The New Economics of Music

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Tim O'Reilly
Jan. 04, 2004 10:29 AM
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Cameron Laird sent me the following note: "The New Economics of Music: File Sharing and Double Moral Hazard is a piece on the music business that made me think of you." (Presumably because of my piece, Piracy is Progressive Taxation).

I agree with Cameron. Umair Hague's piece is one of the most insightful I have ever read on file sharing. It's an absolute must read for anyone in the music industry as well as any policy-makers thinking about online file sharing. For music downloaders, it's an affirming and thought-provoking piece that tells why file sharing makes sense for exploring new music, as well as why you ought to pay for music once you find what you like.

The fundamental argument is this: that an important part of what people pay music companies for is to act as an agent, finding good music (which can be reframed as mitigating the risk of buying bad music). But the music companies have (at least in part) betrayed that implicit contract, by placing other values, such as the economics of scale, ahead of what consumers are paying them for. In economics terms, this is called a moral hazard, since the agent can impose hidden costs instead of the costs that the consumer is actually paying for. File sharing allows users to share the risk of finding good music among themselves rather than transferring it to an agent. But it imposes a second moral hazard on users, since it tempts them to no longer keep their implicit contract to pay for the music.

I'm not as enamored of Umair's proposed solutions as I am of his analysis -- I think that the pay for download services will work just fine, especially when they let market competition determine prices -- so we really don't need the complex risk mitigation scenarios that are used in insurance or securities. I don't believe that price competition will only drive prices down. After an initial period of downward price pressure that lets download services find the optimum price to maximize sales, we'll eventually see the kind of pricing differences (where higher price signals an expectation that the item in question will be in high enough demand to command a price premium) that Umair holds out as the ideal.

P.S. I'm delighted to see that Umair also has articles on bounties for catching virus writers and on gray markets and intellectual property. Can't wait to read them.

Tim O'Reilly is the founder and CEO of O'Reilly Media, Inc., thought by many to be the best computer book publisher in the world. In addition to Foo Camps ("Friends of O'Reilly" Camps, which gave rise to the "un-conference" movement), O'Reilly Media also hosts conferences on technology topics, including the Web 2.0 Summit, the Web 2.0 Expo, the O'Reilly Open Source Convention, the Gov 2.0 Summit, and the Gov 2.0 Expo. Tim's blog, the O'Reilly Radar, "watches the alpha geeks" to determine emerging technology trends, and serves as a platform for advocacy about issues of importance to the technical community. Tim's long-term vision for his company is to change the world by spreading the knowledge of innovators. In addition to O'Reilly Media, Tim is a founder of Safari Books Online, a pioneering subscription service for accessing books online, and O'Reilly AlphaTech Ventures, an early-stage venture firm.

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