On January 10, Amazon.com announced a partnership with Sony BMG Music Entertainment to offer music downloads without digital rights management (DRM) software, which typically limits how content can be used. The Sony BMG deal was significant for Amazon because the e-commerce giant now has all four major music labels, along with thousands of independent ones, selling songs without DRM technology.

DRM encompasses multiple technologies that control the use of software, music, movies or any other piece of digital content. A year ago, Apple CEO Steve Jobs wrote an open letter urging the music industry to drop DRM. Although Apple’s iTunes still sells a lot of content protected with Apple’s “FairPlay” DRM software, songs from EMI Music’s entire catalog are now available DRM-free through iTunes. Amid declining sales, the major music labels are experimenting with new business models, including dropping their previous requirement to protect their music through DRM software.

While DRM may be all but dead in the music industry, experts at Wharton note that the technology isn’t going to disappear completely. It’s just evolving. “DRM will never go away…. It will just become more unobtrusive,” says Wharton marketing professor Peter Fader. Furthermore, Wharton experts observe that consumer tolerance of DRM varies with the entertainment medium.

Indeed, DRM software is still common in online video and movies. On January 15, Jobs outlined Apple’s Movie Rentals service on iTunes at the Macworld conference in San Francisco. “Here’s the deal. We’re going to launch with 1,000 films by the end of February,” said Jobs during his keynote speech. “You can watch them anywhere — on your Macs, PCs, iPhones. You will be able to [download] them in 30 seconds. What are the rules? You have 30 days to start and you have 24 hours to finish. You can transfer movies to another device.”

The rules that Jobs mentioned are enforced by Apple’s FairPlay DRM software. Other video sites such as Joost and Major League Baseball’s MLB.com use different DRM technologies to prevent or limit the saving of content on PCs or restrict viewing by geography. For instance, a consumer may not be able to watch a local baseball game online due to distribution or broadcasting rights.

The reasons why DRM has raised so many hackles for the music industry relative to video presents an interesting case study in consumer habits, says Jeffrey Babin, a lecturer at Wharton and the University of Pennsylvania’s School of Engineering and Applied Science. “Music and video have different consumption patterns. Historically we buy music — [although] technically we only purchase the license for it — and there’s a consumer perception that we own it and can do anything with it. Video is different. It has a pay-per-view business model. We pay to rent movies. And we pay to go to the movies. We subscribe to cable service. That video model online is the same even with new devices and technology.”

Steve Jobs underscored the difference between how most people consume music and movies when he introduced Apple’s iTunes Movie Rentals service at Macworld. “We’ve never offered a rental model in music because we don’t think people want to rent their music…. [T]hey want to own their music…. [Y]ou listen to your favorite song thousands of times in your life. But your favorite movie — most of us watch movies once; maybe a few times. And renting is a great way to do it.”

According to Andrea Matwyshyn, Wharton professor of legal studies and business ethics, music has always been more portable and easier to record and transfer to multiple devices. That creates conflicts with the limits imposed by much DRM technology. Video, on the other hand, has historically been harder to copy and distribute due to limitations on computer storage and data transfer speeds. “Video has a different market dynamic,” says Matwyshyn.

Desperately Seeking a Business Model

What remains to be seen is whether the discrepancy between DRM use with music versus video will continue in the future. While consumers may be generally more accepting of DRM for video, that could change as they expect to be able to move movies and television shows between devices like PCs and portable gadgets like the iPod.

Indeed, DRM’s future role raises a series of questions. Is DRM a necessary component of a media business model? If not, how will digitalrights and compensation schemes for artists, producers, and distributors be honored? And what is the proper balance between the interests of media companies and those of the consumer?

Experts at Wharton were mixed on whether DRM should be a component of the media business model. The music industry, for one, has largely decided that it could sell more songs without DRM, but Babin also notes that the labels have to experiment to offset a decline in traditional CD sales. According to Nielsen SoundScan, total album unit sales fell 15% between 2006 and 2007, and digital song sales rose 45%. Overall, however, the growth in music downloads isn’t offsetting the declining CD sales. “The music industry is desperately trying to figure out a business model that works for them and provides value to consumers,” says Babin, adding that labels are dropping DRM in hopes of boosting digital download sales.

Fader suggests that DRM by itself isn’t an issue for media business models. In some markets, such as video, DRM can work because customers are accustomed to limits. In music, however, it’s clear that DRM was an impediment. “DRM is great when people are unaware of it, but it will not work where people are accustomed to doing things in a certain way and DRM alters that behavior.” A business model’s success comes down to service and selection, Fader argues. For instance, Apple’s iTunes store uses DRM software, but is relatively consumer-friendly in the permissions it allows, so the restrictions largely go unnoticed. “DRM isn’t this horrible bugaboo. And making it go away isn’t the cure all.”

Ultimately, there will likely be some sort of compromise when it comes to finding a media business model that is effective and protects copyright and intellectual property. Television networks, including ABC and NBC, are broadcasting television shows for free online, supported by advertising. Babin and Fader advocate a subscription model, which has an inherent DRM component: If a subscription lapses, so does access to the content.

“We will move closer to a subscription model as we get closer to all media content being accessed everywhere,” says Babin. “This model will require a shift in the consumer state of mind. The consumer will have to realize that he’s only paying for access to the music.”

On the video side of the equation, subscription models already exist. Netflix, for example, offers unlimited online movie streaming for its DVD rental subscribers. “The video model is really a derivative of television,” Babin adds.

Digital Rights and Compensation

While DRM is often hotly debated, it’s just one part of a larger discussion about rights and royalties in the digital era, says Don Huesman, senior director of information technology at Wharton. Huesman argues that there is a looming war between consumers, artists and media companies over digital rights. Indeed, one key issue in the current Hollywood writers’ strike is compensation for content that is distributed digitally.

On November 5, the Writers Guild of America went on strike over its contract with major film and television studios. That strike is ongoing, but the Directors Guild of America, another union, reached its own agreement with studios on January 17. The deal between the major studios and the Directors Guild doubles the compensation for Internet downloads of movies and television shows and establishes residual rates for ad-supported streaming video. The Directors Guild pact gives artists in the union residual rates of 0.7% for television show downloads and 0.65% for films once a minimal number of downloads occur. The deal also includes a “sunset provision” that enables both parties to revisit these terms as new models emerge.

“We have already seen the first shots fired in a war over digital rights — not DRM [software], but digital rights,” says Huesman. “The current writers’ strike is part of the battle over the future of the entertainment business in the wake of digital distribution. Distinctions between digital singles, albums, movies, photography, art, books and other digital content are purely academic in this war.”

DRM technologies will play a role in tracking digital distribution so artists can get paid. The challenge is creating a DRM system that doesn’t annoy consumers. “The artists might be able to make a living if the industry adopts a ‘lite’ version of DRM or a subscription model,” says Huesman.This DRM lite approach can perhaps be seen in Apple’s movie rental model that allows a movie to be viewed on — and transferred between — any iTunes-compatible devices such as Mac OS and Windows PCs along with portable devices such as the iPod and iPhone.

Matwyshyn contends that the explosion of digital content and new devices makes it imperative for media companies to find an alternative way to compensate artists for their intellectual property without limiting consumer behavior with DRM. “You could argue that the whole paradigm today doesn’t work. There needs to be a new compensation scheme, but it will take time,” perhaps five to 10 years, before this new model emerges.

‘Stealthy Audio Watermarking’

While the entertainment industry sorts out new business models to pay artists for intellectual property, DRM will play a prominent role in protecting copyright. Why? No better technology has emerged.

Babin says that the DRM lite model — software that quietly runs in the background to prevent mass distribution of content or copying — is likely to be a winner in the near future. Consumers won’t revolt as long as DRM doesn’t saddle them with overzealous restrictions, he suggests.

One option could be watermarking — a technology that allows the content producer to embed a signature in songs to track usage anonymously. In September, Microsoft won a patent for “stealthy audio watermarking.” In Microsoft’s patent application, the company argues that watermarking technology could prevent piracy. Fader agrees. It would be an unobtrusive way to track usage anonymously and retard piracy, but it wouldn’t hamper the consumer and could provide the content creator with useful data about consumption patterns, he says.

While watermarking technology sounds promising, Babin notes that it could also raise privacy concerns. “If watermarking is no different than a digital stamp, then there’s no problem. But if the music industry starts using watermarking to pursue and prosecute individuals, it will raise new issues and … the ire of consumers.”

The Recording Industry Association of America has aggressively pursued individuals for online music sharing in the past. On January 10, the RIAA said that it sent another wave of 407 pre-litigation settlement letters to 18 universities over what they characterize as “online music theft.” These letters “provide students the opportunity to resolve copyright infringement claims against them at a discounted rate before a formal lawsuit is filed,” the RIAA stated.

Another approach to control digital content could come from Internet Service Providers (ISPs), which may begin to monitor content to limit unauthorized distribution. According to an article in the New York Times, AT&T has been talking to the entertainment industry about filtering out unlicensed copyrighted material on their networks. Network filtering of digital content is possible, Fader says, but it “does more harm than good…. There would be so many false positives. And where would ISPs draw the line?” Meanwhile, he predicts, such filtering would likely increase the stakes in the Net neutrality debate and raise serious privacy concerns.

For now, DRM technology remains the standard since alternative solutions aren’t ready, according to Fader. In the meantime, the entertainment industry should focus on finding the balance between satisfying customers and thwarting piracy. “DRM isn’t dead,” he says. “It’s just evolving.”