Monday, January 7, 2008

Recording Industry and the Economics of Scarcity

I have read many articles debating why the record companies continue to defend a model that technology has rendered obsolete. My two cents in the debate is that the reason is the economics of scarcity.

Since “Boomer” is half of my blog’s name I clearly remember scarcity when it came to music. LPs and 45s were very expensive. They were expensive because there were no alternatives except top 40 radio. No alternatives meant a scarcity premium, which digital technology and the Internet eliminated.

If you look at it then from the perspective of the recording industry, their price has effectively gone up; they lost their scarcity premium but kept the price the same. A higher price compared to alternatives (illegal downloads mostly at first) meant and still means lower sales. It makes sense for them to defend the model though because comparatively they get a large premium with each unit sold. In fact, you could look at the anti piracy activities conducted by the Recording Industry Association of America (RIAA) as a cost effective way to keep the scarcity premium as high as possible while they figure out how to transform their model.

The transformation of the music distribution model (legal downloads and music subscriptions over the Internet) is already well underway. Ubiquitous music purchases through your handheld device such as the Apple/Starbucks deal will rapidly expand. How artists contract with labels is also changing as evidenced by Madonna's deal with Live Nation. This shows how industry and artists will better capitalize on the value of their intellectual property. The deal features revenue sharing better matched with the value the music creates and accounts for touring and merchandise as well as record sales. This deal demonstrates why there is still untapped value in music if an appropriate business model is adopted.

The Wall Street Journal Online, one of the few online news sources that have successfully maintained a subscription model, is a good example of the evolution of business models. Rupert Murdoch will likely eliminate the subscription model expecting his readership will expand from its current 1 million subscribers to 10 million as a result. He will make more from advertising revenue than the $50 million lost in subscriber fees. While the content itself is free, no readers would consume the advertising without the content. The content has inherent value even though they cannot grow subscriptions ten fold with a paid subscription model.

Because digital and Internet technology eliminated scarcity as it relates to the distribution of music, the industry has to and is adapting. The surprise at the end of the tunnel is that the very innovations that created this challenge in the first place also provides the impetus to create new models that will enable the industry and artists to actually increase the value of their intellectual property.


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