Record label EMI (EMI.L) turned in a good quarter yesterday and as part of the presentation, CEO Alain Levy indicated that he believed Apple would go to a multi-tier pricing scheme next year for its iTunes store, presumably with higher prices for well known artists and hopefully with lower prices for lesser known artists. He also had the following quote "We do not set the price, Apple sets the price". Although technically and legally accurate, it's a misleading statement in the real world since it implies that Apple has looked at its business and has decided that it's better for iTunes to increase prices for better known artists - the question is Who Really Sets Digital Download Prices?
The fact remains is that music labels effectively set retail pricing by setting wholesale prices, with an eye toward expected retail price for rational distributors who wish to make some sort of profit. Therefore, if a label wants to see a $.99 retail price point, they charge a $.75 wholesale price, giving the distributor a 20-25% margin, similar to what is seen at retail. If they want to see a $1.49 retail price point for part of their catalog, they will charge a $1.10-$1.15 wholesale price for those tracks. Now there is no question that iTunes or other distributors can continue to charge $.99 per track (or whatever price they want), but it begins to drive an already low margin business into negative margin territory, which makes it hard for distributors to survive, although you see this occur sometimes with loss leaders on new album releases in retail stores.
What's interesting is that Apple is in the best position of any digital distributor to absorb potential losses on each music download due to its massive iPod business - therefore, one could map out a scenario where Apple refuses to change retail prices, which then forces all of its competitors (Napster, Real, Yahoo) to remain at $.99, but they can't absorb the losses through other profit centers, and eventually exit the business, which is exactly what the labels do NOT want, since they would prefer to see a lot of players in the market. This would be more likely if Apple could significantly grow its video download sector, which is an area where it has relatively little competition, and that would offset the possible losses in the music unit due to increased wholesale pricing.
It certainly appears with all of the label signaling (since they theoretically can't conspire - see price fixing settlement) that we'll see different wholesale prices for digital downloads in 2006, with the probable resulting changes in retail prices by rational distributors like iTunes. With the threat of piracy receding a bit in label executive minds due to a series of legal wins, they now appear focused on:
- Cranking up the focus on DRM - see continuing SonyBMG rootkit fiasco and EMI/Macrovision news
- Expanding the legal fight to other sectors - e.g. satellite radio rates and time shifting may be the next big battle
- Nudging download prices towards the higher mobile rates - e.g. see NYT review of Sprint Mobile Store at $2.50/track, even though I believe that the price elasticity of this market would dictate another path.
The good news is that the digital market is starting to deliver rewards for music labels, with it now representing 5-6% of revenue, much of that at very high margins, but they still have a much larger declining CD market, so the scramble will continue to increase revenue from other sources. I've always said, and will repeat, that the labels will end up making more money from digital than they ever made from physical, but it's going to be a rough transition in the next few years due to the different market sector sizes.
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