ISPs and Hollywood: natural partners for new business models?

Despite the enduring call for new business models for improving access to movies, games and music over the internet, these new models are slow to arise. At first glance, the entertainment industries and ISPs seem natural partners: the one creates the content and the other distributes it. However, these two parties have quite a hard time to find each other in practice.

Two economists of ParisTech have studied this question. Their research shows that ISPs and the entertainment industries have conflicting interests in the current state of the market. File sharing contributes to the profits of ISPs as downloading makes investing in a better, more expensive internet connection more attractive to consumers.

The roll-out of broadband networks has been significantly enabled by file-sharing. Furthermore, ISPs, as well as every other actor in the online chain between contentproducer and consumer, stands to benefit from further exploiting and enhancing this situation. In other words: ISPs have the illegal distribution of copyrighted content to thank for generating business en find themselves in a situation where the incentives for innovation lie primarily in furthering this situation, that will further undermine the position of rights holders.

The figure below shows how, with a declining price (on the vertical axis), the demand for broad band internet increases (on the horizontal axis). The leftmost of the three lines, the hyperbolic one, shows how price relates to demand in a situation without file sharing. When the price is high, demand is low. No surprises there. When prices decrease, demand grows. Not only that: demand starts growing faster and faster. This can be explained by considering that when price is high, broadband is used primarily by business users who are less influenced by prices. When the prices decline, broadband suddenly becomes more of interest to private users. The rise is exponential because of the network effects of internet: the more people are connected, the more each individual can do with their connection.

The middle line shows how broadband demand relates to price when users do have access to file-sharing services. You can see that, as file-sharing makes it more worthwhile to users to get a broadband connection, the willingness to pay is considerably higher at the point on the demand line than in a situation without file-sharing. This difference in price, that in the figure has been coloured green, is called a ‘subsidy’ in economic jargon. It is a premium that ISPs receive without having to do anything for it themselves.

 

 

 

This premium, by the way, does not only benefit ISPs, but rather bestows advantages to every player in the chain between the producer of the content and the consumer, except to the rights holders.

This premium that all players in the broadband chain receive as a result of the eager use of file-sharing also provides strong incentives for innovations that are aimed at preserving this premium. Financial interests are at stake with all players that are involved in internet and the distribution of content to further undermine the position of rights holders and to further raise the costs of enforcement.

In other words: those players are rewarded for disturbing the market chances for digital content.

The problem started, the authors state, with the advent of digital means for copying and distribution. Before the digital era, the costs for enforcing copyright were bundled with the price for the carrier of the content: CDs and DVDs.

Now that digital copies zap across the internet, rights holders are in an increasingly sticky situation when trying to incur these costs. The situation has now developed in such a way that enforcement costs for the creative industries become higher as long as file-sharing remains an interesting option.

Economists like self regulation. The authors propose therefore that where possible, rights holders should find a solution together with ISPs. In the US, this works reasonably well, as content providers hold considerable market power there. In Europe, however, the tendency is that market power is more concentrated at the side of network providers. In that case, governments have a role in working out a solution.

An much proposed way to make enforcement easier is a system of graduated response. In economic terms, such a system works by confronting consumers with the costs of their behaviour after all. The sanctions of graduated response, whether it is a fine, a court case or a suspended connection, is presented as a cost, to counter the benefit of file sharing. The reasoning is that if consumers perceive these costs, they will be seen as disproportionate with the benefits and consumers will stop downloading.

At the moment, it is still unclear whether such a system will work the way as it is supposed to. If it doesn’t, the system will just bring extra costs and thus increase the inefficiency of the current situation. However, if it does work, a graduated response policy can put the incentives for innovation in the fields of content creation and distribution on the correct places again. By initially burdening ISPs with a part of the enforcement costs, the distribution channels also have an incentive to work towards redressing the imbalance and invest in technological measures such as watermarking, monitoring and filtering. This, in theory at least, will result in a decline in piracy and therefore also in declining costs for enforcement.