Just quickly read an article from AppleInsider on a report that Apple is being asked to use variable pricing at the track level for all DRM-free songs listed by the major music cartels. Something interesting was said in the article and it makes me wonder if iTunes does start using variable pricing, could it backfire on the labels? I think its possible.

Let me get this out of the way: I’m not sure how each label’s agreement is worded (wouldn’t we all like to know, though), but I’m guessing that each contract is independent; that’s why EMI can list their songs without DRM but Sony and others are still forcing users into access control technology. This means that, despite the conglomerates that control the music industry, they are (for the most part), acting independently of one another; and collusion amongst them to rig prices would be, well, monopolistic. But let’s get back to the main point.

While Apple is the largest digital music retailer, its not the only one. Amazon and Wal-Mart have their own stores and I’m sure there are a few other smaller ones out there that I’m not aware of; regardless, its not hard to set up your own shop once you have the contracts in place to do so. And with all these stores out there offering restriction-less copies of music, you can being to see there is competition out there for downloads. Wal-Mart does offer tracks for less than iTunes and I believe Amazon does the same. This, if it were not for the simple convenience Apple offers its shoppers, puts downward pressures on prices (over time); and if it doesn’t lower them, per se, it keeps them steady for a longer period of time.

Now we add variable pricing into the mix. Stores would be forced to use some algorithm or set price from the music oligarchs which would alter the price of a track based on the demand. The higher the demand, the higher the price; the lower the demand, the lower the price. The idea, of course, is supposed to take advantage of popular music and increase the profits for the record labels. It also has the added benefit of making less popular tracks more affordable to spur demand and sales.

This model works well for tangible products that take limited resources to manufacture. Digital distribution is virtually cost free. Yes, there are some costs associated with it but its very small – and much of it is taken on by the stores and not the labels. So scarcities that exist in the traditional retail world don’t apply here. And because digital products can be reproduced with such little cost and are easily obtained, the price goes down; this is basic Econ 101, here. But because we’re talking about cartels which, much like OPEC, artificially control access to their goods, we’re not dealing with a pure free market. Yet if we were to assume we were, you could find the label’s dreams of profits becoming a nightmare.

So let’s believe that there is competition in the digital music download space. The labels launch their own stores with variable pricing; so does Wal-Mart, Amazon, Apple, Best Buy, Target, etc. Now, you have many different retailers fighting for sales. You also have each track fighting amongst the listeners for a cut of sales from those already competitive stores. So the total volume a particular track becomes fractional compared to what it could have been. This, if we believe variable pricing is based on demand as it is in the physical world, would drive prices low to entice shoppers to visit, say, Target over iTunes or Amazon. Similarly, Amazon will want to lower its price to compete with Wal-Mart and Target. While total demand for a track could be somewhat fixed (or predictable), demand for that track would be lower for each store as each one dukes it out for the sales. The overall effect is that prices drift downward rapidly. And with virtually no cost per track, the retails could push the price to what most digital products cost… Zero.

Now if there is a price floor and price ceiling, this might not happen. But assuming there is, prices could easily drop to that ceiling and there is nothing gained from the experiment. And if the ceiling is still 89 or 99 cents, then the consumers have lost out and are forced a price increase which could cause some people to seek less than legal means of getting the products they want.

I’m not a big fan of the labels (as one might tell) but I want the to make a profit. I’m not convinced, however, that variable pricing is the business model that will work. They just don’t seem to understand the economies of a digital age and suffer for it.