Music Label Unhappiness with ITunes - a Price Elasticity Debate

In what has become somewhat of an annual ritual in the digital music business, the music labels are again complaining about the $.99 price point for tracks on Apple's iTunes digital music service (the other download services aren't big enough to matter and would have to follow whatever Apple does)- good NYT article about it here.  Having lived through this discussion more times than I would like to remember, my first thought was that I was glad not to have to go through it again, but let's look at the primary issue.

The core disagreement is that labels feel that flat rate pricing doesn't capture enough margin for those hot tracks where users would pay more.   Numerous studies will be trotted out, showing that consumers will pay up to $2-3 for hot singles, so the labels are giving up substantial margin by wholesaling all tracks at $.70-75.   Then they will point to ring tones where pricing is 2-3x higher, and that's not even for the whole track or even the song itself in case of polyphonic ringtones.  Finally they will offer up a lower price point which will be added to the equation so that it doesn't look just like a price increase - the goal is probably a $.50-$.75 price point for deep catalog/less desirable tracks, $.99 for the majority of music, and $1.49-$1.99 for more popular tracks, the overall algorithm to be determined in some TBD way.

It's an interesting point - in most markets you see differential pricing along the life cycle of the product - e.g.  a movie starts at $9 in a theater and then goes down the price curve (VOD, DVD, Pay Cable, etc.) until it reaches free in the broadcast market.  Video game consoles are introduced at $300+ price points, and gradually move down to a $99 price point towards the end of the 7 year cycle.  And everyone should be incented to generate additional margin, so why shouldn't the service providers go right along with this theory?

The reason is that most service providers I know (including Listen.com before our purchase by Real) have done their own price elasticity studies which show that digital download purchases are utterly price elastic when measured over a period of time across a large group of consumers - that means that demand for the product is closely related to the price - increasing the price will actually drive down revenue since fewer people purchase the product, while decreasing the price actually increases the overall revenue since many more people purchase the product, more than making up for the lower price per unit. 

I have no doubt that if you picked one hot track, and polled users in isolation to ask them if they would pay more than $.99 for that track, many would tell you yes.  But the studies show that when you measure behavior across a longer period of time, everyone is better off with lower prices for music downloads, with $.50 being actually the magic number, especially for a business which has NO hard cost of goods outside of artist royalties, which are almost never on a fixed basis so they will decrease with the price.  The explosive growth of DVD sales are a classic example of this - DVDs used to cost $90+ and very few were sold outside of rental stores.   Once the price dropped to the $20 range, the number of retail outlets exploded, consumer demand sky rocketed, and DVD sales became the most profitable part of movie studios.

Admittedly, there are other parts to this discussion, such as the operational difficulty of frequently changing prices (one label actually once proposed changing it on a weekly basis according to how many radio spins the track had recorded the previous week - no joke), the confusion in the market place with multiple price points, the seeming amnesia about the continuing massive piracy issue, the bitterness the labels feel about Apple's iPod profits and growing digital market power, channel conflict pricing issues with physical retail,  label concern about "lowering the value of music", label unhappiness that the publishers statutory rate would not go down with the price decrease, etc - but it really comes down to one point - is digital music price elastic and if so, by how much? 

Comments

[barry Ritholtz]

"It may be instructive to look at the pricing model of DVDs for insight into what has happened in the CD market. In case you were unaware, the film/TV industry uses a very different pricing strategy than the music biz.

Studios release far less product each year then the labels, with major film releases numbering in the 100s versus 25,000 or so annual CD releases.

Films have a model where they typically are released from the highest revenue generator down to the lowest. Another way to describe that progression is a dynamic pricing structure going from highest paying users to lowest. Starting with theatrical release (movie theatres), moving next to pay-per-view, and than premium cable (i.e, HBO). After the premium cable run has begun (or ends) is when typically DVDs get released for sale (or rental) to the public. Eventually, movies make their way to basic cable, and lastly, to broadcast TV. (Somewhere in the middle is overseas release, but for our purposes, that's more of a parallel track).

DVD sales do not rely on a static pricing model. They are initially released at a price point consistent with expected demand. After a short period of time, prices drop, and in some cases, significantly.

[othemsthesk]

What an instructive post, but I think in a different way.
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