Is flouting the IP laws really a good innovation strategy?

To what extent should a smart innovator strategically consider flouting IP? Based on a 2 May piece in The Economist, “Shedding the rules”, the answer proposed is maybe “yes”, especially when the innovation is based on the use of digital technology which itself is leveraged by network effects, where first mover advantage is critical. The poster child of the article is YouTube. Consider the description of the circumstances that led to the success of You Tube a decade ago.

“When it launched in 2005, it was one of dozens of video sites competing for both content and viewers. Some, such as Google Video, diligently screened each video for copyright infringement. YouTube was more risk-taking, waiting for copyright owners to complain before taking down videos. The strategy worked …. [A]lthough [YouTube] got a start in life through people posting copyright-infringing clips, it now makes most of its living by sharing advertising revenue with people who post clips they have created themselves.”

Still, the piece falls short of advocating straight-out disregard of IP:

“[F]or more fragile firms, it would be better still if legislators and regulators responded to the emergence of so many innovative, law-testing businesses by revving themselves up to internet speed and adapting their rule book for the digital age.”

I am not sure that I understand exactly what is meant by the notion of a “fragile" firm. One would like to think that innovative fragility is not simply a function of whether or not one is able to disregard the IP laws. This is especially so because, as The Economist must surely know, expecting the legislator to pivot at the same warp speed as an innovator is a pipe dream. As such, the argument put forth in the article seems to take us back to the proposition that a strategically shrewd innovator should have no qualms about disregarding the IP laws if they get in the way of the hoped-for disruptive innovation.

Before you decide to cast all manner of respect for the IP laws into the trash bin as you establish your start-up, however, a word of caution. The conclusions reached by the piece might be deleteriously influenced by the phenomenon of “survivorship bias”. As defined by Wikipedia--

"Survivorship bias, or survival bias, is the logical error of concentrating on the people or things that "survived" some process and inadvertently overlooking those that did not because of their lack of visibility. ….Survivorship bias can lead to overly optimistic beliefs because failures are ignored, such as when companies that no longer exist are excluded from analyses of financial performance. It can also lead to the false belief that the successes in a group have some special property, rather than just coincidence.”

YouTube ignored potential copyright issues while Google Video did not. YouTube survived while Google Video did not. Ergo YouTube made the right strategic decision regarding its manner of adherence to the copyright laws. Yet YouTube did not really flout the copyright law, but merely played the odds against being caught and the likelihood that the offer of take-down would be a sufficient remedy when challenged by an unhappy copyright owner. But what does the YouTube story tell us about situations where “a take-down” –like strategy is not enough?

Consider the three most notable sagas of this type in recent memory—Napster, Grokster and Aereo. Napster’s technology was struck down because of the role played by its central server system in enabling users to share files. Grokster failed before the U.S. Supreme Court despite the fact that its system was wholly distributed among its users; it was enough there was contributory infringement. Aereo’s use of multiple miniature antennae was ultimately found by the Supreme Court to be a violation of the copyright laws when it reversed the decision of the Second Circuit Court of Appeals.

Unlike YouTube, none of these companies is still around. Unlike YouTube, the challenge posed by each of them was a zero-sum game; either what they did would be permitted under the copyright laws or it would not; if not, the enterprise in that form would be shut down. They were no more “fragile” than YouTube; they simply ended up on the wrong side of judicial understanding of the copyright law. The Economist’s survivorship bias would have us believe that YouTube succeeded because it flouted the copyright laws. This is not true--at the most, it merely delayed the need to comply with it. What the YouTube story really tells us is that an innovator should not take on the IP laws head-on. Otherwise, you will face the fate of Napster, Grokster and Aereo.

While Aereo is liquidating, is the "Innovators' Dilemma" still alive and kicking?

After a high-profile IP case is decided by the courts, there tends to be little interest about what happens to the parties post-judgment. This is so, even when the losing party is a defendant that tried to disrupt an industry in a media-savvy way, but ultimately fell foul of an adverse judicial decision. An excellent case in point is the Aereo copyright litigation, which ended in June 2014. As readers will likely recall, Aereo was in the business of streaming over-the-air broadcast signals to customers via the internet, whereby each customer had its own tiny dedicated antenna from which the content was then transmitted to customers. No royalties were paid the broadcast providers for their content. All in all, Aereo’s business model was reasonably simple. The basic package was $8 per month to access the personalized antenna and 20 hours of DVR storage, with the option to pay an additional $4 of month for 60 hours of DVR storage. Compare these fees with the $80 a month charges for cable.

Broadcasters challenged this arrangement, alleging copyright infringement. The 2nd Circuit Court of Appeals ruled in Aereo’s favor, finding that no copyright infringement had taken place. The United States Supreme Court disagreed, ruling that Aereo’s scheme did infringe the U.S. copyright laws and ordered Aereo to stop making further use of their system. The decision put paid to the business model that had been employed prior to the Supreme Court decision. Aereo did not throw in the towel and tried to reconstitute itself as a cable company. However, in October a judge in New York approved a ban that prohibited the company from retransmitting live TV broadcasts.

Several weeks later, in November, the company filed for bankruptcy protection under Chapter 11 of the bankruptcy law, which is intended to enable a company to restructure its operations under court protection. However, on December 24, 2014 the U.S. Bankruptcy Court in Manhattan ruled that Aereo can go forward with the sale of its assets via an auction, which indicates that the company will be liquidated. Significantly, the court issued its ruling only after it reached agreement with certain major broadcasters, including CBS, Comcast, ABC and Fox, who will be allowed to attend the auction. As well, Aereo undertook to provide these broadcasters with a weekly update on the progress of the auction process.

The question immediately jumps to mind: why are the broadcasters so interested in monitoring the liquidation of Aereo’s assets? After all, the Supreme Court effectively shut the company down; what difference will it make to the broadcasters to whom and under what circumstances the company’s remaining hard assets are put up for sale ? The answer seems to lie in the fact that these broadcasters are concerned that the purchaser of these assets could use them as the springboard for another attempt to transmit content to end users without paying the content providers. This is so, even if the company itself has undertaken before the court that it will not recommence such activities in the future.

The concern expressed by the broadcasters is particularly interesting in light of the apparent disdain they have shown for the Aereo business model. Thus CBS chief executive Les Moonves is reported to have said in August 2014 that while Aereo attracted “a lot of attention for a service that virtually no one was using.” More generally, commentators wondered just how many people would ever sign up for the service, given that the broadcast signals are anyway free if one simply uses an appropriate antenna. But even if Aereo was a mere gnat in the firmament of television broadcasting, it was enjoying much more rapid growth than other content distribution channels. The Wall Street Journal estimates that Aereo had 108,000 subscribers in 14 cities when it closed down in June. This number pales in comparison with the reported 35 million subscribers at Netflix and Comcast’s base of 22.5 million. But Aereo’s rate of growth gave the industry pause for concern.

After all, Clayton Christensen’s iconic analysis on disruptive technology, The Innovator’s Dilemma, focused on new technologies being developed on a small scale and seemingly posing no threat to the entrenched industry. Even after the Supreme Court decision, perhaps the broadcasting industry has the “innovator’s dilemma” in mind as it seeks to bear careful watch on how Aereo’s assets will be disposed of.