for a few dollars more (VII)

This may explain why customers didn’t discover some movies before the pay-cable window, but it doesn’t explain what changed during the pay-cable window. Why was the discovery process in the pay-cable window different than discovery in the preceding theatrical and DVD windows?

One reason may be that, in contrast with the theatrical and DVD windows, in which you pay separately for every movie you watch, in the pay-cable window you pay no per-movie charge; once you pay the monthly subscription fee, you can watch anything on the network “for free.” This ability to watch additional movies without an additional fee may allow pay-cable consumers to take a chance on movies they weren’t willing to pay $15 to see in the theaters, allowing them to discover movies they wouldn’t have discovered otherwise.

But this sort of information discovery is valuable only if there is enough differentiation between the channels. For example, after consuming a product in the pay-cable channel, a customer may still want to buy it on DVD. If the products are too similar – for example, if consumers could easily record high-definition pay-cable broadcasts and watch the recordings whenever they wanted to – pay-cable broadcasts could compete with DVD sales instead of complementing DVD sales.

This brings us to our next marketing challenge for sellers of information goods.

Controlling Competition

In their book Information Rules, Carl Shapiro and Hal Varian use the example of CD-based telephone directories in the 1980s and the early 1990s to illustrate how competition can affect markets for information goods. In the mid-1980s, phone directories were controlled by the major phone companies and were licensed to high-value customers (such as the Federal Bureau of Investigation and the Internal Revenue Service) for about $10,000 a disk.

However, as technology made it easier to digitize and duplicate information, these high prices attracted new competitors willing to invest the money necessary to manually copy the information in the phone companies’ directories and make it available to the market. But once these competitors entered the market, the high-fixed-cost-and-low-marginal-cost economics of information goods took over, destroying the standard business models of generating huge profit from selling exclusive information to the highest bidders.

Economic theory predicts that, in a perfectly competitive market for undifferentiated products, prices will fall to marginal cost. Not surprisingly, that is what happened in the phone-directory market. As new competitors entered, prices quickly fell to a few hundred dollars, and then to less than $20. Today, phone-directory information is, essentially, given away.

On the one hand, these lower prices for information are great for consumers, at least initially.

On the other hand, marginal-cost pricing will hurt both producers and consumers if creators are unwilling to invest in new products for fear that they will be unable to recover their fixed-cost investments. Indeed, the desire to encourage investment in markets for information-based products is the reason most modern economies give creators of information goods limited monopoly power over how their products are brought to market.

The creative industries, in turn, take this limited monopoly power and do exactly what economic theory says they should do: They use it to extract value from consumers by preventing direct competition, and by carefully controlling the quality, usability, and timeliness of how their products are made available. In the book business, the sooner a consumer can obtain a low-priced or free copy of a book, the harder it is for publishers to segment their markets on the basis of timeliness.

In the music business, the easier it is for consumers to obtain the information found in bonus tracks and added features, the harder it is for labels to segment their markets on the basis of quality. And in the movie business, the easier it is for consumers to record and store content for future viewing, the harder it is for studios to segment their market on the basis of usability.

This means that whenever someone asks “Why don’t the creative industries make all their products available simultaneously in all potential distribution channels?” what the person really is asking is “Why don’t the creative industries abandon all of their existing business models based on price discrimination and customer segmentation?”

The problem, of course, is that in many ways information technology has already dictated this choice. The very market characteristics that can weaken firms’ control over customer segmentation – rapid information diffusion, easy information retrieval, and nearly costless information duplication and storage – are the basic capabilities of information-technology systems and networks, and their power is growing exponentially.

Today the critical challenge for people in the creative industries is determining how this technological change threatens their sources of market power and the profitability of their business models.