Economics of eMusic and Sony

Most of the press coverage of the eMusic/Sony agreement has been either regurgitated press releases and echoes of the original New York Times story, or stories about the backlash from eMusic subscribers. I have a standing Google search for eMusic and see tons of this stuff. However there is actual smart analysis being done out there, and here are two examples. As seems to be typical nowadays, these are not from traditional media or business journalists but from a blogger turned pro and a musician who blogs.

The first is from Billboard columnist and Coolfer founder Glenn Peoples, who welcomes the fact that Sony is now pricing for profits, not margin. In other words, rather than trying to maximize its margin or profit per sale (i.e., by selling only at relatively high prices), Sony is now looking more seriously at maximizing its profit overall: The goal is not to maximize per-unit margin but to reach more consumers and gain incremental revenue and profits.

How will Sony do this? By practicing price discrimination to identify and sell to more price-sensitive buyers:

A person who doesn't want to pay more at iTunes may be willing to shop elsewhere to save money. How does Sony find this group? It licenses its music to a store known for offering downloads at relatively low costs to high-volume buyers. ... Per-unit revenue may be lower but total revenue and profits should increase.

If Sony can profitably sell through eMusic (and presumably the new $0.40 per track floor price is designed to allow them to do that), and if selling through eMusic doesn’t cannibalize sales through higher-priced outlets (which the 2-year delay in releasing to eMusic is designed to address) then any incremental sales through eMusic are pure gravy as far as Sony is concerned. Those sales are money that Sony would not otherwise have seen—either the buyers would have downloaded unauthorized copies via P2P or they wouldn’t have bothered to get the releases at all.

(I’ll once again plug the book Information Rules, which addresses the problem of pricing information goods like digital music in a quite readable and accessible manner. You can get a flavor of the book by reading the paper Pricing Information Goods by Hal Varian, one of its co-authors—who not so coincidentally is now Google’s chief economist.)

The second example is from David Harrell of The Layaways and Digital Audio Insider, who contends that even with higher prices eMusic’s per-track payout may not change:

... it seems likely that the presence of more name brand artists and albums in eMusic will result in less digital breakage by subscribers. So while subscribers will have fewer downloads available, they'll be more likely to use all of them, which may be enough to offset the effect of the price increase on the final per-track payout to labels. Without significant digital breakage, the per-download payout is bound to be less than 30 cents a track, even under the new pricing model. No doubt some breakage will continue to occur, but it seems likely that the current breakage rate will decrease significantly. Hence, it seems likely that the new subscription plans are more likely to preserve the recent payout amounts I've seen, as opposed to substantially increasing them.

(Digital breakage is the term—apparently coined by Harrell himself—for the money eMusic and labels realize from eMusic subscribers not using all the downloads that they paid for, analogous to the similar phenomenon with gift cards. The music industry term breakage dates back to the days of fragile 78 RPM records, when labels would pay royalties on only, e.g., 90% of records manufactured and shipped, on the assumption that the other 10% were broken in transit and thus never reached consumers. The practice evolved into a standard up-front cut of sales that labels took for themselves on all music sold, no matter the format, and used to reduce royalties paid to artists.)

The final outcome of all this is going to depend on the following factors, among others:

• the growth in the number of eMusic subscribers due to adding major label content;

• the changes in per-track payouts due to changes in subscriber behavior (both by new subscribers and existing subscribers); and

• the changes in the relative fractions of downloads going to indie labels due to competition with major label releases.

If the per-track payout changes are a wash then from an indie label perspective this deal is a net plus only if eMusic significantly increases its subscriber base and indie labels are able to capture a reasonable portion of downloads from the new subscribers. This is obviously a bet the company strategy for eMusic, and it will be interesting to see how it plays out. Digital Audio Insider has the most in-depth analysis of eMusic payouts around, and will be a key place to find clues as to whether eMusic’s bet is paying off for indie labels and musicians.