In an attempt to look at the business and ethical practices of the largest companies in Silicon Valley today, I have done some research and written two papers on Apple’s Digital Media and Google’s ethical responsibility dealing with information gathering. I will present these over the next couple of days in more digestible chunks, and would be interested to hear what others think.

The discussion of intellectual property has entered uncharted waters as the ability to duplicate digital media threatens the business model of the music and film industries. The RIAA has come out of the gates swinging, and has shown that it is willing to take on all challengers – Napster like entities, college students, foreign governments – who violate conventional copyright laws. The United States government joined the fray in 1998 with the passage of the Digital Millennium Copyright Act, but this too has created a sense of overprotection for the industry, and complete exposure of the consumer . Many have argued that it is the industry that needs to change its outdated models, but there was a great deal of resistance to this when digital music was seen as an Internet fad. Quickly thereafter, it was inevitable that something needed to change. When that change came, in the form of he iTunes Music Store, there were mumblings of industry protectionism overreaching its bounds into the user’s consumer rights. This paper will look at whether this claim is true or not, and discuss the implications of intellectual property in a digital age.

In order to survive, the music industry started to evolve its business model in the form of such enterprises as the iTunes Music Store , which accounted for almost five percent of U.S. music sales in 2005. The model is simple. One can buy individual songs for $0.99 or a discounted album for $9.99. The buyer’s right to share the music, without violating the record label’s copyright, is guaranteed using what is known as Digital Rights Management (DRM) software. The buyer of the music can authorize up to three other users the right to access the music. However, they have to be using the iTunes software application. This is one of the problems in regards to the protectionism issue.

One main reason that the demand for digital music increased so dramatically was the increased proliferation of MP3 players. This device is the next step in the evolution of the Walkman, and was a catalyst to push the music industry towards the digital distribution of music. However, it wasn’t until a DRM-enabled MP3 suite was developed that the music industry was willing to open its vast catalogues of music to digital distribution. If an anti-trust case were to be brought against Apple Computer, then the first challenge would be the required bundling of the iTunes Music Store with the iPod MP3 player. When Apple CEO Steve Jobs was asked what he thought about this bundling arrangement he responded, “Well, [the consumers] knew that all along”, and then went on to say that “[n]obody’s ever demanded [interoperability]”. Is it not an anti-trust issue because consumers are willingly entering into a tie-in sale? Job’s second claim of a lack of demand for interoperability also isn’t true as demonstrated by Microsoft’s attempt to integrate the iPod with their Xbox 360 console. Microsoft, and consumer groups in general, are asking shouldn’t the owner of the media be able to use it within their distribution rights? The bigger question that must then be asked is with the iTunes Music Store holding 70% market share , and the bundling of the portability of the music with the iPod, is the consumer harmed by the business practices of Apple Computer and the music industry?

To analyze the issue of tie-in sales, it’s best to go through the characteristics of a tie-in sale and see if they apply to this case. The four characteristics of a tie-in sale are (1) some monopoly power in the tying good, (2) not insubstantial commerce in the tied good, (3) no efficiency defense, and (4) two distinct goods.

First, is there a monopoly in the tying good? Yes. There is significant market share owned by Apple in both the digital music distribution market, and the MP3 player market as shown earlier in the paper. However, one must ask whether this is a first to market advantage or not. As Demsetz argues, innovation creates concentration, profits, and perhaps some monopoly power. Apple’s iPod was by no means the first to market, but its innovative user interface coupled with its ease of use and large storage capabilities made it an innovation in the market. This innovation was enough to give the iPod a peak market share of 92%. Though this number is slowly eroding, there is still yet to be a dominant competitor on the market. Newly emerging Zune has received quite good reviews, and claims to be the next step in the social networking revolution that has helped fuel Web 2.0, but the results are yet to be seen. The competition is a bit stronger in the digital media distribution arena, but the iTunes Music Store still has a significant market share. Therefore, the first piece of a tie-in case could successfully be built.

The next piece of the puzzle comes down to whether there is enough commerce to make this product a matter of concern. It can easily be shown that this is the case. In 2005, the iTunes Music Store become one of the top ten retailers of music. It was able to amass approximately $450 million in sales making it 4-5% of the total music distribution in the United States. In the fiscal year ending in September 2006, 40 million iPods were sold , and the variety of models has made iPod Apple’s dominant revenue stream. This amounts to as much as $565 Million in quarterly revenue of which a significant portion, whether directly or indirectly, is expected to be iPod generated.

The argument against efficiency is difficult to construct in this case. In general, the courts have had a tough time deciphering how an efficiency defense can best be presented , and here too it seems a difficult proposition to see if somehow the combination of the iPod and iTunes Music Store has decreased efficiency. This could be the stickler in building a complete case against the bundling of these two technologies. I think that the economics of it are quite simple. By having a simple to use interface that maximizes the experience and minimizes the time spent configuring, the iPod/iTunes combination maximizes its own utility. This is one of the strongest arguments for continuing this relationship even though it has some semblance of an anti-competitive role in the marketplace.

The final requirement is that there are two distinct products. This isn’t a buttons and shirt situation. There are in fact two very distinct products. The iPod has become a video and photo device, and can also become an external hard drive. iTunes Music Store has music, podcasts, movies, television shows, audiobooks, and all sorts of digital media. However, one problem that does arise is that the iPod can only be conventionally used through the iTunes Music Store. The ability to access and take advantage of data stored on the iPod is also severely limited. Therefore, it might be argued, that in conventional terms the iPod cannot live outside of the iTunes Music Store. I don’t think that this means they are the same product, or two products that necessarily need each other. It’s important to note that this relationship has been constructed for them by Apple’s business strategy, and that they can, and do, survive as separate entities.

Overall, I think that there is a strong case that the iPod exclusively working with the iTunes Music Store could be a tie-in sale case. There is a significant market for the products, and the market share of both products is significant. Both exist independently of each other, but iPods depend on iTunes to work out of the box. Though this creates a shirt/buttons relationship, I would argue that their product lines can exist independently and therefore they should as well. Apple’s business decision to create this dependency doesn’t excuse the tie-in like nature. My only concern is that I wonder how making the price of the iTunes Music Store free affects the construction of a case, but otherwise find the totality of the case to point towards some degree of anti-competitive behavior.

Tomorrow I will post my research on the DRM side of things, and conclude this issue at large.