DeCSS, crypto, law, and economics

John S. Denker jsd at monmouth.com
Tue Jan 7 15:00:41 EST 2003


Regarding the acquittal of Jon Johansen, I quoted CNN
as saying:

> The studios argued unauthorised copying was copyright theft
> and undermined a market for DVDs and videos worth $20
> billion a year in North America alone.

Some elements of the industry did indeed claim that,
but such claims are grossly irrelevant, and to bring
them up is foolish or dishonest.  This case was never
about unauthorized _copying_ of DVDs.  You can make a
bit-for-bit perfect copy of a DVD without decrypting
it.  Indeed it's easier to copy if you don't decrypt
it!

The main thing the industry really had at stake in
this case is the "zone locking" aka "region code"
system.  The studios like to release videos in
different parts of the world at different times,
and to charge different royalty fees in different
places.  This is called market segmentation. The
idea of an open-source player was abhorrent to them,
because it makes it easy to buy a DVD in one region
and play it in other regions.  This is an example of
arbitrage.

For "normal" products, market segmentation is neither
forbidden by law nor protected by law.  Mushrooms that
cost $4.00 per ounce at the supermarket can be purchased
for $4.00 per pound at the Asian grocery down the street.
The stores are free to charge whatever they like, and I
am free to shop wherever I like.  The law is silent on
the issue.

People who engage in market segmentation are always
looking for ways to prevent arbitrage.  For instance,
airlines make sure tickets are non-transferable, to
prevent some ticket agent from stocking up on tickets
at "excursion" prices and reselling them to business
travelers.

Movie studios never had a really good market segmentation
system, because
  -- I can legally own region-1 or region-4 DVDs or some
of both, no matter whether I live in the US or Australia.
  -- I can legally own a region-1 or region-4 DVD player,
or both, no matter whether I live in the US or Australia.

To be clear: the industry was never able to erect a legal
barrier to arbitrage of disks _or_ arbitrage of players.
The closest they could come was to make it slightly hard
to get a _multi-region_ player.  The manufacturers of
player hardware had to do the studios' bidding because of
the the controversial (to say the least) "anti-circumvention"
provisions of the 1998 "DMCA" law.

If we somewhat charitably assume the studios knew what
they were doing, their whole market segmentation scheme
was predicated on the lack of multi-region players _and_
on the assumption that players would remain sufficiently
expensive that users couldn't just buy a stack of players,
one per region.  Less charitably the scheme was predicated
on the foolish assumption that nobody would ever discover
the possibility of inter-region arbitrage of player
hardware.

I repeat, the practical issue in this case was never about
cheating the studios out of their per-disk royalties on
DVDs.

At this point you might be wondering about per-player
royalties.

   First, let's dispose of an irrelevant side-issue.  The
   rights to patents on raw DVD hardware are held by a
   consortium of hardware companies, not movie studios.
   These people presumably collected their cut when Mr.
   Johansen purchased his raw DVD drive hardware.  So
   this case was never about patent infringement.

The studios arguably hold intellectual property rights
in the CSS decoding keys, and they can collect per-player
royalties from hw mfgrs who incorporate such keys in
their products.  AFAIK Mr. Johansen never copied any
such key (or even had one he could have copied), so
this case was never about illegal copying even on a
per-player basis.

The truly amazing thing about this case is that the
"crime" would not have occured if the studios had used
decently-strong crypto.  It's ironic that in an age when
for cryptographers enjoy a historically-unprecedented
lopsided advantage over cryptanalysts, the industry
adopted a system that could be cracked by amateurs.
This probably wasn't simply due to stupidity in the
industry; it is more plausibly attributed to stupidity
in the US export regulations which induced the industry
to use 40-bit keys.

So what we have here are remarkably intrusive laws:
under US regulations the crypto must be easy to break,
while under US law it is illegal to break it.  The
latter is dressed up as a "copyright" law even if no
illegal copying is involved.

This strikes me as analogous to requiring everyone
to use pin/tumbler locks with only a single pin, so
that all locks can be picked using a popsicle stick,
and then arresting people for burglary whenever they
are caught carrying a popsicle stick.

US law is not the same as Norwegian law.  You should
not imagine that this case sets a precedent for US
courts.

Additional remarks:

We should try to avoid overwrought arguments about the
"morality" of market segmentation and/or arbitrage.
Producers and retailers will always try to benefit
themselves by segmenting the market;  consumers and
arbitrageurs will always try to benefit themselves
by defeating market segmentation.

In fact it is easy to demonstrate that _some_ market
segmentation is good for society as a whole.  Please
refer to the graphs in
   http://www.monmouth.com/~jsd/econ/val-cost.gif

In both graphs, the abscissa is the total number of units
(N), for some product.  There are three different ordinates,
all denominated in dollars, namely
  -- the total cost of producing N units (shown in blue),
  -- the total consumer value of consuming N units,
     (shown in red), and
  -- the total market dollar-volume (shown in green).

In both graphs, the blue production-cost curve has a
large Y-intercept at N=0 and a rather small slope
everywhere else.  This is characteristic of a wide
range of products including DVD movies, which have
enormous fixed costs and remarkably small incremental
costs.  Meanwhile, the slope of the red customer-value
curve is steep for small N and less steep for larger N,
conveying the idea that the product is more valuable
to some consumers and less valuable to others.

In the top graph we arbitrarily assume that everybody
pays the same price -- no market segmentation.  Then
the maximum N that can be sold is shown by the tick-mark
on the axis:  this is the point where the market price
(the slope of the green curve) equals the incremental
customer value (the slope of the red curve).  You
can't sell any more units because the product isn't
worth it to additional customers at that price.

The "created wealth" is given by the length of the
magenta line, the difference between the customer-value
curve and the producer-cost curve.

Now we turn to the lower graph, in which there is
some market segmentation.  The customers who value
the product less highly are allowed to buy the product
at a lower price.  This process absolutely necessarily
ends at the point shown by the tickmark on the lower
axis, because this is the point where the incremental
producer cost (the slope of the blue curve) equals the
incremental customer value (the slope of the red curve).
This is the point of maximal created wealth;  there is
no way to sell a larger number of units N without
somebody taking a loss, so that's not going to happen.

Note that in the absence of market segmentation,
the society as a whole is worse off.  Given the
producer and consumer curves shown in the figure,
or anything qualitatively similar, there is no
unsegmented solution that maximizes the created
wealth.  If the sellers insist on selling every unit
at the highest possible price, society loses.  If the
buyers insist on buying every unit at the lowest
possible price, society loses.

It would be the height of foolishness and the height
of hypocrisy to pretend that whatever favors my selfish
interests is "moral" while whatever favors somebody else's
selfish interests is "immoral".  Much of the debate about
intellectual property issues, on both sides, stinks of
foolish hypocrisy.

There are two not-quite-separate sensible questions:
  -- Find a way to maximize the created wealth.
  -- Decide how to divvy up the created wealth among
the various stakeholders:  inventors, authors, performers,
publishers, manufacturers, wholesalers, retailers,
consumers, et cetera.

It would be nice to have an enlightened discussion of
such topics.


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