Radiohead Economics

If one picks up any current magazine dealing with the music industry in any way, be it from a business, critical, or fan boy perspective, one will inescapably run into an article or series of articles dealing with the recent release of Radiohead’s “In Rainbows” as well as the huge deal that Madonna has recently signed. Both are looked at by those outside the industry as indicative of what we can expect from a 21st century music business and by those inside as the death knell of profitability within the industry. Of course, the fact that Radiohead released an album with absolutely no press lead-in and then charged fans anything that the fans felt like giving them, does seem like quite a dramatic turn of events. However, it would be foolish to believe that Radiohead has done anything that will bring down the machinations of the music industry as a whole, and in all likelihood, might actually be forging a way for the industry to revive its’ plunging profitability.

All of this boils down to the economics of the market for music. The industry has been suffering horribly since Napster first began the world’s obsession with downloading music for free in the late 1990s. Lawsuits, piracy protection, and simple finger pointing have all gotten the industry absolutely nowhere as sales have continued to fall. Some fault the industry for not developing talent that is in any way interesting and simply trotting out ‘manufactured’ pop music that they think will sell. There is some validity to this line of reasoning but the real reason for the problems within the industry have much more to do with pure market economics than anything else.

Demand for music, despite the sales figures for material CDs and DVDs, has actually increased since Napster began hurting sales figures. Music is much more accessible in today’s modern ‘click it and its here’ world and music fans are taking advantage, amassing huge collections of music which would be unaffordable if money was actually paid out for each piece. This increase in demand usually, in simple economic terms, leads to a new market equilibrium with a higher price and a higher quantity produced, leading to a larger amount of profit (using a standard microeconomic model of supply and demand of the market for music). This is what the big wigs of the music industry are expecting to see, and the fact that these larger profits are not appearing is what is leading to the panic within the industry. (Note: I’m using the term ‘profits’ to describe the short-run and with the caveat that it is used to describe higher output and price compared with a previous time period. Thinking macroeconomically, in the long-run there are no actual profits as the market moves into long run equilibrium.)

So what is the matter? What externality is preventing the effects of an outward shift in demand from positively impacting the music industry?

The answer, to quote Raiders of the Lost Ark: “They’re digging in the wrong place!”

The demand for music has, indeed, increased, but the demand for physical units of music (CDs, tapes, records, DVDs) has greatly diminished. Thus, the demand curve has shifted to the left, resulting in the problems we see in the industry. So, what does this have to do with Radiohead and their “pay what you want” CD release?
In a standard model, there are two ways to offset a decrease in demand: shift the supply curve outwards or increase the quantity demanded at a given price. Increasing quantity demanded is very difficult to do and shifting the supply curve outwards (producing more CDs) does not necessarily mean that CD sales would increase. Radiohead managed to deftly increase the quantity demanded by doing several extremely important things:

1) They circumvented any leaking of their album by releasing the album online themselves.
2) They released the album at a (relatively) low bit rate.
3) They charged a high amount for a special box-set with extra songs.
4) They plan to also release the album in a standard CD format through a label early in 2008.

Releasing the album and not charging an actual rate for it is the most important part of these different aspects, because they, in essence, leaked their album themselves. This doesn’t seem to be important in changing the quantity demanded because so many people didn’t pay a single thing, but the people that didn’t pay for the download are the same people that would not have bought the album in droves in a CD format. Those that did pay for the download are most likely going to also buy either the CD in its standard release, the box-set, or both, resulting in Radiohead basically charging people a higher price rate than the sticker on any CD purchased actually states. Radiohead also served to further this ‘double charging’ by releasing “In Rainbows” at a bit rate much lower than would be found on a standard CD, meaning that people who want to hear the album in its true glory will be forced to pay for a hard copy of it.

The self-release basically amounts to a hidden charge, and the beauty of it is that Radiohead really doesn’t even need a high rate of people paying for the ‘free if you want it’ download (by some accounts 2/3 didn’t pay) because any amount of money actually paid is still gravy on the mashed potatoes of CD and boxed-set sales to come. The real question is whether the free downloads will impact the actual sales figures of the standard CD release. It will be interesting to see what truly transpires, but even if the sales suffer a bit, it makes logical sense that the sales would be similar because of the way the market has worked since Napster. Nearly all major, and most minor, releases have been leaked in advance of their actual release dates and, since Radiohead in essence leaked the album themselves, their CD sales should continue to be just about what they would have sold regardless of the early release. This just further fortifies the theory that Radiohead have managed to increase the quantity demanded at the given price of their actual CD.

Of course, Radiohead is a very successful and, by all means, a ‘huge’ act and the economics might not relate to smaller, indie bands, but they really don’t have to. The indie community has always, and will continue, to survive on word of mouth, ticket sales, and critical praise. The real problems in the music community are with the profitability of the major labels, which don’t profit off of illegal downloads like the indie community can. Radiohead’s precedent is a sound model which should be verified as a viable way to increase success in the music industry in 2008, but its success also depends on the industry managing to curb leaks and increasing the agility to release albums online quickly and change with the evolving market.



Luke said...

Just a pre-apology for this article to anyone who reads it. It's a bit of self-indulgence for an economist... just be happy I scaled back on the technical jargon and graphs which were in the original draft.


Jameson said...

Luke - I honestly think that the charts and graphs may have helped (although...I am only saying that because I am a little far removed from the Econ...not because I think it would facilitate increased readership). An interesting take on a situation that has certainly been "everywhere".

It is crazy to think it is almost November. Which means that it is almost time to start compiling "year-end lists". Back where we started. 2007 has been a spectacular year for music, so it should be interesting to see how it all shakes out (for me at least). Get working...

Luke said...

Yeah it's going to be an interesting end of year list... mine is shaping up to be a mish-mash of a bunch of really different stuff.

As for increasing readership... come on, everyone loves econ!

(evil laughter)