Strategies for a discontinuous future.

Tuesday, December 06, 2005

iTunes Variable Pricing & Replication Wars

Penenberg's latest article is a lot like my argument why variable pricing is good for the music industry; he extends the general argument by recommending a market where music prices are set. It's a great idea.

-- umair // 11:25 PM //


It sounds like fun, but it wouldn't be a true market.

For example, suppose I buy an option that locks in a future download fee on the next John Fogarty release, hoping that it will be more in demand than people currently think. The old fart's still got it: I saw him on Austin City Limits, and he rocked.

But what good does that do me? I'm not going to be able to obtain the recording, then turn around and sell it, like a rare old vinyl LP. It doesn't belong to me; only the fair-use rights for the copy belong to me. If I got it for, say $1, and it's marked to market at $5, I could sell the download rights to you for $4, I guess. But that's not the same thing as a true option, where the counterparty is obliged to pay me the whole difference. This market has no real liquidity.

To put it more simply, look back at your Econ 101 notes. Why do we pay more for something when it gets popular? Because it becomes scarce.

But digital copies of a pop tune are the antithesis of scarce: Because the user provides their own storage medium, the number of copies is, notionally, limited only by the number of well-equipped users, and there is little if any cost to the distributor.

In real markets, the cost of THIS kind of commodity would tend to fall to zero.
// Blind Tangerine Jones // 3:47 AM

Hey BTJ,

I've addressed the red herring of digital media scarcity in detail before...check the link.

You are talking a market where use and exchange values are traded; hence, the potential for simple arbitrage through secondary markets.

Clearly, this market hinges only on use value being traded, and no secondary markets for options, futures.

We don't always pay more for something because it becomes "scarce". Especially not in the media industry - we pay more because of market power.
// umair // 4:01 AM

Hello Media 2.0,

I don't know if different prices for artists is a good idea. I don't understand the point that a lesser known artist is subsidizing the marketing costs of the more known artist. The accounting between artists isn't a joint account. It's like with Hollywood movies: each artist is a SEPARATE business account with sales, costs and profit etc. Each band has to sign a record contracts where these aspects are pre-determined: marketing costs, production expenses, distribution costs and profit sharing etc.

Now if star artists were allowed to make more per track (they usually compensate their marketing costs with higher sales volume) you are making it MARGINALLY more attractive for the record company to invest more in top stars. This is socially a sub-optimal outcome, which lessens overall the diversity in the music market and lets marketing costs explode because more top guys would get funding (nobody wins in marketing wars - they are just sunk costs).

A more desirable form of price discrimination would be to use time of release as a factor: new stuff would be more expensive, old stuff less expensive. This would create a socially desirable outcome - new and also young bands get financing, while archived old stuff could be mined for niches in the "long tail", thereby mapping the customer's preferences more accurately (because each person is truly different and would benefit from a highly customized audio styling). But I do not think that price discrimination on the popularity of the artist is a socially fair idea.

Furthermore, back to the marketing costs: I do not think that, given the option to charge higher prices, record companies would reduce marketing expenses. It's a two-step game: the top artist is the result of a marketing war in the first step. Once this result has been established it is possible to make revenue with the artist in the second step. For this type of artist the marketing war in the first step cannot be avoided and the possible higher prices will not deter the company from following this path.

What do you think?

Cheers, Chris
// Christof // 4:32 AM

Hi Chris,

Thanks for the comment.

Don't get confused with accounting - accounting is not economic reality.

Every dollar spent on stars has a higher percentage of marketing costs. Every dollar spent on non-stars, by comparison, has a lower percentage of marketing costs.

This implies there is very real economic value flowing from non-stars to stars.

As for time-based price discrimination, it is already in place. Music (movies, whatever) cost more in early release windows.

Variable pricing would give record companies would have the incentive to reduce marketing expenditure in percentage terms. The higher prices of more marketed stars would be met by relatively less demand - economics would be aligned with real value creation.

Of course, in your game, you are assuming at the beginning that demand and prices are not related; rather, that demand is a function of marketing. I think the situation of the record industry tells us exactly the opposite.
// umair // 5:27 AM

Tiered/variable pricing was quietly introduced at Target a few years back; they usually have their wall of 'hits' at $15.99 along a major aisle, with an endcap somewhere less obvious selling "new artists" priced an average of $11 and occasionally as low as $7 for new 'underground' artsists.

I'm not sure who intiated this (the retailer or the labels), but I think it's less of a play leveraging the economics of the industry as much as an attempt to appeal to subcultures which tend to respond to pricing and marketing differently.

But where itunes will (likely) have high visibility for their highest-priced downloads with the vast majority remaining at a more standardized price point, target is going for people who are willing to invest more in search - and using the price to both differentiate and make the purchase of lesser-known acts less of a risk.

I agree the situation the record industry is facing will drive them away from blockbusters, but less due to the economics of mass marketing/production as much as an authenticity/relevance/artistic integrity that is often lacking in work by those artists.

So, yes, I think the tiered itunes pricing will help the music industry - but not in the way it expects. Artists that are in higher demand/cost more to produce will be met with dropping sales as record industries attempt to pass those costs to the consumer - ultimately pushing sales toward the "long tail" of artists.

Target's attempt, while no doubt successful, won't achieve the same results as it has severely limited scale in a retail environment.
// vcmc // 10:59 PM

Hey vcmc,

You said:

"...Artists that are in higher demand/cost more to produce will be met with dropping sales as record industries attempt to pass those costs to the consumer - ultimately pushing sales toward the "long tail" of artists."

That's exactly right - it's exactly the point I'm trying to make. Higher costs for stars will be met by lower demand, and the long tail will happen.
// umair // 11:14 PM
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