do none of these cultural impacts concern prices, quality, or quantity? You are probably right that there are some things out there not captured by CW that make perfect sense to be concerned with. Whether antitrust policy is the right instrument to deal with them is another question. Again, however, I suggest that the burden is properly placed on you with respect to the assertion that CW is not sufficient relative to some other real world alternative.

2) On a related point to (1), I am not attempting to force you to square your objections to the practice in consumer welfare terms. Again, if you believe that there is some concrete notion to which you can point that in terms of these "cultural effects" in which consumers are systematically injured but the harm goes uncaptured by the CW metric, I am listening. But I would argue (perhaps another time) that the CW metric is a good deal more flexible than you are giving it credit for here.

3) This next point is slightly off topic, but since you raised the idea, I thought it appropriate to respond. You refer to the "Chicago school" of economic analysis as being about brick and mortar goods, and failing to provide a more humanistic analysis. While I am perfectly happy to be associated with the "Chicago School," your characterization of this "type" of economic analysis is flawed in at least two separate ways.

First, Chicago School economics is not limited to brick and mortar goods. For example, economic theorists associated with the Chicago School have supplied some of the seminal economic insights with respect to intellectual property and the economics of information. One only read Gary Becker's book with Kevin Murphy on the economics of social interaction to know that your claim that this "type" of economic analysis (by which we really just mean "applied price theory" dont we?) does not address social interaction is plainly erroneous and does a disservice to the economists associated with that movement.

The second error applies more directly to our discussion of antitrust and bundling. It is not just the Chicago school that believes the CW metric is the appropriate one for antitrust analysis, but also those who associate themselves with "post-Chicago" thinking. I am not a huge fan of these labels because it is sometimes unclear what they mean. But in any event, the point is that economists who take far more aggressive interventionist stances than say, myself, have adopted the CW metric.

(4) I thought it would be nice to end on something that we agree on. After all, I am visiting your post. You write that "consumers' nagging sense that they are the victims of sharp commercial practices will persist until we have a better sense of the efficiencies the major players' lock-in strategies really bring us."

I could not agree more. Consumers often-times have a sense that lock-in strategies, or exclusive deals, and various other contractual terms cause consumer harm. The thing is that sometimes consumers are right about this, and sometimes they are wrong. Many contract terms (e.g. the exclusive dealing analysis above, or my work on slotting contracts) that consumers and rivals "sense" are anti-competitive actually increase consumer welfare. We do agree that more work needs to be done to empirically document the consumer benefits deriving from bundling.

In the meantime, let me end with the proposition that a sensible antitrust policy mindful of both Type I and Type II errors should, as a normative matter, require the plaintiff to demonstrate actual anticompetitive effect before condemning such a practice.

8/08/2006 10:17 PM  
Anonymous Anonymous said...

Just on the level of narrative, I'm still not sure I understand why iPod buyers are more at risk of harm than any other early adopters.

8/09/2006 12:31 PM  

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