Music's New Supply/Demand Model

Sept. 6, 2007 — -- The cardinal rule of economics 101 is that prices are ideally determined by supply and demand.

In the struggling music industry -- where it seems no bad idea goes unfunded -- a fledgling Web site is seeking to break new ground with this traditional model.

Last month, Amazon.com announced it had completed a round of financing for a music Web site that prices mp3s on the basis of consumer demand. The site, Amie Street, allows any artist to upload songs, which are then offered for free. As more people buy the songs, the price goes up, to a maximum of 98 cents per track. Artists as big as Johnny Cash and Sarah McLachlan already have songs on the site.

In my record-buying past, I was always excited when albums went on sale for the holidays or due to overstock. The only traditional way of pushing newer artists for less occurred when labels would price new releases at a discount, allowing music geeks like myself to try my luck on twice as many CDs. In those dark ages, we couldn't preview the songs and many times were just buying music based on a single's airplay or from a review in a magazine.

The times they are a changing, and in the case of Amie Street, like Facebook and Napster before it, the company is founded by a group of people under 30 -- in this case, three seniors in Brown University's class of 2006. As co-founder Joshua Boltuch explained, knowing -- or being -- the target consumer is everything.

"We asked ourselves, 'What would get us to buy music? What kind of site would be compelling for a generation that grew up having every song for free?'" he said.

"The idea would be to help people discover new music," he said. "That's why the pricing system is the way it is -- not because we love math." The free pricing for new and obscure music encourages people to try new bands, and through Amie Street's recommendation system, listeners get credit for recommending tracks to friends and helping unknown artists get a toehold.

"For new artists, it makes a lot of sense," said Topher Mohr, a Los Angeles-based singer-songwriter whose songs are currently priced at 39 cents each. Fewer fans, he explained, would take a full 99-cent risk on iTunes. And without record label backing, it is difficult for unsigned or smaller artists to even get placement in the iTunes store.

ABC News contributor Michael Smith is an internationally recognized DJ who has a music-services business. He works with a variety of corporate clients. www.smitheventmusic.com or info@smitheventmusic.com.

It's telling that Amie Street's free-market model is considered an "experiment" in the record business, where the highly consolidated record labels are doing battle with the highly consolidated -- indeed, nearly monopolistic -- distribution system. The result is a pathological market characterized by static prices and dissatisfaction at all levels of the distribution chain, from corporate head honchos to college-aged consumers.

According to Aram Sinnreich, an assistant professor at NYU's Steinhardt School of Media, Culture and Communications, consumers will only pay so much for music before they download illegally, while labels think the iTunes price devalues their product.

If the labels had their way, he said, songs would be priced at $2.50 to $3.

"There's been an ongoing push and pull between iTunes and the major labels over a host of issues, including whether the tracks should include DRM, what the price point should be, and who gets to control the general 'productization,'" he explained. "So far Apple has had the upper hand, but that is beginning to change, and the labels will gain in negotiating power over the next few years."

The playing field is growing, after all, with Wal-Mart entering the digital distribution business, and with RealNetworks, Verizon and Viacom partnering up to form an iTunes competitor called Rhapsody America.

The labels have made "major concessions," Sinnreich said, to dislodge iTunes. Consumers can expect to see prices drop, temporarily, as these new competitors try to take market share from Apple. Consumers can also expect to see more DRM-free music, as record labels try to boost iTunes rivals. Currently some labels have given Apple the right to sell its songs DRM-free for $1.29 each.

Once the labels are free to negotiate among many dealers -- not just iTunes and "everyone else," prices may go higher than they are now, and higher than the demand curve may dictate.

"The labels will never relinquish control over pricing to let it do its job," Simmreich predicted. Even their dynamic pricing models show an unwillingness to embrace market forces, he said. "The problem with most of the dynamic pricing that has been suggested by the labels is that it has a floor of 99 cents. At best I can only get iTunes prices."

Sinnreich is less than optimistic about dynamic pricing, for another reason, too. The current song-by-song "a la carte" model of digital distribution, he said, is doomed from the start.

"It's like pumping gas," he explained. "You have room for tens of thousands of songs. Whether you're paying 50 cents or $2.50 for a song, there's no way you're going to pay to fill that thing up. [Labels] have to offer consumers a flat rate, or bulk pricing to allow consumers to continue filling the tank."

For the time being, though, Amie Street will be watched by labels (and their underwriters) for signs of life. As co-founder Boltuch remarked, "The labels that we do have on the site are really happy with the checks that we're cutting them."

Unlike my early days of playing music lotto at the record store, listeners now have very efficient ways of buying new music through technology alternatives. That efficiency is actually helping to support new artists, including several friends of mine, to survive in a business that even a few years ago would not have allowed them to generate revenue.

ABC News contributor Michael Smith is an internationally recognized DJ who has a music-services business. He works with a variety of corporate clients. www.smitheventmusic.com or info@smitheventmusic.com.