Tuesday, October 16, 2007

Blogging By Request (Radiohead and Music Downloading Edition)

by Tom Bozzo

A friend wrote a couple days ago to suggest I chime in on the much-blogged new album, In Rainbows, from Radiohead. The band's experiment (as they put it) is effectively sacking the middlemen of the recording business, not only the major labels but also Apple and the other online music distributors. In addition to releasing the album themselves, they're offering it mainly as a download of DRM-free MP3 audio files at whatever price (of at least 1p) the purchaser chooses to pay.

Before claims of average selling prices began to leak out, some silly things were said regarding the exercise. Following word from a source that the band had sold 1.2 million downloads, gigwise.com did some math and worked out:
Even if every person who downloaded the album paid just 10 pence, the band will still rake in a massive £120,000.
Massive, eh? That's about four times the average annual household income for the UK, and the previous Radiohead studio album was released in 2003. Likewise, ABC News' Silicon Insider column suggested:
[E]ven assuming the worst-case scenario, that all of those millions of Radiohead fans decide to take In Rainbows for free, it's still hard to imagine how the band loses. After all, it produced the album without a contract, using its own studio outside Oxford, so it hasn't had to pay exorbitant recording fees.
There may be some debate as to whether economists understand opportunity costs, but ABC's columnist certainly doesn't. If the band had 120 grand, let alone nothing, to show for the experiment, there would be champagne corks popping at Parlophone Records [*] in anticipation of re-signing the band on favorable terms.

My correspondent describes a surprising number of music business insiders, who should know better, incorrectly regarding the download revenue as pure profit for the band. To borrow some regulatory terminology, part of it is a "contribution" to cover the costs of producing the album, arranging for industrial-strength web hosting [**], etc. Recording studios don't build themselves, and had Radiohead not occupied theirs for the production of In Rainbows, it could have been collecting recording fees ("exorbitant" or otherwise) from someone else. [***]

Radiohead also reserve the right to charge a 45p transaction fee, which is apparently imposed on lower-priced transactions. Compare Radio 6 DJ Tom Robinson, whose breakdown of the recipients of a 79p iTMS download's revenue, quoted by Macworld UK, suggests Apple and the credit card processors receive roughly 19p. Assuming the charge imposed by the band reflects the actual transaction cost, they've given up roughly £300,000 to inefficient transaction processing.

Now, the band seems to have done a lot better than that, with reports suggesting an average selling price as much as £4. I think I speak on behalf of the quantitative socioeconoblogiverse in saying that actual data on the price distribution would be really interesting. That's not bad, but iTunes terms — which reportedly hand 70% of the sales price to the label, a cut which would go to the band for an independent release — could have given the band £5.59 out of a £7.99 iTMS UK download (or $7 or €7 for US and Eurozone sales, respectively).

Tom Robinson (op. cit.) says "sod that" to the labels getting such a large cut of the legal-download proceeds. While an array of jokes implying record-company inefficiencies may be cued at will [****], it can be forgotten that record labels do useful things for musicians like advancing them money that's to be paid back from music sales proceeds. The terms of the deals may or may not be great, from the performer's perspective. But consider as an exercise what terms you'd require before lending the kids down the street who are Serious About Their Band (say) $50,000 to advance their career.

Reportedly part of Radiohead's desire to avoid iTunes is not so much money issues as control over the sales model; they don't want people diminishing their album-oriented art by picking up tracks a la carte from iTMS or other services. In traditional music retailing, insisting people buy the CD album for a single track would (and does) drive people to free-as-in-beer alternatives. The name-your-price model can address this problem, since someone who would otherwise be willing to buy a 79p/99cent track can get the track (along with the rest of the album) for that price. The customer might even be willing to state a positive cash value for the rest of the album.

Whether a £4 average is sustainable for further sales is a good question (see again, sales data would be really interesting [*****]). I'd expect that super-fans willing to pay at least a standard download charge for In Rainbows are overrepresented relative to the idly curious and passers-by who will take a legal bargain over an extra-legal download among the early adopters. After the initial wave of people willing to pre-order the download given the band's terms, it's hard to see where they'd find a reservoir of high-net-revenue customers. [******]

In the end, I can see things moving to a world in which recorded music is given away to serve as a gateway drug for things like attendance at live appearances which will retain scarcity as data bandwidth and storage costs continue to vanish. Former Creation Records boss Alan McGee says that much with regards to the Charlatans' name-your-price exercise (again from Macworld):
[The Charlatans] will get paid by more people coming to gigs, buying merchandise, publishing and synch fees. I believe it’s the future business model.
Quite probably so. But there is still money in music sales.

[*] Their ex-label.

[**] The band has taken some guff over a site outage caused by inadequate traffic planning.

[***] Lots of people have trouble with the concept of "owners' equivalent rent," see (e.g.) here. Correct imputation of the value of non-market services is important for preventing economics statistics like GDP from mischaracterizing substitution of market for non-market services as representing economic growth.

[****] Such as the one about the mathematician's dog, the engineer's dog, and the record company A&R guy's dog, which is not suitable for a family blog.

[*****] I'd also suggest, in the spirit of undermining elites who don't need special help, that if Radiohead were willing to share data with Steve Levitt, they should publish it for the use of any interested researcher.

[******] On the gross revenue front, some might be willing to pay for a physical CD, though not the £40 super-deluxe box set; that's a higher transaction cost format.

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Excellent post. And I'm glad you've focused on the credit card processing. I work for a merchant group in DC (see us at UnfairCreditCardFees.com) on the issue of the interchange fee. It drives merchants nuts, because the rules on interchange are so complicated it can be next to impossible to offer a cash discount or credit surcharge.

However, Radiohead isn't charging that fee, but they are passing it along. Because they're offering just 2 products (download and Discbox) it's much easier to break out those costs.

The fee is also ridiculously high. It's a major profit center for the banks, and also pays out reward costs. The idea that it covers transaction costs was once true, but now it's a fib to keep the system going. Interchange fees always go up, never down, even though communications costs keep decreasing. It's pretty shady.

One other point -- in fact you can get the album for 0.0 pounds, and in that case they do not ask for your card -- they simply provide the download code immediately. That's pretty cool.

I tested it out, but not until after I paid five quid on the day it came out. I thought it was worth paying for. Based on what I've read, sounds like they made several million pounds last week. Parlophone can put the champagne away, methinks.
Thanks for the comment. My friend had described getting the d/l for $0.00, which I'd misunderstood as 1p + transaction charge. I assume that's a deliberate feature?

The fees are a good example of oligopoly being bad for consumers, directly or via merchant behavior. I worked at a small record store when its first charge terminal was installed -- to obtain a price cut of a percentage point or so -- and am amazed that typical fee rates are higher now. At some point, I should read up on how those have been kept hidden, vs. ATM fee disclosure requirements.

I tried to make the reference to Radiohead's contract negotiations subjunctive -- I think they've done pretty well overall, esp. with zero price being an option. I do wonder if and/or how they'll release a CD.
As a lot of people have said, this business model will probably only work for a few, extremely popular bands (e.g., Radiohead, U2). Most bands aren't so well-off as to own their own recording studios or to have enough clout that the press does all of their marketing for them. In fact, that's one thing that most observers are discounting. One reason that labels are good for (some) bands is that they do all of their promoting and marketing. Radiohead had extremely low marketing costs because of the novelty of this stunt.

And that raises the question, how many times can a band do this before it loses its novelty and marketing power? Radiohead probably has some baseline profit that they'd make, regardless of the number of albums sold in this manner. But my guess is that their profit margin would decrease significantly from the 2nd to 3rd to 4th albums sold through their website. And the more that other bands jump in the game and try the same distribution mechanism, the more structured the informal norms regarding pricing will become. If every band sold their albums this way, some fans who may have paid several pounds for this album will figure out that it doesn't feel drastically different to pay the "standard" one pound for the album. Eventually, prices will converge on some average selling price.
As I said at Marginal Revolution, finding out that it's a 156Kbps download rather limits my willingness to pay.

iTunes does, fyi, allow sales of only the entire album.

And, finally—OUCH. I know he's straight now and all that, but referring to Tom Robinson as a "Radio 6 DJ" is a painful reminder of how young y'all are.

Yeah, Visa/MC are in need of competiton, all right. I've got high hopes for Revolution Money, led primarily by former AOL execs but also including a former MC exec. Who would know best how to undercut the credit card companies but someone from a credit card company?

It's an uphill battle, but I can say merchants will be eager to use it because it lowers the interchange fee substantially -- to about .5%. Now, I am not an economist, but it seems to me it's harder to get merchants to accept a type of card than to get cardholders signed up. So I'm optimistic.

(And yes, I caught the subjunctive. But I love the mental image of record execs having to put the bottles back, unopened.)
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