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.

6 thoughts on “Economics of eMusic and Sony

  1. Amanda (NankerPhledge on eMu)

    Is there any commentary anywhere on the ins and outs of geographical distribution of music? eMusic has decided to exclude anyone from outside US, Europe, Canada entirely which is what most other digital stores already do.

    The fact they haven’t for so long, they are going to grandfather existing users in and only say they will start this new policy “in the near future” leads me to believe it is not a legal issue per se. It is a policy decision, presumably driven by the Sony deal, and other such deals they wish to make in the future.

    Just wondering if there was an analysis anywhere of how that system works. I need to know where to vent my venom!

  2. hecker

    Actually, I don’t think this is eMusic’s fault. In the past eMusic has done stuff for non-US subscribers that is in a legal gray area. For example, if I recall correctly, once upon a time eMusic let people subscribe from Europe but didn’t charge the European Value Added Tax (VAT) or pay royalties to the European rights agencies (instead of the US agencies). They cleaned all that up when eMusic UK and eMusic Europe were created.

    However similar situations occur in other countries (for example, many countries have their own specific rules and agencies for collecting music royalties, and label contracts are often very country specific), and so I suspect eMusic is just trying not to skirt the boundaries of what is legal according to all the existing agreements.

  3. Amanda

    If it is legally grey why would I be allowed to be grandfathered and why wouldn’t they stop it straight away instead of “in the near future”? If you’re a company doing some potentially illegal and you are made aware of that, you don’t say oh well we’ll knowingly act illegally for a little longer and let those who’ve been acting iilegally so far to continue to do so. So I think it’s a policy decision in deference to major labels, not a legal matter.

    I can go to Amazon.com and perfectly legally buy any CD I want and have if shipped here. But I can’t buy the same record in MP3 form. How does that make sense?

    Sorry to be a bit OT Frank but seems to me this is part of the industry dysfunction eMu was something of a corrective to.

  4. hecker

    We could both be right here: it’s a legal gray area *and* eMusic is acting in deference to the major labels, because the major labels likely care more about the issue than indies do. (Or to be more precise, a major label cares more about it than any particular indie label does, because it has much more revenue at stake.)

    A good question on the CD vs. MP3 issue. Can you buy MP3s from Amazon in the same way you buy CDs? I have no idea if geographical distribution arrangements differ for digital downloads vs. physical formats.

  5. Amanda

    No, the Amazon MP3 store is unavailable outside the US. Believe me I’ve tried 🙂 most digital stores and streaming services are not available here.

    I know these are complex issues and I don’t want to rant without the facts. But emu customer service sure ain’t gonna give me a straight answer so I have get it elsewhere.

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