:Fixed Point

Full Disclosure: I own 2 Apple computers, and ipod and have been using Apple’s for 15 years.

The Norwegian consumer body has ruled that songs downloaded from itunes must be playable on other machines. Maniacal Apple fans may see this forced union of itunes with non-Apple hardware as the exploitation of a classy and refined product by a queue of unworthy and inappropriate upstarts. A manifestation of techno-beastiality. I can’t sympathise with such jealousy so won’t comment. But the concerns of some who fear for innovation are more pressing.

Music companies dithered over digital music and their lawyers showed more creativity, admittedly in creating arguments to shut down Napster and co. Into this melee stepped Apple. It’s adorable hardware appealed to gadget freaks; music loving non-tecchies thought itunes a simple and intuitive way to buy music. Exclusivity between hardware and software was critical to the consumer proposition of making it easier to pay for digital music rather than steal it.

Apple’s own Fairplay copy protection system was also key to convincing record companies to buy in. Without exaggeration Apple can claim to have created the market for digital music.

So why do Norway, France and others want to rid themselves of this turbulent, innovative, profit hungry high priest of technology? What’s the problem if you can only play itunes songs on ipods?

Microsoft users will be familiar with the problems caused by a dominant standard with few alternatives: stuck with a second best that you are forced to use because everyone else does; or you buy a rival non-compatible system. In this case, music lovers with files in different formats would have to buy additional players, or also purchase the CD versions and transfer them to their ipods (not always possible with individual songs). This is a genuine consumer hassle with real costs. There’s also the argument that the consumers should not face limitations on their rights; having paid for the music, they should not be tied to a specific player. There is also the technical argument that Apple’s dominance in the market for players and distribution results in higher prices, especially for itunes.

The last argument is unlikely to be true. 99c does not look like exploitative pricing, even if it does represent a large mark-up over distribution costs. The size of the mark-up in this case is a red-herring: ‘normal’ mark-ups over marginal cost are appropriate in many industries, but when you’re distribution cost is essentially zero, this pricing rule won’t cover the fixed costs. There are a variety of solutions, one of which is to charge a high (but obviously market-bearable) per use price. This could lead to very high profits but this should not matter if itunes faces pricing constraints from competitors. A comparison of prices on itunes with HMV, for example, suggests this is so.

The monopoly profits then are just the incentive that forced Apple to tread where others had failed. In time the profits will erode naturally through the competitive process. Forcing the issue and eliminating high profits may blunt incentives for Apple and other firms to innovate further. The argument is similar to that used by pharma companies for the maintenance of patent laws. And there is something to this argument. Without a profit motive, a company won’t do anything. In the then uncertain market for digital music, there was either big failure or big success in the offing.

Except that the innovation has been done and continuing protection would reward past innovation. The presence of rival music stores may lead to the conclusion that innovation is not hampered by Apple’s protection. But, counter intuitively, the more rival stores and formats there are, the more the consumer is harmed and the more important it is for Apple to open up the software. Otherwise consumers’ either restrict themselves to buying from itunes, or buy additional players in order to enjoy the wider choice of music.

The Norwegian proposals would affect all companies. And if the music companies abandon their rigd adherence to DRM, the market would then be completely open. Would there be a return to pre-ipod days and chaos? It’s doubtful.. Behaviourally, downloading music and paying for it is pretty well ingrained and easy. Illegal downloads and file sharing still happen, and always will and some stores will surely suffer. But the survivors will be those who focus on innovation and meeting customers’ expectations. Far from damning the Euro-muddlers, proponents of the free market should welcome the intervention on this occasion.