June 22, 2009

iTunes Lets Record Labels Try Variable Song Pricing

When Apple decided in April to give record labels the option of setting different prices for their songs on iTunes, a number of companies leapt on the opportunity and raised the prices for popular tracks by 20% to 30%, accordintg to a Reuters report. 

Every tune on Pink Floyd's classic rock masterpiece "Dark Side of the Moon," for example, was raised from 99 cents to $1.29.

It goes without saying that no small number of music fans were fuming over the price hikes, while executives from other tech industries and industry bloggers warned the labels that they were taking the wrong approach in trying to turn a profit.

Nevertheless, while the sales for individual tracks on "Dark Side of the Moon" immediately fell by some 11%, revenue from the album remained stable.  Six weeks after the introduction of variable pricing, iTunes reported a 12% increase in overall revenue compared to the preceding six week period"”exactly the results that record labels had crossed their fingers for when, after years of negotiating, they convinced Apple to introduce a three-tier pricing system with 69 cent, 99 cent and $1.29 songs.

As revenue from CD sales has plummeted precipitously in recent years, record labels have been in a desperate scramble to find any means possible to compensate for millions in lost revenue while a number of industry commentators have prophesied the collapse of traditional record companies. 

While tweaking individual prices for iTunes songs is hardly a panacea for the industry's woes, it may help to get them a bit of breathing room.  A Billboard analysis of Nielsen SoundScan data for digital music sales between February and May indicates that the results seen in sales of "Dark Side of the Moon" represented a more general trend in the industry at large. While variable pricing brought on a drop in sales volume, the higher profit margins per song more than compensated, leading to an increase in revenue.

There's no fixed formula, however, to determine for which songs and to what degree this strategy works.  Sales for hit songs tended to stay stable even with higher prices, while sales for other, less-popular tracks declined so steeply that the higher prices were not able to compensate for the loss in volume.  Even this trend, however, was not true for all cases.

Sales for songs in Billboard's weekly top 40 dropped by an average of 11% in the six weeks after iTunes introduced variable pricing, while overall revenue rose by about 10%.

"A $1.29 vs. 99 cents price point has not made a notable difference in consumers' appetite for online music," said Richard Greenfield of Pali Research. "On the album side, you've seen variable pricing for a while and it's not clear that it's had a notable negative impact, so I'm not sure why the single environment would be different."

Variable pricing is not the only factor playing into the revenue mix.  The first quarter of every year almost inevitably sees a general drop in music sales. This year was no exception, as sales of all music across the board fell by 5% during the six-week period after the introduction of variable pricing, regardless of whether the prices had changed or not.

In order to tease-out and measure the direct influence of variable pricing on sales , Billboard examined the sales of some 70 classic songs from popular artists with consistently strong sales, such as Stevie Wonder, Bob Marley, Bon Jovi, Billy Joel, Creedence Clearwater Revival, Sublime, ABBA and others. Because tracks from older artists are generally not advertised or influenced as much by popular media trends, they allow analysts to isolate the effects of price change from other factors. 

Given the enormous size of iTunes music catalogue, Billboard's sample size is too small to be considered statistically significant.  It may offer, however, an overview of how variable pricing has influenced sales.

Billboard's analysis found that sales for these classic tracks fell by 20.9% percent on average compared to the previous six weeks before variable pricing was introduced"”almost double the 10.8% drop observed for the top 40 songs on Billboard's Hot Digital Songs chart. 

Even with this significant drop, however, net revenue increased by about 6%.  Analysts explain that the math behind the phenomenon is elementary: as long as the percentage drop in sales is not larger than the percentage by which prices were raised, the record labels can expect an increase in revenue.

Moreover, the impact of a drop in sales of older catalog tracks pales in comparison to the top 40 songs, which constitute the overwhelming majority of sales.  Typically, the number one song in the music charts will sell more copies than all other catalog tracks combined.  As hot new songs are the least affected by increased prices, they more than compensate for the occasional modest loss on an older track.

Nevertheless, labels have to be extremely cautious with how they implement variable pricing if they don't want to shoot themselves in the foot.  As consumers react differently to changed prices on different tracks, price modifications have to be considered on an artist to artist basis.

Sugar Ray's 1999 hit "Every Morning" is a case in point.  On the iTunes listing for the original album "14:59," the song costs 99 cents, while on "The Best of Sugar Ray" it's priced at $1.29. After the new prices were introduced,  sales of the $1.29 version dropped 41% while revenue from the 99 cent track increased 102%, with the rise in the latter partially offsetting the loss in the former. Overall, however, sales for the two tracks fell by almost 17% spelling a net revenue loss of about 6%.

One record source described the challenge associated with the new variable pricing as a "mix of art and science""”decisions are made partly by looking at tables of data and partly by going with a gut instinct.

A number of labels have started bringing in outside analysts to advise them in the price-setting process.  Still, even with the savviest industry minds working together, many say that deciding on prices is largely a hit-and-miss process.

"For the first year or so the labels are looking at this to see how the market reacts," said analyst Mike McGuire. "It's real-time research, in effect. They need as much data as they can to try to understand where they go from here. I don't know that they have enough data to say whether this has worked or not at this point."

Gift card sales are another factor that analysts are still working to factor into their calculations.  Estimates show that roughly 40% of iTunes sales come from gift cards with fixed values.  If a teenager shopping on iTunes has a $50 gift card, he's only going to spend $50, which, from the perspective of the record labels is all that matters.  Whether he gets 50 tracks or 38 for his money is irrelevant to the label from a financial perspective.

While most of the analysts' focus thus far has been on the $1.29 tracks, they also have to consider sales of the lower-margin 69 cent songs.  Overall, labels have lowered the prices of far more songs than the ones they've raised.  It's yet to be seen, however, just how effective the lower prices will be in convincing consumers to purchase more.  Most of the lowered prices have been for slow-selling older tracks and it's still unclear whether the price drop will trigger a compensatory spike in sales. 

The 1971 Jackson 5 song "Maybe Tomorrow" is one of the tracks that was dropped from 99 cents to 69 cents.  Sales of the track remain at between 60 and 90 copies a week, essentially unchanged compared with sales before the price drop.

The most dynamic changes in sales so far have come when labels combine lower prices with promotional events.  Universal Music Group Nashville dropped the price of six popular George Strait songs to 69 cents during the same week CBS broadcast a live concert of the country music icon.  Weekly sales soared to 283% over the previous six-week average. Lower-priced tracks skyrocketed by 334% while the tracks that stayed at 99 cents rose by 276%.

"You need to set a price point where you're getting people to pay more for more music, as opposed to trying to extract an increasingly higher per-unit price," explained McGuire.

Package deals are another marketing option made possible by lower-priced songs and digital music.  Hot new songs selling for $1.29 can be bundled with less-known artists with 69 cent songs, getting consumers to spend more and feel like they're getting a deal.

"The benefit of digital is that it gives you infinite ways of packaging content," says Greenfield.  "The more the labels think about bundling in, the better."

As digital music sales have begun stagnating in the last couple years, bundling will likely be an integral part of the strategy for getting consumers to buy more music.  Between 2005 and 2008, growth rates for digital music sales dropped from 147% to 27%, according to SoundScan data and iTunes reports that only about 25% of its customers are new users.

Since 1999, sales of physical CD's have fallen by more than 50%.  While two out of three people who still pay for music buy only CD's they are buying fewer and fewer of them, according to the NDP Group.  Problematically, customers patronizing iTunes and other digital music markets tend to buy on a per song basis, leaving more profitable album sales in a downward spiral.

"We're not going to have $14 billion in iTunes and Amazon sales no matter what we do," explained Russ Crupnick, Vice President and senior analyst at NPD Group.

"There's still tens of millions of people who haven't tried the digital music model. Half of them have digital music players. ["¦] We're not making the case for them to buy as many CDs as they used to and not making the case for them to buy anything from digital. Variable pricing is irrelevant."

And this is the point where labels will find themselves having to dabble in other business models. 

Nokia's "Comes With Music" model, for example, has experimented with bundling the music in with other services and products.  Unlike traditional models, it does not hinge on generating maximum revenue-per-unit, but rather on "pricing the consumer versus pricing the content," as one industry expert explained it.

"We think the real story around price as it relates to the audience for digital music is with respect to the new business models that are user-based as opposed to wholesale price-based," explained one executive who preferred not to be named.

Such models in the music industry are still in their nascent phases of development, however, and variable pricing remains the most relevant strategy for the time being.

"With the business continuing to be so hit-driven, having the flexibility to price inventory online the way you do in the traditional world makes a lot of sense," said Greenfield.

"Maximizing the profitability of digital through variable pricing is critical."


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