In Part I of this post, I discussed the nature of two-sided networks and how network effects leads to the success of a small number of companies in ebook distribution. Part II of this post analyzes how the use of DRM in ebook distribution magnifies these network effects.
There has been a lot of discussion as of late regarding the role of DRM in the ebook industry. Many publishing companies have pushed for strong DRM in order to protect their rights as copyright holders. Because replication of digital files is so easy, many fear that unprotected ebooks will lead the proliferation of pirated copies. While publishing companies’ desire to protect their content (and their source of profit) is understandable, the current use of DRM carries unintended consequences.
Ebook aggregators and distributors have responded to publishing companies’ concerns largely with proprietary file formats and DRM techniques. Amazon’s format and DRM are different than Sony’s which are different from Barnes & Noble’s. By allowing these competing formats, publishers have given up considerable power in the value chain. Why? Because proprietary formats and DRM increase switching costs for users and can eventually lead to winner-take-all platforms.
Consider a new ebook consumer who wishes to purchases a dedicated ebook reader. Currently, the individual can choose from Amazon’s Kindle, Sony’s eReader, several small brands, and soon the Plastic Logic device. The individual will consider many factors in making the final decision. However, one of the most important considerations will be the future of the device and the library of titles it is connected to and compatible with. If a consumer chooses a device (or simply buys ebooks) from a distributor that exits the industry in the future, that device and its files could become all but worthless (witness the Fictionwise debacle in January 2009). With proprietary file formats and DRM, it is very costly for a consumer to pick a loser.
So, how does a consumer sort out the winners from the losers? There’s no full-proof method. But the danger for publishers comes when individuals employ the following simple logic: The company with the most users is least likely to exit the business. Strictly speaking, that makes sense. And, the logic becomes self validating as time goes on and additional consumers employ it. Economists have a name for this -- they call it same-side network effects. Any given ebook platform is more valuable (in this case because it carries less risk) when additional users join it.
This can eventually lead to significant control over the market by a single company. Because of this, the current method of ebook DRM does not benefit the publishing industry. If current DRM practices continue, growth in the ebook market will likely lead to increased power among ebook distributors in the supply chain.
