Could the labels actually be right?

Although it's tempting to assume that the evil record labels are once again trying to gouge us, there's some sense in their latest efforts to get Apple to abandon it's one-size-fits-all pricing model. A New York Times article over the weekend reported on the ongoing struggle between the labels and Apple over its fixed $0.99 price point. The labels would like to sell most new music for more--$1.49/track?-- while older or more obscure tracks could go for less.

There's plenty to like about variable pricing. For starters, it's almost always the most efficient way to maximize markets of disparate goods and customers. As Barry Ritholtz puts it:

It's a basic rule of economics: goods that have elastic demand  (i..e, non essential) are highly price sensitive. Further, any item easily available for free (albeit illegally) will have an even bigger response to price increases.

Apple has argued that single-price simplicity was necessary in the early days of the service, when people were just getting used to paying to download music. But now, after 500m tracks have been sold, we're clearly past the early adopter phase. So what's the right pricing model going forward?

Most accounts of the dispute between Apple and the labels have focused on the industry's efforts to raise prices, which are undeniably a big part of their plan. No surprise there. The research we've been doing for the book shows that within the bulk of the online music business--the top 100,000 downloads--only 3.5 tracks on the average CD sell. So the record labels are getting less than $3 in revenue (wholesale) from albums when the music is sold by the track. That's less than half the wholesale price of a CD (although with none of the physical costs of making and distributing a CD). The shift from an album model to a track model is indeed an alarming thing for the labels, and it's easy to see why they'd want to raise retail prices online as a result.

But there's more to the story that that. The labels may be evil, but they're not (all) stupid. They--to say nothing of many of their artists--also see the virtues of dropping the price for lots of their music, too. For decades they've been playing with CD pricing models that range from cut-price classics to top-dollar boxed sets, and when freed of the overheads of traditional retail, they're likely to experiment more, not less. Although some of the more vocal commentators have encouraged Apple to hold the line at $0.99, there's a strong argument that introducing variable pricing might ultimately lead to a more consumer-friendly outcome.

The reason is simple Long Tail math: there's a lot more music in the Tail than there is in the Head, and labels are generally more willing to experiment with discount pricing outside of the top 1,000 than they are with their hits. Those niches represents most of the music available today, measured by number of titles, and because they're only modest sellers individually they're less likely to create channel conflict with CD retailers, who tend to only stock the hits.

Imagine, for starters, that Apple introduces a three-tiered band of pricing: $1.49, $.99 and $.79 (that would no doubt soon expand to include $.49, but below that the transaction costs of credit card processing and the like start to loom large). Tiered pricing--gold, silver, bronze--is still pretty simple for consumers to understand, yet it introduces a valuable new dimension of demand creation.

Rhapsody, for instance, saw demand triple last year when it cut prices in half, to $0.49. And the average usage per customer in the all-you-can-eat subscription services is typically 5-10 times that of the pay-per-download music stores, such as iTunes. Add to that the potential of free music, which Apple has already paved the way for with its podcast service and could easily be extended to music licensed under Creative Commons, and you could grow grow the user base of the commercial music services manyfold.

Once iTunes allowed variable pricing, I imagine labels would do pretty much what they already do with CDs: set a range of wholesale prices depending on age, popularity and target market. Some labels will unwisely try to jack up all their prices and will eventually suffer lower overall revenues as a result. But smarter labels will experiment with all sorts of pricing variations, from lower prices for bands they're trying to break to volume discounts for packages of older music, and even higher prices for special reissues and repackaging for hard-core fans. That's already what they do in the CD world, where even standard retail prices range from around $9 to $18.

Apple may think it's protecting us from record label avarice with $0.99, which may be true in the short term. But long term, one-size-fits-all pricing is just constraining the economics of the industry and holding back the market. If Apple introduced variable pricing, it's not hard to see how the average price might actually fall in a year or two, thanks to the number of titles in the discounted niche/backcatalog categories vastly outnumbering the more expensive hits.

As long as prices can go down as well as up, I'm confident that market forces will eventually reveal the right set of models. And I'm even more sure they will confirm that no one model is right for everyone and every song.

Comments

[Chris Gilbey]

Back in the time when I was an executive in BMG in the early '90's (and prior to that, when I ran a publishing company) I became more and more amazed at the rationale in record companies for pricing.

The problem that I see with record companies setting multiple prices - for both them and for artists and for Apple, and others - is that they will still get it wrong.

The model then (and now) is that the top selling artists are discounted aggressively in order to establish sell in and sell through. New and emerging artists were sold at the full price. Catalogue was sold at a discount.

So the back catalogue that had the capacity to produce the most margin with the least marketing had its margin cut in order to discount and create volume sales - so creating margin leakage in order to deliver revenues fast. The products that needed the most discounting in order to create buy in were sold at the highest price. And the hits that had already at that time become more marketing driven than talent driven had the highest amount of marketing expenditure, the lowest margin, because of enormously increased royalty agreements with artists and the least likely opportunity to become classics....

I don't see the record companies being able to get their heads around the concept that they probably would be better off totally closing down all physical goods sales, which would enable them to get rid of a whole raft of operating costs, and make a commitment to electronic distribution only. They need to move totally to the publishing model where there is no manufacturing and distribution. Instead there is licensing and content acquisition. This requires a significant culture shift. They have got it with ring tones and ring back tones now, but it remains to be seen whether they can really deal with the sort of counterintuitive reasoning that is required in the new century.

By the way please feel free to visit my blog too - its at www.perceptric.com

[Barry Ritholtz]

I'm not against variable pricing -- I simply believe that the Labels have priced music too high relative to their entertainment competition.

Too often, I find the CD soundtrack of a film costs more than the Film DVD itself. Which polycarbonate disc does the consumer than buy -- the 45 minute audio disc, or the 2 plus hour audio/video/out takes/ interview version?

Both Variable and Dynamic pricing makes sense -- but the industry needs to recognize the value proposition music has relative to other forms of entertainment.

Does it make sense to price digital downloads -- with no physical cost to press, ship or warehouse -- the same as CDs?

See these two discussions for more details:
Dynamic Pricing: DVD versus CD Strategies
http://bigpicture.typepad.com/comments/2005/03/dynamic_pricing.html

Are CD Prices Getting More Dynamic?
http://bigpicture.typepad.com/comments/2005/08/are_cd_prices_g.html

[Loren Davie]

"The Labels" that set the pace are four multinationals that have had no qualms about engaging in price-fixing in the past. I somehow sense that the average price of tracks would rise if the labels took control of pricing. This could harm the viability of online music in general. I think that Apple would be wise to retain control of pricing.

[David Palmer]

Interesting insight above from Chris as to how labels think about their pricing structure. Seems like the corporations that own the big music labels are, in fact, pretty dumb, since they seem to neither know or care much about music, or about their customers. For them music is just another commodity, like pork bellies. At least Apple has an understanding of their customer base, and they seem to actually care somewhat about the music. In spite of Long Tail economics, I think Apple has it right. The only thing the labels can be trusted to do is to screw things up.

[Julian Bond]

"$.49, but below that the transaction cost of credit card processing and the like start to loom large" This is easily solved by buying credits. Then you have a single $25 transaction bearing credit card costs followed by 100 (!) single track transactions.

Which brings to mind a business plan that I and others have suggested before, based on what AllOfMp3 are doing.

1) Digitise everything you can get your hands on using a lossless codec. That's the entire back catalogue. Anything and everything that's still on tape (or other format) somewhere in the archives. In your terms, service the long tail.

2) Setup a search and distribution site that converts on the fly from the lossless archive format to the customer's choice of codec and bitrate with no DRM.

3) Charge on the basis of bandwidth used because that's your biggest variable cost. Set the pricing as follows for a typical 192Kbps VBR MP3 of a 3 minute track.
- $0.50 for the first 3 months after release.
- $0.25 for the next 9 months.
- $0.10 thereafter.
Or to put it another way, $10 for a 10 track album in lossless format. ie, the same price as a CD for the same product except that you didn't have to absorb any shipping or distributor costs.

The net results are:-
1) Take advantage of the "must own the latest track now" imperative to charge higher prices.
2) Blow file sharing out of the water because it's just plain easier to spend $0.10 for a properly encoded, named, tagged track than to get the same for free.
3) Make it all back up on volume. (So, 1999!) You want to bet the volume wouldn't be at least a factor of 10 bigger than iTMS, perhaps even a factor of 100?

[John "Z-Bo" Zabroski]

I think the record companies are beginning to change. If anyone caught wind of the Aspen Summit recently, there was a couple of big speeches on DRM. Given that this blog has been discussing DRM consequences a lot lately, it would be good to mention there is finally some forward thinking by content producers with regards to DRM and piracy.

[Choyon Manjrekar]

Nice observation Chris, but I looked at this from another Long Tail perspective. With other music download sites, podcasts, streaming sites and music publishing technology sprouting up, the online music distribution industry is positioning itself into a long tail formation.
Apple is at the head because of its pioneer status, the others form the tail.
I think Apple is trying to consolidate itself at the head, because it can afford to be a price setter because it is the biggest buyer of music and in essence, can dictate how much its rivals pay for music.
The way I see it, i-tunes is a hegemony that could fall apart if the longtail has its way. It needs the price to remain constant without being undercut by the rest. Its a case of the head in danger of being swallowed by the tail.

[Arun D]

Yep - I think multi-tiered pricing makes sense, especially if it means going both sides of 99c.

Another avenue towards a similar destination would be by 'bundling' a few tracks together if you were going to charge more for them. This is actually closer to a 'digital' single than the 99c download. I've got some B-sides from CD singles that I'm pretty fond of! The record company can charge $2.49 by bundling the 'hit' with a b-side/remix that probably wouldn't sell much on its own.

Essentially this is a way to address the problem that will come from big price rises - raising the price, without raising the value proposition AT ALL.

A next logical step for iTunes, would be to have downloadable .mov files of music videos. Perhaps a bundle of the music video and mp3 could warrant more premium pricing and delivering that important increase in customer value.

[Chris Gilbey]

Here is an additional thought/observation about labels and distribution we have been discussing at perceptric ... not sure whether it is long tail or not... I was reading on the BBC site and blogged about this too - 21 year old Chinese woman, records song on her laptop, edits it on same laptop, posts song to free download distribution site in China, receives 1 Billion downloads - gets signed to a label, sells 800,000 CD's.... Her name is Xiang Xiang.

This is what the labels should be watching. Maybe this is a reverse long tail. Get all those freebies in the marketplace, then sell stuff.

I do hear that some of the labels are considering quite actively DRM based downloads to your computer - they have finally woken up to the fact that there is cost to manufacturing and distribution that they can move out of their cost structure and on to the consumer.

[Charles]

But now, after 500m tracks have been sold, we're clearly past the early adopter phase.

There's your syllogism. We're nowhere near past the early adopter phase. There's 10 million accounts (that's from a population with access to Itunes Music Store of what, a billion?) who've bought on average 50 tracks each. Most iPods don't contain bought music - it's peoples' own music.

Ergo, online music buying is not past the early adopter, and isn't yet mature enough for variable pricing.