November 29, 2020

New Study on Filesharing Effect (Part 2)

Continuing yesterday’s discussion of the new Rob/Waldfogel filesharing study, let’s look at the possible effect of authorized downloading services.

As we saw yesterday, one of the main findings of the study is that people derive lots of benefit (about $45 annually per capita for the study’s sample population) from downloading songs that they don’t value enough to buy. In the absence of filesharing, this would have been deadweight loss.

Suppose that CDs cost $15 and that the (marginal) cost of producing and distributing one more CD is $2. Suppose further that Alice would be willing to pay $9 for a particular CD. If the record company could somehow sell Alice the CD for a price between $2 and $9, Alice would buy it and both parties would be better off. The total welfare gain would be $7, the difference between Alice’s valuation of the CD and the cost of providing it to her. But if the record companies have to charge everybody the same price for a CD, they would be foolish to lower everybody’s price below $9 – that would increase their unit sales but lower their total profit. So they’ll keep the price at $15 and a mutually beneficial sale to Alice won’t happen – that’s deadweight loss.

If it’s impossible to sell Alice the CD at a price she is willing to pay, then there is economic benefit in letting Alice download the album without paying – Alice gets the music, and the record company doesn’t lose anything since it wouldn’t have made a sale anyway. Some value that would have been lost is instead being captured by Alice.

But if the record companies can price-discriminate, that is, if they can charge different prices to different people, then they might be able to sell Alice the CD for $8 without lowering the price they charge anybody else. If they can somehow do this, they can eliminate the deadweight loss. But they can only do this if (a) they have some way of guessing how much individual customers are willing to pay, or at least some way of segmenting the customer population into groups that are willing to pay different amounts, and (b) they can prevent people like Alice from buying the CD at $8 and then reselling it to somebody who is willing to pay more.

It’s hard for record companies to price-discriminate in the traditional CD market, but maybe it’s easier for them to price-discriminate by using online music services. Maybe they can cook up a pricing plan that causes people who like a song more to pay more for it. I don’t think anybody really knows how well the industry could price-discriminate in such a scenario.

If, somehow, the industry could price-discriminate perfectly, so that they charged each user just exactly the maximum he was willing to pay for each song, then the deadweight loss would vanish – into the industry’s pockets – and downloading would turn out to be harmful. (Remember, if our goal is to maximize total welfare, we care only that the deadweight loss is gone; we don’t care who pockets it.)

But if we assume, more realistically, that the industry’s price discrimination strategy will have only limited success, then we can’t say whether filesharing will turn out to be harmful. We know that filesharing eliminates $45 (per capita) of deadweight loss. If price discrimination eliminated less than $45, then filesharing would still look like a good idea, considering only direct effects. We know the indirect effects (less music being produced, because of reduced industry incentives) of downloading will be negative, but we don’t know if they’ll be large enough to overcome the positive direct effects.

At the end of the day, the Rob/Waldfogel study doesn’t tell us whether filesharing is helpful or harmful, from the standpoint of total welfare. (Nor, to its credit, does it claim to do so.) What it does tell us is that downloading eliminates a lot of deadweight loss. And so it weighs on the scale – very lightly, to be sure – against the proposition that downloading is harmful.

Comments

  1. Nice post! It reminds me that Andrew Odlyzko has done some really good work on privacy and price discrimination. One of the interesting results is that protecting your privacy around say, music preferences is economically rational. If you don’t protect your privacy, then the music companies will know what you’re willing to pay for the latest U2. If they don’t know, you may well get it for 3.99.

  2. Ah, but there is an elementary and intuitive way to price-discriminate: charge by bitrate. Let’s set up a rational pricing scheme (prices expressed in CD units, though song-units are more natural online):

    $2, AM-quality (96k mp3s?) for impulse listeners
    $5, PC-quality (160k mp3s?) for dorm rooms
    $7, not-quite-CD-quality (256k mp3?) for Alice
    $10, CD-quality (overpriced at $15) for most
    $15, SACD-quality for fanboys and audio obsessives

    Voila! Most people willing to pay at least a few ducats for a record get to hear the whole thing, and transparent pricing ensures nobody gets the used-car syndrome when they find out they paid twice what their neighbor did for the same item.

    The music industry is sufficiently dense that something like this is unlikely. Still, were they to set up tiered prices per quality like this, I would expect their revenue base to increase, and the public’s deadweight loss essentially to vanish.

  3. What an interesting work. And if you forgive me, the article by Odlyzko and one by Adam are in Economics of Information Security (http://www.infosecon.net/text/)

    Price discrimination, well if we want the record industry to obtain all the lost social welfare price discrimination is the optimal response. An alternative response, one that would leave the social welfare with the people who download, is mandatory licensing. There is no reason that the record companies should be able to capture the welfare loss. In fact, a mandatory licensing scheme could provide a way for increased publication and incentive to publish for music that is currently existing but not published. Pricing differences could be based on download order, quality, and speed of download. This leads me to ask,
    Is there any work on reliable mechanisms for distrbuting revenues by download or filtering measure?

    Timing and quality of goods are classic methods of price discrimination. Added-value services would work too as with DVDs – if I love the song I could get the score, the interview, the video. But these would continue to concentrate control over publication in a small set of hands. And one of the things about file sharing that is popular is the distributed filtering. But price discrimination is both an economic answer and a very political answer.

  4. Jean is (of course) right; Andrew’s work in the book is the relevant one. (I’m on the road, so couldn’t cite.)

    All the work I’ve seen on download measures allow for exciting gaming of the system, such as setting up a system without speakers to download and play “Adam’s brass band” over and over again, so I get a cut of the license fees.

  5. Interesting post, but I think you should keep all this talk of price-discrimination to yourself. Seems like the last time the entertainment community tried price-discrimination, we got that damn region-coding on DVDs.

    I’d rather you didn’t give them any more ideas like that.

  6. David Robinson says:

    This is interesting, but it assumes that Alice’s propensity to pay for music is constant. I think an industry representative might argue, plausibly, that there is an inverse relationship between the amount of free downloading that takes place and the average propensity of people to pay for that which is being freely downloaded. The background assumption that one should in general pay for music is a key factor in determining how much Alice will value a song (in monetary terms). The industry correctly perceives this assumption to be under threat — a situation that could become quite costly for them.

  7. If, somehow, the industry could price-discriminate perfectly, so that they charged each user just exactly the maximum he was willing to pay for each song, then the deadweight loss would vanish

    Isn’t this just what the Street Performer Protocol does? Like, exactly?

  8. Nothing in your analysis depends on anything specific to information goods. You might as well look at the “deadweight loss” of people who would buy a Cadillac if it were cheaper and talk about how much better things would be if people could just steal cars whenever they wanted them.

    Legalizing file sharing turns information products into public goods. It is a standard result in economics that public goods are under provided. Enforcing property rights in information would let the market work and would provide a pareto optimal outcome which is not reachable when dealing with public goods.

  9. I think we should at least briefly call into question the assumption that “the indirect effects (less music being produced, because of reduced industry incentives) of downloading will be negative”. Other than the word of record-company executives (and the obvious bundary case of zero compensation) is there any evidence for this? It sounds a lot like the pious threats of high-end CxOs who claim that they just won’t work as hard for the shareholders for $5 million a year as they would for $10 million.

    The typical response of folks whose fixed costs dominate to a drop in unit prices is to try to push more units rather than fewer. You can argue that fixed costs don’t dominate, or that some of the apparently fixed costs are really variable on a per-performer or per-recording basis, but it’s not clear how well that argument holds up.

    Ultimately you get to the argument that actual creators and performers of music will have less incentive to create, but for that to be universal that requires a correlation between music-company revenues and artist compensation rather stronger than exists today.

    I think you can reasonably assume that there will be indirect effects, and that some of them will be negative, but the sign of the aggregate effect should not be assumed without some kind of evidence to support it.

  10. Cypherpunk: there is indeed a part to Felten’s analysis that is specific to information goods:

    Alice gets the music, and the record company doesn’t lose anything since it wouldn’t have made a sale anyway.

    This only applies if the marginal cost of production is close to zero… which is not the case with Cadillacs.

  11. Audience members do, in fact, pay more when they like a song — but it’s in the form of merchandise sales, ticket purchases and memberships. Audiences perceive their relationship to be directly with the artist and not with the label. Because albums are loss leaders for artists, clever artists backburner the file-sharing debate and focus on the long-term upside. Labels, meanwhile, are scrambling to force artists to fork over percentages of tour and merchandise revenues — thankfully, managers are holding firm on those fronts. This is why organizations like Sanctuary Records, which roll up management, records, and live events, are outperforming the major labels on net profits (despite the scary potential for conflict-of-interest with all those functions under one roof).