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When Econ Nerds Write For Music Nerds…

May 4th, 2012 · 2 Comments
Behavioral Econ · Music Biz

I’ve given talks about consumer behavior and the music industry before, and I recently got the opportunity to write my first official article on the subject.  I figure if I’m going to be writing about the music industry, the Berklee Music Business Journal is a good place to start, right?  You can see the article here, and it explains the behavioral considerations that musicians face when trying to price their products:

In 2010, musician Sufjan Stevens sent a letter to his fans via his record label, Asthmatic Kitty. There, he outlined his concern regarding the possibility that Amazon might sell the digital version of his album, The Age of Adz, at a low price point–as it had done with several other bands such as Arcade Fire, who benefited immensely in terms of promotion and chart placement. Stevens was especially concerned about the effect that a low price would have on consumers’ perceptions of the value of recorded music. For him, an album was “worth more than the cost of a latte” and should have been priced so. At the time, Amazon’s general policy had been to pay the artists and label the full wholesale price of the album and then, as a marketing tactic, sell the product at a loss.

It’s tempting to dismiss Stevens’ comments as simply being the manifestation of an artist being himself. From an economic and psychological standpoint, however, his view may have academic merit. To evaluate Stevens’ reasoning, in fact, the landscape of pricing research has to be considered as it applies both to recorded music and the music industry in general.

In going through the article, I noticed that a number of editorial changes were made (which I may or may not approve of), so I am posting the original version in its entirety below.

LPs and Lattes: The Challenge of Pricing Recorded Music

Pricing strategy is a critical issue for virtually any industry, from automobiles to music, and economists and psychologists have plenty to say about pricing that extends far past what one may have learned in Economics 101. Unfortunately, the evidence doesn’t lead to a clear prediction for recording artists, but understanding the tradeoffs involved in setting a low price versus a high price is crucial to developing a profitable and sustainable business model.

As both an economist and avid music consumer, the motivation for much of my thinking on the subject of pricing comes from a letter that musician Sufjan Stevens sent to his fans via his record label, Asthmatic Kitty, in 2010. In this letter, Stevens outlined his concern regarding the possibility that Amazon might sell the digital version of his new album, The Age of Adz, at a low price point, as it had done with several other bands such as Arcade Fire (who benefited immensely in terms of chart placement due to the promotion). Interestingly, Stevens’ concern was in no way a monetary one, since Amazon’s general policy had been to pay the artists and labels the full wholesale price of the albums and then sell the product at a loss as a marketing tactic. Instead, Stevens was concerned about the effect that the low prices have on consumers’ perceptions of the value of recorded music, even going so far as to lament that an album is “worth more than the cost of a latte” and should be priced as such.

It’s tempting to dismiss Stevens’ comments as simply being the manifestation of an artist being an artist, but, from an economic and psychological standpoint, these sorts of statements regarding pricing may actually have objective merit. In order to evaluate Stevens’ reasoning, let’s look at the landscape of relevant pricing research and consider how the principles apply to recorded music and to the music industry in general.

The Law of Demand and the Mere-Exposure Effect

There are a number of potential reasons to set a low price for a product. The first is basic economics- a lower price means that more people are willing and able to buy the product. Depending on how responsive consumers are to changes in price (how elastic demand is, in economic terms), it may be more directly profitable to charge a low price than to charge a high price, especially for digital products that have incremental production costs of virtually zero. For example, it’s more profitable to sell 10,000 digital downloads for $1 each than it is to sell 3,000 digital downloads for $2 each, since each additional download doesn’t cost anything to produce.

In addition, the benefits of increased sales volume potentially extend past direct profit in and of itself. Psychologically, the mere-exposure effect suggests that people simply tend to view things that are familiar more positively than things that are unfamiliar. (Have you ever wondered why you almost involuntarily start to like that song that you are bombarded with over and over on the radio? This is why.) Therefore, musicians benefit indirectly when people buy and listen to their music because, to some degree, those consumers are increasing the familiarity of the music not only for themselves but also for others around them who hear it as well. This familiarity could result in sales of additional products (such as concert tickets) to existing consumers as well as sales to new customers.

The Power of a Zero Price

In addition to the potential benefits from setting a low price, there is a specific psychological appeal of a price of zero. The attractiveness of a zero price (or FREE!, as economist Dan Ariely puts it) goes above and beyond objective economic considerations, and free products appear to have an irrationally strong draw on consumers. For example, Kristina Shampanier, Nina Mazar, and Dan Ariely were able to dramatically shift consumer preferences from a more expensive option to a cheaper option simply by reducing the price of the cheaper option from one cent to zero cents. (This effect occurred even when the price of the more expensive option was lowered by one cent as well.) By this logic, if a musician is looking to use musical recordings as a way to gain exposure and to sell other products (and steal market share from other musicians), it may not make sense to set a high price or even a small nominal price, and it may instead be an overall profitable strategy to exploit consumers’ irrational desire for free stuff.

So far, it would appear that there are significant potential benefits to setting a low price or even a zero price for recorded music. Not surprisingly, however, the issue isn’t that simple, and there are a number of potential long-term drawbacks to low prices.

Price and Subsequent Usage

A low price will probably get more customers to purchase a product, but a low price may also cause people to not use the product as much. Psychologists Hal Arkes and Catherine Blumer, for example, provide experimental evidence for this “sunk-cost effect” by randomizing the price that consumers pay for a season series of theater tickets. What they find is that, despite the fact that the discounts were given after the purchase decisions were made (thus ruling out the possibility that the consumers who paid higher prices simply valued the tickets more), those consumers who paid a higher price for the tickets had a significantly higher rate of attendance over the course of the season. (This phenomenon can roughly be thought of as people being determined to “get their money’s worth,” even when it’s not rational from an economic standpoint.) Given that a musician’s goal is to get consumers to actually listen to and become familiar with his music (and thus be more likely to purchase additional products, suggest the music to others, etc.), setting a low price may actually be counterproductive to a degree if the low price lowers the amount that the consumer interacts with the product.

Price and Efficacy

While economists generally presume that the perceived quality of an item affects the price charged (and paid) for it rather than the other way around, there is evidence that prices can actually affect both the perceived quality and the actual effectiveness of a product as well. For example, economists Baba Shiv, Ziv Carmon, and Dan Ariely conducted a series of experiments to determine the effect of pricing on the perceived and actual efficacy of a popular brand of energy drink. What they found was that the sticker price of the beverage affected not only how well people expected the drink to work, but also how well the drink actually worked to improve cognitive performance. Interestingly, this effect persisted even though subjects in the low-price group were informed of the actual retail price of the drink and told that they simply got the drink at a discount.

If this monetary placebo effect carries over into the music space, it could very well be the case that musicians are hurting their album sales via low prices, since a musician could be inadvertently lowering the perceived quality (and hence sales) of his music simply by offering it to the consumer cheaply. This effect is particularly important to consider if a musician’s goal in selling recorded music is not only to make money from the music itself but also to build a reputation for other products such as concerts, licensing, and merchandise.

Anchoring

Psychological anchoring may play a significant role in consumers’ willingness to pay for music, particularly digital music. An anchor, in this context, is simply an (often arbitrary) initial value that imprints on a consumer and biases her future valuations of an item. Experimentally, the anchoring effect has been shown to be both strong and ubiquitous. For example, Daniel Kahneman and Amos Tversky were able to influence people’s perceptions of how many African countries are members of the United Nations by first spinning a wheel of numbers and asking whether the number of countries is greater than or less than the (obviously random) number on the wheel. Similarly, Dan Ariely, George Loewenstein, and Drazen Prelec were able to manipulate consumers’ willingness to pay for a variety of goods by first eliciting the last two digits of their social security numbers and then asking if their valuations of the goods are higher or lower than that anchor. In both cases, subjects ultimately gave higher estimates and valuations when they had first been asked about a high number than when they had been asked about a low number, even though the original number was completely irrelevant to the objective decision-making process.

By this logic, it should be possible to affect consumers’ valuation of music by asking consumers for the last two digits of their social security numbers and then soliciting whether they would be willing to pay that many cents for a musical track. While this strategy may not be directly relevant in a sales context, it’s worth nothing that an entire generation of music consumers has essentially been given an anchor price of zero by various file-sharing services and independent artists. It’s no wonder, then, that these consumers exhibit a lower subsequent willingness to pay for recorded music, and, while a musician can’t directly control the choices of other companies and artists, he can (and should) think carefully about whether setting a specific anchor price of zero for his own music is the right decision for long-term profitability.

Is Sufjan Right?

While there are certainly both benefits and costs to setting a low price for recorded music, the points above suggest that Sufjan Stevens’ concerns about price and the perception of value are not entirely off the mark. Based on the available evidence, it’s entirely possible (and likely) that setting what is considered a low price point for an album decreases listening and engagement, lowers the perceived quality of the work, and conditions consumers to not pay what artists would consider a “fair” price for their output. One important thing to keep in mind, however, is that these effects are, to some degree, limited to those people who would have purchased the product at a higher price, so the negative impacts of pricing need to be weighed against the opportunity to offer the product at an attractive price to a larger group of customers.

In summary, pricing is hard. What may seem like a simple choice actually has not only significant direct economic effects but also considerable impact in multiple directions from a consumer psychology perspective. That said, understanding all of the different forces at play in consumers’ minds is an important step in developing a coherent and appropriate business strategy.

References:

Kristina Shampanier, Nina Mazar, and Dan Ariely, “Zero as a Special Price: The True Value of Free Products,” Marketing Science, 2007.

Hal R. Arkes and Catherine Blumer, “The Psychology of Sunk Cost,” Organizational Behavior and Human Decision Processes, 1985.

Baba Shiv, Ziv Carmon, and Dan Ariely, “Placebo Effects of Marketing Actions: Consumers May Get What They Pay For,” Journal of Marketing Research, 2005.

Dan Ariely, George Loewenstein, and Drazen Prelec, “’Coherent Arbitrariness:’ Stable Demand Curves Without Stable Preferences,” The Quarterly Journal of Economics, 2003.

At least now I know that my multitasking served a useful purpose:

Tags: Behavioral Econ · Music Biz

2 responses so far ↓

  • 1 Michael Ryan // May 4, 2012 at 11:04 pm

    A friend of mine, Eugene Ahn, quit his day job (lawyer) to be come the rapper Adam Warrock. He gave away free music on his site  www.AdamWarrock.com) for a year before releasing his first album “The War For Infinity” (A concept album based on the Marvel Comics Infinity Gauntlet comics – yes, it’s both great and incredibly nerdy.)

    He gave away his first song on October 1st, 2009 and released the album for sale on October 1st, 2010.

    The album was one of Bandcamp’s bestsellers for weeks after it came out which seemed to prove out Euge’s business model.

    On the other hand, all of the music that he was giving away were songs where he rapped over beats from other people’s songs.

    As an example on his first really great free song “PBR” http://www.adamwarrock.com/?p=241 he used Necro “The Dispensation of Life and Death”

    And much to my amusement he rapped over Myley Cyrus’ Party in the USA. http://www.adamwarrock.com/?p=363

    But the music that he sells uses original beats created for him.

    *****

    I mention all of this not just to plug the music by my friend (well that too) but to point out that it seems like Euge has somehow found a way to use the free price point to create demand for the music that he sells, in part by creating a distinction between the “free” music and the music that people pay for.

  • 2 Punditus Maximus // May 8, 2012 at 10:01 am

    The stupid part of all of this is holding the back catalog hostage. Why does it make any sense to charge anything but a nominal fee for 30 year old music? Often, the artists themselves are, you know, dead.

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