Variable iTunes pricing a moneymaker for artists

DENVER, USA: In April, soon after Apple gave labels the ability to set different prices for their songs on iTunes, every track on Pink Floyd's "Dark Side of the Moon" was raised to $1.29.

Some music fans complained about these price increases, and many technology executives and bloggers proclaimed that labels were making the wrong move.

But while sales of individual tracks from "Dark Side of the Moon" dipped by 11%, album sales remained steady. And all sales combined generated about 12% more revenue in the six weeks after iTunes implemented variable pricing than they did in the six weeks before that.

These are the results labels were hoping for when Apple relented and began selling music at three price tiers: 69 cents, 99 cents and $1.29. They certainly put enough work into getting there: It took years of negotiation to get Apple to break its one-price-fits-all format.

Playing with pricing won't solve the music industry's biggest problem: Digital revenue is increasing too slowly to compensate for the decline of CD sales. But variable pricing will help labels bring in more money from online downloads, according to the results so far.

A Billboard analysis of Nielsen SoundScan data on February-May sales of hits and a sample of popular catalog songs shows that "Dark Side of the Moon" isn't an anomaly. While variable pricing made sales volume decline, higher prices compensate for that to create more revenue.

Not surprisingly, results vary. The demand for more popular tracks is less sensitive to higher prices, so sales don't decrease as much. Most less-popular tracks suffer a larger sales decline and see only marginal revenue gains. There are also notable, if isolated, examples of songs that sell so much worse at a higher price that they bring in less money overall.

The math is simple. So long as sales for higher-priced tracks don't fall more than 29%, labels take in more revenue from $1.29 tracks, after factoring in wholesale rates, distribution fees and mechanical royalties.

Sales of the weekly top 40 tracks -- most of which now have the higher wholesale rate -- fell about 11% in the six weeks after the launch of variable pricing. But retailer revenue from those tracks rose about 10% after the price hike. That means labels took in 20% more revenue for those songs.

"A $1.29 vs. 99 cents price point has not made a notable difference in consumers appetite for online music," Pali Research analyst Richard Greenfield says. "On the album side, you've seen variable pricing for a while and it's not clear that it's had a notable negative impact, so I'm not sure why the single environment would be different."

Other factors surely influenced sales. A seasonal sales dip often takes place after the first quarter. It happened this year, too: Sales of all tracks, most of which have the same price, declined 5% during the six-week period following the introduction of variable pricing. The top 200 digital tracks dropped 8.5% during this time. Making the situation more complex, the price changes took place gradually. On April 7, 33 of the top 100 tracks on iTunes were priced at $1.29; by June 11, 72 of the top 100 had that price.

To measure the impact of price changes alone, Billboard examined more than 70 catalog tracks from popular acts with consistently strong sales -- Stevie Wonder, Bob Marley, Bon Jovi, Jack Johnson, Billy Joel, Creedence Clearwater Revival, Sublime, Norah Jones, ABBA and others. The songs were chosen because they sell steadily but haven't seen spikes from TV exposure or media coverage. So looking at their sales should isolate the effect of price changes.

It's important to note that the size of Billboard's sample is too small to have statistical significance given the thousands of catalog songs sold on iTunes. But it offers a compelling picture of how variable pricing has helped labels so far.

In the six weeks after iTunes introduced variable pricing, the songs that Billboard looked at sold 20.9% less than they did during the previous six weeks. That's a much steeper drop than that of the most popular titles. By way of comparison, the top 40 tracks on Billboard's Hot Digital Songs chart declined only 10.8% in the same time frame. But even this deep drop in unit sales resulted in a net gain to the bottom line. Consumer spending on the catalog tracks dropped about 2% and net revenue to labels rose around 6%.

The revenue increase from those catalog tracks has only a fraction of the weight of the top 40 tracks. In a typical week, for example, the number one track in the country will sell many more copies -- sometimes twice as many copies -- as the combined total of all the catalog tracks in Billboard's sample. Billboard also looked at track sales from albums in which some or all tracks were raised to $1.29. The results varied but each example showed a decline in unit sales greater than the total market's 2% drop during the six-week period.

That's the forest. To really gauge the impact variable pricing can have on sales, one has to examine the trees. Individual results for specific artists show how careful labels have to be when they use their newfound pricing power.

Take Sugar Ray's 1999 hit "Every Morning." On the iTunes listing for the album "14:59," the song is priced at 99 cents; on "The Best of Sugar Ray" it costs $1.29. (Both are priced at 99 cents on Amazon.) During the six weeks after variable pricing started, sales of the $1.29 version dropped 41% compared with the four weeks before the price change.

Revenue from the 99 cent track increased 102%, suggesting that the price difference drove fans to the cheaper option. The decline in revenue from the more expensive version was roughly offset by the gains in the less expensive version. Overall, sales for the two tracks dropped nearly 17% and net revenue dropped by about 6%.

Expect similar fluctuations on individual tracks as the labels continue to experiment raising prices for different songs. The decision to raise the price of a song is "a mix of art and science," according to one label source, meaning that it's based on sales data and gut instinct. But label executives wouldn't say more about how those choices are made.

Some labels, including Warner Music Group and Nettwerk Music Group, as well as the digital distributor INgrooves, have used pricing analysis services like Digonex to help inform their decisions. So far, though, most variable pricing decisions have been made through a process more akin to throwing pasta against the wall to see if it sticks.

"For the first year or so the labels are looking at this to see how the market reacts," Gartner analyst Mike McGuire says. "It's real-time research, in effect. They need as much data as they can to try to understand where they go from here. I don't know that they have enough data to say whether this has worked or not at this point."

It will also take more time to determine what impact price changes might have on gift card sales. NPD Group estimates that about 40% of iTunes sales come from gift cards, which have set values. A teen with a $25 gift card is going to spend $25, whether that amount buys 25 tracks at 99 cents each or 19 at $1.29 each. So far, iTunes hasn't issued cards with new values, and it's too early to determine whether higher prices will lead parents to buy more valuable gift cards.

It's also not yet clear how variable pricing will affect publishers' revenue. While labels can make up for lower sale volume with higher wholesale rates, music publishers receive a fixed mechanical rate per download, regardless of price. Lower volume means less revenue. To them, lower sales volume means less money. And, of course, the biggest publishers are owned by the largest label groups.

So far the bulk of the analysis on iTunes' new pricing scheme has focused on the $1.29 tier. There's also the lower 69 cent price to consider. But just as pricing some tracks at $1.29 probably won't make iTunes users turn to illicit file-sharing, pricing them at 69 cents almost certainly won't convince file-sharers or fans of physical product to begin purchasing downloads. It may not even be the best way to get consumers to buy more music.

Labels have lowered prices on far more tracks than they made more expensive, according to multiple sources. But these changes are only starting to appear in iTunes.

Right now, finding those tracks is a hit-or-miss process. Labels have mostly lowered prices on slower-moving tracks and albums, some from acts that have other popular songs. But Billboard's analysis suggests, and label sources confirm, that lowering prices hasn't resulted in significant sales or revenue increases.

The 1971 Jackson 5 song "Maybe Tomorrow" now costs 69 cents, but it continues to sell between 60 and 90 copies per week, just as it did in February and March. Stevie Wonder's "If It's Magic" from "Songs in the Key of Life," also now 69 cents, sold fewer copies in May than in April or March. Nor did price cuts on all 10 tracks on Canned Heat's "One More River to Cross" result in any increase in volume.

So far, most significant sales increases have come from combining lower prices with promotions or making them part of a package. Universal Music Group Nashville lowered the price of six popular George Strait songs to 69 cents the same week CBS televised a Strait concert. That week track sales jumped 283% from the prior six-week average. The lower-priced tracks rose 334% while the tracks that stayed at 99 cents rose only 276%. Combined digital album sales for the three titles jumped 786%.

The same phenomenon can be seen on Amazon, which often drops the price of an artist's older albums on the day of a new release, then promotes the entire catalog on its home page.

"You need to set a price point where you're getting people to pay more for more music, as opposed to trying to extract an increasingly higher per-unit price," McGuire says.

Looking forward, the lowest price tier may also give labels the flexibility they need to develop digital products other than the album. For example, if a popular new single sells for $1.29, labels or retailers could identify four other songs from similar but unknown acts and sell them as a bundle.

Potentially, the combinations are endless. "The benefit of digital is that it gives you infinite ways of packaging content," Greenfield says. "The more the labels think about bundling in, the better."

This is one way that labels could increase digital sales, which in the past several years have begun to level off. Year-over-year growth in digital music sales has fallen from 147% in 2005 to 27% in 2008, according to SoundScan data. Through June 7 this year, track sales are up 14% from the same period in 2008. About 75% of iTunes consumers are repeat customers rather than new users, according to NPD Group. This won't make up for the big problem: Worldwide physical sales have fallen 52% in the last decade, according to the IFPI.

Simply increasing the price of music on iTunes won't make up for that decline. To do that, the music industry would need to increase digital revenue across the board, not just the part of it that comes from downloadable tracks.

Of the people who now buy music in any format, two out of three still buy CDs exclusively, and they are buying fewer of them, according to NPD Group. Those who do purchase digital music mostly buy it by the track -- which has left more lucrative album sales in decline as well.

"We're not going to have $14 billion in iTunes and Amazon sales no matter what we do," says NPD Group VP/senior industry analyst of entertainment Russ Crupnick. "There's still tens of millions of people who haven't tried the digital music model. Half of them have digital music players. Some of them use. We're not making the case for them to buy as many CDs as they used to and not making the case for them to buy anything from digital. Variable pricing is irrelevant."

This is where other new digital business models could come into play, such as Nokia's Comes With Music model and the kind of collective licensing being pioneered by Choruss, both of which would bundle the cost of music into other services or products. Both rely less on a revenue-per-unit model and more on revenue-per-user. Or "pricing the consumer versus pricing the content," as one label digital executive puts it. "We think the real story around price as it relates to the audience for digital music is with respect to the new business models that are user-based as opposed to wholesale price-based."

These efforts are still developing, of course. Variable pricing is here, and it's already responsible for a 10%-15% increase in revenue on average for affected tracks, according to label sources.

"With the business continuing to be so hit-driven, having the flexibility to price inventory online the way you do in the traditional world makes a lot of sense," Pali's Greenfield says. "Maximizing the profitability of digital through variable pricing is critical."