Based on Research By Dinah A. Cohen-Vernik, Devavrat Purohit and Preyas S. Desai

Digital Rights Management (DRM) Cuts Down On Online Piracy, Yet Major Record Labels Offer Consumers DRM-Free Music Tracks To Increase Profits.

  • Many fear the trend toward eliminating Digital Rights Management (DRM) restrictions in the music industry will increase piracy. But the impact on piracy depends on competition for various music products and how competitive pricing shapes consumers’ buying preferences.
  • In certain instances, removing DRM restrictions reveals an unexpected gain: less piracy and more legal music downloads, along with a decline in the sale of traditional CDs.
  • In any industry where digital content is sold – music, books, video games – managers should consider the nature of competition before assuming that DRM restrictions are the way to go.

Digital Rights Management (DRM) is a collection of technologies used by creators of digital content to stem the tide of online piracy – yes, that’s what it’s called when you access or distribute digital content, such as music, without paying for it. And at least one leading industry group claims that pirates cause $12.5 billion in losses every year. At first blush, using digital locks to protect digital rights make sense. After all, we use physical locks to protect physical property that we own.

However, DRM restrictions are viewed as unfairly punishing the innocent along with the guilty. Think about it. Only law-abiding citizens buy DRM-restricted products, so DRM restrictions put the cuffs on legal users, not pirates. Second, anyone who’s been forced to burn a song to a CD before uploading it for play on a device knows the cost paid in sound quality – all this because DRM often keeps users from making a backup copy of legally-owned music and/or from playing music on a device of their choosing.

Major record labels now are offering consumers DRM-free music tracks. But as DRM-free music takes center stage with record labels, what effect will this have on piracy and profits? Will pirates sail freely through the high seas of a DRM-free music market, brazenly stealing profits out of the hands of vulnerable record labels and retailers?

Not necessarily, according to findings from a study published by Dinah Cohen-Vernik, assistant professor of marketing at Rice Business, and her co-authors. The researchers developed an analytical model of a music distribution channel comprised of both download services, such as iTunes, and traditional retailers of CDs – both of which are distribution options for a record label. The product is a music album that consumers could buy in a downloadable, digital format or traditional CD format. The downloadable version could be either DRM-restricted or not, but consumers have different preferences and utilities (or values) associated with various formats. Notably, if consumers choose to pirate a digital version, then they must face the ethical and technical costs associated with pirating.

Findings from the study reveal that under certain conditions, making piracy easier by removing DRM restrictions provides an unexpected gain: less piracy and more legal music downloads, along with a decline in the sale of traditional CDs. So record labels don’t always benefit from DRM restrictions. Sometimes they are more profitable with a certain degree of piracy in the market. What gives?
First, without DRM restrictions, the legal-download product has the same benefits as the pirated version. All else being equal, eliminating DRM restrictions reduces the incentive for consumers to engage in piracy. But there’s more to it than that. Without DRM restrictions, the cost of piracy drops. But because of the nature of competition, piracy doesn’t necessarily increase. Here’s how it works: In response to the falling cost of piracy, retailers of legal downloads drop prices in order to compete with pirated products. In the end, if retailers’ price for legal downloads falls more than the decline in the cost of pirated products, then piracy will decrease because the value of the legal-download product has improved in comparison with pirated versions.

Also, without DRM restrictions the legal-download product would be a stronger competitor to traditional CDs. In response, retailers of CDs would lower prices while retailers of legal downloads would increase prices – continuing until an equilibrium price was reached. For this reason, Vernik-Cohen and her co-authors argue, DRM restrictions really serve to protect the interests of retailers who sell CDs, whose prices are higher with DRM restrictions, rather than firms that sell digital music. Bottom line: When DRM restrictions are removed, the impact on piracy is determined by the extent of competition among pirated products, legal-download products and traditional CDs, as well as how competitive pricing shapes consumers’ preferences for buying versus pirating.

The researchers also developed additional models to explore the profit consequences of removing DRM restrictions. In doing so, they found that even if piracy increases, profits for record labels are not necessarily reduced. They also found that profit increases for retailers of legal-download products, but that profit could go either up or down for retailers of traditional CDs.

Regardless of a firm’s position in the music distribution channel, a manager’s best bet is to focus on profits, not pirates. Imposing DRM restrictions on customers who already are legally inclined could backfire and motivate them to engage in piracy. Yet the reality is that many folks don’t find the life of a pirate very appealing, and would buy digital music even when it’s available for free. For the rest, managers should consider making legal downloads the preferred choice by, for example, actively promoting the moral costs associated with piracy.

So in any industry where digital content is sold – think music, books and video games – managers should consider the nature of competition before assuming that DRM restrictions are the way to go. Overturning conventional wisdom could help them profit in the presence of online piracy.

Dinah Cohen-Vernik is a marketing professor at Jones Graduate School of Business at Rice University.

To learn more, please see: Cohen-Vernik, D., Purohit, D., & Desai, P. S. (2011). Music downloads and the flip side of digital rights management. Marketing Science, 30(6), 1011-1027.