Different River

”You can never step in the same river twice.” –Heraclitus

June 8, 2005

Intellectual Property, Economics, and Toner Cartridges

Filed under: — Different River @ 4:03 pm

If you’re at all interested in intellectual property law — or in discount printer toner cartridges — here’s a case with an interesting twist:

Lexmark tried to lock in consumers and lock out competition by adding code to their printers and toner cartridges so that only Lexmark toners would work. [North Carolina-based Static Control Components] defeated their monopolist technology and began selling the off-brand chips to aftermarket toner cartridge makers.

What I find interesting about this case is that it’s not a patent case — that is, Lexmark didn’t claim SSC violated any of their patents. Instead, Lexmark claimed that SSC violated the Digital Millenium Copyright Act (DMCA) which makes it illegal (under certain circumstances) to tinker with products you own and figure out how their copy-protection schemes work, or to make or “traffic in” a device that can bypass such a scheme.

The DMCA was passed in part at the behest of the movie and music-recording industries, who don’t like their CDs and DVDs being copied and think that their inability to come up with an encryption system that can’t be broken by adolescent computer hobbyists within days is better dealt with by legislation rather than better engineering. They also want to be able to collect royalties on (for example) every DVD player sold, and view a hobbyist who makes his/her own DVD player is stealing those royalties, even if the player is used only to play legitimately purchased DVDs rather than illegal copies.

Now, Lexmark used this same legislation to claim, in effect, that no one but them can make toner cartridges that work in their printers; that anyone who does so is in effect stealing by violating their copyright on the software their printers use to reject non-Lexmark toner cartridges.

One would think that this would have been resolved by a 1936 Supreme Court case, IBM vs. United States, in which the Supreme Court ruled that it was a violation of the Sherman Antitrust Act to require purchase of only IBM punch cards for use in an IBM (mainframe) computer. This is so analogous a case it seems obvious, but I guess Lexmark thought the DMCA would trumpt antitrust law. There is actually a small diference in theory but not practice: IBM openly asked buyers of their computers to sign contracts promising to use only IBM punch cards (as a condition of buying the computer); they made no direct attempt to prevent other manufacturers from making the cards. Lexmark did the reverse — they made no direct attempt to make customers promise not to buy non-Lexmark toner cartridges, but instead tried to prevent other manufacturers from making toner cartridges that would work in Lexmark printers.

Lexmark’s attempt has failed in the courts — last October they lost at the Sixth Cuircuit Court of Appeals, and now the Supreme Court has declined to review the case.

As one who thinks the DCMA is a horribly misguided way to deal with copyright violation (and I may be the only DCMA opponent who actually thinks that copyright violation is stealing), I think that this chink in the DCMA armor is probably a good think. However, it would be nice to see what an actual expert in the field (hint, hint!) thinks of how much of a chink this really is.

As an economist, I’d just like to point out that this is an old variation on what economists call “price discrimination” — the practice of getting people who have a greater desire for a product to pay more for it. The classic example is Gilette’s safety razor with replaceable blades. They sold the razor itself at loss (to get people to try it), and tried to make back the cost by selling the replacement blades at a huge profit. This way, people who really liked the product would use it more, need more blades, and thus end up paying more for the complete product (razor plus blades) than people who tried it and didn’t like it so much and so didn’t use it as much.

The IBM case is the same — computers in those days took their input from punch cards, and companies that used the computers more would use more cards. Some companies really needed and depended on the computers and were therefore willing to pay a high price; others didn’t need them so much and were thus willing to buy only at a lower price. IBM’s problem was to (1a) try to extract a high price from the customers who had a high willingness-to-pay, without (1b) pricing out of the market customers whose willingness-to-pay was lower, but still high enough to allow some profit at the margin. Or to put it another way, their problem was to (2a) sell to the lower-willingness-to-pay, without (2b) giving the higher-willingness-to-pay customers nearly a free ride. Of course, they couldn’t just have their salespeople ask, “So, how much is our product worth to you?” or they’d all pretend to be barely willing to buy it. And, they couldn’t even estimate the willingness-to-pay of individual customers, since then the low-payers would buy computers and resell them to the high-payers at a profit (but not IBM’s profit!). Presumably, though, companies that have greater need for the computers and thus are more willing to pay for them also have a general tendency to use the computers more intensely — and to the extent that’s the case, they would need more punch cards. So, by “tying” punch-card sales to computer sales, they were in effect able to charge a higher price for the whole package to the customers who were willing to pay more.

When that system was ruled illegal by the Supreme Court, IBM had to stop requiring computer purchases to agree to buy all their punch cards from IBM. Since the patent had expired and punch cards could be made easily and cheaply by any paper company, this effectively put IBM out of the punch card business — and forced them to raise the prices of their computers. Instead of selling the computers at a loss (or nearly so) and making their money from the fact that high-use customers used huge numbers of punch cards, they had to make their money from the initial computer sale alone. This no doubt was great for high-use (big-business) customers, but lousy for the smaller businesses, who found themselves priced out of the computer market entirely.

Which is ironic, because the Sherman Antitrust Act had been sold to the public as a way to “protect” small consumers from big business, not the other way around.

It’s easy to see who the winners and losers are in the Lexmark case, aside from Lexmark and SSC. Lexmark has been practically — and in some cases actually — giving away printers in hopes of making money from cartridges. High-use customers have felt cheated by the high price of cartridges, but low-use customers have been glad to have a free printer — and they never bought that many cartridges anyway. Now, we can expect cheaper cartridges — but no more free (or nearly free) printers.

Whether that’s a good change is debatable. My instinct is that it’s not, but that the chink in the armor of the anti-innovation provisions of the DCMA might be worth it. Perhaps time will tell.