Is it Fair to Force Open FairPlay?

The news keeps getting worse for Apple on the DRM front, with the Dutch and Germans joining the French, Danes, Finns, Swedes and Norwegians in kvetching about Apple quasi-locking iTunes downloads to work only on the iPod.

The press coverage has been a little misleading. When the head of the Consumentenbond tells Dutch consumers they should subscribe to eMusic instead of iTunes, that’s like Ralph Nader speaking, not a government minister. In any country there are activists who attack business decisions (some deservedly, some not). Also, in France and Netherlands (if not Germany) the proposed changes would help domestic consumer electronics companies that compete with Apple.

Here are a few questions about the “fairness” of Apple’s decision to restrict FairPlay-encrypted downloads to Apple players:

• Is the iTunes Music Store open? No, it’s pretty much a vertically integrated distribution and platform system.
• Is Apple misleading people on their openness? No.
• Is Apple trying to create lock-in like other proprietary platforms before it? Of course.
• Do they provide a switching option? Sorta.
• The payoff pitch: Did Apple gain its dominant market position in music players through illegal means, such as tying? No. How could Apple use the market power of its 3% PC market share to force anyone to buy anything?

Apple got their music market share by making a system that works better end to end. The whole business model rests on a cross-subsidy from the iPod to the music store. Apple makes good margins selling new iPods (as long as people are willing to buy them), but (according to a Oct. 9, 2003 estimate in the Wall Street Journal), pays 2/3 of all revenues to record companies and makes a single-digit gross profit off the downloads. If you kill the IP model, then effectively Apple is being asked to run its music store so its competitors can compete away the profit margins that keep the store open.

The U.S. government said Apple’s system is legal, because consumers can choose between competing systems from Microsoft, Sony and others. The case certainly highlights the risk (particularly for American firms) of pursuing IP-based business models, for several reasons.

As the Microsoft case illustrated, European antitrust standards are different than the U.S. ones — in the U.S. you have to demonstrate consumer harm, whereas in Europe harm to competitors is a legitimate criterion. Secondly, outside the Anglo-American rule of law, the division between law-making and law-creating (or interpreting) is not as clearly defined. (To be fair, last summer’s changes in French policy were enacted through the legislative process).

The textbook definition of political risk is a change of government policy that reduces or eliminates the value of a company’s property held in a foreign country. While OECD countries don’t go around confiscating physical property like some Latin American strongman, the rules regarding intellectual property remain far less predictable. Whether or not Apple’s system is ultimately determined to be legal across the EU, as with open source licenses, legal predictability would be good for industry.

Technorati Tags: Apple, business models, intellectual property, iPod, DRM