The Knockoff Economy

by Kal Raustiala

  Even the Supreme Court has noted the centrality of experience in the dining world. In Chapter 2 we described the Taco Cabana-Two Pesos dispute over restaurant trade dress. The issue was whether one somewhat generic Mexican restaurant had copied the décor, and therefore the “trade dress,” of another. In the oral argument in that case, Justice Scalia suggested that the underlying issue was not trivial: the atmosphere of a restaurant was a central part of the restaurant experience as a whole. “I don’t think it is packaging. I think you’re talking about the substance of what’s being sold,” said Scalia. “You’re selling atmosphere and food, the two of them. You can have wonderful food in a lousy atmosphere. I’m not going to pay as much money.”18 Neither restaurant in the dispute had wonderful food. But the atmospheres were equally nice (or lousy) and Justice Scalia’s point was simply that atmosphere was a core element of almost any restaurant’s actual product, not just a metaphorical wrapper placed around the product.

  The same basic dynamic is present in other industries we have looked at. Bars and high-end cocktails epitomize this phenomenon of performance over narrowly defined product. Why else do people pay upward of $15 for a drink that may cost less than $2 to make? As a sage bartender once said, you are not really buying a drink, you are renting a bar stool. And the rent varies, as you would expect, with the quality of the experience. In short, the high-end bar is a live performance venue. The drink is the ticket to the show. Anything that is a live performance must be experienced to be appreciated, and that experience can shelter creativity from the pernicious effects of copying. Why? Because copying all the facets of the experience is very difficult and often extremely costly—and sometimes impossible, as many would-be restaurateurs and bar owners have discovered to their peril.

  The centrality of experience helps explain the co-existence of some otherwise-contradictory trends outside the restaurant industry. Consider the willingness of customers to pay high prices for movie tickets in some theaters, even as streaming video in the comfort of one’s home grows ever more common. Why pay to go out to a movie theater when you can watch the exact same film on your widescreen high-definition television, thanks to one of the many torrent Web sites that feature illegal content? One answer is that the experience is different, and many smart theater owners have been rapidly moving to accentuate that difference as dramatically as they can.

  The tremendous success of the Arclight theater chain in Southern California is a case in point. The Arclight allows customers to reserve seats in advance and to choose their seat as they do so. The theater seats are big, clean, comfortable, and have good sight lines. The screens and sound are top flight. Inside the complex is a restaurant, bar, and gift shop, and at some showings alcoholic drinks can be enjoyed during the show. The overall experience, in short, is at a much higher level than is available at the average mall multiplex. So are the ticket prices, which can approach $16—about twice the national average. Still, the Arclight has proven successful enough to have expanded in just a few years from its original Hollywood complex to three other locations in Southern California.

  The Arclight, and theaters like it around the nation, are far from the norm. Yet they have successfully capitalized on the experiential nature of film. Rather than a product, film becomes a performance. By making the experience one that is very costly to replicate at home, the central good being consumed—the film—becomes just one part of an overall package.* And in turn, that means that copies of the film are copies of but one facet of the overall experience, and therefore are no longer perfect copies, but instead imperfect—and, to many, much less attractive.

  The same dynamic helps explain how in the music industry, the record labels can be imploding while the business of live performance is thriving. Live performance cannot be copied in the way that recorded music can. It is true that tribute bands exist, and so in a sense there is a market, albeit very small and quirky, for “copies” of live performance. And there are videos and films of live acts. But no one is going to mistake Mandonna (an all-male Madonna tribute band) for Madonna,* and no video can substitute for the energy or sound of a live concert. Listening to a CD or MP3 is not at all the same thing as going to an actual show. Again, energy, experience, environment—these all are central to performance and cannot be bottled and sold (or digitized and copied) the way a simple song can.

  In short, as perfect digital copies proliferate there is a countervailing trend in favor of the unique experience of live performance. In the motion picture industry, reinforcing the desirability of the “live” theater performance feeds Hollywood’s box office revenues—which, despite rising worries about copying, reached their all-time high in both 2009 and 2010, in the middle of a major recession, of approximately $10.5 billion in revenues in the United States alone.* In the music world, the major record labels do not have much of a stake in the live performance business. As a result, they cannot (at least yet) recover lost revenues from recorded music via the healthy live performance segment of the industry.

  That is unfortunate for the record labels. But the music industry as a whole is not dying; it is changing. Unlike the recording industry, which is shrinking fast, the live music business is growing. Millions of people every year attend concerts, and between 1999 and 2009, even as the record labels’ revenues were plummeting, concert ticket sales in the United States more than tripled in value, from $1.5 billion to $4.6 billion. Total revenues from live shows grew from $7.3 billion in 2006 to $10.3 billion in 2011.19

  The importance of concert revenues to music is nothing new; for most of history the live show was the musician’s main source of support. That point was made with terrific clarity by Mick Jagger in a recent New York Times interview:

  There was a window in the 120 years of the record business where performers made loads and loads of money out of records,” Jagger says. “But it was a very small window—say, 15 years between 1975 and 1990.”20

  As the Times article noted, touring is now the most lucrative part of the Rolling Stones’ business. (The “Bigger Bang” tour, from 2005 to 2007, raked in $558 million, making it the highest-grossing tour of all time.) The band has also been forward thinking about other pieces of the business, including recruiting sponsors, selling song rights, and flogging merchandise. And this strategy has made it very rich. “The Stones carry no Wood-stockesque, antibusiness baggage,” a Fortune magazine profile noted approvingly back in 2002.21

  Performance is of course no guarantee of riches. Revenues from touring can be erratic, and most of the biggest grossing tours feature well-established acts. For these acts, however, recordings are but a tiny fraction of their earnings; economist Alan Krueger found for 35 top-earning acts in 2002, live concert revenues exceeded recording revenues by a factor of almost 8 to 1.22 Figures for acts in the middle of the pack are harder to come by, but there is at least some reason to think that concert revenues are larger than recording revenues for these performers as well.23

  Growing the live music business is an obvious way to make the industry as a whole less vulnerable to piracy while remaining profitable. There is no good way (yet) to “pirate” a live show.* The importance of touring to the industry’s post-Internet fate is illustrated by a recent comment David Bowie made in an interview with the New York Times: “Music itself is going to be like running water or electricity. You’d better be prepared for doing a lot of touring because that’s really the only unique situation that’s going to be left.”24

  The important point is that concerts are far less vulnerable to copying. And copying plays a very different role in a world in which the primary product is performance. As Sasha Frere-Jones, music critic for The New Yorker, has noted, increasingly “recordings have become advertisements for shows.”25 This spurs some artists to give away recordings, and makes the impact of illegal copies very different: an illegal copy or a free giveway can be equally powerful ads for the real product—the performance. And like any ad, the more widely it is heard or seen, the more effec
tive it is.

  This is not just true of music, dance, or other obviously performative arts. The more a given creation can be transformed from commodity to experience, from product to performance, the more innovators can effectively ignore imitators. Think back to the Kogi taco truck story that we told in the Introduction. Kogi was an innovator in several respects: it fused Korean and Mexican food, upscaled the lowly food truck, and used Twitter and face-book effectively as marketing tools.

  But Kogi’s fundamental product was the Korean taco, and that was soon knocked off—legally—by a rash of imitators. What made Kogi remain a formidable competitor was not just that it was the first, and most famous, Korean taco slinger. It was also that (at least initially) finding the Kogi truck and joining the crowd in line was an experience as much as a meal. A stylized picture on Kogi’s Web site evokes the late night party vibe that made Kogi such a hit:

  FIGURE 5.1 Kogi website image

  Kogi’s legion of copycats may make a decent short rib taco, but they have never been able to quite match the Kogi experience.

  Openness and Innovation

  In his brilliant 2009 book Drive, Daniel Pink offers a fascinating thought experiment. Pink asks us to travel back to the last millennium—to 1995, to be exact—and to imagine a conversation about, of all things, the future of encyclopedias. He starts the conversation by describing two new encyclopedias that are about to hit the market:

  The first encyclopedia comes from Microsoft. As you know, Microsoft is already a large and profitable company. And with this year’s introduction of Windows 95, it’s about to become an era-defining colossus. Microsoft will fund this encyclopedia. It will pay professional writers and editors to craft articles on thousands of topics. Well-compensated managers will oversee the project to ensure it’s completed on budget and on time. Then Microsoft will sell the encyclopedia on CD-ROMs and later online.

  The second encyclopedia won’t come from a company. It will be created by tens of thousands of people who write and edit articles for fun. These hobbyists won’t need any special qualifications to participate. And nobody will be paid a dollar or a euro or a yen to write or edit articles. Participants will have to contribute their labor—sometimes twenty and thirty hours per week—for free. The encyclopedia itself, which will exist online, will also be free—no charge for anyone who wants to use it.26

  And then Pink says that in 15 years—that is, in 2010—one of these two will be the biggest and most widely used encyclopedia in the world, and the other will no longer exist. Which is which?

  You already know the answer. Microsoft shuttered its proprietary encyclopedia, Encarta, in 2009. The all-volunteer, open-source Wikipedia, on the other hand, has grown like kudzu. At its peak, Encarta had entries on approximately 62,000 subjects. Wikipedia currently has nearly 20 million entries, all of them written and edited collaboratively by more than 90,000 volunteer contributors around the world. It is estimated that Wikipedia receives almost 3 billion page views monthly from the United States alone. It is not just the world’s leading encyclopedia. It is, for anyone under 30, practically the only reference source they have ever used.*

  In 1995, of course, virtually no one would have predicted the stunning success of Wikipedia. Most people would have assumed that Microsoft’s encyclopedia, backed by millions of dollars of investment from one of the world’s largest companies and protected by copyright (facts are outside copyright’s domain, but copyright does protect the particular way in which an encyclopedia entry is written), would win out over a start-up enterprise that seemed pretty flaky and even vaguely communist.

  Wikipedia doesn’t charge for access, doesn’t pay contributors, and doesn’t take advertising. It relies on voluntary contributions. And Wikipedia invites people to copy and to edit the content that their volunteers create—the Wikimedia Foundation licenses, free of charge, all Wikipedia content to whoever wants it. In exchange, users must agree to give Wikipedia credit if they publish that content, and to allow others to share whatever they take, including any content they’ve adapted, according to the same conditions. Yet Wikipedia beat one of the world’s most successful firms, Microsoft, at a game Microsoft was determined to win.

  Wikipedia is just one example of a much larger method of innovation: what is usually known as open source. Open source is most famously associated with computer software, that is, software developed mostly by volunteer programmers who work without prospect either of salary or—importantly—legal rights in the code they create. (Yochai Benkler and others have written in detail on the stunning success of open-source software.)27 Open-source software is usually licensed in a way that allows users to tweak it, but bans any attempts to monopolize the code through copyright law. These licenses turn copyright on its head, encouraging copying and blocking ownership.

  Open source is important to this book for two reasons. First, it is another very important area in which creative people engage in significant, persistent innovation despite the fact that their work may be copied. Indeed, they want it to be copied. But second, open source represents a broad method of creation—open, collaborative, intrinsically focused on sharing—that we find present in some unusual places, such as top restaurant kitchens.

  Let’s step back and look at the story of open-source software a bit more closely. After a quarter century of enormous growth, there’s no longer a serious question that the open-source model works. Mozilla Firefox, the world’s second largest browser with over 150 million users, is open source. So is the Linux operating system, which is running on about 25% of all corporate servers. Over half of corporate servers run Apache, the open-source Web server software. And these are just a few of the many thousands of open-source projects.

  What makes software “open source”? The best way to explain it is to distinguish between software that your computer can understand, versus software that you can understand. When you purchase a piece of commercial software (say, Microsoft Office) you get the object code—the strings of 1s and 0s that your computer understands but you do not. In contrast, when you download open-source software, you get both the object code and the source code—that is, human-readable computer code that underlies the object code. Reading source code is a bit harder than reading this book (we hope). You need to understand the computer programming language in which the source code is written. But millions of people do.

  Open-source software distributors reveal the source code deliberately. They want you to understand the software, and crucially, they want you to improve it, extend it, and tweak it. That’s the point of open source—to keep software code open, which really means free of restrictions on copying and improving. Open-source proponents believe—with much justification—that copying and modification can spur, not just retard, creativity. Openness leads to more innovation and better software.

  How is open-source software better? For one, it’s usually free. One consultancy has estimated that open source has saved consumers about $60 billion.28 But the cost savings, even though substantial, are not the principal benefit. More important is open-source software’s transparency and quality. Since everyone can see the source code, anyone can improve the software. And many people do. In other words, open source is an example of how, to use the phrases we employed in the last chapter, tweaking can be as important as pioneering. Pioneers come up with big ideas. But very often pioneering inventions require extensive refinement—tweaking—to actually reach the marketplace, and even more refinement to become truly effective and successful.

  A key to the success of open source is the motivation of those who tweak products to make them better. Some expect to make money by selling services or advice to people who adopt a particular piece of open-source software. A prominent example is Fortune 500 company Red Hat. Red Hat is a major contributor to the continuing development of Linux, and it distributes its own version of Linux—to which others are free to make changes. Red Hat also sells Linux consulting services. And this business model—dealing in open-sou
rce Linux, and servicing it—has made Red Hat an industry giant with a market capitalization of $7.7 billion. (As Wired editor Chris Anderson compellingly details in his 2009 book Free, this basic approach—allow others to copy or take for free an underlying good, but make money servicing that good—can be very lucrative.)

  Red Hat is unusual; many individual programmers don’t hope for or expect riches. They work on open-source projects to learn or to gain a reputation for expertise and innovation among their fellow programmers. Doubtless for some the plan is to turn reputation into dollars—perhaps using connections made working on an open-source project to find a job or get a promotion. But there are others for whom reputation is not a means to an end, but an end in itself. To those for whom the only coin worth having is the metal sort, this may sound strange. But remember the participants in the MathWorks contests; many poured hundreds of hours of work into winning a programming competition whose only prizes are a T-shirt and the admiration of other contestants. Humans are status-hungry creatures, and for many creators, the most important form of status is recognition by other creators. Open source feeds on that desire for reputation. And it provides a way to improve skills and learn by doing.

  There is another, and potentially very important, spur to open-source creativity—the competitive interests of rival firms. Take IBM. IBM is heavily involved in open source. IBM has committed hundreds of millions of dollars and over 600 employees to open-source development, especially in Linux. Yet IBM will not own any of the software this effort aids.

  Why does IBM do this? The answer is simple: Linux is the principal competitor to Microsoft’s Windows Server operating system software. IBM is much better off selling its hardware in a market in which there is vigorous competition among operating systems. Without competition from Linux, Microsoft might be a monopolist in server operating systems, and from that position of strength, better able to suck up more of the profits from selling computer systems to corporations—profits that IBM would like to keep for itself. And so IBM is eager to make sure that Linux succeeds.