September 16, 2009

Is Redbox the next parasitic technology?

Stan Liebowitz has written an insightful and brief article about parasitic technologies, which provide consumers with content created by some other company, but in a way that chokes off the creator company's revenue stream. File-sharing is a clear example: such software provides listeners of music with permanent copies of songs they like, even though those songs were brought into being by the music industry (artists, sound engineers, marketers, etc.). The original revenue came from listeners buying CDs or tapes or albums at music stores, which those stores had to pay the music industry for.

In the extreme, the industry doesn't bring in enough money to cover the minimum costs, thus no more music is made, and so consumers will have nothing new to listen to. Note that this extreme is not even the world where 100% of songs are illegally downloaded -- the extent of file-sharing only has to be great enough for the music industry to cease being a profitable industry long-term. Things probably won't get that bad, but we shouldn't want to go even one step in that direction -- with less revenue, record labels will have to cut costs like crazy to try to stay profitable.

The overpaid studio executives can only have their pay cut so much -- after that it will be the quality of the sound engineering, the number of artists they support, the promotion budgets for the artists, and especially the amount of risk they'd be willing to take on new artists. When you're trying to stay afloat, you can't take huge risks on new artists; rather, you have to appeal to the lowest common denominator. So you can forget about hearing anything remotely novel. Notice how pop music goes to shit during recessions, and only picks up again in quality when we're back into a euphoric spending boom. The simple reason for that is the heightened risk aversion of music companies when consumers' income is pinched.

While the case of file-sharing is completely clear, other technologies are worth at least keeping our eye on. Liebowitz mentions digital radio, which pays little to nothing for the music it provides, thus depriving the music industry of potential revenue. I think it's worth adding Redbox to the list -- those DVD rental kiosks that charge $1 per night and offer movies right when they come out on DVD. (They've been in the news a lot lately as Hollywood tries to keep them from draining their revenue; just search the NYT, WSJ, or Lexis-Nexis for "Redbox".)

Redbox drives down prices for consumers, which is usually good, but it does this not by making better movies or by making movies of typical quality but just more efficiently, and then passing some of the resulting profits on to consumers. After all, they don't create any of the content that they provide. So, it's not similar to a case where Disney produces such great movies and is run so efficiently that they can pass on the savings to consumers by striking deals with retailers for $1 DVD rentals, whereas their competitors in the movie-making industry produce worse quality movies or movies of the same quality but in a more inefficient way.

But Blockbuster and other rental stores don't produce content either -- so why haven't they killed off Hollywood? For one thing, they charge $5 per rental, not $1. And for another, the movie studios get a cut of Blockbuster's revenues, somewhat like the studios getting a cut of the box office revenues from the theaters that show their movies. Aside from a recent deal with Paramount, Redbox in general does not send a portion of their revenue back to the movie studios. Thus, by both draining the market for new DVD copies and yet not funneling funds back to the content creators (as other rental stores do), Redbox poses a new, non-trivial threat to Hollywood's revenues. (Their revenues from the box office are already low and declining further.)

Where else is revenue going to come from to make up for this drain? You can see it now -- five-minute ads interrupting the movie every 10 minutes.

As with music studios, so with the movies: they'd have to start slashing costs to keep their heads above water. Again, overpaid studio heads can only lose so much in salaries -- after that, it's the number and quality of actors they can put in the movie, the editing quality, the sound, cinematography, special effects, screenplay, etc. They could not make a low-budget art film, which could work under such constraints, since the audience for those films is minuscule and could never repay the movie's costs. Even more so than now, studios would pander to the lowest common denominator. And with so little revenue coming in, they'd make far fewer movies.

Redbox would die off soon after, with practically no new movies to rent out, but not after having made a fortune. The fattened executives would fold up Redbox and move on to founding some other parasitic technology, while Hollywood and movie-watchers would be left with nothing.

Make no mistake -- entertainment providers need gigantic revenues in order to make good stuff, and to make it widely available. Most songs and movies are garbage or mediocre at best, so that finding the great ones requires making a huge number in all. If you think it's easy to make only two movies and have them both be superstars, go ahead and try for yourself. Before a movie is made, no one knows how it will turn out, so each one is basically a crap shoot. And to get a single win -- let alone several of them -- you need to throw the dice many, many times.

This is true of most intellectual property, by the way. Look at how many trailblazing inventions came out of Bell Labs and the DoD when both had stratospheric budgets. Many of their ideas went nowhere, but unless you pump out a bunch of inventions, you'll never find the rare gems like transistors, the internet, lasers, cell phones, and so on. Now there are so few ivory towers -- none, really -- which explains why essentially no more cool stuff has been invented for the past quarter of a century.

So how do we keep from heading toward that dystopia? The best solution is to allow movie studios to vertically integrate with distributors and rental / purchase stores, along with movie theaters. Then all of the revenue from DVD rentals / purchases at such stores would go back to the studios and allow them to put out more movies and of greater quality. They could still sell their studio's DVDs to another studio's store, or to other retailers like Wal-Mart, but they would have the option to not pursue that and to only rent out or sell their DVDs in their own kiosks or stores.

This could not allow monopolistic behavior because if you thought Fox's DVD store was restricting output to raise prices, you could always go to Universal's store instead. It would be no different than McDonalds making its own food and selling it in its own stores, and ditto for Burger King and Wendy's. You may have a slight preference for one of their hamburgers, just as you might want to see one of Fox's new movies more than one of Universal's, but if McDonalds or Fox tried to jack up prices, you'd happily defect to Burger King or Universal. In reality, movie studios bitterly compete against each other over scarce dollars that consumers spend on movies. With this added source of revenue, lack of parasitism from Redbox (or whoever), and less wasteful antagonism between studios and stores / kiosks (resulting from common ownership), studios would be more profitable and could put out greater products, more of them, and more efficiently -- and pass along some of the savings to consumers.

Of course, this would all probably be illegal, given that the studios have not been allowed to even own theaters after the completely bogus antitrust case brought against them in the 1950s. But that just means we need to work on voiding the antitrust decision. (See the relevant chapter in Arthur De Vany's Hollywood Economics, featured in the Amazon box above.)

In the meantime, any deals with Redbox should be like those with movie theaters -- the studios should get a certain percentage of Redbox's revenues from a given movie title, in return for discounted DVDs. If Redbox doesn't agree, the studios would simply cut off their supply for the first month after a DVD's release -- Redbox can always get DVDs from commercial outlets like everyone else. (And they have at times.) This would make Redbox much less profitable, hopefully enough so that they'd decide they had bigger fish to fry.

Consumers should obviously patronize places that are sending part of their revenue back to the studios, such as movie theaters or Blockbuster, but they have little incentive to do so when Redbox rents movies for just $1. They might agree with the logic of substantially lower revenues to Hollywood = far fewer movies / lower-quality movies in the future, but the temptation of cheap stuff is pretty strong.

Propaganda notwithstanding, the only group that stands to gain from the way things currently are headed is Redbox executives. Hollywood studios will have to start slashing costs -- and remember, if you can't make 100 movies, don't expect to find a one-in-a-hundred type of a movie. These increasingly mediocre movies will of course draw even fewer dollars from increasingly dissatisfied consumers (at the box office or wherever else), which will only force the studios to cut costs even more, and so on.

That is the heaven that the technological parasites wish to lead us toward -- one with few new things, and they all suck. More, those consumers who loudly insist on cheapness, even when they've had the consequences explained, will get what they deserve -- having only Police Academy 6 to rent every weekend for the rest of their lives.


  1. "After all, they don't create any of the content that they provide."

    It's not about creating content, it's about renting content. They're replacing minimum wage workers with robots.

    "For one thing, they charge $5 per rental, not $1."

    If you've ever seen the breakdown on what what cut goes where when a product is sold in a physical store, you wouldn't be surprised that there is $4 in overhead.

    "And for another, the movie studios get a cut of Blockbuster's revenues, somewhat like the studios getting a cut of the box office revenues from the theaters that show their movies."

    This is actually a reason why Redbox can be better for studios. Marc Cuban explains here.

    The key reasons is this: everyone besides Redbox operates on the consignment model. The money they give the studios is the only money the studios get. If videos don't rent or sell, the studios get nothing. If some of the product breaks or is otherwise unusable, the studios eat the cost. In contrast, Redbox pays up front with no returns. Helping to mitigate revenue risk is a very valuable service.

  2. Where does Netflix figure into this?


  3. "If videos don't rent or sell, the studios get nothing."

    That's actually an incentive for studios to make good movies -- else they make no money.

    And that has been the way studios made money for decades. The theaters bid for the right to show the movies -- one says it'll give 30% of box office revenues, another says 35%, etc. If this model has survived for decades in an incredibly competitive industry, it means it's probably better than obvious alternatives like paying a flat fee for each movie reel.

    Indeed the flat fee per reel / DVD wouldn't get the studios much money at all because they really make most of their money from the blockbusters. If they'd only gotten a flat fee from the theater / rental store, they'd completely miss out on that. In contrast, getting, say, 35% of revenues allows them to cash in on superstars.

    The same goes for the rental store or theater -- they don't want to pay a flat fee because if it's a dud, they're out that money. Paying based on popularity protects them as well as the studio.

    Anyway, Redbox keeps the studios from getting a percentage of the revenues from superstar movies (at the box office, or new DVDs, or DVD rentals), which is the studios' main source of revenues.

  4. i disagree somewhat, the delivery of the good and how it is marketed/packaged/produced may change, but the product will continue to exist as long as the market remains. besides, most of the stuff in redbox is lower end budget films, with lower production costs, as compared with a store like blockbuster that price gauged with late fees until netflix and others made them revamp their product model or fall by the wayside. ie: like how the SUV market crushed many a car company. adapt or die. i'm all for it.

  5. "So how do we keep from heading toward that dystopia? The best solution is to allow movie studios to vertically integrate with distributors and rental / purchase stores, along with movie theaters."

    The problem with that is that the government is not going to allow it. The movie industry started out as vertically integrated, with theaters owned by the production companies. The Paramount Case ended that. Do you really think the anti-monopoly hysterics are going to allow them to try again?

  6. "the delivery of the good and how it is marketed/packaged/produced may change, but the product will continue to exist as long as the market remains."

    No, the good is produced by movie studios, so if they are no longer profitable, there will be no new product for Redbox, Blockbuster, or Wal-Mart to sell or rent out.

    There is demand for all sorts of things -- hover-boards, for instance -- but the supply is 0 because the product is not feasible or is too costly for revenues to off-set the costs.

    "Do you really think the anti-monopoly hysterics are going to allow them to try again?"

    I know the primarily problem is the government and antitrust. That's why I suggested a solution for "in the meantime" -- make Redbox operate like movie theaters or Blockbuster, where some percentage of revenues from a given movie go back to the studios.

  7. There is the thought that less quality art will result if the big studios/labels are hurt. Production values will definitely take a hit.

    But honestly, fuck both Transformer movies. Avatar looks like utter shit as well.

    If either industry becomes a whole slew of people doing it themselves I think there'll be a flowering of creativity.

    Plus, what Hollywood and the record labels have realized is that the cost of making music and film has been drastically reduced with everything going digital. Film and two-inch tape are extremely expensive (and time consuming which adds greatly to costs).

    With the technological improvements made in the last ten years, I don't think it's going to be that big of a hit quality wise. Sure, you're going to lose out on sets and costumes and the like but if that's the price paid I say so be it.

    I'm not worried in the slightest. You'll just have to dig a bit more to find the music and films you like.

  8. The degree to which your argument is correct depends on the elasticity of the demand for films. If films cost $1, will people simply rent more films more often? The marginal cost of a person watching a film is relatively small, so it is definitely a possibility.

  9. agnostic, did you see this recent article from Paul Graham that's somewhat related to your post here:

    Post-Medium Publishing

    here's the intro:

    "Publishers of all types, from news to music, are unhappy that consumers won't pay for content anymore. At least, that's how they see it.

    In fact consumers never really were paying for content, and publishers weren't really selling it either. If the content was what they were selling, why has the price of books or music or movies always depended mostly on the format? Why didn't better content cost more? [1]

    A copy of Time costs $5 for 58 pages, or 8.6 cents a page. The Economist costs $7 for 86 pages, or 8.1 cents a page. Better journalism is actually slightly cheaper.

    Almost every form of publishing has been organized as if the medium was what they were selling, and the content was irrelevant. Book publishers, for example, set prices based on the cost of producing and distributing books. They treat the words printed in the book the same way a textile manufacturer treats the patterns printed on its fabrics.

    Economically, the print media are in the business of marking up paper. We can all imagine an old-style editor getting a scoop and saying "this will sell a lot of papers!" Cross out that final S and you're describing their business model. The reason they make less money now is that people don't need as much paper.

    A few months ago I ran into a friend in a cafe. I had a copy of the New York Times, which I still occasionally buy on weekends. As I was leaving I offered it to him, as I've done countless times before in the same situation. But this time something new happened. I felt that sheepish feeling you get when you offer someone something worthless. "Do you, er, want a printout of yesterday's news?" I asked. (He didn't.)

    Now that the medium is evaporating, publishers have nothing left to sell. Some seem to think they're going to sell content—that they were always in the content business, really. But they weren't, and it's unclear whether anyone could be."

  10. Paul Graham is breathtakingly stupid and totally lacking in imagination.

    Why are movie prices so similar? He *knows* the answer -- they cannot vary that much in content. Has he ever watched movies at all? Of course they vary in content or quality -- enormously. Probably more so than do products that have greater variation in prices, such as cars.

    And it's obvious that that's what they're selling -- the content and quality is why people are interested in books, movies, and songs. He'd see that if he weren't profoundly autistic.

    The same is true for books and songs -- obviously there is huge variation in quality, with little variation in price.

    So, this is a puzzle to be solved by someone with a brain and curiosity. Graham simply denies an obvious truth -- that movies, songs, and books vary tremendously in quality or content -- in order to run on and on about... something or other.

    Here's the real reason, among many other important reasons, why those prices are so close to uniform -- none of the producers know what the quality of the product is before they release it to the public. They only learn about that over the long-term as one movie sells more tickets than another, one book generates lots of buzz while another doesn't, etc.

    Also, each of their products is completely unique -- no movie is the same as any other, and ditto for books and songs. Therefore, they have no idea what the audience's demand for their product is (this is related to their ignorance beforehand about quality). They have no similar cases in the past upon which to base current estimates. Or rather, they have a guess, but with an infinitely large error bar.

    Here's a neat test to show that Graham is wrong: what are prices like in markets where the quality or content of books, movies, and songs, *is* known? Say, when movies are released to DVD, or especially in the used / second-hand markets for movies, songs, books, and video games?

    The reason that Madden '94 (or whatever) costs less than a dollar, while Super Metroid costs $35 *used* is that the latter is superior in quality to the former.

    At this stage, sellers know a lot more about how good or bad their product is, and so how in-demand it will be among buyers. This allows them to vary the prices accordingly, and that's just what we see.

    There are wrinkles of course, like why don't theaters start charging more when they find out a movie is a blockbuster. It could be due to inflaming fairness concerns among viewers, or other things.

    But the key reason why prices are so uniform for "content" industries is that their products are unique, and therefore neither the buyers nor the sellers know how good they are until they're released and people try them out, and spread their judgments.

    By the way, newspapers using ad-only business models -- how's that working out for everyone *except for* WSJ and FT? As a general rule, all tech geeks should be ignored when it comes to economics or business. They know nothing, and have studied nothing on these topics, and are flying by the seat of their pants.

    They (like all pundits) suffer no consequences for being catastrophically wrong, so they have no incentive to get it right on-the-fly. They simply make shit up that comports with their overarching geek worldview, where Linus Torvalds is the light god and Bill Gates is the dark devil. No matter how remote the connection, it all traces back to hating on Microsoft.

  11. "As a general rule, all tech geeks should be ignored when it comes to economics or business. They know nothing, and have studied nothing on these topics, and are flying by the seat of their pants."

    I hate tech geeks as much as anyone.

    Paul Graham is a tech geek, but he's also an entrepreneur who founded and sold a company for tens of millions of dollars, and he's an experienced venture capitalist.

    You're a grad student who's business experience consists of selling blog posts.

    Why Graham "should be ignored," and you listened to on business and economics topics is beyond me.

  12. Ha, venture capitalists -- they totally saw through the dot-com boom, didn't they? They are the Dick Morrises of business. He sold something to Yahoo! in 1998 -- so he's good at suckering fools, but that's it.

    I'm not arguing that one person should be trusted over another because of reputation or experience -- I said that you should trust those who know enough basic economic principles and real-world knowledge on what they're talking about.

    Graham has proven that he has zero real-world knowledge of movies, books, or songs -- else he would know why prices are so close to uniform upon release (although not so much when they are sold second-hand). I do know that -- and so could anyone who's picked up a popular-audience econ book in the past 5 years.

    That he is still ignorant is telling of his lack of curiosity. He can just see the answer.

    And again, anyone who's picked up a newspaper and read about the financial state of newspapers would certainly know that ad-only is doomed to failure, while those who are profitable charge for access -- WSJ and FT.

    What does it say about his insights that a grad student armed only with an internet connection and library access can so thoroughly destroy his arguments?

  13. Graham never says that quality can't vary. Comparing Time and The Economist, he finds that The Economist is cheaper per page and specifically notes that "Better journalism" in this case, that is the higher quality of journalism in The Economist, is slightly cheaper - basically equal to the inferior Time.

    Graham is not really saying that they aren't selling "content and quality." He says that "Almost every form of publishing has been organized AS IF the medium was what they were selling, and the content was irrelevant. Book publishers, for example, set prices based on the cost of producing and distributing books." He's just saying that as far as the economics of publishing, that is the supplying of content, is concerned it's basically equivalent to selling the medium. In setting prices suppliers generally end up converging towards the cost of producing and distributing the medium. Graham doesn't delve into explaining possible reasons for why this is the case; he simply notes that the prices of content in various media, whether paper, CDs, tapes, etc., tends towards the costs of supplying the media.

    In fact I don't think Graham would necessarily disagree with "the real reason" you provide for why "those prices are so close to uniform." He may have something to add or may alter it somewhat. But it's not really that relevant to his discussion insofar as it's merely a longer way of saying that the suppliers of content are almost completely ignorant of the demand for their product. He would agree with the fundamental point that demand for content is virtually unknowable by the supplier and that this is partly why the prices of content tends towards uniformity and towards the costs of supplying the medium.

    And your example with the video games is flawed. You hold the mistaken assumption that prices are supposed to reflect "quality" (whatever that means). And you're trying to prove or support the idea that prices reflect "quality" i.e. high quality will lead to or causes high prices, but you already assume this in your premise. Video game vendor knows that Super Metroid is of higher quality than Madden - so sets price of Super Metroid higher than that of Madden - Super Metroid price is higher than Madden - thus Super Metroid is "superior in quality." It's a circular argument.

    The fact that Madden costs less than Super Metroid is no indication of relative quality (whatever that means). The prices here are at set at the margin. There might be only one copy of Super Metroid left in the world. Or all the video game consumers might hate football or sports. The demand side is completely subjective. There's no objective "quality."

    You're committing a classic fallacy in economics by harping on "quality" (or more commonly "value") and believing that prices are supposed to somehow reflect "quality." The prices of two different goods don't reflect the "quality" or "value" of the class or idea of the particular goods. The prices are set at the margin.

  14. The video game example is not arguing that price differences reflect quality differences. (Although they happen to in this case.) Rather, it is to show that price variation increases a lot once the buyers and sellers have a better assessment of how good a video game is.

    No new video games vary from 1 or 2 dollars up through 50 or 60 dollars, but that's typical for second-hand games, even when the physical condition is the same, since most of those involved know which are the fun and boring games.

    For example, sellers can look up Super Metroid on the GameRankings website, or they could see that it consistently shows up in "best video game" lists, that it was one of the best-selling games for its system, etc. And buyers know this from their own experience, word-of-mouth, or the above sources.

  15. Barbour:

    "Graham is not really saying that they aren't selling "content and quality." "

    Read the second paragraph, where he says that explicitly:

    "In fact consumers never really were paying for content, and publishers weren't really selling it either. If the content was what they were selling, why has the price of books or music or movies always depended mostly on the format? Why didn't better content cost more?"

    He uses the price near-uniformity to support his argument that publishers weren't selling content that varied in quality (hence his use of the word "better").

    He is wrong. The price near-uniformity has to do with lack of predictability of demand, not with publishers selling paper, film, or some other medium.

    Because this is the lynch-pin of his argument that the stuff sold is the medium rather than content, his argument has no leg to stand on, especially when it's so obvious that buyers and sellers of newly released movies, songs, books, etc., obsess mostly over the content and in particular its quality level.

    And later Graham says:

    "If audiences were willing to pay more for better content, why wasn't anyone already selling it to them?"

    This is the second time he's emphasized this point. Of course audiences will pay more for better content -- that's why they'll pay more for a good than a bad movie that's just been released on DVD. You can also bet that they'd pay more for a physical copy of the NYT that first broke the JFK assassination than a randomly chosen issue from that year. It's more valuable to them because of its role in history.

    It's only when things haven't been widely appreciated -- a new movie, or today's newspaper -- that consumers don't know what they want, and thus why sellers don't charge wildly different prices. It has nothing to do with consumers not being "willing to pay for better content." That's too obvious to merit comment.

  16. Paul Graham created a web store. In the middle of the dot-com bubble. Sold it to Yahoo for $45 million in *STOCK*.

    Two years later, the Yahoo stock, which crashed by 95% two years later. Incidentally, that web store that he created? Well, it's no longer in use. Yahoo threw out his LISP code and rewrote the whole thing in C++.

    When there's a lot of hot money going around, anyone can look like a genius.


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