Belmont Copyright Society

In the Beginning... 

There has been a lot of recent commentary circulating the blogs about digital bundling.  Much of the different opinions seem to assume too much and jump to grand conclusions.  In this article, I hope to explore some of the problems and opportunities of digital bundling; all while keeping my feet on the ground and trying not to make too large of leaps.
 
This debate seemed to have been sparked by a recent study done by Harvard Professor Anita Elberse titled Bye Bye Bundles: The Impact of the Unbundling of Music in Digital Channels.  This study finds that revenues decrease significantly as digital downloading becomes more prevalent because consumers switch from buying bundles (albums) to cherry-picking their favorite components (songs) on those bundles.  As this study soon became viral hit within online music business communities, some jumped on the bundling bandwagon, prompting posts claiming that the industries only hope for economic survival is by switching to the bundled model of subscription services.  They also chastised iTunes for offering mixed-bundled options, claiming that the iTunes store is killing the music business.  Further into this article, I hope to delve into these two topics, along with others, but first a little background information on the economics of bundling…
 
Bundles of Joy 
Bundling is the market strategy of offering several products for sale as one combined good.  This is the model that cable television has thrived upon.  Consumers don’t purchase channels individually, instead, they purchase them as a bundle—each cable network also being a bundle of individual programs.  This is also the strategy used by Microsoft to sell Word, Excel, and Powerpoint together as Office Suite. 
 
Bundling can take many forms within the music industry.  For example, an LP or EP (physical or digital) represents a bundle.  Also, the proposed ISP solution—including a “music tax” in your internet access plan to compensate for access to copyrighted musical content—is a bundle plan.  Lastly, subscription and streaming based models, such as Rhapsody or Spotify, utilize bundling.
 
To the consumer, the appeal of bundling is the reduction of the transaction cost—instead of having to figure out how much each part of a package is worth to you, you can make a blanket judgment.  Also, there seems to be a bargain element to the deal provided by what is called an option value—you may never watch all those channels or you might never use Excel, but the fact that you could if you wanted to holds some value.  In the case of Rhapsody, bundling allows for greater ability to discover and sample a vast amount of music which the consumer may never have paid to access individually.
 
A 2003 study titled The Economics of Digital Bundling: the Impact of Digitization and Bundling on the Music Industry explains that the appeal for the producer is that bundling effectively homogenizes the demand for all the songs.  This, therefore, makes demand more predictable and bundling becomes an effective profit-maximizing tool.  This simplifies the challenges of estimating demand and setting a price for music, a non-substitutable good with highly heterogeneous demand.  “Individuals have differing perceptions of a particular album’s value and are willing to pay varying amounts depending on their musical taste.”  The study also found that, to the labels further detriment, the industry practice of setting a single price allows for consumers willing to pay more not being required to, and consumers who are willing to purchase for a lower price to walk away empty handed.  Bundling, on the other hand, “averages out the dispersions between consumer valuations.  Thus, a single price captures a larger number of customers, and generates more revenues.  By bundling high-value songs with low-value songs, the valuation per song approaches the mean for all songs” (Zhu, 266).
 
The previously mentioned 2009 study, Bye Bye Bundles, also celebrates the benefits of bundling.  This study finds that “a drop of around one-third of the total weekly sales across the album and its associated songs is attributable to people switching to buy [unbundled] music online”.  Unbundling allows consumers to switch from buying bundles to cherry-picking their favorite components, resulting in a significant decrease in revenues.  This study also finds that, “while the demand for individual songs is growing at a faster rate than the demand for albums is decreasing, the dollar amounts gained through new song sales remain far below the level needed to offset the revenues lost due to lower album sales.”
 
So far, the bundled subscription model or ISP “music tax” model seem to be the answer to the record label’s prayers—and we all still may be cursing iTunes for their practice of digitally unbundling albums—but let’s not jump to any conclusions just yet.  Both of these studies deserve a closer examination.
 
The Overlooked Effects of Bundling 
One of the main problems of bundling is its powerful influence on competition and industry structure.  If the bundles firms are providing become infinitely large, they would have a strategic advantage in three areas: competing for customers, competing for content, and deterring entry.  In the case of the ISP “music tax” or subscription models, those consumers, who are paying for access to as much music as they want, would find it very difficult to justify an additional purchase—essentially making it near impossible for any alternative market system to thrive.  This means, theoretically, that if this model had deep enough market penetration, pay-per-song models such as iTunes, physical albums, and ad-funded models like Pandora or Spotify could become just another blip in the history of the internet.  This would further consolidate power, and could lead to higher access/subscription fees.
 
Secondly, as Patrick Ross describes in Critiquing Copyright Canards, “for the first time in history creators would be working under a ceiling that pitted one artist against another.”  This means that all artists and labels would be struggling against each other for a fixed amount.  In his argument, he is describing a collective licensing regime such as the ISP “music tax”, but many of his findings also have applications to the subscription based model as well (especially a heavily penetrated model like the one described in the previous paragraph).  To better show this point, Patrick offers this example:
 
“Let’s say there are a million broadband connections in this country [or subscribers to a subscription service], and let’s say a mandatory collective licensing system [or subscription service] imposes a $5 monthly download fee for music.  That is $6 billion annually, a ton of money.  But remember, some will go to the ISP [or subscription service firm] for transferring on the fee.  Some will go to whatever organization is distributing funds, and that organization will have to be active in tracking download and upload activity across the increasingly decentralized Internet so artists could be paid accurately.  So let’s say, based on models that exist currently, $4 billion is left for distribution to copyright owners, including performing artists and songwriters.
 
That is a fixed amount.  No more can be distributed.  The music industry for years grew and grew because more artists attracted more fans.  Now, no matter how many artists, living and dead, were competing out there, a sale for one is a loss for another.  If I download “Kashmir” from Led Zeppelin, that is a wee bit less than Fountain of Wayne will earn that year for “Peace and Love.”  Note I haven’t even mentioned new releases here.  Who would want to enter an industry where you are not paid based on your own success, but rather your financial return is capped and is relative to the success of everyone who has ever recorded in your industry and is still under copyright?”
 
This is enough to make Free Culture aficionados and Lessigites run around screaming about stifling creativity and innovation.  For an industry plagued by obsolescence, “Killing Itself to Live”, and has an “Appetite for Self-Destruction” it doesn’t seem like they could afford to lose any creativity and new material.
 
The Pay-Per-Song Model: is it really that bad? 
Another study, conducted in 2009 titled Optimal Pricing for a Menu of Service Plans: an Application to the Digital Music Industry, found reason to believe that pay-per-song models (an unbundled option) might not be as bad as some thought.  This study establishes the fact that pay-per-song models are more popular than subscription based models with the digital consumers.  Also, it suggests that if optimal pricing strategies were followed, greater overall profits could be realized under the pay-per-song model versus a subscription model.  This study finds that music purchases would increase sharply at a lower price—so much so that record labels would actually raise their overall profits by dropping the cost per song.
 
The results show that, even at zero cost per-song, a record label should charge about $0.23 per-song to a retailer, which in turn will charge around $0.54 per-song to a consumer.  Currently the figures are closer to $0.60 or more for the retailer, which translates to roughly $0.99 for the cost to the customer.  Researcher Raghuram Iyengar’s, says, “if I compare what their profits are when a record company charges a retailer 60 cents a song, I find that overall profits for the entire channel, which is the label and the retailer, are almost 50% lower than what they could optimally be when the record label charges lower wholesale prices.”
 
This recommended price to consumer of $0.54, closely resembles the average willingness to pay of consumers; which was found to be $0.68 in the 2009 study Determinants of Music Piracy in a Sample of College Students.  This number was also based on “the most popular iTunes track at the time”, and suggests that the willingness to pay would significantly decrease for less popular songs.  As expected, the study found that “for a $0.01 increase in price, the probability that the respondent will be willing to buy the song is decreased by 0.6 percent.” Lastly, this study found that “pricing each song at $0.63 would allow decreasing music piracy by 50 percent.”
 
However, labels may not even need to look at these studies to see that subscription models aren’t the answers to their prayers.  In fact, they need to look no further than the consumption habits of their customers.  Consumers seem to be uninterested in subscription models, and seem to prefer the pay-per-song models!  Apple CEO, Steve Jobs, claims that “the subscription models have failed so far” and that “people want to own their music”.  Even though many in the industry hope iTunes will start renting music online, so record companies can make more money from recurring income, Jobs has no plans for an iTunes subscription service.  However, Apple has recently bought out the music streaming service LaLa, which has left many to wonder if Jobs thinks that ad-funded streaming may have a future.
 
 
Small Steps 
The purpose of this article is not to defend iTunes on all of the accusations of its “negative” effects on the music industry.  iTunes heavily popularized an unbundled option for consuming music.  iTunes set the value of a single track of music at $0.99, regardless of the artist/song or length/content, and $9.99 for a bundled digital album.  This has slightly changed since April 2009—individual tracks are now priced at either $0.69, $0.99, or $1.29, based on popularity.  Bye Bye Bundles even claims that “labels did themselves a disservice by granting a player like Apple such power in the channel… the company isn’t even primarily in the business of selling music.” 
 
But, even if Apple’s main focus is on Mac Books, iPods, iPhones, and new hardware like the iPad, they still make up for 25% of the US music market, and 69% of the digital sales. Apple also provides a simple legal alternative for music fans to download music digitally, as opposed to accessing it via a P2P network.  Therefore, iTunes does provide benefit to the music industry—these facts are enhanced by its $1.9 billion 2007 revenue, a cut of which went to artists and labels. So what can be done within the pay-per-song model to continue to provide benefit, while deterring the negative effects of the unbundled option?
 
Anita Elberse offers several suggestions in Bye Bye Bundles.  First, she suggests “smaller, more consistent bundles”.  Could a strategically priced bundled EP prove to be effective? Second, “content producers seeking to avoid declining sales will likely benefit from having the flexibility to price mixed bundles as they see fit.”  This means saying goodbye to the uniform pricing method used by iTunes, and letting the producer have more influence in determining both the price to retailers, and the downstream price to consumers—perhaps following the suggestions in Optimal Pricing for a Menu of Service Plans. 
 
Learning to Fly
Another option would be through a pricing strategy similar to yield management, which is the process of understanding, anticipating and influencing consumer behavior in order to maximize revenue or profits from a fixed, perishable resource.  This is the pricing strategy used by airlines and hotels to fill vacant spots, but with some minor adjustments it could prove efficient for the sale of digital unbundled music.
Unlike airline tickets or hotel rooms, digital music is not a perishable good; but like airline tickets or hotel accommodations, digital music has a highly heterogeneous demand.  The challenge is to sell the right resources to the right customer at the right time for the right price. This process can result in a form of price discrimination, where a firm charges customers consuming otherwise identical goods or services a different price for doing so.  This practice is done in the airline industry by offering the incentive of price reductions for booking far in advance, and increasing the price of tickets as both the date approaches, and demand increases.  Airlines also employ yield management to fill vacancies by severely discounting tickets prior to takeoff—at that point filling a seat for even $1 represents an otherwise unseen increase in revenue.

 
A similar approach could be implemented for the sale of digital music, by flipping the airline system on its head.  At the time of release, a track could be set at a determined value, “singles” priced higher than “filler material”.  As the track became more popular, represented by the number of downloads, the price of the track would increase in increments.  For example, an increase in 10,000 downloads would boost the cost $0.10 (Note, these numbers are for the purpose of example only and should not/cannot be applied universally across the board).  This would allow for higher revenues as the track increased in popularity, and could result in the consumer optioning instead to go with the bargain deal of the bundled album. At the very least, this would provide more incentive to purchase the other less popular “filler tracks” at their reduced price.  Finally, this would provide incentive for music consumers to purchase early, search for new music, and stay ahead of the trends; therefore, encouraging turnover.  This aids in inducing obsolescence.  This would be a good thing for an industry that, much like the fashion, is faced with the difficulty of selling this season’s (album cycle) product, then having to convince customers that last season’s product (album) is out of style and that they need to purchase the new styles.

Update on Thursday, February 11, 2010 at 11:26AM by [Your Name Here]

Does information want to be bundled? or Does it want to be Free? check out the full article here.

Update on Friday, March 26, 2010 at 8:43AM by [Your Name Here]

Justin Bieber "debunks" the bundle and shows impressive numbers across all formats, albums included! (Link)