The Mystery of the 99 Cent iTune

by on May 30, 2006 · 4 comments

Julian Sanchez puzzles out the economics of Steve Jobs’s stubborn insistence on 99 cent music:

One reason is the flip side of an idea Markels broaches: Prices signal quality. People might conclude that an expensive song is likely to be better (because more in demand), and conversely, might be willing to take a chance on an unknown at a lower price. Yet there’s a pheonomenon familiar to marketers where you can sometimes sell more of a product by raising the price, precisely because peoople do sometimes take prices as a proxy for quality. Maybe not for big-ticket items like cars, where you’re going to do a lot of investigating before dropping tens of thousands of dollars, or for items where the quality can be easily measured by casual observation. But I’m willing to bet that, say, for a pair of headphones, a lot of people who want to get good sound but aren’t devoted audiophiles will follow a heuristic like: “Walk into Best Buy and grab the second most expensive pair.” Now music, like a lot of other cultural goods, is a long tail product: Sure, there are those megahits at the top that sell disproportionate numbers, but most of the action and the sales, especially online, where you’ve got a bottomless inventory, is going to be in the aggregate sales of large numbers of smaller niche artists. (This is especially the case as a kind of online feedback effect kicks in, where record industry economics no longer tend to push convergence for most consumers on a relatively narrow mainstream.) If that’s the case, you might not want to signal that a huge portion of your inventory, which when added up actually accounts for most of your sales, is in the digital equivalent of the remainder bin, especially when you’ve got other sophisticated means of suggesting songs tailored to a person’s specific tastes.

That long tail logic also points to another consideration: People are actually going to be a lot less price elastic than you might think, especially for the niche items. That is, suppose Quasi is selling a lot fewer albums than Kanye West. The normal market conclusion would be that Quasi should be priced lower to move more. But that’s not necessarily the case, because most consumers aren’t actually sitting there making the decision at the margin between Quasi and Kanye. Rather, the people who like Quasi are going to buy it whether it’s at 99 cents or 50, and even if it were 10 cents, Quasi just ain’t going to be most people’s cup of tea. Conversely–and this is more speculative–the items at the top are likely to be stuff for which people have thinner preferences, and are therefore more price elastic. That is, a lot of people are going to download Eminem (or whatever) precisely because it’s the hot track everyone else is listening to, but might be dissuaded by an extra 50 cents.

I think this is sound analysis as far as it goes. I think there’s another explanation, though: Jobs doesn’t really care about revenue in the short term, because he’s got an empire to build. In the short term, any price increases will have to be shared with the labels, and might put his service at a competitive disadvantage vis a vis other music-download services. But if Apple maintains its dominant position in the music-download market, by the end of the decade the labels will be getting the majority of their revenue from Apple. At that point, Jobs will be in an incredibly strong bargaining position vis a vis the labels, and will be able to set whatever price he wants and keep more of the profits. He may also simply begin signing up artists himself, cutting out the middleman entirely. The paltry profits he might get from raising prices now pale in comparison to the money he’ll make if he becomes the Bill Gates of the digital music business.

As I’ve written before, Apple’s ability to lock in its customers is helped immensely by digital rights management technology and the DMCA that gives it legal teeth. It will be incredibly ironic if DRM is the industry’s undoing.

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