Sunday, July 12, 2009

Companies Tony Loves: Pandora

This week's Company Tony Loves is an update from the vault. On April 29th, I wrote a piece called Downlifting and Pandora. Here's an excerpt. For the whole thing, check out the original post:

In the 2000s, music piracy (now called downlifting) was the number one issue facing the music industry. It was so pervasive that ordinary people became criminals en masse. We all knew that downlifting was stealing, but many of us felt that the music industry was already stealing from us at the rate of $20 per CD (that's compact disc, not certificate of deposit).

From an economic perspective, we should have seen this coming. Two factors made a showdown between music executives and Internet pirates inevitable:

1. Existing forms of music were basically files stored on awkwardly shaped discs. As memory cards became smaller and bandwidth became faster, it made less sense for people to carry around CDs. Companies came out with iPods and other portable music players (the Walkman, anyone?) -- understandably, consumers ate these up. This was precisely where the market was going.

2. These new forms of digital storage were much less secure from theft. In electronic file format, music became easy to copy and easy to distribute. Quite literally, the only remaining obstacle to owning our favorite song was our sense of morality. Those with fewer scruples from downlifting had more songs in their collections.

These new innovations made music non-excludable from those who don't pay. The word non-excludable sounds like a good thing, but it is terrible for the good's sellers, and therefore, for the good's buyers. Why's that? If nothing was done about the emerging non-excludability of music, no one would ever want to pay for music.

If no one wants to pay for music, why would anyone make music? Internet radio gives an interesting model for dealing with non-paying customers in the music industry.

Internet radio's solution? Don't charge a listener when you can charge an advertiser. Radio and television stations figured this out long ago. In these industries, the secret to success is to expand your audience and charge advertisers for air time.Loads of Internet radio stations are out there, but my favorite is Pandora [...]

I wrote those words nearly three months ago, and I still believe them. But, mostly due to a messy lawsuit from the Recording Industry Association of America (RIAA), Pandora has changed its business model.

Now, Pandora offers 40 hours per month of free, advertiser-sponsored listening, and if you want to listen more, it costs $0.99 per month, which is charged to your credit card if you exceed the 40 hour listening limit.

Digital music in any form remains non-excludable. Moreover, Pandora has been providing an innovative solution to the non-excludability. All this makes me wonder if the RIAA has chosen the wrong enemy. The enemy is non-excludability, and Pandora has an innovative way to get around that.

Why sue Pandora when forming an alliance makes more sense on efficiency grounds? Sure, the RIAA wants to extract more revenue from Pandora, and that makes sense. But, suing Pandora has made Pandora more difficult to use for heavy users. One possible side effect is that these users will return to even-harder-to-detect music piracy. And, no one wants that.

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