Law in the Internet Society

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AlexeySokolin_FirstPaper 9 - 25 Nov 2011 - Main.AlexeySokolin
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Ready for second review.
 
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 -- By AlexeySokolin - 17 Oct 2011
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Introduction

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Transitional Stages Matter

 
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On the horizon is a world where cultural goods are distributed freely and quickly to everyone who wants them. Such a world fundamentally challenges the conventional conception of private property in ideas. Now is a time of transition. Transitional stages are important because define how power is distributed and the principles that will drive cultural norms in the coming phase. It matters how we move from intellectual property regimes of today.
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On the horizon is a world where cultural goods are distributed freely and quickly to everyone who wants them. Such a world fundamentally challenges the conception of private property in ideas and the businesses built on that foundation.
 
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Now is a time of transition. Transitional stages are important because define how power is distributed and the principles that will drive cultural norms. It matters how we move from intellectual property regimes of today and how we restructure our industry. This paper explores various economic models which have emerged to address the needs of tomorrow.
 
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Economic Axioms

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Economic Axioms for Digital Goods

 
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Digital goods such as software, music, video and text have a marginal cost of zero. It costs nothing to duplicate and transfer an mp3 or ebook file. Digital goods do not have zero fixed cost. This non-zero fixed cost includes the cost of financing which is a function of the risk of the venture. Higher-risk ventures involve a higher cost of equity.
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Digital goods such as software, music, video and text have a Marginal Cost of zero. It costs nothing to duplicate and transfer an mp3 or ebook file.
 
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Many such goods are cultural goods and enrich the lives of those that consume them. Cultural goods exist in varying quality (Bach vs. Limp Bizkit, Harry Potter vs. Picasso), which is independent from popularity. Such goods also differ in fixed cost, the time it takes for fixed costs to be recovered, which in turn depends on the number of consumers that pay and do not pay for the good.
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They are also called pubic goods and are nonrival, non-excludable, and subject to free ridership. While some may indeed be emergent (e.g., music, literature), many require significant capital investment. In other words, they have a non-zero Fixed Cost. Western economic theory suggests that because public goods are free to consume, they do not get produced at adequate quantity or quality without substantial subsidy. Free software may suggest otherwise.
 
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Ethical Axioms

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Examples of digital with high fixed costs goods are blockbuster movies (Harry Potter), high-end video games (Starcraft), and professional software (Adobe Photoshop). These goods cost nothing to share, but large sums of money to create, requiring employees, office buildings and financing. This also includes the cost of financing which is a function of the risk of the venture. Higher-risk ventures require a higher rate of return as part of the fixed cost—start-ups and movies are expensive to finance.
 
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We pick two principles that define an “ethical” approach to business. The first is Rawlsian “veil of ignorance,” which implies a set of preferred rules regardless of position in the genetic and geographic lottery. We also rely on Kant’s second formulation of the categorical imperative, which holds that no person can be used as a means to an end.
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A Survey of Business Models

 
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From behind the veil of ignorance it is clear that MC=0 goods should be free.
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Pay for Product. In the most conventional business model, people pay directly for the product or service they consume. The product has value, and the buyer is willing to pay up to their personal assessment of that value. The parties split that value assessment such that the buyer is better off and the seller is better off, subject to bargaining power (e.g., monopoly). Ethical concerns arise when the seller uses coercive political force to appropriate most of the value to itself, as in the case of Telecoms overcharging consumers to use free-to-produce text messages. Prior to the digital economy, large firm organizational structures were needed to build distribution infrastructure and spread out costs through economies of scale. Pricing power followed. In the digital economy, goods are free to distribute and the asymmetric capture of rents by oligopolies becomes difficult to justify. Even more controversial is the distributive result: those unable to pay rents are deprived of access to public resources.
 
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? can say if you believe this, then this model, if you believe this, then this model
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Sharing. The free economy shifts the balance of power to consumers, providing on demand access to any digital good. For some, however, sharing raises ethical questions about misappropriation from other consumers. A classic free riding problem can occur, such that one group of people benefit from the contribution of another group of people (producers, sellers, or the buyers which pay and subsidize fixed costs) without their consent. For institutions structured to produce costly digital goods, this interferes with generating market compensation and leads to antagonism with a powerful and otherwise beneficial distribution channel. More people see the content but less profit is made.
 
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We want access to music and the internet if born in New York or India. Less clear is how much access we want—perhaps there is a line to be drawn between necessary cultural goods (learning the classics) and luxury cultural goods (StarCraft? ). One empowers, lifts people from their station into the flow of human progress; the other entertains and distracts. The two are not synonymous in function and moral weight. The problem encountered in this distinction is who decides, and how.
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Freemium. Services can be tiered: one group of people uses a free product, while another pays for additional functionality. Examples include Flickr, and Dropbox. Usually the free product is targeted for personal use and the premium product is for professional use. This model is ethically attractive: all groups understand how revenue is being generated and opt-in to the system. The difficulty is reaching appropriate scale and getting enough free users to convert to premium such that the entire venture is funded.
 
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Only once basic economic principles have been discarded in favor of some new theory of the moral economy. The question is whether to have a free market or to engage in creating monopolies for private benefit using public coercive power. The ethics of that decision may be discussed, I suppose, if they don't seem evident without substantial "re-theorizing." But those aren't the ethics of business models. Those are the ethics of public corruption.
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Advertising and Data. Instead of making money from a product directly, businesses can generate large user-bases and sell their audience. For example, 96% of Google’s revenues are from advertising. Attention is scarce and valuable to companies that sell products for which people pay directly. An alternate spin on this is to sell the underlying behavioral data of the user-base. The data provides insight on what happens next and how to best market to this population. While ingenious, these two approaches can erode the user experience, as well as their secrecy, anonymity and autonomy.
 
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Sure, public corruption. Alternately, distribution of utility, income, cultural goods, whatever. The questions boils down to who gets what. I agree with your conclusions on the distributional result. But I feel squishy about the dismissal of a desire to have a reason for the logic for distribution. This country decides to set taxes at X and achieves a gini coefficient. It is a philosophical argument that gets us to flatter income equality, not a guide on how to maximize deductions.
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Differentiated Marketing. Another way to escape zero pricing is to market a product so that it is not a commodity, and commands a premium. Technology commentators advocate connecting with fans and generating a reason to buy with value separate from that of the free product, such as a superior experience or emotional connection. While functionalists tend to dismiss branding as brainwashing, some believe that well-marketed products create legitimate emotional benefits. The pricing can be done either by tiering, or using auctions. In the auction set-up, people self-discriminate and bid up to their willingness to pay. For some this is zero, for others it is a positive value. Successful examples are Radiohead’s “In Rainbows” (1.2 million downloads), Nine Inch Nails ($1.6 million in one week), and Kickstarter ($75 million raised). Inherent in the auction model is a utility so positive that people pay as expression of gratitude. The creator must be particularly good at signaling the differentiation of the good from a commodity such that price does not equal marginal cost.
 
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Adjacent Product Bundling. A version of freemium and marketing, some businesses give away their core product using the distribution mechanism of sharing and make money but selling related services. A popular musician can bundle t-shirts with their music, an artist can sign limited edition prints of their digital drawings, an expert blogger can do speaking engagements on top of her regular content.
 
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Kant’s categorical imperative has several restrictive implications. We may not use information on users without their express permission. Advertising and data mining are prohibited unless consented to a priori. We postulate that few people would opt-in even if this funds the consumption of their favorite media junk food. Second, a business may not charge one set of users for one thing, and then arbitrarily give that thing away for free to everyone thereafter. Such a scheme would use one set of people as a means for others.
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How Do We Decide

 
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What? I will admit that in general I am somewhat sympathetic to the position once expressed by a distinguished professorial colleague of mine in this law school: "Never lend money to a Kantian." But putting aside the teaching of half a century toddling around universities with respect to the heightened rate of immorality prevailing among moral philosophers, I have no idea how you have reached the conclusion that Kantians can't hold clearance sales. If this is a proposition you really want to defend, I think you need to spell it out more fully, with no steps missing, and be prepared to meet a good deal of vigorous skepticism,
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Structuring the digital economy raises a host of ethical considerations. Are we achieving the right distributive result? Are we coercing one set of people to benefit another without consent? Are our core privacy principles being undermined? Business models adapt to the philosophies we choose. We must do so carefully in this transition.
 
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I will try to address, but I am not sure I understand the gist of the criticism. What I don't like is the idea of subsidizing production of digital goods. Kant's proposition of not using people as a means to an end seemed like a reasonable place to park that emotion. Using one set of people, without involving them or any sense of choice on their part, to benefit some group with which they are not in social contract (I don't believe that we are in requisite social contract with citizens of other nations) seems like using them as a means to an end.

Onto Business

Goods with marginal costs of zero are pubic goods. They are nonrival, non-excludable, and subject to free ridership. While some cultural public goods may indeed be emergent (e.g., music, literature), others require significant capital investment and equity returns. Examples of such goods are blockbuster movies (Harry Potter), high-end video games (Blizzard), and professional software (Adobe Photoshop). These goods cost nothing to distribute, but they do need large sums of money to build initially, requiring employees, office buildings and financing.

We can make money from public goods by turning them into “club goods,” meaning layering on top of them a power to exclude others. Venture Capital firms look to invest in such endeavors, focusing on building barriers to entry, platforms to keep value, monopolistic potential and long-term profitability above normal returns. This is insurance against the chance of failure, which in a software context can be quite high. On average, VCs achieve normal or below normal returns, which may justify the types of businesses they invest in. The economic rents Facebook extracts is a subsidy for all the Facebooks that failed. Without this insurance aspect, financing may be much more expensive.

Still, this breaches our ethical compass, at least for cultural necessities. It may not breach our ethics in the case of superfluous goods—it is one thing to provide Chinese students with textbooks, and quite another to give them movies that costs millions of dollars to produce.

Really? Textbooks may well embody knowledge it costs millions of dollars to produce and acquire: ask what it has cost us to learn what is presented in any text on planetary astronomy, for example. You're going to need an additional element or two to make out the particular line of distinction you are trying to set up here.

Point well taken. I think it's a fuzzy distinction that goes to life of the author and fixed costs, and is probably out of scope.
But, we cannot coerce businesses to generate cultural goods without covering fixed costs and financing costs.

Nor do we have to subsidize with private ownership privileges forms of cultural activity that a sufficient collection of people wouldn't voluntary each pay a sufficient share of the costs of having made. The use of state power to create monopoly only results in the coercion of those who are made to pay for cultural production which, once existent, they have as much right to share in as any other human being who happens to have a larger disponible income.

I will try to look for examples of "cultural activity that a sufficient collection of people would voluntarily each pay a sufficient share of the costs". I think that's key to what I am trying to explore.

Arbitrarily charging those first in line and distributing for free to the rest of the world is unethical.

Unestablished. See above.

If advertising and data-mining are unethical as well, we must fund the product by user contributions and bifurcate paying users from non-paying users.

Not unless you can establish the very unlikely premise you are reusing above. Otherwise all we need to do is to adopt the principle of "from each according to his ability or her voluntary willingness to pay, to each according to his need or willingness to accept," and allow production and consumption of culture to reach the new, more just and not less satisfactory, equilibrium.

This is the crux of the matter. It is the normative philosophical principle according to which your distributive argument is being made. This is also why I tried to start with some reflection of my personal moral compass--perhaps not all of us agree with the distributive principle quoted above, or its superior justice.

There must be enough paying users to get the product to the point where MC=0. Two ethical models have emerged: (1) auction, and (2) freemium.

No, if that's supposed to be an exclusive list. Pure sharing has also done fairly well, as has direct social subsidy to potential creators, for example.

Fair. I will focus on expanding this descriptive section to include sharing in a useful way, as well as provide other examples. I will try to learn more about this. No list of innovations is exclusive.

In the auction set-up, people self-discriminate and bid up to their willingness to pay. For some this is zero, for others it is a positive value. Successful examples are Radiohead’s “In Rainbows” (1.2 million downloads), Nine Inch Nails ($1.6 million in one week), and Kickstarter ($75 million raised). Inherent in the auction model is a utility so positive that people pay as expression of gratitude. The creator must be particularly good at signaling the differentiation of the good from a commodity such that price does not equal marginal cost.

The second approach emphasizes marketing and tiering value. Technology commentators advocate connecting with fans and generating a reason to buy with value separate from that of the free product. That value is either a superior experience that deserves compensation by choice, or comes bundled with physical items whose MC is not equal to zero (e.g., signed limited edition prints, t-shirts). Similarly, many technology start-ups use a freemium model to charge for upgraded service and provide the core service for free, allowing users to self-discriminate.

These models do not guarantee that fixed costs are covered, especially for capital intensive, experimental projects. In that case, we need public subsidy to offset the innovator’s temptation to build club goods. A hybrid solution could involve indication of private interest (via Kickstarter), a significant public subsidy once a goal is reached, and a Creative Commons license on the final good produced.

At no point is it made clear why we need to foresee the large number of contexts in which people may choose to participate in the economy of sharing. We don't feel it's necessary, on the other side, to write essays explaining the two ethical business models for owning. We take for granted that the ecology of material society is complex: that there are many roles for participants in the market, and that the set is not closed, with clever people constantly inventing new ways of making a living. The same is true in the sharing economy, and this crabbed and static approach to analysis needs to be opened up more than a little if it is to avoid a framing error that we would never make on the other, more familiar side of the 21st century economy.

I need more help to understand the "economy" of sharing, and will steer the essay in that direction. I don't understand the other comment. Sharing is driven by its own ethical considerations (like the distributive princple you quote, and certainly others). There are essays out there arguing why those principles are appropriate (e.g, any of these links perhaps).
 





Revision 9r9 - 25 Nov 2011 - 18:05:24 - AlexeySokolin
Revision 8r8 - 23 Nov 2011 - 21:47:51 - AlexeySokolin
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