Tuesday, April 23, 2002

Code enforces cartel contracts Cartels are good for an industry and bad for consumers because they keep prices high. But cartels are also unstable because every company has an incentive to cheat and try to grab marketshare by lowering price. It's tough to punish cheaters because throwing them out of the cartel means they keep on cheating, and inviting them back into the cartel means they can just cheat again. Punishing the cheater by starting a price war just hurts everyone (except consumers, who do quite well).

You can't draft private contracts enforcing cartel rules because such contracts are illegal. However, suppose you built such a "contract" into the code of a system--there would be no paper-trail, the cartel would be enforced, and you would remove all incentive to cheat.

CSS region encoding on DVDs does exactly that. Content owners want to price discriminate between different countries, but how do they keep distributors from reimporting DVDs from low-priced to high-priced countries? The MPAA did this by building regional encoding into the technology itself, DVDs imported from Europe can't play on US DVD players, and vica versa. DVD player manufacturers aren't too happy about this as it means 1) their costs go up and 2) their markets shrink, so to placate them they get a royalty from DVDs sold by region (giving them a cash incentive to support regional encoding) AND their machines can switch between regions 6 times (or something like that) meaning people can move across the Atlantic a few times and their equipment still works. Remember, the point of regional encoding is to stop re-export in DVDs.

All of this is collusive price-setting and would be illegal if written in paper form. But build it into the code, and you get a stable cartel. Nice.

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