Managerial Decisions: iTunes Music Pricing

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Abstract

Starting in 2003, Apple Inc. began selling digital music for the iPod through its iTunes store (Brickley, Zimmerman, & Smith, 2009). Each song sold for the same price under a flat fee structure. At the time, file-swapping threatened the music industry’s ability to collect any returns on its digital music. Offering songs at a low price encouraged customers to buy music online and increased music industry revenue. Eventually, however, the music industry began to pressure Apple to vary the price structure according to demand (Leeds, 2005). Government regulators clapped down on illegal file-swapping and paying for downloaded music became the norm. With less competition from other sources, the music industry wanted to maximize its profits by increasing the price of some songs (Leeds, 2008). Presumably, Apple had less incentive to maximize profits from digital music sales than did the music industry. Eventually, the music industry found other distributors, including Amazon, to compete with Apple for access to digital content (Leeds, 2008). This lessened the market power Apple controlled, leading to a shift in bargaining power between Apple and the music industry (Brickley et al., 2009). Apple could have implemented different types of pricing structures but adopted the recommendation by the music industry (Brickley et al., 2009). Even after the price increase in 2009, Apple enjoyed an increase in net sales on music (Apple, Inc., 2009). The most recent 10-K filing shows that Apple continues to enjoy healthy increases in net sales in this category (Apple, Inc., 2013).

Managerial Decisions: iTunes Music Pricing

Beginning in 2003, Apple began a form of price bundling by selling digital music for its iPods through its iTunes store (Brickley, Zimmerman, & Smith, 2009). Each song sold for the same price under a flat fee structure. At the time, file-swapping threatened the music industry’s ability to collect any returns on its digital music. Offering songs at a low price encouraged customers to buy music online and increased music industry revenue. Eventually, however, the music industry began to pressure Apple to vary the price structure according to demand (Leeds, 2005). Government regulators clamped down on illegal file-swapping and paying for downloaded music became the norm. With less competition from other sources, the music industry wanted to maximize its profits by increasing the price of some songs. Apple had less incentive to maximize profits from digital music sales than did the music industry because it relies on other revenue streams (Brickley et al., 2009). Eventually, the music industry found other distributors, including Amazon, to compete with Apple for access to digital content. This lessened the market power Apple wielded, leading to a shift in bargaining power between Apple and the music industry (Brickley et al., 2009).

Variable Pricing Strategy

Apple anticipated a variable pricing strategy would drive potential customers away from a distribution system in its early stages. In some ways, however, a variable pricing strategy encourages new customers, in particular those interested in purchasing “classic music,” which would be priced at a lower rate. This could increase revenue. Also, the increasing price would provide more revenue per more expensive song. Depending on whether or not Apple loses customers because of the price hike and then the number of customers lost, Apple could still see an increase in sales revenue from the variable pricing strategy (Brickley et al., 2009).

Alternative Potential Pricing Strategies

There are other options besides the variable pricing strategy proposed by the music industry. Block pricing—a form of menu pricing—could be offered. Apple could sell a large number of songs as a block at a smaller per unit price and individual songs at a higher per-unit price (Brickley et al., 2009). Alternatively, Apple could increase the per-song price, but offer coupons and rebates. Customers willing to find and mail-in coupons and rebates would self-select. Others simply would pay the increased price (Brickley et al., 2009).

Price discrimination and group pricing are two ways of charging different amounts to different groups of customers. Pricing managers must gather reliable information on customers to understand segments of customers and their varying demand levels (Brickley et al.). One possibility would be to advertise a coupon or rebate to a certain type of customer on websites or in magazines targeting that audience.

Risks and Potential Costs of More Sophisticated Pricing Schemes

As with any pricing scheme, there is always the potential of losing customers by setting the price too high, on the one hand, or losing potential profits by setting the pricing below what the customer would pay, on the other hand. Additionally, with a more complex pricing arrangement, customers might decide the product is no longer a good value (Leeds, 2005). They might also decide it is too difficult to determine whether the product is offered at a reasonable value, choosing to go to a competitor with an easier system to understand.

Also, there are certain variable pricing schemes that are illegal in some jurisdictions. The risk of costly litigation can determine whether certain price strategies are implemented (Brickley et al., 2009).

Apple’s Pricing Objective vs. Music Industry’s Pricing Objective

Apple’s pricing objective doesn’t appear to be the maximization of revenue from downloaded music. Apple’s 2004 10-K filing with the Securities and Exchange Commission lists “Other Music Products”—the category into which digital music falls—as only about 3% of Apple’s net sales (Apple, Inc., 2004, p. 28). In a New York Times article, Leeds explains that most of Apple’s revenue is generated by Apple’s proprietary hardware and software, as opposed to digital content (2005). This is in stark contrast to the pricing objective of the music industry, which is to maximize revenue from content (Leeds, 2005). The diverging interests of Apple and the music industry led directly to the tension over prices.

Apple’s Ability to Control Pricing in the Future

In January 2009, Apple announced a shift in prices to the pricing structure requested by the music industry. In exchange, the music industry allowed Apple to sell songs without the digital rights management software it formerly had required. The competitive power of Amazon and other content distribution channels (Leeds, 2008) applied enough pressure to cause this change (Apple, Inc., 2009, p. 9). Interestingly, Apple saw an increase in net sales by 21% from the sale of digital music during 2009 despite the price increase. This increase was lower than the 34% increase in similar net sales in 2008, it was still an increase (Apple, Inc., 2009, p. 41). The company’s 2013 10-K showed that this growth has not slowed down, despite Apple’s fears, with a 25% growth in net sales in 2013 for the digital music category (Apple, Inc., 2013, p. 27). It appears that the market for digital music is continuing to grow and with increased demand, comes the possibility of an increase in prices to exploit a greater profitability margin.

References

Apple Inc. (2004). Form 10-K 2004. Retrieved from SEC Edgar website: http://www.sec.gov/edgar.shtml.

Apple Inc. (2009). Form 10-K 2009. Retrieved from SEC Edgar website: http://www.sec.gov/edgar.shtml.

Apple Inc. (2013). Form 10-K 2013. Retrieved from SEC Edgar website: http://www.sec.gov/edgar.shtml.

Brickley, J., Zimmerman, J., & Smith, C. W. (2009). Managerial economics and organizational structure (5th ed.). McGraw Hill-Irwin. Retrieved from www.mhhe.com/brickley5e

Leeds, J. (2005, August 27). Apple, digital’s music angel, earns record industry’s scorn. The New York Times. Retrieved from http://www.nytimes.com/2005/08/27/technology/27apple.html?pagewanted=all&_r=0

Leeds, J. (2008, January 14). Music industry, souring on Apple, embraces Amazon service. The New York Times. Retrieved from http://www.nytimes.com/2008/01/14/technology/14clash.html