By Daniel Costello
Yes, elementary economics shows that market prices are set when supply equals demand. But businesses know there is gold in getting individual customers to pay higher than average prices for things they cherish more than others. Think about airlines: few people on the same flight pay the same fare. Airline profits rely on the fact.
New research by two economics professors at the University of Pennsylvania found that Apple's oft-praised 99 cent per song business model may not be optimizing the tech giant's profits.
The professors started by asking 500 Wharton students to listen to the 50 most popular songs on iTunes that month and then asking what each student was willing to pay for a song - essentially building a demand curve for online music from scratch.
According to an article on the research in the Economist:
The exercises showed that even a uniform price per song that maximized revenue among the students was quite high--$2.30 in 2008 and $1.46 in 2009. Wharton students may be particularly fond of music, but it is also possible that the market would sustain a higher uniform price than 99 cents. More important, knowing the uniform price that maximized revenue also allowed the authors to evaluate other ways to price online music.
One alternative is song-specific pricing, much favoured by record companies. (Apple has already moved a bit in this direction with its multi-tier system.) But the research suggested that this would increase profits by a mere 3%. Part of the problem was that people who valued one song highly also tended to place a high value on others. This implies that person-specific, rather than song-specific, pricing would be more efficient. But sellers' data are not refined enough to set different prices for different people. People may resent such pricing anyway, so it could harm sellers' brands. Crude profiling--by race or sex, say--would be illegal. In any case, the authors found that basic demographic information did not tell them much about musical tastes.
Charging an "entry fee" for use of the service and then a small, fixed per-song cost for downloads turned out to benefit both the seller and the buyer. The most revenue, according to the 2009 survey data, would be generated by charging the students $21.19 for entry and 37 cents a song. This could raise the producer surplus by 30% compared with uniform pricing. Consumer surplus would also rise in this instance, because some people would buy songs they would have not have done at a higher uniform price. Spotify, a rival to iTunes, has a model somewhat like this for its premium service, where it charges a monthly fee for songs without limit.
categories: Fun With Economics