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In case you haven’t heard, Adele has a new album titled 25 coming out. (If this refers to you, let me know and I will send help to get you out from that rock you are under.) Now we’re being told that we won’t be able to stream said album anytime soon:
Not gonna lie- from the numbers I’ve seen, it’s entirely possible that this withholding strategy is profit maximizing as far as recorded music is concerned. To get a handle on this tradeoff, consider some numbers:
So what is the “break even” point? At which point are Spotify listens more profitable than selling music? In other words, how many times would someone have to listen to your song on Spotify until it is the equivalent of them actually buying the song for the typical price of $1? (a typical full length now a days usually goes for $10, and a typical full length is usually around 10 songs, or $1 per song) We can calculate that quite easily. Taking the value of the song at $1 per person, we can simply divide the $1 by Spotify’s royalty payment of $.0072, and we get about 139. If you want to account for the cost of the CD to the artist, (about $1 per CD, or $.10 a song) we divide $.90 by $.0072 and get 125. If an artist can get every single fan interested in buying their music to listen to each song at least 125 times on Spotify, the artist will make out better on Spotify. If not, the artist will make out better on CD sales or downloads.
If you want to put some personal perspective on this, there are a number of applications that will look at your iTunes library and give you a play frequency distribution for your songs. To be fair, however, this analysis is a bit too simplistic in that it ignores revenue from streaming listeners who wouldn’t have actually paid for the CD or track (and, in Adele’s case, revenue from just dumped people listening to Someone Like You on repeat for days at a time). But this isn’t the main point, so let’s not get distracted…
The fact of the matter is that today’s musicians don’t only sell recorded music- they also sell concert tickets, merchandise, licensing rights, and many other things. If a musician’s team is smart, it will attempt to maximize profit over all revenue streams together and not just on recorded music by itself. Such a strategy would likely involve using streaming services (and recorded music more generally) as somewhat of a loss leader to gain exposure and drive demand for complementary goods such as the aforementioned concert tickets and merch. This approach likely explains why many artists have chosen to remain on Spotify…but then why is Adele different?
As it turns out, the incentive to cross-subsidize with a loss leader decreases when a producer doesn’t have a whole lot to drive demand to. In Adele’s case, well, she hates touring. Okay, that’s a bit of an exaggeration, but if you google “Adele hates touring” you will see what I’m talking about. For example:
During a recent interview with On Air with Ryan Seacrest, Adele said she’s not entirely sure if she’s ready to take that next step.
“I definitely will do as many shows as I’ve always done before,” she revealed. “I’d love to do a world tour and I’d love to be able to say I’ve done it in the end, but I don’t know if I’m strong enough for it.”
Before you judge, keep in mind that her view on touring is driven by not only by the fact that she doesn’t like it but that she also means “strong enough” quite literally, since a large number of shows puts a strain on her voice and has put her out of commission a few times already. Nonetheless, her strategy is exactly what the economics of the situation would predict- if you don’t have razor blades to sell, you’ve got to focus on actually making profit from the razors directly. And if you think that casual listeners are not going to make up for lost revenue from more die-hard fans (and don’t need the exposure since the world is doing that for you), then staying off of streaming maximizes profit from your recorded output.
Fun fact: it used to be the case that tours were used as loss leaders to sell recordings rather than the other way around…though when people describe Adele as retro, I don’t think that this is what they mean. Personally, I’m hoping that her long-term strategy is to engage in temporal third-degree price discrimination*, since I’m not a huge Adele fan but would like to explore her new work on Spotify eventually.
* Technically, temporal third-degree price discrimination refers to lowering the price over time once customers with higher willingness to pay have actually purchased in order to capture revenue from more price elastic customers. It applies here, however, since adding one’s product to a free (at least in a marginal sense) service can be viewed as a form of price decrease.
A little while back, I gave a talk about deviating from economic rationality might actually lead to good market outcomes, so let’s take the analysis a little further and put that theory to the test:
I guess I should’ve known better than to do that whole faith in humanity thing. =P
See, when I don’t keep up with my shows I miss out on including things like these in my posts…
So remember that time when JCPenney tried to stop BSing its customers with artificially high prices and constant sales? In case you forgot, it didn’t go so well. Now we have another attempt that appears to be about as successful:
See, it’s funny because if you ask consumers what they want, they for the most part say that they want to be treated with respect rather than be tricked by the latest marketing ploy. (or “phished,” as Akerlof and Shiller would likely put it) But then when companies give consumers what they say they want, consumers respond by taking away their dollars. The obvious answer is that consumers aren’t particularly self aware creatures (shocker, I know). But what exactly are consumers not self aware about?
The answer likely lies with the concept of transaction utility. The general idea is that transaction utility is the utility people get from feeling like they got a good deal, and, as a result, feeling like you got a good deal actually increases the perceived total utility you get from consuming an item. This, in turn, implies that feeling like you get a good deal makes it more likely that you will purchase an item, even though it doesn’t make you like the actual item more. Companies understand this (even though they likely don’t use the term “transaction utility”), so many of them manipulate the way in which they present information in order to keep your transaction utility high.
Economists generally think that transaction utility is a function of the difference between a “reference price” and the actual price charged for an item. This reference price could be what is put out as a regular price, what a consumer was expecting to pay for an item, etc.- the point is that one way companies can instill transaction utility is to figure out how to give consumers a high reference price. In this case, the company is putting what is, in my opinion, a ridiculous price on a single suit ($600-$800 for a pretty crappy suit, if I recall correctly from a while ago) and then offering a huge effective discount for those poor saps who apparently need to buy their suits in bulk. Consumers probably aren’t so stupid that they are totally unaware that something along these lines is happening, but that doesn’t necessarily mean they are immune from feeling the transaction utility and having it affect their choices.
Fortunately, there appears to be a limit as to how much companies can do to manipulate consumers’ reference prices- for example, it’s apparently illegal to call something a “regular price” of an item unless the item has in fact been sold at that price regularly. I guess what I’m really saying is to expect price tag terms such as “compare to,” “value,” etc. to become even more prevalent than they already are (just spend an hour at an outlet mall to see what I’m talking about). The upside for researchers is that we’ll get more data on whether these words have the same effect on transaction utility as a “regular price” does.
tl;dr: Dear consumers: Don’t hate the player, hate the game, especially since you all appear to be part of the problem.
OH MY GOD YOU GUYS…based on my informal data collection, I really think that we’re approaching peak Uberbitching- I’ve been called upon multiple times in the past week or so to talk about this issue and why it gets people’s panties all in a twist, and I’m not even that popular. (It’s also funny because an economist is possibly the least-qualified person to explain why a scenario that approximates a free market would be bad.) Case in point:
(For the record, Nora has the best radio voice ever, and I am not too proud to admit that it does give me a bit of a hankering for Alec Baldwin’s Schweddy Balls.) I kid because I love- I am happy to talk to anyone about anything economics-y, I just might not always say what you want to hear. I’m also sort of convinced that people are hearing about the Uber research done at Northeastern, googling to get more info, and finding me by accident. (If that’s true, hi!)
Overall, I HAVE THOUGHTS…more thoughts that can fit into sound bites, so I’ve tried to organize them here:
I can ask for things I want on the Internet, right? I guess I always figured that that is what the Internet is here for. Well, that and screaming into the void. Uber and I aren’t friends on LinkedIn yet, so I’ll just leave this here for now:
As an economist, I am certainly not against the idea of surge pricing on principle. That said, unpredictable price changes make it really hard for both drivers and riders to make rational decisions and maximize their welfare with regard to your service. Therefore, I would really appreciate it if you would try one of the following, in order of priority:
1. Based on what I’ve come up with after thinking about this issue for way longer than a reasonable person should, it occurs to me that Uber should be able to get more drivers on the road using demand information rather than price increases. While it is true that workers tend to more more when wages are higher, it’s important to keep in mind that an Uber driver’s effective wage depends not only on the surge multiple but also on how quickly a driver can find passengers. In periods of high demand, it stands to reason that drivers should be able to find riders more quickly than during slower periods. This feature by itself actually creates higher effective wages during busier periods without the need for a surge multiple! As these drivers’ (not, as per legalese, but in spirit) employer, can’t you just provide information to drivers that signals times of high demand and remind them that it’s easier to make money when there are lots of available customers? You could even do this with more than zero seconds of notice in a lot of cases, since I’m guessing your data shows some pretty regular patterns in demand. It seems like drivers don’t respond much to the price surges anyway, so it’s likely the case that there is at least as much of an information/logistical problem as there is an incentive problem.
2. I’m guessing that, as a consumer, you wouldn’t want to plan to go out to dinner and have the restaurant refuse to tell you what its prices were until you’re about to sit down to eat, and you might still be annoyed even if you were cool with the restaurant changing prices to keep supply and demand in balance. In this spirit, won’t you please consider communicating an anticipated surge schedule to drivers and riders? You could still deviate from it when there are truly unexpected events (snowstorms, etc.), but this would go a long way towards helping market participants make price-based decisions. It would also likely mean that smaller price surges could keep supply and demand in balance since drivers and riders would be better able to change their behavior in response to price changes (i.e. could be more price elastic). I know that lower prices don’t necessarily sound good to you, but you’d be getting your 25 percent on more rides than you would with a larger price surge, so you could actually end up better off. If you wanted to be really cool, you could even develop a system to let people lock in a surge multiple- their return trip from that out-of-the-way location could still send them into bankruptcy, but at least they’d know ahead of time.
In conclusion, I really do believe that, in many circumstances, markets can be very powerful tools to create economic value, but I also believe that a well-functioning market would take into account the logistical realities of the environment it is operating in.
P.S. UberPool is awesome, but I might just think that because I really like being quoted a flat fee in advance.
And now we wait.
Update: We have some more information thanks to an economist who went the extra mile, literally…
— Nathanael Snow (@NathanaelDSnow) November 6, 2015
I spoke at this event last week, and, for the record, I did not say that Gabe Kapler was sexy and smart…damn you Mr. Mind Reading Emcee. Also, the Spock cutout seemed like a good idea until I realized I had to keep stuffing him in an Uber the rest of the day:
I suppose this explains why Homer and Spock give very different ratings to Uber drivers. Anyway, I try to put together something new and (hopefully) interesting for each one of these, since I feel like it’s not really enough to basically give a book report on social science research without some sort of central thesis. (Or maybe I’m just still butthurt over one of my talk drafts a while back being referred to a a Dan Kahneman book report.) This one is about how it’s important to keep in mind that irrational “mistakes” don’t always lead to market inefficiency, and sometimes even the opposite can be true. Here’s the talk…
…and some notes/sources:
You know you’re a nerd if you get approached with questions regarding a “dry and technical” Supreme Court case and you’re all “Eeeeee, they’re talking about me!” Or at least what you study. Anyway, this actually happened recently:
JUSTICE KENNEDY: If there were a student in Economics I, it seems to me that he would conclude and his professor would conclude that wholesale affects retail, retail affects wholesale, they’re interlinked, which means you win the case, except that the statute makes a distinction. We have to make a distinction.
Oh Kennedy, does anywhere even offer “Economics I” anymore? I mean, there’s the classic Econ 101 of course, and Greg Mankiw’s Ec10, and I think the last principles course I taught had a course number of 1116 (nope, didn’t even try to make sense of that one), but this sounds a little outdated. Nonetheless, your reasoning seems correct. Given that the goods in wholesale markets are technically an input to production at the retail level, changes in wholesale prices should lead to changes in retail prices. In addition, though less obvious and straightforward, changes in retail prices due to either changes in retail demand or changes in retail supply (not caused by changes in the wholesale price, of course) should affect wholesale prices.
That’s technically the issue that I was asked to look at, but I noticed that things get way more economically interesting as the argument went on:
Second, what they have said is that this changes the effective rate. But what I would say in response to that, Your Honor, is that if I go out and buy a Ferrari for $100,000, everybody thinks that the price of the Ferrari is $100,000. Nobody thinks that the price of the Ferrari is actually $107,000 because I’m foregoing the $7,000 tax credit I can get if I bought an electric car.
I swear this was the only thing going through my mind when I read that:
Just replace “Kato” with “Solicitor General Donald Verrilli”…technically, I suppose this is true only if your best outside option was the electric car, but economists do certainly point out the importance of thinking about opportunity cost as the measure of true economic cost and, by extension, opportunity cost as the relevant measure of “price.” (Or, more simply, the price or cost of something is what you have to give up to get it!) So yeah, if you were going to buy the electric car and decide to buy the Ferrari instead, you not only have a $100,000 explicit cost but a $7,000 implicit cost of the forgone tax credit.
Chief Justice John Roberts does better both at coming up with relatable examples and at thinking like an economist later on:
It may be the same point as your Ferrari hypothetical, but if…if FERC is basically standing outside McDonald’s and saying, we’ll give you $5 not to go in, and the price of the hamburger is $3, somebody goes up there, their the price of a hamburger is actually, I think most economists would say, $8, because if they give up the $5, they’ve still got to pay the $3.
Dingdingding! Tell the man what he’s won, other than a Supreme Court judgeship. By now, I’m guessing that you are wondering what on earth is going on in this case. In a nutshell, the Federal Energy Regulatory Commission only has the authority to regulate prices in wholesale energy markets, but, in order to prevent wholesale price spikes, they are paying businesses to not use energy during peak demand times- essentially doing the equivalent of paying people to not go into the McDonald’s. The argument, then, is mainly over whether this behavior is within the boundaries of FERC’s authority or whether it falls under regulating retail prices, which is left to state authority. In other words, the case is pretty much squarely in the overlap in the Venn diagram of Econ 101 and Introduction to Semantics.
The person asking for insight on the case wanted to make it “fun,” so I obliged and put together a seriously Feynman-esque analogy involving apples:
Let’s say we have a wholesale and retail market for apples. As usual, companies buy apples in bulk on wholesale markets and then sell them in smaller quantities to consumers in retail markets (think Whole Foods). But let’s suppose that, for some reason, the price of apples is fixed in the retail markets, so I know that I will always pay 50 cents for an apple. (Sidenote: I just realized I have no idea how much apples cost.) Also, let’s assume that retailers are obligated to provide an many apples as consumers demand at 50 cents per apple. Not surprisingly, the popularity of apples fluctuates over the course of the year- for example, fall is great for apple cider, so demand is likely higher than normal right now (though not to a pumpkin spice level of hysteria). Because of this, the retailers are obligated to buy more apples than normal on wholesale markets, but getting additional apples is more costly than it was to get the original apples (note that I chose apples because the “low hanging fruit” principle applies literally). In order for suppliers in wholesale markets (i.e. apple pickers) to be willing to go and get the harder to reach apples, they need to be incentivized with a higher price, so the increase in retail demand results in an increase in wholesale price. Unfortunately, the cider maker buying apples at Whole Foods doesn’t get a signal that maybe she should think more carefully about her apple consumption, since the price of apples to her is still 50 cents, and a price spike in wholesale markets results. One way to avoid such price spikes would be to offer to pay some of the apple consumers not to buy apples in the fall, and this mechanism should be effective in regulating wholesale prices, which is what the federal apple regulators want to do. The question in the case is whether such incentivizing counts as messing with prices in retail markets, which the federal apple regulators are not supposed to do. One side of the argument is that the incentives don’t directly change the sticker price and therefore shouldn’t count as regulating retail price. The other side of the argument is that if you pay someone $1 to not buy a 50 cent apple, you’ve effectively changed the price of the apple to $1.50. (This latter definition of price is what most economists would view as a true economic price.) More generally, we’re usually good at seeing how fluctuations in wholesale or input markets affect retail prices (since at least some cost increases get passed on to the consumer), but it’s important to note that fluctuations in retail markets can also affect wholesale prices, which is partially why FERC is arguing that its actions are in scope, at least in spirit.
Or, of you prefer, you can just listen to the overall podcast here– it’s part of a series called “The World and Everything in It” by World News Group. I would point out that this is great example of how important it is to understand basic economics, except that I was asked the inevitable “so what would you decide” question and gave the typical “on the one hand” economist answer due to the semantic nature of the issue. So I guess what I’m saying is that we’re really not that helpful even when we know stuff. =P
I am definitely not watching the Treehouse of Horror marathon on FXX and waiting for a great reference to the overchoice problem:
In case you were looking for reading material, you can see one of the main source papers for overchoice here, or read about it in my chapter in Homer Economicus. On a related note, kids are probably lucky that I was too busy to think of a Halloween experiment this year, since it would probably have involved psychologically torturing little kids by giving them 100 kinds of candy to choose from (or, alternatively, making them really happy in the event that they havn’t yet become utility maximizers who succumb to the paradox of choice).
I am also definitely not thinking about the importance of diminishing returns in Halloween costume complexity:
It’s a costume. It counts. Deal with it.
I’m trying something new with my class this semester…
I’m not able to put the videos up in real time (who knew that video editing takes time?), but I’m trying to have most of them up so that my students can review for their final exam. Low rivalry in consumption goods being what they are and all, I figured it made sense to alert you to the existence of the videos as well. The first one is above, and you can see the whole playlist here.
So George Akerlof and Robert Shiller have a new book out:
Bob Shiller: So should I make this out to Jodi?
Me: No, actually, could you make it out to Raja?
Shiller: Sure…who’s Raja?
Me: She’s my cat.
Shiller: Ok…wait, what?
Me: Well, you talked about tasting your cat’s food in your book, and it’s spurred a number of discussions in my household regarding Raja’s revealed preferences. Also, that whole Animal Spirits thing of yours, you know?
Shiller: You realize I won a Nobel Prize, right?
— just kidding, that didn’t happen, though it probably should have —
Shiller: *looks marginally resigned, signs book*
This counts as a book review, right? You’re all so demanding- fine…the book is entertaining but light on economics. That said, the topic is appropriate at least for Akerlof since the “manipulation” issues described are often a function of asymmetric information- i.e. the lemons problem that won Akerlof his Nobel Prize. Happy now?
The most hilariously awkward part of this exchange is that Shiller had literally just signed a book for an actual human person named Raja (a nickname, technically, but still). Also, I posted this to my friends on Facebook and none of them even questioned the situation- I can only infer that this is well within the normal level of cat entitlement. (Some have even pointed out that even the subtitle is pretty cat appropriate.)