Author: Larry Downes

Marketing professionals have learned the hard way that no matter what they do or do not plan to do with consumer information, privacy matters. In part, that’s because marketing has always been something of a black art. When an ad appears to speak to a consumer directly, of course, it’s likely to be most effective. But that’s also the moment when the creepy response kicks in. How did they know what I wanted, perhaps even before I did?

Couple the lack of transparency of marketing generally with the shock of new technology, and you get anxiety over information use that increasingly translates into calls for legislation or regulatory intervention.

New laws aimed at specific technologies, however, are the worst possible outcome. Legal solutions are by their nature blunt instruments for managing uncertainty. At best, they add significant enforcement costs without solving the problem. Spam e-mails were made illegal by a 2003 federal law, but all that law has done is to provide lifetime employment for lawyers at the Federal Trade Commission.

At worst, special laws simply ban the new thing before its developers have the chance to test it in the market and make adjustments. In the U.S., for example, advocacy groups initially demanded that Congress outlaw Google’s Gmail when they learned the service would be paid for with contextual advertising that “reads” the content of user messages.

FCC Commissioner Ajit Pai recently referred to such efforts as “Red Flag Laws,” an allusion to legislation passed in response to the initial panic over an earlier disruptive technology: the automobile. He writes:

The temptation to overregulate new technologies is strong. It’s also misguided. Today, everyone would agree that it would be absurd for the government to require an automobile to be preceded by a person carrying a red flag to warn people that a car was coming. Or worse, imagine if regulators required motorists to stop, disassemble their vehicle, and conceal the parts in bushes if the car frightened a passing horse. The first actually happened at the dawn of the automobile age — they were called Red Flag Laws — and the second nearly happened, passing the Pennsylvania state legislature unanimously, only to be stopped by the Governor’s veto.

In retrospect, of course, Red Flag Laws always look ridiculous. But in the heat generated by torch-wielding mobs, the absurdity of calls to do something — anything — to stop the march of progress aren’t always so easy to counter. Consider what Techdirt’s Mike Masnick has called a “moral panic” over the release in a year or so of Google Glass, a head-mounted computing device that projects information onto a tiny display positioned in front of one eye.

Glass will also be voice activated, capable of performing many basic computing functions (sending messages, looking up information), and of recording and sharing audio and video. The product is about to enter a controlled beta release to some 8,000 early users, or what the company is calling “explorers.”

In a literal sense, Google Glass is nothing new. Head-mounted displays have been around for decades, initially designed for military and advanced simulation applications but now cost-effective for consumers. At this year’s Consumer Electronics Show, I saw perhaps a dozen companies offering such devices, pitched for the convenience of hands-free computing, as aids to those with disabilities, or for high-end immersive gaming.

Nor are any of the functions performed by Glass especially novel. The device will simply mimic some of what billions of us can already do with a smartphone. Except that you wear it on your head rather than holding it in your hands. As many of us also already do with Bluetooth headsets.

There is, I suppose, one difference that’s worth mentioning. The product will be made and sold by Google. On the one hand, that seriously ups its coolness factor, making Glass a “must have” for the technorati. On the other hand, it also increases the anxiety level of those already uncomfortable with the company, and with smartphones and other mobile devices that can record audio and video more or less without notice.

The Red Flags are flying high. A White House petition asks the Obama Administration to “ban Google Glass from use in the USA until clear limitations are placed to prevent indecent public surveillance.” (So far, 38 of 100,000 required signatures have been collected.) One site, Stop the Cyborgs, already offers downloadable signs businesses are encouraged to display announcing that “Google Glass is Banned on these Premises.” They also sell t-shirts, though one customer complained that the material used was so thin as to be transparent, an unfortunate irony.

Lawmakers are eager to get in on the fun. A West Virginia legislator, after reading a short article about the product, immediately introduced a bill that would prohibit driving while “using a wearable computer with head mounted display.” And last week, eight members of a bi-partisan Congressional “Privacy Caucus” wrote Google CEO Larry Page to say they were “curious whether this new technology could infringe on the privacy of the average American.” The questions that followed made the point clearer: we don’t know what this product will be, but we don’t like it.

I shouldn’t be flippant. It’s certainly true that ever-smaller and ever-more-powerful mobile devices raise important questions about the costs and benefits of persistent surveillance, and of the line between personal autonomy and acceptable social behavior.
These, however, are more philosophical issues than legal problems, or at least they should be. We already have privacy laws on the books, and there’s very little about Google Glass that suggests a need to start over. (Driving while using head-mounted displays is already either legal or illegal, depending on each state or country’s law regarding distracted driving.)

What’s more interesting has been Google’s response to the uproar over a product that doesn’t even have a launch date. By and large, the company has said nothing, other than to actively promote Glass’s future release and highlight its great potential.

For years, I have advised companies of the importance of getting ahead of privacy concerns on new applications, especially those that might trigger the creepy response. That’s because the real privacy constraint on companies has always been consumer outrage. Thanks to social media, that’s become an ever-more potent force — arguably more compelling than anything lawmakers might do.

Once the moral panics start, it’s impossible to predict where they will lead. So the wisest course is to head them off. The important take-away for product makers isn’t so much about what they do with personalized data, but how they design and test a new offering, launch it, explain it to consumers, and provide tools for information management.

Public education and transparency can do a great deal to defuse angry mobs before they’ve had a chance to storm your castle. The difference between personalization that everyone loves from the beginning (Amazon and iTunes recommendations, TiVo suggestions) and personalization that stimulates a fatal rejection (Facebook Beacon, Google Buzz, LinkedIn personal ads) has little to do with the nature of the data being used. It’s all in how you explain it. And you don’t get a second chance.

But Google seems to be taking a different tack — at least so far — by largely ignoring the rising tide of negative commentary. The company has refused numerous requests for comment. At a developer’s conference last week, Glass product director Steve Lee said only that “Privacy was top of mind when we designed the product.”

It’s hard to know if this is actually Google’s strategy, or whether they’re waiting for a more appropriate moment to leap directly into the fire. But maybe the company has evolved to the next stage of privacy management. Perhaps they’ve decided that saying anything in response to pre-launch fears of product misuse only adds fuel to a generalized moral panic that is now more-or-less persistent.

Given the high level of irrationality around privacy these days, Google might be onto something. Perhaps arguing logically with those who are reacting emotionally just makes things worse. One way or the other, marketing executives should keep a close eye on how the Google Glass story plays out. It may prove the best case study yet in how to — or not to — manage privacy fears.

Innovations in Digital and Mobile Marketing
An HBR Insight Center

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This week Eric Schmidt of Google went on record saying that cheap, miniature “everyman” drones should be banned by international treaties. Not only does he want to keep such devices from falling into the hands of terrorists, he also worries about their potential to invade privacy. Let’s say, for example, you were having a dispute with a neighbor. “How would you feel if your neighbor went over and bought a commercial observation drone that they can launch from their back yard. It just flies over your house all day,” Schmidt asked. “How would you feel about it?”

This is the kind of worry, as I discussed in an earlier piece, that is driving many state and local governments to enact bans and restrictions on the use of unmanned aircraft in advance of 2015 FAA rules that will allow them into US airspace.

Unfortunately, most of these drone regulators are seriously jumping the gun. Legislating ahead of emerging technologies, history has made amply clear, is always a recipe for unintended negative consequences. And as a general rule, regulation by torch-wielding mobs never leads to optimal, or even helpful, solutions. Lawmaking, to work, needs to be deliberative and rational.

And regulating the design and use of drones according to fifty different sets of state preferences, not to mention counties and cities, can’t possibly be efficient or effective. It’s not clear that anybody except the FAA even has authority to regulate here, or at least not at altitudes over 400 feet. Which would be just as well. One set of rules, whatever they are, would be far better, especially for technically-complex and rapidly-changing products such as drones.

To introduce some rationality to this debate, it’s probably a good idea to separate private uses of drones from use by law enforcement. The first poses much less of a threat. Your neighbor might post a YouTube video of a raucous party in your backyard, after all, but only law enforcement uses have the potential to put you in jail.

What’s more, regulations against the private use of information-gathering and reporting technologies often run afoul of the First Amendment, which broadly protects freedom of speech. So even if state and local laws against drones aren’t preempted by the FAA, they may otherwise be held unconstitutional.

The real concern with privacy rights ought to be with law enforcement uses. Here, the U.S. Constitution breaks in the other direction. The Fourth Amendment protects citizens from “unreasonable searches and seizures” by government, a clause that has been interpreted since the 1960s to provide Americans with a “reasonable expectation of privacy” that limits the ability of law enforcement agents to collect without a warrant not only tangible items but also information.

What constitutes a “reasonable expectation of privacy,” however, is intentionally unclear. Since the Supreme Court first articulated the “right to privacy,” courts have regularly been called upon to decide if some new form of technologically-enabled electronic surveillance — wiretapping, GPS, heat sensors, DNA tests, ultra-sensitive microphones — does or does not violate the Fourth Amendment.

In each case, the court asks whether the warrantless collection of information violated the defendant’s expectation of privacy, and whether that expectation was “reasonable.” Each new technology gets its own analysis. In a 2012 case, for example, the U.S. Supreme Court ruled against the police in a case involving GPS tracking devices. Attaching one to a suspect’s car without a warrant, the Court said, violated the defendant’s reasonable expectation of privacy.

Over time, of course, we get used to the fact that new technologies make it harder for us to operate in secret, especially outside of our homes. Put another way — the way law enforcement often puts it when novel uses come under judicial scrutiny — what constitutes a “reasonable” expectation of privacy is constantly changing … and usually shrinking.

(Law breakers, at the same time, can also make use of new technologies to hide their activities, creating a kind of arms race.)

But even if the courts ultimately decide that drones are or will become so commonplace that it’s no longer reasonable to expect that police aren’t using them, Congress or individual states can still impose a warrant requirement on police if they want to make use of drone-collected evidence. They can also ban them outright — at least for law enforcement.

Today, for example, no one should be surprised to learn that it’s easy for police to record calls over either wired or wireless telephone networks. But a 1968 law nonetheless requires a warrant to record domestic calls; a 1986 amendment similarly protects locally-stored emails. The same model could well be applied to drones, for whatever length of time lawmakers decide is appropriate, including permanently.

As for the private uses, legislative efficiency as well as the danger of crushing a potentially valuable industry in its infancy suggests the wiser course is to wait to see what, if anything, goes wrong.

Once it’s clear what the real harms are, and equally clear that market forces have failed to correct them, then legislators — the fewer the better — can step in and fashion rules carefully crafted to fix the intractable problems. Assuming, of course, that existing laws are found not to apply, or to apply effectively. The kind of harassment suggested by Eric Schmidt’s hypothetical, for example, is certainly already illegal, whether by drone or otherwise.

Drones will by no means be the last Big Bang technology to invoke the creepy factor. So it’s worth underscoring the fact that in privacy law, a little outrage can go a long way, and often in the wrong direction. Caution is a virtue more honored in the breach, unfortunately.

Even today, for example, the most influential law review article on privacy is one that was written for the Harvard Law Review in 1890 by future Supreme Court Justice Louis Brandeis and his law partner Samuel Warren. The two, outraged by new technological advances that challenged their notion of personal privacy, called on governments to enact strong new protections to safeguard what they called “the right to be let alone.”

Few states took up the call, and those that did have largely backtracked. Which is probably just as well. The creepy new technology that upset Brandeis and Warren was short-exposure photography and the ability it gave newspapers to capture and report news events with pictures.

For better and for worse, it’s hard to imagine the world without those developments. Just as someday it may be hard to imagine a world without millions of drones flying around, doing our bidding.

If you had a fleet of drones to call your own, what would you do with them? What problem would you use them to solve in whole new way? What existing solution-provider, in so doing, might you manage to obliterate?

The question is not just a flight of fancy. While military-grade Predator drones can cost as much as $4 million, it’s already possible to buy one of a new generation of hobbyist aircraft — unmanned aircraft systems complete with cameras, GPS, infrared sensors, and microphones, all under the control of a smartphone or tablet — for less than $300. Not surprisingly, people are lining up to buy them. The Federal Aviation Administration estimates that, within a decade, private drones will constitute a $90 billion industry.

There is another reason, too, that the drone market is set to take off. Currently, according to FAA rules, noncommercial uses of drones are permitted only so long as they stay below 400 feet (the official designation of U.S. airspace) and are flown away from populated areas. Above 400 feet, only the government and specially-permitted drones are allowed. But that is about to change. In February, as part of an FAA spending bill, Congress ordered the agency to develop rules by 2015 that would allow military, commercial, and privately-owned drones to operate in U.S. airspace.

Thus, mass-market drones clearly hold potential for what Paul Nunes and I call “big bang disruption.” This is a kind of innovation that, thanks to fast-evolving technology, arrives in the marketplace simultaneously better, cheaper, and more capable of improving than the existing alternatives. Just what current products and services will be disrupted by drone technology remains to be seen, although a few applications are easily predicted. In the realm of law enforcement, drones could offer better performance in search-and-rescue operations, riot suppression, traffic control, surveillance of suspects or fugitives, and in cases of emergencies, natural disasters, or kidnappings.

As George Mason University’s Jerry Brito pointed out in a thoughtful essay last month, “Small drones are made from many of the same components as smartphones, and the economies of scale of that industry have driven the cost of gyroscopes, accelerometers, GPS chips, and CPUs to the ground. As a result,” Brito writes, “the widespread use of drones in commerce is imminent — unless politicians overreact to the bad press.”

That last phrase, of course, is a big “unless.” The FAA’s impending deadline has created panic among state and local governments, who are falling over each other to legislate who gets to use drones and for what purposes before the FAA rules are issued. According to the American Civil Liberties Union, thirty states have already passed or are considering restrictions on drones, if not outright bans.

Local authorities are getting in on the pre-regulation act as well. Recently, the town of Rancho Mirage, CA joined Charlottesville, VA, St. Bonifaciuis, MN, and Seattle, WA in considering or adopting local rules restricting or prohibiting drones in their respective communities. In Alameda County, near where I live, a public hearing on a plan by the sheriff to deploy drones for law enforcement quickly turned ugly. “We oppose the use of public resources to buy machines to surveil its citizens,” one resident was quoted as saying. Another rejected just the potential use of drones by the police as “an assault on my community.”

It’s not surprising that potential private and law enforcement use of drones invokes intense emotional responses, including fears of an expanded police state with an “eye in the sky” and the further erosion of personal privacy. The Rancho Mirage ordinance, for example, had its origins when a private citizen saw a model drone flying over his backyard. He asked the operators to relocate their activities, and they did. But he wrote to his mayor the next day anyway.

The visceral objection we’re seeing to drones is a great example of the “creepy response” I wrote about in a previous post. Novel uses of information technology often trigger deeply negative emotions, particularly among Americans. The truth is that we usually adjust to the new technology by coming to recognize that its benefits outweigh the costs. In the interim, however, the temptation to regulate it out of existence is hard to resist.

And of course, the use of the term “drone” doesn’t help. Drones, like many of the most valuable innovations of the past century, began life as military technology, and have notably been used for targeted killings as part of the so-called “war on terror.” Hobbyists have made a serious tactical error in adopting the same term for unmanned aircraft that, at least so far, have no weapons attached to them.

As understandable as the psychological response may be, however, there is a serious problem with the rush to regulate. Overreacting to fears of the unknown could prove disastrous to the development of technology with tremendous potential to benefit society. Drones could make safer and cheaper a number of essential activities that today require human pilots, and also make other activities possible that are today simply unfeasible. These include emergency transportation of supplies to remote areas, agricultural monitoring and maintenance, aerial photography and mapping, protection of wildlife from poachers, pipeline inspection — perhaps even local delivery.

As with any emerging, potentially revolutionary new technology, it is impossible to anticipate all the uses to which unmanned aircraft might be put once they reach mass markets. And therefore, it is hard to know whether existing laws are adequate to limit or ban the potentially destructive uses. Indeed, many of the local authorities considering drone legislation believe the FAA’s current restrictions give them a rare opportunity to regulate before a dangerous new technology gets a chance to become mainstream. “We certainly want to get ahead of that curve before there are some abuses of that information,” one Virginia legislator said.

As drones continue to become better, cheaper, and more useful, the legal debate is sure to heat up. But until and unless we get more evidence of what “abuses” will actually appear, drafting appropriate laws will be impossible. The mishmash of laws, restrictions, and bans add up to a response that is inefficient, imprecise, bound to cause collateral damage — and certainly not worthy of a drone.

When the U.S. Supreme Court rendered its decision on Kirtsaeng v. John Wiley & Sons, it dipped a toe into waters that run much deeper. As I discussed in an earlier post, that case addressed the question of whether a book buyer, having taken ownership of a physical book, is at liberty to turn around and sell it. But that question is, to slightly mix metaphors, only the tip of the iceberg. The decision says little about the much bigger fight brewing over ownership of digital products — e-books, digital music files, and electronic copies of movies and software.

Does the “first sale” doctrine the court applied in Kirtsaeng also apply to these goods? Do consumers have the right to resell songs purchased from Apple’s iTunes store, or books downloaded to their Amazon Kindles, or other media accessed entirely through the cloud — goods, that is, of which they never took possession as a physical copy, standalone or embedded? What role will first sale play in a future where all information products, like software, are increasingly produced and distributed entirely through the cloud?

For the past decade, emerging digital markets have operated under the assumption that, despite the obvious similarity between a music CD and an MP3 downloaded from iTunes, digital goods are different. Despite what is often sloppy use of terminology, Apple, Amazon, and others maintain that you don’t “buy” a copy of an e-book, nor do you “own” the music in your iTunes library or the copies of apps loaded on your mobile phone. You rent them. Or, to use the legal term, you license their use.

How does that happen? The short answer is through terms-of-service agreements and other click wrap. When you check the “I agree” box, you enter into a contract with the seller, including a litany of conditions that restrict how you can make use of the licensed good. Depending on the license, that includes how long you can use it, how many users can simultaneously access it, and, notably, what rights you have to transfer your license to someone else.

The short answer to that last question? In most cases: no (re)sale.

The disproportionate bargaining power of licensors and licensees aside, there are sound economic reasons why producers of digital media have insisted — so far successfully — on licensing rather than selling their goods. In brief, resale markets are dangerous, especially for information goods. If they are particularly robust, they can drive down the price for first sales, undermining the opportunity for copyright holders to recover their high sunk costs. Which is, in turn, the whole point of copyright’s “exclusive rights” in the first place.

Publishers and media companies may not have worried much about second-hand stores when it came to physical goods. Used physical goods deteriorate rapidly and, in the days before near-perfect market information, were relatively hard to find. Since media purchases are often impulse buys, customers tended to be willing to pay a premium price to avoid even a short delay — buying hardcover instead of paperback. Likewise, many music lovers are willing to just click the “buy” button for a music track rather than wait for the song to come around again on Pandora.

But a digital copy of the latest “Iron Man” movie is a perfect replica, and infinitely reproducible at a marginal cost of zero. Stored in the cloud, it will remain a perfect copy so long as there is software that understands the format it’s been encoded into. (Which may not be as long as nervous media executives think.) An unrestricted ability to resell could, therefore, easily lead to efficient second-hand markets that directly compete with first sales. The result could be, ironically, less original content in the first place — a lose-lose outcome.

So the media industry’s slow acquiescence to allow their copyrighted works to be distributed in digital form at all has come with the quid pro quo that reselling is forbidden. In theory, consumers have implicitly traded the right to resell for a lower price and more content to choose from.

Courts have so far upheld license terms that forbid resale against arguments that they violate “first sale.” Kirtsaeng, as copyright scholar Eric Goldman notes, is of no help. In the licensing of digital goods, after all, there was no sale, not even a first sale. Just a rental.

But even if courts and legislatures continue to support licensing agreements that bar resale, that doesn’t end the discussion. Market pressure has long been building for changes in the relationship between media companies and their customers, and customers are gaining the upper hand, thanks again to near-perfect market information. Many of those customers prefer, if only for sentimental reasons, to own rather than to rent their digital goods. Today, they cannot do so — at any price.

Several start-ups have foundered on the rocks of copyright law trying to bridge the gap. In 2000, for example, MP3.com lost a life-or-death case over a service that allowed consumers to “register” music CDs they owned and access the contents from the company’s servers. The court found that whatever the “equities” involved, MP3 could not lawfully make and distribute copies without permission “simply because there is a consumer demand for it.”

A more recent start-up, ReDigi, is now facing its own existential struggle with copyright law. The company’s beta service allows users to barter MP3 files licensed from iTunes (and soon other digital sellers) to other ReDigi users at discounted prices. In effect, ReDigi operates a market for license transfers among iTunes users.

According to the company’s website, the value of such transfers can only be used to acquire other licenses — users cannot cash out whatever price they can get from each other for used iTunes licenses. They are simply “recycling” their music purchases. Everything stays within the iTunes universe.

Not surprisingly, the company’s self-imposed limits didn’t satisfy the highly litigious music industry. Capitol Records quickly sued the company, and the case now awaits decision in a New York federal court. Capitol argued that the service necessarily makes copies of protected works without permission — straight-up copyright infringement. ReDigi argues that no copy is made — that it transfers the “exact file” from the seller’s device to its servers. More to the point, the transfer of the licensed file does not violate the copyright holder’s exclusive distribution right, because, like Dr. Kirtsaeng, they are immunized by the first sale doctrine.

ReDigi is another good example of a business model I would call “barely legal by design.” Here, the company is putting its eggs entirely in the “first sale” basket. If the court decides there is no “particular copy” that an iTunes customer “owns,” the first sale defense will fail. It’s hard to see how the service can continue in that event. For what it’s worth, the relevant case law, if applied, bodes poorly for the startup. (The company did not respond to a request for a comment.)

But even if ReDigi becomes the latest casualty in the war between media companies and their customers, it will hardly be the final word. The merchants themselves may find that a carefully designed second-hand market can generate profit without undermining primary markets. According to a recent New York Times article , both Amazon and Apple have filed patent applications for systems that would create digital resale systems, at least for the digital goods they respectively market. (Amazon’s patent has already been granted.)

Reading between the lines of the applications, the companies seem to have in mind markets that would allow their customers to transfer licenses to other customers within the system. You might someday be able to trade, sell, rent, or even loan out your Kindle books to other Kindle readers, in other words, but only under the watchful eyes of Amazon.

Will that be enough? Perhaps you, like many consumers, have a visceral reaction to the very idea that you have not purchased but merely rented your digital goods, and under highly restrictive terms. “I bought it,” you might be thinking even as you read this, “It’s mine. And I can dispose of it any way I like.” That, of course, is the essence of the consumer mindset, one that manufacturers have strongly encouraged ever since the Industrial Revolution made possible identical, cheap goods sold at fixed prices.

But operating in parallel with the consumer paradigm, there have always been markets for licensed goods. When you buy a ticket to a movie, you are licensing the use of a seat in the theater, for one particular showing of the film. Your ticket is yours to keep, but it doesn’t give you the right to watch the movie again, or to sell someone else that right. No one feels outraged or cheated when they have to vacate the seat.

That’s the only workable model, content companies believe, for digital goods. As books, entertainment, and software are being distributed less and less in physical media, the companies argue that what you are paying for is much more like a movie ticket than a manufactured gooda limited right to use, but nothing to own. You can listen to the music, read the book, watch the movie, or access the software. But only at agreed-upon times and places.

Economically, they may be right. If so, however, the reeducation of consumers from buyers to renters will be a long, uphill battle. Consumers will resist, and start-ups will try to push the legal envelope to help them. The courts, in any case, are on the side of the incumbents. At least so far.

Long term, however, media companies can take heart in the realization that our digital future is one in which the benefits of owning for consumers are being quickly outweighed by the costs of storing, maintaining, and replacing quickly outmoded and inferior versions. Licensing is also more flexible than ownership, and that could mean that in the future we’ll see more rental options (pay-as-you-go, all-you-can-eat, subscriptions, ad-supported, hybrids), each with its own price.

We may be more comfortable emotionally with ownership, in other words, but may soon come to see the superiority of licensing. For ourselves, not just the producers.
Author Kevin Kelly argued in a provocative 2009 essay that the very idea of ownership for digital goods is an anachronism, an unnecessary and expensive way of thinking about information which is quickly losing relevance. Indeed, says Kelly, usage rights are far more consistent with the economics of information than the ownership of copies. “An idea can’t be owned in the way gold can; in fact an idea has little value unless it is shared or used to some extent. Its value paradoxically can increase the less it is owned privately. But if no one owns it, who gains the benefit of that increase in value? In the new regime users will often assume many of the chores that owners once had to do. And so in a way, usage becomes ownership.”

Kelly may be further up the evolutionary ladder than the rest of us. For many consumers, outright ownership still matters, whether an information good takes physical form or not. So it should matter to them, too, what role the courts and legislatures play in deciding how such questions are resolved.

The U.S. Supreme Court this week stepped into the middle of an ongoing war between content producers and their customers. In a 6-3 decision, the Court ruled that books printed and purchased abroad could be legally imported into the U.S. and resold at higher prices without the permission of the publisher. (The decision, Kirtsaeng v. John Wiley & Sons, can be found here.)

The case involved Supap Kirtsaeng, a Thai graduate student. To help support his education, Kirtsaeng had family members buy English-language editions of textbooks at Thai bookstores, where prices were much cheaper, and ship them to him at Cornell. He then resold them on eBay, repaid his family, and used the difference to help pay his expenses.

Wiley, a leading textbook publisher, sued him for copyright infringement, citing a provision of U.S. law that gives copyright holders “exclusive rights” to “distribute copies…by sale or other transfer of ownership.” Two lower courts agreed with Wiley, and fined Kirtsaeng $600,000 under the “statutory damages” provision. (As here, statutory damages often far exceed the actual profit of the infringer.)

To many, this might seem an unjust result. After all, Kirtsaeng’s family paid retail price for the books. What right did the publisher have to control what he did with his property?

To understand Wiley’s argument, it’s important to know why Wiley (or in this case a wholly owned Asian subsidiary) was producing and selling the same books for different prices in different parts of the world in the first place.

The practice goes under the unfortunate name “price discrimination,” which makes it sound much more insidious than it is. The economic theory is that when different markets have different price sensitivities, producers must adjust their prices to optimize profits. For example, I just paid $3.00 for an energy bar at the airport, which would have cost about $2.00 at my local grocery store. My willingness to pay the higher price reflects both the convenience to me of getting the bar at the last minute, as well as the fact that the retailer’s costs at the airport are likely higher. Both are also factors in the price differences between Thailand and Ithaca.

Consumers in Thailand, on average, have less to spend on books and other media than Americans. But since books have low marginal cost (printing and distribution) relative to fixed costs (research, writing, and editing), Wiley can profitably sell its textbooks there at lower prices. In theory, this means more people can have access to the content — the ultimate goal of copyright law. If Wiley charged U.S. prices in Thailand, fewer books would be sold.

Regional strategies, in which products are made available at different times or different prices, are a time-honored feature of the publishing ecosystem. At least until recently. Price discrimination is increasingly difficult to enforce. That’s because price discrimination only works when markets can be kept separate. But for many goods, including books, markets are increasingly global.

Consumers also have a wealth of new information sources on price, quality, and location of goods, much of it provided by other consumers and all of it available on whatever device they happen to be holding. Paul F. Nunes and I, in our recent HBR article, refer to this phenomenon as “near-perfect market information.” Near-perfect market information lowers what Ronald Coase famously called “transaction costs,” which in this example means that price, time, and location-based arbitrage is nearly impossible to maintain, even when it is employed in part to promote social welfare.

Dr. Kirtsaeng’s defense rested on an exception to the “exclusive right” noted above, a special rule that makes clear — or maybe not so clear — that consumers can resell copies that they own, even for works whose contents are still subject to copyright. The exception is known as the “first sale doctrine,” one of several consumer protections built into the copyright laws of most countries. Originally a judge-made principle, “first sale” was codified in a 1909 revision of U.S. copyright law.

Against “first sale,” Wiley’s argument hinged on a strained reading of another section of the copyright law, which prohibits importation “of a work acquired outside the United States” without the copyright holder’s authorization.

A 1998 Supreme Court decision had made clear that first sale took precedence over that provision for goods manufactured in the U.S., sold abroad, and then imported back to the U.S. But the Court left open the question of whether the same reasoning applied to goods manufactured abroad.

Justice Stephen Breyer, writing for the majority in Kirtsaeng, rejected Wiley’s argument, holding that first sale trumped the importation ban, even for foreign-made copies.

Kirtsaeng, for better or worse, may put an end to geographically-based differential pricing for books. But it’s also important for what it says about digital content, especially when that content is embedded in physical products. The majority was notably concerned about the implications of Wiley’s argument in a time when nearly every product bought and sold on world markets has embedded within it some piece of copyrighted software or packaging. That’s because software, like books, is protected by copyright. (I’ll pick up this argument in a separate post.)

If Wiley was correct that the importation ban took precedent over first sale, an unintended “parade of horribles” might quickly ensue. Resale markets for appliances, consumer electronics, and smartphone markets would suddenly be at the mercy of possibly unknown copyright holders. Wiley’s interpretation, Breyer wrote, “would prevent the resale of, say, a car, without the permission of the holder of each piece of copyrighted automobile software….Without that permission a foreign car owner could not sell his or her used car.”

And that, of course, would spark a revolution.

In a post yesterday, I mentioned Aereo TV, a new Barry Diller-backed business launched last year, calling it an example of a start-up that is “barely legal by design.” Since the courts are about to make a ruling that will profoundly affect its prospects, it might interest you to learn more about how its entire business is engineered to exploit existing copyright law.

First, this service takes full advantage of unchallenged U.S. law that makes over-the-air television free to anyone who puts up an antenna and connects it to a receiving device. Unlike countries such as the U.K., for example, the U.S. has no television license tax. Broadcasters in the U.S. make their money based on advertising, plain and simple.

Second, it relies on the seminal 1984 Sony Betamax case, in which the U.S. Supreme Court ruled that using a home videocassette recorder to “time shift” programming received over the air for later viewing did not violate copyright law. Even though the VCR was technically making a copy of the program without a license to do so, the Court found that copying fit into a narrow exception to the otherwise exclusive rights of the copyright holder — an exception known as a “fair use.”

Since the programming was being made available at no charge, the Court reasoned, making a copy simply to watch at another time did not disturb the market of the copyright owner — the key to fair use analysis. While the VCR was capable of illegal uses — notably making more copies and selling them to others — the studios who sued Sony had asked the court for an outright ban on the device, a request the Court rejected. If some VCR owners were going beyond time-shifting, the Betamax decision held, then the plaintiffs needed to sue those individuals and not the maker of the device.

Both the reasoning and the borders of the Betamax case have proven difficult for courts to fully unravel, and innovators have been exploiting that confusion ever since. If a home VCR used for time shifting was legal, for example, why not its digital equivalent, the DVR? And if viewers were exercising “fair use” with VCRs in their home, why not a DVR located
offsite but controlled by the consumer through the cable system?

Those were questions addressed in a 2008 case brought by television networks against cable provider Cablevision, which had created a service known as the “Remote Storage” DVR. The system configured virtual DVRs for each Cablevision customer — essentially cheap high capacity hard drives — maintained at Cablevision’s facilities. Operated by customers through their cable box, the remote DVRs separately recorded and stored the program selections of each individual customer, then replayed them at the customer’s convenience.

To fit within the Betamax decision, Cablevision designed its RS-DVR system to store individual copies of the program, even though from an engineering standpoint it would only have needed one to handle the replay. If a million customers each asked Cablevision to record the season finale of “Top Chef,” well, Cablevision’s remote DVRs would make a million separate copies of the show as it was aired and store them on the remote DVRs. When each individual later pressed play, they were watching the copy “they” recorded. Just like a home DVR.

The plaintiffs in the Cablevision case argued that the remote DVRs were really just a ruse to let Cablevision offer their content as on-demand programming without paying extra for it. The difference between a home VCR and a remote DVR was legally significant, they said. Indeed, it was the difference between fair use and an unauthorized rebroadcast. But the court agreed with Cablevision, and allowed the service to continue.
That gave Aereo the opening they needed. Aereo, like Cablevision, runs data centers that receive and record TV programs, in Aereo’s case based on customer programming entered via the Internet. Unlike Cablevision, however, which captured content it was already receiving from its channel partners, Aereo TV simply gets its content from the airwaves.

To preserve the “fair use” defense of the Betamax and Cablevision cases, however, it does so by maintaining hundreds of thousands of tiny antennas (each about the size of a dime) — one for each of its customers. It’s just like having your own antenna and a DVR at home, the company argues, except that the antenna and the DVR are both remote, and you control both through the Internet and not your television. It’s not just timeshifting. It’s “placeshifting.”

Just as Cablevision only needed one copy of the programming stream, Aereo only needs one antenna. The individual antennas and the software to manage them are there solely to satisfy the legal requirement that the individual consumer make and access her own personal copy.

So what’s the real innovation here? Is it the company’s unique combination of cheap, miniature antennas and cheap data storage controlled by proprietary software and combined to create a cloud-based service that piggybacks on the customer’s existing Internet connections to simulate a small cable company? Or is the innovation the close reading of relevant case law, and a business model that just barely extends existing precedents to allow Aereo to operate without paying any licensing fees to the content providers?

Of course there are larger trends at work here. Consumers raised on the Internet’s “pull” model of content delivery are starting to revolt against the pre-packaging of channels offered by cable and satellite providers. Some consumers — soon, perhaps, most — prefer to get their programming a la carte, and on whatever devices they happen to have in front of them.

As Internet TV devices and services from Apple, Roku, Boxee, Slingbox, Hulu and others test out new ways of distributing and monetizing television programming, Aereo argues that it’s just pushing the envelope slightly, and in a direction the courts have already determined is legal.

Too far, according to local broadcasters, who sued the company almost from the moment of its launch. Broadcasters say the company is retransmitting their programming without paying fees required by law for cable and satellite providers. Aereo says it’s just helping its customers exercise established fair use rights using the latest technology, for which the company charges a correspondingly modest fee.

Who’s right? Digital rights advocates at the Electronic Frontier Foundation, for one, are siding with Aereo. Calling the broadcasters’ arguments “depressingly familiar,” EFF says the case is really about who gets to profit from new technologies that make TV watching better. The broadcasters, the group says, argue that every innovation someone else invents is theirs to control; that “they have a right to the profits generated, and a veto power over features.” Aereo is just a rerun of Betamax, the group argues, and Aereo should win.

Not so fast. Many local broadcasters are already struggling to stay profitable and relevant as fewer and fewer consumers get their programming over the air. They increasingly rely on the FCC-regulated retransmission fees paid by cable and satellite packagers, a trend that will only increase as more network programming becomes available on the Internet and the need for local affiliates shrinks further. If Aereo succeeds and more viewers cut the cord with cable and satellite, many of the stations Aereo relies on may not stay in business. Obviously that doesn’t help anyone.

Legal hair-splitting aside, in other words, what’s clear here is that the supply chain of the content industry is coming apart. No one knows yet who will be left standing when a new one is ultimately forged, or in what position they’ll find themselves. Both sides here are counting on the courts to protect their position. If Aereo’s only innovation is to gingerly pluck legal loopholes to accelerate the destruction, broadcasters are equally guilty of using the law — in this case FCC regulations going back to the early days of cable television — to hold them off until they can figure out what else they can do in a future content ecosystem.

This isn’t a fight about control of new technology that makes television better. It’s about which law will determine the winners and losers in an industry where disruptive change is inevitable: Betamax and Cablevision on the one hand, or the FCC’s retransmission rules on the other. Neither, of course, was intended or anticipated to decide the future of Internet television. Once again, technology change has outpaced legal change, causing yet another collision at their accident-prone intersection.

So far, Aereo has won the early skirmishes in the lower court, fighting off a request by broadcasters for a preliminary injunction. (For a similar service offered on the West Coast by another startup, the maverick has lost the early rounds.) But in the fall, a federal appeals court in New York took up the Aereo case. A decision is expected sometime soon that will likely save or sink Aereo. The company, meanwhile, has announced plans to expand its service to 22 additional markets.

Interestingly, the three-judge appellate panel included, by chance, Judge Denny Chin, who was the trial judge in the 2008 Cablevision case. Chin had ruled against the Remote Storage DVRs, but his detailed opinion was harshly rejected on appeal. Now Chin is himself an appellate judge, and one of the three votes that will decide Aereo TV’s fate.

As disruptive innovations enter the market with faster velocity and increased firepower, entrepreneurs are finding themselves dealing sooner and more intimately with the law.

Sometimes, the innovation is just too new, creeping out consumers and lawmakers who hurriedly work to ban it. Few people remember, for example, that the day after Scottish scientists announced in 1996 the successful clone of a sheep named Dolly, President Bill Clinton issued an executive order banning the use of federal funds for cloning in the U.S and urged Congress to outlaw the technology. (Before that, it had been a subject only for science fiction novels.)

But more often the imposition of legal constraints comes indirectly, the maneuverings of incumbents caught off-guard by something dramatically better and often cheaper than their core products and services. Performing a bit of regulatory judo, they often respond to such threats by pressuring regulators who oversee their own activities to declare the innovator illegal or otherwise in violation of rules that were never designed to cover it. Internet-dispatched limousines and ride-sharing services such as Uber, Lyft, and Sidecar, for example, are dealing with such challenges on a daily basis, as trade groups press local taxicab commissions to prohibit the new services.

Incumbents also run to the courts, filing sometimes-dubious infringement lawsuits based on a yellowing sheaf of patents, copyrights, or trademarks. Implicitly, these lawsuits are often aimed not at stopping the new entrant so much as to slow it down, wasting its precious time and limited funds.

Here, think of the response of the music, film, and other mass media to the advent of digital distribution of content. Much of it, at least in the early days, might in fact have been illegal. But incumbents who continue to rely exclusively on the courts are only putting off the inevitable. The same year the music industry successfully shut down Napster, Apple launched iTunes.

One result of the uncomfortable and increasingly frequent collisions of once-separate worlds of innovation and law is that entrepreneurs now engage with lawyers much sooner in their lives. They must, if only to secure their own patents and copyright or fight off life-threatening lawsuits.

Now, more startups are even opening their own policy offices in Washington, Brussels, and other lawmaking capitals. Only four years into its existence, for example, Twitter opened a D.C. office headed up by a former senior Congressional and FCC staffer. Facebook’s D.C. office has almost 30 employees. Google, Microsoft, Yahoo and other Silicon Valley brand names all have their own, often extensive, government operations. For the new breed of disruptive innovators, it’s a necessary evil.

Beyond being used both offensively and defensively with lawmakers, regulators, and litigants, legal constraints on innovation are increasingly finding their way directly into product design. In the U.S., the Federal Trade Commission has been using its general consumer protection powers to shape how Internet service providers do and do not make use of user-generated information and other content. (In the E.U., regulators are likewise groping to find ways to enforce more specific, but still undefined, privacy directives.) The buzzword for social media these days is “privacy by design,” a concept that unfortunately hasn’t advanced much beyond the purely rhetorical.

At the extreme are start-ups created specifically to satisfy legal loopholes, and perhaps to push them open just a little further. Think of these as “barely legal by design.” For this category, I’ve collected several recent examples of companies whose major innovation is to creatively adapt new technologies to old laws.

Perhaps the most interesting is Aereo TV, a start-up launched last year and backed by investors including former Fox Chairman and CEO Barry Diller. For as little as $8 a month or $80 a year, Aereo lets users watch and record TV programs offered by local over-the-air broadcasters and play it whenever they like over the Internet—including on their smartphones, tablets, and home computers. The service is currently available to 19 million residents in the New York metropolitan area, though the company declines to say how many it has actually signed up.

In essence, Aereo offers its customers a virtual DVR for over-the-air channels, and uses the public Internet to replay live or recorded programs on any connected device. But here’s the catch: unlike cable and satellite providers, who are required by law to pay broadcast stations for the right to retransmit their programming, Aereo is paying the stations absolutely nothing. And, the company has maintained in several preliminary courtroom appearances, it is not violating any law or FCC regulation.

How’s that? The company is delicately threading the needle — successfully so far—of several important court decisions involving copyright law. Indeed, it is little stretch to say that the company’s entire business is engineered around those decisions. To make a long story short, it does so by maintaining a tiny antenna (about the size of a dime) for each of its customers — completely unnecessary to accomplish the technical feat but a handy way to fall within the “fair use” doctrine established back when Betamax and Cablevision first posed their technology-based threats to broadcasters.

Aereo is arguing that it is no different than having your own antenna and a VCR at home. Now those are simply located remotely, and you control them through the Internet and not your television.

Not surprisingly, Aereo has been fighting legal challenges. At a recent oral argument, Judge John Gleeson, appeared skeptical of Aereo’s business model. He characterized the individual antennas as a technical “fiction” designed solely to shoehorn the Aereo service comfortably between the Betamax and Cablevision cases. “You don’t have all these little antennas because it makes any sense,” he said. “It’s a belt-and-suspenders approach to the Copyright Act.”

That’s clearly the case. But does that make it illegal? As innovation and law bump up against each other more frequently and in more awkward positions, entrepreneurs might actually be well-advised to wear both belts and suspenders, if not a few dozen other technical and legal forms of support. When a single case can make or break your business, there’s no such thing as too much innovation — or too much lawyering.