Executive Summary
The Recording Industry Association of America (RIAA) estimates that music sales declined from $13.7 billion in 1998 to $8.5 billion in 2008. The music industry has been unequivocal in blaming this trend on online piracy. While music piracy is not a new phenomenon, what is new is the industry’s focus on individual consumers, such as college students, as pirates. Technology has been a key strategy in combating such piracy through systems such as digital rights management (DRM), which strives to make it difficult, if not impossible, to reproduce and distribute copies of legally purchased digital music. However, it is also possible that the cumbersome restrictions imposed by DRM have contributed to the slow growth in digital music sales. Because DRM-encoded music files limit many aspects of a consumer’s ability to use music, it should not be surprising if DRM also limits the market for such products.
In this article, the authors investigate the impact of DRM restrictions on the demand for music downloads. The authors explore this issue by developing a new model that introduces the concept of “hardcore pirates” and estimates the impact of DRM on consumers’ willingness to pay (WTP) for songs (both favorites and nonfavorites) and on the producer revenues and profits. Based on two studies of more 2000 college students, the results suggest that despite the potential advantages offered by some DRM restrictions, on balance the elimination of DRM has a net positive impact on producer revenue, profit, and consumer welfare. The reasons for these surprising results are twofold: (1) a decrease in the propensity to pirate due to the removal of DRM, which results in some hardcore pirates converting to paying customers, and (2) an increase in market participation by low-value consumers due to the joint impact of both an increase in their utility and WTP pertaining to DRM removal and an optimal price reduction. Furthermore, for this sample of college students, the profit-maximizing price of a favorite DRM-free song varied from $.80 to $.89, depending on the marginal cost of producing these songs ($.00–$.20).
These results provide an important rationale for the emerging trend toward a DRM-free environment for music. The study provides music publishers and retailers with a novel and more nuanced perspective on DRM and its impact on the market for online music. This perspective also provides new support for the notion that under certain circumstances, consumers may prefer to pay for a product, even if they could obtain it for free.
Biography
Rajiv K. Sinha is Professor of Marketing and the Center for Services Leadership Board of Advisors Distinguished Fellow in the W.P. Carey School of Business at Arizona State University. He holds a BA (Honors) and an MA in Economics from Delhi University (India) and a PhD from Pennsylvania State University. His research pertains to topics such as diffusion of innovations, digital goods piracy, online brand communities, time-inconsistent behavior, and pricing of information goods. His publications have appeared in the leading marketing, management, and engineering journals, such as Marketing Science, Journal of Marketing Research, Journal of Marketing, International Journal of Research in Marketing, Strategic Management Journal, Information Systems Research, Production and Operations Management, Supply Chain Management Review, and IEEE Transactions in Engineering Management, among others.
Fernando S. Machado is Associate Professor of Marketing in the School of Economics and Management at Universidade Católica Portuguesa (UCP). He holds a PhD in Agricultural Economics from the University of Reading and two BSc’s in Business Administration and in Economics from UCP. His current research interests revolve around digital piracy, analysis of consumer preferences, and consumer valuation of both market and nonmarket goods (e.g., health, life expectancy, environmental quality). His research has appeared in Marketing Science, Environmental and Resource Economics, Empirical Economics, Journal of Agricultural Economics, and European Review of Agricultural Economics.
Collin Sellman is a doctoral candidate in Marketing at Arizona State University. He has a bachelor’s degree from Northern Arizona University and a MBA from Arizona State University. Before returning to academia, he worked for 15 years in the high-technology industry, focusing on the management and development of new, Internet-based networking technologies. His research interests are in the areas of business-to-business innovation and solution development and the market for digital goods.
Journal of Marketing, Volume 74, Number 2, March 2010
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