Bitching Brew

Tuesday, December 06, 2005

The online music market: a better solution?

Before I begin, let me note that there's a guy listening to Sufi music here in the computer lab. Oh, he's got earphones on, but it's still very audible. I mean, it's Sufi music, so this should be a memorable moment! Sadly, it's not; it's really irritating me now.

I read an article on today about the digital music market. In it, Adam Penerberg argues that the current 'one price fits all' policy isn't an optimal one. For example, iTunes charges 99c per track, no matter how (un)popular that song currently is.

He proposes a pricing model where demand is the main determinant. That is, prices would fluctuate depending on the purchasing decisions of other users. So the hits de jour could be retailing for $5, while rather obscure tracks could be snapped up for less than 30 cent. He suggests a price floor to cover costs, but not a price ceiling.

You know, it's an intriguing idea. On the face of it, it would seem logical to charge more for the hits, and less for the general mass of music - much of which is difficult to find in real stores, simply because of the low return it generates. I'm not opposed to a new pricing model for online music.

I'm not sure I endorse this model though. Basic economic theory tells you that under imperfect competition for a single good, perfect price discrimination (selling a good at precisely the price a buyer is willing to pay) can actually improve welfare. But erm, that's not the case here. This is 'monopolistic competition', i.e. the songs aren't identical products - they're close substitutes. So it's not that kind of price discrimination. No big gains here for society as a whole.

It's quite clear that the main beneficiaries would be record companies and big artists, and the big losers shall be those people with, shall we say, common tastes in music. Certainly, it would benefit consumers with less populist tastes like myself. We'd rarely find ourselves paying above-average for a track. Assuming the (weighted) average price were to stay at 99 cent (a highly dubious assumption!), then my average expense per track would fall significantly. My net consumer surplus (net benefit) would rise accordingly, and producer revenue would fall. A fall in prices would probably encourage individuals to diversify their music collections, giving a wider audience to less-known artists. That would seem to be a good thing.

But - it depends on how you look at it. This policy would result in individuals changing their buying decisions. But why would they be changing? Not because of a change in their preferences - but because of the change in relative prices. This happens all the time in markets, but I'm not sure it can be used as a reason to justify this change. Arguing in favour of this is to be arguing in favour of (a very mild form of) social engineering. It's not up to me, or the government, or anyone else, to tell people what music to listen to, nor to deliberately engineer a change in the music they buy. Of course, governments and advertisers do this all the time, but that doesn't mean it's necessarily legitimate.

As with books, most music sales come from a select group of very popular artists and albums. That's unlikely to change. Thus, the huge number of people who buy that music would lose out under the new system. Their consumer surplus would be eroded in favour of mine - nice for me, admittedly...

How would artists and publishers figure? At present:

The record companies' best strategy is to provide an easy-to-use service that offers music downloads at a fair price. But what price is "fair"? Apple says it is 99 cents a song. Of this, Apple gets a sliver—4 cents—while the music publishers snag 8 cents and the record companies pocket most of the rest.

Ho hum. Big-selling artists have some leverage over the record label, so they're certain to get a higher cut of the revenues than less popular ones. Thus we can assume an upward-sloping relationship between sales and the percentage accruing to the artist/publisher. That's the current situation; it's highly unlikely to change. (I know different deals may exist under indie record labels, but let's stick to the majors.)

Thus popular artists (that tiny minority) stand to gain big time from a system of price discrimination, where popular songs could retail at five times the current price. What about the other 95% of artists though? Currently, they take a small cut of the 99 cents on each song. The proposal would mean that they'd take a small cut of the less than 99 cents on each song. Possibly as low as 25 cents per song. That's not much of an incentive for them to keep producing music, now, is it?

Maybe in the long-run it would work out. I don't know - this isn't an analysis from every angle. (Ahem.) So good insights and suggestions are welcome - I typed this in a bit of a flurry. Shame on me.

Note: I'm going to work out a basic economic assessment of this, and post it up. It's on my to-do list. Maybe I'll ask the author of the article too.

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