CD or not CD?

The online music service eMusic is probably best known for selling songs in the MP3 format, with no electronic locks. That’s been verboten among the major record labels (at least until EMI’s recent initiative), so the service has never offered music from any content from the Big Four (Universal Music Group, Sony BMG, EMI and Warner Music Group).

But another feature of the service is proving to be even more problematic for the major labels, as well as some top independents. Unlike your average downloadable music store, eMusic sells tracks in bulk: 30 songs for a little under $10. The more you buy, the deeper the discount, with prices per track going as low as 25 cents. The catch is, you’re on the hook to spend another $10 next month for an additional 30 songs, unless you cancel your subscription.

On the surface, this seems like a lousy deal for labels and artists. Why sell your music for something less than 33 cents a track (after all, eMusic takes a cut off the top) when Apple and the other stores pay about 70 cents wholesale? One reason is that the price per track isn’t as discounted as deeply as it appears. Some subscribers don’t download all the tracks they’re entitled to, so the revenue per song stays above 33 cents per track. But a more important factor, as hundreds of lesser-known labels have concluded, is that even a discounted price is better than nothing, which is what they would be paid if no one bought their releases.

That works for artists who toil in relative obscurity, whose releases never make it onto radio or into the shrinking CD displays at Wal Mart and Target. But eMusic’s approach begs a different and crucial question for larger labels and artists, one that has yet to be explored in the market: Would lowering the price of music generate more total revenue? The goal, after all, isn’t to make more money per unit sold. It’s to make money more money, period. If cutting prices by 50% triples your sales, you win; if it increases sales by 50%, you lose.

Every manufacturer of consumer products has to confront some version of this issue. How do you make the product available to every potential buyer, at the highest price that the buyer is willing to pay? This is particularly important for record labels, who have seen not only a steep slide in CD sales, but also an unsettling drop in the number of people buying music—by eMusic CEO David Pakman’s calculation, the decrease has been more than 30% since 2000. This has coincided with the spread of file-sharing networks that make unauthorized copies of almost every title available for free, strongly suggesting that the steep decline has been caused by people getting music without paying for it.

In many industries, the solution is to offer variations that are more or less expensive than the basic product. Take auto manufacturers, for example, or detergent makers. That’s not so easily done in the music business. Labels have tried selling more expensive versions of an album by adding DVDs, bonus tracks or other extras, but there’s not been much movement in the other direction. Besides, what would a stripped-down CD release look like? Cheaper plastic?

Hollywood’s strategy has been to sell the same product at different prices over time. The initial release of a movie, to theaters, carries the highest price per household. Subsequent releases on DVD, to premium cable channels and to broadcasters, reduce the viewers’ cost gradually to zero. That model effectively lets the studios get the most dollars out of the people with the greatest interest in seeing a movie. The main threat to this “windowing� model is the pressure from file-sharing networks, which make bootleg copies of movies available online practically from the day they hit the theaters.

The labels have windows, too, albeit a much simpler set. Older titles often carry a wholesale price a few dollars less than new releases. Labels may also offer newly signed or developing artists at a lower wholesale price than established bands, while charging a premium for brand new releases from top sellers. As a result, retail prices range from about $8 to $18. (Universal Music Group broke from the pack four years ago and cut the wholesale price for new CDs by 25%. The effort withered in the face of opposition from retailers, who complained that Universal was trying to bring down prices by reducing their profit margins.)

The major record companies have developed plenty of lower-cost alternatives to the CD, including ringtones, 99-cent singles, three- and four-song bundles, downloadable music videos. They’ve even supported a rental model of sorts through services such as Rhapsody and Napster, which charge about $10 a month for unlimited access to an online jukebox. A new album by a top artist frequently gives rise to a dizzying array of product offerings, particularly online and through mobile-phone networks. The result for the labels has been a rapid increase in revenue from the digital side of their businesses, although not necessarily enough to overcome the slump in CD sales.

What’s missing, though, is a sustained attempt to measure whether lower prices could revive music sales. Pakman argued in a recent blog post that the prevailing digital rate—99 cents per track and $9.99 to $12.99 per album—is more than consumers are willing to pay for music, especially if they’re not familiar with it. And given how tight the playlists are for most local radio stations, the average consumer is familiar with a fraction of the enormous amount of music that’s been recorded.

Lower prices may not be a tonic either. Russ Crupnik, a market analyst at NPD, said his research suggests that consumers care more about the value they receive from a CD than the price. Paying $18.99 for an album filled with good songs is more attractive than paying $7.99 for a mediocre one, or even $2, he said. And Derek Sivers, founder of CD Baby—an online retailer that sells discs by independent artists—said the bands that use his site have been able to raise prices over the past few years without losing customers.

On the other hand, Sivers said CD Baby has also been able to breathe life into moribund titles by offering them for $5—less than half the price of most albums on the site. This suggests that there are two price thresholds: one for fans and one for the merely curious.

The challenge is for labels to find a way to segment the market so that an artist’s fans will still pay top dollar for a new album, while those who aren’t so devoted can be tempted to take a chance on the band. That’s no mean feat, given the ease with which consumers can find the cheapest source of virtually any product online. At eMusic, the segmentation comes in part from the business model—only the most avid music consumers sign up for subscription services—and in part from the obscurity of the music offered. Its catalog is filled with independent-label fare, some of which isn’t even available on iTunes.

Another interesting approach taken by lesser-known artists is dynamic pricing. At AmieStreet.com, the price per song climbs from 0 to 98 cents as sales grow. That approach doesn’t measure what price will produce the most revenue, however; instead, it simply raises the price based on previous demand.

The major labels, which account for about 80% of all music sales, aren’t likely to roll their acts down AmieStreet anytime soon. But they are showing increasing interest in advertiser-supported on-demand services and other approaches that cut the price of music—a notion that was anathema in the early days of digital music, when label executives talked relentlessly about the danger of devaluing music. And one or two may accept Pakman’s challenge to offer eMusic subscribers some of the titles that aren’t selling anywhere else. As analyst Mike McGuire of Gartner, a market research firm, put it, the majors are starting to understand the need to find as many legitimate outlets as they can for each song, “to get people to pay for it at least one time.�

Jon Healey is a Times editorial writer; he runs the BitPlayer blog. Send us your thoughts at [email protected].