The irony is that although DRM was designed to protect artists and record labels, increasingly it is causing them to lose competitive advantage to the digital music player manufacturers. As long as DRM remains in use, the party who is in control of the dominant DRM gains the most competitive advantage as it confers the ability to control when and how the technology modularizes.

In light of this, Apple’s strategy looks particularly impressive. It has been announcing that it will support DRM-free music only if the record labels agree. So long as the future includes DRM, it is a matter of time before the record labels will come up with a competing DRM solution – Sony has been working on a solution, and BMG has been developing one through its Napster acquisition. However, if the record labels agree to a future without DRM, then it will be a level playing field. This is reflected in the comments of Apple Senior Vice President Phil Schiller in an interview with CNET News, “The iPod makes money. The iTunes Music Store doesn’t. Just trying to have a business around downloadable music would be tough.” Since Apple currently has the competitive advantage, it is in a strong bargaining position. This also allows Apple to blame the fact that iPod only plays tracks from iTunes on the record labels, deflecting consumer frustration and EU regulatory concern.

The industry equilibrium, i.e. the outcome that makes everyone most happy, appears more and more to be a DRM-free world. More and more artists such as Barenaked Ladies, Avril Lavigne, Sarah McLachlan, and Paul Van Dyk are increasingly voicing opposition against DRM. Record labels, beginning with the ones under most financial pressure have also started to offer DRM-free music, and Jupiter Research analyst Michael Gartenberg expects others to follow suit within the year.

Forced to relinquish DRM, record labels will lose the control over distribution that they traditionally had. Labels will have the tendency to outsource what is deemed unimportant to their core business, relinquishing the distribution of the music on CDs, focusing instead on promoting artists. We might finally see customers burning CDs at home and at retail stores. As audiences become increasingly fragmented as more independently produced music is available, and rely on promotion through social sites such as MySpace, record labels will find their future under threat.

Christensen predicts that when product functionality is not yet good enough, vertically integrated companies that produce proprietary solutions make the most money. In the new value chain involving digital music, customers were most needing improvements in the area of the device. Apple’s iPod was the first music player to provide a superior integrated solution, playing only music bought from their iTunes music store protected using their FairPlay DRM. Apple, unlike Microsoft and its hardware vendor partners, was a unique company that could take advantage of this situation, having both software and hardware production capabilities in-house. Competitors who had modularized could not take advantage of this phase-shift in the value-chain. Interestingly, Microsoft’s recently launched music player Zune is not compatible with their PlaysForSure DRM, following the vertically integrated model of Apple’s iTunes.

But how long will this last? Not long. If Apple’s history is any gauge, it’s continued growth is dependent on its ability to keep up a constant stream of innovations at the technology frontier. It is not a company that has a culture of embracing modular systems – its recent move to the Intel platform for its Macs perhaps a propitious exception.