Strategies for a discontinuous future.

Who's Wearing the Goggles?
The MPAA, Lemons, and the Replication Economy

‘Risk comes from not knowing what you're doing' – Warren Buffett

Sometimes, organizations come up with strategies that you can predict will not just fail, but fail enormously. These strategies, even if they succeed, have unintended consequences whose costs massively outweigh the intended benefits. If such a strategy fails, it fails – but if it succeeds, it fails spectacularly.

The MPAA’s new plan to scan for pirates in cinemas by equipping ushers with night-vision goggles has been rightly derided for being heavy-handed – but it’s much more than that. It’s actually a great example of the above – a massive strategic error, that especially in success, will lead to a rather impressive crash-and-burn. In fact, what the MPAA are doing is what economists might call reverse adverse selection - taking the lemons out of the market.

To understand how, let’s think about the economics of pirated films. Pirated versions of a film have hugely differing, and often unpredictable, quality levels. Some may lack a 5.1 soundtrack; others may lack subtitles; others still (especially in the third world) may have had advertising inserted into them. But the most notorious of these is what’s referred in the 3rd world as the ‘camera print’ – a copy of the film made by someone sitting in the cinema with a cheap handicam.

Camera prints are often replete with all of the less-than-charming aspects of a cinema: silhouettes of people’s heads blocking the camera’s vision, laughter/applause/gasps/whispering from the audience. And given the circumstances of replication, camera prints are often close to unwatchable, because their resolution is terrible and the picture itself often jerks and shakes.

We can think of the market for a film, then, as made up of two kinds of goods – pirated versions, whose quality is highly variable and highly unpredictable, and official versions, whose quality is high, stable, and predictable.

Buyers with different preferences will choose either of these two goods – risk averse buyers, or those who derive great value from a DVD will choose official versions, and risk-seeking buyers, or those who derive relatively less value from a DVD, will choose pirated versions. But since the difference in price between the two kinds of goods is very large, it’s likely that the average buyer will choose the ‘pirated’ version – unless the extra cost of the risk of buying a lemon is high. Remember that last bit – it’s gonna be important in a paragraph or two.

Now let’s think about the likely effects of the MPAA’s plan. In fact, let’s fulfill the MPAA’s wildest fantasy, and imagine that this strategy is 100% ‘successful’. Let’s imagine that Terminator-like usherdroids with night-vision goggles and positronic brains can in fact detect would-be handicam pirates with 100% accuracy, and then lobotomize them, so they can never ‘steal’ from the MPAA again.

What happens next? Well, no more camera prints get made. In our terms, the lowest quality good – lemons – gets pushed out of the market. In our case, the lemons are camera prints. But all this does is make buyers more certain of the quality of the goods they buy – it reduces the risk of buying a lemon, which is really a hidden cost that ‘pirate’ buyers pay. So what the goggles strategy does is, for the same amount of risk, push the average quality of a pirated version up. In fact, because camera prints are so undesirable to most people, this strategy pushes the average quality of a ‘pirated’ film way up, by massively reducing the amount of risk in the market.

What happens next? Since the average quality at a given amount of risk has gone way up, more and more buyers are willing to buy pirate versions – because now, the risk of buying a lemon has been eliminated. Every buyer of pirated films now gets more bang for the buck. Some of the new pirate buyers will be people will be people who defect from buying the official version, and some (probably many) will be entirely new. But to the MPAA, this is a double whammy – because in either case, it’s likely that almost no one will buy both versions. So the market for the ‘pirate’ version will grow – at the expense of the growth of the official market.

So in the end, the goggles strategy causes unintended consequences of the worst kind (if you’re the MPAA) – the growth and betterment of a parallel market at the expense of it’s own. So why doesn’t the MPAA see this?

Well, to put it bluntly, because the old dudes in charge of our media industries are thinking in first-order terms – not strategically. That’s what the RIAA is doing by suing file-sharers, which will have similarly unintended consequences. Think what Prohibition did to alcohol – suing file-sharers is similarly helping create grey markets for replicated music, but this time, the barons are guys like the owners of AllofMP3.com.

Of course, the really interesting bit is that MPAA is ignoring the real strategic problem: it’s own intellectual and artistic bankruptcy. Hollywood relies more and more on hits – which is another way of saying that because it’s business model is in the very process of massive disruption - the film industry relies more and more on marketing, and less and less on film-making. It’s easier to try and prop up a dying business model with Manichaean tactics like this than it is to find new, innovative ways to create value – at least in the short term. Which is how the RIAA got itself into the mess it’s in. The MPAA should take note, and take heed.

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