Apple’s negotiations with the record labels could be described, in game theory terms, as an "iterated mutual hostage game". Looking at it from this perspective, we can expect a drawn out process of each side switching between cooperating and not, until eventually both sides start to play nicely together (i.e. the music labels give Apple DRM-free music, whilst Apple concedes to some of the record labels demands). To achieve this, Steve Jobs will need to be nice, provokable and forgiving. Here’s why.
A mutual hostage game is one where, from each players perspective, the choice between cooperating or not cooperating seems impossible (in game theory terms, neither strategy dominates). The payoff of the game for each player is determined by his opponent’s choice. So, for example, in a real hostage situation, if you choose to give your hostage back, that’s great news for your opponent, but bad news for you if he does not reciprocate. In a one-off exchange, the results are therefore pretty random, since neither side knows if the other is going to cooperate. But if both sides are holding the same number of hostages, over time the negotiators on each side may build trust, to the point where all hostages are returned, two at a time.
With Apple and the record labels, the hostages are music sales. Both sides stand to gain from selling music on the iTunes store, but both sides want this to happen on their own terms. If neither side cooperates, both will be punished by lost sales. Of course, the record labels can sell through other stores such as Amazon, but Apple has historically been a better partner. Equally, Apple could survive on iPod/iPhone sales alone, buy why cede control of the download business?
So both sides want to reach a deal, but both sides are willing to hold out a little (“defect”) to get the best deal that they can. That’s why you can expect to see the record labels making exclusive deals with Apple’s competitors, whilst Apple will use its formidable PR machine to grandstand about the labels' truculence. But ultimately, behind the scenes, both sides know that they must reach an agreement in the end.
Successful strategies for a mutual hostage game tend to have some things in common. It is critical to establish trust, but it’s also important to demonstrate that you’re no push-over. You will retaliate if your opponent cheats. But ultimately, you must be ready to forgive a cheater when they come back in line - after all, both sides lose in the long run if no one co-operates. The press love to describe Jobs as “mercurial.” They probably imagine that Apple hates this kind of coverage. In fact, from a game theory perspective, for mercurial read provokable, and it plays to Apple’s advantage to let the record labels know that non-cooperation will be punished.
I have a feeling that the Music DRM game is coming to an end. If the music industry are giving non-DRM music to Amazon, why not give it to Apple as well. After all, most end users still don’t seem too averse to DRM, so iTunes' digital sales may well continue to be much larger than Amazon’s. All the time that the music industry allows Apple to carry on selling DRM music, they’re increasing Apple’s lock-in with end users. Precisely the scenario that the music industry wants to avoid. Time to end the game.