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Digital Audio Insider is David Harrell's blog about the economics of music and other digital content. I write from the perspective of a musican who has self-released four albums with the indie rock band the Layaways.

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November 30, 2007

The Digital Pricing Conundrum Part IV: The Loss of Resale
by David Harrell
In a comment to Sub Pop records' recent announcement of the sale of digital downloads, one potential customer summarized the shortcomings of digital downloads relative to compact discs:
We are asked to pay something not too far from what we would (especially given sale prices) for the physical product, which includes tangible artwork, often lyrics, and a lossless source that we can rip from in any bitrate we choose, as many times as we choose.
But one difference wasn't mentioned -- the right to legally sell or trade a disc that you don't like or have simply grown tired of. (Or, to be cynical, one that you've already ripped to mp3, though ripping and then selling/trading a disc is considered a "fair use" no-no.)

Granted, many consumers never sell or trade CDs and some discs have little (if any) value in the resale market. But even if you never opt to sell a disc -- the ability to do so has an economic value and it's one that seems to have been frequently overlooked in the transition from physical CDs to "licensed" digital files. (Though Zune honcho J Allard recently noted that you can't trade a digital album for a burrito.)

How much is that value? That's tough to say. Unlike new CD prices, which generally stay within a somewhat narrow range, regardless of the relative popularity of the release, once you enter the used market, it pretty much comes down to supply and demand.

continue reading "The Digital Pricing Conundrum, Part IV: The Loss of Resale"

The used CD prices on Amazon.com seem to be a fairly accurate representation of this relatively efficient market. I've seen "like new" copies of recent releases selling for close to the price of a new disc from Amazon, while on the other end there's the ubiquitous "one cent" discs offered for sale. That one-cent price is a bit misleading, however, as Amazon tacks on a $2.98 shipping charge.

While it's impossible to assign a fixed universal value for used discs, in an attempt to estimate the average value, I looked at the top-selling digital albums on both iTunes and Amazon.com's mp3 store. I then compared the prices of the download versions to the least expensive used copy offered by Amazon.com sellers. I used the "sell yours here" link to find out exactly how much you'd receive for selling a used copy for the current low price, and subtracted postage and packaging costs, to arrive at the final price you'd receive for selling the disc. For example, here's what you can expect to receive for selling a used disc for $6.99 on Amazon.com:
Used CD price: $6.99
Amazon shipping credit: $2.98
Amazon commission: - $2.84
Mailing costs: - $1.81
Packaging: $0.50
Net return: $4.82
By subtracting that number from the price of the new disc (based on the current Amazon.com price), I arrived at the out-of-pocket cost for the consumer who buys a new CD, decides he longer wants it, and opts to sell it via Amazon.com. The difference between that amount and the cost of the digital download version of the album might be considered the "premium" the consumer is paying due to the lack of resale for digital albums.

A few caveats: Obviously, this analysis doesn't quantify the hassle factor associated with selling a used CD. And I'm also assuming that all new CDs were purchased from Amazon.com with no sales tax or shipping costs. (My informal Amazon.com shipping survey from earlier in the year revealed that many Amazon shoppers avoid shipping charges by bundling purchases or via an Amazon Prime membership.) Also, some label types might argue that $9.99 CD prices are artificially low, due to loss-leader pricing by Amazon.com and big box retailers. That may be true, but the $9.99 retail CD price is an increasing reality for many consumers, regardless of the economics behind it.

Let's start with top sellers at Apple's iTunes store. To make the comparison as fair as possible, albums where there was no identical CD version of the iTunes album were ignored. Interesting, I had to go all the way to the 24th top seller to find top-10 albums that had identical CD versions (no iTunes-only bonus tracks, no bonus DVD with the CD version, etc.)

Here are the top-selling digital albums at iTunes, as of Tuesday, November 13th. The "Used Net" column lists what a seller ends up with after commission and mailing/packaging costs. The "Out of P" column lists the difference between the cost of the new CD and the Used Net. Subtracting that amount from the cost of the iTunes album then reveals the "Premium" that purchasers of digital albums are paying because of the loss of resale value:

iTunes digital pricing premium
On average, you'd pay $10.19 for one of the top-10 titles in iTunes, as opposed $11.49 for the equivalent CD. But you could, on average, net $6.23 for subsequently selling your CD. So the mean potential "loss of resale" premium for these iTunes albums was $4.93.

That premium varied considerably across the top 10. Timbaland's "Shock Value" is much cheaper as a download ($9.99 vs. $13.98 for the CD) and the current market price for the used disc is relatively low. So an iTunes purchaser gives up just 39 cents due to the loss of resale. On the other end of the scale, an iTunes purchaser actually paid more for the download version of the Killers' new Sawdust record than the CD ($11.99 vs. $9.99) in addition to giving up a net resale value of $6.42, resulting in a digital premium of $8.42.

I conducted the same experiment for Amazon.com's mp3 store:
Amazon.com digital pricing premium
Here, because of the lower average prices for download albums ($8.69), the average digital premium due to loss of resale was significantly less than that seen for iTunes purchases, just $2.86. Also, two Amazon.com mp3 albums -- Pink Floyd's "The Wall" and Amy Winehouse's "Back to Black" -- had no measurable loss-of-resale premium, further contributing to the lower average. The mp3 price for the former is less than half of the cost of the CD version. Similarly, the "Back to Black" album was priced significantly less as download than as a CD.

All's Fair in Love and Music Retailing
So is it fair to say that download albums are overpriced by the loss-of-resale premiums shown above?

Not really, because not every purchaser intends to sell his or her copy of a purchased CD. The market price of a used CD reflects the relative supply and demand for the album -- if everyone opted to sell, the market value would plunge because of a supply glut and the premiums shown above would also diminish.

And there's also the inconvenience factor -- selling an individual CD via Amazon.com is relatively easy, but it requires listing the disc, packaging it, and mailing it. For many music listeners, it's just not worth the bother for a few bucks. While sellers always have the option of lugging a stack of CDs to a local used CD shop to sell in bulk, they're likely to receive less money per disc.

Further, if you take free shipping from Amazon.com out of the equation and assume buyers of new discs are paying $2.98 for shipping, the average premium for iTunes album purchasers drops to just $1.95. The premium actually disappears for purchasers of mp3 albums from Amazon.com.

Finally, these comparisons are based on the assumption that digital downloads and CDs are an interchangeable format, and that consumers are carefully pluses and minuses of each format and the relative prices before making a purchase decision. While my personal belief is that the lack of artwork, lower fidelity, and loss of resale value associated with digital albums requires a significant discount from the CD price -- something close to the eMusic price of approximately $3 for an album -- other consumers clearly feel differently. Digital downloads offer immediate gratification, with no waiting for discs to arrive and no need to rip them for use on a portable device. And for many listeners, the diminished sound quality of digital downloads is negligible.

Hence, I'm reluctant to assign a specific dollar amount to the loss of resale premium, in isolation from the other differences between physical CDs and digital downloads. However, for the subset of consumers who truly care about resale, it seems fair to say that digital albums need to be priced approximately three to five dollars below the total cost of the equivalent CD to compensate for the loss of a resale value. (At least for recent, top-selling albums.)

Of course, while consumers can argue about what's "fair," sellers of products aren't obligated to determine the most reasonable price relative to an older format. In an industry that's struggling to figure out where it's going, pricing really comes down to charging whatever the market will bear for a product. The iTunes store established that price as $9.99, but as a tight-fisted consumer, I'm happy to see some downward pricing pressure from the new Amazon.com mp3 store and cheap downloads from Wal-Mart. [Note -- the previous paragraph was modified on 12/01/07. In the original version, I wrote that the $9.99 digital album price seems likely to persist, but after further thought, I'm not so sure. Every digital album sold via Amazon.com for $8.99 or less is bringing down the average amount paid for digital albums. If some sort of price elasticity of demand for digital music is observed, the labels might be likely to embrace even lower prices, especially for older releases.]

One final thought: While my analysis here is solely for digital albums, the fact remains that most digital sales are single songs, not full albums. And I don't think 99-cent single song downloads are overpriced at all, given the huge value of being able to buy a single song as opposed to an entire album.

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    THE LAYAWAYS

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