File Sharing, CD and Video Pricing

If its Tuesday, we’re talking Tunes.

Today’s focus: an intriguing article on the MGM vs Grokster case this past week by Berkeley professor Hal Varian in the NYT.

Although the focus was on the longstanding battle between technology and copyright, I found his historical review of video pricing quite fascinating. We looked at this recently in Dynamic Pricing: DVD versus CD Strategies.

Varian notes that after the studios lost the Sony Betamax case, they were "forced them to take the home video
market seriously:"

"Their first instinct was to set a $50 to $60 price for videocassettes. But by
choosing a high price, they stimulated the development of the video rental
market, giving users inexpensive access to movies.

On the other hand, the availability of rentals stimulated the demand for
VCR’s. As VCR prices declined, more people bought them and the video rental
industry flourished, creating a new, rapidly growing outlet for studio
productions.

In the late 1980’s Disney began to experiment with lower prices for videos,
hoping to bypass the rental stores and sell directly to home users. Disney’s
1987 video release of "Lady and the Tramp" was priced at $29.95 and sold over
3.2 million copies, making it the best-selling video as of that date. Its record
was soon eclipsed by "E.T.," which sold 14 million copies at $19.95 apiece.

These examples convinced Hollywood that if it priced its product low enough
it could successfully compete with the rental market. When DVD technology came
along in 1996, Hollywood understood that pricing under $20 was critical. DVD
technology has been hugely successful because the prices of the players and
discs have continued to decline, making it highly affordable and widely used."

Contrast this with the CD side of the recording/content industry. Only recently has there been even the slightest experiment in pricing structures. The Record Industry is way behind the curve on this.

A friend points out that this is an unfair comparison: DVDs are a secondary market, while CDs are a primary market. He states that DVDs come out after theatrical release, pay-per-view, then Cable and Satellite. This allows DVD producers to be more flexible in pricing than CDs.

I have two problems with that argument: First, the economics should be such that pricing attempts to maximize unit sales and therefore profits. Second, the business model of selling CDs as a primary revenue producer is definitely not true from the Artist’s perspective.

High CD pricing maximizes profits for the labels at the artists expense. Less sales equals less exposure, concert ticket sales, t-shirts, etc. Musicians are entrepreneurs of sorts — they cannot merely rely on CD sales.

As to the labels, the internet is in the process of disintermediating them from between the artists and the music fan. Labels must adapt — or die.

The video industry learned about pricing a long time ago:

"The critical lesson from the history of the VCR is this: If consumers have
ways to share content, either via rental markets or via the Internet, you will
have to set low prices to induce them to buy. But low prices may well stimulate
enough volume to make up for the lost revenue.

Apple’s iTunes,
with its 99-cent price for songs, has driven this lesson home, but there are
those who argue that prices should be even lower.

In 2004, RealNetworks
experimented with charging 49 cents for digital songs and sold more than three
million downloads in a three-week period. The chief executive of RealNetworks,
Rob Glaser, says that "the pricing that will result in the biggest overall
market for music will involve some kind of tiered pricing," with "new mainstream
songs for 99 cents retail, and up-and-coming artists and back catalog artists at
a lower price."

It is worth observing that this is similar to the pricing strategy used in
the video industry in the 1980’s: a high price for the videos that were likely
to be viewed only once, making them natural candidates for the rental market,
and a low price for videos that warranted repeat viewing, making them candidates
for purchase."

That is only one possible example of Dynamic Pricing. When will the Record Industry pay some attention to the economics of this?

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Sources:
File-Sharing Is the Latest Battleground in the Clash of Technology and Copyright
By HAL R. VARIAN
NYT, ECONOMIC SCENE, April 7, 2005
http://www.nytimes.com/2005/04/07/business/07scene.html

Dynamic Pricing: DVD versus CD Strategies
Tuesday, March 22, 2005
http://bigpicture.typepad.com/comments/2005/03/dynamic_pricing.html