The Old as a Barrier to the New

19 04 2012

Techdirt has an interesting piece on the follies of the publishing industry in shifting its business model over to ebooks and digital publishing, focusing on the utter and infuriating pointlessness of DRM, or digital rights management.

It makes the salient point that DRM fails because it makes a legitimate product less useful, and therefore less valuable, than a pirated one, which can be acquired easier and cheaper than the legitimate product.

However, the piece also raises a bigger point about the impact of change on existing industries. And there’s a little psychology and decision theory to explain why almost all industries almost always screw up the transition phase, largely motivated by their desire not to go extinct, and then go extinct anyway. This is particularly true of publishing and the media.

Here’s the story:

Company A has an existing product, X,  which sells for a high price and achieves a good margin.

A new disruptive technology emerges which, like most disruptive technologies, make things less expensive to produce and/or disseminate.

This results in a cheaper product Y that competes with the more expensive old technology product X.

Company A now has a number of choices – and it’ll always choose the wrong one:

1) Lower the price of X to compete with Y, thus crippling its margins and forcing it to lower the quality of X to appalling levels. This is what most newspaper publishers have done in response to the internet. Now their print editions and online editions are scraping the bottom of the barrel, while online outlets, like the Huffington Post, boom.

2) Sell both X and Y. However, now they’re competing with themselves, and Y will win, putting the long-established X department out of business. But X makes a good margin and the company doesn’t want to lose that, or change its business model. So the company raises the price of Y well above its cost to make X competitive against it. However, now Y is unreasonably overpriced in the eyes of consumers, who can probably easily get Y free illegally. This is what book publishers are doing by pricing ebooks at only a fraction lower than print books, and television and movie studios with DVDs vs. downloads. Then company B comes along, unhindered by the old technology, and it only produces product Y, and puts company A out of business anyway, like iTunes did to the music industry.

3) Transition from product X to Y, and either phase out X entirely, or find an equilibrium between the two. Y will rarely entirely replace X, and X will likely have to change, such as bestseller fiction moving to ebooks while quality hardbacks remain in print, or top 10 music going digital while vinyl lives on. Y will be priced such that it’s competitive, and it’ll supplant X fairly rapidly, with the business model adapting and departments probably closing. Businesses almost never take this option, even though it’s the most rational.

Basically, management, when faced with the decision of competing with themselves or continuing business as usual, will almost always continue business as usual. And, in doing so, they effectively let other companies compete with them and put them out of business anyway.

This is because most management are intrinsically conservative, they seek to protect the business model they know (and thus their own jobs), even at the expense of the business at large. Few managers have the courage to actively destroy part of their company in order to compete in a new environment, and thus passively destroy the entire company.

I’ve seen this phenomenon unfold a dozen times in my career, and I expect it’ll continue as long as new disruptive technologies emerge.

The upshot is we’re currently living in a transition time where many industries are busy making their mistakes, but they haven’t gone out of business quite yet. When they do, and new business emerge that embrace the new technology, then things will settle into a new equilibrium – and BitTorrent will suddenly decline in popularity, as did music filesharing systems once iTunes emerged.

I look forward to that day.

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