Asymmetrical Information

This is only true if you assume that the large record companies are the only source of music. What actually is happening is that peopal are finding other sources too - independent artists selling direct or through smaller intermediaries like cdbaby or mp3.com. These sales (or downloads) don't show up in the record industry figures because they are not through the covered channels, and because they are generally far enough down the Zipf distribution that they don't show up in the top few percent that are covered as charts. In aggregate they are significant. The flattening you discuss is indeed happening as the slope of the Zipf distribution changes.
There is downward price competition here - I expect in time the labels will grasp the equivalent of the Laffer curve and sell downloads at a reasonable price - after all the marginal costs and fixed costs are far lower for digital files than plastic discs.

I think there is room for a new complementary economic model for digitl media, and I have described it in detailover at http://mediagora.com

Nobody reasonable is arguing that theft is justified. Are you trying to berate immature idiots, or are you trying to persuade reasonable people to your point of view?

If your point is that file sharing has reduced recording publishers revenue, then you are going to have to come up with some facts because all the facts and studies I've seen have shown the opposite. This doesn't justify stealing, the publishers have the right to destroy their own business as they see fit. Just as I have the right to wish them luck.

I got on the sharing bandwagon only recently, and I have had an absolute blast listening to the songs I haven't been able to listen to since my turntable broke. It's also caused me to buy more CDs, but only from the used market (smile).

Revenues are down year-on-year for the last three years by an enormous margin, far more than one would expect from the recession. We'll see when the economy turns up again, of course, but since young people form a disproportionate source of revenue, and as far as I can tell they aren't buying anything, I'd be surprised if it turns up.

But this is predicated on the "if file sharing becomes more widespread"; if it stays where it is now, the market is still sustainable. I think it unlikely that filesharing will stay at its current level.

OK, but just because revenues are down doesn't necessarily mean they are down because of sharing. All the data I've seen that is explicitly linked to sharing activity shows increased revenue. Ref Baen books and Janice Ian and mine and friends personal habits.

I would posit that sales are down because people are tired of giving money to an industry that abuses and insults them. That's why I never buy new anyway. eBay makes secondhand sales so easy that probably has a significant effect on new sales too.

We had sharing in the 80s too - it was called cassette tapes (smile).

There seems to be a fallacy here, namely that producers with a high fixed cost and low marginal cost "have to" raise prices to recover the fixed cost. It comes up a lot in sports economics, when a team signs expensive free agents and then claims that higher ticket prices are necessary. Quoth Joe Sheehan* (http://www.baseballprospectus.com/news/20020219daily.html):

The price of tickets is not set to recoup costs, but to maximize revenue.

For "tickets" you can substitute CD's or any other product with effectively zero marginal cost.

Now it's probably true that increased file sharing will cause the profit-maximizing price to be higher. This is more likely to be true if the people who share files have the lowest price threshold, but in that case it sets up a vicious cycle in both directions.

We already see people claim that they pirate files *because* the prices are so high; the people who ridicule this as a moral justification seem to be missing the point that as a simple choice explanation it's somewhat rational. On the margin, might there be people who have a little moral compunction, but not a lot, and so they'd buy an $18 CD but "share" the same CD if it were $22?

*- In some on-line baseball fora, Sheehan is infamous for having once described the American people as "economically illiterate b-tches." :-)

The other thing about the baseball ticket comparison: When a team signs expensive free agents, while some people are willing to pay more for tickets because they think they're getting a better on-field product, there are also a lot who will honestly believe the "we raised prices because we had to" crap, and so either not complain as much as they would have or else blame the players.

Analogously, record companies can quite profitably demonize file-sharers if enough people are gullible enough to believe that "we had to prices to stay afloat" and so blame those damn college kids instead of the record companies.

Record label revenues are down about 10%-15%. Some of this is caused by the recession, and some is caused by filesharing. Given the *ENORMOUS* scale of file sharing, it seems that (for whatever reason) .mp3s and CDs are pretty imperfect substitutes. I don't know why this is, but it seems to be a fact.

Moreover, the things you describe as "fixed" costs are actually pretty variable. Record companies have alot of discretion about investment in promotion etc. and the cost of studio recording equipment has fallen through the floor. Economies of scale may dictate which type of record labels need to seek (right now it's a hit driven industry) but that can change too.

So file trading may simply mean labels shift the type of CDs they produce to where there is less file trading, or the two markets may be seperate enough that file trading is simply price discrimination (which need have little effect on prices).

Finally, mp3s and CDs are substitutes in some ways, but they are also complements in others. A complementary effect may offset some of the substitution and maintain average price (which determines the decision to enter).

But I see music as being an area pretty ripe backward integration by consumers. Just like content. Happy blogging.

It seems like the Grateful Dead had this all figured out decades ago: encourage sharing, encourage home taping, and make millions on tour. There's more than one business model out there.

Jane, Liebowitz's paper in progress on this issue gathers some interesting statistics - he looks at per capita album sales for 20 years, and it is the recent peak that is anomalous, not the dips.
http://wwwpub.utdallas.edu/~liebowit/knowledge_goods/records.pdf
There are many interacting factors involved, and online copyright voilation is only one.
A key one IMO is substitution - many people at the rich end of the purchasing market who once collected music and bought high-end stereo systems ot play it on now buy expensive Home Theatre systems, and collect DVDs instead. DVDs on average cost less or about the same as CDs, but offer many hours of video and high-qulity audio instead of just sound.
Another possible substitution effect was mentioned by Dan Bricklin - you are far more likely to see someone chatting on a mobile phone in public than listening to a walkman.
Another factor is the death of the singles market - US labels don't sell them any more. In the UK, revenues are up year on year, adn there is a thriving singels market, though the 'singles' are in fact often multimedia CDs wiht 4 tracks and digital video and interactive bits for customers with computers.
Janis Iasn suggestion for the labels to sell deleted back catalog online at a reasonabel price makes perfect sense.

I agree that not all of their fixed costs are fixed costs, that there can be shifting, etc. But it's my opinion that file sharing is currently limited by the technology, not the will. . . older people are less apt to file share, because they're less apt to do anything on their computers. I see the market growing as that segment ages out of its prime music buying years (music buying is really slender after about 55-60) and are replaced by people who use MP3's and burn their own. Maybe it takes ten years. But eventually, I see no way that the music industry can compete with perfect digital copies of their stuff.

But I don't see labels shifting away from Brittany to opera CD's; it's the former that subsidize the latter, and the former's sales seem to be the most hurt by file sharing.

This isn't the first time that the music industry has hit a big slump... there was one in the 70's I beleive... and maybe one in the 80's as well. There is a slump, but quite a bit of it could be attributed not only to file sharing and the recession but the normal cycle of the music industry.

The big record companies will probably make their profits in the future by demanding a cut of concert and merchandise revenue from their artists. However there's no question that they will suffer.

I'm not sure that's a bad thing for society though. Because while digital technology is lessening the viability of traditional record companies, it's greatly lessening the need for them as well.

In addition to bringing the marginal cost for producing music down to zero, digital technology dramatically reduces the fixed cost of producing music, and also dramatically reduces information costs to consumers who want to find out about music.

The record companies' traditional function of putting up the money to pay for recording, manufacture, distribution, and marketing of the product will be no longer needed for many artists, since they will have the means to do this themselves. It's true that those artists won't make any money from selling thier recordings, but the vast majority of artists don't make money off of royalties in the current system anyway. They'll still be able to make money off of conerts, merchandising, radio royalties, etc.

Artists who can produce a quality product on their own will do better under the new system. However artists who need expensive outside producers, songwriters, and image makers in order to succeed will suffer. The result will be better art in general.

Well, but if the record companies take a cut of concert revenues, that's even less for the artists. And while concert revenues are large, they're also very expensive to generate, relative to CD's. I'm not sure that the profit margins on concerts would be enough to cover record labels expenses, much less record labels and the artists.

I am not sure that file downloading is mostly bad. Sure, the public domain will grow slower if file downloading puts publishers, music companies and movie studios out of business, and the commercial finish of the remaining products will be lower. However, as it is the public domain is not growing because these same companies lock up content for life+70 years! (Not, I'm certain, what the founders meant by "for a limited time".) Further, these periods keep getting retroactively extended. As a result, by the time a work enters the public domain, it very likely has not survived, or is not intact or is not in a usable form. Only the very few most popular and profitable bits will have survived.

Take Star Wars as an example. The original prints were within a few years of deteriorating past the point of salvation when they were restored by the copyright owner (most films in this condition are not restored). Even then, parts of the movie were changed, with the originals not kept around (Greedo did *not* shoot first), so the original work is actually gone, though most of it survives in the reworked editions of the film. How many albums were never converted to digital form - and will never be? How many of those will have surviving and accessible masters when their copyright runs out late this century? Will the owners of those masters then make them available to someone to put out a digital version? Will there be equipment that can do this? I suspect a lot of the albums I have will not survive, if they've not already been converted. Which is why I'm planning on ripping them to MP3s and sharing them - so that they will survive. (Note, I won't be sharing commercially viable stuff, just stuff that's not available digitally otherwise.)

I guess what I'm trying to get at is that it is fine to get upset at people blatantly stealing all of the current music that they can, as long as it is realized that there is another side to the story. The sad fact is, if we can't reduce copyright to a reasonable term (like 14 years plus a possible one 14 year extension), we will lose much of the cultural heritage that copyright is supposed to protect, and the extra material produced in the interim will be of at most transient value.

-jeff

This line nearly made me choke on a glass of oolong tea:

"You do realize that the more file sharing there is, the higher the price of CD's will be, don't you?"

Your fourth post on this subject is going to actually review some factual data that justifies the assumptions (I count at least four or five) behind that statement...right?

The whole point of this debate, so far, is whether file sharing is ACTUALLY causing economic damage to the record companies, or whether the current slow down is mostly coming from other factors -- the correction phase of an anomalous peak, declining quality of product output, outdated business model, etc.

File sharing makes for a nice bogeyman because it's easy to point out. But is its relevance overall justified by the data? I've seen it argued both ways but have yet to find a study that conclusively demonstrates that file sharing (1) prevents more purchases than it promotes, (2) affects enough players in the market to be significant, or failing condition two, (3) is spreading across the market base sufficiently to ultimately become significant.

Also, Jane, a couple of quibbles with your specific arguments:

-- Most of the technological changes that made high quality home recording possible are just a side product of faster computers, and the investment which produced that technology certainly didn't come from record company revenue. Also if you actually look at the prices of recording software, even the 'professional' versions are quite affordable, usually $1000 dollars or less. So it's not the case that only record companies can afford them.

-- Are concerts really a high marginal cost industry? After all, once you've built a concert venue, the marginal cost of hosting another concert in it is relatively small. Also, if you're a band, once you've assembled the gear and personnel necessary for mounting a tour, the marginal cost of adding another concert date to your tour might also be relatively small.

--Is it really the case the high FC/low MC industries have intrinsically higher rates of innovation? If anything, it seems to me that such industries would be more susceptible to monopolies or oligopolies, which might reduce the incentive for innovation.

--Why are record companies the only institutions that can act as a gatekeeper? Radio stations in particular won't face any change in their incentives. If what people want is top 40 style radio, that's still what radio stations will play. And if people need extra filtering and gatekeeping to find out about good music, the marketplace will provide it, in the form of more music magazines, websites, etc.

Just wanted to point out a couple of developments that have reduced my CD purchases: Net radio and cable/satellite television music channels. It's just a lot easier to find music I want to hear without buying it than it was 5-8 years ago. (The change probably isn't as noticeable to people in large metro areas where there has always been a lot of choice on radio, but it is fairly dramatic in Wichita, America.) Plus the speaker systems available for computer and television are as good as what had been available only for stereo systems, so you don't miss much on sound quality either.

Add to that the fact that there's not a lot to get excited about being produced by the big labels these days. There have been several shifts in popular music between music put out by musicians and that put out by performers, bands verses "singing groups." We're in a singing group phase right now, and have been for a few years. Boring. So at a minimum we need not only the end of the recession, but also the appearance of the next Nirvana to know how big a problem the recording industry really has.

I still fail to see what the big difference is between file sharing and tape recording; why this particular innovation is going to be the one that puts the record companies out of business.

Ewin - "I still fail to see what the big difference is between file sharing and tape recording; why this particular innovation is going to be the one that puts the record companies out of business."

The big difference is access. For me to get a copy of your tape, I'd have to know you. For me to copy your mp3, I (and a million others) simply have to log onto the internet. Its now easier for me to get a song by downloading it than it is to get in the car, drive to the store, and spend who knows how long looking through the store's CD bins for the song I want.

Again, reading chapter 7 of "Re-Thinking the Network Economy", as well as the Stan Liebowitz paper Kevin cited above, will prove to be the antidote to much of the emotional wrangling going on here over all this.

BTW, Brad DeLong is also on to this topic.

Matt is correct in saying that there is a fallacy here. Since the CD industry is stuck with its existing fixed costs, the firm will continue to "produce at a loss" since the selling price exceeds the average variable cost.

It's also unclear whether prices will move up, or down. Since MC is fairly small, and since demand for music is elastic, the firm may lower prices to induce a greater quantity sold. The increase in quantity sold may possibly deter music-lovers from tedious downloads, burning CDs, etc.

The most likely outcome is for the industry in general to reduce future investments in music.

I cannot confirm this directly but I have heard from a reliable source that the typical cost for a CD manufactured in volume can be as low as $0.25 (and as high as $1.50 or something like that).

But suppose I were one of the half-dozen conglomerates that presently control the mainstream music industry. What would I have to gain from keeping the price high under the present circumstances and NOT pursuing a competent online business model?

For starters, the ability to point at file sharers as the root of all evil when supporting legislation to tighten my control over consumer use.

And what ends might that ultimately serve?

Why, eventually, I would attempt to consolidate the entire market for media content (entertainment media especially) into a rigid pay-per-view system where EVERY SINGLE TIME that work I control is viewed/heard, I am guaranteed to take profits.

Hmmm....

1. Lots of costs incurred by the big labels are wasteful luxuries, not truly fixed costs.

2. Re-examine one other major factor that has not been mentioned once by RIAA, the fact that over the time period these numbers have been accumulated most of the chosen pop music idols just haven't released any compelling products. The only real breakthrough that I'm aware of has been Josh Brogan. Many of the other major pop stars haven't produced very well received albums lately. And I don't mean just sales-wise. I mean critically panned or yawned at with many fans for once agreeing with the critics.

This discussion is missing a couple of historical points. As noted above, this is hardly the first time that music sales have slumped; in the late '70's and early '80's, the RIAA was screaming about lost sales to home taping, and demanded a 'tax' on blank cassettes (thankfully, never passed, although they did manage to kill consumer Digial Audio Tape in its infancy).

Of course, the RIAA wasn't honest about the reasons for its losses, which were in large part due to over-production of unwanted product (can you say, "disco"? I thought you could!) and paylola to radio stations for lousy artists and/or songs that nobody wanted to buy even after hearing them.

The record companies saved themselves in part by turning to CDs, and convincing music fans to go back and buy new, more expensive digital copies of records that they already owned. As that cash cow dies off through saturation, it's understandable that CD sales are going to drop. Add to that a very similar situation to the late '70's in low-quality "music" being marketed through the lockstep programming of CrapChannel radio and its clones, again, it's no wonder that sales are dropping.

I'm still waiting to hear a compelling reason for CrapChannel and the RIAA record companies to maintain a virtual monopoly position in music distribution. Look at some of the biggest successes in popular music over the last 20 years--Metallica, R.E.M., U2, even Rush, all of whom built an audience well below the radar screen of the mass media, with virtually no radio airplay (and incessant touring) and all of whom have had 20+ year careers. With the advent of digital distribution, the successors of those bands may never need the RIAA. If the next Garth Brooks or Britney Spears does need them, fine, they'll all make money, and good for them. But why should I care?

The main difference between tapes and MP3's is the perfect quality, and the ease of access.

It may well be that sales are off because the product is crap. But if 60% of the American population thinks there's nothing wrong with file sharing, I don't see how the industry remains viable as the technology spreads. I just don't buy the idea that MP3's and CD's are complementary rather than substitutable over the long run.

I don't disagree, Jane. I don't think the old business model of selling music on plastic discs *is* going to be viable for much longer. Neither was the buggy industry after the car was mass-produced. Setting aside the legal and moral issues for a moment (and for the record, of course downloading music you don't own without paying for it is neither legal nor moral), digital distribution is a reality, and it can't be wished away, or convinced to stop, or legislated out of existance.

The question is, what comes next? I think there's evidence that lots of artists can succeed without the RIAA and the old business model--although no doubt there are plenty who can't (and I'd be less than honest if I didn't admit that I won't miss most of them).

Canada, not surprisingly, went the taxation route on this. There is a levy charged on recordable media sold in Canada (currently up to 77 cents for each CD-R Audio sold, likely to go up January 1). In theory the money collected goes to the industry to compensate artists whose works are copied. Here are some links to more detailed discussions for anyone who is interested.

http://neil.eton.ca/copylevy.shtml

http://www.internetcouncil.ca/images/home/headings/headline_02_cdtax.gif

I'm not sure what the long-term affects on the industry would be from a tax like this (I suspect they are not good from the consumer's point of view), but short-term it sure makes me less sympathetic to moral or legal arguments against downloading and burning CDs when the Government assumes I'm a pirate and makes me pay royalties up front every time I buy a blank CD.

"...since demand for music is elastic, the firm may lower prices to induce a greater quantity sold."
Posted by Ram Ahluwalia

Interestingly enough, this appears not to be true:

http://wwwpub.utdallas.edu/~liebowit/knowledge_goods/records.pdf

3) Income does not appear to be an important factor in record sales changes during the last 30
years. Therefore the current recession does not appear to be responsible for the current decline,
contrary to my previous expectations.

4) [snip]

5) Inflation adjusted list prices fell during the 1970s but have remained almost constant for the last
twenty years. Increased sales by discounters has probably slightly lowered the price paid by
consumers. Price does not seem to play a role in record sales fluctuations.
--------endquote------->>

"I just don't buy the idea that MP3's and CD's are complementary rather than substitutable over the long run."
posted by our gracious hostess

Again, from Stan Liebowitz:

does not appear to be zero. But neither does it appear to be ‘large.’ Given the enormous number of
MP3 downloads, which are themselves an incomplete portion of the entire MP3 phenomenon, it seems
safe to say that the CD equivalent of MP3 downloads is at least equal to the entire sales market for CDs.

"If MP3s converted at a 1 to 1 ratio, there would be no CD market to speak of. If they converted
at 4:1 the album market would have dropped by 25%. ...it would appear that the conversion rate at the moment is on the order of 7 or
8 to 1. Not large but not small. "

Ewin,
I used to copy vinyl records onto tape. The result was both too good (it picked up every scratch and imperfection on the record surface) and not good enough (it added an annoying "tape hiss").

Copying a CD onto a blank CD yields a perfect copy of the original. And it's not too difficult to program the computer to not copy the parts of the CD that you don't care for. With vinyl and tape, I had to make manual edits in real time.

As with many good theories, my belief that MP3's are perfectly substitutable with CD's over the long run can certainly be falsified empirically. But I'd argue that we're too short a time into the phenomenon; as broadband spreads, I think we'll see more and more substitution. But it's too soon to tell either way.

Denise has it right for me as well; I do have some pirated MP3's in my collection, but not very many (perhaps 30 songs, but in any case much less music than I had on tapes in high school). Most of what I listen to other than top 40 radio consists of DJ mixes that are unedited radio broadcasts (which I believe are perfectly OK to trade; no identification or advertising has been removed) and MiniDiscs I've recorded off Net radio stations (which is OK on two counts; recording radio is perfectly legal, and MD blanks come with a surtax that is paid out to people involved with music, though I don't know if it's ASCAP/BMI or RIAA members).

Anyway, I don't particularly care if the RIAA dies. They've repeatedly indicated that they don't want to sell what their customers want at any price less than that of a CD and the time it takes to rip and encode.

Interestingly the DVD comments raise another interesting point.

Why are DVD prices in the $15-25 range (save for some of the snazzier multi-disc special releases) while CDs tend to hover around $15-18? Consider:

- The CD contains up to 74 minutes of content, usually all audio; the DVD contains 3+ hours of audio/video.

- The market limitations for each are similar, high FC/low MC, although the MC for producing a DVD is slightly higher AFAIK.

- The marketing dynamic for each is similar; movies try to recoup FC at the box office while labels look to do the same through concert tickets and associated merchandising.

One explanation I encountered that seemed fair to me was...competition. If DVD prices go up, it sends more business to Blockbuster et al, where a single disc may service dozens of rental requests. The movie companies would like to limit or even kill Blockbuster's business, so they maintain DVD prices low enough to convince additional consumers that a sale might be a better option than renting.

Think there may be a related lesson for the music industry? I do know this (speaking strictly for myself of course), if a new CD was about half as expensive as the current price, I would own more than twice as many -- because impulse buying is easier to justify at $9 than at $17. At current prices, I want to KNOW if the artist is any good before investing, because a wasted $17 is easier to regret than a wasted $9.

What's next, another WWJD campaign?

What would Jesus Download?

>>Revenues are down year-on-year for the last three years by an enormous margin, far more than one would expect from the recession.
As others have pointed out the recession and a lack of "hot releases" from the teen acts drives this. A third factor is that the boomers have finished replacing their vinyl with CDs. (I'm about done.)

The fixed costs in the industry are in part due to the enormous fat. From what I have read, at every level in the record business, for jobs comparable to those in the book industry, the recording industry pay is much, much higher. Example: a producer of a record will get $20-100k up front, plus points (for a couple of weeks work); a book editor gets a salary, maybe a bonus. The record industry also still has to contend with indirect payola to the radio business - to get a "single" on national Top 40/Pop playlists cost $250k in payouts. (See Salon for a bunch of articles on this and the influence of Clear Channel in the radio business.)

Other factoids: artists get about 5% of the gross in the record business. They get 30% of the gross in the concert business. (See the current InfoWorld.)

Their business model doesn't work, when compared to the other IP industries that had the fat burned out of them by competition (books, and to a lesser degree, film & TV).

As an abstract matter I'm not sure it's right that CD prices will rise. If we assume zero marginal costs then CD's should be priced to maximize total revenue. This mens price elasticity of demand = 1. Otherwise there would be more revenue available at a higher (elasticity1) price.

It's reasonable to suppose copying reduces demand, but we don't know how it affects the shape of the curve. if the shape remains the same, though, then the price at which elasticity = 1 drops. So revenue maximization leads to a lower price.

Of course total revenue also drops, which means fewer positive NPV projects are available. In practical terms, this means record companies will choose to promote fewer artists. (The "go out of business" case is when they promote no artists). Of course the lesser diversity available may cause the demand for those that are still around to shift back out, raising prices again.

Well, I said I wasn't sure.

One explanation I encountered that seemed fair to me was...competition. If DVD prices go up, it sends more business to Blockbuster et al, where a single disc may service dozens of rental requests. The movie companies would like to limit or even kill Blockbuster's business, so they maintain DVD prices low enough to convince additional consumers that a sale might be a better option than renting.

No way. Not only do the movie studios not want to kill Blockbuster and other rental outlets, they rely on them as sources of aftermarket revenue to help recoup costs on marginal movies. Greenlighting any project for a studio is contingent not only on projected domestic box-office gross, but on overseas markets and rental fees. In fact, you'll often see a movie on a studio's slate that eventually is deemed "unreleasable" that might go straight to video, or receive a release window of only a few weeks before being released for sale and rental. Prior to the home video market, studios had to write the production costs off forever; now, they can make them back via rentals.

Blockbuster, especially, has sweetheart deals with the studios regarding how many copies they'll buy of new releases and how little they'll pay per copy of they make them a "featured" or "Guaranteed-to-be-here" rental. Smaller video retailers in Texas sued Blockbuster over it and were denied class status in their suit. The case was eventually dismissed.

Make no mistake, the studios loooooooove Blockbuster. It's one of their biggest revenue streams, especially for B-list and back catalog titles.

The 'sunk costs' argument is the essence of Janis Ian's 'release the back catalogue online' idea. One worry formt he labels is that sales of back catalogue woudl cannibalize new sales, but that is happening anyway.

Okay, Phil, thanks for the clarification. But the argument holds that if the 'hotter' DVD viewings go to Blockbuster rentals instead of purchases, the studio is going to make less money, which is an incentive for them to hold DVD retail prices at the point where they still make plenty of money, but that borderline customer chooses to buy instead of rent.

After all, which brings the studio more income: two or three rentals whittled down through contractual incentive deals, or a single $20 sale on an item that had very low physical cost and two middlemen?

CDs have no similar competition. Libraries sometimes stock a rather limited selection for check-out but otherwise...

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