Wednesday, April 26, 2006

iTunes Music Pricing

Over at Marginal Revolution, there's a discussion of Apple's uniform pricing for songs (99 cents per song). Tyler Cowen finds this pricing behavior peculiar, and posits some possible explanations. Let's look at them:

1. The confusion and resentment costs of different prices might be blamed on Apple. But surely we see different prices in many other retail arenas.

2. Perhaps Apple is solving a status game problem. If everyone else is selling for 99 cents and your song sells for $1.20, yours looks special. Music companies might set prices too high, not taking into account the lower demand for iTunes, and music, more generally.

3. Could Apple be enforcing music company price collusion, while receiving implicit kickbacks in the rights agreements? This would require the complainers to be in the minority.

4. Apple makes much of its money on hardware, especially iPods. Low song prices cross-subsidize the hardware, to some extent at the expense of music companies. That said, some music companies wish to charge lower not higher prices.

5. Hit songs are kept at artifically low prices to discourage people from moving into the world of illegal downloads.

6. Price is a signal of quality and Apple doesn't want to admit it carries "lemon" songs. But won't demand for the hits go up?

7. Uniform pricing is a precommitment strategy for a durable goods monopoly game.

Let's see:
  • #6 just isn't believable. Even if price is a signal of quality, uniform pricing as a solution would have to mean that "low-priced" songs make up a bigger fraction of sales at iTunes than "high-priced" songs; otherwise differential pricing would be better. Plus, come on, really?
  • #7 and #4 may or may not be valid, but they are arguments for low prices, not uniform prices.
  • I've never heard of a "status game problem" (#2). Whatever it is, if it's a problem, then it's a problem for anything that prices differentially. What's special about MP3s? Also, I don't see why music companies would price too high. (Nor do I see what that has to do with the "status game.") Raising the price of a song would send some iTunes customers to purchase other songs instead, which the record company may not internalize, but Apple would. So the record companies would raise price too little, not too much. (And that's again an argument for low prices, not uniform ones.)
  • Of course, there's another externality the record companies don't internalize- iPod sales (#4). But, as already stated, that doesn't explain uniform pricing.
  • #3 could be, I guess. But as the author points out, this could only be the case if the complainers were in the minority. (Or if it wasn't implicit, and they all agreed to complain to deflect suspicion. But now I think we are giving them too much credit...)
  • #5 also seems to be an argument for low prices, not uniform ones. A comment at Marginal Revolution argues that the "price" of all pirated downloads is the same (just time and effort), and so a uniform price for legit downloads is just set to the necessary differential. That argument sounds good, except it's not true. It's easier and quicker to download popular songs on file-sharing networks, so if this was the reason, we should see lower prices for more popular songs on iTunes.
  • So that just leaves #1. We do see differential pricing in many other retail areas, but there are also lots where there is uniform pricing, also against immediate intuition. (Movie theaters, candy bars at a convenience store, and flavors of ice cream within a brand are some examples.)
My gut is that it has to be #1. Customers are likely somewhat annoyed by differential pricing (especially if that pricing is variable over time, which relates to #7 above), and it seems unlikely to me that the gain Apple would get be varying song prices by 10-20 cents either direction would yield far greater profits absent that effect on customers. So if the potential gain is small, and enough customers would be put off, then uniform pricing would be rational.

And, of course, there is probably something to the gimmick of pricing at 99 cents that appeals to customers and to Apple as a marketing tool.

Lastly, I wonder if the uniform pricing scheme might have something to do with the fact that songs are not bundled into a virtual "shopping cart" at iTunes, but rather each song is purchased as it is clicked. So customers don't get the chance to overview all of their purchases before finalizing their order; maybe a 99 cent per song pricing scheme allows them to track their spending more easily during a session?
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