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Innovations in Pricing in Digital Distribution

Digital Distribution of Music


Brief History of Music Pricing
The music industry is composed of basically 3 structures that shape the dynamics of
this industry. Composers and songwriters create songs, lyrics and perform live on
stage. This is recorded and distributed to customers or licensed for some other use.
This structure has divided the music industry in 3 parts: the recorded music industry
focused on recording and distribution of music to consumers; the music licensing
industryprimarily licensing compositions and arrangements to businesses; and
live musicfocused on producing and promoting live entertainment, such as
concerts, tours, etc.
Music Artists earlier required the support of a record label to produce, promote and
distribute music. However the pricing mechanism was more based on historical
prices rather than competition. Artists signed exclusive contracts with record labels,
which enabled the record labels to charge retail price levels consistent with how
much a customer is willing to pay rather than the quality of the music, resulting in
consistent pricing strategies.
In the 1960s, the distribution of music in the form of albums gained ground. Record
labels created music bundles that increased its fan-following. This gave the record
labels an opportunity to raise prices for additional content. However, the pricing
mechanism for full-length albums stayed relatively consistent across albums and
artists regardless of its quality or popularity. A highly popular music album had the
same cost structure as an unpopular one. Many releases were not able to recover
their upfront production costs. Consistent pricing strategies made matters worse.
Record labels had to rely on the success of a few albums to make up the losses
incurred by a majority of unpopular releases.
The Growth of Digital Music
The music industry has experienced significant changes in the past decade with the
growth of internet and digital distribution. It all started with the launch of a file
sharing service called Napster by Shawn Fanning that allowed users to download
and share music without compensating the recognized rights holder. However, it
was eventually forced to shut down by music industry. This service ushered in a new
era of music digitization.
The first company that was able to create a successful online service for legal sales
and distribution of music was Apple, through its service iTunes Music store. Apple
was able to convince the major labels that music consumers would buy music
legally if they were offered an extremely simple service that allowed them to buy
and download music for less than a dollar per track. The retail sales of recorded
music in United States dropped from US$13 billion in 1999 to US$10.6 billion in
2003[1]. During the same time, Apple iTunes customers expanded from 861,000 in
July 2003 to 4.9 million in March 2004 [2], signaling the popularity of digital music.

The music industrys digital revenue grew by 4.3% in 2013 to US$5.9 billion.
Globally, digital now accounts for 39 percent of total industry global revenues and in
three of the worlds top 10 markets.

Current Digital Music Pricing


Shapiro and Varian [7] describe three strategies for pricing information goods:
versioning, bundling, and fixed-fee pricing. Digital music track bundles can be
purchased for a fixed price. It comprises of a full album or some compilation of
tracks compiled by the service provider. Altinkemer and Bandyopadhyay [6]
demonstrate the application of flexible bundling strategies for digitized music based
on an economic model. Different prices for different versions of digital music have
also started to surface. For example, BuyMusic from Buy.com provides 256 kbps
songs for a premium price. Also, many online digital music retailers offer fullcontent or partial-content try-before-buying versions with lower audio quality.
Previously, Naxos (www.naxos.com), a leading discount classical music label,
provided full download capabilities for individuals, although recently they have
altered their strategy to only permit potential customers to download 25% of the
total content. Music versioning is also being considered in the physical CD market.
BMG Germany began testing a new pricing model by offering three-tier versioned
CDs: a 9.99 low-quality version with no cover art; a 12.99 medium-quality
standard version; and a 17.99 high-quality version with bonus tracks and online
extras (www.bertlesmann.com)
Moorthy and Png [3] suggest that offering multiple versions of a physical good
allows retailers to reach a market segment that may not already be served, yielding
higher profits. Riggins [4] extends their model to an information good setting with
tiered Web sites. However, the same characteristics of information-based goods that
allow for easy versioning also allow unscrupulous users to violate copyrights by
engaging in piracy activities. Wu et al. [5] have argued that it is even possible to
fight the piracy of information goods with versioning. Still, versioning may become
an effective tool in digital music pricing and marketing because it promotes selfselection.
There are two basic pricing strategies for digital music: song based purchase pricing
and subscription services. iTunes was a pioneer in song based pricing mechanism by
offering a simple service to buy and download music for less than a dollar. In 2013,
iTunes Music Store was the worlds largest music retailer (offline and online) and it
had sold more than 25 billion songs since its launch in 2003. Apart from the digital
download service provided by iTunes, more radical legal music services also came
into picture. These services did not offer individual tracks at a set price, but offer
the user access to a large music library which they may listen at their leisure. The
users normally pay a monthly subscription fee that allows them to listen to as many
songs in the library as they want, how often as they want.

However, these access-based music services have struggled to convince record


labels to license their catalog to their services as well as convince users to enjoy
music without actually buying and owning a copy of the track or album. The
challenges are certainly considerable but the music service that so far has received
the most attention of the international music industry and the one that could
possibly have found the right path is a service called Spotify. It has been able to
transform the mindsets of both users and rights holders and will most likely be a
music technological milestone on the magnitude of the Walkman, the Compact Disc,
and Apple iTunes.
Spotify model was an ad-supported music service that would be free for music
listeners but the ads would generate revenues for licenses to copyright holders.
Over the years Spotify has moved from being a service solely funded by
advertisements to a more advanced version, which is funded by subscription fees
also.
Spotifys model with two or more different service versions where the most basic
version is free and the more advanced versions are offered on a subscription basis
is usually called freemiuma play on the words free and premium. Often, the profit
margin for the free version is very low, or even negative, and it is expected that it is
the subscription fees that will generate enough revenues to make the service
profitable. The logic behind a freemium service model is that users shall be willing
to use the service for free and that they while using the service gradually will make
behavioral and emotional investments in the service that will increase the costs and
efforts to switch to another service. The goal is to make as many of the users of the
free version to convert to the subscription version. In order to achieve that goal, the
free version has to have a number of increasingly annoying features (such as
advertising) or lack a few key features (such as the ability to use the service on
certain devices) that are removed/ available on the premium versions of the service.
In Spotifys case it has achieved a conversion rate of approximately 20 percent,
which means that 20 percent of the total user base is using the premium version
and pay a monthly subscription fee. Spotify has reported that 70 percent of their
revenues from ads and subscriptions has been paid in royalties to rights holders. At
the end of 2013, the company has generated more than a billion dollars for rights
holders around the world, which according to Spotify is proof that their model does
work.
Online Music and Videos
Another recent phenomenon in music digital distribution has been the advent of
internet radio and online streaming platforms. The surge in smartphone markets has
given a boost to this segment as well. Applications such as Pandora, Google music,
YouTube etc. operate in this segment. These services play videos and music online
based on the user selection. The pricing mechanisms involve a free subscription
supported by advertisements and a fee based subscription without ads. YouTube for
example embeds advertisements to its free videos and these advertisements are
the major source of its revenues.

Online audio distribution has further evolved, enabling its users not just to listen
shared songs but also upload, record, promote and share originally-created sounds.
Sound cloud which has over 40 million registered users and 200 million listeners is
one its kind. These applications also work on a freemium basis, providing a limited
sharing space for free and charging premium if the sharing space has to be
increased. In this way it provides opportunity to aspirating artists and musicians to
bring their sound to the world.
Current Licensing Environment
The Digital services discussed above are required to license two separate
copyrights: the sound recording copyright and the underlying musical composition
copyright. The sound recording copyright is controlled by record labels, while
publishers and songwriters own the latter. The picture becomes even more
complicated considering the numerous independent labels, publishing companies,
individual performing artists and songwriters whose licenses add tremendous
perceived and actual value to a digital music service. Multiple owners further
complicate the process of obtaining a license due to disagreements among the
owners of a copyright.
This means that services such as iTunes or eMusic must secure individual licenses
from every sound recording they offer. Apart from the download stores, broadcast
streams must also obtain public performances from both sound recording copyright
owner and music composition copyright owner. Each of the services discussed have
to negotiate licenses with labels and publishers in order to build a catalog vast
enough to attract listeners.
Piracy Control
Tackling piracy and maintaining the shift to licensed consumption remains very
challenging in markets which have the highest potential. According to the Recording
Industry Association of America (RIAA), global piracy of music causes $12.5 billion in
economic losses every year and has contributed to a 50% decline in CD sales over
the last decade [8]. This has brought the concept of digital rights management
(DRM) technologies that make copying difficult. DRM controls how end users can
access, copy, or convert information goods, such as software, music, movies, or
books. For example, the original iTunes Fairplay DRM system restricted users from
installing music on more than five authorized computers or burning a song more
than seven times, and songs downloaded from Walmart Music can be played only on
Windows PlaysForSure licensed products [9]. Other digital goods also have some
form of DRMa movie purchased and downloaded from the iTunes store can only be
played on an authorized computer, and books purchased for the Kindle cannot be
read on any other device. All these constraints are designed to protect digital
products from unauthorized copying and distribution and thus reduce the level of
piracy.
Recent Developments

Improvements in the handling of user generated content (UGC) have been of


immense help to rights holders allowing them to grow income from YouTube and
other licensed platforms. Taking the case of Googles ContentID system (and other
systems used by other platforms), these platforms have made it easier for rights
holders to differentiate between video types, thereby allowing the streaming of nonofficial user-generated content such as mashups to be licensed and generate
revenue, rather than removed for infringing copyright. YouTubes TrueView tool for
advertising is also having a positive impact in monetizing music videos. According
to YouTube, revenues generated from UGC on its platform have now overtaken those
generated by official videos. You tube, until now had an exclusive advertising
supported service, is planning to enter subscription based pricing for its content.
Internet Radio has also incorporated effective pricing mechanisms to generate
revenues from stores. For example, iTunes radio service has the feature of a buy
button which directs listeners to iTunes store. Artists in countries with high rates of
streaming have recognized the benefits of streaming based revenue model giving
their songs a longer life. There has now been a major focus to create music based
applications on mobile further expanding the sources of revenues.

Digital Distribution in Video Games


Pricing in the Digital World
Digitization is seen as a threat to revenue and profitability by many components of
the different entertainment industries. The biggest example is the oft-quoted trade
cable dollars for internet pennies. Although the evolution of content, services, and
software to digital formats can indeed destroy a traditional businesss profitability,
often however it is poor transition management that is to blame.
According to Docters [14], some of the changes that accompany the shifting from
traditional to digital are splitting of product from services, splitting products into
sub-categories and re-bundling them, embedding new content and functionality,
improved coordination among parties to a transaction, greater customization by
segment and user, disintermediation between users, buyers, R&D, and product
management.
There are three principles that ought to be kept in mind while developing a pricing
strategy in the digital world:
1. Digitization should be seen as an evolution and not revolution and segmentation
needs to reflect this in a realistic manner.
2. The unit for charging has to change with the shifting requirements and as it fits
the market in question.
3. Where there is a multi-element (sophisticated) sale, changing the lead element
can make all the difference. A Free is more often an option in the digital world due
to lower incremental costs, and so add-ons can precede the main product.
There is very little benchmarking that can be done with reference to other industries
in digital distribution as it varies not just from one industry to the other but also

from one product to another. For a company that has not matured enough when it
comes to pricing, it might be a good approach to let the market decide, and to
separate the price and product development on existing product lines. Give both
digital and non-digital products their best shot. This approach actually requires less
effort than reorganizing all the resources to emphasize the new digital product.
The Digital Entertainment Revolution
This study conducted by CapGemini [15] discusses the revolutionary changes to the
entertainment industry that will be brought upon by the digital age in the coming
years. This is not limited to the music and gaming industry but even TV and movie
industry are forecasting massive changes. These industries are analyzed for their
compatibility with the new shifts and how the present business models would have
to be modified to still have a future. Shifts in Business Models are Inevitable to gain
advantage in this highly competitive market. There will be large scale disruption
caused by the impact of digital and the rapidly changing demands of consumers
with more control than ever before. Changes will have to be made to physical and
digital operations in order and a cost structure balancing the size and margins
associated with shift in physical and digital content sales will have to be invented.
But its not only challenges. Unprecedented opportunities to engage customers 24/7
will present themselves through this connectivity. With changes to the IT systems,
interconnecting with content delivery networks, advancements in advertising
capabilities and creation of entirely new interfaces with distribution partners,
companies stand a chance to tap into $10 billion in revenue opportunities made
possible by the advent of digital electronic entertainment.
Video games are well positioned to benefit from the digital transition. Unlike the
movie and music industry, video games are inherently interactive, have multiple
pause points that permit the gameplay to be interrupted and return to it
whenever convenient. Features that improve the users experience, connect with
online communities, and provide downloadable extensions that extend gameplay
time or add features to the original version of the game can be very easily provided
and are an integral part of the gaming industry strategy.
Future trends of the industry are discussed with reference to the increasing
penetration of digital technology and internet in the industry, improvements in
technology, the invasion of PC in the living room and changing buying and
consumer behavior.
The Obstacles and Opportunities for Digital Distribution
Grutzky [16] focuses on the opportunities and obstacles for digital distribution in the
video game industries and its implications for the industry actors such as the
retailers, the developers, the payment solution providers and the publishers. The
video game industry today has a significantly higher turnover than even the film
industry and the consequences of changing the distribution forms can be enormous.
The video game industry is going through a significant change in how the
consumers are and will eventually obtain the content. Digital distribution, increasing
internet bandwidth, curtailing of the used game market, increased prevalence of e-

commerce are some of the factors that will eventually lead to the disappearing of
specialized retail stores for video games.
The paper tries to answer the questions of the future of video game retail, whether
it will develop or decline, the obstacles in digital distribution and the movement
towards smaller digital packages. Two methods of information collection have been
used, a literature study and semi-structured interviews. The traditional video game
distribution industry is discussed followed by an analysis of the existing video game
value chain. Different revenue models that have been discussed are free to play /
micro transactions, subscription model, episodic entertainment and advertisement
driven. The digital distribution is discussed and then compared against the existing
digital music industry.
The paper declares that hardware compatibility, piracy, DRM, the lack of computing
power in most laptops and the rise of console gaming have led to the decline of
video game retailing. They see bandwidth, hard drive space on consoles and decent
technical support as being the main obstacle for digital distribution. The current
trend of breaking up albums into songs and then selling them for cheap is not a
direction that can be taken up by the games industry as the initial investment will
be much larger for the video game. A SWOT analysis is done for the digital
distribution framework. The strengths are unlimited supply, rapidly growing
business and increased customer value with 24-hour access without travel. The
weaknesses are strong dependency on the development of bandwidth
infrastructure, limited hard drive storage space on consoles, lack of drive storage
space on consoles, lack of personal service and lack of options for youth. The
opportunities are ability to use different price points and micro-transactions, new
revenue streams from digital content, diminishment of used game sales and
increased piracy control. The threats are new players taking over the market,
resistance from retailers and diminishment of the retail channel and fear of low
payment security.
Value Modelling in Online Digital Distribution
Online markets are very dynamic and have grown continuously in a very short span
of time and have emerged as the main marketplace for many products and
services. Within this marketplace, there is a section which caters to selling products
which are software themselves, not just the transaction. The video game industry
constitutes a huge chunk of this market. It is characterized by big volumes of sales
and a very complex market. The variety of business models used by the companies
in the sector has led to a variety of innovative solutions which are of great interest
to areas outside the digital domain. This paper aims to enhance the value chain
with a set of logic rules to manage price policy and choose the most effective value
model for given market characteristics with the ultimate goal of building a tool
which, once provided with information on the market (number of clients, average
payment per user), can compute the expected volumes of value exchange and
recommend a business model that best fits market demands.
Ceci [17] discusses the current video game market on the bases of price elasticity,
price levels, menu costs and price dispersion. It also analyses the various pricing

models currently prevalent in the market such as micro transactions involving both
virtual goods and dual currency, subscription, free to play, crowdfunding, early
access and DRM.
A similar pricing model may be in employment by Steam which is one of the biggest
online distributor of video games. Its pricing is very arbitrary and communities are
built around specific products by means of special sales. Prices are not bound to
fixed costs and can be managed with flexibility. This semi-automatic management
of prices fulfils three goals, maximizes the revenue from the business process,
optimizing the number of paying users while avoiding measures such as DRMs and
grants access to digital entertainment to all types of consumers by simply
rearranging (virtual currency, free-to-play, special sales) the method how different
customers are likely to purchase the product.
Prohibition of Resale Markets for Information Goods
According to existing research frictionless resale markets are unable to decrease the
profits of monopolist producers of perfectly durable goods. Therefore producers
should welcome a well-functioning resale market activities. However this paper
suggests that these findings do not hold true for goods such as video games where
users tire of the product after repeated use by presenting logical arguments. These
resale goods end up fulfilling a residual demand and fetch a low price discouraging
forward looking customers who would have otherwise factored a high resale price in
their buying decision. This assumption also implies that the impact of resale is an
empirical question. In the video game market producers can and most likely would
legally prevent resale by distributing their products digitally as downloads or
streamed rentals. The above empirical assumption is thereby applied to this market.
Estimation is then done in two steps. First, demand parameters are estimated using
a dynamic discrete choice model in a market where resale is allowed, using data on
new sales and used trade-ins. Secondly, with these parameter estimates, prices,
profits, and consumer welfare are simulated under counterfactual environments.
The data was constructed from two datasets, the NPD group, provides information
on monthly sales and average prices of new copies of video games by game in the
U.S. and the second dataset contains used game auctions from an online
marketplace over November 2005 to December 2008. These latter data serve as a
proxy for the monthly quantity of used games traded-in by consumers which then
needs to be scaled up to be at the same level of entire US region. Time-invariant
variables include game characteristics like critic review scores from the NPD group
and replay value scores from reviews.
The results show that profits from selling video games would be higher by 100% for
non-resellable goods. The increase in amount was sensitive to the assumed market
size. Non-resellable good profits were also much higher than rental profits, almost
100%. These findings stand in contrast to most previous empirical and theoretical
papers focusing on products for which consumers do not lose interest which found
that monopolists profits do not decrease with frictionless resale. The difference in
findings suggests that the rate at which consumers lose interest has high impact on
resale on producer profits. This can help policy makers in deciding the mode of sale

since the types of goods matching this assumption, such as entertainment


information products can be distributed as non-resellable downloads.

Digital Distribution of Movies and TV Shows


Emergence of online movie and TV shows distribution
Changing technological and lifestyle trends over the past decade or so have
threatened to derail the conventional cable TV industry. With a desire for
convenience, and the opportunity to freely access content without any time
restrictions at a relatively low cost; online streaming is rapidly gaining popularity
as a means of watching TV.
Gaming consoles are an especially fast-growing platform for online streaming.
39% of homes own 7th Generation Gaming Consoles, i.e. consoles that have the
capability to stream videos. These include the Microsofts Xbox 360, Sonys
PlayStation 3, and Nintendos Wii.
Access to these additional streaming services requires a monthly subscription
fee in the region of $15 paid to the console owner however this gives one
access to all internet-enabled content as well as bonus gaming features. It does
not require an additional fee to Netflix, Hulu or YouTube or any of the streaming
platforms themselves.
Another major revolution to the streaming industry has been the introduction of
Roku. The company was founded in 2002 in California, and offers a product that
is similar to a set-top box that is similar to what cable operators provide. Roku
however functions completely through the Internet, and is organized in the form
of channels. Users can add and remove channels as they please, and will only pay
for what they consume. In addition, it is an economically viable for the TV
consumer. Roku has 4 types of boxes available, the cheapest of which is a onetime cost of $5015. Roku merges the key elements of traditional cable/satellite TV
(high quality programming, access to a variety of channels) with those of YouTube
(user-generated, niche content) to create a concoction that is in many ways the best
of both worlds.
According to Pisharody[19], from a consumer standpoint, there are two major
drawbacks of the current television model: a lack of flexibility and the potential
for clutter. Cable and satellite services are usually structured as a packaged deal
featuring a multitude of channels and programming. While access to more
content may be desirable in some ways, most consumers have very specific
tastes in terms of what they want, thereby rendering most of the channels they
subscribe to worthless16. Additionally, cable limits the consumer to only
watching shows one their television sets and at a specific time.
Smartphones and social networking in particular have changed the way in which
people interact with media and the outside world. The combined availability of
streaming services and multiple devices have enabled consumers to pick and
choose what they watch and bypass the conventional cable model should they
wish to do so. 48% of 5 million households in US watch TV content through

subscription services, reiterating the value of being able to choose and pay for
what you watch[1].

Purchase Preferences
According to 2013 report on Accenture video over internet consumer survey [2], the
following were the major findings:
The majority of consumers (62%) are willing to pay for a monthly subscription to
access on-demand content on a PC, TV or tablet. Despite the difficult economic
climate where ancillary or secondary expenses are drastically reduced there is an
element of resilience in paying for online video services. However, most consumers
report they will pay the equivalent of less than $10 on a monthly basis. The
propensity to pay remains particularly strong in regular subscription and TV license
fee models more than in pay per view. While 37 percent of consumers pay for
access to video content through a regular subscription or TV license fee, just 10
percent of respondents reported paying per view for video on-demand, down from
12 percent in 2012. These results show an important media consumption trend,
where the transactional model is no longer the preferred way to pay for
entertainment.
Consumers increasingly scrutinize the content for which they will pay a premium. As
online consumption is maturing, and consumers are getting more sophisticated,
they want to pay less for content overall, but they will pay more for getting
specifically what they want. In other words, if providers demonstrate value in
premium content, consumers are willing to pay. Otherwise they will opt for
consuming content for free: two-thirds of consumers said they mainly watch free
video content.
Similarly, 45 percent of consumers would be interested in an la carte menu for
their video/TV access to show only their top 10 most watched channels. Among
those interested in an la carte menu, 70 percent said they would expect at least a
25 percent reduction in their monthly TV bill for this approach. 41 percent said they
would expect a reduction of 50 percent or more.
In short, consumers confirm that they have an appetite for online video and are
willing to pay for good content, making watching online a viable source of revenue.
Business Models
A study commissioned by European Commission [21] on the business models for the
sale of online videos lists the following models:
1. Platforms for digital content rentals, on which the film is downloaded / streamed
for a specific period of time (up to 30 days or 24 or 48 hours) and DRM
technologies prevent playback after agreed rental period

2. Platforms to download movies to own and pay-per-item, e.g. Apples iTunes


store; either with or without the right to record the movie on DVD. Content
portability is often restricted
3. Producer/broadcaster platforms to stream movies from libraries or archives of
TV stations or AppleTV or Zattoo; usually sold on subscription on the basis of
monthly or yearly fee. DRM technologies prevent the video from being watched
after the subscription expires; The video version of the freemium model
attracts consumers with a package of free ad-supported channels and gives
the option of paying more and receiving premium content without advertising;
4. Advertising-based free of charge streaming of videos, mostly applied to
independent or low-budget productions
5. Free-of-charge streaming or downloads of limited movies for marketing reasons
6. Platforms for hosting self-made online videos of users, e.g. YouTube
7. Platforms in social networks in partnership with online video services, e.g.
Facebook and
8. YouTube.
9. Consumers may download or stream from a variety of platforms, including
Internet-enabled television, PCs, console game player or smartphones.
Encouraging Digital Video Collection
Research findings by Dr.Steirer [22] show the following ways to encourage digital
video consumption:
1. Electronic video sell-through services should consider implementing artificial
supply constraints on digital video productseither through limited sales
windows or as part of a versioning strategyin order to spur collecting.
2. An in-service resale market would increase the value of ownership for
consumers; if fees are priced correctly, such a market should not result in
decreased revenue.
3. A Digital Rights Management system that managed and provided for the
exercise of consumers rights in addition to those of copyright holders would
supply added value to digital video; such a service could also be used to
rehabilitate DRM in the eyes of consumers.
4. A digital video service could obtain a strong competitive advantage by fully
integrating its own Web 2.0-styled communication tools; too heavy a reliance
upon external social networking services such as Facebook hinders the
formation of service-based communities.

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