Brief History of Music Pricing

The music industry is composed of basically 3 structures that shape the dynamics of this industry. Composers and songwriters create songs, lyrics and perform live on stage. This is recorded and distributed to customers or licensed for some other use. This structure has divided the music industry in 3 parts: the recorded music industry—focused on recording and distribution of music to consumers; the music licensing industry—primarily licensing compositions and arrangements to businesses; and live music—focused on producing and promoting live entertainment, such as concerts, tours, etc.

Music Artists earlier required the support of a record label to produce, promote and distribute music. However the pricing mechanism was more based on historical prices rather than competition. Artists signed exclusive contracts with record labels, which enabled the record labels to charge retail price levels consistent with how much a customer is willing to pay rather than the quality of the music, resulting in consistent pricing strategies.

In the 1960s, the distribution of music in the form of albums gained ground. Record labels created music bundles that increased its fan-following. This gave the record labels an opportunity to raise prices for additional content. However, the pricing mechanism for full-length albums stayed relatively consistent across albums and artists regardless of its quality or popularity. A highly popular music album had the same cost structure as an unpopular one. Many releases were not able to recover their upfront production costs. Consistent pricing strategies made matters worse. Record labels had to rely on the success of a few albums to make up the losses incurred by a majority of unpopular releases.

The growth of digital Music

The music industry has experienced significant changes in the past decade with the growth of internet and digital distribution. It all started with the launch of a file sharing service called Napster by Shawn Fanning that allowed users to download and share music without compensating the recognized rights holder. However, it was eventually forced to shut down by music industry. This service ushered in a new era of music digitization.

The first company that was able to create a successful online service for legal sales and distribution of music was Apple, through its service itunes Music store. Apple was able to convince the major labels that music consumers would buy music legally if they were offered an extremely simple service that allowed them to buy and download music for less than a dollar per track. The retail sales of recorded music in United States dropped from US$13 billion in 1999 to US$10.6 billion in 2003[1]. During the same time, Apple iTunes customers expanded from 861,000 in July 2003 to 4.9 million in March 2004 [2], signaling the popularity of digital music. The music industry’s digital revenue grew by 4.3% in 2013 to US$5.9 billion. Globally, digital now accounts for 39 percent of total industry global revenues and in three of the world’s top 10 markets.

Current digital Music pricing

Shapiro and Varian [7] describe three strategies for pricing information goods: versioning, bundling, and fixed-fee pricing. Bundles of digital music tracks can be purchased for a fixed price. These are either a full album from one artist or some compilation of tracks compiled by the service provider. Altinkemer and Bandyopadhyay [6] demonstrate the application of flexible bundling strategies for digitized music based on an economic model. Different prices for different versions of digital music have also started to

surface. For example, BuyMusic from Buy.com provides 256 kbps songs for a premium price. Also, many online digital music retailers offer full-content or partial-content “try-before-buying” versions with lower audio quality. Previously, Naxos (www.naxos.com), a leading discount classical music label, provided full download capabilities for individuals, although recently they have altered their strategy to only permit potential customers to download 25% of the total content. Music versioning is also being considered in the physical CD market. BMG Germany began testing a new pricing model by offering three-tier versioned CDs: a €9.99 low-quality version with no cover art; a €12.99 medium-quality standard version; and a €17.99 high-quality version with bonus tracks and online extras (www.bertlesmann.com)

Moorthy and Png [3] suggest that offering multiple versions of a physical good allows retailers to reach a market segment that may not already be served, yielding higher profits. Riggins [4] extends their model to an information good setting with tiered Web sites. However, the same characteristics of information-based goods that allow for easy versioning also allow unscrupulous users to violate copyrights by engaging in piracy activities. Wu et al. [5] have argued that it is even possible to fight the piracy of information goods with versioning. Still, versioning may become an effective tool in digital music pricing and marketing because it promotes self-selection.

There are two basic pricing strategies for digital music: song based purchase pricing and subscription services. Itunes was a pioneer in song based pricing mechanism by offering a simple service to buy and download music for less than a dollar. In 2013, iTunes Music Store was the world’s largest music retailer (offline and online) and it had sold more than 25 billion songs since its launch in 2003. Apart from the digital download service provided by itunes, more radical legal music services also came into picture. These services did not offer individual tracks at a set price, but offer the user access to a large music library which they may listen at their leisure. The users normally pay a monthly subscription fee that allows them to listen to as many songs in the library as they want, how often as they want.

However, these access-based music services have struggled to convince record labels to license their catalog to their services as well as convince users to enjoy music without actually buying and owning a copy of the track or album. The challenges are certainly considerable but the music service that so far has received the most attention of the international music industry and the one that could possibly have found the right path is a service called Spotify. It has been able to transform the mindsets of both users and rights holders and will most likely be a music technological milestone on the magnitude of the Walkman, the Compact Disc, and Apple iTunes.

Spotify model was an ad-supported music service that would be free for music listeners but the ads would generate revenues for licenses to copyright holders. Over the years Spotify has moved from being a service solely funded by advertisements to a more advanced version, which is funded by subscription fees also.

Spotify’s model with two or more different service versions where the most basic version is free and the more advanced versions are offered on a subscription basis is usually called freemium—a play on the words free and premium. Often, the profit margin for the free version is very low, or even negative, and it is expected that it is the subscription fees that will generate enough revenues to make the service profitable. The logic behind a freemium service model is that users shall be willing to use the service for free and that they while using the service gradually will make behavioral and emotional investments in the service that will increase the costs and efforts to switch to another service. The goal is to make as many of the users of the free version to convert to the subscription version. In order to achieve that

goal, the free version has to have a number of increasingly annoying features (such as advertising) or lack a few key features (such as the ability to use the service on certain devices) that are removed/ available on the premium versions of the service. In Spotify’s case it has achieved a conversion rate of approximately 20 percent, which means that 20 percent of the total user base is using the premium version and pay a monthly subscription fee. Spotify has reported that 70 percent of their revenues from ads and subscriptions has been paid in royalties to rights holders. At the end of 2013, the company has generated more than a billion dollars for rights holders around the world, which according to Spotify is proof that their model does work.

Online music and videos

Another recent phenomenon in music digital distribution has been the advent of internet radio and online streaming platforms. The surge in smartphone markets has given a boost to this segment as well. Applications such as Pandora, Google music, Youtube etc. operate in this segment. These services play videos and music online based on the user selection. The pricing mechanisms involve a free subscription supported by advertisements and a fee based subscription without ads. Youtube for example embeds advertisements to its free videos and these advertisements are the major source of its revenues.

Online audio distribution has further evolved, enabling its users not just to listen shared songs but also upload, record, promote and share originally-created sounds. Sound cloud which has over 40 million registered users and 200 million listeners is one its kind. These applications also work on a freemium basis, providing a limited sharing space for free and charging premium if the sharing space has to be increased. In this way it provides opportunity to aspirating artists and musicians to bring their sound to the world.

Current licensing Environment

The Digital services discussed above are required to license two separate copyrights: the sound recording copyright and the underlying musical composition copyright. The sound recording copyright is controlled by record labels, while publishers and songwriters own the latter. The picture becomes even more complicated considering the numerous independent labels, publishing companies, individual performing artists and songwriters whose licenses add tremendous perceived and actual value to a digital music service. Multiple owners further complicate the process of obtaining a license due to disagreements among the owners of a copyright.

This means that services such as itunes or eMusic must secure individual licenses from every sound recording they offer. Apart from the download stores, broadcast streams must also obtain public performances from both sound recording copyright owner and music composition copyright owner. Each of the services discussed have to negotiate licenses with labels and publishers in order to build a catalog vast enough to attract listeners.

Piracy control

Tackling piracy and maintaining the shift to licensed consumption remans very challenging in markets which have the highest potential. According to the Recording Industry Association of America (RIAA), global piracy of music causes $12.5 billion in economic losses every year and has contributed to a 50% decline in CD sales over the last decade (RIAA 2009). As a result, a significant amount of effort has gone into developing digital rights management (DRM) technologies that make copying difficult. DRM controls

how end users can access, copy, or convert information goods, such as software, music, movies, or books. For example, the original iTunes Fairplay DRM system restricted users from installing music on more than five authorized computers or burning a song more than seven times, and songs downloaded from Walmart Music can be played only on Windows PlaysForSure licensed products (Duchene et al. 2005). Other digital goods also have some form of DRM—a movie purchased and downloaded from the iTunes store can only be played on an authorized computer, and books purchased for the Kindle cannot be read on any other device. All these constraints are designed to protect digital products from unauthorized copying and distribution and thus reduce the level of piracy.

Recent Developments

Improvements in the handling of user generated content (UGC) have ben of immense help to rights holders allowing them to grow income from YouTube and other licensed platforms. Taking the case of Google’s ContentID system (and other systems used by other platforms), these platforms have made it easier for rights holders to differentiate between video types, thereby allowing the streaming of non-official user-generated content such as mashups to be licensed and generate revenue, rather than removed for infringing copyright. YouTube’s TrueView tool for advertising is also having a positive impact in monetising music videos. According to YouTube, revenues generated from UGC on its platform have now overtaken those generated by official videos. You tube, until now had an exclusive advertising –supported service, is planning to enter subscription based pricing for its content. Internet Radio has also incorporated effective pricing mechanisms to generate revenues from stores. For example, itunes radio service has the feature of a buy button which directs listeners to itunes store. Artists in countries with high rates of streaming have recognized the benefits of streaming based revenue model giving their songs a longer life. There has now been a major focus to create music based applications on mobile further expanding the sources of revenues

REFERENCES

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3. Moorthy, K.S., and Png, I.P.L. Market segmentation, cannibalization, and the timing of product introductions. Management Science, 38, 3 (March 1992), 345-359.

4. Riggins, F.J. Market segmentation and information development costs in a two-tiered fee-based and sponsorship-based web site. Journal of Management Information Systems, 19, 3 (Winter 2003), 69-87 5. Wu, S. Y.; Chen, P. Y.; and Anadalingam, G. Fighting information goods piracy with versioning. In J. Valacich, L. Jessup, and J. DeGross (eds.), Proceedings of the 24th International Conference on Information Systems, Seattle, WA, December 2003, 617-621.

6. Altinkemer, K. and Bandyopadhyay, S. Bundling and distribution of digitized music over the Internet. Journal of Organizational Computing and Electronic Commerce, 10, 3 (2000), 209-224.

7. Shapiro, C. and Varian, H. R. Information Rules: A Strategic Guide to the Network Economy, Boston, MA: Harvard Business School Press, 1999.

8. According to the Recording Industry Association of America (RIAA), global piracy of music causes $12.5 billion in economic losses every year and has contributed to a 50% decline in CD sales over the last decade (RIAA 2009).

9. Duchene, A., M. Peitz, P. Waelbroeck. 2005. Marketing digital music: Can DRM help? Telecom Paris Economics Working Paper EC-05-02, Telecom Paris, Paris. http://ssrn.com/abstract=739247.

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