The issue of using hardware- or software-based digital rights management, or “DRM”, to restrict how music and movies can be copied or shared has spurred fierce debate between those who think DRM is essential to protect content from unauthorized use, and those who believe it undermines consumers’ rights to do whatever they want with the content they purchase. On February 6, Apple CEO Steve Jobs added to the controversy by posting an open letter on Apple’s web site entitled “Thoughts on Music,” in which Jobs proposes that the recording industry simply do away with DRM all together.

In the memo, Jobs stresses that the requirement to protect music from unauthorized copying comes not from Apple, but from those who own the content, primarily the “big four” music companies — Universal, Sony BMG, Warner and EMI — all but one of which are owned in whole or in part by European companies.

The recording industry was quick to respond, indicating that it feels Apple, not DRM, is the problem, and urging Jobs to license its copyright-protection software, called FairPlay, to competitors. Individual music companies, such as EMI, have stepped into the fray as well.

With the battle lines drawn between those who want to assure that digital content is controlled and those who think it is to everyone’s benefit if music files can be freely copied, we asked Wharton marketing professor Peter Fader, and Don Huesman, senior director of information technology at Wharton, for their views on the subject.

Knowledge at Wharton: Steve Jobs has suggested that the record companies should drop DRM from their digital content. Is he right?

Fader: I think he’s right. I think this is a move that’s been a long time coming. It was just a question of who was going to say it first and how the industry would respond. I think that it’s absolutely brilliant on his part. I think that it has much more impact than if it came from one of the industry insiders.

I think the contradiction that some people have pointed out makes it all the more delicious and I think makes it all the more credible for him to be saying it. It will be very interesting to see what the ripple effects continue to look like.

Huesman: I think that it’s brilliant as well because it certainly represents a winning strategy. It builds him fans; it certainly positions Apple on the side of the consumers. However, I think that in fact it’s wrong. I think that if Steve had really wanted to do something revolutionary, he would take up the challenge to make FairPlay an industry standard by licensing it for other manufacturers. 

At the risk of infuriating the listeners, I am a fan of a light version of DRM and I think it has the potential for benefiting the one group who has always lost out in these business arrangements and that’s the creative artist.

Knowledge at Wharton: Also — just to take the side of those who think that this is not a good idea — don’t record companies have a responsibility to their shareholders to protect the value of their assets by assuring that only legal copies of songs are downloaded?

Fader: I think that the record companies have an obligation to maximize the value of the assets that they have. And, I think putting the kinds of restrictions that they have used to date have only hurt it. I’m not saying that letting everything go free is necessarily the best way to go, though I’m not exactly sure what light DRM would mean and how successfully it can be implemented.

But, I think that they are leaving a great deal of money on the table, by restricting the kinds of things that their listeners can do. To go back to your opening statement, I don’t see it as a matter of consumer rights. I just see it as a matter of good business and making these kinds of files available so that people are messing around listening to your music, instead of listening to someone else’s or doing other kinds of activities is good business. 

Knowledge at Wharton: Don, maybe you can answer Pete’s question about light DRM. Could you tell us what [exactly] you have in mind?

Huesman: Yes, I think it’s FairPlay. I think Apple has done another brilliant example of a user interface that works. It’s my experience at least that FairPlay is not onerous in terms of the way it’s implemented DRM. It allows for use of multiple devices. It certainly has not slowed down something like two billion individual instances of downloads, over the last four years. And, I think that it can serve as the basis for sort of a new model of doing business.

My thinking about DRM light is basically an effort to, in a very non-draconian fashion, implement a security system that just keeps honest people honest. This is not that it is strong enough to prevent a dedicated pirate from breaking a code, but rather that, I liken it a bit to the kind of security that I have on my 15 year old Mitsubishi. I know for a fact, that a dedicated criminal can break into my car, but I keep it locked when it’s on the street, because I don’t want the kids to get themselves into trouble and I like to keep honest people honest. 

Knowledge at Wharton: That’s a very good answer. Let’s assume that DRM controls are removed. Doesn’t that get us back to having to sue people who distribute content as the only means of controlling lost revenue?

Fader: It’s a tempting path for the rights holders to follow, but it’s a mistaken one. They shouldn’t have begun those lawsuits in the first place. They’ve been very ineffective, not only in stopping the flow of unauthorized music, but in creating value for the assets and for the firms that control those assets. I think it was just a terrible mistake.

So, again it’s not a matter of what these firms can or can’t do, it’s what they should or shouldn’t do. We’re seeing the same battle being fought right now on the video side, with some of the content holders who were first saying that “YouTube was our friend and we’re going to use it for promotion and distribution.”

Now, they’re backing off and pulling these assets out of there and shooting themselves in the foot in the process. It’s really only a matter of what stupid things these firms are going to do to “protect” their assets, while at the same time diluting the value of those same assets.

Huesman: I think it’s important, too, to note that this is an interesting time for change in the model, in that CDs are still probably the dominant way in which tunes find their way on to an iPod, other than pirated downloads. I’ve seen estimates that as high as 90% of downloads today are essentially illegal and would represent lost revenue to the asset holders.

So, I think that it’s in that context, as we’ve seen the CD disappear, that these new models are emerging. We’re not yet at that new day, so we have an opportunity to sort of rethink this from the get go. This is what’s exciting to me about the prospect of — for the first time, I think in maybe 100 years–actually trying to return some revenue back to the people who are the creative artists that make the industry work in the first place.

Fader: And, if I could pick up on Don’s point. Obviously, it’s a fact that CDs are still where the lion’s share of the revenue comes from in the music industry. And, I think before we call it dead and write it off and just wonder what’s going to happen with the digital future, I think that CDs will continue to be the dominant source of revenue for a long, long, time. 

And if the industry played its cards right, it could stay that way for the foreseeable future. I think part of that is using songs as ways to promote CDs. And part of that is trying to make DRM as minimal as possible — encouraging people to share the songs so that they’ll go out and buy the album and find whatever other added value there might be from the album itself. 

I think that’s a really good business model. I think the technology is in place to make people want to buy albums, but it’s just not the way that the Labels are doing business today and that’s no one’s fault but their own.

Knowledge at Wharton: Why do you think that Jobs felt the need to post a public statement of his views? Does he really want to eliminate DRM or does he merely want to make it clear that the decision isn’t up to him; it’s in the hands of the music companies?

Fader: There’s a lot of speculation about it. Some people are saying it’s because of the lawsuits that he’s facing in Europe. Some people are saying that he just likes the attention and that he wanted to preempt some of the other folks who are poised to make similar kinds of decisions.

He is a smart man and it’s very hard to understand his true motivations, because in fact there are so many motivations here. There are the legal aspects and all of these possible reasons make sense. I’m not so much worried about the reason why he did it. I’m much more interested in the consequences of what will happen now that that argument is on the table.

Huesman: It will be interesting to see what comes of this in the sense that certainly Apple stands to win in any of the whole set of scenarios. In addition to being the dominant player in the DRM business today, they are also, of course, set to benefit from just an increased sort of a rejuvenation of the music industry at large. This is because of their hardware sales.

So again, I think that anyone who is in the consumer electronics business as a major manufacturer stands to win by just simply increasing activity. Anybody that is in the music distribution business like a Yahoo or a Google or a YouTube also stands to win based on advertising. The consumers also of course stand to win if music is freely distributed.

The only people who stand to lose are the creative artists who originate all of this. I think about my friends who have bands that sell CDs at the back of a hall when they’re done on a Saturday night gig. And I wonder if there isn’t an opportunity to stimulate more creative work as we turn the apple cart over with this particular industry.

Knowledge at Wharton: I wonder if we could talk a little bit about the RIAA’s [Recording Industry Association of America] response to Jobs. The music industry was not happy with Jobs. And what’s interesting to me is that while they reportedly praise Jobs for his offer to license FairPlay, the memo seems to reject that idea entirely. Did the RIAA simply misinterpret the memo or was this their attempt to move the debate back to the issue of licensing FairPlay technology?

Fader:  I think that it’s a deeper story than just that. There’s a very interesting love/hate relationship between the RIAA and Steve Jobs. At first he was the savior who was going to fix everything wrong with the industry. Once they realized his own motivation, which was of course to sell iPod’s and not necessarily to rejuvenate the music per se, they realized that first of all, he has far more control than they ever wanted him to have and he’s not willing to play by their rules.

He’s not willing to use the kind of price flexibility that they’d like him to use and [there are] many other sources of tension along the way. And, every time some of this tension comes up, it’s always the industry backing down, realizing that Jobs is holding all of the cards.

At this point I think that the industry has realized that they’ve made a lot of mistakes by giving him, not just too much control, but too much credibility. I think that it’s important for them to kind of strike back, to say “Wait a minute, this is our industry not yours.” But like with everything they do, it’s too little, too late.

Huesman: I know they’ve done a few experiments of late, but they’ve been very modest. Nora Jones has given away a song in order to increase interest in her most recent album. But I would concur with Pete that these are very timid and modest steps. I have no interest in doing anything that would assist these monoliths that have sort of dominated the music scene for so long.

I suspect that one of the reasons that sales are off at Warner and other places is not just in part to piracy, which I do think is a factor, but to the fact that they just haven’t tended to their own fields. They haven’t encouraged talent to grow in places that are new and promising. And again, this is just another sign of a lack of creativity in that industry.

Knowledge at Wharton: What’s your take on the related story that EMI may have been exploring the idea of dropping DRM from its music for some time, but is looking for the retail sales companies like Apple and eMusic to pay them an upfront risk insurance fee?

Fader: One of the good bits of news here is that they’re just willing to try things. Again, it might be too little, too late. It’s hard to say because the Jobs story just kind of overshadows everything that they were talking about. It’s nice to see them messing around with these ideas. I don’t think it’s enough to provide the kind of rejuvenation that the industry really needs. But whatever they’re doing, it isn’t working.

And I think it would be important not just for EMI, who is in the deepest trouble of all, but for every one of the labels to be trying things and for each one to be trying things different from the other labels. I think that we need to have a broad variety of experimentation here to try to find out what business models work and which ones they should just let go of. 

Huesman: In fact, in that regard, I would put out a plea to the creative sorts at Apple to assist the small labels and the independents in a deployment of FairPlay technology that might allow them to reap more direct benefit from their own work, instead of working through this convoluted 20th century distribution system that is dominated by four players.  

Fader: And, if I could add one thing to this. One of the down sides of this discussion, which is very interesting, is that it’s actually calling attention away from what I think is the best and the most promising business model of all, which is the subscription streaming model. Once we get it back to MP3 this, Light DRM that, it comes back to just people downloading music and filling hard drives with it.

I still believe that the subscription model, which is done on the television side with cable, is absolutely the best way to go both for the firms and for the consumers. And I find it very dismaying — I was out shopping for a Mac computer this afternoon — to realize that I can’t get Rhapsody or Napster or these kinds of wonderful services on the Mac. That’s just a shame.

Knowledge at Wharton: We’ll come back to the subscription model in a bit. I was just wondering if I could ask you about some of the other players, apart from Apple. Microsoft, for example, a few days after Jobs’ essay came out, on February 12th demonstrated a new Digital Rights Management System called PlayReady. It claims that it can allow users to create a domain of devices within which content can be shared. Do you think that this is a step in the right direction?

Fader: Any step might be in the right direction. It’s better than not stepping at all. But Microsoft has been stepping all over its own feet in this area, with everything from PlaysForSure, to the format that they came up for the Zune and this new one over here. The issue is twofold. One is that people just don’t trust Microsoft.

The whole idea that DRM is kind of evil and restrictive fits well, unfortunately, with the image that people have of Microsoft. They have just been very bad at it. Their attempts have been clumsy, they have been poorly communicated, and they haven’t worked very well from a technical standpoint, from my own personal experience. So it’s hard to imagine that this is going to be the one to get it all right.

Huesman: Again, what I said earlier applies here as well. If you want to turn to somebody who knows how to work a user interface in a manner that makes the user experience pleasant, we go to Apple. So, I would not trust designers at Microsoft to come up with the right approach to this. 

Knowledge at Wharton: So, what’s the bottom line? If the music companies sell digital content without DRM protection, will it help or hurt their profits?

Fader: Well, it all depends upon the rest of the business model. I think that if they can just create a value proposition with albums, and view songs as advertisements for albums and get people to buy this really interesting bundle, not just of music, but of other kinds of creative content, then it’s a huge win for the industry.

They’ll make far more money and it will change consumer behavior in a far more productive way. If it’s just a matter of using this format versus that and it’s basically not going to steer people away from LimeWire or some of these other unauthorized networks, then it’s not going to change much at all. Unfortunately, despite the interest in this particular announcement, I don’t see it being a watershed event for the industry as a whole — at least not yet.

Huesman: I would say that, in particular, there are opportunities for segments of the market and that this would remain profitable. The Nora Jones selection as an experiment was, I thought, interesting. I think her music appeals to an older generation and to a group of people who are very ready to sample a song and then plop down the necessary money to pick up the CD. I don’t know if that’s true as well for people who are a bit younger than I. 

Knowledge at Wharton: Maybe we should come back to what you were saying earlier, Pete, about the streaming of the subscription model with Rhapsody and what’s called the Celestial Jukebox [I think]. I think it’s a great idea but I wonder why it hasn’t gotten more traction. ITunes and the other download “Pay As You Go” kinds of models have sort of overshadowed it. Is there anything that you see in the future of this model that can help change that situation?

Fader: Sure, well I think the reason why it hasn’t really taken off is purely marketing. I think that RealNetworks has done what it can. But one firm by itself, especially one that’s in the shadow of so many larger firms, can’t turn the tide. I think that the labels really, really need to get behind these kinds of services. They should be agnostic about which service people choose. They should do a better job of bundling the services with the hardware.

I think Real has done that very well with SanDisk. They have a wonderful combination of software and hardware that almost nobody knows about. It’s a terrific consumer experience, far better than iPod plus iTunes. Anyone that uses it loves it, but that’s almost nobody. So, it’s a matter of getting everyone in the industry together and saying, “Hey customers, this is the best thing for you”.

One of the great things about it is that it’s a very nice revenue generator. It’s a great way to reward artists for their hard work. And, from a marketing research standpoint, it’s a great way to track people’s actual consumption — to know what songs they are listening to, when and so on. This is very rich information that you can’t get when it’s people simply downloading or swapping MP3 files.

Huesman: I would entirely agree with Pete that access is the future, that software as a product is a very dated concept, and I think that applies as well to any digital content. I would even look forward to a day when it isn’t just music and video that we’re talking about, but any intellectual property — books, graphic art that’s available in digital format, virtually everything — would be available to me after I’ve paid my dues. This is so that the people who created this material are appropriately rewarded and stimulated to create more and yet, with no onus on me to make the thing work on the collection of contraptions I happen to buy that year.

Knowledge at Wharton: You were talking about books and other digital forms. What about movies? What about the Hollywood system? I mean studios have claimed that copy protections are essentially preventing piracy of their films. What advice would you give the studios in this area?

Fader: One thing is that they have to recognize the differences between movies and music. Most of the movie piracy that’s occurring is real piracy. It’s people stamping out illegal copies of DVDs and so on and a lot of that is happening in other countries. From the digital side, downloading of the movies, illegal or legal, has been far slower. It’s been just a much less big deal than anyone would have possibly predicted by 2007.

So, just from the pure digital side, I don’t think it’s as big a problem. It’s still a big nuisance for people who want to do it and the upside of having this enormous file in your hard drive is small compared to the downside of obtaining it. Where as, with music getting songs and so on — it’s a very different kind of behavior.

So yes, they need to be cognizant of some of these issues. Everyone keeps saying, “Well, bandwidth is becoming so readily available, that what happened with music today will happen with movies tomorrow.” I don’t see it happening quite that easily. And it’s nice to see that players in the movie industry have been more progressive about trying out different digital distribution channels. It’s hard to say which ones will win, but at least they’re not doing it in a purely reactionary manner.

Huesman: Let me add one other thought to this conversation too, that actually isn’t directly related to movies. Although it affects purchasing behavior there, I think it’s stronger in the area of music. It is this sort of psychological dimension to the history of people owning their music on a device.

In some physical form, they can walk through the lyrics, look at the albums or have some kind of personal ownership over a product. I do think that the age of access that we were talking about earlier will come more slowly because that pattern of ownership is deep in the American psyche and will take a generation or so to get rid of.

Knowledge at Wharton: One last question for both of you. Let’s say that Steve Jobs and the heads of the big four music companies were with us in this room, right now. What advice would you have for them?

Fader: Well, I think I’ve already given that advice which would be to push quickly and decisively towards a streaming subscription model. I still believe that Apple will move in that direction. Steve Jobs hasn’t made some of the really harsh pronouncements against it, as he has done in past.

I think that once they announce “iTunes Premium,” which will provide you all the music that you want, for some monthly fee, perhaps with some DRM associated with it — I think that’s the revolution that I am waiting for. And it would be for the labels to try to beat him to the punch, to try to support the existing services or to try to come up with a new one, which they haven’t been very good at doing. I think that’s what’s going to make their customers very happy. 

Huesman: I would ignore the executives from the four major distribution groups and talk directly to Steve Jobs. I would ask him to set up a FairPlay non-profit foundation and [make sure] that all of its additional revenues are spent to assist in stimulating creative artists — to take advantage of this new opportunity for reaching out to very highly segmented listening groups across the planet.